A lot has been made of the role of speculation in grains as the driver of food riots across the globe. Leaving aside definitions of ‘speculation’ what is clear is that wheat, corn and oats prices broke multi year price ceilings in mid 2006. Rice broke its ceiling in mid 2007 and has more than doubled since: only highly volatile wheat has risen further - nearly tripling before losing 40% of its late 2007 peak. But, politically, it is rice that has pulled the trigger.

It is of no immediate relief where required, but general US inflation expectations are, in fact, tame. The recent sell off in US 10 year bonds was interpreted here 10 days ago as a sign of bond market fear over resurgent price pressure. That is looking a wrong view: markets continue, it seems, to believe most in the deflationary prospects being heralded by banks frightened to lend; and by contracting house prices which may be presaging rising unemployment and lower consumption.

In any case grains are not, historically, particularly correlated with financial markets - these deflationary trends would not normally be applicable to them. But as large, interest rate sensitive leveraged flows have surged into grain markets correlation has grown. And price volatility (with the curious exception of rice) has also risen dramatically.

One core question is whether or not the massive leveraged flows into grains are helping price discovery and flashing production signals to farmers. The stone hearted response is that this is irrelevant: if it is price discovery, it is a good thing for supply will rise (eventually) and bring lower prices and equilibrium. And if it is not, the market will end up impoverishing many of the black box quants playing the volatility game and mark prices lower anyway.

This line of reasoning, while neat, deals only in ends. There is little doubt that a lot of hot money is in grain prices. That is very probably not assisting price discovery mechanisms: it is true that stocks of most grains are tight but price action lately speaks mainly to noise - not trend.

Which may indeed be only a temporary state of affairs. But the crux of the matter is that at these price levels the leveraged flows into grain are an imminent source of great harm. Expectations of price volatility or, where rough rice is concerned, straightforward price rises are promoting hoarding, export controls and a vicious cycle of more leveraged buying. Meanwhile, in Port-au-Prince and company, rising food expenditures have been reducing real wages by large, double digit percentage amounts. That, literally, can to kill bystanders.

For it does not take much of this to cause catastrophe - even though the end result, in due course, will be lower prices. The last grain boom in 1972 to 1975 saw a major famine in Bangladesh triggered by a tripling of rice prices over a three-month period in 1974. A million, on some estimates, died.

Yet, leveraged money or not, grain prices have not so far breached historical highs and remain comparable to previous peaks - there is still time to make sure that the actual, unhappy, constellation of aligning stars does not lead to a disaster.

On this count, and bearing in mind the dollar pricing of food commodities, a small, visual suggestion of a readily available resource that might well put a brake on the unfolding events:


Exhibit 1: from the FAO's November 2007 Food Outlook


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5 comments

  1. Fred // 4/28/2008 03:53:00 AM

    You are ignoring the disastrous policies of governments around the world. Some of those policies are recent and some are longstanding.

    Recent policies to "protect" food supplies by restricting exports are absolutely evil. Long running policies to provide cheap food to urban poor around the world have led to corruption and the destruction of local farmers who are restricted in what they can charge for their rice or wheat.

    Export taxes are intended to insure that food stays in country. All they really do is restrict planting. Farmers will plant for their market. If the market is the world they will plant more than if their market is just their own country. Argentina's export tax on wheat caused Argentine farmers to reduce planting by 15%

  2. RJH Adams // 4/28/2008 08:15:00 AM

    Yes, that is absolutely correct - there are usually shocking preconditions which contribute to famines. Clearly that was the case in Bangladesh in 1974. This is why I referred to price levels as "triggers" only without reference to any given country framework.

    It has been a long time since I read development economics; I did not want to reproduce academia. But there is a great deal of informative material in various economic journals for the interested.

    Thanks for the comment.

    R

  3. CB // 4/28/2008 09:45:00 PM

    It's possibly evident, Rawdon, that the reality behind presumedly improved living conditions in the third world for the last generation has been food price deflation (stability, that is, from the consumers' POV). An environment which no one outside of farming ever considers to be a problem, the nearby CBOT wheat contract spent, for 26 and a half years prior to June 2007, a total of seven weeks above its November 1980 highs - that's about 0.5% of the time. It seems that the leftovers from Galbraith's feeding the elephants analogy fall either to farmers or to consumers - but not to both.

  4. RJH Adams // 4/28/2008 10:48:00 PM

    Yes, in real terms the prices of food commodities are well below 1972 to 75 levels. But cost of production data would make the debate more interesting.

    Re: wheat, it is probably the only grain/soft with a very long price history. The CBOT hawk a graph (http://www.the500yearchart.com/chart2.jpg)
    with 500 years of wheat prices which could be read as showing wheat in an at least 100yr uptrend.

    That would be a rather uncharitable conclusion for wheat farmers on simple glacial timing grounds (and before any consideration of volatility).

    But I mention the timing since - blindingly obvious - I do believe that is the key today (together with one specific rice market characteristic).

    It's not, in my view, a farmer/consumer trade-off (if I'm reading you right). In fact I don't think that's at issue now even if it were a zero sum (maybe you're saying it should be). It's just that there is just no chance of an adequate policy response - despite famine watch, famine alerts and all the rest - if rice does a Bangladeshi triple inside one quarter. In that case there will be starvation.

    Government and NGOs, despite market inefficiencies, poor policy choices and all the rest of it, can plan around gradual price pressure. But not for the threat of sudden positive price velocity that margined funds in grains pose.

    Moreover, rice is peculiar in that the 'float' in world trade is less than 10% of global production - it is produced for local consumption. This (still looking at the data on what follows) appears to account for its (ever lower) volatility but does seem to make it especially vulnerable to sudden (if not frequent) violent trend swings.

    It's not at '74 levels in real terms for sure; but it's going to get there other things being equal.

  5. Anonymous // 4/29/2008 10:52:00 AM

    I'm not sure what my point is, but it's pretty apparent that, if starvation remains a possible outcome in 2008, any or all of various plans didn't perform as advertised and any appearance to the contrary was fairly dependent on an environment of price deflation for foods. Disatisfaction with the amounts the elephant left behind is now being expressed in a number of locations.

    CB

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