price volatility, reserves and public policy brian wright chair, agricultural and resource economics...
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Price Volatility, Reserves and Public Policy
Brian WrightChair, Agricultural and Resource Economics
UC Berkeley
ICABRRavello Italy June 19, 2013
Post- “Inside Job” I perceive a need for disclosure:
Recent or current grant support:• AMIS initiative of G20 • Energy Biosciences Initiative (UC Berkeley, UIUC, LBL, BP,
funded by BP) – researches cellulosic biofuels• USDA• NIH• NSF• USPTO• Giannini Foundation
Disclosure (contd.)• Current consulting relationships:
– World Bank– FAO
• No recent positions in commodity markets• No investments in agricultural input or service providers, or significant
commodity market or energy market participants.• In past 2 years, I was a consultant/expert witness engaged by an entity that
produces and exports agricultural products. I was recently an expert witness in a case involving generic drug entry in pharmaceuticals
• I recently made a presentation at a major agricultural bank• Last month I was compensated by a leading investment firm for a
presentation at their head office• I am happy to identify any of the firms involved in the above activities,
should any audience member request that I do so.
Global Grain Markets: Assumptions for a simple model
1. Production is seasonal, most often with one grain harvest ht per year. – positive trend due to productivity increases.
2. There is an inevitable one-year lag between the investment in planting an area At and the harvest. – within-year planned supply can be approximated as pre-determined.
3. Expected harvest at planting, Et-1 ht, is roughly proportional to planted area.
4. The realized harvest is subject to random shocks proportional to expected harvest, due to variation in the weather, the prevalence of pests, and other shocks.
5. Grain consumption is a negative function of price. – Positive trend due mainly to (exogenous) population increase.– Other demand shifters such as income and tastes and tend to be slow-acting, not
“shocks”
– So we can write the inverse consumption demand as pt = F(ct).
Simplest S-D model is consistent with long run increasing production trend
• Obvious (linear?) uptrend in production
• Obvious downtrend in price in long view
Index of World Detrended Price vs. Index of Detrended Production for Rice (1961-2012)
After detrending, simplest S-D model cannot explain rice price volatility
• No consistent relation even before 2005• Simplest Marshallian S-D model fails if applied to rice alone
Try Adding Storage to the Marshallian Market Model
Assume stylized facts of major grain markets: 1. Grains can be stored from period to period
without cost, waste, or “shrinkage”2. Grain stocks cannot be negative. 3. Consumption cannot be negative.
Available supply is used in two ways:
1) for consumption in year t, ct and for carryout stocks, which become carryin stocks xt for the next year.
2) for carryout stocks, which become carryin stocks xt for the next year.
Available supply at time t, at, for a given year comes from the current harvest ht and from stocks xt-1 carried in from the previous harvest:
• at = ht + xt-1
Available supply is used in 2 ways:
• Consumption• Carryout stocks
ct = at – xt.
Sources of available supply
• Available supply at for a given year comes from the current harvest ht and from stocks xt-1
carried in from the previous harvest.
• at = ht + xt-1
If storers are competitive and aim to maximize expected profits, and the only cost of storing is the (constant) opportunity cost of capital r, then their behavior will result in the following complementary conditions for equilibrium intertemporal arbitrage:
Nonlinearity of Inverse Total Demand Function and Price Dynamics
Does Storage Dynamics Explain Prices?
Rice: Index of Detrended Price versus Observed Stock-to-Use Ratio
• No consistent relation even before 2005• Adding storage to the rice market model does not make it fit
Try Aggregation of Rice, Maize, and WheatCalories price and grain prices
Index of World Detrended Price vs. Index of World Detrended Production for Calories
• Simple S-D model fails even for aggregate grains
Was there a perfect supply storm?
Weather and Global Warming?Really?
US Corn Harvest
0 1 2 3 4 5 6 790%
100%
110%
120%
130%
140%
150%
Ratio of Index of Prices Received for All Crops to Index of Prices Paid for Production Items, Interests, Taxes and Wages Rates
U.S., 1972-1979 vs. 2005-2012
2005-20121972-1979
Cost push?
1990/1991
1991/1992
1992/1993
1993/1994
1994/1995
1995/1996
1996/1997
1997/1998
1998/1999
1999/2000
2000/2001
2001/2002
2002/2003
2003/2004
2004/2005
2005/2006
2006/2007
2007/2008
2008/2009
2009/2010
2010/2011
2011/2012
2012/2013
-4%
-2%
0%
2%
4%
6%
Corn Rice Wheat Total
Consumption Surge in India and China?Consider their net exports:
Let’s try: Aggregation Plus Storage
Calories of 3 major grains:Index of Detrended Price versus Observed Stock-to-
Use Ratio - maize, wheat and rice: Now it works!
But are stocks consistent with the naïve model?
19611963
19651967
19691971
19731975
19771979
19811983
19851987
19891991
19931995
19971999
20012003
20052007
20092011
0.6
0.9
1.1
1.4
1.6
1.9
2.1
2.4
2.6
price implied by stocks data detrended observed price
Detrended Price-implied Stocks Data vs. Detrended Observed Price Index for Calories
19611963
19651967
19691971
19731975
19771979
19811983
19851987
19891991
19931995
19971999
20012003
20052007
20092011
0.10
0.15
0.20
0.25
0.30
0.35
actual stocks data stocks implied by price and estimates
Calories: Actual Stocks vs. Stocks implied by Price Data and commodity model
19611963
19651967
19691971
19731975
19771979
19811983
19851987
19891991
19931995
19971999
20012003
20052007
20092011
0.10
0.15
0.20
0.25
0.30
0.35
0.40
actual SUR SUR implied by price and estimates
Actual SUR vs. price-estimates-implied SUR for Calories
(why good fit only through 2004?)
Calories: Index of Detrended Price versus Observed Stock-to-Use Ratio
Transfer to Farmer Wealth:Financial crisis plus biofuels
Permanent Mandate Anticipated and Imposed
Shifts due to a Temporary Mandate versus Permanent Mandate
Implication of Storage Model
• Relation highly nonlinear due to influence of stocks levels
• Cannot calculate “percentages of blame”
• Marginal effect is the key: Relevant for policy• Linear SR time series irrelevant
Policy Options
• Self sufficiency:• Strategic reserves• Virtual reserves (IFPRI 2008)• Subsidize storage• Ban Export Bans (if you can)• Limit biofuels use of grains and sugar• Farmer risk management• Acquire foreign farmland and grow the national staple • Biofuels diversion contracts• GM crops?
Policy Options: Tools for Execution?
• Strategic reserves
Subject to political interference - almost always against security and in favor of pressing political interests
Acquisition and disposal rules contentious (see e.g. commodity fund rules)
Policy Options: Tools for Execution?
• Strategic reservesUS strategic petroleum reserve as example
But substitution reduces effectiveness inevitablySpeculative attacks look bad, but actually can increase
efficiencyUS silver reserve as cautionary tale (among
others)
Public and Private Stocks: Interactions
Policy Options: Tools for Execution?
• Strategic reserves
US silver reserve as cautionary tale (among others)
Policy Options: Tools for Execution?
• Virtual Reserves (IFPRI 2008)
Naked short positions where necessary to convince markets that their price expectations will not be fulfilled?
What would have happened if adopted in 2007/08?
Ban Export Bans?
• Prisoner’s dilemma• Export bans can prevent hunger in weak regimes
• Fundamental trade problem:Biofuels as classic (but huge) price discrimination
Divert grain from inelastic (food) to elastic energy) demand market
Acquire foreign farmland and grow the national staple
• Acquire foreign farmland and grow the national stapleGood deal for all? Capital or oil for land output
and supply security?Sovereign risk?Political commitment durability?
Policy Options: Tools for Execution?
• Acquire foreign farmland and grow the national stapleBuy-in from private sector?Buy-in from resident peasants?“terra nullius??”
Policy Options: Tools for Execution?
• Subsidize storage?
– Advantage: depoliticize buy-sell decisions
Policy Options: Tools for Prevention/Amelioration?
• Political alliances, naturally
• Reduce incentive to use biofuels by moderating oil prices?
• Support transparency in grain markets– AMIS initiative– Reduce ignorance that generates panic
Policy Options: Tools for Execution?
Impact of Biofuels: Limit biofuels use of grains and sugar
• Not just in EU and US
• Huge transfer to landowners and farmers
• Huge transfer from poor consumers
Transfer to Farmer Wealth:Financial crisis plus biofuels
Relevance of GM for poor?
• Depends on biofuels policy• Increase RFS continually?• If so GM can do nothing for poor• Not North/South issue but
Landowner/Consumer
Summary
• Nonlinearity of response• Huge distributional effect of biofuels• Will it continue?• If US RFS expansion leads, others including
LDCs will follow• More redistribution away from poor than any
development policy• The “GM for poor” is red herring
What are the sources of insecurity?
① Price spikes like 2007/8? Wealthy countries are minority consumers – can
tolerate a doubling of farm gate food prices Poor countries (and especially the poorest non-
farmer citizens of such countries) are vulnerable Spikes force government intervention,
suppression of private sector development?
What are the sources of insecurity?
① Price spikes like 2007/8? Expect continued grain market pressure and
instability if biofuels use of grains continues to expand as US farmers expect (or hope)
E10 to E85!
What are the sources of insecurity?
① Price spikes like 2007/8? Expect continued grain market pressure and
instability if biofuels use of grains continues to expand as US farmers expect (or hope)
E10 to E85!
What are the sources of insecurity? :
②Export bans like 2007/08? Really bans?? May be exacerbated by state trading, lack of
decentralized private initiative Let’s get real!-no exporter government will starve its citizenry and hope to live to enjoy the rewards of trade Can be fatal: Niger drought disaster after
neighbors reneged on commitment to open borders
What are the sources of insecurity?
③Credit market failure like 2008? Problems financing stocks and trade?
What are the sources of insecurity?
④Interruption of physical access?blockade? Sea lanes interruption? (Persian Gulf?) Landlocked may face closed borders
What are the sources of insecurity?
⑤Obligation to neighbors in distress?
Saudi Arabia and Gulf states?Serious topic: Blockade of Straits of Hormuz?No oil outNo grain in to Gulf States
Whether all or most of these factors will continue to impact markets for food and agricultural products in the years to come is difficult to say. It does, though, appear that extreme weather events have become more likely as a consequence of ongoing climate change. That factor alone may mean that markets may continue to exhibit a marked degree of volatility in the future, even larger than the 'traditional' volatility that has always plagued agricultural markets. Also
Nonlinearity of Inverse Total Demand Function and Price Dynamics
References:• Bobenrieth, E., Wright, B. D. and Di Zeng. “Stocks-to-use Ratios and Prices as
Indicators of Vulnerability to Spikes in Global Cereal Markets.” Agricultural Economics (forthcoming).
• Cafiero, Carlo, E.S.A. Bobenrieth, J.R.A Bobenrieth, and B.D. Wright. 2011.“The empirical relevance of the competitive storage model.” Journal of Econometrics, 162: 44-54.
• Wright, Brian D. and C. Cafiero. 2011.“Grain reserves and food security in the
Middle East and North Africa.” Food Security, (Suppl 1): S61–S76DOI: 10.1007s12571-010-0094-z.
• Wright, Brian D. 2011. “The Economics of Grain Price Volatility.” Applied Economic Perspectives and Policy, Vol. 33, No. 1: 32-58. DOI:10.1093/aepp/ppq033.
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