Two Americas
07-22-2010, 01:01 PM
The great hunger lottery
How banking speculation causes food crises
Take the highest stakes, riskiest economic behaviour ever devised, and marry it to the most fundamental basic need of humankind, and you have the subject of this report. Over the past decade, the world's most powerful financial institutions have developed ever more elaborate ways to package, re-package and trade a range of financial contracts known as derivatives. A derivative is not based on an exchange of tangible assets such as goods or money, but rather is a financial contract with a value linked to the expected future price movements of the underlying asset. Derivative contracts are traded on a growing number of underlying assets, from share prices, to mortgages, bonds, commodity prices, foreign exchange rates, and even index of prices.
Derivatives trading has been one of the most lucrative parts of the financial industry, but it is the increasingly complex, opaque and disconnected nature of these and similar products that ultimately triggered the collapse of the banks and the worst financial crisis in human history. Of course, the financial crisis has been an economic disaster of seismic proportions for millions around the world, plunging many countries into recession causing millions to be thrown out of work, soaring public debts and cuts in vital public services.
But while betting on the value of sub-prime mortgages or foreign currency values undoubtedly leads to disastrous consequences, there is another area where the speculative behaviour of the world's largest banks and hedge funds represents a threat to the very survival of people: food commodities.
In The great hunger lottery, World Development Movement has compiled extensive evidence establishing the role of food commodity derivatives in destabilising and driving up food prices around the world. This in turn, has led to food prices becoming unaffordable for low-income families around the world, particularly in developing countries highly reliant on food imports.
Nowhere was this more clearly seen than during the astonishing surge in staple food prices over the course of 2007-2008, when millions went hungry and food riots swept major cities around the world. The great hunger lottery shows how this alarming episode was fueled by the behaviour of financial speculators, and describes the terrible immediate impacts on vulnerable families around the world, as well as the long term damage to the fight against global poverty.
In the report we describe how the current situation came to pass, the risks of another speculation induced food crisis, and what specifically can be done by policymakers here in the UK as well as in the US and EU to tackle the problem.
But at its heart, The great hunger lottery carries a very straightforward message: allowing gambling on hunger in financial markets is dangerous, immoral and indefensible. And it needs to be stopped before any more people suffer to satisfy the greed of the banks.
...
In 2007 and 2008, there was a huge increase in the price of food and energy. The International Monetary Fund's (IMF) food price index increased by more than 80 per cent between the start of 2007 and the middle of 2008. Oil prices went to almost $150 a barrel. The impacts were felt across the world. In rich countries, consumers were paying more for food and energy. High prices contributed towards pushing countries into recession. And high levels of inflation led central banks into maintaining strict monetary policy whilst economies went into decline. The story of commodity prices is a key part of the recent financial crisis and economic difficulties.
But across the global south, the impacts were even more serious. Households in developed countries tend to spend between 10 and 15 per cent of their income on food. While poor households in developing countries tend to spend between 50 and 90 per cent.1 High food prices left households spending a lot more money on food or eating less. Combined with lower incomes due to the global economic slowdown, high food prices led to the number of chronically malnourished people increasing by 75 million in 2007 and a further 40 million in 2008.
As well as eating less food, households have been forced to:
* Eat less fruit, vegetables, dairy and meat in order to afford staple foods.
* Reduce any savings, sell assets or take out loans.
* Reduce spending on 'luxuries' such as healthcare, education or family planning.
In this report we argue that part of the reason for the spike in food and other commodity prices was financial speculation. Speculation rides on the back of underlying changes in supply and demand, amplifying their impact on price. This speculation continues to impact on price, and as long as it remains unregulated, there is a danger it will contribute to a huge spike again.
From early 2007 to the middle of 2008 there was a huge spike in food prices. Over the period there was more than an 80 per cent increase in the price of wheat on world markets. The price of maize similarly shot up by almost 90 per cent. Prices then fell rapidly in a matter of weeks in the second half of 2008. There are various reasons to explain a general increase in food prices over this time. But only financial speculation can explain the extent of the wild swings in the price of food.
The history of modern commodity speculation has its origins in the mid-19th century, when so-called 'futures contracts' were created for agricultural products traded in the United States. These contracts allow farmers to agree a guaranteed price for their next harvest well in advance, giving them greater certainty of income when planting crops. Futures contracts remain very important for farmers, although in global terms they tend to only be available to larger, wealthier farmers.
However, in the early 20th century futures contracts started to be bought and sold by financial speculators who had nothing to do with the physical production, processing or retailing of food. This activity began to affect the actual prices of foodstuffs on the daily 'spot markets', causing them to become more volatile and to rise and fall more sharply. Following the Wall Street crash, the Roosevelt government in the United States recognised this problem, and introduced regulations such as position limits to prevent excessive speculation through the Securities Act of 1933, the Securities Exchange Act of 1934 and the Commodity Exchange Act of 1936.
In the 1990s and early 2000s these regulations were weakened in the face of intense lobbying by the financial industry. For instance, in 1991 lobbying by Goldman Sachs exempted many commodity speculators from the limits on trading created in the 1930s.6 At the same time, new and more complicated contracts were created based on the price of food. Derivatives in food, just as in property and shares, expanded massively.
Banks such as Goldman Sachs created index funds to allow institutional investors to 'invest' in the price of food, as if it were an asset like shares. Goldman Sachs' commodity index fund was created in 1991,7 the same year it was exempted from position limits. These commodity index funds have since become the primary vehicle for speculative capital involvement in food commodity markets.
The number of derivative contracts in commodities increased by more than 500 per cent between 2002 and mid-2008. Between 2006 and 2008 it is estimated that speculators dominated long positions in food commodities. For instance, speculators held 65 per cent of long maize contracts, 68 per cent of soybeans and 80 per cent of wheat. In a major study on the issue, another UN body, the United Nations Conference on Trade and Development (UNCTAD) concluded that: "part of the commodity price boom between 2002 and mid-2008, as well as the subsequent decline in commodity prices, were due to the financialization of commodity markets. Taken together, these findings support the view that financial investors have accelerated and amplified price movements driven by fundamental supply and demand factors, at least in some periods of time." This analysis is widely shared within the financial industry itself. 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 the start of the food price boom, one hedge fund manager told the Financial Times: "There is so much investment money coming into commodity markets right now that it almost does not matter what the fundamentals are doing. The common theme for why all these commodity prices are higher is the substantial increase in fund flow into these markets, which are not big enough to withstand the increase in funds without pushing up prices."12 As the food price spike reached its height in 2008, another hedge fund manager quipped that speculators held contracts in enough wheat to feed every "American citizen with all the bread, pasta and baked goods they can eat for the next two years".
http://www.wdm.org.uk/sites/default/files/hunger%20lottery%20report_6.10.pdf
How banking speculation causes food crises
Take the highest stakes, riskiest economic behaviour ever devised, and marry it to the most fundamental basic need of humankind, and you have the subject of this report. Over the past decade, the world's most powerful financial institutions have developed ever more elaborate ways to package, re-package and trade a range of financial contracts known as derivatives. A derivative is not based on an exchange of tangible assets such as goods or money, but rather is a financial contract with a value linked to the expected future price movements of the underlying asset. Derivative contracts are traded on a growing number of underlying assets, from share prices, to mortgages, bonds, commodity prices, foreign exchange rates, and even index of prices.
Derivatives trading has been one of the most lucrative parts of the financial industry, but it is the increasingly complex, opaque and disconnected nature of these and similar products that ultimately triggered the collapse of the banks and the worst financial crisis in human history. Of course, the financial crisis has been an economic disaster of seismic proportions for millions around the world, plunging many countries into recession causing millions to be thrown out of work, soaring public debts and cuts in vital public services.
But while betting on the value of sub-prime mortgages or foreign currency values undoubtedly leads to disastrous consequences, there is another area where the speculative behaviour of the world's largest banks and hedge funds represents a threat to the very survival of people: food commodities.
In The great hunger lottery, World Development Movement has compiled extensive evidence establishing the role of food commodity derivatives in destabilising and driving up food prices around the world. This in turn, has led to food prices becoming unaffordable for low-income families around the world, particularly in developing countries highly reliant on food imports.
Nowhere was this more clearly seen than during the astonishing surge in staple food prices over the course of 2007-2008, when millions went hungry and food riots swept major cities around the world. The great hunger lottery shows how this alarming episode was fueled by the behaviour of financial speculators, and describes the terrible immediate impacts on vulnerable families around the world, as well as the long term damage to the fight against global poverty.
In the report we describe how the current situation came to pass, the risks of another speculation induced food crisis, and what specifically can be done by policymakers here in the UK as well as in the US and EU to tackle the problem.
But at its heart, The great hunger lottery carries a very straightforward message: allowing gambling on hunger in financial markets is dangerous, immoral and indefensible. And it needs to be stopped before any more people suffer to satisfy the greed of the banks.
...
In 2007 and 2008, there was a huge increase in the price of food and energy. The International Monetary Fund's (IMF) food price index increased by more than 80 per cent between the start of 2007 and the middle of 2008. Oil prices went to almost $150 a barrel. The impacts were felt across the world. In rich countries, consumers were paying more for food and energy. High prices contributed towards pushing countries into recession. And high levels of inflation led central banks into maintaining strict monetary policy whilst economies went into decline. The story of commodity prices is a key part of the recent financial crisis and economic difficulties.
But across the global south, the impacts were even more serious. Households in developed countries tend to spend between 10 and 15 per cent of their income on food. While poor households in developing countries tend to spend between 50 and 90 per cent.1 High food prices left households spending a lot more money on food or eating less. Combined with lower incomes due to the global economic slowdown, high food prices led to the number of chronically malnourished people increasing by 75 million in 2007 and a further 40 million in 2008.
As well as eating less food, households have been forced to:
* Eat less fruit, vegetables, dairy and meat in order to afford staple foods.
* Reduce any savings, sell assets or take out loans.
* Reduce spending on 'luxuries' such as healthcare, education or family planning.
In this report we argue that part of the reason for the spike in food and other commodity prices was financial speculation. Speculation rides on the back of underlying changes in supply and demand, amplifying their impact on price. This speculation continues to impact on price, and as long as it remains unregulated, there is a danger it will contribute to a huge spike again.
From early 2007 to the middle of 2008 there was a huge spike in food prices. Over the period there was more than an 80 per cent increase in the price of wheat on world markets. The price of maize similarly shot up by almost 90 per cent. Prices then fell rapidly in a matter of weeks in the second half of 2008. There are various reasons to explain a general increase in food prices over this time. But only financial speculation can explain the extent of the wild swings in the price of food.
The history of modern commodity speculation has its origins in the mid-19th century, when so-called 'futures contracts' were created for agricultural products traded in the United States. These contracts allow farmers to agree a guaranteed price for their next harvest well in advance, giving them greater certainty of income when planting crops. Futures contracts remain very important for farmers, although in global terms they tend to only be available to larger, wealthier farmers.
However, in the early 20th century futures contracts started to be bought and sold by financial speculators who had nothing to do with the physical production, processing or retailing of food. This activity began to affect the actual prices of foodstuffs on the daily 'spot markets', causing them to become more volatile and to rise and fall more sharply. Following the Wall Street crash, the Roosevelt government in the United States recognised this problem, and introduced regulations such as position limits to prevent excessive speculation through the Securities Act of 1933, the Securities Exchange Act of 1934 and the Commodity Exchange Act of 1936.
In the 1990s and early 2000s these regulations were weakened in the face of intense lobbying by the financial industry. For instance, in 1991 lobbying by Goldman Sachs exempted many commodity speculators from the limits on trading created in the 1930s.6 At the same time, new and more complicated contracts were created based on the price of food. Derivatives in food, just as in property and shares, expanded massively.
Banks such as Goldman Sachs created index funds to allow institutional investors to 'invest' in the price of food, as if it were an asset like shares. Goldman Sachs' commodity index fund was created in 1991,7 the same year it was exempted from position limits. These commodity index funds have since become the primary vehicle for speculative capital involvement in food commodity markets.
The number of derivative contracts in commodities increased by more than 500 per cent between 2002 and mid-2008. Between 2006 and 2008 it is estimated that speculators dominated long positions in food commodities. For instance, speculators held 65 per cent of long maize contracts, 68 per cent of soybeans and 80 per cent of wheat. In a major study on the issue, another UN body, the United Nations Conference on Trade and Development (UNCTAD) concluded that: "part of the commodity price boom between 2002 and mid-2008, as well as the subsequent decline in commodity prices, were due to the financialization of commodity markets. Taken together, these findings support the view that financial investors have accelerated and amplified price movements driven by fundamental supply and demand factors, at least in some periods of time." This analysis is widely shared within the financial industry itself. 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 the start of the food price boom, one hedge fund manager told the Financial Times: "There is so much investment money coming into commodity markets right now that it almost does not matter what the fundamentals are doing. The common theme for why all these commodity prices are higher is the substantial increase in fund flow into these markets, which are not big enough to withstand the increase in funds without pushing up prices."12 As the food price spike reached its height in 2008, another hedge fund manager quipped that speculators held contracts in enough wheat to feed every "American citizen with all the bread, pasta and baked goods they can eat for the next two years".
http://www.wdm.org.uk/sites/default/files/hunger%20lottery%20report_6.10.pdf