Food price rises: it\’s not the speculators dingbats

Hey, this guy has the Nobel for Economics, you going to listen to him at least?

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.


But the main point is that the demand for grain is highly price-inelastic: it takes big price rises to induce people to consume less, yet collectively that’s what they must do given the shortfall in production.

So would the World Development Movement please shut the fuck up?

12 thoughts on “Food price rises: it\’s not the speculators dingbats”

  1. Wheat, sugar and corn prices have all been rising since the time Bernanke started chatting about QE2. Same with every other commodity, and pretty much every stock market. But there are other factors, specific to individual commodities (such as the one Krugman points out).

  2. Demand exceeds supply, so prices must rise to match the two. Seeing this, speculators buy, adding to demand and raising the price higher than it would otherwise reach. When speculators finally slope off to another market, prices slip back to their “real” equilibrium. Meanwhile, more people starve than is necessary.

  3. grahams: Let’s count up your errors…

    1) Demand cannot exceed supply; they are curves, not quantities.

    2) As has been pointed out ad infinitum, prices going up now is what we want, as it leads to proper resource allocation. Wheat is a scarce good right now, and should not be wasted. (The alternative is for prices to remain low, wheat toe be wasted, and far more of the world’s poorest to starve. Do you hate the poor grahams?)

    3) There is no such thing as a “real” equilibrium.

    4) As above, speculators reduce the starvation. They also reduce price volatility, and are in general crucial for markets to work efficiently and price resources appropriately. And as already covered, such efficiency is a very good thing if your a starving peasant.

    So to recap, everything you said is wrong. Not a single one of your points, arguments, or conclusions is correct. Are you an idiot, a troll, or both?

  4. inflationwatch: Your link isn’t really relevant, and fails to address the point’s PK raised.

    The argument – from PK and many many others – is basically twofold:

    (1) It’s been a bad year for wheat, in large part due to adverse weather events. In other words, supply is slightly constrained.

    (2) Asia is getting richer, eating more food in general, and eating more meat in particular. Meat takes a lot of grain to produce, so this has caused a much larger impact on consumption than might be apparent. In other words, demand is booming.

    The combination of point (1) and (2), plus the elasticities of demand (as mentioned by Krugman), is MUCH higher prices.

    Your link, in contrast, presents a counter argument: That supply is slightly constrained, and therefore…it’s all just some sort of bubble. As theories go, it’s colourful, but by ignoring the demand side (where all the action is taking place right now) it’s quite clueless. Further, it’s an answer looking for a problem; the rise in wheat prices is well understood and adequately explained.

    The bottom line is this: Asia wants more wheat, and they can afford to pay. Either we figure out how to produce a lot more, we don’t allow Asia to buy all the wheat they want, or the world’s poorest (Egypt being first and foremost in the line) go hungry. It’s a piss poor situation, and it’s going to get worse before it gets better – but if it’s to get better at all, we need to identify the problem. A failure to do so hurts the world’s most vulnerable, and is inexcusable.

  5. Cody,

    I agree that Krugman is making a point about elasticities, but a 50 percent price increase on a 5 percent drop of supply? That is a highly implausible . If you are unsure of this, think about a counterfactual. Suppose supply had increased 10 percent, would the price fall by 100 percent (as implied by an elasticity of 10)?

    Besides, we have been through this before. Remember 2008? Prices went through the roof, only to come crashing down. At that time, the same arguments were used; falling supply, Asian growth, elasticities.

    Besides, Wheat is just one commodity on the rise. Sugar prices have risen much further. Meat prices are also rising. Then there is oil. Need I go on?

    The speculation, in my view, is driving the price upwards, very much as it did in 2008.

    However, I am in agreement with you on Egypt. Rising food prices have the potential to destabilise many regions in the world.


  6. Don’t forget that Western govts are borrowing money left right and centre to spent on their spendthrift populations, incurring massive debts. They are also ‘printing’ money hand over fist. Many think that the only way out of these debts is a period of sustained inflation.

    What is the logical course of action in such conditions? I would suggest it is to invest your fiat currency in something that cannot be replicated at the pressing of a cental bankers keyboard.

    No amount of wishful thinking can create one extra grain of wheat. An extra billion or two dollars can be created in milliseconds. Which would you prefer? Paper currency or hard commodity?

  7. inflationwatch:

    Actually, the elasticities are highly plausible. Recall that a given elasticity is valid only for a single price or range of prices, and large discontintuities are common.

    Further, note that as a relatively well-off Westerner, I am currently consuming pretty much all the wheat I wish, for a total cost that is an essentially unnoticeable fraction of my total consumption. Any fall in price will have almost zero impact; I’m not going to buy an extra loaf of bread just because it becomes a few cents cheaper (which is all the change I’d see at a retail level, even in response to a very large change in wholesale wheat prices). In fact, for me to consume 10% more wheat would take an extremely large price change indeed; possibly even one approaching 100%.

    From the linked Krugman article:

    The USDA has estimates of price elasticities. For the United States, they put the price elasticity of demand for breads and cereals at 0.04 — that is, it would take a 25 percent rise in price to induce a 1 percent fall in consumption.

    That sound perfectly about right to me. Certainly I wouldn’t wish to argue with the USDA on the point. (And Egyptian peasants, of course, would be expected to have even lower price sensitivities. I can respond to my dinner rolls being more expensive by buying corn torillas insteas. They respond by starving.)

    You also seem to be suffering from some confusion. Speculators are a means by which an efficient market converts future shortages (or the risk of future shortages) into current prices in order to allocate scarce resources. A speculator noticing poor Russian harvests may well drive wheat prices higher, but this is precisely what we want, as it leads to lower volatility and less starvation.

    I trust we can both agree that these last two outcomes are positive, yes? (Consider the alternatives – no higher prices until we actually run out of wheat. That would be vastly worse. 2008, in short, is an example of what we WANT to happen in response to adverse events, and we seem to be seeing a repeat. That’s good!)

  8. Cody,

    There is much we can agree on. Lets start with speculators, who are only responding to incentives. If real interest rates were positive, then they would perform the stabilising role you describe. So, I am sorry if I gave you the impression of being confused about speculators.

    Likewise, the price of wheat should be a powerful signal indicating relative scarcity. Over time, suppliers will respond appropriately.

    Moving onto some possibly marginal disagreements and elasticities, Krugman was being quite naughty when he quoted that elasticity. This is the demand elasticity for US consumers.

    The one that matters for our purposes is the world supply elasticity. I agree with everything you describe about your own demand elasticity, but I question, politely, whether it is totally relevant.

    Besides, there are all sorts of simultaneity issues. I was being a bit misleading by suggesting it was 10.

    Even if I believed the USDA estimate for US consumers, I still don’t find the idea that a modest decrease in supply, on its own, could generate such a huge increase in world prices. As an aside, I have no problem with arguing against USDA elasticity estimates.

    Here, it is really important to clarify the timing of events in the world wheat market. Supplies in 2010 fell by around 0.1 percent. Prices went up 50 percent. Projected, but nonetheless reliable supply estimates suggest a future fall of another 5 percent in 2011.

    If you were a rational speculator, what would you do? Borrow money at negative real interest rates, buy a futures contract. The price goes up and you are in the money.

    You aren’t the only one who knows the 2011 projection. Everyone sees that wheat commodities futures are going through the roof. What happens next? Investors seeking higher yields jump into the market. The surge of liquidity pushes both spot and futures prices upwards. Suppliers hoard wheat and the poor get nailed.

    Like all bubbles, it will burst. Just like it did back in 2008. But not before all this speculation has brought down one of the West’s most reliable partners in the middle east. (I am not moralising here, just pointing out the causality).

    The root of the problem is not the behaviour of speculators per se. The problem is monetary policy. Low interest rates have created the necessary conditions for a 50 percent hike in wheat prices.


  9. Let’s cut to the chase: In a functioning market, prices are a result of supply and demand. You posit that the change in supply has been only 5%, while the change in price has been 50%. Since this is (you argue) larger than would take place in a functioning market, you conclude that the market is not functioning properly, and nominate speculators and/or negative real interest rates as the culprit.

    But what about demand? It can’t be ignored, but you don’t even mention it. Demand from Asia is strong and increasing, and easily accounts for whatever price increase is left over after we account for the decreased supply of wheat. In short, wheat prices (appear) to reflect fundamentals, and there is therefore no evidence that the market isn’t working, and thus nothing to explain.

    I highly recommend this article:

    The point, basically, is that a big chunk of the world’s wheat consumers are becoming richer, consuming more wheat, and (importantly) becoming much less sensitive to the price, which leads to volatility.

  10. Cody,

    I wince when I hear any agricultural market described as “properly functioning”. All over the world, governments fix prices, maintain buffers stocks, and provide subsidies to farmers. However, that is a discussion for another time.

    Turning to your point about demand. Yes, it is true. Asians have been buying more wheat. However, it has been true for a very long time. Here is the irony about this particular point. The real price of wheat, deflated by say, hourly earnings has been falling over the last thirty or so years. It doesn’t matter whether you use chinese or UK data. At the same time, the World economy has grown at around 4 percent or more a year.

    Two additional points here. First, I saw a press story highlighting some report that found that one in ten people in the world are now obese. I don’t know if that is true, but it does emphasise that food is becoming cheaper, at least over the long run.

    Here is a slightly more interesting observation. World population growth is decelerating. At the moment, the world is adding about 70 million a year, but that number is progressively declining. Meanwhile, agricultural productivity continues to grow at a brisk pace. Personally, I am not convinced that the world faces a long run upward trend in food prices.

    In other words, the wheat market didn’t just discover that China was growing rapidly last June. It has known about it for at least two decades. If anything, the long run expectation is for lower prices.

    Returning to your points, of course, prices are the result of supply and demand. What you are missing is the forward looking aspect.

    Think about this from a rational expectations perspective. If you expect the price to go up with a high probability, and fall with a low probability, what happens to supply and demand. Suppliers hold up supplier, and consumers try to buy now.

    However – and here is the key point – this is an intertemporal optimisation on the part of market participants. The interest rate and the availability of liquidity plays the deciding role as to whether suppliers can in fact hoard supply.

    Just to recap, I am not blaming speculators. I am making a point about monetary policy. Monetary policy has allowed speculation to temporarily push the price of wheat up. Forecasting is always hazardous, but in the absence of higher interest rates, I think prices will go higher. Then, I expect them to fall. I could be wrong, but that is my best forecast.

    I work in finance. I am always perplexed to the “it is different this time” rationalizations that appear when a bubble blow ups. The answer seems to be that people outside of markets haven’t got a good feel for liquidity conditions. Therefore, when prices jump they have a tendency to look for changes in market fundamentals.

  11. @Inflationwatch: You and others who blame ‘evil speculators’ for the rising food prices forget that the futures markets are zero-sum. For every speculator who guesses the right way and makes a fortune there is another speculator who guessed wrong and lost a fortune.

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