Kasinomics

Why the world should be thankful for high food prices

Commodity prices for agricultural products are rising - which is a troublesome sight for many least-developed and developing countries. Riots over the prices of basic food items, such as rice, wheat, corn, are threatening to destabilize many countries around the world. The development programmes of the United Nations and various other international organizations are saying they need more money to accomodate the increasing rallies in these markets.

Just today, a Spiegel-Article blamed some of the price hikes on speculation in the futures market. Futures are contracts for to buy or sell something (for instance a certain volume of an agricultural product) at a certain time in the future. In John C. Hulls Book on Futures and Options three types of traders in the future markets are indentified:

• Hedgers, which uses futures to minimize risk about the development of a price in a certain market, such as the producers or sellers of the products in these markets;
• Speculators, which bet that a certain price is going into a certain direction;
• Arbitrageurs which want to create riskless profit by trading in various markets at the same time.

All three types are necessary to keep financial markets efficient and functioning.

Without arbitrageurs, markets for the same product would have different prices and producers and byers have to continously assess which markets are better. Because of arbitration most market participants can assume that market prices are reflecting true market conditions, from supply and demand.

Speculators are necessary because they not only reflect today’s demand and supply but also future demand and supply. In other words, speculators make markets sustainable in the long run.When speculators bet on rising food prices, it is not because they want to harm the poor in the least-developing countries. They simply recognize that demand is exceeding supply in some of these markets. But is that necessary bad?

1. Food prices are rising because a large number of people in developing countries can now afford to buy food which was too expensive for them a decade ago. Rising food prices reflect growing wealth, it means that millions of people are being lifted out of poverty.
2. Food prices are rising because more and more agricultural production is used for producing biofuel. This is also too be welcomned, it means a more sustainable energy source for transport and mobility.
3. High food prices means that the agricultural industry in developed countries will need less and less subsidies from governments. This opens the door for a compromise in the Doha Development Agenda at the WTO, where high agricultural subsidies of developed countries where always the biggest obstacle to moving forward (see this article at the Center for Global Development - via Dani Rodrik).
4. High food prices means that ecological farming can be more competitive because they can either match the price of traditional farming products or even charge an additional premium for ecological agriculture.
5. High food prices encourages local trade because local farmers in developed countries can easier compete with low-cost farmers in developing countries because demand is going up for both of them.
6. High food prices can contribute to rural development in developed and developing countries and reduce the flux of people into the big metropolis of this world.
7. Famine and starvation do not result from high food prices, but from poverty and reliance on food-imports. High food prices should be an incentive to develop local farming in developing countries as well.
8. Bilateral agreements for agricultural products and export restrictions which are caused by high food prices will not do anything to alleviate the problems of some countries, in fact they simply push the food prices to the consumers, especially the poorest in least-developed countries.

High food prices are not necessarily a problem. The real problem is that political power also shapes these markets. So while the economic and political power of the developed world shapes the agricultural markets as well, consumers in the developed countries will have to bear only moderate price increases while consumers in the least-developed countries will feel the full force of price increases. This is the real injustice in the agricultural markets.

See also

• Hull: “Fundamentals of Futures and Option Markets”
• What is a Hedge Fund (or how do they differ from mutual funds)?
• Summary of the recommendations of the Meltzer-Report
• Organizational Changes of Markets and Exchanges
• Intergovernmentalism in Financial Regulation
• IFIAC - International Financial Institution Advisory Commission
• G8-Action Plan on Local Bond Markets - Missing Follow-Up Documents