Accurate market price formation model with both supply-demand and trend-following for global food prices providing policy recommendations


Cite as:

Marco Lagi, Yavni Bar-Yam, Karla Z. Bertrand, Yaneer Bar-Yam, Accurate market price formation model with both supply-demand and trend-following for global food prices providing policy recommendations. PNAS (September 26, 2015). doi: 10.1073/pnas.1413108112


The causes of rising global food prices (and the Syrian crisis)

CAMBRIDGE (Oct 26, 2015) -- The disintegration of Syria and Europe’s refugee crisis are only the latest tragic consequences of two spikes in food prices in 2007/08 and 2010/11 that triggered waves of global unrest, including the Arab Spring. Researchers at the New England Complex Systems Institute (NECSI) have traced these spikes and spiraling crises to their root causes: deregulated commodity markets, financial speculation, and a misguided U.S. corn-to-ethanol fuel policy that removes nearly 5 billion bushels of corn from markets each year. With world food prices currently in retreat, now is the time to changes policies.

In a paper published in the Proceedings of the National Academy of Sciences, NECSI researchers explain how the Arab Spring was triggered by sudden spikes in global food prices. When food becomes scarce, desperate people riot. Riots destabilized Syria and other poor countries, testing governments and sometimes leading to their fall. Many causes for the rapid rises in food prices have been suggested, but NECSI quantitatively determined that speculation caused these sharp rises in price. Additionally, the mandated conversion of corn into ethanol was linked to a steadier rise in food prices that has a serious impact on hunger worldwide.

Remarkably, the paper uses fundamental physical methods, invented for quantum field theory and developed in statistical physics and complex systems science, to determine the implications of policies intended to alleviate world hunger. This paper also provides strong validation for the role of nontraditional behavioral agents in large deviations from equilibrium market prices. This is evidence that speculation and trend following causes bubbles and crashes, a long standing controversy in economic theory.

Physical methods can be used to identify the most important behavior-affecting factors in a complex system. In this case, they point to the role of speculators and ethanol in world food prices. The fitting of actual prices to theory has a p value of 10^{-60}, and the out of sample fit is as good as many theories’ in-sample fit, p<0.001. This demonstrates the incredible accuracy that is possible for this kind of theoretical analysis of real world problems.

The ethanol mandates and the Commodities Futures Modernization Act of 2000, which allowed speculation in the commodities market, are both disastrous policy decisions that should be rolled back. However, as NECSI’s president Yaneer Bar-Yam points out, “Because of large profits for speculators and agricultural interests, a very strong social and political effort is necessary to counter the deregulation of commodities and reverse the growth of ethanol production.”

As NECSI has demonstrated, short-sighted market policies in the US sparked food riots, which triggered the Arab Spring, which destabilized Syria. The millions of internally displaced Syrians and migrants fleeing civil war and ISIS are just the latest event in a worldwide chain reaction. If nothing is done to restore stability, this will not be the last disaster.

Abstract

Recent increases in basic food prices are severely affecting vulnerable populations worldwide. Proposed causes such as shortages of grain due to adverse weather, increasing meat consumption in China and India, conversion of corn to ethanol in the United States, and investor speculation on commodity markets lead to widely differing implications for policy. A lack of clarity about which factors are responsible reinforces policy inaction. Here, for the first time to our knowledge, we construct a dynamic model that quantitatively agrees with food prices. The results show that the dominant causes of price increases are investor speculation and ethanol conversion. Models that just treat supply and demand are not consistent with the actual price dynamics. The two sharp peaks in 2007/2008 and 2010/2011 are specifically due to investor speculation, whereas an underlying upward trend is due to increasing demand from ethanol conversion. The model includes investor trend following as well as shifting between commodities, equities, and bonds to take advantage of increased expected returns. Claims that speculators cannot influence grain prices are shown to be invalid by direct analysis of price-setting practices of granaries. Both causes of price increase, speculative investment and ethanol conversion, are promoted by recent regulatory changes—deregulation of the commodity markets, and policies promoting the conversion of corn to ethanol. Rapid action is needed to reduce the impacts of the price increases on global hunger.

News Coverage

Motherboard Commodity Traders Helped Spark the War in Syria, Complex Systems Theorists Say
by Brian Merchant
Physorg The role of food prices in the Syrian crisis, and the way forward
Homeland Security News Wire Syria’s civil war, Europe’s refugee crisis the result of spikes in food prices: Experts




Food prices and model simulations - The FAO Food Price Index (blue solid line), the ethanol supply and demand model (blue dashed line), where dominant supply shocks are due to the conversion of corn to ethanol so that price changes are proportional to ethanol production and the results of the speculator and ethanol model (green and red dotted lines), that adds speculator trend following and switching among investment markets, including commodities, equities and bonds. The green curve is fit till March 2011 (vertical blue bar), the red curve is fit till Jan 2012. Thus the matching of the former to data after March 2011 is an out of sample fit.

 

 

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