المنتدى العالمي المعني بالأمن الغذائي والتغذية

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    • Since I haven't seen any posts on buffer stocks I wanted to say something about this as well as give some context. 

      In the past 50 years buffer stock schemes disappeared from the international agenda, and are given scant attention by most economists. Yet the rationale for international commodity buffer stocks, especially in a world of global climate change, is stronger than ever. This post tries to put in perspective the role that supranational commodity buffer stocks can play as opposed to national or private buffers, and what that might mean for global food security.

      Market volatility and persistence (a long continuing movement away from the mean path) in prices for staple grains, and other primary commodities are well accepted phenomena.   This volatility creates havoc for producer incomes, calculations of long run opportunity costs, optimal investment paths and food security for consumers. The inelasticities that exist in commodity supply and demand, herd behavior in speculative global markets, production lags and cob web cycles in quantity and prices, hoarding with rising food insecurity and beggar thy neighbor trade policies by nations, mean that there are large welfare losses that arise from commodity price volatility.   Market prices for staple foods regularly lose their efficiency properties and normative trade theories that demonish governments for stabilizing food prices and holding national buffer stocks often loose their saliency.

      Governments that stabilize domestic food and fuel prices at a low cost to economic growth and with participation by their citizens are typically rewarded with greater political stability, food security and domestic welfare gains [[1], [2]]. Both importing and exporting countries that stabilize stable grain internally will use the world market to dispose of surpluses or meet deficits through imports.  By and large Asia, the US and Europe have figured out how to do this domestically but with large negative spillovers to the rest of the world.  Africa does not have a viable strategy for stabilizing their domestic food prices, and the continent suffers even more from the instability in world markets transmitted from the Asian, Europe and US approach to price stabilization, agricultural subsidies, taxes and agricultural trade policies.   At its heart we have a coordination problem that has resulted in a food crises every three decades, and a system where both public and private sectors in poor regions undervalue agricultural investment and have a bias towards urban domestic policies [[3]]. 

      When talking about global markets and food security, it is important to take note of the actual size of world grain stocks, access to these stocks, and the role that private versus public inventories play in smoothing or destabilizing prices.  Those fearful of global warming have advocated that world grain stocks should increase to 110 days (enough stocks to feed the world without any further harvest) to avoid rising volatility.  World grain stocks from1985 to 2000 were often over 100 days. Since 2000, global grain stocks, normalized by consumption, have averaged 12 percent lower than 100 days [[4]] and this might explain higher commodity price volatility.

      Studies have found that price volatility, while related to many different factors, when coupled with low world stocks can generate large price swings [[5]].  Low interest rates reduce the cost of storage, and can promote private stores that can smooth commodity prices when shocks to supply and demand are thought to be temporary, or idiosyncratic. However private inventories have little effect on the deviations of prices originating from persistent or macroeconomic shocks, as long-lasting shocks do not allow inventory smoothing to be profitable. [[6]]

      In a low interest rate environment, the price impact of idiosyncratic shocks is reduced but persistent or common shocks still affect prices and as a result there is a much higher positive correlation between commodity prices [[7]]. Other explanations for the increase in correlation between commodities is financialization of commodities [[8]], and the growing prevalence of common shocks, combined with lower interest rates.

      It is possible that public commodity buffer stocks [[9]] may be better at stabilizing prices when there are persistent shocks since governments can go beyond short term views.  In China, where public stocks are more common price volatility and correlation across commodities is lower that in similar commodity prices traded in US financial markets [[10]].  However commodity or grain stocks are not evenly distributed across countries.  For example China with its immense government resources and positive historical experience with the ‘ever-normal granary’ has stockpiled enough grain for 6 months consumption.  With only 20% of the world’s population, China had 45% of corn, 32% of wheat, and 44% of rice world stocks in 2013 [[11]]. 

      If we accept that government buffer stock policies may improve the welfare of a country, ignoring the negative spillover effects that policies have on other countries, very few countries are endowed with the resources to finance such stock piles.  Indeed it is typical that those who would best benefit from stockpiling, countries that are dependent on particular primary exports, are least suited to maintaining buffer stocks.  When prices decline and incomes are reduced producer cartels are the least able to spend money in buying stocks and stabilizing the price.  In addition, there is limited incentive to reduce prices and sell from their stockpile when prices are high. This is one reason why producer commodity buffer stocks often fail. 

      Likewise, while there is evidence that the size of Chinese stockpiling may have supported world prices in a number of commodities, it did not help dampen price increases since their longer run goal was to secure supplies which created an asymmetric policy of buying when prices were low but not selling when prices were high.

      Once we accept the rights of a country to protect its own interests despite the negative spillovers of their national trade policies, such as hoarding during a food crisis, subsidizing inefficient producers, we will find that both national and private stores will be ineffective in stabilizing world market prices from persistent shocks and insulating the poor from food insecurity.

      International Buffer Stocks

      The simple solution is to have international commodity buffer stocks protecting both producers and consumers.  Various famous economists such as John Maynard Keynes, Richard Kahn, Benjamin Graham, and Nicholas Kaldor all advocated international commodity buffer stocks.  It was argued that this would give autonomy to national actions by limiting the negative spillovers of their national trade policies.  By introducing this residual buffer there would be more welfare improving free trade and commodity supply would be made elastic.  The buffer stocks would be run by an international commodity corporation (ICC) with both producing and consuming countries represented on its board. A corridor floor and ceiling could stabilize either individual prices or a commodity index, and this would encourage long term investment, stabilizing speculation with private inventory smoothing within this range.  Price stabilize would be based on some long run average, discerned by technocrats and experts in charge of running the buffer stock.  The commodity target would be pre-announced and modified rarely.  The ICC would buy commodities when prices fall below a pre-stated floor and sell when prices rise above a pre-stated ceiling. An alternative to individual commodity buffer stocks is the stabilization of a basket of commodities or an index where commodity amounts are weighted in relation to their significance in world trade. This allows individual prices to fluctuate with market supply and demand, and the ICC buys or sells the basket to stabilize the index.  There are some who debate whether stabilizing an index will ultimately stabilize individual prices, but as long as a single commodity in the basket does not dominate the rest, there are no monopoly producer goods included, and there is positive correlation between prices without the ICC, then the stabilization of the index will not only stabilize individual prices but reduce the positive correlation between commodities.  Idiosyncratic shocks  peculiar to each commodity will still be smoothed by private inventories.

      While international buffer stocks are a top down policy, they would invest in bottom up growth through the establishment of local storage areas at commodity futures exchanges, ports, and even on-farm silos.  Regular and independent audits would need to occur since the process of storage would be tied to an expansion of local credit facilities. The local exchanges and commodity credit unions could be subsidiaries of the ICC. Small scale farmers would have reduced risk, and the buyer of last resort role of the ICC would disempower transnational intermediaries from making excess profits.  Many developing countries dependent on the export of commodities, would attain the income guarantees necessary for growth and economic diversification away from commodity dependence (not by disinvesting in commodities and agriculture, but rather by investing in commodities and allowing that surplus to finance industrialization and urban growth). 

      The discussion over international commodity buffer stocks have a long history.  They were the mechanism for international counter cyclical monetary-fiscal policy in the original 1941 Keynes proposal for Bretton Woods.  International buffer stocks were outlined during the creation of the FAO in 1943. They were in the outline agreed to at Bretton Woods for an international trade organization.  They backed the new commodity reserve currency proposed by Nicholas Kaldor at the first UNCTAD meeting in 1964. And they were central in the discussions over the creation of a Common Fund in 1971.  The political economy of why these proposals have been so thoroughly quashed each time they raise their head is due to an addiction by powerful entities to cheap resources and speculative profits. Their establishment was identified by the US as a transfer of income from developed country consumers to developing country producers.  Since the 1980s and the move to free market economics, national buffer stocks have been dismantled under the criticisms that they were inefficient, corrupt, and destabilizing. Instead producers are encouraged to use futures and forward markets to lock in prices. While such insurance policies may stabilize incomes they do not guarantee stability in world supplies of commodities nor their market prices. In addition they are costly and oriented towards short horizons.

      A 2009 World Bank report [[12]] estimated that an international stock-pile to stabilize international grain prices during the 2008 food crisis would have required 10% of global production, worth roughly $66 billion, and costing $4–6 billion to maintain ($1.4 billion in storage costs and $3–5 billion of spoilage costs based on losses in high-income countries). To put this in perspective, total losses to all consumers from rising food prices in 2007 were estimated by the World Bank at $270 billion. Given that people, producers and consumers, value stability over instability, and that food spikes have large welfare losses, $6 billion seems like a small expense.  Despite this, sourcing the cash flow, or loan, even if it is collateralized by the commodity stocks, will be a difficult task for the ICC, let alone a diplomatic nightmare. However, this financing problem was already solved in the original proposals by Keynes, Goudriaan, Hayek, Graham, and Kaldor.  By having the ICC issue a new currency backed by commodities, this body can simply print money, effectively inventory receipts, which will be valued since they are backed by a basket of commodities, and transferable in the market place.  This would involve the creation of a new secondary international reserve, something that many economists are calling for, and allow commodity trade to be denominated in this new currency, thus removing a large component of volatility due to USD exchange rate movements.  

      Having supranational body that prints money is not any different from a national central bank. For example, the Federal Reserve bought USD 3 trillion worth of financial assets over the past 7 years, which they now have as assets on their books. These assets will be unwound when the time warrants, and in the process they reduced the risk of deflation, recapitalized the banks, and helped the economy by injecting liquidity into the system.

      An international commodity buffer stock bank would do something similar. By standing ready to buy commodities during a period of low prices they would inject reserves and liquidity into the system when commodity prices are low with direct payments to farmers (if needs be). Security in commodity incomes would alleviate country balance of payment constraints and allow them to borrow or earn the new international reserves.  These new assets could recapitalize country balance sheets and stimulate world demand.

      The ICC would offer the world an elastic supply of resources to facilitate industrialization and growth, a stable income and price level to producers that would encourage investment, inject liquidity (reserves) into the global financial system on a counter cyclical basis, reduce the negative spillover effects of national trade policies, and offer the world an alternative international reserve to the USD and thereby help amend the global imbalances problem between the US and China which has been blamed as a reason for the international financial crisis which led to the international food crisis [[13]].

      Criticisms

      There are a number of criticisms and questions regarding this proposal, and I list here only those that I have thought relevant to a discussion on food security and trade policy:

      1)    An ICC would encourage production of mono-culture crops.

      2)    An ICC reinforces the old colonial system where developing countries produce the raw materials which are sent to the developed countries to produce manufactured goods with higher returns.

      3)    An ICC would distort commodity prices and ultimately create a surplus of commodities that would later have to be destroyed.

      4)    An exorbitant amount of commodities would need to be stored to stop speculators from betting against and breaking the ‘bank,’ during rising commodity prices.

      5)    The cost of storage is expensive and needs to be financed through taxes on countries which will never agree to pay.

      6)    Stabilizing an index does not stabilize individual prices

      7)    Such a proposal is not politically viable

      I will answer these criticism briefly, although each requires further study.  My answers vary depending on the specific operations of the ICC, for example, an ICC that stabilizes a basket versus one that stabilizes multiple individual buffer stocks. The answers here will in most cases assume the more complicated basket buffer stock scheme is used with the ICC announcing a floor and ceiling index price target.  This is similar to the Federal Reserve which targets an overnight interbank interest rate corridor, and offers an infinitely elastic supply of bank reserves until the rate is between their target floor and ceiling.  In our case, supply functions of individual commodities are made more elastic but never necessarily infinitely elastic due to substitution between commodities in the basket. To simplify my explanations, price elasticities of demand for each commodity are considered to be similar.  It is assumed that the weights of the basket (based on some pre-specified objective measure of international trade) approximate a fixed ratio of inputs into ‘balanced’ economic growth (these weights may be updated year to year in a transparent fashion).  The commodities will consist of internationally traded homogeneous goods, that are cheaply stored, and easily rated in terms of quality (e.g Durum wheat US grade No.2).  Most likely they are commodities that are already traded on international commodity futures exchanges and stored at exchanges located near the place of production.

      1)    An ICC would encourage production of mono-culture crops.

      This criticism is correct in that the role of the ICC is to stabilize and promote international traded commodities. Producers will prefer to grow one of the crops that is included in the basket rather than outside the basket, to the extent that the market for in-basket commodities is more liquid. However, since commodities are substitutable, even out-of-basket grains will have their prices stabilized relative to in-basket grains. If an ICC promotes more trade due to stable prices, this will promote investment in cash crops for export. 

      An ICC does not stop governments from subsidizing their own national choices. For example, if there were individual buffer stocks, and the selling price of the buffer stock was set at the marginally efficient producer, then governments that chose to subsidize mono-culture crops would have to bear the burden of those costs by raising taxes on its own nation, rather than have such production depress international prices and burden producers in developing countries.

      In an index, excess production by rogue states can still depress prices and may even raise prices of the other commodities in the basket if the ICC is forced to buy.

      2)    An ICC reinforces the old colonial system where developing countries produce the raw materials which are sent to the developed countries to produce manufactured goods with higher returns.

      Nicholas Kaldor [[14]] along with many other development economists [[15]] argue that agrarian reform and investment in agriculture is essential to industrialization and the reduction of agriculture as a percentage of ones economy. This policy does not promote commodity dependence on exports. Rather it encourages a stable income for commodity exports such that countries can avoid the commodity curse and rely on this surplus to import capital and transform into an industrialized country.

      3)    An ICC would distort commodity prices and ultimately create a surplus of commodities that would later have to be destroyed.

      Knowing where to set the price has been solved with either of two methods. Kahn and at Keynes preferred individual international commodity buffer stocks where experts in the field would manage the buffer stock in order to ‘curb irresponsible movement of the price rather than establish stability within a narrow range of fluctuations’ [[16]] .  Kahn had no stated corridor and the size of the buffer stock would be kept secret. The management would have free discretionary powers to avoid speculators betting against it, and to manage its presumably limited funds to its best advantage. The only rule would be to ‘sell early [when prices rise] and buy late [when prices fall]’ which maximizes efficiency of the buffer stock and is different from private speculators who are concerned with short term profits and tend to buy early when prices start to rise and sell early when prices start to fall.  The buffer stock manager would take a long view and would need their own assessment of the ‘normal’ price working to carry surplus stocks that are ready to hamper extreme price movements.  Financing for these buffer stocks would have come by issuing loans collateralized by the stocks.

      While the buffer stock was not a panacea, and there may have been times that the stockpile would be depleted, it is unlikely it would create an excess since the purpose of the buffer stock was to protect consumers from high prices and eliminate marginal producers who required prices above the marginally efficient price to stay in business.

      Graham and Kaldor were much more open to non-discretionary transparent policies where an index would be stabilized at a preannounced level (perhaps based on the average of the past 10 years of prices). By stabilizing the index to a peg, individual commodity prices would be free to fluctuate in accordance with market supply and demand, thus precision on the ‘fundamental long run equilibrium’ index was not so important.  Open market operations by the ICC run by technocrats would entail buying and selling the basket, selecting the commodities, and setting the weights in accordance to some objective measure.

      The purpose of the buffer stock is to create aggregate demand during a slump by paying producers directly. This would create additional employment and purchasing power in the production of primary commodities have a multiplier effect to add employment and trade activity in other lines, promoting growth and using the ready reserves of raw materials accumulated over the slump by the ICC.

      Rather than destruction or restriction of production, these proposals come from a view that economic growth is needed to absorb the commodities, destruction which is complete madness.  Raw materials, even if in abundance, should be considered an international treasure rather than a burden. 

      To make this growth more ‘green’ renewable commodities, or sustainably produced commodities could be specified as a minimum percent of the basket.

      4)    An exorbitant amount of commodities would need to be stored to stop speculators from betting against and breaking the ‘bank,’ during rising commodity prices.

      If the ICC pegs the price or index too low, then there is a chance that speculators may be on the right side of history and break the ICC, in that it runs out of buffer stocks. In such a case there will be run on the CRC.  However, if the CRC is full backed, the real value of the CRC will remain the same basket as promised. Thus while the ICC might run out of commodities, it will simply cease to operate in a period of rising commodity prices and the market will reinstate its dominance in setting the price. The CRC up until that point will still have been beneficial to price stabilization.

      5)    The cost of storage is expensive and needs to be financed through taxes on countries.

      The ICC can issue a fiduciary (unbacked) amount of CRC and in the process pay for other assets or expenses.  Another method is that a tax could be charged on all countries that hold CRC reserves. This is like a negative interest rate that helps pay for the storage of the commodities (just like storing gold incurs a cost rather than a positive interest rate) and it also limits hoarding of the CRC.  However, hoarding in our model is not a cause of global imbalances because for each creation of a CRC rather than debt being the flip side of this creation it is an actual asset, and income to producers. This means that the money multiplier is tied to a consumption multiplier and should have a strong counter cyclical effect on international demand.

      6)    Stabilizing an index does not stabilize individual prices

      This criticism needs further research. It is no doubt that the stabilization of an index, will lead to a more complicated price transmission than the one we state here.  Cross substitution and cross price elasticities will mean that there is no simple way of knowing what will occur. However, if commodities are positively correlated due to persistent common shocks then the ICC stabilizing an index will tend to stabilize individual prices.  If individual prices are idiosyncratic and not correlated, then the ICC should let private inventories stabilize these price movements as much as possible. By giving extra liquidity to inventories by being a buyer of last resort, the cost of private inventories should go down, and private entities will be more willing to hold individual commodity inventories to buy and sell in a stabilizing manner, if individual instability is prevalent.

      If growth is balanced, that is input ratios remain steady, then stabilizing an index will stabilize prices and support growth at the same time.

      7)    Such a proposal is not politically viable

      This bold plan for a reserve currency backed by commodities has been proposed before and while it has had eminent economists in favor of it, it required more imagination than was possible.

      The ideology of free markets took over in the 1980s and led to deregulation and dismantling of price boards and commodity programs. We have not seen great stability in commodity prices nor significant development and industrialization of countries that depend on commodities for export with this deregulation. Instead, we saw a growing number of countries becoming dependent on commodity imports, especially food imports. It could be said that the current system has not worked. Commodity prices are much more volatile now than they were under Bretton Woods, and not valued as highly as they should be.

      I treat this topic as one of social learning, and so did Keynes. In his support for a new international currency that was indexed to a basket of commodities (a tabular standard) he said:

        “I have no quarrel with a tabular standard as being intrinsically more sensible than gold. My own sympathies have always fallen that way. I hope the world will come to some version of it some time.  But … the right way to approach the tabular standard is to evolve a technique and to accustom men's minds to the idea through international buffer stocks. When we have thoroughly mastered the technique of these, which is sufficiently difficult without the further complications of the tabular standard and the oppositions and prejudices which this must overcome, it will be time enough to think again” (Keynes 1944, 429-430) [[17]].

      There should be greater discussion on commodity buffer stocks – be they private, national or supranational - especially in a world threatened by global warming and extreme weather patterns. Even when long term market prices are desired, the ruthless actions of markets on short term even transitory events must be steadied.

       

       

      Endnotes


      [3] Timmer 1995, p.470.  Timmer, C.P. 1995 Getting agriculture moving: do markets provide the right signals. Food Policy 20 (5), 455-472.

      [12] World Bank (2009) p. 127-130. Global Economic Prospects 2009: Commodities at the Crossroads http://issuu.com/world.bank.publications/docs/gep_2009/.

      [13] Caballero, R.J., E. Farhi, and P. Gourinchas (2008) “Financial Crash, Commodity Prices, and Global Imbalances” Brookings Papers on Economic Activity, Fall, pp 1-55.

      [14] Kaldor (1967) Strategic factors in Economic Development. Cornell University Press. Ithaca.

      [15] A world without Agriculture: The Structural Transformation in Historical Perspective. Wendt Memorial Lecture (American Enterprise Institute, Washington DC). http://www.aei.org/wp-content/uploads/2014/06/-a-world-without-agricultu...

      [16] Richard Kahn Papers, preserved in the Modern Archives of Kings College Cambridge and cited in Fantacci et al (2012) http://w3.uniroma1.it/marcuzzo/pdf/spec_buffer.pdf

      [17] Keynes, J.M. (1944): Note by Lord Keynes. The Economic Journal, Vol. 54 (215/216): 429-430.