Presentation at USDA 22nd of October 2008

1. “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

2. 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

3. 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

4. • 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 ?

5. What food crisis?
• Political destabilization
• Macro-economic / inflation
• Poverty and hunger

6. 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

7. 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
Overall
Food
Mexico
Source: Data from government statistics.

8. 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)

9. 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

10. 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)

11. 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

12. • 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?

13. 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
7.0
Jan-02
Apr-02
Jul-02
Oct-02
Jan-03
Apr-03
Jul-03
Oct-03
Jan-04
Apr-04
Jul-04
Oct-04
Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
NumberofcontractsforRoughRice(Thousands)
NumeberofcontractsforWheat,soybean,andcorn(Millions)
Wheat Corn Soybeans
Rough Rice Wheat Corn
1 contract = 5,000bushels
Source: CBOT
1 contract = 5,000bushels
Source: CBOT

14. SOURCE: U.S. Commodity Futures Trading Commission
b. Open interest index

15. SOURCE: U.S. Commodity Futures Trading Commission
c. Future contracts: ratio volume to open interest
(monthly volume / monthly open interest)

16. 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

17. 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)

18. • 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?

19. • 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?

20. • 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?

21. 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

22. • 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

23. • 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

24. • 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

25. • 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

26. • 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

27. 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

28. 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

29. 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)