Can Anything Be Done?

June 29, 2011Marketsby Jeffrey Frankel

Can Food Prices be Stabilized?
The Great Food Price Balancing Act

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In the meantime, some obvious steps should be taken. For starters, bio-fuel subsidies should be abolished. Ethanol subsidies, such as those paid to American corn farmers, do not accomplish policymakers’ avowed environmental goals, but do divert grain and thus help drive up world food prices. By now this should be clear to everybody. But one cannot really expect the G-20 agriculture ministers to be able to fix the problem. After all, their constituents, the farmers, are the ones pocketing the money. (The US, it must be said, is the biggest obstacle here.)

It is probably best to accept that commodity prices will be volatile, and to create ways to limit the adverse economic effects – for example, financial instruments that allow hedging of the terms of trade.

What the G-20 agriculture ministers have agreed is to forge a system to improve transparency in agricultural markets, including information about production, stocks, and prices. More complete and timely information might indeed help.

But the broader sort of policy that Sarkozy evidently has in mind is to confront speculators, who are perceived as destabilizing agricultural commodity markets. True, in recent years, commodities have become more like assets and less like goods. Prices are not determined solely by the flow of current supply and demand and their current economic fundamentals (such as disruptions from weather or politics). They are increasingly determined also by calculations regarding expected future fundamentals (such as economic growth in Asia) and alternative returns (such as interest rates) – in other words, by speculators.

Related: World Food Price Hikes Driven by Speculation and Derivatives

Related: Your Daily Bread is Goldman Sachs’ Hottest Commodity

But speculation is not necessarily destabilizing. Sarkozy is right that leverage is not necessarily good just because the free market allows it, and that speculators occasionally act in a destabilizing way. But speculators more often act as detectors of changes in economic fundamentals, or provide the signals that smooth transitory fluctuations. In other words, they often are a stabilizing force.

The French have not yet been able to obtain agreement from the other G-20 members on measures aimed at regulating commodity speculators, such as limits on the size of their investment positions. I hope it stays that way. Shooting the messenger is no way to respond to the message.

Jeffrey Frankel is the James W. Harpel Professor of Capital Formation and Growth at the John F. Kennedy School of Government in Harvard University. Frankel served under the Clinton Administration as a member of the Council of Economic Advisors and is currently the Director of Program in International Finance and Macroeconomics at the National Bureau of Economic Research.

Copyright: Project Syndicate, 2011

Can speculators really act as a "detector of change" or a "stabilizing force"? Or do they work only to serve their own self interest? Have your say below.

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