The current food crisis has several causes—rising demand for food and feed, biofuels, high oil prices, climate change, stagnant agricultural productivity growth—but there is increasing evidence that the crisis is being made worse by the malfunctioning of world grain markets. Given the thinness of major markets for cereals, the restrictions on grain exports imposed by dozens of countries have resulted in additional price increases. A number of countries have adopted retail price controls, creating perverse incentives for producers. Speculative bubbles have built up, and the gap between cash and futures prices has risen, stimulating overregulation in some countries and causing some commodity exchanges in Africa and Asia to halt grain futures trading. Some food aid donors have defaulted on food aid contracts. The World Food Programme (WFP) has had difficulty getting quick access to grain for its humanitarian operations. Developing
countries are urgently rebuilding their national stocks and re-examining the “merits” of self-sufficiency policies for food security despite high costs.

These reactions began as consequences, not causes, of the price crisis, but they exacerbate the crisis and increase the risks posed by high prices. By creating a feedback loop with high food prices, they further increase price levels and volatility, with adverse consequences for the poor and for long-term incentives for agricultural production. Because they impede the free flow of food to where it is most needed and undermine the flow of price signals to farmers, these market failures impose enormous efficiency losses on the global food system, hitting the poorest countries and people hardest.

Why Is This Happening?
Changes in supply and demand fundamentals cannot fully explain the recent drastic increase in food prices. Rising expectations, speculation, and hoarding have also contributed to the increasing level and volatility of food prices. The flow of speculative capital from financial investors into agricultural commodity markets has increased drastically, as shown by the rise in the number of traded futures contracts in recent years. Excessive speculation in the commodity futures market can, in principle, push up not only futures prices but also spot prices above levels justified by supply and demand. Despite the fact that still more research is needed to clearly identify the causal links between speculation and cash prices, it is apparent that some activity in the futures market reflects a genuine concern about future supply and demand and a desire by consumers to hedge against risks.

To analyze whether recent price increases reflect higher levels of speculation or hedging activity, we examined weekly reports by the U.S. Commodity Futures Trading Commission (CFTC) on trading activities in futures markets by commercial and noncommercial traders. Commercial traders enter futures markets mainly for hedging purposes, whereas noncommercial traders speculate mainly in search of financial profits. We found that for maize, wheat, soybeans, and rice, the total number of positions in futures contracts by noncommercial traders as a fraction of the total positions (commercial plus noncommercial) has significantly increased in the past six months, implying the possibility of a price bubble above what is justified by fundamentals.

Continue to read the brief (with Joachim von Braun).

(Photo credit: Daniella Van Leggelo-Padilla/World Bank via Creative Commons)