Massive bank and hedge fund speculation causes food prices to soar
The recent steep rise in wheat prices has raised fears of another global food crisis. As Tim Jones explains, it is the banks and hedge funds speculating on the price of food that are primarily responsible for this spike in prices.
IN just one month in July 2010, the price of wheat increased by 60%. The huge increase in the price has already led to people across the world paying more for the staple food. The sudden change in the price of wheat has had knock-on effects on other crops. The global maize price increased by 40% between the start of July and the end of August.
the end of August, demonstrations against rising food and fuel prices
were held in
and the consequent fall in
real reason for the large and rapid increase in wheat price lay in banks
trading in exchanges in
The ugly face of banks and hedge funds speculating on the price of food had raised its head once again.
Speculation in derivatives
speculation in food began in the 1800s when so-called 'futures contracts'
were created for agricultural products traded in the
in the early 1900s futures contracts started to be bought and sold by
financial speculators who had nothing to do with the physical production,
processing or retailing of food. This activity began to affect the actual
prices of foodstuffs, causing them to become more volatile and to rise
and fall more sharply. Following the Wall Street crash, the Roosevelt
government in the
In the 1990s and early 2000s these regulations were weakened in the face of intense lobbying by the financial industry. For instance, in 1991 lobbying by Goldman Sachs exempted many commodity speculators from the limits on trading created in the 1930s. At the same time, new and more complicated contracts, collectively known as derivatives, were created based on the price of food. Derivatives in food, just as in property and shares, expanded massively. Further deregulation in 2000 exempted many commodity derivatives from any regulation at all.
number of derivatives contracts in commodities increased by more than
500% between 2002 and mid-2008. The
From early 2007 to the middle of 2008 there was a huge spike in food prices. Over the period there was more than an 80% increase in the price of wheat on world markets. The price of maize similarly shot up by almost 90%. Prices then fell rapidly in a matter of weeks in the second half of 2008. There are various reasons to explain a general increase in food prices over this time. But only financial speculation can explain the extent of the wild swings in the price of food.
Jayati Ghosh, Professor of Economics at Jawaharlal Nehru University, New Delhi, says: 'From about late 2006, a lot of financial firms -banks and hedge funds and others -realised that there was really no more profit to be made in the US housing market, and they were looking for new avenues of investment. Commodities became one of the big ones - food, minerals, gold, oil. And so you had more and more of this financial activity entering these activities, and you find that the price then starts rising. And once, of course, the price starts rising a little bit, then it becomes more and more profitable for others to enter. So what was a trickle in late 2006 becomes a flood from early 2007.'3
Many investors such as pension funds have made little if any return on the money they have put into commodity markets. The main beneficiaries have been banks which charge fees for arranging derivative contracts. They then use the information gained from their central role in commodities trading to gamble with their own money, often betting against their own clients. The World Development Movement has estimated that Goldman Sachs made a $1 billion profit in 2009 from speculating on food.
The UN Commission of Experts on Reforms of the International Monetary System, chaired by Joseph Stiglitz, concluded that: 'In the period before the outbreak of the [financial] crisis, inflation spread from financial asset prices to petroleum, food, and other commodities, partly as a result of their becoming financial asset classes subject to financial investment and speculation.'4
This analysis is widely shared within the financial industry itself. As early as April 2006, Merrill Lynch estimated that speculation was causing commodity prices to trade at 50% higher than if they were based on fundamental supply and demand alone.5 At the start of the 2007 and 2008 food price boom, one hedge fund manager told the Financial Times: 'There is so much investment money coming into commodity markets right now that it almost does not matter what the fundamentals are doing. The common theme for why all these commodity prices are higher is the substantial increase in fund flow into these markets, which are not big enough to withstand the increase in funds without pushing up prices.'6
The impacts of commodity speculation
The increase in the price of food has been disastrous for people across the world. There were 75 million more hungry people in 2007 and a further 40 million in 2008.7 The latest estimate by FAO in June 2009 was that over one billion people are now chronically malnourished due to 'the global economic slowdown combined with stubbornly high food prices'.8
But the impact of high prices goes well beyond not getting enough to eat. Poor households in Southern countries tend to spend between 50% and 90% of their income on food, compared to an average of 10-15% in Northern countries.9 It is estimated that the food price spike increased the number living in poverty by between 100 and 200 million.10 As well as eating less food, households have been forced to:
* Eat less fruit, vegetables, dairy products and meat in order to afford staple foods.
* Reduce any savings, sell assets or take out loans.
* Reduce spending on 'luxuries' such as healthcare, education or family planning.11
Women tend to manage the food budget and often bear much of the suffering. Women may also try to increase income through taking on insecure and risky employment such as becoming domestic workers, mail-order brides and sex workers.12
High food prices affect poor farmers as well as the urban poor. A high percentage of rural households are net buyers of staple foods. In Kenya and Mozambique, around 60% of rural householders are net buyers of maize.13 Very few poor farmers produce a significant surplus to sell.14 In Zambia, 80% of farm households grow maize, but fewer than 30% sell any.15 In addition, any increase in income was for many producers negated by increasing costs of farm inputs such as oil and fertiliser. The cost of fertiliser almost doubled in 2007 and 2008.16
Furthermore, in general terms wild price swings make it difficult for farmers to make decisions about what crops to grow and in what they should invest precious resources. As Prof. Jayati Ghosh says: 'The world trade market in food has started behaving like any other financial market: it's full of information asymmetry . So farmers think, "Well, wow, the price of sugarcane is really high," and they go out there and cultivate lots of sugarcane. By the time their crop is harvested, the price has collapsed. So you get all kinds of misleading price signals. Farmers don't gain.'17
Volatility of prices is a huge problem for countries, whether importing or exporting commodities. FAO says: 'The wider and more unpredictable the price changes in a commodity are, the greater is the possibility of realising large gains by speculating on future price movements of that commodity. Thus, volatility can attract significant speculative activity, which in turn can initiate a vicious cycle of destabilising cash prices.'18
Paez, former Economy Minister in
The food price spike is not over
Whilst food prices fell rapidly in mid-2008, they have still generally remained higher than before the 2007 and 2008 food price crisis. During 2010 food prices have shot up again, most notably wheat which has had knock-on impacts on crops such as maize.
However, other crops have also been subject to speculation. During the spring and early summer of 2010 a British hedge fund called Armajaro bought huge numbers of cocoa bean contracts, pushing prices up to a record 33-year high. Armajaro even went as far as buying real food, purchasing 7% of global cocoa production for storage in European warehouses.
was attempting to manipulate the market, hoarding a huge amount of cocoa
now to push up the price and profit later. In July 2010, 16 European
traders said they were 'shocked with what is happening on the
cash crop, coffee, has also been subject to big swings in price. The
price of coffee traded in
Response to the speculation problem
officials from several Northern countries have recognised the problem
of commodity speculation. Gary Gensler, head of the
Michel Barnier, European Commissioner for the internal market, told the European Parliament: 'Speculation in basic foodstuffs is a scandal when there are a billion starving people in the world. We must ensure markets contribute to sustainable growth. We have to look at derivatives. Speculation is linked to derivatives which are linked to raw materials. That is something we want to regulate very carefully in order to tackle speculation in raw materials.'20
Despite the sentiments of Commissioner Barnier, the European Union is yet to take action on commodity regulation. The European Commission will make proposals on regulating commodity derivatives by the end of 2010, which will then be debated between the European Parliament and EU member state governments.
The European Parliament's key economic and monetary committee has called for 'the planned regulation of derivatives to include rules relating to the banning of purely speculative trading in commodities and agricultural products, and the imposition of strict position limits especially with regard to their possible impact on the price of essential food commodities in developing countries and greenhouse gas emission allowances'.21
the Commission's proposals are not currently expected to go as far as
the European Parliament has called for. Some member states are thought
to be resistant to commodity regulation, particularly those such as
action to regulate commodities would be agreed at the global level but
the summits of the Group of 20 (G20) major economies have yet to agree
on strong coordinated action on commodity speculation. However, at the
end of August 2010, President Sarkozy of
discussions on how to implement the
Campaigners and social movements have begun to coordinate joint plans and activities. Strong country and global campaigns are needed to stop the recurring cycle of food and commodity price spikes.
Tim Jones is a Policy Officer with the World Development Movement, a UK-based anti-poverty campaigning organisation.
More information on WDM's campaign on food speculation is at http://www.wdm.org.uk/food-speculation. For more details on the campaign or to link into regional and global activities, contact WDM campaign officer, Gary Dunion <firstname.lastname@example.org>. WDM's report 'The great hunger lottery' is at: http://www.wdm.org.uk/food-speculation/great-hunger-lottery.
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Ghosh, J. (2010). Interview with therealnews.com 05/05/10. http://therealnews.com/t2/index.php?option=com_content&
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21 Committee on Economic and Monetary Affairs. (2010). Report on derivatives markets: Future policy actions. Committee on Economic and Monetary Affairs of the European Parliament. Rapporteur: Werner Langen. 07/06/10.
*Third World Resurgence No. 240/241, August-September 2010, pp 20-23