The Food Crises: A Quantitative Model of Food Prices Including Speculators and Ethanol Conversion

Abstract

Recent increases in basic food prices are severely impacting vulnerable populations worldwide. Proposed causes such as shortages of grain due to adverse weather, increasing meat consumption in China and India, conversion of corn to ethanol in the US, and investor speculation on commodity markets lead to widely differing implications for policy. A lack of clarity about which factors are responsible reinforces policy inaction. Here, for the first time, we construct a dynamic model that quantitatively agrees with food prices. The results show that the dominant causes of price increases are investor speculation and ethanol conversion. Models that just treat supply and demand are not consistent with the actual price dynamics. The two sharp peaks in 2007/2008 and 2010/2011 are specifically due to investor speculation, while an underlying trend is due to increasing demand from ethanol conversion. The model includes investor trend-following as well as shifting between commodities, equities and bonds to take advantage of increased expected returns. Claims that speculators cannot influence grain prices are shown to be invalid by direct analysis of price setting practices of granaries. Both causes of price increase, speculative investment and ethanol conversion, are promoted by recent regulatory changes—deregulation of the commodity markets, and policies promoting the conversion of corn to ethanol. Rapid action is needed to reduce the impacts of the price increases on global hunger.

Quote from Peter Timmer, Cabot Professor of Development Studies emeritus, Harvard University

"This paper does three important things. First, it shows how closely the accelerating trend in food prices over the past decade tracks the rising share of US corn production going into ethanol. We are, quite literally, paying a high price for an increasingly doubtful improvement in energy security and environmental sustainability. Second, the two price spikes and collapses along that trend are explained very precisely by a simple model of trend-following speculators. These “investors” face opportunity costs from stock and bond markets to their investments in financial instruments that track commodity prices. The investment dynamics that result show clearly how financial speculation causes price spikes. And third, the model that combines these two factors far surpasses any other effort to explain food price formation since the turn of the millennium. The model highlights the perverse impact that commodity market deregulation and subsidies for bio-fuel production have had on the global food economy. Fixing these problems will be very difficult because of the substantial vested interests now represented in both arenas."

Press Release: Scientists flag global food pricing too hot to ignore

A new Cambridge study issues stern warning for policy makers

(CAMBRIDGE, MA) --September 15, 2011 -- A paper on the surge in world food prices is calling on private and public policy makers to recognize the serious impact that price spikes in food bring to the world′s most vulnerable populations. The paper, "The Food Crises: A Quantitative Model of Food Prices Including Speculators and Ethanol Conversion," was prepared by the New England Complex Systems Institute in a study partly funded by the U.S. Army.

The surge in food prices has been frequently linked to numerous factors, while this study maintains two specific reasons account for the price increases. The authors slam and analyze the two culprits -- speculators playing in the commodities markets and corn-to-ethanol conversion.

The authors refer to "since-debunked claims of the role of ethanol conversion in energy security and the environment." They say a significant decrease in the conversion of corn to ethanol is warranted.

Using direct tests and statistical analysis, the paper pinpoints what is going on in global food pricing today. The authors discuss the motivations, techniques, and impact of commodity speculation, weather, development, and additional factors that are rounding out the pricing puzzle -- exchange rates and energy costs.

The authors are Marco Lagi, Karla Bertrand, Yavni Bar-Yam, and Yaneer Bar-Yam. "The immediate implications of our analysis are policy recommendations for changes in regulations of commodity markets and ethanol production," the authors state.

A list of topics / talking points:

A model of speculators and ethanol conversion matching price data (Fig. 1)
Market dislocation due to speculation is manifest in higher inventories with higher prices. Global inventories of grain rise one year after price bubble when higher priced contracts affect grain delivery (Fig. 2)
Speculators: an explicit model for the first time, showing bubble/crash dynamics (see figures 8 and 10)
Our analysis correctly estimates the duration of a bubble as about 12 months due to the planning time of companies in contracts for grain.
Ethanol: direct match between food price growth and ethanol growth (Fig. 6)
Failure of supply/demand model to explain price dynamics
Oil prices do not explain food price rise (Figure 3 F shows wheat prices are high before oil prices, see also paragraph 2 on page 17).
The link of food prices paper to revolutions in North Africa and the Middle East is made in a linked paper.
Dominos of global dependence: the mortgage crash -> stock market crash -> commodities bubble -> social unrest, food riots and revolutions
Economics: there is a breakdown of optimal allocation due to both regulation (in the case of ethanol subsidies) and deregulation (in the case of speculation).

Manuscript is available at: http://necsi.edu/research/social/
food_prices.pdf.

For figures, click here.