ASEAN and Global Economic Situation: Foods Security and Financial Market

Introduction

There have been several crises hitting the world economy, one of which has been on Asia, especially East Asia. The severest crisis in the previous century was the well known The Great Depression in 1930s. The newest one in the 21st century was in 2008-09 which is now dubbed The Great Recession. Another crisis in Asia was in 1997, started by the Baht Crisis in July 2nd in Thailand, triggering the fall of the Baht currency. It has been followed by the contagion effects to other countries in East Asia, but saved several strong economies like the PRC, Japan, and so on. But the hardest hit by the crisis was Indonesia, where the local currency has been depreciated around 80-85 percent. The currencies of other countries in the region fell between 30-40 percent in value.

Other countries in the region were not so severely hit compared to Indonesia. It has been a nightmare for the country, both for the government and business sectors as well. Unfortunately for Indonesia the economic crisis was exacerbated by the harvest failure due to a severe drought and then followed by region-wide haze. The financial crisis was followed by an economic crisis, completed by political crisis. Student protests appeared against the long ruling Suharto, which was considered as an authoritarian president and in October 1998 Suharto was forced to withdraw from the presidency. The other countries in the region did experience economic crises, but it was not accompanied by a political crisis as it happened in Indonesia.

The global crises in 2008 originated in the United States, triggered by the so called sub-prime mortgages, a low quality loans in housing sector. But the impacts were global, contagion effects, and the ASEAN and other East Asian countries could not escape from negative effects. This time, the impacts were different from country to country. Indonesia, after gaining experiences from the 1997 financial crises, has been avoiding borrowing the foreign exchange as much as it was in 1997, especially the private sector. And as a blessings in disguise, the prices of primary sector products from mining and agricultures in 2008 were much higher in dollar and then in local currency. Indonesia is luckily rich in several natural resources and agricultural products. This must be different for countries where their products to be exported are mostly or dominated by the manufacture products, namely Singapore, and to some extent also Thailand and Malaysia.

The 1997 with its severe impacts on the exchange rate of the currency has triggered the countries in the region to seek an aggressive export, where one of the objectives is to provide sufficient foreign currency reserves when needed at the time of crisis. In most cases the strategy was successful, the region has been amassing a substantial amount of the dollars specifically, and PRC has been leading in that effort, accumulating more than 2 trillion dollars in its foreign currency reserves. It has its own deficiency, because the export-led development strategy was the roots of the global imbalance, suspected to be one of the trigger of the latest global financial crisis.

The Global Context of the Crises

The globalization process has been perceived differently from several points of view. The strong supporters have been stressing the positive effects, both in trade and finance. Trade is expected to boost specialization in production, following the thesis of Adam Smith, which further will be taking benefits from the exploitation of economies of scale. In finance it is slated to bring about global investments opportunities, searching for the highest return to every dollar spent. The global dimension of investment is expected to raise the global economic growth. Such have been the claims of its supporter.

From the other side, the contenders of globalization revealed the facts on the negative impacts of the globalization, in the form of rising inequalities of income and wealth, either inside any country or between one country to the other, especially between the advanced and less developing country. Globalization has been accused to be the source of the crises in economic and finance, and the labor force has been considered the same as the other factors of production. This point of view is in contrasts to the encyclical of the Popes, from Rerum Novarum to the latest one, Caritas in Veritate. The latest encyclical has been very critical to the increasing role of finance in the global economy.

One of the highly criticized roles of globalization is the commoditization of many food stuffs, like rice, corn, CPO, natural rubber and so on. The negative role of speculation in raising the prices of many food stuffs has been far out-weighting its stated positive role to stabilize prices. The stabilizing role of speculation has been seen as only a textbook case, but not in real life. The latest phenomenon of the financial market is the use of the HFT (High Frequency Trading). In 2010, around 70 percent of the transactions in the Wall Street were conducted by the HFT system. The HFT is used so, where in the morning, the agents invested their funds, but in the afternoon, it have been totally disinvested. It means that net investment at the end of the day is zero. But through its programmed trading in the market, the HFT could get a lot of money in the range of ten or even hundred thousand dollar, without real work in the sense of Laborem Excersens. A recent event was that of Knight Funds experiencing a loss of 400 million dollar as a cumulative result of the programmed trading for several times, where its program was in fact wrong. But in general the HFT has been resulting positively, capable of amassing a lot of profits, without real sense of investment. It is really a casino economy as Keynes wrote.

The problem here is that the so called investment is done in a very short time, which could be in a time span of one or several microsecond, or even less than one microsecond. What does investment mean now? Our usual understanding of investment is buying an asset or production system with a purpose to produce goods and or services. For that the assets are put in operation by producing and then selling goods or services, and then get the revenue cumulatively during a span of time or years of operation. The revenue is the result of real act of investment, employing labors and using raw materials as inputs in the production activities. Unfortunately the financial market has revolutionized or changed this normal operation of the investment. The question is whether this is a good thing for the world economy and the people in general. The question is further posed on whether there are other negative consequences of the new financial revolution.

One of the negative consequences of this development could be the lack of investment in the real sectors, namely in the food sectors. The high potential of very quick yielding from HFT has shifted the interest of investors from investing in real assets into financial assets. From the other side, the investment in financial assets could be resulting in the amount of paper demand for one commodity several times higher than the real available physical commodity in the market. Based on the law of supply and demand, if demand [virtual] is higher than supply, the price will rise. In spite of the virtual demand, the price is affected to rise, even though the real demand is lower than that. It means there were negative effects of financial assets in raising the prices of the commodities itself. Virtual demands originating from financial instruments’ generated demand are suspected to be manipulated always to be higher than the physical supply. In reality real supply could be higher than real demand, and normally the market prices should go down. But not here.

The World Facing Scarcities

The thesis of Thomas Robert Malthus on the insufficiency of foods for nourishing the world population on earth would lead to global food crisis. Luckily, the arrival of green revolution has seemed invalidating the prediction of Malthus. But it will not be so in the coming decades. The high predicted global population, the absence of new potential for agricultural breakthrough as it was in the green revolution has augured a probable crisis, if nothing is done to prevent them. The Club of Rome study has also predicted the lack of raw materials from natural resources for producing goods needed to cope with the rising demand supporting the life style of world population. This is especially true for non-renewable natural resources, like iron ore, coal, crude oil, natural gases, cobalt, and so on. But some of the renewable resources, namely food, will be limited due to unavailability of new arable land to enlarge the production area and/or the limited productivity of those existing foods agriculture technology.

Moeller [2010] identified several resources that will limit the world economic growth in the future. The resources are: foods, industrial raw materials, energy, water, and clean environment. Foods and water are fundamental necessities for living, without which there will be no human life in the world, existential threat for humanity as a whole. Water becomes crucially scarce because there is a conflict between household use of water and agricultural use, which could be in tandem with electricity generation. Prices become crucial because there is divergence between the social with the private price. In most cases the market prices are less than the social price, entailing to incorrect relative prices of the products in the society, which leads to social inefficiencies of the economic system. The non renewable resources will be diminishing, and the relative prices should be reflecting these tendency. In order to keep the economic system maintains its service function in a sustainable way, the recycling process of those materials should be part of the economic productive system. Or there should be a revision of consumption, based on the facts that all resources are now limited. The old consumption based on the abundant natural resources should be changed into the new reality, a scarcity paradigm. The new paradigm should be based on effectiveness, efficiency and sufficiency on consumption.

Food Prices and Investment in Food

Since the beginning of the Great Recession of 2009, there has been an important rise and fall in the food prices. In a longer perspective, the figure 1 shows the development of food price volatility since 1990, with a rising trend. Such volatility incites the financial institution to offer a hedge instrument to cope with the situation:

«In 2010 alone, food prices rose by one-third, causing an additional 40 million people to plunge into absolute poverty. There was another record high: by the end of March 2011, capital investors like insurance companies and pension funds had invested 600 billion dollars in bets on commodities, including corn and wheat, in the form of securities launched by investment banks and hedge funds.» [FoodWatch Report 2011]

But the hedge securities were deflected into new instruments for speculation, which were then known as new investment opportunities. From a protective financial instrument it has been transformed into a new investment security. What is more, as was stated in other part of this paper, this kind of investment was not intended for increasing the production of physical foods, but only as an investment in financial securities. As a matter of facts, that kind of investment in the commodities-backed securities, are mostly bets, where it did comprise foods. The originator of those commodities-backed securities was the well known investment bank Goldman Sachs in 1990. It created an index named the Goldman Sachs Commodity Index (GSCI), which was a derivative instrument, especially the future contract. Originally future contract was intended to stabilize the agriculture products that are deeply influenced by the highly irregular weather situation. The new GSCI instrument was certainly far from a stabilizing instrument but a speculation vehicle on commodities in general, including foods. Another well known institution dealing with the derivative on commodities are the Deutsche Bank, Morgan Stanley, Shell, BP, Cargill, Bunge, and ADM have been taking part in this highly remunerative speculation.

By paying more attention to Figure 1, it is clear that the meat products are more stable than other products, especially compared to sugar. The less volatility of meat is suspected to be in relation to its highly perishable characteristic if kept without preservative stuffs in inventory longer than certain period of time, while other foods are less perishable when retained in longer time period. The most volatile stuffs are sugar, then oil and followed by dairy products. But for the four food products, their volatilities in the year 2009 were much higher than they were before 2007. An analysis of volatility comparing individual decades within the 50-year period, revealed that price volatility in the recent period of 2006-10 was higher than in that in the nineteen nineties [OECD, Huchet-Bourdon, M. (2011)]. One question comes up as a consequence of this development. If the role of hedge instrument was limited to the protective measures, why the volatilities of the prices of those commodities were rising? The terminology volatility is understood as the variation, both in amplitude and frequency of commodity prices around its average value. Either a high displacement from its mean value and/or the high frequency of the variation occurrence, constitute a high volatility. As such, the concept is different from the usual statistical measure, namely standard deviation. The additional component in the volatility concept is the frequency of the occurrence. One wanders as to which of the market characteristics that contribute to the frequency of the occurrence. The writer is of the opinion, that speculation takes part in that process.

Figure 1. International food price volatility by food group (1990−2010)

Source: FAO

From another report of the OECD in 2009, we can present one of the results of their study on the issue of historical agricultural price volatility, which joined the previous conclusion, especially the suspected role of speculation on that matter.

«A frequent culprit of increased price volatility is “speculation” based on investing in futures contracts on commodity markets to profit from price fluctuations. … The likely explanation of price increases since the beginning of 2007 to mid-2008 seems to be a combination of economic fundamentals and factors specific to the financial markets, which might have amplified price changes.» [EC, Directorate General for Agriculture and Rural Development, Historical Price Volatility, 16/07/2009, p. 9]

The global context of food situation is exacerbated by the entry of the financial system to the food market, which was before 1990 was not so intensely taken into consideration by the capital market. There is no relation between the action of the supply and demand of the financial market instrument with and the supply and demand in the physical food market reality. The latest information shows that the financial paper demands for some foods are several times the supply-demand of the physical food commodities.

Food Cooperation in ASEAN

Food problems in ASEAN have been considered as one of the important problems for the region. As a consequence of that, the food issues have entered the organization’s list of priorities. The following facts reveal that.

  • In 1968 the food production and supply cooperation was instituted,
  • In 1979, there was Agreement on the ASEAN Food Security Reserve,
  • In 1993 there was Ministerial Understanding (MU), identifying 7 (seven) priority areas, including food,
  • In 2008, there was ASEAN Summit, where the ASEAN Integrated Food Security Framework and Strategic Plan of Action on Food Security were constituted for 2009-2013.

Seeing the development of the latest global food market, where the financial institutions become an active and important player in the sector, the ASEAN organization’s agility to the issue was highly appreciable and respectable. The ensuing agreements on the issue of food security were the reflection of their prophetic insights to that fundamental challenge of food scarcity for human life. In a report to the US Congress in 2008, we can extract the next passage on the severity of the price hikes in a short period of times, 2007-2008.

«Since late 2007, U.S. and international markets for major grains and oilseeds have experienced a period of tight supplies, strong demand, and high prices not seen since the mid-1990s (…) While agricultural commodity prices rose sharply during 2007, they jumped precipitously in early 2008. For example, export prices for the world’s two major food crops — wheat and rice, rose by 81% and 21%, respectively, during 2007, but have surged even higher in early 2008. Wheat prices (HRW No. 2, f.o.b., U.S. Gulf ports) rose 44% between November 2007 and March 2008 — rising from $334.6 per ton to $481.5 — before falling back in April and May.1 Rice export prices (100% Grade B, f.o.b. Bangkok) have more than doubled since November 2007, rising from $358.3 per ton to $1,020 in late May 2008 — an increase of nearly 185%.» [Randy Schnepf (2008) High Agricultural Commodity Prices: What Are the Issues?, CRS]

The previous citation shows how the volatility of prices of certain commodities was in the tumultuous period 2007-2008. Wheat and rice rose by 81 and 21 percent respectively in the year of 2007 alone. Then it was followed by a rise of 44 and 185 percent for wheat and rice in the period of November 2007 and March 2008. Rice is a staple food for most of population of the region, where a significant part of them is still in a poverty situation. What a nightmare. It is sure that a higher portion of the population became falling into a more impoverished life.  As it is seen in the passage, the fob price of rice in Bangkok has risen 21 percent in 2007, and then another 185 percent the next period till May 2008.

Figure 2. U.S. Season Average Farm Prices for Corn, Soybeans, Wheat, and Rice: 1960/1961 to 2008/2009

Source: CRS report, previously cited.
            The 1997 crisis was also accompanied by drought, entailing a scarcer food situation. The recurrence of severe price hikes of its staple food in a time period of ten years, is a warning sign to food price issue in the region. The number of population in the region is more than half a billion persons.  the price hikes of its staple food happened again is a warning sign that the food problem has to be taken into consideration more sincerely.

Table 1. Paddy production in ASEAN countries, 2008-2010

Source: ASEAN Commodity Outlook, 2010 in http://afsis.oae.go.th accessed November 10 2012

From table 1 it is observable that the regional production in the year of 2009 and 2010 was more than sufficient to cover the domestic demand. In spite of that the ASEAN Integrated Food Security Framework and Strategic Plan of Action on Food Security has to act more aggressively and creatively, in an effort to provide foods for world population. Nonetheless it is clear that the regional food situation is different from one country to the other. The difference in the food production could lead to the comparative advantage of the countries in ASEAN in rice production, entailing several countries to be specialized in paddy cultivation, while the other countries will be doing other agricultural products.

Table 2. Paddy yields in ASEAN countries, 2008-2010

Source: ASEAN Commodity Outlook, 2010 in http://afsis.oae.go.th accessed November 10 2012

Table 2 shows, that Indonesia and Vietnam are two countries that well placed in rice production, while the paddy yields in the two countries are higher than the ASEAN mean. Of course there should be other consideration to taken into account, namely the sufficient availability and suitability of land for paddy cultivation to produce more rice. The less paddy yield in ASEAN is in Brunei, namely 1.29 ton/HA in 2009, and 2.16 ton/HA in 2010. There is an improvement in yield, but it is still far below the other countries.

The following table 3 shows the comparison of physical productivity of five products, namely rice, soybean, maize, sugarcane, and cassava. Rice or paddy as it was before, the two most productive countries are Vietnam and Indonesia; soybean, two most productive countries are Thailand and Camboja; maize is for Malaysia and Lao; sugarcane is for Thailand and Vietnam; cassava is for Lao and Camboja.

Source: ASEAN Food Security Information System.

Another factor that has to be taken into consideration is the occurrence of drought which will reduce the crops in any country, and it is not predictable. The case of drought in 1997 in Indonesia for example was a case in point. Here the Agreement on the ASEAN Food Security Reserve in 1993 should come to the rescue and play a decisive role for maintaining the continuous supply of foods in the region. The negative effects of the global climate change should be a push factor to the preparation of defense system, and the Agreement in 1993 should be empowered by providing an analytical power group within ASEAN. Such an institution should build a global network for preparing a world action against fatal impacts of the global climate change and predicting its time of arrival. How is the potential change in the foods productivity in conjunction with the global climate change? And which kind of foods will be the most negatively affected in each country of the region? Where will the potential decrease in productivity and where will the potential increase in productivity due to rising intensity of carbon dioxide?

ASEAN Food Security

As a response to the food crisis in 2008, the member countries discussed the concept of ASEAN Integrated Food Security (AIFS) Framework in Chiang Mai. To concretize the concept, it is constituted a Strategic Plan of Action on Food Security (SPA-FS). As a starting point, the following definition is adopted:

Food security exists when all people, at all times, have physical and economic access to sufficient, safe and nutritious food that meets their dietary needs and food preferences for an active and healthy life. (World Food Summit, 1996, cited in AIFS, 2009-2013).

There are three dimensions of Food Security: Availability, Accessibility and Utilization.

Food availability: The availability of sufficient quantities of food of appropriate

quality, supplied through domestic production and/ or imports (including food aid).

Food accessibility: Access by individuals to adequate resources (entitlements) for

acquiring appropriate foods for a nutritious diet. Entitlements are defined as the set of

all commodity bundles over which a person can establish command given the legal, political, economic and social arrangements of the community in which they live (including traditional rights such as access to common resources).

Utilization: Utilization of food through adequate diet, clean water, sanitation and health care to reach a state of nutritional well-being where all physiological needs are met. This brings out the importance of non-food inputs in food security. (AIFS website)

The AIFS Framework consists of four components, and further supported by six strategic thrusts. The four components and the six strategic thrusts are as follows (AIFS website):

Component 1: Food Security and Emergency/ Shortage Relief

Strategic Thrust 1: Strengthen Food Security Arrangements.

Component 2: Sustainable Food Trade Development

Strategic Thrust 2: Promote Conducive Food Market and Trade

Component 3: Integrated Food Security Information System

Strategic Thrust 3: Strengthen Integrated Food Security Information Systems to

Effectively Forecast, Plan and Monitor Supplies and Utilization for Basic Food

Commodities

Component 4: Agricultural Innovation

Strategic Thrust 4: Promote Sustainable Food Production

Strategic Thrust 5: Encourage Greater Investment in Food and Agro-based

Industry to Enhance Food Security

Strategic Thrust 6: Identify and Address Emerging Issues Related to Food

Security

It is clearly seen that the AIFS Framework does not consider the potential negative impacts of the latest development of financial intrusion into the commodity market that comprise food market. As was discussed before the negative role of the agricultural commodities contracts have been raising the food prices in the market, because the agents are only playing the virtual demand with an amount higher than the physical supply. The G-20 summit last June made a commitment to introduce so-called “position limits” which cap the number of agricultural commodities contracts any one investor can buy, but as yet no country, apart from the United States, has adopted these. In this respect, Indonesia as a member of G-20 should play a more important role to reduce the highly influential of the investment banks and funds in the agricultural commodities market.

Food Farming Sizes in View of Efficiency

One of the widespread use of economic concepts is the economies of scale, which says that the bigger the size of the activities, equivalent to the size of the corporation, the higher its productivity. But the research of Amartya Sen in his country of origin showed that for people agriculture, which is could be interpreted as small holder agriculture, that law is not valid. The conclusion of his research said that the larger the size of the farming, the less its productivity. The same conclusion was obtained by other researchers, but is not presented here. Clearly, the law of economies of scale is contradicted in agriculture, producing staple food product in the region. These facts should invite a different policy for the people agriculture, necessitating an appropriate land reform policy, facilitating the small size farming. This should be in line with the MDG to eradicate poverty, because most of the poor people are engaged in agriculture.

Table 4 Production Value per acre in Rupe according to land size and mode of exploitation: West Bengal
Size of exploitation (acre) Pure Ownership (Rs/acre) Agriculture: Partly Production Sharing
Total Productivity (Rs/acre) Productivity on his own land (Rs/acre) Productivity on Production Sharing (Rs/acre)
0 – 3 1313 798 867 604
 3 – 5 1044 909 1099 709
 5 – 8 960 842 1130 676
 8 – 12 691 843 959 604
12+ 624
All 902 851 1047 658
Source: Sen [1981: Tab 2] cited in Debraj Ray Developmental Economics [1998: Table 12.5], p. 454
Two last groups of land size were regrouped due to lack of data

One of the lessons from the United States in the domain of agriculture is the fact that there are nine States in the Mid-West region where corporation farming were not allowed. The only form of farming activity is family farming. The writer is ignorant about the arguments behind that situation; whether the 9 States in the US were based on the same insights of the nature of farming or it was based on different arguments.

One lesson from table 4 is the conclusion that the productivity for production sharing is lower than when people work in their own land. This is in line with the theoretical prediction in development economics, that the productivity of the farmers is higher if they work on their own land. But it could be otherwise interpreted, that his productivity is higher when the fruit of his effort belongs to him, not shared with other person, namely to the land-owner in case of production sharing. It has a vast consequence for land reform politic, where the state authorizes farmers to work on state land without sharing products. Basing on the previous productivity data, it is expected that the foods products will be more abundant than if it was conducted through corporation farming.

 

Appendixes

Apendix table 1. Paddy production in ASEAN, 2008-2010

Source: ASEAN Commodity Outlook, 2010 in http://afsis.oae.go.th accessed November 10 2012

Appendix table 2. Rice balance sheet of ASEAN countries, 2009 (milled rice)

: ASEAN Commodity Outlook, 2010 in http://afsis.oae.go.th accessed November 10 2012

Additonal citation related to speculation issues:

HOW GSCI OPERATE (GSCI was created in 1991; new deregulation 1999, where future contract was without limit)

« But Goldman’s index perverted the symmetry of this system. The structure of the GSCI paid no heed to the centuries-old buy-sell/sell-buy patterns. This newfangled derivative product was “long only,” which meant the product was constructed to buy commodities, and only buy. At the bottom of this “long-only” strategy lay an intent to transform an investment in commodities (previously the purview of specialists) into something that looked a great deal like an investment in a stock — the kind of asset class wherein anyone could park their money and let it accrue for decades (along the lines of General Electric or Apple). Once the commodity market had been made to look more like the stock market, bankers could expect new influxes of ready cash. But the long-only strategy possessed a flaw, at least for those of us who eat. The GSCI did not include a mechanism to sell or “short” a commodity.

This imbalance undermined the innate structure of the commodities markets, requiring bankers to buy and keep buying — no matter what the price. Every time the due date of a longonly commodity index futures contract neared, bankers were required to “roll” their multi-billion dollar backlog of buy orders over into the next futures contract, two or three months down the line. And since the deflationary impact of shorting a position simply wasn’t part of the GSCI, professional grain traders could make a killing by anticipating the market fluctuations these “rolls” would inevitably cause. “I make a living off the dumb money,” commodity trader Emil van Essen told Businessweek last year. Commodity traders employed by the banks that had created the commodity index funds in the first place rode the tides of profit. » [Frederick Kaufman: “How Goldman Sachs Created the Food Crisis” 21 April 2011]

Jayati Ghosh, professor of economics at Jawaharlal Nehru University in New Delhi, was one of 450 economists who last year called on the G20 to regulate the commodities market. She says that, although factors such as biofuels are important, speculation is now another “driving force” behind price hikes. She cites the example of world wheat prices doubling between June and December 2010, even though there was no fall in the global supply of wheat. Grace Livingstone : “The real hunger games: How banks gamble on food prices – and the poor lose out”, April 01, 2012. The G20 summit last June made a commitment to introduce so-called “position limits” which cap the number of agricultural commodities contracts any one investor can buy, but as yet no country, apart from the United States, has adopted these. … Christine Haigh, a campaigner from the World Development Movement, says the EU’s proposals “need more teeth”, but there is “still all to play for”. The WDM is particularly concerned that Britain is advocating a weaker form of regulation known as “position management”, rather than strict caps. … At present, 82 per cent of trading in the European commodities market is “over-the-counter” – private deals made between two parties that are not registered on any exchange. This makes it impossible to see what’s driving the price changes.

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