Goldman Sachs and all the other nasty speculators made a fortune out of starving people.
There are so many things wrong with this it\’s unbelievable.
Then, through the 1990s, Goldman Sachs and others lobbied hard and the regulations were abolished. Suddenly, these contracts were turned into \”derivatives\” that could be bought and sold among traders who had nothing to do with agriculture. A market in \”food speculation\” was born.
No, you never did have to prove that you were either a farmer or a baker in order to trade in wheat futures. The whole point of any form of futures market (which in itself is a derivative) is to allow speculators, those not directly involved in the market, to buy and sell. For it is they that take the risk off the shoulders of the farmer or the baker.
But much, much, worse is that he\’s got the entire process of speculation wrong.
At the end of 2006, food prices across the world started to rise, suddenly and stratospherically. Within a year, the price of wheat had shot up by 80 per cent, maize by 90 per cent, rice by 320 per cent. In a global jolt of hunger, 200 million people – mostly children – couldn\’t afford to get food any more, and sank into malnutrition or starvation. There were riots in more than 30 countries, and at least one government was violently overthrown. Then, in spring 2008, prices just as mysteriously fell back to their previous level.
Let\’s agree that this is what happened.
Now, let us also consider what we would like to have happen.
Back in 2006 there were concerns that biofuels were going to take a huge chunk out of the market: what could feed people was going to fuel cars. Thus food in the future was going to be in short supply. Let us stick with wheat.
What we want is some method of reducing the future demand for wheat while also increasing the amount of wheat that will be planted. We want both consumers and producers to react rationally to this mooted future shortage. We want consumers to substitute for wheat: eat rice, cassava, teff, rye, oats, instead. We want producers to change their production processes: it\’s a standard of farming that you can go for extensive or intensive methods and there\’s a spectrum between them. You can add a little more fertiliser for example, but you\’ll only do so if the rise in price is great enough for the marginal production to cover the cost of your marginal fertiliser use. And of course we\’re all making predictions, something which is difficult about the future.
What might we use as a transmission method for this message? Use less wheat and grow more please because it\’s going to be much more expensive in a year or two?
Well, actually, what we did use to do this is the futures market. The price of wheat for delivery later that year, for delivery next year, went up as all those speculators saw an opportunity to make a profit. Even the price of wheat now went up as people saw that you could buy now, store, and then sell when the price had risen (so both spot and futures markets contributed to the price rise). They could give a shit about the starving and less than two shits for for the farmers\’ profits of course. But their very actions, piling into wheat futures, sent the message humming along the wires that wheat\’s gonna be in short supply soon and it\’s gonna get more expensive!
And what was the result of this message? Yes, demand fell and supply rose:
Most of the explanations we were given at the time have turned out to be false. It didn\’t happen because supply fell: the International Grain Council says global production of wheat actually increased during that period, for example. It isn\’t because demand grew either: as Professor Jayati Ghosh of the Centre for Economic Studies in New Delhi has shown, demand actually fell by 3 per cent.
Riiiight, we\’ve got our higher prices leading to lower demand, good. Oh, and supply rose did it? That\’s the other thing we\’re looking for, isn\’t it? Excellent. So, our filthy, lucre seeking, bastard speculators have actually managed, purely through the application of their own greed, to do exactly what we wanted to happen.
They\’ve reduced demand, increased supply and thus solved the looming shortage of wheat.
We should also remember something else. Derivatives markets (futures, options etc) are by definition zero sum for the speculators in them. For every £ that Goldman Sachs made in that market, someone else lost a £.
This doesn\’t apply to the system as a whole though: the transfer of risk from farmer and baker to the speculators is of value, as are the price signals that the system as a whole produces. But for the speculators within it, it\’s zero sum. So, just as many people have lost money (or rather the amount of money lost is the same as the money made) as made it in bringing us these two useful things: risk transfer and price information, a prediction about the future.
Now the thing is there\’s no mystery to any of this at all. It\’s laid out (in his usual exhaustive manner) in page after page of Adam Smith\’s Wealth of Nations. Here in fact.
The interest of the inland dealer, and that of the great body of the people, how opposite soever they may at first sight appear, are, even in years of the greatest scarcity, exactly the same. It is his interest to raise the price of his corn as high as the real scarcity of the season requires, and it can never be his interest to raise it higher. By raising the price he discourages the consumption, and puts everybody more or less, but particularly the inferior ranks of people, upon thrift and good management. If, by raising it too high, he discourages the consumption so much that the supply of the season is likely to go beyond the consumption of the season, and to last for some time after the next crop begins to come in, he runs the hazard, not only of losing a considerable part of his corn by natural causes, but of being obliged to sell what remains of it for much less than what he might have had for it several months before. If by not raising the price high enough he discourages the consumption so little that the supply of the season is likely to fall short of the consumption of the season, he not only loses a part of the profit which he might otherwise have made, but he exposes the people to suffer before the end of the season, instead of the hardships of a dearth, the dreadful horrors of a famine. It is the interest of the people that their daily, weekly, and monthly consumption should be proportioned as exactly as possible to the supply of the season. The interest of the inland corn dealer is the same. By supplying them, as nearly as he can judge, in this proportion, he is likely to sell all his corn for the highest price, and with the greatest profit; and his knowledge of the state of the crop, and of his daily, weekly, and monthly sales, enable*70 him to judge, with more or less accuracy, how far they really are supplied in this manner. Without intending the interest of the people, he is necessarily led, by a regard to his own interest, to treat them, even in years of scarcity, pretty much in the same manner as the prudent master of a vessel is sometimes obliged to treat his crew. When he foresees that provisions are likely to run short, he puts them upon short allowance. Though from excess of caution he should sometimes do this without any real necessity, yet all the inconveniences which his crew can thereby suffer are inconsiderable in comparison of the danger, misery, and ruin to which they might sometimes be exposed by a less provident conduct. Though from excess of avarice, in the same manner, the inland corn merchant should sometimes raise the price of his corn somewhat higher than the scarcity of the season requires, yet all the inconveniences which the people can suffer from this conduct, which effectually secures them from a famine in the end of the season, are inconsiderable in comparison of what they might have been exposed to by a more liberal way of dealing in the beginning of it. The corn merchant himself is likely to suffer the most by this excess of avarice; not only from the indignation which it generally excites against him, but, though he should escape the effects of this indignation, from the quantity of corn which it necessarily leaves upon his hands in the end of the season, and which, if the next season happens to prove favourable, he must always sell for a much lower price than he might otherwise have had.
What Hari has got wrong, because he doesn\’t understand even the most basic points about economics, is that this greed for profit produces exactly the outcome we desire. The high prices which would accompany the coming shortage are brought forward in time and thus influence both consumption and production now and into the future. Meaning that the highly undesired famine doesn\’t happen as consumption falls and production rises.
Or, in short, futures allow speculation upon the future: which is why we have them, for speculation upon the future allows us to sidestep the very things which we do not desire to happen in that future.
Now, of course, you could design an alternative method of doing this. The wise, omniscient and altruistic politicians and bureaucrats could send a fax to all farmers telling them to plant more. Signs could appear in every breadshop telling us all to eat our crusts.
Except, of course, those wise, omniscient and altruistic politicians and bureaucrats are precisely the fuckers that got us into the mess in the first place by insisting that we should put wheat into cars rather than people.
“Except, of course, those wise, omniscient and altruistic politicians and bureaucrats are precisely the fuckers that got us into the mess in the first place by insisting that we should put wheat into cars rather than people.”
And this is the undeniable clincher in our post-expenses scandal era that slam-dunks any leftie wailing about the evils of the market: “What would you have instead? Politicians decide?!?”
Governments upset apple carts. Markets settle them.
What he (and others) are trying very hard to do is use the financial crisis to shift the blame from those who actually caused the food shortages and consequent deaths (the Eco-fascisti of greenpeace, WWF, etc), to others, hoping that they can get away with it. They just might, there’s a powerful set of interests very interested in doing so.
I dunno about economics, but would someone please teach him some history.
through the 1990s, Goldman Sachs and others lobbied hard and the regulations were abolished. Suddenly, these contracts were turned into “derivatives” that could be bought and sold among traders who had nothing to do with agriculture. A market in “food speculation” was born.
I seems to remember a slightly amusing movie called trading places. It was all about people with absoloutely no connection to agriculture who speculated on the prices of certain agricultural products (pork bellies, wheat, frozen concentrated orange juice) . It was made in 1983 and implied the practice was quite long established even then.
Why is it necessary to explain all this to Hari at his age?
Many of us must have discussed this with our fathers in our teens: is he dim or just too obstinate to listen?
Tim, how do you explain this little snippet:
As Professor Ghosh points out, some vital crops are not traded on the futures markets, including millet, cassava, and potatoes. Their price rose a little during this period – but only a fraction as much as the ones affected by speculation. Her research shows that speculation was “the main cause” of the rise.
Also, can you explain why the losers in this case are not the farmers selling the grain and the bakers buying it, surely they have to participate in market at some point?
Tim adds: You’ll note that those are three crops that no one is trying to turn into petrol perhaps? And why are the farmers losing? The price they get for their grain has just gone up!
Tim, he’s a meeja man. Lefty through and through.
Why would you expect him to know anything about finance and economics other than how big his paycheck is?
@Andreas Paterson: I can’t comment on millet & cassava as they are not UK crops, but potatoes are. Potatoes are not an internationally traded product. There are no bulk carriers of spuds criss-crossing the globe. So the price of potatoes is a national affair. If the potato crop in the UK does badly, you get little notices in chip shops saying ‘Due to the price of potatoes going up, chip prices have had to rise to x per portion, sorry’. (Strangely the chip prices never seem to come down the next year when there is a good crop, but thats by the by).
Equally the production of potatoes is a specialised affair. You need a) particular type of land (deep stone free soils) and b) large expensive machinery. So from year to year the area of ground under production remains pretty constant.
Whereas grain production is easier – all you need is a plough and a seed drill, and any old bit of land can be put into production, if the price is good enough. Grain is traded internationally. there are facilities to import/export grain at all major ports. So the demand for grain is international, and the supply also. Grain used in the UK for bread making may come from Canada (harder milling varieties are easier to grow there) whereas softer animal feed varieties grow well in the UK, and are exported elsewhere.
Thus the grain crop is subject to much greater international demand/supply changes than the UK potato crop, making its price much more volatile.
Also no-one was suggesting using potatoes as the feed stock for ethanol production, as was not only the suggestion in 2006, but actual reality – several plants have been built in the UK, and many others planned. I’m not sure if they have made it into production yet, or ever will do, but they actually exist. This was a driving force behind the rise in grain prices.
Let us not forget the significant, if unintended, distortion of the grain market via biofuel subsidies by various western governments. Lots of details here.
Maybe I’m being oversimplistic here, but I would have thought that what people would want here is for people not to starve and stuff, rather than reducing demand and increasing supply of wheat (which may be desirable but which isn’t interesting in itself).
But people did starve. So I think saying that having a futures market provided “exactly what we wanted” is clearly a little off base.
“They’ve reduced demand, increased supply and thus solved the looming shortage of wheat.”
Well, they managed to ‘solve’ the shortage without solving the problem of people starving. Well done them I guess?
I seem to remember it was the monks of Riveaulx Abbey in Yorkshire in the Middle Ages who cottoned onto the principle of futures trading in sheeps’ fleeces so we can assume it had/has the Lord’s blessing.
Who the f*** is Hari to object?
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Thomas – the farmers and speculators have solved the supply problem. The supply problem was caused by people wanting to use grain asa biofuels and therefore causing the price to rise. Of course it would be nice if the food supply could react instantaneously to shifts in demand but it doesn’t. Without the subsidies for biofuel production, and the insistence that biofuels were the future, the “poor” would have had enough grain.
A couple of points:
– There is a market for financial products as well as a market for foodstuffs. All sort of funds started ‘diversifying’ into soft commodities derivatives around about the period under discussion for a number of reasons (China demand, biofuels, liquidity looking for a home). Expectations were that prices were going to go up. These expectations backed by speculative demand helped ensure they did. (As an aside, financial and physical markets can move out of sync for periods and for that reason price signals in futures markets don’t always tell you what you think they might. In this instance, farmers may have been sceptical about investing on the back of a bubble. Similarly, oil companies never discounted their projects on a $150/barrel basis).
– The supply of agricultural products is sticky, i.e. it takes up to a year for supply to respond to demand (growing stuff takes time). In this delay people can starve: prices remain high and consumers can find themselves unable to buy as much as they need. In the medium term there may well be plenty; but in the medium term they’re dead.
For these reasons Hari is on to something. He might not be able to express why but nevertheless, he is.
However, if one were to decide the state of affairs prevailing at the that time was unsatisfactory, it’s not easy to work out what should have been done. Put up interest rates and restrict credit would be one solution – as we know to our cost, the liquidity that was sloshing around the world back then fuelled a number of speculative frenzies. Not all of them killed people, however.
Green Greed and “greenie politicking” seem to be very evident in these 3 graphs:
http://icecap.us/index.php/go/joes-blog/2005_energy_bill_and_grain_prices/
… of the futures price of wheat, corn and soy when:
“The 2005 Energy bill mandated that 4 billion gallons of renewable fuel (mostly corn-based ethanol) must be added to the gasoline supply in 2006. That amount rises to 4.7 billion gallons in 2007 and 7.5 billion in 2012. This still represents a small fraction of the estimated 140 billion gallons of gasoline the US consumes every year. But it is the subsidies and tax credits that have made this ethanol market what it is – without government interference, consumer-driven demand would be nothing and the ethanol market would be SIGNIFICANTLY SMALLER.”
http://www.dailyestimate.com/article.asp?id=8756
It is always amazes me how historical facts are seemingly “forgotten” in pro-Green arguments.
Also no-one was suggesting using potatoes as the feed stock for ethanol production
In fact the government has been discouraging this for centuries
http://en.wikipedia.org/wiki/Poitín
Goldman Sachs would not exist without government invention. Yet you are horrified when there are regulations to protect food production.
Bio-fuel production shouldn’t be allowed when it is just to provide luxury for the west at the expense of people eating in the global south. Also, most bio-fuels actually use more energy than to produce than they provide.
Another point is that it is the food corporation middle men that make money. The markets do not protect the farmer.
http://vimeo.com/12258201
Adam Smith’s invisible hand doesn’t always work and isn’t always appropriate. Otherwise we wouldn’t live in a world where people starve even though there’s enough food.
Finally, part of the point of the article is that economics has become so convoluted is hard to understand. We have put our faith in something most people don’t understand.
“Adam Smith’s invisible hand doesn’t always work and isn’t always appropriate.”
So should we just take your word on that?
“We have put our faith in something most people don’t understand.”
Are you talking about global warming again?
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The World Development Movement is far from alone in calling out the problem of excessive speculation in commodities. And it is far from a “lefty” cause.
A number of of studies by respected institutions such as MIT, Yale, University of Chicago, Citigroup, Deutsche Bank, Oppenheimer, IMF, UNCTAD, OPEC, G8 finance ministers and more have shown that excessive speculation in commodity markets was an aggravating factor in the 2008 food and energy commodity bubbles.
A partial list of these studies is at http://accidentalhuntbrothers.com/?p=661.
Yes, there were clearly supply and demand factors involved, but the deregulation of the commodity markets, especially in the U.S. in 2000 with the CFMA led to out of control commodity markets.
The U.S. financial reform bill does a decent job of addressing the problem, but more needs to be done.
Tim adds: CFMA having anything to do with it sounds most unlikely. I mean, have you actually bothered to read the Act? Firstly, it largely simply codifies the ad hoc arrangments that had grown up before its passage. Secondly, those few departures from previous practice did not extend to agricultural products or derivatives.
Further, the list you direct us to is specifically about oil prices, not agricultural or soft commodites.
Finally, you absolutely have failed to understand the important part of my critique. Which is that even if it was all simply a bubble driven by financial speculation (caused, as you agree, at the beginning, by real supply issues but which then got out of hand) this is exactly what we actually want to happen. We want speculators to move prices in time, we want prices to rise in the face of supply problems so that consumption is constrained and supply encouraged.
Even if it was a bubble driven by speculation, what happened is exaclty what we wanted to happen.
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Pingback: Johann Hari’s defence doesn’t work
What I marvel at is reading Mr Worstall talking about the wonders of markets as we head for the abyss. Dr Pangloss rides again.