The source of food price swings and their effect on developing economies

Scientific Essay, 2012

17 Pages, Grade: 1,3


Table of contents

1. Introduction

2. Food price swings

3. Influence Factors to world market prices

4. Influence factors to domestic prices in developing economies - the pass-through effects

5. A five percent price increase and the effects

6. Conclusion

7. Appendix

8. Reference List

1. Introduction

In the following short paper, I am going to evaluate the economic effects of food price swings on emerging and developing economies. In recent years, we witnessed enormous increases and volatilities in commodity- and especially food prices. Concerns of starvation are therefore strengthening. These economies tend to have a high percentage of food in their standardized consumption basket, which means they spend more of their income on food in general. Since food is an essential good of living, the recent price developments over the past ten years are threatening the social stability of these economies as well as the well-being of their inhabitants. In contrast to developed economies, the population of these relatively “poor” economies is facing enormous problems feeding themselves and their children.

This paper antends to give an answer to the extend of the pass-through effects of price increases to developing economies and the driving effects of those prices.

In the first part of the paper I am going to give a short overview over recent price developments, then discuss the topic of influential factors on these prices, especially the extend which speculation has on aforementioned price inand decreases.

In the second part, I am going to eruate the pass-through effects of world food prices to developing economies as shown in the autumn study of the international monetary fund (hereinafter mentioned as IMF), namely what effect a 5% increase of food prices on international trade markets has on these economies, especially their output gap, and the foreign exchange value of the curreny. The question to evaluate will not only be how price developments are created but also how they influence the economies and social stability of developing countries.

2. Food price swings

In recent years, Food prices underwent significant volatility. As exemplified with wheat - an important cornerstone of the world population’s nourishment - prices rose to as much as 450 Dollar per ton, then collapsed about -70% to about 200 Dollar and then almost doubled back to a pre-crisis level of 400 Dollar. Similar examples could be made with millet or rice, which was traded to an all time high of 22$, then plummited to an after crisis level of 9$ and then rose back to 18$.1

The IMF statistic data, using the UN Food and Agriculture Organisation’s (FAO) index of basic food cornerstones shows that Food prices have risen dramatically since the year 2000 and have peaked before the 2008 crisis years. Current prices are 150% above the year 2000 levels, with ongoing concerns about driving forces, pushing prices to even higher limits. With the very recent late August 2011 “crash” on worldwide stock- and commodity exchange markets, commodity prices suffered large draw backs of 30% and higher, but experts expect them to rise up again in the nearer future2.

3. Influence Factors to world market prices

There are several factors influencing the prices of food commodities such as wheat or corn. Often, one or few countries produce a vast share of the world’s food production in a specific commodity. Russia for example produces a significant share of the worlds wheat production (therefore has high influence on wheat market prices).3 4 If Russia had a long draught over the summer and production suffered, world market prices could be influenced in the following. Such a development could be witnessed during enourmous bushfires during the summer of 2010 in Russia: Due to the severe damages in the landside and especially the cornfields, Russia laid a trade embargo on all wheat exports in order to ensure it’s own population’s nourishment. In effect, wheat prices rose in a short amount of time for about 75 percent. Russia contributes to about 10 percent of the overall world wheat production.5

Other often metioned factors are for instance global warming, demand pressures in emerging markets or the rising production of bio-fuel and the herefore used areas of cultivable land. Experts are off the opinion that global warming will contribute to world wide draughts and therefore leaner crop harvests. If harvests might turn out leaner, or the cultivable landscapes are used otherwise for the production of bio-fuel, these factors might be other price inflaters in the nearer future to come. In regards to demand pressure, the social luxury of eating meat is becoming more and more popular in emerging and developing economies. This might have significant effects on the wheat price in the future: About eight kilogram of wheat or corn is needed in order to produce one kilogram of meat. With more demand in meat, more wheat and corn is fed to cattle other than selling as wholefood stock.6

Since we are talking about global pricing, one might wonder how bad the last harvest came out in different regions of the world or how much the meat- demand in emerging countries fell, if suddenly, in August 2011 the majority of food commodity prices such as wheat or rices plummits, meanwhile prices of other crisis-indicating7 commodities such as gold or silver skyrocket and reach all-time highs (with gold peaking at almost 1950$ per ounce).

To tell results first; There were no draughts in all of the wheat-producing parts of the world or significant demand shifts in emerging countries, that could justify such drastic price movements as illustrated above:

For the last decade, institutional investors (namely pension funds, asset managers, investment banks etc.) discovered food commodities as a speculation object, since these speculations are “naturally” attractive, especially when given the possibility of physical assets backing up the speculation. Growing populations, demand pressures and economic expansion ensure a steady price pressure and therby making commodities an attractive speculation target. In the meantime, about 600 billion dollars have been invested at global commodity exchanges. This development was enabled by regulatory institutions in north america and europe, deregulating the future markets and enabling institutional investors - always seeking for new investment ideas - to enter these markets, before only availabe to specialized commodity brokers, traditionally in order to hedge farmer’s harvesting results in the upcoming seasons.8 Hereby, market participators (with physical assets existing or about to grow) were able to hedge and secure their profit against volatile market prices in the future. Today, an estimate of 80 percent of the future market consists of speculation with the financial future products, whereas in beforehand it only contributed about 30 percent9. With further participation of institutional investors in commodity future markets, world food commodity prices seem to have developed a correlation to world equity and stock markets.10 11 When stock and equity markets suffer pressure from meta- economical crises, institutionals seek to withdraw their colleterals from commodity speculation accounts and secure it from further price decay.


1 C.f.

2 Schruefer (2011)

3 IMF (2011)

4 FAO (2011)

5 Id. (2011)

6 This is a common trading strategy in Investment Fund strategies focusing on emerging country strategies: Investing in food commodities since more and more people can afford the luxury of diversified nutrition and meat meals.

7 Schruefer (2011)

8 Barclays Capital (2011)

9 Berg (2011)

10 Schruefer (2011)

11 Berg (2011)

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The source of food price swings and their effect on developing economies
Zeppelin University Friedrichshafen
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Food price;, commodities;, price swings;, developing countries;, price increase;, starvation;, speculation;, commodity pricing;, Influence Factors;, pass-through effects;
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Thilo Trost (Author), 2012, The source of food price swings and their effect on developing economies, Munich, GRIN Verlag,


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