Food security: stocks, speculation and sanctity of contract

by Robbin Johnson
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The Russian government’s recent decision to embargo wheat exports has put food security back on the agenda of policymakers. The food situation does not seem likely to deteriorate into the volatility that characterized world markets in 2007-08, when prices for food staples like wheat and rice tripled. Prices, however, have not fallen back to pre-2007 levels, nor has the number of global hungry retreated much from its post-2008 spike to 900 million. Consequently, the stress on the world’s poorest and hungriest may be severe, even with smaller disturbances to global markets.

For this reason, debate is renewing over what steps may be taken to reduce food insecurity. Three ideas deserve review. They are global, virtual stocks, and contract sanctity (supplemented with purchasing-power aid).

Global stocks

The notion of food reserves reaches back to biblical times, if not before. More recently, it was the leading recommendation coming out of the First World Food Conference in Rome in 1974, and it resurfaces regularly when food supplies tighten. Unfortunately, it poses several insurmountable problems.

One involves who should accumulate and release these stocks. No international agency has the credibility or the resources to execute such a program.

Moreover, getting agreement on when to accumulate and when to release stocks has proven elusive. Food-import-dependent countries want stocks released at low prices. Export-dependent countries want them released, if at all, only at very high prices. No inter-governmental agreement between these conflicting views seems likely.

Finally, stockholding is a costly exercise. Acquisition costs are incurred up front. Interest and storage costs accumulate over time. Any “forward positioning” of stocks in regions particularly vulnerable to shortfalls adds in transportation expenses while putting such stocks “out of position” to serve emergency needs elsewhere. And the existence of stocks tends to depress prices (which deters production), to displace private stockholding (which undercuts the basic purpose of reserves) and to discourage market- and private-sector-adjustments to supply/demand shifts.

Virtual stocks

Proponents of virtual stocks take a different approach in assessing the cause of food insecurity and in addressing its remediation. They acknowledge that tightening carryover stocks create the preconditions for aggravated food insecurity, but they recognize the costs and burden-sharing issues that prevent “global reserves” from becoming a reality.

They conclude that it should be possible to avoid the extremes of price volatility that occur in tight markets by counteracting what they label as speculative buying on futures markets. So, when feverish buying of futures occurs, they would have some new international entity begin selling aggressively in those markets to counteract this speculative fever.

Virtual stocks pose many of the same sovereignty and conflict-of-interest issues as global stocks do: To whom should such authority be ceded? How would it be funded? At what price levels should it act?

To this shared set of problems should be added one more. Speculative activity in futures markets (as distinguished from physical hoarding by sellers or buyers) generally has been shown to dampen price volatility rather than to accentuate it. It does so by encouraging those who can to reduce use while signaling producers to expand output. Trying to counter such speculation, then, actually could worsen the situation, and it does nothing to address physical hoarding.

Sanctity of contracts

Rather than blaming markets and empowering governments to “manage them better,” contract sanctity would attack public misbehavior in food markets. Global trade in food staples averages around 10% to 15% of annual consumption (a little less for rice, a little more for wheat). These international trade flows, in other words, typically supplement local supplies.

This incremental supply is vital to market stability. If markets were free to function, there would be a symbiotic relationship between exporters and importers (even with traditional import barriers and export taxes in place). Exporting countries in particular should recognize that sales to importing countries are as integral a part of their markets as domestic usage.

Governments have a long history of distorting markets through subsidies of various kinds. They also, typically, give preference to local producers and consumers. As long as these distortions are moderate and predictable, exporters and importers may do business reliably and confidently. But when governments replace market forces with fiats — whether longstanding measures like usage mandates or unforeseen interventions like price controls, cutting across contracts or embargoing sales — food insecurity rises.

Therefore, the simplest, least costly action with the likely greatest food security benefit would be for food-exporting countries to renounce such disruptive actions through enforceable commitments. Such enforceable commitments may be through the World Trade Organization, where they might be linked to negotiated market-access commitments from food-importing countries. They also may be achieved through bilateral agreements with importers, where supply and demand commitments could be made on the basis of a moving average of recent years’ sales.

Respecting contracts between buyers and sellers as sacrosanct would go a long way toward stabilizing global markets. Contract sanctity enables all buyers and sellers to rely on their commitments and removes the risk of disruptive government action. The resulting certainty of performance also would enable markets more generally to arbitrage shortfalls across time and geography.

Even so, some poor food-importing countries likely would need supplemental purchasing power assistance in years when their food import costs surge. They also may need assistance to finance targeted feeding programs rather than rely on price controls.

Contract sanctity and targeted purchasing assistance, however, are likely to be less costly and more negotiable than stockholding regimens, whether real or virtual.

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