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.
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.”
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.