Food shock: Market volatility a bigger threat than grain shortage

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The global food crisis that has been looming for years has arrived: Only it's not the one we've been expecting.

Fears about the food supply have been high since prices spiked with oil in 2008. When a third of the Russian wheat crop fell to drought this summer and the country slammed its borders to exports, a new panic was triggered: Wheat prices soared 50 per cent, pushing up other cereals. Food riots broke out in Mozambique. The United Nations convened an emergency meeting of experts. Just this week, drought-stricken Ukraine announced export quotas on wheat pegged to last through December.

But for all of this, there is no real shortage of food in the world. Instead of a supply crisis, what has dawned is a new era of increased volatility. Unpredictable spikes and tumbles in some of the world's most vital food commodities, most of them grains, are becoming more frequent.

The shocks are provoking anxiety from the farm gate to government offices and the trading floors that lie in between. More critically, they are prompting governments to take steps to tame jittery markets, steps that experts say are fuelling the volatility rather than dampening it.

"What governments have done is to accelerate the problem by closing exports when they want to protect their domestic consumers. That adds to the volatility," said Per Pinstrup-Andersen, a Danish economist and food policy expert at Cornell University who won the 2001 World Food Prize. Government leaders, he said, are guilty of assuming a food supply crisis is looming.

"The problem is not what some of the food apocalypse books are telling us. The problem is not that we're running out of food," he said.

Nations who act as though food supplies are running low only further beggar their neighbours - unless their neighbours are developed countries, that is. Raw commodity costs - the pennies' worth of wheat in a loaf of store-bought bread, for example - comprise such a tiny fraction of overall food expenditures in richer countries that we barely notice when markets jump.

But for poor countries where many people spend more than 70 per cent of their income on food, the price swings can be punishing.

The perception of scarcity

The decimation of a third of Russia's grain crop didn't have a major impact on the world's wheat supply, buoyed this year by the third-best global harvest on record. Since the price spikes of 2008, countries have been rebuilding grain stocks to lower their risk of future exposure to crisis conditions, so inventories were already solid going into the harvest.

It was the mere prospect of a repeat of 2008 that induced the midsummer panic and sent prices climbing. That only heightened when Russia announced that its borders will likely be shut to wheat exports through 2011.

"It's understandable from a political point of view. There's a concern that you're not going to feed your own population," said Wyn Morgan, an economist at the University of Nottingham and a consultant to a British government initiative that examined food price projections through 2050.

"The last thing you want are food riots. But [trade bans]tend to exacerbate the problem because you make the commodity more scarce in the world market," he said.

Or you create the perception of scarcity, which can have the same price-spiking effect.

"We believe here that [the 2010 grain price hikes]were a symptom of the nervousness of the markets, said Piero Conforti, a Rome-based economist with the UN's Food and Agriculture Organization. "Conditions on the ground and in global markets are far different from what they used to be two years ago."

Indeed, when food commodities spiked in 2008, grain stocks were thinning on a worldwide scale. The price of oil - a significant factor in the cost of cereal production - was also climbing.

What links the market volatility of 2008 and 2010 is the role of speculators. In 2008, a massive influx of index funds - which began buying up commodities as a hedge against future inflation - into commodity markets "launched us into a new era for price volatility and price ranges," said Dan Manternach, the chief wheat economist at Doane Agricultural Services in St. Louis. "They became very, very major players."

At times since, index funds have controlled up to 50 per cent of the underlying volume in commodities, Mr. Manternach said.

And while investors aren't being blamed for instigating the 2010 price spikes, experts say they have increasing clout in commodity markets.

"What investors … can do is really magnify one price movement," said the FAO's Mr. Conforti.

Combine that dynamic with the uncertainty created by the effects of climate change on crop yields and you have a commodities market that is more vulnerable to volatility than ever before.

"Volatility is not good for markets, particularly for food markets," Mr. Conforti said. "It's something that makes it hard to plan, hard to predict. It's bad for everybody, and in particular, the people who are more dependent on food prices."

The people most vulnerable to boomeranging food prices are not the rural poor in developing nations we instinctively associate with endemic hunger. While chronically undernourished, their isolation, due to lack of roads and economic development, gives them some insulation from price swings. It's their urban counterparts - particularly those in import-dependant, food-riot-prone regions of West Africa, Central America and the Caribbean - who bear the full brunt of the price swings.

The question is what to do about it.

There is a consensus among international food economists that previous, market-based attempts to mitigate volatility, through the institution of commodity agreements and price bands, are not the way forward.

"They all failed. They were very expensive and they fell into disrepair," Prof. Morgan said. A more favoured option among economists, he said, is to liberalize markets.

"The more you can have free trade, the more you'd expect volatility to be cured by market conditions," he said, adding: "At a textbook level, it's that easy to solve. But we don't live in a textbook world."

In fact, most starving, Third World nations are not sufficiently connected to markets to be so cured, were they functioning perfectly.

"In a number of countries, the issue is not [first]investing in agriculture, but improving the infrastructure that surrounds it - roads, logistics, access to the fundamental equipment you need to be able to trade and let the market function effectively," Mr. Conforti said.

Where those elements are in place, experts say the most pragmatic approach to mitigate the effects of price volatility is to invest deeply in agriculture improvements and research, particularly in areas that appear increasingly vulnerable to the one-two punch of volatile price swings and climate change.

"What you try to do is look at making crops more robust, more weather resistant, more disease resistant. You look at alternative crops … crops we haven't identified yet that would help us provide protein and calories in the future," Prof. Morgan said.

Another option, he said, is to look at whether "there are ways in which we can be creative with derivative markets … giving [developing countries]access to some of these rich [risk]management tools like hedging on futures," he said.

Currently, most farmers in underdeveloped nations do not have access to the futures markets that industrialized farmers and food producers invest in to insulate themselves against price shocks.

Having better access to international commodity markets could also help underdeveloped countries convert price volatility into an opportunity. Unlike farmers in developed nations, isolated farmers in poor sections of Africa, for example, cannot readily use high international price signals to increase their prices (because they're not selling to the international market) or their yield (farming practices are not advanced).

That could easily change, Dr. Pinstrup-Andersen said, if developed countries work to convince developing countries to invest more in agriculture and related infrastructure.

"What's missing is the developing country priority in making those investments," he said. "Farmers in Africa can produce more than they are now. We have lots of productive capacity. It's just a matter of investing in it," he said, adding: "A really important message coming out of this for policy-makers is to get ready to help manage increasing fluctuations in food prices. That means risk management. Be ready for this."