The Role of Commodity Futures Markets in Promoting Climate Change Adaptation
What Can Grossman and Stiglitz teach us about Adaptation?
My news feed provides me daily climate change news. This piece has an eye catching title;
This news article discusses this technical paper.
I want to discuss the role that commodity futures markets can play in helping us to adapt to the challenges that Kornhuber et. al. claim we face.
These authors claim that our food supply faces more risk in the future than we are currently aware of. They are concerned that if we are blissfully unaware of a future food shortage then we won’t adapt and when horrible weather occurs in the future that damages crop production that poor people could starve as the price of food soars. The price of food, in the absence of storage, is set by aggregate demand and supply. If aggregate demand is rising because of growing world population and income and aggregate supply declines due to bad weather then prices rise. This research team is predicting future pain caused by bad future weather and BAD climate models.
I am an economist and I want to approach this question from the perspective of dynamic economic analysis.
In the technical article, they discuss Maize and Wheat. Let’s focus on Wheat. Suppose that Wheat Futures Markets go out 10 years into the future. This would mean that in the year 2023 that you can buy the right to purchase Wheat in the 2033 at a fixed price such as $12 (inflation adjusted) per bushel.
Suppose that in the year 2025, an entrepreneur is alerted that the price of this 2033 futures Wheat contract has sharply risen. This means that financial speculators believe that the price of wheat is going to rise in the future. Such an entrepreneur would have an incentive to ask questions and to contact experts in the field. The rising futures price acts as a “Paul Revere” early warning system that there could be future scarcity. Since such scarcity raises future commodity prices this creates a business opportunity for an entrepreneur who can devise a substitute.
My point in this column is that price dynamics for commodity futures contain valuable signals of information. As speculators become aware that past climate models were too optimistic, they trade on this information and this information becomes encoded into futures prices. These prices signal to business people new opportunities. In the world economy, there a huge number of entrepreneurs looking for new opportunities. Some of them will fail but others will succeed. The net impact on our food supply is that the successful entrepreneurs will enhance our food supply and their efforts would be triggered by rising futures prices.
The implicit tone of the science article presented above is one of “doom and gloom”.
Here is the first paragraph in their conclusion;
I respect this paragraph but they are ignoring some basic economics. If poor nations grow richer over the next decades, then even their poor people will have the income to pay more for food. As people grow richer, they spend a smaller and smaller percentage of their income on food. In a richer world, higher food prices will not cause conflict. Instead, higher food prices will make farmers richer.
So, to adapt to commodity output risk in the future, we need the world to grow richer and we need futures markets to signal rising prices to unleash food entrepreneurs to devise new ways to deliver the nutrition we need to thrive. Beans, fish and other intake can substitute for Wheat. The substitution possibilities that exist today do not have to be our future “menu” of substitutes if entrepreneurs are aware of the profit opportunities brought about by future possible wheat price spikes.
Note that in this piece, I haven’t even discussed storage technology as a way to save commodities during boom times. This is another adaptation strategy.