Saturday, February 5, 2011

Yes, world food prices are higher because of speculation

World food prices have become highly politicised. Two views are battling it out. First up; the supply-siders, such as Paul Krugman and Ben Bernanke, who claim that prices are up because of global warming, declining harvests and world population growth.

Then, there is everyone else, who claim that it is the fault of speculators.

Here is how Mr. Krugman put it:

"What’s behind the surge in food prices? The usual suspects have made the usual claims — it’s all about the Fed, or it’s all about speculators. But I’ve been looking at the USDA World supply and demand estimates, and what stands out from the data is mainly that we’ve had a huge global harvest failure."

He also said:

" sure looks like climate change is a major culprit. And it’s not just the (Former Soviet Union): extreme weather elsewhere, which again is the sort of thing you should expect from climate change, has played a role in bad harvest around the world."

Lets dispense with the climate change issue first. World wheat supply fell by 0.1 percent in 2010, and it is projected to fall by 5 percent in 2011. As the chart below suggests, there is nothing unusual about recent supply developments. In fact, projected 2011 wheat production is the fourth highest since 1995.

The World supply of wheat jumps around every year. This is due to fluctuating weather conditions. Anyone with a passing knowledge of farming knows that. Is the recent fall due to climate change - absolutely not. Linking recent food inflation to climate change is just absurd.

However, climate change point was merely an addendum to Krugman's argument. What about the more substantive point linking food inflation to a supply shock?

All speculative bubbles start with some kind of supply or demand shock. It is part of the pathology of speculation. The more substantive issue is whether originating shock can fully explain the subsequent price movement. In other words, can a 5 percent reduction in supply generate the following price movements?

Wheat prices are up about 50 percent in six months. The supply decline during that period was 0.1 percent. However, the anticipated decline in supply for this year is over 5 percent. That sounds a lot like speculation. Buy now on the expectation of higher prices in the future.

Low interest rates facilitates speculation in wheat. Suppose a speculator can take out a loan at 1 percent, buy a few tonnes of wheat at $200, stash them away in a warehouse and sell them six months later at $325. Does that not sound like a familiar wheeze? Here is a clue; think houses, companies, and currency futures.

Meanwhile, the rest of the world pays more for their food. Moreover, there is a kicker. The greater the amount of inflation, the greater the incentive for commodity dealers to speculate. More speculation means more hoarding, which in turn, creates more inflation. There is only one thing that can stop this cycle - higher interest rates.

For a liberal like Mr. Krugman, this is a very uncomfortable chain of events. He argued vociferously for lower rates. He believed that looser monetary policy would reduce the interest burden on US borrowers and prevent a further deterioration in US economic activity.

However, those low rates are now facilitating a speculative binge that is seriously hurting the world's most economically vulnerable people. At the risk of being excessively emotive, low interest rates may have protected debtors in the developed world, but at the cost of high food prices in the developed world. It is just one more miracle of Globalization


  1. in anticipation of higher prices, governments from india to indonesia entered the market to buy stockpiles of rice and wheat...

    are they speculators?

  2. Krugman's point is that there is no evidence of hoarding: "... for food, it’s just not happening: stocks are low and falling." You make no reference any evidence. You're just speculating, about speculation.

  3. First, questions:

    (1) What's the source for that wheat-price graph?

    (2) Is it possible to find the same information for a much longer timeframe?

    (3) Does anyone publish histories of world supply for this and other commodities?

    (4) Does anyone publish histories of world consumption for this and other commodities?

    Then a comment:

    As I understand it, the "fundamentals" argument is that world food demand has risen to levels that exceed even the healthy production levels of 2008-2010 shown in the graph, with the result that stockpiles have been dwindling and are now at or near all-time lows.

    If that is the case, then in the absence of strong cooperative world leadership, foodstuffs are ripe for trouble caused by panic buying and hoarding as well as by speculators willing to take advantage of the situation.

  4. P.S. - I absolutely agree that speculators ARE making price swings worse than they otherwise would be, probably by a lot.

    Prices for the basics of life should not be set by speculative markets - that's an affront to basic human decency.

  5. Evidence please! No one wants to offer evidence. It's Alice in Wonderland. Conclusions first, evidence afterwards, if at all.

  6. Karen,

    The price chart comes from the FAO, the supply data comes from the USDA. You can google it.

    As for a longer time series, it is possible to get more price data. I haven't seen any longer series for supplies.

  7. I think you will be changing your opinion on this matter soon. Climatic changes are affecting world crops dramatically and will effect prices:

  8. Currency futures? You say: "Low interest rates facilitates speculation in wheat. Suppose a speculator can take out a loan at 1 percent, buy a few tonnes of wheat at $200, stash them away in a warehouse and sell them six months later at $325. Does that not sound like a familiar wheeze? Here is a clue; think houses, companies, and currency futures."

    You are admitting that demand for real resources is driving prices and claiming that in the case of food stuffs the demand is not final demand but hoarding physical commodities for future sale or final use. There is good evidence of that in petroleum, copper, etc., but you have not shown that Krugman is wrong in saying that there is little evidence of it in food.