Stop bankers from betting on food and causing hunger | World Development Movement

Frequently asked questions about food speculation

How does betting on food prices in financial markets work? How does that affect the price?

Futures contracts’ were first created in the United States in the 19th century to help farmers deal with the uncertainties involved in growing crops, such as unforeseen weather conditions. A ‘futures contract’ enables farmers to sell their crops at a future date, at a guaranteed price. This gives farmers greater certainty when choosing which crops to grow.

To buy a futures contract you do not need to buy or sell actual food and so financial players such as banks started to buy and sell these contracts which in turn undermined the system as it caused price fluctuations in real food.

Following the Wall Street Crash in the 1930s, regulations were introduced by the US government to limit speculation on food prices. But these regulations were weakened in the 1990s through corporate lobbying and so banks were able to engage in rampant betting on food markets.

Complex contracts were created called ‘derivatives’. This just means that the value of the contract is ‘derived’ from the commodity being traded. But no actual trading of the physical commodity needs to take place. Derivatives are based on the concept of a ‘futures’ contract but have become more complex.

The price of derivatives in food is affected by demand and supply. As more derivatives in a food are bought, the more the price of a derivative contract rises. This causes the ‘future’ price of food to rise. As mentioned above, this rising price of food in the future has a knock-on effect on the real price of food now.

How is speculation on food prices done and who does it?

The main way that investors speculate on food commodities is through ‘commodity index funds’. These indexes put money into derivatives across a range of commodities. They were mainly created by banks such as Goldman Sachs and Deutsche Bank. It is estimated the total money into such index funds increased from US$46 billion in 2005 to US$250 billion in March 2008. Money began to be taken out of the index funds in the couple of months before food prices began to fall dramatically in mid-2008.

Commodity indexes are open for anyone to invest in, just as is the FTSE 100 index for shares. However, they are rarely marketed at ‘ordinary’ people, and instead tend to be used by institutional investors such as pension funds, insurance companies and mutual funds (a professionally managed fund which pools money from individual investors).

Banks play an important part in how index funds work. Banks tend to arrange the buying of derivatives contracts for their clients as well as act as the seller to contracts the index fund is buying. This effectively means banks are trading against their own clients. One commentator at the Financial Times noted in 2007 that investors in commodity index funds were losing large amounts of money, and exposed that the main beneficiary was the trading arm of Goldman Sachs.

The largest banks at the centre of the commodity speculation are Goldman Sachs, Bank of America, Citibank, Deutsche Bank, HSBC, Morgan Stanley and JP Morgan.

Aren't high prices good for poor farmers in developing countries as they'll get better prices for their produce?

No, high food prices affect poor farmers as well as the urban poor. A high percentage of rural households are net buyers of staple foods. In Kenya and Mozambique, around 60 per cent of rural householders are net buyers of maize. Very few poor farmers produce a significant surplus to sell. In Zambia, 80 per cent of farm households grow maize, but fewer than 30 per cent sell any. The few households which make-up the bulk of maize sellers have significantly higher incomes.

Any farmers who do have a surplus to sell may see little benefit of higher prices. The FAO says that consumers in urban areas are more likely to see the effects of higher prices than producers in rural areas. Moreover, large producers which are part of large (sometimes multinational) companies are most able to benefit from high prices.

Africa has gone form being a net exporter of food in 1970 to a massive net importer. Around 55 per cent of developing countries are net food importers and almost all countries in Africa are now net importers of cereals. This means they are hugely reliant on the world food prices of their staple foods and higher prices has a direct impact on their ability to feed themselves.

Did the price of all foods rise in 2007 and 2008?

No, there were differences in how food prices changed between commodities. There were changes in supply and demand which would have caused price changes without speculation. However speculation amplified the impacts of these price changes. For example, Brazil has rapidly increased production of sugar and exports, with a higher quantity available in the world market, there has been no scope for speculation to amplify a price change. Consequently, there is evidence that there was no increase in financial speculation in sugar futures in 2007 and 2008.

Some important staple foods such as sorghum, millet and cassava are not traded on futures markets. Prices for such crops rose in 2007/08, though by nowhere near as much as for wheat, maize and rice. This is evidence of the role of financial speculation in driving up prices of crops such as wheat and maize. Specifically in reference to the potato, research for the FAO says: “being absent in the major commodity exchanges, there is no risk of potato bearing the ill-effects of speculative activity, which cannot be said of cereal commodities”

However, if the price of imported food such as wheat and maize has risen, this is likely to have a knock-on impact on locally produced crops such as sorghum. Speculation probably had an indirect impact on prices of such traditional staples through its impact on the price of staples which are traded in futures contracts.

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via wdm.org.uk