Volatile conditions in the world wheat market in the 1970s have revived interest in the subject of wheat price stability. Real wheat prices declined steadily after 1946, and by 1970 prices were as low as at any time in this century except for the trough of the Great Depression in 1932.' Prices began to rise in 1971, and they reached their post-war peak in the crop year 1973-74. Since then they have declined, and by the middle of 1977 they hovered near their 1932 level ($1.20 per bushel in terms of 1967 dollars). Several explanations of this episode in the history of wheat prices have been offered, and we have emphasized the importance of government trade policies that attempted to insulate domestic markets from foreign disturbances (Johnson, Grennes, Thursby; see also D. Gale Johnson, Josling). Other interpretations stressed the inadequacy of grain reserves, and recently several world grain reserve plans have been proposed to attenuate future price instability. The U.S. government proposal calls for a reserve of 25 million tons of wheat, a number which emerges from several other proposals as well. For a discussion of some of the plans see Warley, Trezise, Eaton and Steele, and Sarris, Abbott, Taylor. The level of inventories and the volume of international trade are not unrelated (Johnson and Sumner), and the purpose of this study is to carry out a quantitative investigation of that relationship. Our analytical framework will be a World Wheat Trade Model which we have employed to study related problems (Johnson, Grennes, Thursby), and we will apply it to the circumstances of 197374). Because of the downward pressure on wheat prices since World War II, the major policy problem in the wheat exporting countries before 1972 was how to avoid lower prices and larger inventories. The United States and Canada acquired large inventories as a result of their price support programs, and at times these stocks were larger than a year's wheat production. Two effects of these large-scale government stock operations were (1) to reduce price variability around a declining trend and (2) to reduce the profitability of inventory holding by private firms and other governments. Eventually, the considerable expense of this policy led to an effort to deplete inventories by production controls and export promotion. At a time when the United States was aggressively giving wheat away to some countries and subsidizing commercial exports to other countries, several events, beginning in 1972, brought about a reversal of world market conditions from surplus to shortage. A small world wheat crop in 1972-73 plus a decision by the USSR to respond to a small domestic crop by resorting to imports resulted in the first substantial increase in the real wheat price since 1947. In spite of a record world crop the next year and a substantial reduction in Soviet imports, wheat prices doubled in 1973-74. Prices were destabilized in the United States in 1973-74 by trade policies in other countries that attempted to insulate domestic markets from conditions in foreign markets. Specifically, in importing countries such as Japan and the European Economic Community, tariffs were lowered, and in exporting countries such as Canada, Australia, and Argentina, foreign sales were discouraged. Notice that insulation does not refer to the level of protection as measured by a tariff or an export tax. It consists of changing the level of protection in response to a change in the foreign price, so as to hold the domestic price constant. Thus, an insulating trade policy involves decreasing the protection received by domestic producers when the world price increases, and increasing protection when the world price decreases. This result is automatically achieved by the EEC variable import levy; and, earlier, the English Corn Laws achieved some automatic insulation by employing both a variable tariff and a variable export bounty (Haberler). Perfect insulation is accomplished when the domestic price is held constant and the effective import demand becomes perfectly inelastic. The World Wheat Trade Model employed here (Grennes, Johnson, Thursby, chap. 4, and Johnson, Grennes, Thursby) takes both production and inventories as exogenous variables,2 and it distinThomas Grennes is an assistant professor in the Department of Economics and Business and Paul R. Johnson is a professor in the Department of Economics, School of Agriculture and Life Sciences, at North Carolina State University, Raleigh. Marie Thursby is an assistant professor of economics at Syracuse University. Paper 5204 of the Journal Series of the North Carolina Agricultural Experiment Station, Raleigh. SFor a discussion of the history of U.S. wheat prices in this century, see Grennes, Johnson, and Thursby, chap. 1. 2 We do not offer a positive theory of the behavior of wheat inventories nor have we seen a satisfactory one. We have also avoided the issue of optimal inventories (see Gustafson, Johnson, and Sumner). Our contribution is the modest one of specifying the implications for trade and prices of alternative exogenous inventory policies.