Speculators Gonna Speculate

March 5, 2011 11:40 AM

The World Development Movement (WDM) published a report six months ago on How Banking Speculation Causes Food Crises. It describes why the deregulation of commodity derivatives, specifically food commodity derivatives, has led to a state of global instability in the price of food. Political instability in the Middle East is not helping either. The European Commission is considering methods to introduce regulation in commodity derivative markets [Strategy Outline PDF]. In the meantime, speculators gonna speculate.

The WDM's Food Speculation page is fairly successful in summarizing the status quo.

posted by lemuring (26 comments total)

If we want to reduce the world price of food, the easiest way is for the US to cease converting half its corn crop into fuel ethanol.
posted by Chocolate Pickle at 11:46 AM on March 5, 2011 [1 favorite]

Why would you use *that* link for the Hunger Lottery Report when you could use the one from WDM itself that actually includes link to a downloadable PDF? Whatever that issuu.com site is doing is annoying.
posted by R343L at 11:48 AM on March 5, 2011 [1 favorite]

Yup, sorry about that. To download the report from Issu, you need to register. But as you said, the WDM offers a direct download of "How Banking Speculation Causes Food Crises"

posted by lemuring at 11:54 AM on March 5, 2011

Cross posted from the other food thread.
Food Speculation
What for a poor man is a crust, for a rich man is a securitised asset class.
Previously on the blue.
posted by adamvasco at 12:30 PM on March 5, 2011

If that grain wasn't going into ethanol the land would be paved over for shopping malls and subdivisions, or sitting fallow. People would still go hungry and commodities prices would still be unstable. Biofuels have actually been good for our food supply because they've increased the incomes of farmers and made farmland more valuable.
posted by humanfont at 12:38 PM on March 5, 2011 [1 favorite]

From the WDM food speculation FAQ: "The main way that investors speculate on food commodities is through ‘commodity index funds’."

Is this supposed to be some kind of parody? It's not very funny.
posted by sfenders at 1:15 PM on March 5, 2011

Consumers, the Food Crisis, and Index Funds concludes
Perhaps futures market trading had nothing to do with the real market prices for products, even though large increases in fund activity coincided with abnormally high prices and volatility. However, the issue is so important that skepticism of conventional beliefs, not faith in the perfection of free markets, is appropriate for any study of the issue. The American public and a hungry world deserve at least that much.
posted by adamvasco at 1:34 PM on March 5, 2011 [1 favorite]

Just found a video interview on Democracy Now's website entitled, "The Food Bubble: How Wall Street Starved Millions and Got Away With It." The interviewee, Frederick Kaufman talks about an article he wrote for Harper's in their July 2010 issue about commodity index funds as they relate to the food price instability.
posted by lemuring at 2:25 PM on March 5, 2011 [1 favorite]

I've read and listened to several of these reports, and I still come back to this problem: where's the causation? Why should we think high prices were caused by speculators when there are so many natural and political factors decreasing supply and increasing demand? If Russia is refusing to export wheat, shouldn't prices go up?

I'm sometimes skeptical of the societal value of derivatives and futures, yet food is the place where hedging has proven the most useful for keeping farmers afloat and food supply stable. Plus an index fund is pretty far from a CDO-squared.
posted by anotherpanacea at 2:43 PM on March 5, 2011 [1 favorite]

adamvasco, quoting Wallace C. Turbeville: However, the issue is so important that skepticism of conventional beliefs, not faith in the perfection of free markets, is appropriate for any study of the issue.

Yeah, hopefully we can all agree on that. I'm all for skepticism. It's the combination of ignorance and certainty exemplified by the first link in this post that bothers me. They seem to have the same kind of grip on reality that Glenn Beck demonstrates can somehow manage to be popular with a lot of people. It's just sad to see it in an apparently well-meaning NGO.

Regarding Turbeville's comments, I think perhaps he over-estimates the practical difference between arbitrage and tactical trading, as from the great distance I view them so many on Wall Street often appear to do. You can't hardly take advantage of that particular sort of arbitrage opportunity without being a bit tactical about it, can you? It may be a bit of a disconnect between his understanding and the more academic approach of the study. Or, as I strive to reinforce my skepticism here, maybe I'm missing his point.

It's a possibility that the index funds did move the market in 2008, and it's also a possibility that the market has by now adapted to their presence. It's also a possibility that they didn't make a damn bit of difference, and people simply mistook the correlation of index fund growth and price rises for causation where there wasn't any. It's easy to do.

That correlation, even if it was there at all, seems to have gone away. Since prices started taking off somewhere around last June, "index investment" net long positions according to the CFTC in for example CBOT wheat have fallen from the equivalent of 221 thousand contracts, down to 202 thousands as of January 31. For corn they've risen all the way from 428k up to 429. Cotton, down from 77 to 60. Generally, if one believes that data, index fund "investors" have been taking their profits and if anything, one would suspect, keeping prices marginally lower these past few months as they cash out. It's consistent with market psychology, that. After 2008, these crazy speculators who can't be bothered to trade real futures don't believe that prices will stay this high for long.

And lest you all think I'm just talking about this because I'm part of the evil conspiracy to drive up prices, I do not actually trade any kind of food-related derivatives at all, and only rarely dabble in crude oil futures when I feel like enjoying some relaxing entertainment. I held an option on an index fund once for a few days, but that was a long time ago and I regret it.
posted by sfenders at 3:12 PM on March 5, 2011

Banking speculation has brought stability to production and lead to the abundance of food available. The Soviet Union was a net grain importer and punished food speculation, following the end of communism, even with the loss of the "breadbasket" in the Ukraine the Russians rose to be major Wheat exporters until their drought last year. When speculators buy into markets they provide more capital to make farm more productive. Ultimately though speculators can't actually do anything with the extra food produced, all their contracts are thus hedged with buy orders offset with sell orders. They are hoping to make money off the difference, while farmers and major consumers are hoping to offset their risks. In fact subsidized food prices are the worst thing you can do for this situation. You simply create an unsustainable population bubble and you destroy your own agricultural capacity. Look at places like Haiti which have abundance agricultural capacity, but who are importing cheaper grain from the USA. It improves the situation with regard to short term hunger but utterly destroys you in the longer term raising the birthrate and exposing you to global food markets. The focus needs to be on getting countries and people to feed themselves better.
posted by humanfont at 4:38 PM on March 5, 2011 [3 favorites]

Annoyingly, non-speculative explanations for changes in food prices only get a few paras in chapter 4. The key piece of evidence presented against such explanations is not the directions of the changes in price: the authors admit that " Yields offer an explanation for a general rise in price through 2006 and 2007, and a fall in 2008". Rather, they offer the magnitude of the changes and the degree of volatility as convincing proof that speculation is responsible for "pushing prices higher, and making them more volatile."

Ok, the magnitudes are easier to explain. You need to eat about the same amount of food whatever the price, and if you can afford to, you will pay what it happens to cost. As such, if supply of food falls or is expected to fall, the price goes through the roof. So small changes in supply = big changes in price.

For volatility, the big deal for the authors is the fall in prices in mid-2008. This was a dramatic drop, not much connected to any news about food production. The authors reason that if a sharp drop is inexplicable by some cause, then neither is the sharp rise that preceded it - I don't argue with that. So lets focus on the drop.

Demand for biofuels causes food prices to become correlated with oil prices: as oil rises in price, demand for the now relatively cheaper biofuel increases; with less grain available for food, the price of food rises. And of course, when oil drops in price, the reverse happens.

So, what happened in mid-2008, anyone remember? A huge fucking recession is what. That killed demand for oil, leading to a drop in the price of a barrel of light crude from about $130 in mid-2008 to less than $50 in 2009. That's how you get a sudden drop in grain price in 2008.

Other factors probably exacerbated the crisis; for instance, as poorer countries imposed export bans on food, the international market became even more volatile. It would be foolish to say that speculation could not possibly have had an effect - traders aren't omniscient, and the market can't reliably remove incorrect beliefs if everyone holds them (at least not in the short run). But speculation is neither a simple nor a normal explanation of market movements - it makes the strong claim that the usual forces of supply and demand have become decoupled from reality, whereas economic history says that that is the exception rather than the rule. So the existence of good explanations that do not depend on commodities speculation is a blow against the WDM theory.

The irony does not escape me, that in exonerating commodities traders from responsibility for this mess I've probably convicted the guys a few desks over involved in sub-prime.
posted by topynate at 8:29 PM on March 5, 2011 [1 favorite]

"Banking speculation has brought stability to production and lead to the abundance of food available.... When speculators buy into markets they provide more capital to make farm more productive."

Seriously, what does this mean? Is there a law that guarantees a constant relation between inputs of capital and output of grain?
posted by sneebler at 8:42 PM on March 5, 2011 [1 favorite]

Hm. By 'speculation is neither a simple nor a normal explanation of market movements', I meant speculation not founded on analysis of the fundamentals, and movements of the kind seen in 2007 and 2008. Obviously speculation in the broad sense moves the market all the time, but I'm talking about bubbles.
posted by topynate at 8:43 PM on March 5, 2011

Seriously, what does this mean? Is there a law that guarantees a constant relation between inputs of capital and output of grain?

Empirically, logically, morally: yes, provided that the capital is not misinvested - and a market is the best known way of preventing misinvestment. Can you think of a country with high agricultural capital intensity and low productivity, or low capital intensity and high productivity?
posted by topynate at 8:50 PM on March 5, 2011

low capital intensity and high productivity?

That describes a couple of Central European countries now that I think about it. Slovakia, for instance.
posted by joedan at 10:20 PM on March 5, 2011

Grain production is linked to fuel costs because agricultural productivity is depenent on fuel availability to run tractors, combines as well as the price of fertilizer. Not to mention that shipping and cooking the stuff. The challenge in showing the impact of biofuels on food prices is to understand how much less supply would be available if there was no demand from the biofuel industry. Also is biofuel production lacing out our production and leaving us short for making bread. Agricultural commodities are a very difficult marketplace.
posted by humanfont at 12:25 AM on March 6, 2011

Is there a law that guarantees a constant relation between inputs of capital and output of grain?

Not a constant one. In a way unlike you find in most of the manufacturing industry for instance, agriculture is famously subject to the law of diminishing returns. As they imply in the article, once you're using the best fertiliser available in the ideal amount, adding more doesn't do any good. There is not even a constant increase as you bring more land into production, since the best land is already used and the new farmland you're expanding into is generally going to be less productive. There is a large amount of world agriculture that can greatly benefit from more capital investment, but there's also quite a lot that doesn't benefit very much. The more of the world already using the best high-tech yield-enhancing technology, the closer we are to the end of the ability of production to keep up with further demand growth.

So not a constant one, but sure there is a relationship.
posted by sfenders at 3:39 AM on March 6, 2011 [1 favorite]

While we may discuss the role of markets and derivatives and speculation in commodity prices, that discussion is at best a benign distraction from a far more serious issue: we must control our population.
Well, really, that's a lie - no external force will make us control our population. No beneficent father figure is going to turn up and say "gee, guys, maybe 2^33 is enough". No hidden aspect of human sociobiology is going to gradually make us stop breeding. No invisible hand will gently manifest to ensure no child is born only to be doomed to starve. "Must" is entirely the wrong word, but it's so much more pleasant than "won't".
Perhaps high commodity prices result in some hunger now, and any suffering is bad, but really, we won't control our population, and billions will die of hunger and of the wars that hunger drives. More people than can walk past you single-file in a lifetime are going to starve to death, and you are (at least initially) going to watch it on TV and think "well, it's not me". This is not a personal criticism - I'm no doubt going to do the same thing, a majority of us are.
This is an issue beyond the scope of any individual - we are as helpless as the cells in a metazoan, or the that atoms in a protein. It's up to meta-us, the larger scale social structures that drive (to us) senseless wars, meaningless markets, arbitrary social rules. We sense these structures dimly, thrill in the struggles, despair in the injustices, but in the end all we can contribute is to be ourselves.
So yes, speculators gonna speculate, and legislators gonna legislate, outcomes gonna come out - I'm in no position to judge their value, and neither, I believe, are you. By all means, exercise what power you have, spread your word, stand up and be counted, but don't tell me there is a moral imperative for your little crusade - for all you know you are the enemy.
posted by overyield at 10:34 AM on March 6, 2011 [1 favorite]

Population crashes have been uncommon in human history. There is every reason to think that as food becomes scarce people will have fewer children. Malthus was wrong about population growth. Populations usually expand to meet food availablity and while famines have occurred they are mostly from political scarcity rather than global food supplies.
posted by humanfont at 12:51 PM on March 6, 2011

It isn't good for the environment though. As populations start to approach full exploitation of available resources, concerns relating to anything else goes out the window. pushback against depletion of marine ecosystems due to overfishing or water draining for example is overwhelmed by the demand, risking a crash and wipe-out of that resource. Historical examples are lake Chad or the Aral Sea if my limited dilettante understanding is right.
Hopefully artificial supply restrictions like tariffs or quotas are able to hold back demand enough for food related resources to be sustained and eco-crashes avoided.
posted by Catfry at 1:35 PM on March 6, 2011

Lester Brown has some indepth on what he calls the great food crises of 2011.
Some snippets
Total meat consumption in China today is already nearly double that in the United States.
In the United States, which harvested 416 million tons of grain in 2009, 119 million tons went to ethanol distilleries to produce fuel for cars. That's enough to feed 350 million people for a year.
Today, half the world's people live in countries where water tables are falling.
The Arab Middle East is the first geographic region where spreading water shortages are shrinking the grain harvest.
In France, Germany, and the United Kingdom, wheat yields are no longer rising at all.
The current surge in world grain and soybean prices, and in food prices more broadly, is not a temporary phenomenon.
posted by adamvasco at 1:41 PM on March 6, 2011 [1 favorite]

I'm completely opposed to the idea that there is no more scope for expansion of the global grain and soybean harvest. All my comment said was that there is a tolerance limit for the exploitation of many ecosystems and it is best to implement safeguards before those limits are reached.
posted by Catfry at 2:19 PM on March 6, 2011

Is there a law that guarantees a constant relation between inputs of capital and output of grain?
Yes, with some lag. As prices rise, more money is invested in grain production (e.g. down to the level of the farmer putting the back forty that has a low yield to work, and is only worth the seed/fuel/time in periods of high prices).
posted by bystander at 4:07 PM on March 6, 2011

Lester Brown has been predicting imminent global famine for the last 45 years. Not just a long term threat to our food security but imminent 5 year famine and death.

Let's look at your points:

-High meat consumption is a marker of food abundance and a rising middle class. As food prices rise in China and the US meat consumption will drop. As will the consumption of soda pop (currently 5-10% of US corn production).
-Farmers only plant crops they think they can profitably sell. The 119 million tons wouldn't necessarily have been grown without ethanol subsidies. In fact land may simply have been fallow.
-Water is a big problem and we should solve it, but we have some time the water isn't going to run out tomorrow.
-Regarding France, Germany and the UK. Note that the EU has shifted it's Common Agricultural Policy and reduced the percentage of expenditures from its budget going to agricultural subsidies. The last round of global trade talks also reduced direct agricultural subsidies in the developed world economies. This has hampered growth, though perhaps with rising prices we will see a increase in productivity.
-Commodity prices are highly volatile. There is no reason to think that it is any different this time. Options, derivatives and other trading schemes exist to let various players reduce their exposure to this volatility. Building an efficient commodities futures market has helped stabilize agricultural business models and enabled further capital formation. This results in more food for everyone.
-It would seem that the Middle East is in the midst of political turmoil brought about by a refusal of the local governments to address the food issue. The issue I see is that for too long food and fuel were kept artificially low, resulting in expanded birth rates and a huge youth population. It would have been better for these places had the prices for bread been higher and the money spent on family planning and women's education. It isn't too late; but it is going to be a tough adjustment. I hope Europe, the US and Russia will be able to figure out how to accept migration from this region; but I really have a bad feeling about it.
posted by humanfont at 6:34 PM on March 6, 2011

Here's an interesting Bloomberg article chock full of information about the international food market with the headline feature a look at the russian wheat production and the effects of a ban on export in the wake of droughts last summer. Russian farmers cannot get as high prices at home as they could on the international market and thus decide to switch to other crops, lowering total production.

http://www.bloomberg.com/news/2011-03-07/wheat-planting-falls-to-four-year-low-in-russia-as-export-ban-hits-farmers.html
posted by Catfry at 5:53 AM on March 7, 2011