Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
This is Part 2 of the blog I started yesterday outlining the case to regulate food price speculation out of existence. This discussion is part of the policy section of what will soon be my latest book (with co-author, Italian journalist Thomas Fazi) which traces the way the Left fell prey to what we call the globalisation myth and formed the view that the state has become powerless (or severely constrained) in the face of the transnational movements of goods and services and capital flows. In Part 3 of the book, we aim to present a ‘Progressive Manifesto’ to guide policy design and policy choices for progressive governments. We also hope that the ‘Manifesto’ will empower community groups by demonstrating that the TINA mantra, where these alleged goals of the amorphous global financial markets are prioritised over real goals like full employment, renewable energy and revitalised manufacturing sectors is bereft and a range of policy options, now taboo in this neo-liberal world are available. This discussion is part of a chapter that will concentrate on financial market reforms (what to do with banks etc) and considers what can be done about food speculation. We argue that food speculation causes havoc in poor nations and a progressive stance should make it illegal. The enforcement would be through the new institutional framework I outlined previously. In today’s blog I complete the arguments advanced to justify our position.
In Part 1 of this blog – Ending food price speculation – Part 1 – I showed how food price speculation had led to a breakdown in the market mechanisms of supply and demand in food markets.
The market failure that followed in this case was catastrophic because it led to starvation and increased poverty while the investment banks made billions.
Today we trace the evolution of this disaster and consider what can be done about it.
How it happened
Kaufman (2010: 27) traces the beginning of this phase in speculation to 1991 when:
… nearly everything else that could be recast as a financial abstraction had already been considered. Food was pretty much all that was left. And so with accustomed care and precision, Goldman’s analysts went about transforming food into a concept.
The Goldman Sachs Commodity Index (GSCI), which is now known as the S&P GSCI became a focus of food price speculation and spawned the proliferation of similar food indexes by other financial institutions.
As Kaufman notes (2010: 27):
Investors were delighted to see the value of their venture increase, but the rising price of breakfast, lunch, and dinner did not align with the interests of those of us who eat. And so the commodity index funds began to cause problems.
The first problem occurred in Wheat markets where the prices began to accelerate in 2006 (along with other cereals). Kaufman (2010: 28) reported that:
Since Goldman’s innovation, hundreds of billions of new dollars had overwhelmed the actual supply of and actual demand for wheat, and rumors began to emerge that someone, somewhere, had cornered the market. Robber barons, gold bugs, and financiers of every stripe had long dreamed of controlling all of something everybody needed or desired, then holding back the supply as demand drove up prices. But there was plenty of real wheat, and American farmers were delivering it as fast as they always had, if not even a bit faster. It was as if the price itself had begun to generate its own demand-the more hard red spring cost, the more investors wanted to pay for it.
The problem, of course, is that “In 2008, for the first time since such statistics have been kept, the proportion of the world’s population without enough to eat ratcheted upward. The ranks of the hungry had increased by 250 million in a single year, the most abysmal increase in all of human history” (Kaufman, 2010: 28).
The betting on food prices reached frenzied proportions during the GFC and this caused large price fluctuations in staples such as wheat, corn and soya beans.
What was previously a market as a conduit between farmer and consumer became another room in the speculative casino that financial market deregulation had created.
How did financial market deregulation cause this?
The US government deregulated commodity markets in the late 1990s, which permitted this explosion of speculation on food prices by institutional investors (investment banks etc).
On May 20, 2008, Michael Masters, a Wall Street hedge fund manager, gave evidence before the Committee on Homeland Security and Governmental Affairs United States Senate (Masters, 2008).
It was a compelling 19-page submission which concluded that as a result of financial market deregulation, institutional investors had become primary causes of rising food and energy prices.
Masters (2008: 2) said that “Commodities prices have increased more in the aggregate over the last five years than at any other time in U.S. history”. He also noted this had nothing to do with supply problems in the physical market. With adequate supply, price inflation has to be due to rising demand.
But Masters asked “how do you explain a continuing increase in demand when commodity prices have doubled or tripled in the last 5 years?” (p.2).
The answer was clear: the rise of institutional investors in speculative activity in commodity futures markets – the so-called
“index speculators” (p.2)
[Reference: Masters, M. (2008) ‘Testimony’, Committee on Homeland Security and Governmental Affairs United States Senate, May 20. LINK]
In the past, it was clearly recognised that such speculative activity “should not be allowed to dominate the commodities future markets” (Masters, 2008: 7).
That sentiment was embodied in the US Commodity Exchange Act 1936.
As the Wall Street tentacles spread in the early 1990s, the US Commodity Futures Trading Commission, which is entrusted ” Ensuring the integrity of the futures and swaps markets”, caved in under pressure from Wall Street traders and began relaxing rules on speculative position limits and over-the-counter transactions.
The International Swaps and Derivatives Association (ISDA) lobbied hard to remove the safeguards on abuse of agricultural markets. The link between buyers of produce and sellers was broken as these new profit seekers, with no interest in food per se took over the markets.
Masters (2008: 8) concluded that these shifts in regulation “effectively opened a loophole for unlimited speculation”.
The situation deteriorated further then the US Congress introduced the Commodity Futures Modernization Act 2000, which President Bill Clinton signed the Act into law on December 21, 2000.
I discussed some of the players and scandals associated with this piece of deregulation in this blog from 2009 – Being shamed and disgraced is not enough.
Many of the names like Robert Rubin (then US Treasury Secretary), Alan Greenspan (then Federal Reserve Chairman) and Lawrence Summers (then Deputy US Treasury Secretary) feature in a very grimy period of US history.
The consequence of the Act was to open the doors further to the food speculators. Grace Livingstone (2012) wrote that when the Act was passed “there was an influx, led by Goldman Sachs, of purely financial players who had no interest in ever buying food, but who sought solely to profit from changes in food prices”.
[Reference: Livingstone, G. (2012) ‘The real hunger games: How banks gamble on food prices – and the poor lose out’, The Independent, April 1, 2012. LINK]
Olivier De Schutter, who was the UN special rapporteur on the right to food, wrote in his 2010 Briefing Note that (De Schutter, 2010: 1):
… there is a reason to believe that a significant role was played by the entry into markets for derivatives based on food commodities of large, powerful institutional investors such as hedge funds, pension funds and investment banks, all of which are generally unconcerned with agricultural market fundamentals. Such entry was made possible
because of deregulation in important commodity derivatives markets beginning in 2000.
[Reference: De Schutter, O. (2010) ‘Food Commodities Speculation and Food Price Crises’, Briefing Note 02 – September, United Nations. LINK]
So the food we eat, and which keeps impoverished communities from starvation, was no longer anything special in this new casino world.
The investment bankers promoted the benefits of speculation on the newly created food price indexes including more stable returns when compared to bonds and shares and a better inflation hedge.
But the reality has been different.
The problem is index speculation generates a “vicious circle of prices spiraling upward: the increased prices for futures initially led to small price increases on spot markets; sellers delayed sales in anticipation of more price increases; and buyers increased their purchases to put in stock for fear of even greater future price increases” (De Schutter, 2010: 4).
The January 2012 Friends of the Earth publication – Farming Money – provided new insights into the role of financial markets in the rising food prices.
[Reference: Friends of the Earth (2012) Farming Money, January 2012. LINK .]
Friends of the Earth (2012: 9) explored the role of “Twenty nine institutions from nine European countries3 were selected on the basis of size, market dominance, brand recognition and other characteristics such as expertise in agricultural financing.”.
These instutions included European banks, pension funds and insurance companies, including Barclays, RBS, HSBC, Deutsche Bank, Allianz, BNP Paribas, AXA, Generali, Allianz, Unicredit and Credit Agricole.
Their analysis revealed that “The huge growth in financial speculation has led to prices no longer being solely driven by supply and demand, but also increasingly by the actions of financial speculators and the performance of their investments” and that “A significant number of financial institutions across Europe appear to also be involved in financing land grabs directly or indirectly.” (p.7)
The largest futures exchange in the world (Chicago) witnessed a massive increase in speculative traders. Global Agriculture (2016) reported that:
Since the 1990s, the deregulation of commodity futures trading in the United States made it possible for institutional investors to enter this market on a large scale. Since then, on the world’s most important futures exchange CBOT in Chicago, the percentage of commercial traders has decreased remarkably while the number of speculative traders has exploded. In 2002, eleven times the actual amount of wheat available was traded on the CBOT; in 2011, 73 times the actual US wheat harvest was traded.
[Reference: Global Agriculture (2016) Food Speculation, http://www.globalagriculture.org/report-topics/food-speculation.html.]
Agricultural product markets shifted from being dominated by hedgers who provided certainty to farmers and processers to speculators who introduced wild price fluctuations and chaos.
The US-based Better Markets Organisation provided testimony before the US Permanent Subcommittee on Investigations on November 3, 2011 in relation to the problems relating to food speculation (Better Markets, 2011).
Better Markets (2011: 5) noted that the official data from the US Commodity Futures Trading Commission showed that:
Historically, when commodity markets have worked well (i.e., when there is sufficient liquidity and meaningful price discovery for all physical hedgers who want to hedge), physical hedgers have constituted about 70% of the futures market and financial speculators have been the remainder, or about 30% of the market. Today, the ratio of participants have reversed in many commodities markets, with speculators now accounting for about 70% or more of the open interest in some markets while bona fide physical hedgers have declined to only about 30 per cent participatin (and much lower in some markets).
On June 25, 1996, the CBOT (Chicago) Wheat trading was dominated by hedgers (72 per cent). By June 29, 2010, the hedgers constituted on 35 per cent of the market.
[Reference: Better Markets (2011) Testimony Before the Senate Permanent Subcommittee on Investigations, November 3. LINK.]
The creation of the commodity index funds in were the single most important determinant of the increased speculation in the CBOT Wheat market.
The IMF (2013), in its inimitable fashion, tried to claim that:
… food price increases were the result of per capita income growth in China, India, and other emerging economies which fed demand for meat and related animal feeds such as grains, soybeans, and edible oils.
[Reference: IMF (2013) Impact of High Food and Fuel Prices on Developing Countries-Frequently Asked Questions, http://www.imf.org/external/np/exr/faq/ffpfaqs.htm.]
Olivier De Schutter’s briefing note (2010) contradicted this claim by the IMF (2010: 3):
… closer examination reveals that the abovementioned arguments of supply and demand are insufficient to explain the full extent of the increases and volatility in food prices …
It is also difficult to accept the IMF’s thesis that the food price increases were the result of per capita income growth in China, India, and other emerging economies which fed demand for meat and related animal feeds such as grains, soybeans, and edible oils. That interpretation is not corroborated by data collected by the FAO for the period concerned: that data shows variously, that the supply and utilization of wheat and coarse grain increased at roughly uniform rates, that end of season stocks for grains had generally increased signi cantly, and that China and India exhibited falling aggregate and per capita food grain consumption (emphasis in original).
Further, Better Markets (2011: 7) argued that the commodity index funds were “liquidity takers and not liquidity providers, and are depriving bona fide hedgers of sufficient market liquidity”.
In other words, despite the myths propagated by the financial markets that these index funds actually inject liquidity into these markets (improving the lives of farmers etc), the reality is that the “commodity index funds do not trade on the basis of supply and demand fundamentals or in response to liquidity demands” (p.7).
By continually rolling the “contracts forward as they regularly expire” the index funds “compete directly with hedges for market liquidity” (p.8).
The investment strategies pursued bear no relation to the market fundamentals (supply and demand) in the physical market. As a consequence, the commodity index funds introduce price fluctuations unrelated to the physical realities, which “imposes direct costs on businesses legitimately using the markets to manage price risk” (p.8).
Bona fide hedgers experienced dramatic increases in their costs, which were then passed on to the consumer via price rises.
The 2009 report from the US Senate Permanent Subcommittee on Investigations found that (2009 :10):
… that a typical grain elevator faced a 300% increase in hedging costs in 2008, compared to 2006.
[Reference: Permanent Subcommittee on Investigations (2009) Excessive Speculation in the Wheat Market’, Majority and Minority Report, United States Senate, June 24. LINK]
But the worst consequences were in a time of adequate harvests and food production, the price hikes caused by the speculation meant that an increasing proportion of household budgets were being spent on food and, at the margin, hunger increased and starvation rates rose.
Starvation for people
Once food prices deviate from the fundamentals of supply and demand, the impacts on the poorest citizens become magnified. While the sharp price spikes in the food markets generated massive profits for the investors in the index funds, they also increased food insecurity and led directly to increased starvation rates.
The rising food prices that (Ghosh, 2009: 11):
… were transmitted at least to some degree to retail prices in the developing world, was felt most sharply in poor countries where most people tend to spend around half of their family budgets on food items.
As food prices skyrocketed, food riots broke out in places like “Haiti, Guinea, Mauritania, Mexico, Morocco, Egypt, Senegal, Uzbekistan, Yemen, Bangladesh, Philippines and Indonesia” (Ghosh, 2009: 11).
In 2000-02, there were 929.6 million people enduring undernourishment and by 2005-07 that number had increased to 942.3 million (FAO, 2015).
[Reference: Food and Agricultural Organization (2015) The State of Food Insecurity in the World 2015, Rome. LINK]
The latest FAO – The State of Food Insecurity in the World 2015 – notes that (FAO, 2015: 17) “that just over one in every nine people in the world are currently unable to consume enough food to conduct an active and healthy life” and that number accelerated as a result of the out-of-control food speculation in the 2000s.
Friends of the Earth (2016) noted that “The United Nation’s Food and Agriculture Organisation estimates that the food price crisis of 2008 pushed 100 million people into hunger and malnutrition.” (see also World Development Movement, 2010; 2011)
[Reference: Friends of the Earth (2016 ) Food speculation – questions and answers, LINK.]
[Reference: World Development Movement (2010) The Great Hunger Lottery, July. LINK]
[Reference: World Development Movement (2011) Broken Markets, September. LINK]
What can be done about this?
The starting point has to be a recognition that affordable access to food is an intrinsic human right. As the Friends of the Earth note (2012: 39) note:
It is not access to financial markets for speculators that is of paramount importance, but fair access to food for people …
That principle has to motive the regulative response.
I have outlined some financial market reforms previously in these blogs – Operational design arising from modern monetary theory and Asset bubbles and the conduct of banks.
There are two broad approaches that can be taken in regard to food speculation. The first seeks to limit rather than ban it (for example, the imposition of so-called positional limits). The second, recognises that there is no productive value at all in the activity and seeks to ban it outright to restore the credibility of the agricultural markets.
My preferred position is to declare illegal all speculative behaviour that was not directly related to improving market fundamentals.
The vast majority of financial transactions would fall into the non-productive category. Financial markets are the most unproductive of all activities in our economy.
So it would seem that this sort of financial activity would fit into the category that should be regulated out of existence.
The problem raised by those who recognise this damaging speculative behaviour is that if it is banned outright then the markets will lose the ‘good’ speculating.
In this context, Friends of the Earth (2012: 39) consider that:
Alternative means to support agriculture other than hedging through commodity derivatives need to be promoted in order to meet the needs of farmers, food producers, processors and consumers, and to ensure stability in, and adequate finance of, the food supply system.
So how might we accommodate the two objectives – eliminating the destructive impact on food prices from speculation but still promoting the market fundamentals through hedging activities?
Using the first approach, the reform process must adopt the goal that “Speculative trades that cannot be proven to serve the needs of sustainable development must be restricted” (Friends of the Earth, 2012: 40).
This clearly requires that “most of the de-regulation that has taken place over the last 20 or so years” (p.40) be reversed.
How would the restrictions manifest?
Friends of the Earth (2012: 40) say that:
… limiting positions held by speculators on commodity futures contracts, limits on daily price changes, and measures to deal with high volume and high frequency food commodity derivatives trading.
The World Development Movement (2011: 34) say that:
Individual position limits cap the amount of the market that can be held by an individual trader. These position limits can be used to prevent market manipulation where one participant corners the market by holding the majority of the market for the underlying commodity and squeezing up prices.
But these limits do not constrain the overall speculative impact on the market. To address that problem, so-called “aggregate position limits” (p.34), which “cap the amount of any market that can be held by any category or group of traders in total” (p.34) are proposed.
The role of the regulator is to oversee and discipline these limits.
There are many variations proposed to this approach (for example, position management, increasing margin requirements, Robin Hood Taxes, etc)
A detailed critique of these approaches is not provided here. Suffice to say that while there are legal loopholes available, the voracious investors will find ways to exploit them.
A limit is not a ban.
Other approaches recommend bringing the range of so-called over-the-counter (OTC) derivative products into “well regulated public exchanges” (Friends of the Earth, 2012: 40).
The overall problem with these approaches is that they continue to allow unproductive activities which can still be destabilising forces to operate.
The regulator remains prey to the captors.
The alternative approach is to “Ban institutional investors and investment funds from food commodity derivatives” (Friends of the Earth, 2012: 40).
Further, “products like commodity index funds and exchange traded funds (commodity-ETFs) and notes (commodity-ETNs), as well as high frequency trading (HTF) should be prohibited in food commodity markets” (Friends of the Earth, 2012: 40).
This is the preferred approach.
This would require legal initiatives to force the speculative institutions to “(l)iquidate all open positions and refrain from further activities in food commodity derivatives and related funds” (Friends of the Earth, 2012: 41)
As outlined in this blog – Asset bubbles and the conduct of banks – banks would be prevented from engaging in speculative positions as would other organisations who function to advance well-being (such as pension funds).
A blanket ban is better than trying to limit or restrict certain categories of food speculation that is not linked to the fundamentals of the market.
The trends are not hopeful at this stage.
In the Financial Times article (August 15, 2012) – Banks withdraw food commodity funds – we read that (Blas, 2012):
European banks are withdrawing vehicles that allow investors to speculate on food prices due to reputational concerns amid pressure from campaigners and politicians.
The Financial Times noted the resistance from “among institutional investment executives” who challenged the claim that speculation had increased prices.
[Reference: Blas, J. (2012) ‘Banks withdraw food commodity funds’, Financial Times, August 15. LINK]
Self-regulation will not be the answer.
Until the general public realises that the vast majority of financial market activity is unproductive and in some cases highly damaging to the poorest people in the world (as in food price speculation) the regulators and legislators will find it difficult dealing with the problem.
Ultimately, the problem reflects a break-down of morality. It is clear to me that if everything was guided by a moral compass then no-one would seek to profit on food speculation at the cost of someone not being able to eat enough or feed their children adequately.
The logic of capitalism is amoral in that sense so regulation has to be introduced.
The legislative task is to keep the productive speculation while outlawing the rest. If successful, the financial sector would decline dramatically and productive investments would increase (chasing the capitalist return). The vast majority would be better off. The most disadvantaged might even get enough to eat.
The series so far
This is a further part of a series I am writing as background to my next book on globalisation and the capacities of the nation-state. More instalments will come as the research process unfolds.
The series so far:
The blogs in these series should be considered working notes rather than self-contained topics. Ultimately, they will be edited into the final manuscript of my next book due later in 2016.
That is enough for today!
(c) Copyright 2016 William Mitchell. All Rights Reserved.