Policy Research Working Paper 5028

International Grain Reserves

And Other Instruments to Address

Volatility in Grain Markets

Brian Wright

The World Bank

Europe and Central Asia Region, Agricultural and Rural Development Unit

Development Research Group, Trade and Integration Team

United Nations, Food and Agriculture Organization

August 2009

WPS5028 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized
Produced by the Research Support Team

Abstract

The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development 

issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the 

names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those 

of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and 

its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.

Policy Research Working Paper 5028

In the long view, recent grain price volatility is 

not anomalous. Wheat, rice, and maize are highly 

substitutable in the global market for calories, and when 

aggregate stocks decline to minimal feasible levels, prices 

become highly sensitive to small shocks, consistent with 

storage models. In this decade, stocks have declined 

due to high income growth and biofuels mandates. 

Recently, shocks including the Australian drought and 

biofuels demand boosts due to the oil price spike were 

exacerbated by a sequence of trade restrictions by key 

exporters beginning in the thin global rice market in the 

fall of 2007, which turned market anxiety into panic. To 

protect vulnerable consumers, countries intervened in 

This paper—a product of collaboration among the Agricultural and Rural Development Unit, Europe and Central Asia 

Region; the Development Economics Research Group; the Food and Agriculture Organization of the United Nations; and 

the European Bank for Reconstruction and Development—is part of a larger effort to understand the impact of commodity 

price volatility on developing countries. It was prepared at the invitation of Russian Government on the occasion of the 

St Petersburg World Grain Forum in June 2009. Policy Research Working Papers are also posted on the Web at http://

econ.worldbank.org. The author may be contacted at wright@are.berkeley.edu.

storage markets and, if they were exporters, to limit trade 

access. Recognizing these realities, vulnerable countries 

are building strategic reserves. The associated expense 

and negative incentive effects can be controlled if reserves 

have quantitative targets related to the consumption 

needs of the most vulnerable, with distribution to the 

latter only in severe emergencies. More-ambitious plans 

manipulate world prices via buffer stocks or naked short 

speculation to keep prices consistent with fundamentals. 

Past interventions of either kind have been expensive, 

ineffective, and generally short-lived. Further, there 

is no significant evidence that prices do not reflect 

fundamentals, including export market access. 
International Grain Reserves: And Other 

Instruments to Address Volatility in Grain 

Markets

Brian Wright

UNIVERSITY OF CALIFORNIA, BERKELEY

This working paper disseminates the findings of work in progress to encourage the exchange of 

ideas about development relevant issues. It was prepared as an input for the World Grain Forum 

2009 and into subsequent discussions. The findings, interpretations, and conclusions expressed in 

this paper are entirely those of the author and do not necessarily reflect the views of the three 

sponsoring organizations, the Food and Agriculture Organization of the United Nations, and the 

European Bank for Reconstruction and Development, and the World Bank or those of the 

Executive Directors of The World Bank or the governments they represent. 
– i – 

Context and Acknowledgements 

The dramatic rise in global food prices in 2007/08 was widely viewed as a threat to global food 

and nutrition security that endangered millions of the world’s poorest and most vulnerable. It 

brought political instability to some countries and the prospect of unrest to many more. The rapid 

increase in world food prices was caused by a combination of cumulative effects of long-term 

trends, more recent supply and demand dynamics, and governmental responses that have 

exacerbated price volatility. This crisis has exposed existing and potential weaknesses and 

vulnerabilities of households, governments, and the international economy to food and nutrition 

insecurity. The global community has responded with a range of initiatives and established 

instruments to assist the neediest nations. Major stakeholders worldwide continue to discuss 

potential instruments to address the recent food crisis and to prevent or reduce the impact of 

future crises. Besides agricultural productivity improvement and national food self-sufficiency 

targets, physical grain stocks (“humanitarian food reserves”) have resurfaced in these 

discussions. And more recently, the idea of “a ‘virtual’ internationally coordinated reserve 

system for humanitarian purposes”—first mentioned in the G8 Leaders’ Statement on Global 

Food Security at the Hokkaido Toyako Summit on July 8, 2008—was added to the debate. 

In conjunction with the St. Petersburg International Economic Forum, the Russian Federation 

hosted, on June 6 and 7, 2009, the World Grain Forum 2009. During the Forum, which intends to 

shape a common vision of issues facing global food security and to inform future G8/G20 

meetings, high-level discussions covered global grain production and marketing, food aid 

programs, new challenges of world trade in grain, and mechanisms for the stabilization of grain 

markets including an international grain reserve. 

In view of the controversies surrounding the topic of grain stocks and other instruments to reduce 

price fluctuations in commodity markets, and at the request of the Organizing Committee of the 

World Grain Forum 2009, The World Bank (WB), the Food and Agriculture Organization of the 

United Nations (FAO) and the European Bank for Reconstruction and Development (EBRD) 

(the three sponsoring organizations) commissioned the present working paper on international 

grain reserves and other instruments to address volatility in grain markets. The purpose of this 

paper is to inform international debates on issues and options related to price volatility in (food) 

commodity markets with special reference to international grain reserves. 

The paper was prepared by Dr. Brian Wright, Professor of Agricultural Economics at the 

University of California, Berkeley. The three sponsoring organizations facilitated a peer 

reviewing process in which the following reviewers provided guidance and suggestions to the 

author: Ms. Eugenia Serova, Senior Advisor, Investment Centre Division, FAO; Ms. Heike 

Harmgart, Principal Economist, Office of the Chief Economist, EBRD; Mr. Christopher 

Delgado, Advisor, Agricultural and Rural Development Department (ARD), WB; Mr. Marc 

Sadler, Senior Agricultural Economist, ARD, WB; and Mr. Christopher Gilbert, Academic 

Director, Doctoral Program in Economics and Management, Centro Interdipartimentale per la 

Formazione alla Ricerca in Economia e Management (CIFREM) and Department of Economics, 

University of Trento, Italy. 
– ii – 

The author would like to gratefully acknowledge the patient advice and constructive guidance of 

Matthias Grueninger of The World Bank and insightful contributions from Will Martin and Don 

Larson, also of The World Bank, and three other team members—Abdolreza Abbassian and 

Emmanuel Hidier of FAO and Marc van Strydonck of the EBRD. The paper benefited 

enormously from the comments of the interagency peer review team assembled by The World 

Bank, including Eugenia Serova, Senior Advisor, Investment Centre Division, FAO; Heike 

Harmgart, Principal Economist, Office of the Chief Economist, EBRD; Christopher Delgado, 

Advisor, Agricultural and Rural Development Department (ARD), WB; Marc Sadler, Senior 

Agricultural Economist, ARD, WB; and Christopher Gilbert, Academic Director, Doctoral 

Program in Economics and Management, Centro Interdipartimentale per la Formazione alla 

Ricerca in Economia e Management (CIFREM) and Department of Economics, University of 

Trento, Italy. In addition I received wise counsel and informed advice from Concepcion Calpe of 

FAO and valuable input from Eugenio Bobenrieth, University of Concepcion, Chile; Arthur 

Boman; David Dawe of FAO; Han Fei; Philip Verleger; Jeffrey Williams, University of 

California, Davis; Elena Wright; and Marguerite Wright. Excellent research assistance was 

provided by Di Zeng and Han Fei, editorial assistance was provided by Natalie Karst, and special 

help was given by Carlo Cafiero of the University of Naples Federico II. This paper is built upon 

research funded by the Energy Biosciences Institute. Any remaining errors should be attributed 

solely to the author. 
– iii – 

Summary 

1. The recent crisis. Increases during 2007/08 in the prices of many major consumption 

commodities came as a shock to consumers and governments. Urban consumers, alarmed by 

jumps in the cost of their staple foods, participated in protests, often violent, that peaked at about 

the time world grain prices peaked, in the middle of 2008. Some demonstrations were serious 

enough to threaten to destabilize their governments. Millions of the world’s poor were forced to 

reduce their daily calorie consumption. 

2. The aftermath. Grain prices have receded significantly from their 2008 peaks. But food 

prices remain high and volatile. As this forum indicates, the policy focus has switched from 

short-term tactics for crisis management to strategies to manage price volatility and assure that 

consumers worldwide not be denied access to the grain they need by chaos in world grain 

markets. Suggestions for global grain reserves have figured prominently in international 

discussions, including proposals for special emergency reserves, international reserves, and 

“virtual reserves” controlled via commodity futures and options trading. 

3. The charge. At the suggestion of the European Bank for Reconstruction and Development, 

the Food and Agriculture Organization and The World Bank, this paper was drafted to provide a 

technical foundation for policy discussions about the appropriate role for public grain reserves 

and related policies in managing grain market volatility. 

4. Price volatility: recent evidence. Before considering policy alternatives, it is obviously 

important to start with questions about the nature of the problem and its underlying causes. Are 

we witnessing the beginning of a new regime characterized by more volatile, if not higher, 

commodity prices? 

5. The long view. A review of grain price histories reveals that the deflated prices of food grains 

have followed downward long-run trends, interspersed by episodes of steep price increases, 

followed by even more precipitous falls. In the long view, the recent price spikes do not seem 

anomalous. Relative to the other episodes experienced over the last 40 years, the real grain price 

volatility of the last few years has not been particularly high. 

6. What led to the recent price spikes? Among the more persistent changes that set the stage 

for the grain price spikes of 2007/08 were sustained rapid increases in income in many countries, 

including China and India, which increased grain demand, especially for animal feeds. Public 

support for biofuel production was a large and persistent shifter of demand for maize and 

oilseeds, whereas funding of production-oriented crops research was neglected. By 2007, these 

factors could hardly have been surprises that could cause prices to jump. Their net effect was 

rather a progressive tightening of the aggregate supply-demand balance for major grains in the 

preceding years. 
– iv – 

7. Unpredictable factors in 2006–2008 included the boost in biofuel production beyond planned 

levels, induced by a spike in petroleum prices, the unprecedented extension of the multi-year 

Australian drought, other regional production problems, transport cost increases and exchange 

rate movements contributed importantly to price rises in global market made vulnerable by lack 

of stocks. Finally, the sequence of export controls, taxes and bans adopted by key exporters 

beginning in the thin global rice market in the fall of 2007, initially in response to consumer 

concerns about wheat supplies, turned market anxiety into panic. 

8. Grain storage economics. To interpret the asymmetric and episodic behavior of grain market 

prices, and identify the causes of high volatility, it is crucial to understand the relation between 

prices, consumption and stocks. Accumulation of stocks when price is low can prevent steep 

price slumps. Disposal of these stocks when price is higher can smooth price spikes, but only so 

long as stocks are available. In a competitive market, short hedgers perform these functions, 

holding carryover stocks when the expected price covers the cost of storage and interest. Futures 

markets encourage storage by short hedgers by facilitating the transfer of price risk to long 

hedgers (such as grain users) or long speculators, and protecting all participants from 

counterparty risk. 

9. Stock adjustments buffer, but do not eliminate, effects of supply shocks on consumption.

When stocks run out, aggregate use must adjust one-for-one to negative supply disturbances.

Less grain goes to feed animals or produce biofuel, and/or the poorest consumers must reduce 

their calorie consumption, incurring the costs of malnutrition, hunger or even starvation. The 

demand of wealthier consumers is much less responsive. When stocks are at minimum levels, 

large price changes are needed to induce aggregate consumption to adjust to even relatively 

small shocks. 

10. The argument for storage interventions. There are two related problems associated with 

total reliance on private storage for national food supplies. The first is that only those who have 

the necessary resources or “entitlements” can acquire food via the market. The other is that, in a 

food emergency (such as the one experienced in many countries in 2008), governments are often 

pressured by anxious consumers to take actions against storers or “hoarders” that reduce private 

storage. Recognizing their lack of ability to commit to keep markets open when price is high, 

governments intervene to increase total storage when price is low and availability is high. 

11. Focus on consumption by the vulnerable, not on price. One class of storage policies aims 

to ensure a minimum consumption level for all. A large international grain reserve controlled 

jointly by national governments to mitigate global food supply crises could economize on stocks 

and storage costs in providing a globally adequate amount of storage, and help maintain the 

valuable stabilizing role of free international trade in grains. Unfortunately such an ambitious 

scheme appears to be infeasible, absent improved means of guaranteeing continued international 

collaboration during food emergencies. 

12. National strategic reserves. Given the infeasibility of a global grain reserve, importers will 

inevitably be forced to consider national strategic reserves as part of a policy for domestic food 

security. If these reserves are designed to meet quantitative targets for distribution of food on the 

basis of need, such as “food for work” and targeted feeding, and only in severe emergencies, 

their disincentive effects on private traders and storers will be less severe. Choice of the size of 
– v – 

the reserve is a challenge that involves a compromise between food security and the cost of 

storage, including interest on the capital invested in the stock. 

13. A small emergency reserve to respond quickly to regional emergencies would help speed up 

responses of international organizations in aiding groups in distress. The free market cannot be 

relied upon to service this need, for such groups lack the resources to bid for the food they need. 

Since regional emergencies often involve landlocked nations, contingent contracts may be useful 

to ensure adequate transportation of grain when needed. 

14. Market price interventions. Another class of policies aims to operate by limiting price 

volatility. Focusing on price is less effective in ensuring food security for the vulnerable than 

focusing on their consumption. Use of price band rules to operate international or domestic 

market stabilization schemes has the advantage of transparency. But the effects on the behavior 

of prices and aggregate costs of operation are much less straightforward than often assumed. The 

price tends to hover at or near the upper or lower bound of the band (the “ceiling” or the “floor” 

price). The overall effect on volatility, relative to competitive storage, is ambiguous. Release of 

stocks at the ceiling price smoothes price peaks as long as stocks are available, but anticipation 

of this discourages private storage as price rises to the ceiling, and suppresses the stabilizing 

production response to anticipated shortages. Theory predicts, and experience with international 

commodity agreements confirms, that these programs inevitably fail, even if there is no 

underlying trend in price. 

15. Virtual Buffer Stock One possible variant of the price-band scheme is a “virtual buffer 

stock” designed to operate in futures markets to smooth price spikes. Long futures positions 

would be taken to raise the incentive to store, inducing a buffer stock indirectly. This virtual 

scheme, if large enough to move markets, is financially risky and subject to manipulation by 

traders, would lose money on average, and eventually exhaust its budget. 

16. Short speculation as a stabilization program. In another interpretation, the “virtual 

reserve” would apparently adopt no long positions and hold no stocks in normal times, but would 

stand ready to take naked short positions (not backed by stocks or prospective harvests) when a 

price surge unrelated to fundamentals is detected by a global intelligence unit endowed with 

information about the market or with special forecasting powers unavailable to other market 

participants. The assumption that such a group can consistently out-forecast the market is hardly 

plausible after a half-century of work indicating the contrary. Such a speculative program risks 

losing huge sums of money to others who bet against the intelligence unit and in favor of the 

rationality of the market price. 

17. The emergence of domestic biofuel demand, and the global surge in animal feeding, 

have reduced stock levels, but also offer new opportunities for stabilization. Option 

agreements with domestic biofuel producers and animal feeders could guarantee mutually 

advantageous diversion of grain from biofuel production to human consumption, in specified 

severe food crises. If severe crises are relatively infrequent, such options might be more effective 

than domestic storage. 

18. Strengthening of the World Trade Organization (WTO) disciplines on export controls

and their extension to export taxes would increase the cost of such policy choices, and reinforce 

the capacity of exporters to keep markets open in the face of pressure from domestic consumers. 
– vi – 

19. Better collection and sharing of information on global grain stocks and production 

prospects could improve the international response to regional or global shortages as they 

develop, and help prevent the onset of market panic. 

20. Destabilizing speculation? Available empirical evidence does not support claims that 

noncommercial traders have increased the volatility of grain prices. Nor has a cogent rationale 

been presented for intervention against long-run noncommercial traders, including index traders, 

in grain futures markets.
– 1 – 

1. Introduction: The food price crisis of 2007/08 and the re-emergence of 

concerns over commodity price volatility 

The increases during 2007/08 in the prices of many consumption commodities, including the 

major grains, came as a shock to consumers and governments. In many developing countries, 

consumers were alarmed by increases in the cost of their staple foods, and millions of the 

world’s poor were forced to reduce their daily calorie consumption. Urban consumers 

participated in protests, often violent, that peaked at about the time world grain prices peaked, in 

the middle of 2008. Demonstrations in some countries were serious enough to threaten to 

destabilize their governments. 

In response, many nations adopted short run policies to reduce the effects of rising world prices 

on domestic consumers. Though perhaps rational for each country acting individually, the 

collective effects of these policies exacerbated international price volatility, and often penalized 

the domestic farmers and traders whose supplies to the market prevented more serious shortages. 

To make matters worse, importers’ concerns about food market access were heightened by news 

that key rice exporters were discussing the possibility of an export cartel. 

Grain prices have receded significantly from their 2008 highs. But food prices remain volatile.1

As this forum indicates, the policy focus has switched from short-term tactics for crisis 

management to strategies to manage price volatility and assure that consumers worldwide not be 

denied access to the grain they need by chaos in world grain markets. Suggestions to increase 

global grain reserves have figured prominently in international discussions. Proposals have been 

made for special emergency reserves, international reserves, and “virtual reserves” controlled via 

commodity futures and options trading. Some observers have also recommended regulation of 

the commodity futures trading of noncommercial investors. Others have pressed for reductions in 

subsidies or mandates for biofuel production, on the grounds that such policies threaten the 

stability of food markets. 

 

1

 In June 2009, wheat prices surged to their highest prices since October 2008. 
– 2 – 

This paper focuses on the role of grain reserves and related policies in managing grain market 

volatility. Before considering policy alternatives, it is obviously important to start with questions 

about the nature of the problem and its underlying causes. Are we witnessing the beginning of a 

new regime characterized by more volatile, if not higher, commodity prices? Is the recent turmoil 

in prices an aberration, involving irrational bubbles, unconnected to market fundamentals? Does 

it reflect purposeful manipulation by global monopolies? What have been the roles of futures and 

options markets, noncommercial speculators, and global international financial flows in all this? 

Or is the problem that global warming is changing the distributions of crop yield disturbances, 

and/or that the world is finally facing a global land or water constraint? Have fertilizer and oil 

prices been major causes of market gyrations? How significant is the role of expansion of biofuel 

supply in destabilizing grain markets? 

Many of these questions cannot be answered definitively, although information is available to 

shed considerable light on pertinent issues. The designated task of this study is, given the 

evidence at hand, to address the merits of recent proposals formulated in response to the sharp 

price spikes experienced in the last year or so and to focus on increasing the food security of 

vulnerable consumers. 

Fortunately, the topic is not a new one. Many of the policy proposals have precursors in 

programs advocated or adopted after previous periods of market instability. Models have been 

developed to help us understand why prices in food markets can jump so abruptly. These models, 

and the observed results of previous policy responses designed to reduce market instability, can 

help us decide what to expect from recent policy proposals in the current market environment. 
– 3 – 

2. Price volatility: Recent evidence 

First consider the evidence about the behavior over the past few years of aggregate food price, 

which was less variable than the prices of many of its components, including food grains in 

particular.2 In 2005 the United Nations FAO food price index (Figure 1) showed evidence of a 

modestly rising trend that had moved the index less than 20% higher than the 1998–2000 

average. In 2006 prices started to accelerate, and by October were on a sharp uptrend that 

continued until summer 2008, when the index exceeded twice its 2005 level. 

Figure 1. 

UN FAO food price index (1990–2009) (2002/04=100 

(Source: FAO) 

 

2

 Although we must focus on aggregate numbers here, it is important that they mask a tremendous amount of 

variation between countries, due to trade barriers, domestic price and tax policies, and transport costs. As trade 

barriers, tariffs and transport costs have changed abruptly, the scope of various international markets has also been 

redefined. Furthermore, consumers in large or landlocked countries international prices often face widely varying 

prices. For many, international prices, and global policies discussed here, might have little relevance. 
– 4 – 

By late summer, prices had fallen from their peaks. By year’s end the index had reverted to the 

range it had attained in early 2007, still much higher than in its level at the turn of the century. 

This aggregate food price index understates the fluctuations in the prices of the major food grains 

that have attracted the bulk of the attention in discussions of food prices. One example, shown in 

Figure 2, is the price of Soft Red Spring Wheat, for which tripled in price between the spring of 

2007 and the next winter, but gave up most of those gains in the following year. 

Figure 2. 

Weekly prices of wheat 

U.S. No. 2, soft red winter wheat, U.S. Gulf (Tuesday) International Grain Council 

(Source FAO) 

Figures 3 and 4, which offer a longer view, show that the prices of wheat and maize followed 

downward trends for decades, reflecting the fact that yields have generally outpaced demand 

growth, contrary to Malthusian predictions of the 1960’s. Along their downward paths, prices 

generally fluctuate moderately within a fairly well defined range. However, episodes of steeply 

rising prices, followed by precipitous falls, are prominent features of the data. The price series 

are asymmetric; there are no equally prominent troughs in the price series to match these spikes. 

When price is relatively low, the probability of a sudden fall becomes negligible. 
– 5 – 

Figure 3. 

Price of wheat (1950–2009) in dollars per bushel deflated by U.S. CPI (1982–1984=1) 

Figure 4. 

Corn, average price received by farmers in dollars per bushel deflated by U.S. CPI 

(1982–1984=1) 
– 6 – 

Figure 5 confirms that these features are characteristic of commodities more generally. It is 

interesting that the recent episode of spikes prices in so many agricultural commodities, 

including minerals and petroleum, comes just over 30 years after a period of similar multicommodity price turmoil of the mid-1970s. Note also that, relative to other spikes in the figure, 

those of the last few years are not particularly high, when properly deflated. 

Figure 5. 

Long run movements of prices 

IMF Commodity price indexes deflated by the U.S. CPI 

The overall downward trend in prices can be attributed principally to the remarkable success of 

plant breeders and farmers in continually developing and adopting new crop varieties offering 

increases in yields, and to the development of cheap and plentiful supplies of fertilizers and other 

inputs. Figure 6 shows the increases in world consumption of the major grains that have occurred 

even as the scope for expanding the area of cultivated land has diminished or disappeared in 

most countries. Note also the recent surge in diversion of maize to biofuel uses. 
– 7 – 

Figure 6. 

Global consumption of grains 

(Source: World Bank Development Research Group) 

These aggregate figures mask great regional variation in prices and consumption. But 

globalization of markets and reduction in shipping costs offer great opportunities for smoothing 

local fluctuations. Figure 7 shows rice production for China and India, both major producers and 

consumers, and for the world as a whole. The bottom panel shows deviations from trends. Both 

China and India cover so many production environments that each can, to some extent, smooth 

out internal regional supply and demand variations via internal trade and public reallocations. 

Nevertheless, pooling the entire world’s output variation and sharing it proportionately would 

reduce the variation of China’s and India’s shares by about 40% and 60%, respectively. For 

many smaller countries the effects would be far greater. The figures for wheat and maize show 

that the international pooling of production risks could similarly smooth national supplies. 

Currently, global cereal trade achieves only a fraction of these potential pooling benefits. 
– 8 – 

Figure 7. 

World rice production 1961–2007 

(Source: FAO) 

The trend increase in demand for human consumption of grain has recently been driven mainly 

by the increase in the global population, and the rate of increase has been slowing down in recent 

decades. Only in poorer countries is increase in income an important driver of grain consumption 

per capita, which is naturally limited by the capacity of the human stomach. For grains used for 

animal feed, the trend increase in consumption has been greater, because human consumption of 

animal products continues to rise with income long after minimum calorie requirements have 

been satisfied. Use of maize as an animal feed has boosted its demand beyond what would be 

expected from its use as a staple food in many countries. Animal feed accounts for a smaller but 

still significant share of wheat production, notably in Europe. Rice is used predominantly as a 

food. 
– 9 – 

There is substantial agreement about the drivers of these longer run trends in grain consumption 

and prices. By contrast, there is a wide diversity of opinion regarding the causes of recent grain 

price volatility. 
– 10 – 

3. What caused recent grain price fluctuations? 

In 2008, when the rise in food prices had caught the attention of the worldwide press, observers 

quickly lined up a confusing array of suspects as the cause. Economists stepped in to assist in 

apportioning blame. 

A consensus is now forming with regard to the roles played by several factors in the recent 

events in the markets for major grains. These include, first, recent rapid increases in income in 

many countries, especially China and India, and recent neglect of crops research on a global 

basis. Excellent discussions of these factors are available elsewhere.3 The paper does not further 

address them except to note that these factors, although an important influence on the tightening 

overall grain market situation in prior years, could hardly have been surprises in 2007/08 except 

to the extent that continuations of already established trends were unexpected. Factors such as 

the unprecedented extension of the Australian drought, other regional production problems, 

possible effects of global warming, and exchange rate movements, were much less predictable. 

However, as noted elsewhere, their influence has not been large enough to explain most of the 

price spikes seen recently. Three other market disturbances that could not have been well 

predicted before 2007 were global in influence, and deserve particular attention. They are the 

changes in biofuel policies and biofuel demand, and spikes in the prices of fertilizers and fuel, 

which relate directly to recent price spikes in the petroleum market. 

Biofuel demand 

In addition to income and population increases in the emerging economies, another currently 

popular suspect for aggravating recent price increases is the conversion of oilseeds into biodiesel 

in Europe, the United States, and elsewhere and of maize into ethanol in the United States.4

 In 

the United States in particular, the diversion of corn and soybeans to biofuel is now very 

 

3

 See Abbott et al. (2008, 2009), Mitchell (2008), Timmer (2008), and Gilbert (2008). 

4

 Though Brazil is a major biofuel producer (using sugar cane), its production reportedly has not diverted large 

acreages from grain production. However conversion of sugar producing land to cereal production has led to a sugar 

price crisis recently. 
– 11 – 

substantial (approaching 30% for corn and 20% for soy) and will continue to increase under 

current policies using subsidies and mandates, as well as protection from competition from more 

efficient Brazilian sugar-based ethanol production that might less directly stress short-run food 

supplies. 

By comparison, a drought or pest infestation that reduced United States maize output by 30% in 

a given year would be viewed as a production catastrophe. The southern corn leaf blight 

infestation of 1971, which cut U.S. corn supply by only half that percentage, was viewed at the 

time as a very serious shock. It directed new attention to the security of the U.S. food supply in 

general and in particular to the conservation of plant varieties for agriculture and diversification 

of genetic resources available to plant breeders. Furthermore, the mandates for diversion of 

United States maize for biofuel, being quasi-permanent, and indeed slated to increase, have had 

much more serious implications for supplies of maize for feed and food than equivalent yield 

drops due to a transitory, weather-related shock. 

On the other hand, diversion of grains to biofuel was not a complete surprise by 2006. To the 

extent that existing government mandates for ethanol use were viewed as solid policy 

commitments, strong demand for biofuel was clearly foreseeable before prices took off. 

Similarly, increased demand for oilseeds for biofuel use in Europe was no short-run surprise. In 

both cases, however, unexpected oil price jumps must have encouraged upward revisions in 

expected growth of biofuel-related demand for grains and oilseeds, as did upward revisions in 

mandates in the United States. Even if anticipated, the diversions were too great to be made up in 

the short run by increased yields. They must have had large effects on the decreases in grain 

stocks, and the steady increases in prices, in the years immediately preceding 2007/08. As we 

shall see, these trends made food markets much more susceptible to market shocks. 

To substitute for maize diverted to ethanol, and oilseeds diverted to biodiesel, wheat and other 

food grains were diverted to animal feed. Consumers increased their demand for rice, to replace 

the wheat used for feed. Biofuel demands and surges in meat demand caused by rising incomes 

also affected food grain markets less directly by diverting inputs from food grains to production 

of feed and biofuel. Some rice land might have been diverted to production of corn or soybeans 

but this is unlikely to have had a strong impact on overall rice production; the best rice land tends 
– 12 – 

to be ill-suited to corn or soy production in the temperate zones where much of the world’s corn 

and soybeans are grown. However, on Asian croplands where two or three crops are grown in 

succession each year, wheat can be substituted for rice as a dry-season irrigated crop when its 

relative price increases. 

Prices of fertilizers and fuels 

Worldwide adoption of modern high-yield plant varieties and a decline in the opportunities for 

expansion of cultivated area have increased the demand for fertilizers. Prices of some fertilizers 

rose faster than any agricultural commodity price in the last few years, reflecting short run 

supply constraints, energy costs, transport costs, and a 100% export tax imposed by China on all 

fertilizers.5

 Recently, maize farmers and ethanol producers in the United States have blamed 

fertilizer and oil prices for high grain prices. 

The case of potash, a major fertilizer ingredient, is instructive. As Figure 8 shows, potash prices 

did not really form a spike until well into 2008, after most of that year’s crops were in the 

ground. It is clear that grain prices associated with previous harvests preceded fertilizer price 

movements, rather than vice versa. Although there have been reports that farmers are reducing 

fertilizer applications, worldwide fertilizer supply is not likely to have diminished. There may of 

course have been reallocations to biofuel production and high-value crops. Reductions in 

fertilizer use should show up as yield or acreage reductions, but yields in 2008 generally appear 

to have been good. 

Given a few years to invest in capacity, fertilizer supplies can expand. But for fertilizers 

dependent on minerals deposits, increased demand might generate sustained higher prices and 

greater rents rather than higher supply. Injudicious advice to further subsidize particular uses of 

such inelastically supplied fertilizers will, if heeded, certainly increase the profits of their 

producers. Subsidies will have little effect on supply in the short run, but will divert global 

supplies from unsubsidized uses to less efficient subsidized uses, reducing overall production 

efficiency. 

 

5

 Bloomberg.com April 17, 2008 (http://www.bloomberg.com/apps/news?pid=20601082&sid=a2QZ._5PDbEs, last 

accessed July 9, 2009). 
– 13 – 

Figure 8. 

Potash price 

(Source: World Bank Prospects Group) 

Crude oil, like fertilizer, is an important input—both directly and indirectly—into modern 

agriculture. Its price is virtually independent of disturbances in grain markets. Crude oil prices 

have been very high recently, but again there does not seem to be a large effect on acreage or 

yield even in the countries that use petroleum intensively in production. Farm land prices in the 

United States rose dramatically as grain, fuel, and fertilizer prices were all rising, indicating the 

net effect on farmers’ profits and incentives was positive and large. 

Factors such as income growth and planned increases in biofuel production no doubt have 

affected the balance between grain consumption and production. But since they were 

foreseeable, they should not have produced price spikes. 

On the other hand, unpredictable changes in petroleum prices affected grain demands. As noted 

previously, jumps in petroleum prices now not only affect farmers’ costs but also shift the 

demand for the grain they produce via increased biofuel demand. This is a new phenomenon. 
– 14 – 

When ethanol production exceeds mandated levels, marginal fuel price changes increase total 

demand for grains even as they increase input costs. 

Pursuing this line of argument, a reasonable expectation might be that income growth and 

biofuel demand should have had less influence on the volatility of rice prices relative to maize 

and wheat prices. Yet the fact that the price spike was the highest for rice in 2008 points to 

another significant contributor to chaos in the world grain markets: panic in the rice trade.

Panic in vulnerable markets 

When, on October 9, 2007, the government of India announced a ban on exports of rice other 

than basmati, it increased rice availability to its consumers to reduce their concerns about 

inflation and adequacy of staple food supplies after a poor wheat harvest. The rice price outside 

of India began to rise (Figure 9, after Mitchell (2008)). Thus a problem with wheat supply 

triggered a sequence of events—also involving other major exporters—that led to the crisis in 

rice prices and market access discussed in colorful detail by Slayton (2009). 
– 15 – 

Figure 9. 

Thai rice price and the Indian export ban 

(Source: World Bank Development Prospects Group and Mitchell (2008)). 

As reports of production problems in other countries surfaced, governments of grain exporting 

countries were pressured by their own urban consumers to act to reduce grain prices. These 

pressures outweighed the interests of producers and traders in selling to the highest bidder. One 

by one, rice exporters imposed their own export restrictions, including, in March 2008, Vietnam, 

an important supplier.6

 It also became clear that China, apparently adequately supplied, would 

also act to insulate itself from market turmoil, rather than make its substantial grain stocks 

available to the international market as supplier of last resort. Key wheat suppliers also imposed 

export bans or taxes. 

Countries that relied on imports for an important share of their food became increasingly anxious 

to secure foreign supplies adequate for their needs so they could satisfy politically powerful 

urban consumers concerned about food security. Thailand and the United States remained in the 

 

6

 Vietnam had announced a ban on new sales in July 2007 (Slayton 2009). 
– 16 – 

market as exporters. Many countries—particularly importing countries—also reduced their 

tariffs on imports. Reductions in import tariffs reduce domestic prices relative to world prices, 

but also contribute to increasing those world prices. One discouraging example of inadequate 

international cooperation was the failure to negotiate the timely sale, to desperate international 

importers, of Japanese stocks of rice, imported by Japan in reluctant compliance with World 

Trade Organization mandates, and never destined for domestic consumption.7

 The crisis in trade 

access and prices was resolved only after it became clear, in the Northern summer, that the 

current harvest was good and that, overall, 2008 rice production would be close to its trend line. 

Several influential reviews of the above influences on the grain price volatility of the past few 

years have allocated percentage shares of responsibility to each. This approach makes sense if 

the factors have a linear cumulative effect on food price volatility. But their effect is highly 

nonlinear. When supplies are already tight, a small reduction can cause an unusually large price 

increase. This fact is a key to understanding recent market events and constructing appropriate 

policy responses. 

The economics of storage activity explains the relationship between grain prices and storage, and 

helps in the evaluation of other factors identified in discussions of recent grain price behavior, 

including distortion of futures markets by international financial flows, and an irrational or 

manipulative bubble in grain prices. These issues are best discussed after a review of some 

features of grain storage as an economic activity. 

 

7

 See Timmer (2008). It appears Japan has not yet sold these stocks. 
– 17 – 

4. The nature of grain storage 

To interpret the behavior of grain market prices, and identify the causes of high volatility, it is 

crucial to understand the relation between prices and stocks. A glance at Figure 10 reveals that 

the wheat price spikes in the 1970s and in 2007/08 occurred when world stock-to-use ratios were 

low. For the market to function effectively, a virtually irreducible minimum amount of grain 

must be held in the system to transport, market, and process grains. Though stocks data are 

notoriously imprecise, minimum working stocks are apparently close to 20% of use.8 Comparing 

Figure 10 with Figure 3 shows that stocks are very unresponsive to price at these minimum 

levels. Similarly, comparison of Figures 4 and 11 shows that spikes in corn price occurred when 

stock-to-use ratios were low. 

 

8

 Above minimum stocks, small additional fractions of stocks are placed on the market only when the incentive is 

high, because they are in relatively inaccessible locations or perform valuable roles in keeping the system operating 

efficiently. These stocks are ignored here; they play only a minor role in the determination of price volatility. See 

Bobenrieth, Bobenrieth and Wright (2004). 
– 18 – 

Figure 10. 

World wheat stock-to-use ratios 

(Source: USDA Foreign Agricultural Service – Production Supply and Distribution) 

Figure 11. 

World corn stock-to-use ratios 

(Source: USDA Foreign Agricultural Service – Production Supply and Distribution) 
– 19 – 

A common feature of all such physical storage activity is that aggregate stocks are constrained to 

be non-negative. If current stocks are zero, it is impossible to “borrow from the future.” Another 

important feature of these grains (and of most minerals) is that the marginal cost of storage per 

period, including physical protection, insurance, and spoilage, in practice is usually modest, and 

the assumption of constant unit costs is a generally reasonable approximation.9

 Increases in 

stocks are not generally limited by storage capacity. In contrast, storage of extra water in a 

reservoir may incur virtually no extra cost until it reaches full capacity, beyond which extra 

storage is infeasible in the short run. Above-ground storage of petroleum is similarly limited. 

The fact that their supply is usually seasonal is a distinctive feature of major storable agricultural 

commodities. For simplicity, the discussion here considers annual variation and assumes a fixed 

interest rate. Like most studies of grain storage, the focus is on market aggregates, ignoring 

spatial variation and product heterogeneity, as well as on national policy variation regarding 

trade barriers, subsidies, and taxes, all of which affect the relation between reported global prices 

and prices faced by consumers.10 As already noted, transfers via storage are unidirectional; 

negative storage, “borrowing from the future,” is not feasible. This reality makes modeling 

storage behavior interesting and challenging. A profit is realized only if the value of the grain 

when released exceeds both the cost of storing it and the interest on capital.11

The value of storage today depends on its expected value tomorrow, and so on to infinity. It 

seems necessary to know the answer for tomorrow before solving for the problem today. There is 

a solution to this problem.12 Here the focus is on the implications of that solution for arbitrage 

and grain price behavior. 

 

9

 Paul (1970). Deterioration is not important for grains stored in appropriate environments but can be serious in hot 

and humid environments. 

10 Transaction costs associated with adding or removing stocks are assumed to be negligible. 

11 Discounting by the cost of capital also makes the timing of benefits and costs to producers, traders and consumers 

important in determining who gains and who loses from policies affecting storage activity. See Wright and Williams 

(1984). 

12 The first paper to pose the solution to this problem in a modern analytical fashion is Williams (1936). The first 

satisfactory solution following the approach proposed by Williams did not appear until the 1950s in the pioneering 

dynamic model of Gustafson (1958). A solution method for storage models with responsive supply and rational 

expectations was first presented in Wright and Williams (1984). See also Williams and Wright (1991, chapter 3). 
– 20 – 

5. The economics of storage activity 

Assume that one crop is sown annually. The harvest in year t, ht, is random, due to weather and 

other unpredictable disturbances. The effects of storage on consumption and price of grains, 

illustrated in Figure 12, is the result of the horizontal addition of two demands. One is the 

demand for consumption in the current period, ct; the other is the demand for grain stocks in 

excess of essential working levels, xt, to carry forward for later consumption. Consumption 

responds to price according to the downward-sloped function P(ct). Stocks xt cannot be negative. 

To keep things simple, deterioration is ignored. 

Figure 12. 

The role of stocks in buffering shocks 

Equivalent shocks

Demand for consumption 

Market demand, inclusive of stocks 

Quantity 

Price 

Different impact 

on prices 

With stocks 

Without stocks 

When stocks are low, price 

becomes very sensitive to 

disturbances in supply 
– 21 – 

In any period, regardless of the economic setting (monopoly, competition, state control of 

resource allocations) two accounting relations hold. The first defines available supply At is the 

sum of the harvest and stocks carried in from the previous year: 

Ahx t tt   1 ,. 

The second states that consumption is the difference between available supply and the stocks 

carried out: 

. t tt c Ax  

Assuming competitive storage, stocks xt are positive (in excess of minimal working stock levels) 

only if the expected returns cover costs. (Competition between storers prevents them from 

making greater profits.) This means that the current price of a unit stored must be expected to 

rise at a rate that covers the cost of storage k and the interest charge at rate r on the value of the 

unit stored. 

Given available supply, At, storers carry stocks xt from year t to year t+1 following a version of 

the age-old counsel to “buy low, sell high” represented by the competitive “arbitrage 

conditions:” 

 r 1

1 Cost Storage + Pricet Expected Pricet+1, if stocks exceed essential working 

levels,

 r



1

1 Cost Storage + Pricet Expected Pricet+1, if stocks equal essential working levels.13

As shown in Figure 12, when price is high and stocks (excluding essential minimal levels) are 

zero, the market demand is the same as the consumption demand. 

 

13 That is, the arbitrage equations for risk–neutral competitive storers who maximize expected profits can be written 

1 1

1 1

1 ( ) [ ( )], 0; (1 )

1 ( ) [ ( )], 0, (1 )

t t t tt t t

t t t tt t t

P A x k E P x h x if x

r

P A x k E P x h x if x

r

 

 

    



    



 

 

where Et denotes the expectation conditional on information available in year t, and t 1 h 

 and t 1 x  

are random variables. 
– 22 – 

Those who consume grains such as rice, wheat, or maize as their staple foods are willing to give 

up other expenditures (including health and education) to continue to eat their grain, so the 

consumption demand is very steep and unresponsive to price (“inelastic”); large changes in price 

are needed if consumption must adjust to the full impact of a supply shock unmoderated by 

adjustment in stocks. In 1972/73, for example, a reduction in world wheat production of less than 

2% at a time when stocks were almost negligible caused the annual price to more than double, as 

indicated in Figure 3. Figure 12 also shows how, when stocks are clearly above minimum 

working stocks, storage demand, added horizontally to consumption demand, makes market 

demand much more elastic (less steeply sloped) at a given price. 

The responsiveness of this aggregate consumption demand to price is difficult to estimate, for 

several reasons. One is that, in empirical demand studies at the level of the individual consumer, 

it is difficult to distinguish consumption from storage (including stocks held by consumers) as 

prices fluctuate, and when the two get confounded the estimated response overstates the 

consumption response. Secondly, at the aggregate level, years with high prices and negligible 

stocks above working levels are too rare to establish, by themselves, the steepness of the 

consumption demand. Estimation of the dynamic storage model enables us to use data from all 

available years in determining consumption demand. However, the storage model has been 

difficult to implement empirically. One major hurdle is, again, the lack of reliable stock (or 

consumption) data for global markets. (In recognition of this, grain statistics refer to 

“disappearance” rather than consumption.) Work that pioneered the econometric estimation of 

this model in the 1990s, assuming no supply response, finessed the data problem by estimating 

the model on prices alone.14

Recent application of a model in this tradition to prices of a set of commodities suggests that 

aggregate food-consumption demand responds very little to changes in the price of major 

commodities; the slope of the consumption demand curve for major grains may be even steeper 

than previously believed.15 To compensate for the low price response of consumption, more of 

 

14 Deaton and Laroque (1992, 1995, 1996). 

15 Cafiero, Bobenrieth, Bobenrieth, and Wright (2009). For major grains, confirmation of this result is the subject of 

ongoing empirical research. 
– 23 – 

the commodity is stored and stocks run out less frequently. The storage implied by the model 

smoothes prices, replicating the kind of price behavior observed for major commodities. 

By acquiring stocks when consumption is rising and price is falling, storers can reduce the 

dispersion of price and prevent steeper price slumps. Disposal of stocks when supplies become 

scarcer reduces the severity of price spikes. If the supply of speculative capital is sufficient, 

storage can eliminate negative price spikes but can smooth positive spikes only as long as stocks 

are available. When stocks run out, aggregate use must match a virtually fixed supply in the 

short run. Less grain goes to feed animals and the poorest consumers reduce their calorie 

consumption, incurring the costs of malnutrition, hunger, or even death. 

Storage induces positive correlation in prices and is least effective when harvests are positively 

correlated; storage cannot eliminate price changes caused by persistent shifts in demand such as 

the recent subsidized surge in biofuel production. Note also that the storage demand shown in 

Figure 12 would shift up, pulling total demand with it, if the supply variance rose or interest 

costs fell. 

If producers can respond to incentives with a one-year lag, that response is highly stabilizing for 

consumption and price. Their competitive adjustments of planned production increase the 

effectiveness of adjustments of stocks in smoothing consumption and price. When supplies are 

large, for example, expected returns to production are low, so producers cut back production in 

response to lower returns and hold more stocks. 
– 24 – 

6. Storage-related policies for grain markets 

Since ancient times, national leaders have recognized a responsibility to ensure adequate 

domestic availability of staple foods. For example, the Ch’ing Dynasty in China maintained a 

nationwide granary system with responsibilities that included moderation of seasonal 

fluctuations and famine relief. In capitalist economies, an undistorted free market might be 

expected to equalize the marginal value of a given grain supply across alternate uses, and also 

with its expected value in storage. 

There are two serious problems with total reliance on private storage for national food supplies. 

The first is that in a free market only those who have the necessary resources or “entitlements” 

can acquire food. The destitute may starve without affecting prices at all. The other is that in a 

food emergency (such as experienced in many countries in 2008) governments are pressured by 

consumers, who are naturally preoccupied with their current consumption needs. In response to 

this powerful constituency, governments often force traders who have accumulated grain to 

surrender those stocks to the government or directly to consumers, often without compensation. 

Sometimes such so-called “hoarders” are also punished or even killed. At such times, the 

argument that the “hoarders” might be the sole source of supply if the next crop fails gets scant 

consideration.16

Anticipation of such treatment discourages private storage for distribution at a high price in time 

of need. Even if a government commits not to confiscate stocks (or otherwise penalize hoarders) 

in emergencies, a commitment against all intervention is not credible. Hence governments often 

choose to supplement private storage with publicly acquired stocks or storage subsidies. (Even if 

the government manages all market stocks, consumers inevitably store some domestic supplies.) 

When public stocks are released to consumers (other than those with no money at all for food), 

they will, to some extent, have a negative effect on prices. Anticipation of this price effect 

reduces private storage incentives. Hence it is natural to expect that governments will intervene 

 

16 In the United States, long-run speculators, whose futures positions provide the incentive for storage by shorthedgers, are currently enduring a great deal of negative attention regardless of a lack of evidence of excessive 

stocks. 
– 25 – 

actively when supplies are plentiful to increase grain stocks and thereby help ensure supplies for 

the needy and/or stabilize the market.17

6.1 Storage responses to ensure adequate minimum consumption levels 

Emergency food reserves 

Operation of disaster relief programs typically requires reserves to be on hand to ensure a smooth 

and timely response to food supply emergencies and related humanitarian disasters. An example 

of such a reserve forms the first part of a recent three-point proposal by von Braun et al. (March, 

2009). It sketches an outline of a small “independent emergency reserve” of about 5% of the 

current annual food aid flow of 6.7 wheat-equivalent metric tons. This would be a decentralized 

reserve managed by the United Nations World Food Program and held in existing national 

storage facilities at strategic locations with essentially a call option on the grain deposits at precrisis prices. One would anticipate that this type of stock would be used for local and regional 

food shortages, often in landlocked countries or failed states. Such shortages are often unrelated 

to global market conditions so the exporter commitment problem previously discussed is less 

relevant. Recent difficulties involving lags in food aid responses and mismatches between years 

when aid is plentiful and years when it is needed might be alleviated by such a reserve. On the 

other hand, care must be taken to minimize disincentives caused by the price-depressing effects 

of food distribution for the local farmers and merchants who are the first line of defense against 

famine for such countries18. 

The reserve would be useful in improving the speed and flexibility of short-run responses to 

local food crises. But its operation presents many challenges familiar to administrators of aid 

programs. For example, measures should be taken to ensure that transport will be available for 

delivering this aid, especially for landlocked countries such as those in Africa that have recently 

encountered food crises. It seems likely that direct assistance to the neediest, where feasible, 

would be more effective than attempting to reduce prices by supplying extra grain to regular 

 

17 For a more extensive discussion of the rationale for public intervention in storage markets, see Wright and 

Williams (1982b) and Williams and Wright (1991, chapter 15). 

18 Even if we ignore this difficult issue, optimization of the details of location and operation presents a challenging 

spatial-temporal problem that deserves considerable attention before the proposal is implemented. See Brennan, 

Williams, and Wright (1997) for a spatial-temporal model of an exporting region that gives some hint of the issues 

involved in modeling imports of food aid for a geographically dispersed population. 
– 26 – 

food markets. Public employment programs for those needy who are able to work have been 

successful in cases where it has been possible to keep the reward for work low enough to be 

unattractive to those with other employment alternatives.19 The proposed modest reserve could 

be crucial for tackling local humanitarian crises. But its impact would be negligible on the global 

market volatility that is the focus of this paper. 

National strategic reserves 

One reason that grain prices have not declined further from recent peaks is that many countries 

are rebuilding or expanding their grain reserves in reaction to the export bans and export taxes 

observed recently.20 Such actions appear almost inevitable at the national level given the inability 

of exporters to commit to being reliable suppliers in emergencies. According to a recent report, 

the United Arab Emirates, presumably capable of offering a logical food-for-oil deal, were 

unable to obtain blanket assurances from Pakistan that grain produced from the Emirates’ 

planned agricultural projects in that country would not be subject to export controls.21 Futures 

contracts eliminate counterparty risk but can expose countries to location-basis risk and sudden 

large margin calls. Further, a futures market might be shut down or exports banned in an 

emergency; both actions were taken in India in 2007 at a time when the situation in world grain 

markets fell far short of emergency conditions. 

A key question is how large the reserve should be. The answer must depend on the facts of each 

case, including the diversity of food supplies, dependability of traditional suppliers, and cost of 

the program. Such stocks tie up capital for the substantial intervals between releases and can be 

expensive to maintain, especially in humid tropical countries.22 Their efficient management also 

uses scarce human capital and temptations for corruption can easily arise. 

If the public stock’s management can commit to hold the stocks for release only in circumstances 

in which private stocks would be exhausted, the disincentives to storage by the private market 

can be reduced. For a landlocked country, this type of emergency situation might be the second 

year of a severe drought. For an importer, it might be the second year of a global shortage. In 

 

19 See, for example, Subbarao (2003). 

20 Recent reports indicate that Saudi Arabia, Egypt, Iran, China, Russia, Jordan, Mozambique, Morocco, and Malawi 

are among the countries placing grain in national reserves. (Marc Sadler, personal communication, April 30, 2009.) 21 Oxford Analytica, Global Strategic Analysis, April 20, 2009. 22 Stocks would be “rolled over” with no net release as frequently as needed to maintain quality. 
– 27 – 

such real emergencies, releases of stocks via direct distribution outside the market can be 

targeted to ensure that all consumers receive what is minimally needed, as previously discussed 

for the case of the small emergency reserve. A release policy designed to operate via its effect on 

the general market price is likely to be more costly and less effectively targeted to those in need. 

Thus the national storage activity discussed here is appropriately directed at a stockpile of a 

certain size deemed appropriate to meet security goals rather than aimed at modification of the 

behavior of prices. In practice, many public storage interventions are targeted at price behavior 

rather than consumption goals. These include many international commodity agreements and 

some programs proposed recently. 

6.2 Commodity agreements and national market price interventions 

Many different policy interventions have been used to address problems associated with price 

volatility in grain markets. These include controls or sanctions on private “hoarding” or 

“speculation,” buffer stocks, buffer funds, strategic reserves, use of options and futures, rationing 

of low-priced supplies, marketing boards, and price floors, all of which obviously affect storage 

incentives. Other measures that can also affect storage are trade barriers, export taxes, interest 

rate policies, and production controls. 

Since 1931 there have been more than 40 international commodity agreements worldwide. The 

products covered include wheat, sugar, rubber, coffee, cocoa, olive oil, tea, and jute. In the 1930s 

international commodity agreements were explicitly designed to address the severe problems of 

over-supply and low prices associated with the Great Depression by restricting exports and 

raising prices. They had some degree of success until the over-supply problem was eliminated by 

the onset of the World War II. 

In the 1970s, a major element of the economic doctrine of the “new international economic 

order” was negotiation of international commodity agreements (ICAs) under the auspices of the 

United Nations Conference on Trade and Development (UNCTAD).23 Important programs were 

directed at sugar, coffee, cocoa, tin, and rubber. The first two of these, like the pre-war 

agreements, managed storage only indirectly via commitments to control exports, but the others 

 

23 See Gilbert (1996, 2005) and Gardner (1985) for excellent surveys of international agreements. 
– 28 – 

involved attempts to control prices using versions of price-band schemes. When a price fell to 

the floor of the band, acquisitions were to be made; when a price reached the ceiling, stocks 

were, if available, released from the stockpile by the program’s management. A later Australian 

wool reserve price scheme acted more like a floor price scheme with a variable release price and 

a buffer stock. Because of the distinctive nature of Australian wool, this program was akin to an 

international agreement in its effect on the market. The United States from the 1930s until the 

1970s operated price support schemes involving buffer stocks of major commodities and the 

European Union has also made use of similar storage-related programs to support and stabilize 

markets. 

6.3 Proposals for price stabilization 

A proposed international coordinated global food reserve 

The recently evident failure by many grain exporters (especially in the rice market) to commit to 

uninterrupted market access has highlighted the desirability of commitment-reinforcing 

mechanisms for international grain market participants. One such mechanism, an international 

coordinated global food reserve, has recently been discussed.24 This reserve could help reassure 

importers that they could rely on exporters to supply them in time of need. The proposal is 

sketched as an agreement by members of a “club” that would include members of the G8+5 plus 

major grain exporters such as Argentina, Thailand, and Vietnam. The members would commit to 

holding specified amounts of public grain reserves in addition to reserves held by the private 

sector. The public stores would be used to intervene in the spot market as directed by a “high 

level technical commission” appointed by the club on a permanent basis. The commission would 

have full decision-making authority. Operation of this reserve would be coordinated with 

operation of a virtual reserve (see next section). This proposal has some features in common with 

the security provisions of the International Energy Agency for dealing with disruptions of 

petroleum markets. A major, and perhaps insurmountable, challenge for such a commitmentreinforcing program is to ensure commitment by the participants themselves to honor their 

obligations when markets are under stress. 

 

24 von Braun et al. (March 2009). 
– 29 – 

A proposed global virtual reserve 

Another related proposal is for a global “virtual reserve.” Nations that are members of the “club” 

would commit funds amounting to US$12–20B to be provided, if necessary, by the high-level 

technical commission for operations in the futures markets.25 One version of the proposed 

intervention characterizes it as a dynamic price-band system (von Braun et al., p. 3) operated by 

a “global intelligence unit” that also makes market forecasts and determines when markets are 

not functioning well. This unit would be part of an institution that “already has the long- and 

medium-term modeling infrastructure for price forecasting.” 

It seems that this virtual reserve would be designed to address “excess price surges caused by 

hoarding and speculation” and aim at restoring confidence in the market, preventing ad hoc trade 

policy interventions, and allowing the market to guide resource allocation in response to 

fundamental changes in supply, demand, and production costs. A win-win solution is anticipated 

for producers and for consumers, exporters, and importers. 

Were the virtual reserve designed to increase stocks to buffer a later emergency, it could be 

operated by adopting long futures positions when the price is at the bottom of the band, thereby 

raising the incentive to store. Thus a buffer stock is induced indirectly and the ultimate 

stabilizing effect is similar to that of a conventional buffer stock scheme. If, later, “excess price 

surges” were detected, the long futures positions could be offset by short sales, encouraging 

releases of stocks and reducing the current price. This virtual scheme, if large enough to move 

markets (and if allowed under the rules of relevant commodity markets), is financially risky and 

subject to manipulation by traders, will lose money on average, and will eventually exhaust its 

budget. As reported in Peck (1976), the Federal Farm Board intervened in the United States’ 

cotton and wheat markets using futures contracts to try to stabilize prices in the face of a bear 

market. This turned out to be an expensive exercise that ended up stabilizing American wheat 

prices for a year or so before essentially owning the United States’ wheat stocks and losing a 

great deal of money—$188 million dollars—before being disbanded by Congress in 1933. Peck 

concludes that operating in the futures market did not yield the clear benefits anticipated by 

Houthakker (1967). On the other hand, regional supplies were severely distorted even within the 

 

25 Operation of this large program in futures markets would require ready access to margin financing and could be 

subject to gaming by traders aware of the program’s operating rules. 
– 30 – 

United Stated market, creating shortages in some localities and gluts in others, a lesson of 

relevance to modern proposals for price interventions. 

In another interpretation that more closely reflects written sketches by von Braun and Torero 

(2009) and Robles, Torero, and von Braun (2009), the “price band” that they mention appears to 

be irrelevant; indeed, the function of the floor price is not discussed. The “virtual reserve” would 

apparently adopt no long positions and hold no stocks in normal times but would stand ready to 

take naked short positions (not backed by stocks or prospective harvests) when a price surge is 

detected by a global intelligence unit endowed with information about the market or special 

forecasting powers unavailable to other market participants. The idea is to arrange access to 

financial resources from nations that are club members to back these interventions, which “will 

reduce spot prices and should make speculators move out of the market” (von Braun and Torero 

2009, p. 3). 

That is, the intervention is designed to reduce levels of stocks deemed excessive by the global 

intelligence unit. (Price does not fall unless consumption increases; increased consumption must 

come from stocks in the short run.) This is a puzzling response to propose as a way to address 

recent price spikes which, as hereafter noted, occur only when stocks are at minimum levels 

relative to supplies available to the market. The short sale itself does not increase stocks; it is 

equivalent in its effect on supply to borrowing stocks from the market and selling them forward. 

If the global intelligence unit does convince the market to release stocks it would otherwise hold 

but its forecast of the future supply turns out to be too optimistic, market participants will know 

that the program, as a short speculator, will have to cover its naked short commitments. Prices 

will rise further than if the program had not intervened and the program will lose the entire 

change in value of its short positions. 

Indeed, the specific motivation for this program is not clear. Given the multibillion dollar cost, 

estimated by the proposers (von Braun and Torero 2009, p. 12) at $12–$20 billion U.S. dollars, 

where the lower bound is around half of the entire public agricultural research budget worldwide, 

this initiative requires critical attention. 

The implementation proposal (von Braun and Torero 2009) quotes the results of Robles et al. 

(2009), which are Granger noncausality tests that actually find no evidence of influence by 
– 31 – 

noncommercial long speculators on wheat or maize and only two significant cases of influence 

among 47 samples for rough rice, about what one would expect by chance at a 5% significance 

level. They find only one instance of effect of index traders (less than expected by chance) for 

maize. They also find a few other instances of rejection of Granger noncausality with respect to 

trading volume and short speculation, neither of which has been generally viewed as problematic 

recently. 

Although the Granger causality tests of Robles et al. are overwhelmingly negative, this type of 

casual use of the test merits comment as it has become popular in searches for harmful effects of 

speculation. The concept, even when assuming it has been implemented as intended by Granger, 

is controversial from a philosophical viewpoint. Furthermore its implementation requires that all 

relevant information variables except the candidate cause be included. In Robles et al. only lags 

of own-price and a speculation proxy variable were included as determinants of the current price. 

The problem with missing information is illustrated by the following thought experiment. You 

see through your window a man walking past. He raises his umbrella. A minute later it starts to 

rain. If a sample is constructed using a number of instances like this, a Granger causality test 

including only rain and the raising of umbrellas could show umbrellas to be a significant cause of 

rain. Add other variables (thunder, for example) and the finding of causality of rain by the raising 

of umbrellas could be supplanted by a finding that thunder causes rain. Of course, neither finding 

demonstrates true causality. Likewise, in commodity markets, omission of relevant variables 

(candidates could be the closing of the Indian export market, new biofuel policy announcements, 

and weather changes) renders the results uninformative. 

On the basis of their tests, which, as noted, were overwhelmingly negative, von Braun and 

Torero (2009, p. 2) concluded that “Appropriate global institutional arrangements for preventing 

this kind of market failure are needed.” Assuming the proposal is a serious plan to commit 

multiple billions of dollars, it is unfortunately necessary to point out that they present no example 

of a verified finding of an irrational price surge linked to the speculation they aim to curb. 

Indeed, their evidence makes no real case for suspecting a negative role of speculation, provides 

no evidence of (unspecified) market failure, and offers no reason to believe that the proposed 

interventions will have any desired effect at all. 
– 32 – 

7. How interventions to stabilize price do (and do not) work 

In assessing a price-band proposal and other market problems and interventions to be addressed, 

it is helpful to keep the following points in mind: 

1. Any activity or policy that does not change consumption in a market does not affect 

prices in that market. On the other hand, if a policy decreases price, it increases 

consumption and decreases stocks. If planned production is responsive, it also decreases 

when the price drops. 

2. Unless they address the fundamental source of disturbance (for example, disease, war, or 

weather), “stabilization” policies must actually destabilize some key variables (stocks or 

public budgets, for example) as they stabilize others (such as price). 

3. There is no evidence that any chosen group of experts, no matter how well qualified and 

motivated, can reliably determine when a competitive market is acting in a way not 

justified by fundamentals. Indeed, the evidence against the general proposition that 

designated experts can outperform the market in forecasting or trading has grown 

overwhelmingly in the last several decades. Certainly the major international 

organizations concerned with food markets for the poor have no record of demonstrating 

such performance and wisely make no assertions of the capacity to do so. 

4. In any intervention, net efficiency gains to the society as a whole are typically dwarfed by 

redistribution of gains and losses between producers and consumers. Those who most 

enthusiastically and effectively support storage interventions naturally tend to be the ones 

who are expected to gain from those policies. To comprehend these distributional effects, 

it is necessary to recognize the dynamic nature of the problem and the importance of 

private responses to public actions. 

Policy makers find price-band policies appealing because they seem simple and easy to explain. 

The claim that the band keeps prices stable and concentrated around the center of the band is 

intuitively appealing. Unfortunately, it is also misleading. To see why, it is instructive to 
– 33 – 

consider first a simpler version consisting of a price floor at which the manager makes an open 

offer to buy or, subject to availability, to sell any amount of the grain in question. 

A simple public floor price program 

For simplicity assume a market with no short- or long-run production response and a random 

harvest.26 What happens if a public floor price program is announced and immediately 

implemented, and the announcement is totally unanticipated? 

If the initial price is below the floor price, , the immediate effect is to increase the price and 

stocks, draw down government funds, and reduce consumption. If the initial price is above , 

and no private storage is allowed, the effects of introduction of the floor price on storage, 

price, government funds, and consumption are delayed until there is a harvest large enough that 

it pushes the price below if it is all consumed.27 In the long run there is a significant 

probability that the price is at the floor. Whenever the program holds stocks, the price stays at the 

floor; when stocks are exhausted, the price rises above the floor to a level that reflects the 

outcome of the most recent harvest. 

If, on the other hand, there is competitive private storage and the price is not too far above , 

introduction of the price floor raises the price higher immediately and reduces consumption. The 

existence of the floor raises expected price and encourages more private storage, increasing total 

demand, as illustrated in Figure 13. Government expenditure is delayed, however, until the price 

falls to , and the remaining stocks are sold out to the government at the floor price in a 

“speculative attack.” 

In each of these scenarios, the earliest nonzero effect of the price floor scheme on the commodity 

price must be positive since the first public purchases must precede the first public sales. This 

means that producer revenues are increased by the early effects of the program as stocks are 

accumulated. The effects will be reversed later when the stocks are released, but the time value 

 

26 The harvest disturbance is assumed to be independently and identically distributed. 

27 If there is supply response, consumption and price but not government revenue are affected before the floor price 

is reached. 
– 34 – 

of money dictates that the earlier gains to producers tend to dominate the later losses.28 If land is 

priced to reflect the current present value of the profits that it can produce over time, land prices 

jump when the program is introduced even if the effects on the commodity price are delayed. 

Figure 13. 

The effect of a price floor on market demand 

If private storers are allowed to co-exist with the public program, the floor is less frequently in 

effect so in that sense the price is less stable. But variation of price when it is above the floor is 

dampened by the action of private speculators as long as they have stocks and in that sense the 

 

28 To see this, consider that the early gains could be invested and earn interest before they are balanced by equal 

dollar outflows. (See Wright (1979) and Williams and Wright (1991, chapters 12 and 13) for more on distributional 

effects of market stabilization.) 
– 35 – 

market is made more stable by private speculation; public and private stocks are complements in 

smoothing the market.29

Price-band buffer stock programs 

The floor price scheme just described is pedagogically useful for its simplicity. International 

agreements involving commodities, including rubber, cocoa, and tin, have often combined the 

floor price with a higher “ceiling” or “release” price, a plausible way to protect consumers from 

the most extreme effects of price spikes. In the past, prominent economists have advocated that 

prices should be stabilized in a band bounded by the floor and ceiling prices to reduce the “boom 

and bust” gyrations typical of commodity prices (Keynes 1942, Houthakker, 1967, Newbery and 

Stiglitz 1981). 

A strong intuition is that such a program keeps the price around the middle of the price band 

most of the time if the band is judiciously chosen. But numerical examples made possible by 

advances in computing and dynamic programming show that this is not true.30 As illustrated in 

Figure 14, for a program with a floor that is 87.5% of the mean price of $100 and a ceiling set at 

112.5%, the program greatly reduces the probability of spikes above the ceiling. But the 

probability that the price will be at the ceiling is almost 30% and there is a probability of about 

15% that the price will be at the floor. 

There is little probability that price will be located between the mid-point of the band and the 

top. Most of the time, the market appears to be “challenging” either the floor or the release price. 

The price ceiling discourages production and storage and increases volatility of the price as the 

latter approaches the ceiling. 

 

29 Program administrators might view private speculators as the culprits in sporadic “speculative attacks” on the 

public stockpile, acquiring the whole stock when the price rises above the floor and dumping their stocks on the 

government program when the price reverts to the floor. These actions may be viewed as “destabilizing” the 

stockpile but they tend to stabilize consumption and to moderate large changes in price. (See Williams and Wright 

(1991, chapter 13).) 

30 There are important interactions between band width, private storage within the band, the supply response, the 

expected rate of accumulation of losses, and the maximum level of stocks. See Williams and Wright (1991, chapter 

14). 
– 36 – 

Figure 14. 

Price probabilities under a price floor and a price band 

Are consumers willing to submit to a high probability of the price remaining at the ceiling well 

above the free-market median in exchange for less frequent food emergencies that may, in the 

absence of intervention, occur between once and perhaps three times in a generation? 

Another serious consideration is budget cost. When a program chooses a price floor p 

F

that is no 

higher than the free-market mean (adjusted for a perfectly estimated trend if necessary) or a price 

band where the mean of the floor and ceiling price equals the free-market mean, the program has 

commonly been assumed by economists to be “self-liquidating”—that is, financially sustainable 

based on the fact that expected net balances should equal zero and on the intuition that the 

summed funds from purchases and sales after several years of operation should be close to their 
– 37 – 

initial values. But this intuition is wide of the mark even for a simple floor price scheme in a 

market with no underlying trend.31 

The fund may in the short run accumulate great profits, appearing to affirm the manager’s skill 

and inducing pressure to raise the floor. Such pressures can be very difficult to resist.32 Even if 

the manager can commit to the original rules, any given operating reserve will be depleted in 

finite time. 

In practice, postwar experience has affirmed that the “finite time” within which such programs 

fail is disconcertingly short, often less than a decade or two. Recent failures in programs for tin 

and wool, among others, have shown that the largest price effect of these interventions can be the 

severe price collapse that accompanies their inevitable failure.33

When such price support programs do fail, there is generally a public consensus that the 

intervention price was wrongly set and management is often blamed for faulty trend forecasting. 

There is scant recognition that failure is inevitable at any relevant intervention price even if the 

fundamentals are stationary. Higher floor prices merely advance the time of reckoning and priceband programs tend to fail sooner because they tend to accumulate stocks at a faster rate. 

One way to avoid such failure might be to revert to a simple price floor rule but adjust the floor 

price down somewhat after one or two years of low prices. This enhances sustainability by 

reducing accumulation of debt. Competitive storage in effect achieves this. Figure 15 illustrates 

three probability densities for prices conditional on current prices at, respectively, 74%, 94%, 

and 114% of the mean generated by a numerical model of competitive storage. In this example, 

if price is 94% of the mean, there is virtually no chance it will be below 70% of the mean the 

 

31To see this, consider the simple case in which demand is linear and planned production is constant so the mean 

price is exogenous. Assume further that the harvest has a symmetric stationary two-point distribution, that there is 

no private storage, and that is set at the mean price—the price when consumption equals mean production. 

Imagine a “buffer fund” scheme whereby the government pays for each unit sold at each time . 

Negative payments are receipts by the government. The fund’s monetary balance, , with initial value , follows 

a random walk. Given an infinite horizon, the balance passes any finite negative bound in finite time and the 

probability that it is zero at any future date is the same as the probability that it is never zero before that date and 

quickly becomes negligible (see Feller (1967, lemma 1, p. 76)). Similarly, a price floor backed by a buffer stock 

generates a fund balance that hits zero with probability one in finite time (that is, “infinitely often”). If a price 

ceiling is added, the expected time to a zero balance is shorter. 

32 The history of the Australian reserve price scheme for wool (a more complex version of a floor price sheme) is a 

salutary example where short-run success hastened the later catastrophic failure. 33 See Bardsley (1994), Gilbert (1996), and Haszler (1998). 
– 38 – 

next year. If the price does fall to 70% of the mean, there is virtually no chance it will fall below 

60% (or rise above 110%) the following year. The market is acting like a floor price program 

with a “soft” floor price adjusted in response to recent experience to prevent excess losses. 

Note also that if the price is 114% of the mean the figure indicates a much larger chance of a 

lower price than a higher price the following year. There is a modest right tail indicating the 

probability of a price at least 14% above the mean but the model is acting much like an 

imperfectly effective price-band program with a ceiling at 114% of the mean price. 

Figure 15. 

Probability of price in period t+1 when current 

price Pt is 74%, 94%, or 114% of the mean price of $100 

In short, much of the stabilizing benefits of a price-band scheme are furnished by competitive 

private storage in a free market in which there is no fear of punitive measures against “hoarding” 
– 39 – 

or other perceived offenses. Price-band schemes in theory are bound to fail if the bands are not 

adjusted to reduce losses. In practice, failure comes fairly quickly. If, on the other hand, bands 

are adjusted to reduce accumulation of losses, the program tends to mimic what the free market 

can provide. Price-band schemes are unsustainable and expensive, in theory and in practice. 
– 40 – 

8. Other recent proposals to address price volatility 

Besides measures affecting storage activity directly, other policies might be considered to reduce 

market volatility and/or increase market access. Some of these have considerable merit; others do 

not. We now turn to several of these, starting with the more promising. 

Agreements to improve exchange of critical information 

One striking feature of recent chaos in grain markets is the paucity of timely data on available 

stocks in each country and particularly in Asia. Earlier and more accurate data can reduce 

volatility, improve planning, and encourage international confidence and cooperation. Policy 

innovations that could overcome the tendency of key participants to keep stock data secret might 

well do more to stabilize world markets than more direct interventions. 

Commitments to divert grains from biofuel and feed uses in emergencies 

Modern food markets are, in an important sense, more inherently stable than their predecessors. 

Now, an increasing portion of food grains and oilseeds is being used for biofuel. But in a food 

supply emergency, it should be possible to commit to reducing biofuel manufacture and releasing 

the feed grains and oilseeds for food use without undue hardship to energy consumers. If there is 

no contemporaneous energy price spike, the market can divert supplies from fuel to food use as 

food prices rise. (Biofuel mandates eliminate this flexible, market-stabilizing response.) If energy 

prices are also spiking, such market-based substitution might not occur. In anticipation of such 

cases, the food supply authority could purchase a call option on grain from biofuel producers. 

However, if biofuel feedstocks are switched to permanent stands of miscanthus or other 

perennial inedible grasses, some of this flexibility could be lost. If biofuel conversion of such 

inedible crops becomes more efficient, producers may well be tempted to increase the area 

planted to them. In that case, the threat to food supply security could become much more serious 

than it is at present. 
– 41 – 

Commitments to refrain from using export restrictions 

Recent experience in the rice market has demonstrated the hazards associated with reliance on 

imports to satisfy needs for a staple commodity. Exporters and importers have a joint interest in 

keeping trade open when prices are high so they can together reap the full benefits of the 

smoothing role of trade, which can exceed what can be achieved via storage. But commitments 

of governments beyond the term of the current administration are difficult to achieve and can 

easily collapse when governments face pressure from politically powerful urban consumers. One 

useful policy change to improve the commitment capacity of exporters would be a reform of 

WTO disciplines on export bans and export taxes consistent with existing rules against import 

tariffs and quotas. 

Futures market regulation 

In any grain price crisis, futures and options traders get blamed sooner or later. This happened in 

the United States, for example, in the last century when many forms of futures and options 

trading were banned and it is happening again now. This time, the critiques come with novel 

twists. 

The major critique focuses on the entry of new money from (1) index funds holding persistent 

long positions (contracts to purchase grain in the future at a set price) and managing those 

positions by rolling the hedges over to later maturities or increasing or decreasing their positions 

to maintain portfolio allocation shares, and (2) speculative investors such as hedge funds. The 

argument is that these long positions have added buying pressure, raising prices for the physical 

commodity above the levels justified by supply and demand. 

For United States futures markets, the facts tend to contradict the assumptions underlying this 

critique.34 First, for soybeans and maize in particular, short-hedging by producers, merchants, 

and processors grew more from 2006 to 2008 than did long speculation. For wheat, the increase 

in long speculation was greater but the relative magnitudes stayed within normal ranges.35

Second, the commodities for which index investment grew most over the two years saw no 

significant price increases. Third, commodities neglected by index funds (such as rough rice and 

 

34 See Irwin et al. (2009). 

35 See Verleger (2009) for related findings for the market for crude oil. 
– 42 – 

fluid milk) experienced large price increases, as did commodities with no futures markets at all 

(apples, edible beans). Fourth, index funds rebalance as grain prices rise, reducing long positions 

to maintain portfolio shares, and thus stabilize prices somewhat like a more flexible variant of a 

price-band policy. Fifth, empirical work has shown no evidence that position changes by 

speculators help forecast price changes in these markets.36

Finally, if long futures market positions exacerbated price spikes last year, they must have 

reduced consumption and increased commodity stocks. But stocks were around minimal feasible 

levels in 2007/08. To the extent that speculators might have influenced the market by increasing 

stocks in previous years, their unwinding of those positions last year should have increased 

consumption and moderated price, which are hardly undesirable effects. 

Policies to prevent irrational or manipulative bubbles 

The reality that overall grain availability increased last year prompted a quite different 

rationalization of the crisis in the grain markets: there were irrational or manipulative bubbles 

attributable to “greedy” speculators that burst in the spring and summer of 2008. In 2007, one 

story goes, prices got out of line in the grain markets and supplies were withheld in anticipation 

of greater profits later. The sharp reversals of grain price trends in different months of 2008 are 

viewed as confirmation of this interpretation: the “bubbles” proved unsustainable, as bubbles 

always are, and burst at different times. Given the global disarray in financial markets at present, 

an explanation dependent on greed and irrationality can be both plausible and attractive. 

Unfortunately, recent research on models of commodity markets like the one represented in 

Figure 12 but with slightly different, though hardly unconventional, demand behavior has 

shown37 that irrational bubbles are difficult if not impossible to distinguish from normal rational 

investment behavior by nonmanipulative market participants, just as “greedy” investors are 

difficult to distinguish ex ante from regular “profit maximizers.” 

There is another reason to discount the need to prevent bubbles. If a bubble occurred in a grain 

market last year, to affect price it must have increased stocks. But, as previously noted, stocks 

were at or close to minimum levels. Where were the increased stocks to be found? More 

 

36 See the Granger causality tests in Sanders, Irwin, and Merrin (2008). 37 See Bobenrieth et al. (2000, 2008). 
– 43 – 

fundamentally, is it prudent to force the release of scarce stocks if there is no guarantee that the 

next harvest will be better? 

Controls on the investment of excess global liquidity 

A related set of arguments points to the entry of holders of new and cheap capital into 

commodity futures markets in the past few years as a key cause of grain price spikes. One part of 

the argument has some plausibility and is favored by respected researchers in international 

finance. A brief sketch goes as follows. A large pool of global capital accumulated largely in 

China was invested in the United States housing market until that market collapsed. Hoards of 

these global dollars, seeking new targets, were dumped into the commodity markets through 

hedge funds and other investment vehicles. These new dollars caused commodity prices to 

soar.38

All but the last sentence is plausible. The real cost of capital to major financial and commodity 

markets was low until the United States financial sector descended into disarray and international 

dollar surpluses were a part of this phenomenon. As previously noted, lower interest rates tend to 

be associated with higher stocks, higher current prices, and lower futures prices. But the facts 

regarding key agricultural commodity market behavior just quoted fail to imply any causal 

relation between the cash inflow and commodity price spikes. This is not surprising. No one has 

demonstrated that this cash increased grain stocks when, as previously noted, stocks were around 

minimal feasible levels for normal market operations. If the cash did not increase stocks, it 

cannot have reduced consumption or raised the market price in the short run. If it did increase 

stocks earlier, their release before the price spiked must have moderated the price increase and 

smoothed consumption. 

 

38 See Caballero et al. (2008) for a version of this argument focused principally on the oil market. 
– 44 – 

9. Recent grain price spikes: A reappraisal 

If international income growth, futures market speculation, and global financial flows do not 

explain the recent grain price spikes, what does? Why were they so large? Were they caused by 

the oil price surge shown in Figure 5? Were they irrational bubbles, unrelated to fundamentals, 

after all? 

An important part of the answer is that the spikes, appropriately deflated, were not unusually 

large. Look again at Figures 3 and 4. There were comparable spikes around 1996—smaller for 

wheat, larger for maize. Another glance at Figure 5 shows that those spikes were clearly 

unrelated to oil prices, which were stable around that time. They could hardly have been caused 

by index fund investment—one of the two major indexes was not even in existence then. 

A more promising line of investigation is suggested by Figure 16, which shows world stock-touse ratios for the sum of the three major grains (corn, wheat, and rice).39 Around 1996, the world 

aggregate stock-to-use ratio was much higher than recently. But the world figure was distorted 

by the huge holdings of China, which exported no grain in that period. If China’s effect is 

removed, the ratio around 1996/97 looks as tight as observed in 2007/08. The lack of stocks in 

both episodes left the market susceptible to large price spikes from small supply disturbances. 

One possible objection to this assertion is that the ratio was about as tight around 2002–2004 and 

yet the price changes observed then were much smaller. But in that period, in contrast to the 

other episodes, China made substantial exports of maize and rice, increasing available supplies in 

the global grain market. The recent price spikes are not as unusual as many discussions imply 

and the balance between consumption, available supply, and stocks seems to be as relevant for 

our understanding of these markets as it was decades ago. 

 

39 This figure and the associated argument draw on the work of Dawe (2009). 
– 45 – 

Figure 16. 

World stock-to-use ratios for the sum of the three major grains (corn, wheat, and rice) 

(Source: USDA Foreign Agricultural Service – Production Supply and Distribution) 
– 46 – 

10. Conclusions 

The storability of grains causes the price response to a change in supply to vary with the level of 

available supply. The major grains—wheat, rice, and maize–are highly substitutable in the global 

market for calories. When their aggregate supply is high, a modest reduction can be tolerated 

with a moderate increase in price by drawing on discretionary stocks. But when stocks decline to 

a minimum feasible level, the price becomes much more sensitive to small net shocks. In a free 

market, poor consumers with little wealth may be forced by high prices to spend much of what 

resources they have on food and reduce consumption at great personal cost. Others reduce 

consumption very little even when prices soar. 

In 2007/08 the aggregate stocks of major grains carried over from the previous year were at 

minimal levels due largely to substantial mandated diversions of grain and oilseeds for biofuel 

and strong and sustained increases in income in China and India. Lack of stocks rendered the 

markets vulnerable to modest but unpredictable disturbances such as regional weather problems, 

the further boost to biofuel demand from the oil price spike in 2007/08, the unprecedented 

extension of the long Australian drought, and other production problems. However, supplies in 

the market were sufficient to meet food demands without jumps in price had exporters not 

panicked, leading to a cascade of export bans and taxes that cut off importers from their usual 

suppliers. 

A review of the history of grain prices reveals that the deflated prices of food grains followed 

long-run downward trends interspersed by episodes of steep price increases immediately 

followed by even more precipitous price falls. Relative to other episodes of grain price spikes, 

volatility in the real grain price the past few years has not been particularly high. There is no 

evidence of a change in the global grain price regime. 

If in the future more serious supply problems arise, there is little doubt that export bans will 

recur. Governments that recognize an obligation to protect poor consumers or are sensitive to 

pressure from consumers in general tend to intervene when food prices rise sharply, distorting 

private storage incentives and cutting off importers’ access to supplies. Given these realities, 
– 47 – 

there is a case for public interventions when supplies are more plentiful in anticipation of future 

crises. 

Recent experiences in the grain markets in the past few years have encouraged many 

governments to build or expand national grain reserves. If such reserves are aimed at ensuring 

minimal levels of consumption, they should be designed to meet the needs of vulnerable 

consumers by nonmarket distribution in emergencies. Decisions about their size should reflect 

both the advantages of secure supplies and the substantial costs of acquisition, storage, and 

administration. 

The recent food price spikes have led to several proposals for international intervention in 

commodity markets. One suggests that creation of a small emergency reserve to respond quickly 

to regional emergencies would help speed up responses by international organizations in aiding 

groups in distress. The free market cannot be relied upon to service this need, for such groups 

lack the resources to bid for the food they require. Since regional emergencies often involve 

landlocked nations, contingent transport contracts may be useful to ensure adequate and timely 

distribution of stored grain. 

A large international grain reserve, held at optimal locations and controlled jointly by national 

governments to mitigate global food supply crises could economize on stocks and storage costs 

in providing a globally adequate amount of storage and help maintain the valuable stabilizing 

role of free international trade in grains during emergencies. Unfortunately, such an ambitious 

scheme appears to be infeasible without improved means of guaranteeing continued international 

collaboration by the participants during food emergencies. Stronger WTO disciplines on export 

tariffs and adoption of disciplines on export bans are would increase incentives for collaboration, 

but are unlikely to be persuasive in serious food price crises. 

Other recent responses to the events of the last few years include proposals for a combination of 

international physical reserves provided by members of a group of national participants and 

“virtual” reserves to control speculative price behavior in grain markets. Interventions would be 

triggered by a price band that so far lacks clearly specified objectives and rationales. In at least 

one version, the interventions would be naked speculative short positions taken when a global 

intelligence unit using special knowledge unavailable to the market decides, using criteria not 
– 48 – 

identified, that prices do not reflect “fundamentals.” Similar proposals made many years ago 

were easier to take seriously. In the last half century, a large body of work including theoretical 

and empirical analyses has shown how difficult it is, even for top experts, to be sure that markets 

are out of equilibrium and that proposed price interventions will do more good than harm. 

Use of price-band rules to operate international or domestic market stabilization schemes is less 

simple than often assumed and less effective in ensuring food security for those most at risk. The 

price tends to hover at or near the upper or lower band, private storage is reduced or eliminated, 

and production is discouraged just when it is most needed. Theory predicts, and experience 

confirms, that these programs inevitably fail even if there is no underlying trend in price. Naked 

short speculation to stabilize prices is no less risky and indeed could quickly lose vast sums of 

money, especially if positive initial results increase the confidence of management, encouraging 

decisions that lead to greater financial exposure. 

Recent experience indicates the need for greater caution in adopting policies that subsidize or, 

worse, mandate further diversion of grains or grain-producing land to biofuel. These are likely to 

have serious negative effects on the security of grain for consumption by the world’s most 

vulnerable consumers. 

On the other hand, the reality that substantial quantities of grains and oilseeds will continue in 

the near future to be converted into biofuel or animal feed in many countries suggests a new 

strategy to ensure that the most vulnerable consumers have access to sufficient food (as distinct 

from stabilizing market price). Options could be created to give governments the right to acquire, 

in serious food supply emergencies, grains or oilseeds that would otherwise be allocated to 

biofuel production or animal feed. These grains could then be distributed to the target recipients, 

assuming appropriate prior investment in the infrastructure necessary to identify qualifying 

recipients and ensure effective food distribution. All parties could gain from such diversion 

options, which could be written as contracts with specific biofuels producers; they are not 

necessarily dependent on the existence of a commodity exchange. 
– 49 – 

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