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Another
Looming Food Crisis* |
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| Jul
25th 2012, C.P. Chandrasekhar and Jayati Ghosh |
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Once
again food prices have reached exorbitant levels in
world trade, surpassing previous peaks and creating
fears of another major global food crisis of massive
proportions. What is particularly shocking this time
around is how little has been learned from the last
crisis just a few years ago, and how criminally slow
the international community and national governments
have been to put in place measures that would prevent
a recurrence of these crazy fluctuations in prices.
It is not just that public memory is short - the more
worrying feature is the denial on the part of policy
makers about at least some of the important factors
that have caused these dramatic price fluctuations;
and the associated and continued refusal to take measures
that will address the problem. As the last round of
food crisis builds up once again and threatens the
lives and material conditions of millions of people
across the world, it is imperative to take a close
and hard look at the evidence on global food prices
and their determinants.
One major problem that prevents clarity of understanding
on this matter is the persistent belief that prices
in global food markets are still fundamentally determined
by changes in real demand and supply. There is no
doubt that medium to long term trends are drive by
this, and that the expectations that drive speculative
behaviour in food markets are also deeply influenced
by perceptions about changes in real demand and supply.
But the pattern of price behaviour in global food
markets in the past few years, and particularly the
volatility in prices that can be observed, bears much
less relation to actual supply and demand shocks,
and much more to activity spurred by expectations
about prices.
Chart
1 >>
(Click to Enlarge)
Chart
1 shows the behaviour of global food prices indices
since 1990. The underlying trend for the aggregate food
price index is definitely rising, and this is also true
for cereals and edible oils (albeit to a lesser extent).
It is widely accepted that the long years of policy
neglect of agriculture and the agrarian crisis that
affected many developing countries from about the mid
1990s must have had some impact in not enabling food
supply to keep pace with the rising demand that is also
widely perceived to have resulted from the rapid income
growth of some countries with large populations.
However, this conventional interpretation of the food
price increase becomes less convincing when the period
is broken down into sub periods. Charts 2a and 2b show
that the period from 1990 to 2005 was quite different
from the subsequent period in terms of food price changes.
In the first period shown in Chart 2a there was some
volatility to be sure, but the overall price trend over
the period was if anything slightly downward. This is
despite the same features described earlier - supply
side issues like agrarian crisis in the developing world
and insufficient agricultural investment as well as
supposed demand side forces like more food demand stemming
from rising incomes in low or middle incomes countries
- being just as marked in that period, especially the
later part of it.
In fact, the real change in prices comes after 2005,
as prices zoom upwards on a volatile path around a rapidly
rising trend. Obviously something much more was at work
in this period than the medium term ''real'' tendencies
that were described above. A further issue of significance
that has affected grain prices is the impact of biofuel
subsidies in the US and EU, which have diverted both
acreage and maize production towards ethanol. Since
these subsidies became large only from 2003 onwards,
it is to be expected that the impact on grain prices
would be felt after this.
Chart
2a >>
(Click to Enlarge)
Chart
2b >>
(Click to Enlarge)
Such a pattern has also prevailed for prices of other
food commodities, as evident from Chart 3. In the medium
terms dairy prices have shown the largest increases,
but more recently the big spike has come in sugar prices.
Chart
3 >>
(Click to Enlarge)
In previous issues of MacroScan, we have elaborated
on the newer forces that have affected price formation
in global food markets, in particular the involvement
of financial players in commodity futures markets, such
that food markets became more and more like other financial
asset markets, plagued with the same problems of asymmetric
information, herd behaviour and extreme volatility.
It was shown to have affected the rapid rise and then
fall of commodity prices in the period 2007-09, as financial
agents first moved to and then away from commodity derivatives
during the run up to and eruption of the global financial
crisis.
But in the more recent period things have got even more
complicated. Certainly it remains the case that financial
activity in commodity futures markets remains strong
and this plays a role in the price movements. And therefore
there is obviously a strong case to be made for bringing
all commodity trading onto regulated exchanges, restricting
the role of purely financial players and enforcing strict
position limits and other such measures.
The measures that have been implemented thus far are
unfortunately halting and inadequate even in the US
(which currently has the strongest such regulations
with respect to commodity markets among advanced countries
because of the Dodd-Frank Law). This has meant that
in the context of very low interest rates and few other
avenues of profitable financial investment, the incentives
for private players continue to be loaded in favour
of such speculation that can dramatically affect global
prices of these essential items.
Even so, it is increasingly simplistic to suggest that
this is all that is going on and that financial regulation
of the kind noted above would be enough to curtail speculative
activity in such markets. This is because large commodity
traders themselves now engage more and more in what
is essentially speculative activity, betting on changes
in prices in order to benefit from these movements even
beyond their requirements of the commodities for ''real''
purposes. The line between purchases of futures contracts
for hedging or speculative purposes is now almost impossible
to draw, especially as large agribusiness and commodity
trading corporations have discovered that there is a
lot of money to be made from purely financial dealings.
This obviously makes the problem of fixing the detail
in financial regulation even more complex, but it also
raises the issue of ensuring that the expectations that
are driving such markets are controlled more effectively.
Obviously, addressing issues of global supply - particularly
through ensuring the greater viability of small scale
production in the developing world - is of critical
importance in this.
Chart
4 >>
(Click to Enlarge)
However,
the sheer volatility of recent price changes around
this increasing trend (as evident from Chart 4)
suggests that even addressing supply issues may
not be enough. A related but slightly different
issue relates to the role of information and the
nature of its spread in what are essentially very
opaque global markets. This can be illustrated with
reference to food grain markets, and particularly
the global wheat market. Wheat is widely seen as
the most significant traded grain and the role of
futures contracts in this market (particularly through
the Chicago Board of Trade) is well-developed.
In the past two years, wheat prices have shown the
highest volatility in terms of monthly price changes.
Chart 5 shows how prices of US wheat nearly doubled
in just six months, between June and December 2010,
then fell again until early 2011 and then rose once
more.
Chart
5 >>
(Click to Enlarge)
In
terms of ''real'' forces of demand and supply, however,
the global wheat market has been remarkably stable
in the past decade. Chart 6 tracks the behaviour
of aggregate global production and ''utilisation'',
which can be taken as a proxy for demand, according
to FAO data. In the entire period shown in this
chart, both production and utilisation have increased
at average rates of around 2 per cent, and indeed
the rate of increase of production has been slightly
faster than that of utilisation overall.
Clearly, the price changes have borne little relationship
to these two forces. In fact, global wheat prices
appear to have risen in years when supply (production)
was higher, often significantly higher, than demand.
Chart
6 >>
(Click to Enlarge)
Chart
7 >>
(Click to Enlarge)
Chart
7 suggests that the price changes in the wheat market
have also had little to do with closing stocks of
the same or previous period, while exports have
sometimes (but not always) responded to higher prices.
Of course, it needs to be noted that data on stock
holding is notoriously unreliable. FAO relies on
data from governments on their stock levels, but
some governments do not reveal these data (such
as China). Possibly more significantly, there are
no data on private corporate stock holding, and
given the size and spread of multinational companies
dealing in grain, this can also be substantial.
So if it is not actual changes in demand and supply
that explain the price volatility, what is going
on? One possibility worth considering is the considerable
role played by rumour, and therefore by the media,
in altering expectations. For example, in the period
from June 2010 when global prices rose sharply,
the media were full of reports about the failure
of the harvest in Ukraine, a major wheat exporter,
and then replete with doomsday predictions following
on the export ban in Russia. These certainly drove
up price expectations and pushed up prices in the
futures market very quickly.
Subsequently, FAO data reveal that global production
of wheat had actually increased in this period,
largely because of expanded wheat output in Asia.
But the period of sharply rising prices, while it
involved many losers including the poor throughout
the developing world, also had some winners. The
large commodity trader Glencore went for a public
stock offering in early 2011, and when doing so
it revealed that it had doubled its profits the
previous years, largely because of gains made in
the wheat trade.
Something similar is happening at present - the
media are awash with scaremongering stories about
the drought in the US and other factors affecting
global grain supply. Already wheat prices in the
first half of July 2012 have increased by more than
22 per cent, even though FAP estimates still suggest
that globally this will be a bumper year with a
record wheat output. Once again poor people will
suffer because of higher food prices, without even
realising that private profiteering at different
levels is generating that disastrous tendency in
global prices.
*
This article was originally published in the Business
Line print edition dated 24th July, 2012.
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