If you wonder why I spent so much time the last few years writing two books focused on speculation in commodity futures markets (my wife certainly does), then look no further than this recent policy paper by Isabella Weber of the University of Massachusetts-Amherst and co-authors entitled, “Buffer Stocks against Inflation.” A hat tip to Craig Pirrong for pointing out the paper over on his blog Streetwise Professor. The heart of Weber et al.’s argument is found on page four of their paper: “The war caused massive hedging and speculation on global markets, pushing up prices further that had already been soaring during the pandemic.” There it is in living color. Those @#%^& speculators at it again!
The citations in the paper by Weber et al. pretty much tell the story. They read like a Who’s Who from the anti-speculation side of the last go around on about speculation after the 2007-08 price spikes. UNCTAD, Oxfam, Joachim von Braun, Sophie van Huellen. It is a long list. Not a single mention of the huge literature on the other side of the speculation debate from the last 15 years. Fair and balanced for sure. As an aside, I had a quite memorable debate with von Braun at a conference in 2009. As I recall, he was quite astonished that anyone would disagree with him that speculation was one of the main drivers of high commodity prices.
Weber et al’s proposed solution to the problems created by supposedly recalcitrant speculators in commodity markets is an old one: buffer stock programs. Just one problem. There is now a very long list of buffer stock programs that have failed in many different commodity markets. In theory, these programs do have the potential to cut off the highs and lows of commodity price movements. Whether that is ultimately a sensible economic thing to do has been argued for a long, long time in the economics literature.
But, regardless of whatever theoretical arguments you want to make, one conclusion is unavoidable—buffer stock programs in practice have uniformly been abysmal failures. The reason is that theoretical models fail to account for the politics of buffer stock programs. For one thing, governments have a strong tendency to avoid releasing stocks as prices rise to avoid making producers angry who of course benefit from high prices. The politics are just a big giant mess in reality. Agricultural economists have been documenting this since the 1970s.
The late great Bruce Gardner has my favorite commentary on the management of government stabilization programs in his classic 1981 book entitled, “The Governing of Agriculture.” It is worth quoting at length his review of the 1970s experience (p.104):
For example, it was argued for years that while the old sugar program raised U.S. prices above world prices most of the time, the program provided insurance against fluctuations on the high side. Yet, when world supplies shrank and prices exploded in 1974, the U.S. price went right up with world prices. The insurance was worthless when we really needed it. Likewise, in 1977/78, a new sugar program was implemented which boosted returns considerably to producer by holding the U.S. price at perhaps twice the world price by using import controls and stock accumulations. Yet, U.S. consumers paid no less than the world price in 1979/80, when world sugar prices rose. Similarly, the International Coffee Agreement, which the United States joined in 1975, was advertised as a stabilizing device; yet, when the Brazilian frost struck in July that year, it could do nothing to prevent two years of high prices.
Even in the grain market, where CCC stocks had helped in smoothing out relatively minor fluctuations in prices during the 1960s, they were of little use when stabilizations was really needed in the mid 1970s. Indeed, in this episode it seems likely that government was in important agent of instability: first through subsidizing wheat exports in 1972 and by not moving quickly enough to dismantle production restraints, then by selling off stocks too quickly in 1973 and 1974 (it was not private speculators but our own CCC that mishandled this), then by attempts to redress the error via exports controls during the period 1973 to 1975, and finally by encouraging farmers through 1976 to believe that a new era of high prices and prosperity had dawned, thus promoting the classic cobweb cycle of overproduction in 1977. Moreover, the actions of foreign governments worked to exacerbate the instability of U.S prices, by attempting to isolate their domestic markets from world conditions of supply and demand.
The reasons for government’s failure in the area of stabilization were not that Congress and the executive branch had back luck or were incompetent. Just as with market failure, governmental failure arises from the failure, not of individuals, but institutional arrangements.
The rules for a stabilization scheme—acquisition prices, release prices, size of stocks, storage subsidies—are the outcome of a political decision process. It is difficult to observe the political scene in any detail without becoming skeptical about complex economic justifications for governmental intervention in agriculture or of congressional statements concerning the goals of farm programs which are expressed in broad social and economic terms. When we get to the bottom of it, the ends of politics are the ends of individuals as they act in the political arena—the same kinds of private and personal goals that taken for granted in the private sector.
Holy smokes! If that does not give you pause about the difficulty of stabilizing commodity markets through government programs, including buffer stock programs, then I don’t know what will. There is a reason we don’t talk about the Farmer-Owned Reserve anymore.
I highly encourage you click on over to Craig Pirrong’s takedown of the latest buffer stock program proposal from Isabella Weber and her co-authors at Streetwise Professor. His analysis is quite interesting, and he has the snark turned up to 11. You will definitely be entertained.
I wrote a post earlier this year that on what I call the “Anti-Speculation Cycle” that is (sadly) relevant to today’s post. And of course, my two books where speculation takes center stage:
Speculation By Commodity Index Funds: The Impact on Food and Energy Prices
Laurence J. Norton Chair of Agricultural Marketing
University of Illinois at Urbana-Champaign
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