Questions in The Guardian we can answer

As food prices reach record highs, how much is the speculation in agricultural commodites to blame?

Zero. Nada. Zilch.

Next question?

And that\’s not the only stupidity in this piece by Ms. Lawrence.

After intense lobbying, banks won deregulation of commodities markets in the US in 2000, allowing them to develop these new products.

There was no deregulation in 2000.

There was simply a clarification of the pre-existing law. It was confirmed by legislation what the Common Law (or common practice) already allowed.

CME argues that the volume of speculation is not a problem, because the overall composition of the agricultural commodities market has not changed; the increase in activity by index funds has been matched by an increase in trading by those who are commercial participants, that is those who have a direct interest in the physical goods.

Quite, for each and every long position there must be an equal and opposite short one. That\’s simply true, by definition, of any derivatives market.

\”That\’s an indefensible position,\” Chicago–based hedge fund manager Mark Newell of Quiddity retorted. He and another hedge fund manager, Mike Masters, prepared testimony to the US Senate when it was looking into the effect of speculation on food prices in 2008.

\”When billions of dollars of capital is put to work in small markets like agricultural commodities, it inevitably increases volatility and amplifies prices – and if financial flows amplify prices of food stuffs and energy, it\’s not like real estate and stocks. When food prices double, people starve ,\” Masters said.

I really wouldn\’t want one quite so ignorant of basic economics managing my money.

If you go off and speculate in something, and if your speculation increases price volatility, then you will be losing money. The aim is to buy low and sell high, recall? So when you buy low you\’re reducing the price volatility at the bottom of the cycle. When you sell high you\’re reducing price volatility at the top of the cycle. You\’re taking in over-supply at one point, increasing supply at the other.

The only way you can be increasing price volatility is if you\’re buying high and selling low. Which means we don\’t really have to worry about you too much as you\’re not going to be in the market all that long, you\’ll be bust.

Speculation can move high prices from the future to the present, sure, but that in itself reduces long term price volatility (Wealth of Nations, Book IV, Chapter V, start at para 40).

Can we please get this straight? Speculation can change prices, yes. Can increase them or reduce them. But it does not increase price volatility, it does the opposite, it reduces it.

 

5 comments on “Questions in The Guardian we can answer

  1. The Guardian should print a special “Guardian Barbie” T-Shirt with “Maths is too Hard – Let’s Go Protesting” written on it.

    I assume they just do not understand what volatility means. Statistics is, like, Maths for boring people. Well even more boring people.

  2. I will admit that this is something I don’t understand fully. Why doesn’t an increase in the volume of cash being used to trade in a market above and beyond the rise in physical product production not lead to a price rise? Surely more money entering a market will push up prices?

    I do not know a vast amount about economics, but I’m prepared to say that Mr Masters has a point when he says an increase in trading activity causing a rise in food prices would be a bad thing in the short-term. While additional incentive to innovate in the market is no bad thing, paying for it with lives is probably a bad thing. Brutally, those lives don’t appear to be being costed into the increase in trading activity taking place in the market.

    Tim adds: Because in a derivatives market you must have equal numbers of bets going each way. If I go long (ie, buy expecting prices to rise) then by definition, someone must have sold me a short contract: they must be betting that prices will fall. So an increase in money in derivatives markets won’t push the price one way or the other.

    Now, in a physical market, if I buy and store cocoa (say) then yes, I’ll have pushed the cocoa price up. But then you’ll be able to see that cocoa stocks are rising. And we didn’t see physical food stocks rising in 07/08: therefore hoarding was not the cause of the price rises.

  3. I tend to agree with the points made, except I’m nowhere near as certain about the reality.

    For instance, clearly a lot (most?) of commodity investors did lose money in 2008, so how can the argument that they did not increase volatility in the slighest rely on the argument that they could only have done so if they lost money?

  4. Matthew2 – some investors lost money, others did well. Prices moved substantially, so substantial losses or gains were more likely. But is was not speculation itself that caused the market to move. Speculators simply provide liquidity to the market; without them the market would likely be more lumpy/volatile.

  5. Could you point to some evidence that investors were broadly neutral after the commodity crash of 2008? I find it very hard to believe.

    Also you’re simply asserting that speculation didn’t cause prices to move, but Tim is saying that investors could be a disstabilising effect if they lose money. I think he’s right.

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