Food Game: Cake For Speculators And No Bread For People
By Countercurrents.org
26 October, 2012
Countercurrents.org
Speculation with food is an area of huge profit by financial institutions. “More than 40 percent of grain futures can now be traced to financial institutions, which nearly doubled their commodity bets over the last five years — from $65 billion to $126 billion”, write Yaneer Bar-Yam, president of the New England Complex Systems Institute, an independent academic research institution in Cambridge, Massachusetts, and Greg Lindsay, an affiliate of NECSI and a visiting scholar at New York University [1]. A month ago, on September 26, 2012, the European Parliament agreed on plans to improve financial market transparency and end speculation, notably deal-making blamed for volatile food prices [2].
Howard Schultz, Chief Executive, Starbucks Coffee Company, said: “Without any real supply or demand issues we are witness to the fact that most agricultural food commodities are at record highs at once, and coffee is at a 34-year high. Through financial speculation …the commodities market is in a very unfortunate position.” Similar opinions were expressed by Nigel Miller, President, National Farmers Union, Scotland and Peter Orszag, Vice Chairman, Citigroup [3].
Yaneer and Greg write:
Spikes in grain prices are regularly blamed on oil shocks, droughts and emerging markets’ hunger for meat. The real culprit in the three bubbles-and-busts of the last five years, however, isn’t the weather. It’s financial speculation.
The Midwest drought this summer, the worst in a half-century, produced a bumper crop of profits for derivatives traders like Chris Mahoney, the director of agricultural products for Glencore, the world’s largest commodities trading firm. Mahoney noted during one August conference call that tight grain supplies and the resulting arbitrage opportunities “should be good for Glencore.”
They’ve been a disaster, however, for the world’s poor.
More than 40 percent of grain futures can now be traced to financial institutions, which nearly doubled their commodity bets over the last five years — from $65 billion to $126 billion.
During that time, food prices have bubbled and burst twice — leaving millions of people to go hungry and stoking global unrest — before climbing to new heights this summer. Corn prices soared 65 percent between June and July alone, the same month the World Bank’s food price index recorded its highest rise ever, breaking the previous record set in February 2011.
What’s fueling this stunning price fluctuation is financial speculation. Our research team at the New England Complex Systems Institute built mathematical models to test possible explanations for the price spikes of 2007-2008 and 2010-2011 — including all the above, in addition to the rise of ethanol production. We could replicate a rise in prices but couldn’t explain the bubbles and crashes. When we added speculation, the model fit precisely.
When it comes to food, our faith in markets is contingent on their ability to match supply and demand at prices that benefit farmers, while ensuring the greatest number of people can afford to eat. Speculation in grain futures knocks these prices out of equilibrium. During past bubbles, for example, bountiful harvests piled up in silos because grain was too expensive for consumers to buy. This grain accumulation eventually bursts the bubbles after a year or more – the time elapsed between harvests.
While Americans will likely only feel a pinch of drought-fueled speculation this year – the Department of Agriculture projects a 3 percent-4 percent rise in food prices next year – the situation is direr in the developing world. Those living on less than a dollar per day already spend most of their income on food.
The price bubble of 2007-2008 led to food riots in more than 30 countries, including Mexico’s “tortilla riots” and the overthrow of Haiti’s government, before prices peaked again in February 2011, during the Arab Spring.
The current bubble is behind the fresh protests in Haiti, where food prices have gone up 40 percent since the election of President Michel Martelly last year. In eastern India, mobs robbed government granaries.
Hunger and revolutions have always gone hand-in-hand, of course — the latter is what happens when you let them eat cake but the people have no bread. But at which point do prices pass the point of no return?
Our research has found that food riots are most likely to occur when the Food Price Index, compiled by the United Nations Food and Agriculture Organization, rises above 210. It’s currently 216.
Recognizing the dangers of food speculation, six European banks – including Commerzbank, Germany’s second largest – this summer removed agricultural products from their commodity funds altogether. Wall Street, however, has not been so accommodating.
Last month a federal judge vacated tough new rules designed to rein in commodity speculation that would have taken effect Oct. 12. The rules would have closed loopholes and instituted new position limits that would cap the number of derivative contracts a commodities trader could hold, in the hopes this would dampen volatility and prices.
But Judge Robert L. Wilkins channeled Wall Street’s objections when he questioned whether these rules were appropriate or necessary. In his decision he quoted Michael V. Dunn, a former commissioner of the Commodity Futures Trading Commission, who had doubted whether “excessive speculation is affecting the market.” Dunn once declared, “at best position limits are a cure for a disease that does not exist, or at worst it’s a placebo for one that does.”
CFTC Chairman Gary Gensler has vowed to push ahead with the rule – including the possibility of appealing. Commissioner Bart Chilton meanwhile has proposed drafting an “interim final rule” that would appease Wilkins’ objections and could be instituted quickly. “Position limits are simply too important,” Chilton said earlier this month in a speech at the UN Food and Agriculture Organization headquarters in Rome.
They are. But if the rule that’s eventually passed is to be more than the placebo Dunn fears, it will be necessary to close the loopholes added to the bill to appease derivatives traders – who instead sued to have it overturned.
The proof will be in seeing if speculation actually decreases. Current volumes are three to five times higher than what’s necessary for the smooth functioning of the markets, according to our research. At a time when the US corn harvest is expected to be less than annual consumption, we can’t afford to gamble with our food.
The European Parliament's economic affairs committee unanimously agreed – 45 votes in favor – new rules based on a proposal last year by the European Commission to update EU regulation on markets in financial instruments, known as MIFID.
Under the agreement, market players and trading operators would be required to lay down clear rules and procedures for fair and orderly trading, objective criteria for executing orders efficiently, and transparent criteria for determining which financial instruments may be traded via their systems.
The rules notably would provide a structure for Organized Trading Facilities (OTF), which are currently not regulated.
To fight speculation of food products, the rules also limit the number of positions traders can take in a set time on commodities on the derivatives market.
The MEPs also tightened up a EC proposal on high-frequency algorithmic trading, in which computers trade millions of orders per second, with little or no human intervention.
This technology can be used to check what buyers would pay, with a view to exploiting tiny price differences.
The committee voted provisions to ensure all orders be valid for at least 500 milliseconds, meaning they cannot be cancelled or modified during that time.
All firms and trading venues would also have to ensure that trading systems are resilient and prepared to deal with sudden increases in order flows or market stresses. These could include "circuit breakers" to suspend trading.
The Socialists and Democrats group in parliament dubbed the agreement "a very important step forward to increase transparency and to ensure a smooth price formation process on European exchanges."
NGOs, including Oxfam and Friends of the Earth, welcomed the plan but said it continued to fall short of what was needed to tackle food speculation.
The rules will need to be adopted by a parliament plenary, probably in November, before being submitted to EU finance ministers who will have the final say.
On the issue of speculation with food Nigel Miller said: “It is deeply alarming that the greatest proportion of activity in the futures markets no longer involves those in the supply chain but is, instead, taken up by speculators. Food commodities are too important to be played about with by day traders and speculators.” Peter Orszag said: ‘‘Financial flows (including index funds) can, over brief periods, exert a noticeable destabilizing effect […] Trying to use inventory levels to measure how far the market is out of whack may not work that well. As a result, “multiple equilibriums” of plausible market prices can persist over a surprisingly long period before supply-and-demand fundamentals finally exert themselves.”
Food speculation refers to bankers and other financial investors betting on food prices. Food speculation occurs if ’futures contracts’ are written for the sole purpose of money making. Originally, future contracts allow farmers to sell crops at a future date at a guaranteed price - helping them to overcome unforeseen variations in crop production. Over the last two decades, bankers have successfully lobbied for weaker regulations on food speculation. They are now able to buy and sell futures contracts to make money. Bankers have also created special products and funds to help other financial companies make money from betting on food [4].
Source:
[1] “The real reason for spikes in food prices”, Oct. 25, 2012, http://blogs.reuters.com/great-debate/2012/10/25/the-real-reason-for-spikes-in-food-prices/
[2] EUbusiness, “European Parliament moves to fight market speculation”, Sept. 26, 2012, http://www.eubusiness.com/news-eu/markets-finance.ik6
[3] Make finance work for people and the planet, “Financial speculation on food drives up and distorts prices”, http://www.makefinancework.org/the-food-crises-the-us-drought/food-speculation/
[4] http://www.makefinancework.org/home-english/food-speculation/briefings-and-reports-70/
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