Commodities Speculation Doesn't Increase Food Prices

By Tim Worstall of Forbes. Excerpt:

"A few years back it was all the rage to go around shouting that commodities speculation drove food prices higher. This betrayed a startling lack of understanding of how commodities markets actually work but it really was popular to say so. This led to proposals to limit the amount of speculation that could be done in things like wheat futures and so on. Not a good idea and not likely to be a productive public policy simply because it wasn’t the speculation driving prices higher. We’ve now also got an interesting little data point with which to refute that original contention.

The basic claim was that as more people went and played with corn and wheat futures this drove up the price in the physical market and thus poor people starved. No, even us capitalist plutocrats don’t like that idea so if it were true something would indeed be necessary to stop it. But that’s to misunderstand how commodity markets work. Futures prices collapse down to physical as the maturation date approaches. Rather than futures prices driving up physical. As both Craig Pirrong and Paul Krugman pointed out you can only have futures driving the physical price if you also see hoarding or stockpiling. And we saw no evidence at all of such stockpiling so don’t think that high futures prices were driving high physical ones.

People really were quite irate about this:

Since the publication of the foodwatch report “The Hunger-Makers” in October 2011, foodwatch has demanded that banks cease all speculative trading with soft commodities in order to eliminate the risk of speculation-related food price spikes. With Commerzbank , Landesbank Baden-Württemberg (LBBW), Landesbank Berlin (LBB), DekaBank of the Sparkassen and now DZ Bank and Union Investment, the list of banks abandoning food speculation is getting longer and longer. On the other hand, Deutsche Bank , Germany’s largest player in this field, announced their decision at the start of the year to continue distributing products that speculate on the price development of soft commodities.

And the egregious Deborah Doane was also on the case:

The irony, of course, is that while they’re serving up a few meals, their core business is virtually starving people at the same time. In 2012, the US investment bank made an estimated $400m from speculating on food. The World Bank estimated in 2010 that 44 million people were pushed into poverty because of high food prices, and that speculation is one of the main causes.

Since Goldman led the drive to deregulate commodity markets in the 1990s, after constraints were imposed following the 1930s Wall Street crash, they’ve been at the vanguard of creating and promoting complex commodity instruments, from which they’ve raked in huge profits. Wallace Turbeville, a former vice president and the inventor of commodity index funds, has been outing the company’s methods. He says that in his time at Goldman, investment increased from $3bn in 2003 to $260bn in 2008, and commodity prices rose dramatically during the same period, increasing from 2006 to 2008 by an average of 71%.

In 1996, speculators held 12% of the positions on the Chicago wheat market, with most of the market being made up of the legitimate users of food – from farmers to producers. But the legitimate hedging element of commodity markets has virtually disappeared in the intervening years. By 2011, pure speculators made up a staggering 61% of the market. Of course, Goldman Sachs isn’t the only player, but it is certainly the largest.

The allegation really was more speculation, higher food prices, thus poor people starve. Which brings us to this interesting little chart from Mark Perry:



Food is now cheaper than it was before the spike supposedly caused by speculation. And there hasn’t been any reduction in the amount of speculation, far from it. In the near zero interest rate world of the past few years speculation in commodities has risen, not fallen. Thus our conclusion must be that it isn’t the volume of speculation which drives food prices. Entirely contrary to the entire story behind that campaign.

The lesson for our public policy from this being twofold. The first is that if the volume of speculation doesn’t drive food prices then we don’t need to control the volume of speculation in order to keep a lid on food prices."