By Sasha Breger, a lecturer at the Josef Korbel School of International Studies at the University of Denver and author of the recent book Derivatives and Development. Her research includes global finance, derivatives, social policy, food, and farming. Cross posted from Triple Crisis
In my last two posts (http://triplecrisis.com/a-great-sucking-sound-part-2/, http://triplecrisis.com/a-great-sucking-sound-part-1/), I addressed the roles of debt, farmland acquisition, and physical commodity hoarding in helping finance siphon wealth from global agriculture. In this final post, I discuss the role of derivatives and insurance markets in this redistributive process. I then turn to some of the potential critiques of my argument.
Derivatives Markets
Derivative and insurance markets are implicated in the redistribution of wealth from agriculture to finance in at least two ways. First, derivatives—and some retail insurance products based on them (e.g. Brazilian CPR, micro crop and revenue insurance)—are increasingly marketed to farmers, traders and/or consumers as a means of reducing market and weather risks in agriculture (demand for such products has been catalyzed by the erosion of public arrangements to prevent and mitigate agricultural risk). To my mind, this arrangement in many cases resembles a case of unequal exchange. An hedging product of mediocre quality is being exchanged for a stream of fees and commissions to the financial sector. Indeed, hedging with commodity futures and options is a tricky proposition without guarantee of success. Contracts are too large and relatively short-term (relative the positions of many food system participants), trading and brokerage accounts are difficult, expensive and time-consuming to establish (especially for smaller traders), and future prices are both volatile and inefficient in many cases (this complicates derivatives trading by increasing the frequency of margin calls, as well as driving basis risk).
In fact, recent speculation in agricultural derivatives (more below) has introduced such inefficiency into future prices that hedgers have been petitioning regulators to introduce new limits on speculative trading. A 2008 letter from the Missouri Farm Board to the US Commodity Futures Trading Commission (CFTC) comments on rising basis risk for hedgers: “For almost three years farmers have experienced a widening of basis levels for most commodities…The lack of convergence between an expiring futures contract and the cash market has… presented major challenges to producers trying to carry out marketing plans involving futures and options contracts.” Even as speculators render cash prices more volatile, and effective risk management thus more essential, these same speculators are disabling one of the few price risk management options that remain for agricultural actors. I hear that sucking sound growing louder.
Second, agricultural derivatives markets have become a key investment venue for global financial firms, with these investments in “virtual” commodities pushing up global food prices. Here, financial investment comes at the expense of price volatility for food system actors. As Collins notes (among many others), institutional speculators (like investment banks, hedge funds and pension funds) have taken a growing interest in agricultural derivatives, both in the lead up to the 2008 housing market crash and since (commodity prices tend to be negatively correlated with other asset prices). Via new derivative instruments—commodity index swaps—large institutions have been taking speculative, “long-only” positions in agricultural derivatives markets (this means that they only bet prices will rise, across a weighted basket of commodities). The sheer scale of these positions has pushed future prices higher, irrespective of underlying supply and demand fundamentals (by 2008 speculators outweighed hedgers in global commodity derivatives markets 2:1). To make matters worse, trends in future prices spill over into the underlying cash markets, driving distortions here as well (this is because future prices influence storage decisions and are used as benchmark prices for spot transactions). As one observer notes, “As early as April 2006, Merrill Lynch estimated that speculation was causing commodity prices to trade at 50 per cent higher than if they were based on fundamental supply and demand alone.”
Critiques
At this juncture, you likely have some critical questions. Isn’t the use of metals markets to illustrate food commodity hoarding by financial firms spurious? Don’t some of these financial strategies actually reduce risk, rather than augment it? Isn’t there a lot of research that fails to find a connection between financial market behavior and global food prices? And, don’t speculators in derivatives markets just take money from each other, limiting the damage to ordinary folks?
First, of course metals behave differently than other commodities. But, my point wasn’t really to suggest that food and metal were the same thing. Rather, I want to suggest that the financial sector increasingly treats these commodities as identical from an investment perspective, and the tactics for hoarding in metals markets may thus be applied to certain food commodities (clearly more easily for wheat, let’s say, than butter, in the context of a commodity-backed fund). I do not think it is unreasonable to try to learn about investor behavior in one set of commodity markets with an eye toward its future application in others. These days investment strategies are replicated across markets that otherwise have little in common—e.g. index speculation in oil and coffee, or securitization of mortgages and student debt. As many researchers have remarked, this is one of the problems with commodity index speculation—all commodities get the same treatment, regardless of individual market characteristics.
In answer to the second question, yes, sometimes these financial activities reduce risks. Commodity storage can smooth revenues, and stabilize local/regional/global market prices (as with buffer stocks, for example). Buying farmland and equity in food trading companies may balance portfolios. And, commodity derivative investments do allow some actors to hedge their market exposures. As observers (and regulators) have noted, it is quite difficult in practice to gauge where hedging leaves off and speculation begins. But, as indicated in some of my other posts on Triple Crisis, there are two major pitfalls to this line of thinking. First, those actors in the food system most vulnerable to risk—poor urban consumers and poor smallholders—are generally least able to utilize the risk reducing strategies so common among financial actors and agribusiness. Second, and related to the first point, the costs of commodity hoarding, land acquisition, investment in food trading companies and derivatives trading are, at least in part, borne by external, third-party actors via the resulting price changes and dislocations. Risk reduction for some means rising risk for others.
Third, yes, there has been disagreement about the role of financial speculation in causing food price volatility. But, the disagreement centers not on whether financial speculation played a role, but how large of a role it played. At this point in time, many researchers much more conservative than myself agree that speculation played a role in global food price run-ups over the past decade. For example, a 2011 report to the G-20 co-authored by the World Bank, IMF, UNCTAD, FAO, UNDP, WTO and others notes, “While analysts argue about whether financial speculation has been a major factor, most agree that increased participation by non-commercial actors such as index funds, swap dealers and money managers in financial markets probably acted to amplify short term price swings and could have contributed to the formation of price bubbles in some situations.”
Fourth, it is surely true that the gains of speculators in derivatives markets sometimes come from the losses of other speculators who have taken up the opposite position in the marketplace. Moving forward, this may be the case even more often as speculators increasingly outweigh hedgers in the marketplace. Yet, to repeat my prior point, there are third parties, uninvolved in derivative transactions that pay a cost as well (there are negative externalities)—the price volatility induced by speculators penalizes actors in underlying markets, aggravating global poverty and inequality.
To conclude, there many ways that finance redirects wealth from agriculture into the financial system itself, further impoverishing and disempowering farmers, consumers and the Earth. Luckily, there are lots of good options available to help us create a more just and equitable global financial system. From alternative arrangements for procuring farm inputs for smallholders, to sovereign debt restructuring mechanisms and capital controls, from new rules on commodity warehousing to regulatory curbs on speculation, positive change is possible. Indeed, the health of the global food and farming system depends on it.
16 comments
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The evidence that hedge funds manipulate to various degrees is essentially overwhelming. It seems easier to do in non-ag commodities (like oil), and there’s been solid research in that area to show that speculation drove prices in 2008:
http://www.iie.com/publications/pb/pb09-19.pdf (forgive the Peterson Institute link, but it’s a good study)
And we’ve even seen the authorities go after OIL manipulators:
http://online.wsj.com/article/SB10001424052702304520804576343830615621402.html
And we can go all the way back to the tulip bubble and wonder whether it would have happened had there not been futures contracts available to speculate on margin.
But of course the evidence is still up in the air whether the benefits market participants get from being able to smooth risk with hedging outweighs the risk of abuse by manipulators. However, market chicanery, particularly by hedge funds and other big actors, is not up in the air:
http://www.labaton.com/en/about/press/Hedge-Fund-Industry-Survey-Commissioned-by-Labaton-Sucharow.cfm
I think individual nations have good rules to regulate markets and ensure good faith and stability. But the chaos comes in the international markets — oil, currencies, — where the big guys don’t want to bother with any regulations on anything really.
There is definitely a balance to be struck here. We need to strengthen manipulation laws and beef up the regulators so that they can at least scare the big players into following rules (and perhaps we need more specific rules fighting bad acts). And a paper trail helps us retroactively investigate any abuse. But the market also reflects facts on the ground, and if there’s droughts and government hoarding of ag commodities, then prices will sensibly rise, and there’s no reason why they shouldn’t rise to reflect conditions, even if it leaves people unfed.
Because in the end, the market allocation of that food helps enable suppliers and buyers to come together in a much more efficient way than if governments controlled the market for the resources instead. So in my opinion, the net consumer surplus of private market allocation of the ag commodities is still positive, despite obvious downsides to the current system.
There is a unclosed bold tag somewhere in this article.
“First, those actors in the food system most vulnerable to risk—poor urban consumers and poor smallholders—are generally least able to utilize the risk reducing strategies so common among financial actors and agribusiness.”
This is the heart of the problem. It should be the primary aim of reform.
I’d say that’s a case for mini-contracts in ag commodities :P
Hey, I’m not a Reformer. I respect the HOLY S(tr)EE(t). I’m risk aversive (esp regards my neck).
‘Investments in “virtual” commodities [are] pushing up global food prices.’
This is a hoary old myth to which those with an ax to grind habitually resort: it’s all the fault of evil speculators.
The facts are quite otherwise. Take a look at a 3-1/2 century chart of real wheat prices (link below). As with most commodities, the long-term trend is DOWN:
http://www.marketoracle.co.uk/images/2011/Feb/wheat-prices.jpg
In her academic ivory tower, Sasha Breger doubtless would be shocked to learn that this is a major reason why only 2 percent of the U.S. population are engaged in farming today: because FARMING DON’T PAY all that well. Despite their dastardly best efforts, evil speculators can’t change that: attempts to manipulate or corner the market will be overwhelmed by new supply.
Sasha Breger’s heartrending handwringing over commodity derivatives sounds like a rehash of Paul Ehrlich’s famous bet with Julian Simon that commodity prices would carry on rising. Ehrlich lost.
UNCTADseems to disagree with you.
I will have to read the rest of Sasha’s analysis, but I believe that futures markets are necessary for farmers, (how else could they obtain the funds to plant and grow a crop) but the spot markets are often remarkably narrow. As an example, in 2001 many farmers in Idaho were asking $6 to $6.5 per hundredweight of russell burbank potatoes, while the market was offering $4.50. However, it was a hot year and production was quite high and those who chose to take the risk of not having a contract ended up plowing their potatoes under when the spot market price crashed to $0.50. Potatoes are a particularly narrow market, dominated by J.R. Simplot and it seems to me that some form of farmer cooperative (yes, collusion) would increase the stability of prices. BTW – I happen to know a couple of farmers and neither of them very often gets their hands dirty. The real work of farming is mostly contracted out, performed by immigrant labor or nomadic jobbers. The landowner-farmer spends most of his work time playing the markets. I’m sure this isn’t universally true, but it is my experience.
You may have missed her point about basis risk. Basis risk is when the hedge doesn’t move in line with the underlying risk begin insured.
She says (and I’ve read this elsewhere) that futures have not been converging to spot at contract close the way they are supposed to, leaving farmers and others in the food chain (pun intended) with large losses. And this big rise in basis risk appears to be the result of speculation. I saw an article in IIRC the NYT on this, problem is they didn’t use the term “basis risk” which makes it hard to locate quickly.
‘It seems to me that some form of farmer cooperative (yes, collusion) would increase the stability of prices.’
This has been tried many times, with many different ag products. As the NBER found, over three centuries it never worked:
http://www.nber.org/papers/w14748
At the most basic level, ag commodity volatility is tied to the vagaries of weather, with its wildly non-Gaussian, fat-tailed extreme events.
But it seems to me that some form of military-industrial-scientific cooperative could increase the stability of weather …
…Blah, blah, no price fixing, deriviative bets going down, etc.
So I guess that means you wouldn’t mind us removing the Commodity Futures Modernization Act then? Eh Jim? And also wouldn’t mind seeing your chart since 2000(CFMA) vs. the long run of 300 years.
I’d add that we already have an example of a “collective” that colludes to control prices in a market — Oil (OPEC).
And if you take a look at their volatility past decade — clearly it’s not the solution to stabilizing prices :)
Markets are still the best determinants of price and resource allocation. They’re certainly not perfect, and need to be well-regulated to prevent shady behavior and particularly competitive activity, but there are no real solutions that would be better than markets. Occasional inefficient outcomes and irrational behavior doesn’t make markets terrible it just makes them imperfect, and I’d argue less imperfect than the alternative.
FALL OFF CLIFF
The first three months of 2013 saw wages fall 3.8%, the largest drop in 65 years.
That despite an increase in worker productivity. High unemployment frees employers from fear employees will go elsewhere. The U.S. recovery has been marked by a decoupling of rising productivity from stagnant wages.
The gloomy outlook partly reflects the predominance of low-wage service jobs.
44 million minimum wage. Increasing the Minimum Wage would offset downward pressure
to the bottom.
The recovery has been great at the top. CEO pay is at record highs of 9.7 Million per year.
I’m just not sure we need the evil speculator argument – though clearly banksters have been at this for centuries. Lots of financial stuff has origins in making production more efficient – discounted cash flow, repo and all that jazz. Farming has long had contracts secured over many years and varieties of insurance and subsidy.
The analysis we need really concerns what financialisation is about. A great deal of this does seem to be about creating opportunities to make easy money which devalues that produced through hard work and fairly competitive business or public sector provision.
What we are told, all the time, is that the financial and private sector are vastly more efficient than the public sector, government or democracy. In 45 years of observation I have seen nothing like argument with evidence on this matter. One gets a bald loon, assuring us that he was on a mission as bank CEO and fighting with his troops in the trenches – evidence enough to strip him of the millions he is taking and to send him to a convalescence home to become sane enough for real work. Sure, one can red from Critical Theory to neo-con economics – but I for one struggle to see what the evidential argument is (I know about paradigms and incommensurability but this doesn’t help).
I eat a lot of Heinz beef broth (it’s all I eat three days a week on semi-fasting days) and have seen the price double in 4 years. The cider and beer I drink are 3 pence a pint at the factory gate and £3 in the pub glass. Much modern science relies on the iterative ability (mega-numbers of repeat calculations) of computing and it should not be beyond us to create spreadsheets that track back from the retail price through all the costs. Business process analysis for the consumer. We could see on a broad scale who gets paid for what.
My point may look simplistic, but it strikes me as very important we do not have such a transparent system and instead have to invent argument when we have the technology just to know.
More extreme spreadsheeting would tell us relations between speculation, TARP-BARF-QE-Euroquasi-QE,prices in the cost of general living and the proportion of neurotic looting we call financial services. If I saw a manufacturing or agriculture business with a fifth of its costs in finance (roughly the relation of agriculture-manufacturing and finance in global GDP) I’d be looking to reduce the financial costs 100 fold.
The snag is we never know what it is we are paying for or how – but we do know the money accrues as debt to us and assets for the rich.
I don’t have problems thinking of food like non-perishable commodities – much of it in correct storage lasts many years – and think many other areas fit with food cost analysis – such as this on UK Rail privatisation (as a series of disasters with hidden public costs) – http://www.tuc.org.uk/tucfiles/603/The_Great_Train_Robbery_7June2013.pdf – or any of Yve’s analysis on the transfer of real jobs from our economies into plantations abroad and middle-men operations and tax avoidance.
Financialisation and the private sector looks more and more like a perpetual motion machine running on a hidden energy supply – our backs, people’s very lives and chronic poverty.
We need food stocks and reasonable finance in the supply chain – the issues are old and simple competition doesn’t work and isn’t other than the name of the game. Economics should be facilitating planned change – http://aciar.gov.au/files/node/14983/climate_smart_agriculture_a_food_policy_perspecti_15867.pdf
and there are many issues other than evil speculators – http://agbioforum.org/v16n1/v16n1a01-degorter.htm
including marketing – http://www.spaa-network.fsaa.ulaval.ca/uploads/tx_centrerecherche/Mattos_and_Poirier_-_SPAA_WP_2013-2_01.pdf
weather and national food security planning – http://ageconsearch.umn.edu/bitstream/143015/2/SAEA%202013%20Paper_Impact%20of%20US%20Drought%20on%20Rice%20Economy.pdf
It is becoming increasingly apparent that the post-
2004, across-the-board, commodity price increases,
which initially appeared to be a spike similar to the
ones experienced during the early 1950s (Korean War)
and the 1970s (oil crises), have a more permanent
character. From 1997–2004 to 2005–12 nominal prices
of energy, fertilizers, and precious metals tripled, metal
prices went up by more than 150 percent, and most
food prices doubled. Such price increases, especially in
food commodities, not only fueled a debate on their key
causes, but also alarmed government officials, leading
to calls for coordinated policy actions. This paper
examines the relative contribution of various sector and
macroeconomic drivers to price changes of five food
commodities (maize, wheat, rice, soybeans, and palm
oil) by applying a reduced-form econometric model on
1960–2012 annual data. The drivers include stock-to-use
ratios, crude oil and manufacturing prices, the United
States dollar exchange rate, interest rate, and income.
Based on long-run elasticity estimates (approximately
−0.25 for the stock-to-use ratios, 0.25 for the oil price,
−1.25 for the exchange rate, and much less for others),
the paper estimates the contribution of these drivers to
food price increases from 1997–2004 to 2005–12. It
concludes that most of the price increases are accounted
for by crude oil prices (more than 50 percent), followed
by stock-to-use ratios and exchange rate movements,
which are estimated at about 15 percent each. Crude
oil prices mattered most during the recent boom period
because they experienced the largest increase.
http://www-wds.worldbank.org/external/default/WDSContentServer/IW3P/IB/2013/05/21/000158349_20130521131725/Rendered/PDF/WPS6455.pdf
Evil speculators should be hung, but storage to use ratios don’t indicate they are at the bottom of this problem in creating false shortages and monopoly in food directly. Prices across the board may be adjusting to oil/energy prices.
One might add that banks selling ‘insurance’ not fit for purpose is hardly new either, whether as hedges that don’t hedge or not. For that matter, it’s long been a good idea not to have someone from the bank in a company boardroom if you want to avoid a bank foreclosure fire sale leaving it with your assets. Is this a strategy to gain farm land by foreclosure? They’ve had many such in the past.
I’m just not sure we need the evil speculator argument – though clearly banksters have been at this for centuries. Lots of financial stuff has origins in making production more efficient – discounted cash flow, repo and all that jazz. Farming has long had contracts secured over many years and varieties of insurance and subsidy.
The analysis we need really concerns what financialisation is about. A great deal of this does seem to be about creating opportunities to make easy money which devalues that produced through hard work and fairly competitive business or public sector provision.
What we are told, all the time, is that the financial and private sector are vastly more efficient than the public sector, government or democracy. In 45 years of observation I have seen nothing like argument with evidence on this matter. One gets a bald loon, assuring us that he was on a mission as bank CEO and fighting with his troops in the trenches – evidence enough to strip him of the millions he is taking and to send him to a convalescence home to become sane enough for real work. Sure, one can read from Critical Theory to neo-con economics – but I for one struggle to see what the evidential argument is (I know about paradigms and incommensurability but this doesn’t help).
I eat a lot of Heinz beef broth (it’s all I eat three days a week on semi-fasting days) and have seen the price double in 4 years. The cider and beer I drink are 3 pence a pint at the factory gate and £3 in the pub glass. Much modern science relies on the iterative ability (mega-numbers of repeat calculations) of computing and it should not be beyond us to create spreadsheets that track back from the retail price through all the costs. Business process analysis for the consumer. We could see on a broad scale who gets paid for what.
My point may look simplistic, but it strikes me as very important we do not have such a transparent system and instead have to invent argument when we have the technology just to know.
More extreme spreadsheeting would tell us relations between speculation, TARP-BARF-QE-Euroquasi-QE,prices in the cost of general living and the proportion of neurotic looting we call financial services. If I saw a manufacturing or agriculture business with a fifth of its costs in finance (roughly the relation of agriculture-manufacturing and finance in global GDP) I’d be looking to reduce the financial costs 100 fold.
The snag is we never know what it is we are paying for or how – but we do know the money accrues as debt to us and assets for the rich.
I don’t have problems thinking of food like non-perishable commodities – much of it in correct storage lasts many years – and think many other areas fit with food cost analysis – such as this on UK Rail privatisation (as a series of disasters with hidden public costs) –http://www.tuc.org.uk/tucfiles/603/The_Great_Train_Robbery_7June2013.pdf – or any of Yve’s analysis on the transfer of real jobs from our economies into plantations abroad and middle-men operations and tax avoidance.
Financialisation and the private sector looks more and more like a perpetual motion machine running on a hidden energy supply – our backs, people’s very lives and chronic poverty.
We need food stocks and reasonable finance in the supply chain – the issues are old and simple competition doesn’t work and isn’t other than the name of the game. Economics should be facilitating planned change –http://aciar.gov.au/files/node/14983/climate_smart_agriculture_a_food_policy_perspecti_15867.pdf
and there are many issues other than evil speculators – http://agbioforum.org/v16n1/v16n1a01-degorter.htm
including marketing – http://www.spaa-network.fsaa.ulaval.ca/uploads/tx_centrerecherche/Mattos_and_Poirier_-_SPAA_WP_2013-2_01.pdf
weather and national food security planning –http://ageconsearch.umn.edu/bitstream/143015/2/SAEA%202013%20Paper_Impact%20of%20US%20Drought%20on%20Rice%20Economy.pdf
It is becoming increasingly apparent that the post-
2004, across-the-board, commodity price increases,
which initially appeared to be a spike similar to the
ones experienced during the early 1950s (Korean War)
and the 1970s (oil crises), have a more permanent
character. From 1997–2004 to 2005–12 nominal prices
of energy, fertilizers, and precious metals tripled, metal
prices went up by more than 150 percent, and most
food prices doubled. Such price increases, especially in
food commodities, not only fueled a debate on their key
causes, but also alarmed government officials, leading
to calls for coordinated policy actions. This paper
examines the relative contribution of various sector and
macroeconomic drivers to price changes of five food
commodities (maize, wheat, rice, soybeans, and palm
oil) by applying a reduced-form econometric model on
1960–2012 annual data. The drivers include stock-to-use
ratios, crude oil and manufacturing prices, the United
States dollar exchange rate, interest rate, and income.
Based on long-run elasticity estimates (approximately
−0.25 for the stock-to-use ratios, 0.25 for the oil price,
−1.25 for the exchange rate, and much less for others),
the paper estimates the contribution of these drivers to
food price increases from 1997–2004 to 2005–12. It
concludes that most of the price increases are accounted
for by crude oil prices (more than 50 percent), followed
by stock-to-use ratios and exchange rate movements,
which are estimated at about 15 percent each. Crude
oil prices mattered most during the recent boom period
because they experienced the largest increase.
http://www-wds.worldbank.org/external/default/WDSContentServer/IW3P/IB/2013/05/21/000158349_20130521131725/Rendered/PDF/WPS6455.pdf
Evil speculators should be hung, but storage to use ratios don’t indicate they are at the bottom of this problem in creating false shortages and monopoly in food directly. Prices across the board may be adjusting to oil/energy prices.