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Solving world hunger with forward contracts [Agriculture
Posted on March 28, 2013 @ 09:02:00 AM by Paul Meagher

When we think about solving the problem of world hunger, one solution that might come to mind is sending more food aid to nations unable to feed their populations. This may help to address the immediate problem but does not solve the longer term problem of ensuring that these nations can feed themselves; in fact, it can be detrimental to that goal (e.g., flooding these nations with cheap food aid and wiping out local farmers who can't compete).

Another way to solve the problem of world hunger that is gaining momentum is to develop a forward contracts market for farmers. According to Wikipedia:

A forward contract or simply a forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed upon today. This is in contrast to a spot contract, which is an agreement to buy or sell an asset today. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position. The price agreed upon is called the delivery price, which is equal to the forward price at the time the contract is entered into.

In North America we are probably under the impression that the reason we have an abundance of food is because we are able to grow a lot of food. That is true, but another key element in the equation is that farmers have a forward contracts market for the food they produce that helps to take some of the risk out of growing food and inspire enough confidence to buy the inputs and equipment necessary to grow food. The raison d'etre for the Chicago Commodities Exchange is to offer this risk-management service to farmers.

Even at a smaller scale we see forward contracts happening in Community Support Agriculture where a farmer asks that subscribers agree to pay a price ahead of time for the produce that they will produce or jointly-produce over the course of a season. These forward contracts are often flexible in the sense that if a farmer has a rough year, subscribers will generally agree to pay the subscription fee even if the amount of produce received does not live up to expectations - we are in this together through good times and bad. As long as the farmer put in an honest effort, planted the right amount of seed, worked the land, and did her share, then if conditions beyond their control transpired to reduce yield we are generally sympathetic enough to honor our subscription fee pledge. One wonders if the forward contract markets for hungry nations will be similarly forgiving.

The effort to solve the world hunger problem in this way is being spearheaded by the largest food-relief agency in the world, the World Food Program (WFP), which has a 6 billion-a-year budget (see Purchase For Progress). In addition, Bill Gates and Warren Buffet are offering their money and expertise to the cause of developing a forward contracts market for farmers. It is interesting to reflect upon the idea that the most powerful tool we have at our disposal to tackle world hunger may be a financial concept, the concept of a forward contract and setting up commodity exchanges in developing countries to make them work better.

To learn more about the role of finance in solving world hunger, I'd recommend the book I'm currently reading called Bet The Farm: How Food STOPPED being Food, 2012, by Howard Kaufman. Here you will also learn about the dangers of a market-based approach to solving world hunger, the dangers that speculators and derivatives pose to the proper functioning of such markets.

As you eat your Easter meal this weekend, you might reflect upon the role of forward contracts in making this bounty available, whether forward contracts are indeed part of the solution to world hunger and, if so, how they should be structured to work as effectively as possible.

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