“Virtual Global Food Reserve Policy

to Protect the Poor and

Prevent Market Failure"

Joachim von Braun and Máximo Torero

IFPRI

Presentation at USDA

22nd of October 2008

Sources and features of the food crisis

1. Income and population growth

2. Energy and biofuels

3. Slow agricultural supply response

4. Market and trade policy

5. Speculation and market fundamentals

Ad hoc trade measures add up to policy

failures

• Export bans/restrictions:

- Reduce global market size, increase volatility,

and harm import-dependent trading partners

- Stimulate cartel formation, undermine trust, and

encourage protectionism

• Price controls:

- Reduce farmers’ incentives to produce more food

- Divert resources away from those who need them

most

• Low stock levels and ill-designed policies promote speculation

• Main categories of speculators: - Governments

- farmers, households, small traders

- Commercial traders

- Non-commercial traders

Speculation: a symptom and a source ?

What food crisis?

• Political destabilization

• Macro-economic / inflation

• Poverty and hunger

The food crisis tradeoffs

+ Mass protests in more than 60 countries

+ Inflation and macro-economic imbalances

+ Environmental sustainability consequences

Political security

risks

Energy security

risks

Food security

risks

Food putting pressure on overall inflation

-2

0

2

4

Jan-05 Jan-06 Jan-07 Jan-08

Overall

Food

China, y-o-y India, wholesale

-2

0

2

4

6

Jan-05 Jan-06 Jan-07 Jan-08

Overall

Food

Ethiopia

0

5

10

15

20

25

Jan-05 Jan-06 Jan-07 Jan-08

Overall

Food

-2

0

2

4

Jan-05 Jan-06 Jan-07 Jan-08

OverallFood

Mexico

Source: Data from government statistics.

Surge in cereal and oil prices

0

20

40

60

80

100

120

140

0

100

200

300

400

500

600

700

800

900

Maíz

Arroz

Trigo

Petroleo (escala derecha)

Sources: FAO 2008 y IMF 2008

Corn

Rice

Wheat

Oil (right scale)

IFPRI’s scenarios[Models for changes in structural supply and demand factors

(2000-05 and 2006-15)]

Source: M. Rosegrant (prelim. results with IMPACT-WATER).

0

100

200

300

2000 2005 2010 2015

Rice Wheat Maize Oilseeds Soybean

US$/ton

The spike is not explained by

fundamentals

0

20

40

60

80

100

120

140

0

100

200

300

400

500

600

700

800

900

Maíz

Arroz

Trigo

Petroleo (escala derecha)

Sources: FAO 2008 y IMF 2008

Corn

Rice

Wheat

Oil (right scale)

Explanation 1: Export bans and restrictions

• Because of highly concentrated markets

• Simulations based on MIRAGE model showed that this explains around 30% of the increase of prices in basic cereals

Explanation 2: Speculation in the futures markets

• Significant increase of volume of globally traded grain futures & options

• Governments increasingly curb hoarding (e.g. India, Pakistan, Philippines)

• Non-commercial share in future transactions increase

• etc

Two explanations for the spike

• Changes in supply and demand fundamentals cannot fully explain the spike in food

• Rising expectations, speculation, hoarding and “hysteria” are among the additional factors

• The flow of speculative capital from financial investors into agricultural commodity markets has been drastic.

• In 2007, volume of globally traded grain futures & options increased by 33 & 48% (Chicago Board of Trade)

• By May 2008, the volume of globally traded grain futures and options increased significantly compared to the same period in 2007.

Does speculation explain the spike

in the first six months of 2008?

SOURCE: U.S. Commodity Futures Trading Commission

a. Increase in volume

0

10

20

30

40

50

60

70

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0Ja

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Jul-

02

Oct

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Jan

-03

Ap

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Jul-

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Oct

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Jan

-04

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Jul-

04

Oct

-04

Jan

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r-0

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Jul-

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Oct

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Jan

-06

Ap

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Jul-

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Oct

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Jan

-07

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Oct

-07

Jan

-08

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Wheat Corn Soybeans

Rough Rice Wheat Corn1 contract = 5,000 bushelsSource: CBOT1 contract = 5,000 bushelsSource: CBOT

SOURCE: U.S. Commodity Futures Trading Commission

b. Open interest index

SOURCE: U.S. Commodity Futures Trading Commission

c. Future contracts: ratio volume to open interest

(monthly volume / monthly open interest)

SOURCE: U.S. Commodity Futures Trading Commission

COMMODITY: CORN - CHICAGO BOARD OF TRADE; 5,000 BUSHELS (contract code 2602)

Description: the graph shows the total number of long/short positions by non-commercial traders as a

fraction (vertical axis) of the total reportable long positions (commercial + non-commercial)

d. Non commercial traders

e. Evidence of causality

Indicator of speculation activity Wheat Corn Soybeans Rice

1.      Monthly volume (futures contracts CBOT)

2.      Monthly open interest (futures contracts CBOT)

+ +

(Apr/05 -

Oct/07)

(Dec/04 -

Jun/07)

+

(Sep/05-

Mar/08 )

+ +

(Jan/05-

Jul/07)

(Aug/05-

Feb/08)

+

(Jan/06 –

May/08)

Source: von Braun, Robles, Torero (2008)

-          “+”: evidence of causality

-          Starting period of evidence of causality in parenthesis

-          * It combines futures and options positions, data available since January 2006.

5.      Ratio non-commercial positions to total reportable

positions (short)

6.      Index traders net positions (long – short positions)* N/A

Commodity

3.      Ratio volume to open interest (1)/(2) (futures

contracts)

4.      Ratio non-commercial positions to total reportable

positions (long)

• Spikes in prices of 3 months or more could have

severe effects over poor and their nutrition with

long term effects => food security risks

• Mass protests in more than 50 countries has

shown that the poorest suffer most and do so

silently => political security risks

• Could create inflation and macro-economic

imbalances

Why is it important to avoid speculation?

• Should physical, public, globally managed

grain reserved be developed?

Answer: NO

Why:

a. high storage costs

b. slow transactions.

c. Will create more pressure of the

demand

What to do?

• Should we reform commodity exchanges by:• limiting the volume of speculation relative to hedging

through regulation;

• making delivery on contracts or portions of contracts

compulsory; and/or

• imposing additional capital deposit requirements on

futures transactions.

Answer: probably NO

Why:a. Difficulties in walking a line between ineffective

regulators and overzealous ones.

b. Market regulation also raises political economy

concerns (lack of institutional capacity, some groups

benefited over others)

What to do?

This arrangement consist of two prongs:

• A minimum physical grain reserve for

humanitarian assistance, and

• A virtual reserve and intervention mechanism

to calm markets under speculative situations,

backed up by a financial fund.

What we propose A New Global Institutional Arrangement

• A modest emergency reserve of around 300,000

metric tons of basic grains—about 5 percent of the

current food aid flows of 6.7 million wheat-equivalent

metric (responsibility G8+5

• This decentralized reserve would be located at

strategic points near or in major developing-country

regions, using existing national storage facilities.

• The reserve, to be used exclusively for emergency

responses and humanitarian assistance, would be

managed by the WFP and factored into a new Food

Aid Convention

Prong 1: An independent emergency reserve

• A coordinated commitment by the group of

participating countries. Each of the countries would

commit to supplying funds if needed for intervention

in grain markets

• Determining the size of this fund will require further

analysis as commodity futures markets allow for high

levels of leverage. For example, a fund of US$12 to 20

billion might cover 30 to 50 percent of normal grain

trade volume

• These resources would be promissory, or virtual, not

actual budget expenditures.

Prong 2: A virtual global food commodity exchange

• The intervention will take place in the futures market => A

signal of a potential intervention will be announced

• Intervention will happen when the “global intelligence unit”

triggers the alarm that prices are significantly above their

estimated dynamic price band based on market

fundamentals

• The intervention would consist of executing a number of

silent short sells over a specific period of time in futures

markets around the world at a price lower than the current

future price.

• The global intelligence unit would recommend the price or

series of prices to be offered in the short sales

How the virtual reserves will work

• The increase in the supply of future sells (short)

should lower spot prices and minimize speculative

attacks

- If there is a response it will imply that speculators

will have to ask for a higher price which will imply

a profit for the virtual reserve

- If there is a response with a lower price then the

reserve will loose money but prices will be even

lower

• The virtual fund will come into play only if there is a

need to realize the future sells

• Usually, this action would not be necessary and the

whole operation would stay virtual.

Why it will work

• McKinnon; (1967). Futures markets, buffer stocks, and income

stability for primary producers. JPE, 75 (6), pp. 844-861

• McKinnon; (1971). Futures markets and buffer stocks: a reply to

William Poole. JPE, 79(2), pp. 351-355

• Turnovsky; (1983). The determination of spot and futures prices with

storable commodities. Econometrica, 51(5), pp.1363-1387.

• Crain S and Lee J; (1996). Volatility in wheat spot and futures

markets, 1950-1993: Government farm programs, seasonality, and

causality. The Journal of Finance, 51(1), pp. 325-343.

• Gilbert; (1983). Futures trading and the welfare evaluation of

commodity price stabilization. The Economic Journal, 95(379),pp.

637-661.

• Kawai; (1983). Price volatility of storable commodities under rational

expectations in spot and future markets. International Economic

Review, 24(2), pp. 435-459

• etc

Evidence that future prices could affect spot prices

What is the institutional design behind the reserves

Country

commitment to

supplying funds

Intelligence unit• Model fundamentals

• Model dynamic

price band

• Trigger alarm

High level technical

commission

• Approve intervention

Appoint

Futures market

delivery occurs in less

than 2 percent of all

agricultural contracts

traded Backwardation

should happen

Final remarks

1. Poor can not afford speculation

2. Governments can’t afford speculation

3. There is clearly a need to regulate the basic

grains futures commodity market

4. A virtual reserve is an option which is mostly

a signal which could avoid speculators

coming in to this market

5. If speculators get the signal this would

become real regulation - minimizing the costs

to the poor

What could be expected?

• Food price stabilization

• Access to food supplies at reasonable and

stable prices in times of crisis

• Calm food markets and price speculation

containment

• Comprehensive Cost / Benefit assessment

must go beyond agricultural markets (incl.

security and poverty considerations)