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Placing the 2006/08 Commodity Price Boom into Perspective

John Baffes's picture

The 2006-08 commodity price boom was one of the longest and broadest of the post-WWII period. The price boom emerged in the mid-2000s after nearly three decades of low and declining commodity prices (see figure). The long-term decline in real prices had been especially marked in food and agriculture. Between 1975-76 and 2000-01, world food prices declined by 53 percent in real US-dollar terms. Such price declines raised concerns, especially with regard to the welfare of poor agricultural producers. In fact, one of the Doha Round’s chief motives (and also one of its perceived main obstacles) was the reduction of agricultural support and trade barriers in high-income countries—a set of reforms that was expected to induce increases in commodity prices and hence improve the welfare of low-income commodity producers. Starting in the mid-2000s, however, most commodity prices reversed their downward course, eventually leading to an unprecedented commodity price boom.

Source: World Bank, Development Prospects Group

Between 2003 and 2008, nominal prices of energy and metals increased by 230 percent, those of food and precious metals doubled, and those of fertilizers increased fourfold. The boom reached its zenith in July 2008, when crude oil prices averaged US$ 133/barrel, up 94 percent from a year earlier. Rice prices doubled within just five months of 2008, from US$ 375/ton in January to $757/ton in June. The price surge led to a various heated debates on its causes and its consequences, including the role of biofuels, speculation, policy reactions, and, most importantly, whether high agricultural prices are beneficial or harmful to the poor. A paper we just published* revisits the causes of the boom and reaches a number of interesting conclusions. The paper is part of a larger project that examines the issue high food prices and poverty. Key results of the project will be published soon in a book edited by Ataman Aksoy and Bernard Hoekman, Food Prices and Rural Poverty,Center of Economic and Policy Research, 2010.

Apart from strong and sustained economic growth, the price boom was fueled by numerous factors including low past investment in extractive commodities, weak dollar, fiscal expansion and lax monetary policy in many countries, and investment fund activity. On the other hand, the combination of adverse weather conditions, the diversion of some food commodities to the production of biofuels, and government policies (including export bans and prohibitive taxes) brought global stocks of many food commodities down to levels not seen since the early 1970s, created a "perfect storm" further accelerating the price increases that eventually led to the 2008 rally. The weakening and/or reversal of these factors coupled with the financial crisis that erupted in September 2008 and the subsequent global economic downturn, induced sharp price declines across most commodity sectors. Yet, the main price indices are still twice as high compared to their 2000 real levels, begging once more the question about the real factors affecting them.

The paper concludes that a stronger link between energy and non-energy commodity prices has been the dominant factor in the boom of agricultural and food prices, and is likely to be the dominant influence on developments in commodity, and especially food, markets. The analysis shows that demand by emerging economies, often cited as a key factor behind the food price surge of 2008, in fact it was much less of a factor than is often sited. The paper also argues that the effect of biofuels on food prices has not been as large as originally thought. On the other hand, the use of commodities by financial investors (the so-called ‘financialization of commodities’) may have been partly responsible for the 2007/08 spike. Finally, econometric analysis of the long-term evolution of commodity prices supports the view that price variability overwhelms price trends. This conclusion implies that suggested policy actions essentially aiming to alleviate the impacts of price spikes on developing countries through reliance on some level of buffer stocks (whether physical or virtual) risk resproducing the failure of previous collective measures designed to prevent the decline or reduce the variability of prices.

* - The paper has been co-authored by John Baffes and Tassos Haniotis


Submitted by Boussard on
Interesting contribution: How can we found the original article (the link is not responding !) ? Regarding agricultural commodities, I am pretty sure financialization did not play a large role in the price surge. See "Should agriculture be liberalized?" Science publishers, Enfield (NH) , by J.M. Boussard, F. Gerard ans MG Piketty : the whole story had been fairly well reproduced in 2005 by a recursive MCEG model starting from the GTAP 2001 data base. The model was deprived from any speculation submodel, which means that speculation was not necessary in order to explain what happenned. Actually, the lesson of the model is that the whole thing can be explained from the fact that world prices had been extreemely low during the last ten years before 2006. As a consequence, farmers did not invest. It was not apparent as long as public stocks existed. But when the public stocks were exhausted, the surge occured...Thus, it is a mere classical cobweb phenomenon... I am bound to suppose a similar mechanism is at work with petrol...

Indeed, low stocks have been important. But, the recent boom was a result of a "perfect storm", hence most of the 10 or so factors can be assigned the "blame" of being the key factor. (When the boat sinks, is it the last ("marginal") person that causes it to go down?) In fact, a quick look at the literature shows that at least five of these factors have received the blame as being the single most important cause of the boom (biofuels, low stocks, speculation, excess liquidity, demand by China/India).

Submitted by walt on
I find that the link to the paper has been corrected. I find Boussard's comment premature in that he hasn't read the paper. He should run his model on the current data and show the results here.

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