Ebook: Global Uncertainty and the Volatility of Agricultural Commodities Prices

Commodities markets and prices have become a sort of Babel Tower of topics since the turn of the century. They once were a specific part of energy economics for oil and coal, of natural resources economics for minerals and precious metals, of agricultural economics regarding wheat, corn, rice, fruits and vegetables, and more generally regarding food grown on land. This traditional view of the markets for commodities appears today as jeopardized. This book wants to explore to what extent it has to be questioned regarding agricultural commodities. Main institutional changes occurred at the end of the Nineties, with two major acts passed under the second term of the Clinton Presidency. One is the Financial Services Modernization Act (November 12, 1999), which repealed the Glass – Steagall Act of 1933; the other is the Commodity Futures Modernization Act (CFMA, December 21, 2000) which abrogated the Commodity Exchange Act of 1936 and is the most relevant for this book. Ms. Brooksley Born was ousted from the Commodity Futures Trading Commission which she had been heading since 1996, to decrease resistance from the CFTC. Adopting CFMA had repercussions throughout the entire international economy and raised to a large extent the issues which this book deals with.

And the new ‘Babel discipline’ of commodities entails not only agricultural economics aspects, but energy economics, international finance and all related powerful psychological factors which may have a renewed role in these analyses. Researchers and policy makers have sometimes felt ‘abandoned’ (in J.-C. Trichet's words in the heading to the introduction of this book) by accepted wisdom when the new crisis emerged in 2007–2008. To be sure, Brooksley Born was awarded the J.F.K. Profiles in Courage Award in 2009 in recognition for having been right too early, but macroeconomics is unfortunately still plagued with deepest uncertainty in prescriptions to the world economy.

Important issues on Agricultural Commodities Markets today ask whether prices on these markets are foreseeable, whether their evolution can be either predicted or, in a much weaker sense, convincingly simulated, and by which methods and models. One of the key issues here pertains to the possibility of some kind of stabilization or of lesser volatility of these agricultural commodities prices. The role of speculation is, in this last respect, one of the hot issues debated. Other core policy issues pertain to the role of these commodities in helping develop countries, whether within the Newly Independent State Community or within the less developed countries. More fundamentally, the question regarding the possibility of adjusting macroeconomics to these new developments is the question behind all others.

A group of first quality experts from several countries, institutions and background are bringing to the reader of this book a renewed wisdom on some of the core issues in the world economy mentioned above.

May this book inspire fruitful applications in policy making and improve world population's welfare.

Bertrand R. Munier

Emeritus Professor, Sorbonne's Business School,

GRID, ENSAM/ESTP and IAE de Paris

Momagri chief Economist

The highly disputed effects of agricultural trade liberalization are mostly simulated with static models. Our main objective in this paper is to evaluate the robustness of the static simulation results to the consistent modeling of dynamic behaviors and to the linked specification of price/return expectations. Focusing on a complete trade liberalization scenario of arable crop markets by developed countries, we find that available static results are quite robust to dynamic specifications and to most expectation schemes. Endogenous market fluctuations due to expectation errors may appear following trade liberalization. These fluctuations are nevertheless limited by the many feedback effects revealed by our general equilibrium framework.

Volatile and rising agricultural prices put significant strain on the global fight against poverty. An accurate reading of future food price movements can be an invaluable budgetary planning tool for various government agencies and food aid programs. Using the asset-pricing approach developed in Chen, Rogoff and Rossi (2010), we show that information from the currency and equity markets of several commodity-exporting economies can help forecast world agricultural prices. Our formulation builds upon the notion that because these countries currency and equity valuations depend on the world price of their commodity exports, market participants would price expected future commodity price movements into the current values of these assets. Because the foreign exchange and equity markets are typically much more fluid than the agri-commodity markets (where prices tend to be more constrained by current supply and demand conditions), these asset prices can signal future agricultural price dynamics beyond information contained in the agri-commodity prices themselves. Our findings complement forecast methods based on structural factors such as supply, demand, and storage considerations.

Commodity resources offer vast opportunities for development. In the long run, however, the performance of commodity-rich countries tends to fall short of expectations, as commodity rents induce macroeconomic volatility and undermine incentives to improve institutions. The paper looks at the strategies that countries can adopt to avoid the “resource trap”. These strategies aim at diversifying the economy, promoting financial development, building up stabilization buffers that lower macroeconomic volatility, and reducing inequality. The resource-rich EBRD countries of operations have embraced these strategies to varying degrees, and with varying success. Improving institutions remains the key challenge.

Rising food prices cause considerable policy dilemmas for developing country governments. Letting domestic prices adjust to reflect the full change in international prices generates inflationary pressures and causes severe hardship for poor households lacking access to social safety nets. Alternatively, governments can use food subsidies or export restrictions to stabilize domestic prices, yet this exacerbates global food price increases and undermines a rules-based trading system. The recent episode shows that many countries chose to shift the burden of adjustment back to international markets. Corn and oilseeds use for biofuels' production will result in a recurrence of such episodes in the foreseeable future.

This paper deals with the precise policy issue raised by the increased volatility in grain prices. While price stabilization implies different sorts of costs, it brings benefits to several social groups, as well as to society in general. The case of rice in Asia is used as an illustration of such benefits. Assessing the benefits should not rely too heavily on Armington elasticity considerations, as the latter appear as highly policy-dependent in a number of cases. On another hand, trade policy seems more effective as regards food security than price stabilization considered as a safety net for the poor, contrary to prevailing opinion. The paper argues that trade restrictions may be welfare improving under some circumstances and that it makes more sense for the world market to act as a shock absorber than for domestic consumers and producers to be the shock absorbers, at least in the poorest countries. Instead of discretionary government interventions, tariffs could be rule-based, though this would call for changes in WTO's agreement. The private sector could consequently act in favor of food price stabilization, long term contracts being then used as complements to actions resulting in price stabilization.

This paper analyzes price formation on the world's rice market using simple supply and demand models as a start, but moving to “supply of storage” models—a staple of commodity-market analysis for more than half a century—to explain hoarding behavior and its subsequent impact on prices. The supply of storage model, however, does not account adequately for the influence that “outside” speculators have on prices. This paper quantifies the impact of financial factors and actors on commodity-price formation using very short-run prices and Granger causality analysis for a wide range of financial and commodity markets, including rice. The results are highly preliminary but are also very provocative. Speculative money seems to surge in and out of commodity markets, strongly linking financial variables with commodity prices during some time periods, but these periods are often short and the relationships disappear for long periods of time. Finally, the paper addresses the long-run (since 1900) relationships among the prices of the three basic cereal staples, rice, wheat and corn (maize), which have declined more than 1 percent per year over the past century. The decline accelerated after the mid-1980s; only the recent run-up in cereal prices in 2007–08 returned them to the long-run downward trend. Despite these common features and important cross-commodity linkages, however, price formation for rice has several unique dimensions worthy of further study.

This paper argues, on the basis of statistical evidence of recent sharp volatility increases in agricultural commodity markets, that such financialized markets should be modeled differently than simple markets for physical goods. The Momagri 2 Model has been designed as a multi-regional modular model. The originality of it lies in the fact that it connects a microeconomic out of equilibrium market module, characterizing agricultural price behavior on the basis of their specific sources of uncertainty, to a macroeconomic computable constrained general equilibrium model. The emphasis is laid on market microstructure, heterogeneity of boundedly rational agents, and the specifics of agricultural markets. Simulations show that under conservative parametric specifications, the integrated model produces strong price volatility of the magnitude and scope experienced in the first decade of the 21st Century. A scenario of markets liberalization increases, rather than decreases, the volatility of commodity prices. We argue that producer's boundedly rational expectations as well as the ones of short term investors, together with market's structures and risk attitude account for the largest part of this volatility. It is suggested that the modular approach used in this paper be applied to all “financialized” markets. Some characteristics of it should indeed also apply to general economic modeling.