The UN on speculation in food futures

This is a right dog\’s dinner of a document. First, the good news:

Traditional speculation in agricultural commodities markets
is based on market fundamentals – above all on the demand
and supply for any particular commodity. Thales purchased
his option on the oil presses because he expected the supply
of olives to increase. The farmers sold him the option because
the were hedging against the risk of a poor olive harvest. This
form of speculation is generally considered necessary and
useful in the market: it facilitates commercial hedging against
risk, and it allows for price discovery, assisting farmers and

buyers in discovering the reasonable price for a particular
commodity in individual trades and on spot markets27. If the
buyer is willing to offer a higher price for a future than before,
it means that she expects the eventual price of the commodity
to increase further. As such, if the price of commodity futures
goes up, it signals to sellers on spot markets to raise their
prices. Indeed, the grain futures prices quoted by the Chicago
Mercantile Exchange28 tend to be incorporated directly
into grain trade contracts the world over. Moreover, it is
conventionally thought that such speculation reduces price
volatility, because speculators provide a market for hedgers,
and because they buy when the price is low and sell when the
price is high, thus evening out extremes of prices29.

So, the conventional economic view, one we can trade certainly back to Adam Smith, is correct. Speculation in food commodities is a good thing. So all those ignorants in this Guardian comment section, those who are demanding the banning of such speculation, can fuck right off.

Banning speculation will kill people, capisce?

However, they then go on to talk about the rise of the commodity index funds and how they, using momentum trading, have upset this beneficial process and thus brought higher volatility.

Sadly, there\’s a horrible intellectual error here. Truly horrible.

They\’re right of course, in that lots of money did enter the markets. That many of the funds were long only. That they used only futures, not involving themselves with the boring stuff like grain elevators and warehouses.

However, they\’ve entirely missed the point that the futures market is, for those inside it, a zero sum game. By simple definition, by accounting identity, for every long position there must be an equal and opposite short position. It isn\’t possible for me to agree to sell wheat in 6 months at price x without there being somone else on the other side agreeing to purchase wheat in 6 months at price x.

So, the existence of large long only funds is irrelevant: by their very existence we know that there must be equal and opposite large amounts of short speculation going on.

This the UN entirely ignores thus making their analysis of the effects of the commodity funds and momentum investing wrong. No, not arguable, simply wrong.

Which is something of a bad bit.

Another bad bit:

The sudden massive entry of index funds into commodities
should be placed against the background of developments in
the broader financial markets. Following the passage of the
U.S. Commodity Futures Modernization Act in 2000, Over The
Counter (OTC)43 derivatives were exempted from the oversight
of the U.S. Commodity Futures Trading Commission (CFTC).

Nope, that\’s flat out wrong. The CFMA simply confirmed pre-existing regulatory matters. There was no major change in regulation: only confirmation of what was already the case.

So, what should we do about it all?

In general, certain steps could be taken to prevent improper
speculation in the commodities derivatives markets.
n Certain important regulatory bodies comprise too few
experts in commodity markets65: a first improvement could
be simply to begin remedying this imbalance.

Yes, that sounds sensible. We could start by getting the UN Special Reporter on the subject, the writer of this report, up to speed on the subject perhaps?

Once the distinction is made, access to commodities
derivatives markets could be restricted to traders and
specialist brokers. A number of proposals could be
considered, such as an outright ban on momentum-based
speculation, and the compulsory registration of actors
trading on commodity futures markets, in order for such
exchanges to exclude financial traders69.

Cretin. The financial traders provide the liquidity that everyone else is using. The entire point, in the wider world, of having futures markets is to transfer risk. To transfer it from the farmer and the baker to the wheat speculator. We want the \”financial traders\” to be there so that the financial traders end up holding the risks. This is the whole point of the entire system!

Aside from these regulatory changes, strengthening of
spot markets may be brought about by investing in better
warehousing facilities, communications services and in
transport infrastructure72. Such steps will not only reduce
the influence of non-commercial commodity futures traders,
and increase the participation of farmers on such markets,
but will also improve the ability of commodity futures to act
as price signals.

Now that is a good idea, although not quite for the reasons they give. Warehouses, comms and transport enable more farmers to enter the system, more farmers to transfer their risks. This is good, we are expanding the system and moving risk from those who do not want it to those who do…..or rather, are willing to accept it for a price.

As they go on to say:

This is to be desired even if one rejects the speculationbased
explanation for the food crisis. It may be noted that
the Abhijit Sen Committee Report to the Indian Ministry of
Consumer Affairs, Food & Public Distribution called for such
strengthening of spot market73, even though it found that
speculation in commodity futures did not fuel inflation in food
prices74.

Quite. Speculation in foodstuffs is good, risk transfer is good. So let\’s have more of it please.

Just to give you an idea of the limited level of knowledge of this paricular report writer, how about this?

Petrol
is an integral component of modern food supply chains,being used for fertilizers, food processing and transportation,
and the rise of bioenergy leads to an increased merger of
the food and energy markets42.

Yes, oil derivatives are indeed important: although I have a very strong suspicion that it is diesel, not petrol, which is used in both processing and transportation. But apologies to the numpty that wrote the report, fertilizers are not made from petrol or any other oil derivative. They are made from natural gas.

Guess what Caroline Lucas has to say about this?

Green MP Caroline Lucas called for tighter regulation of the food trade. \”Food has become a commodity to be traded. The only thing that matters under the current system is profit. Trading in food must not be treated as simply another form of business as usual: for many people it is a matter of life and death. We must insist on the complete removal of agriculture from the remit of the World Trade Organisation,\” she said.

Agriculture must be removed from the WTO? Seriously? An organisation which is one country, one vote (thus giving everyone, even the smallest, an absolute veto), an organisation which is, in reality, only there to ensure that governments do live up to what they\’ve promised to live up to: this should be removed from the market for food?

This stuff is bad is it?

The WTO establishes a framework for trade policies; it does not define or specify outcomes. That is, it is concerned with setting the rules of the trade policy games.[34] Five principles are of particular importance in understanding both the pre-1994 GATT and the WTO:

  1. Non-Discrimination. It has two major components: the most favoured nation (MFN) rule, and the national treatment policy. Both are embedded in the main WTO rules on goods, services, and intellectual property, but their precise scope and nature differ across these areas. The MFN rule requires that a WTO member must apply the same conditions on all trade with other WTO members, i.e. a WTO member has to grant the most favorable conditions under which it allows trade in a certain product type to all other WTO members.[34] \”Grant someone a special favour and you have to do the same for all other WTO members.\”[35] National treatment means that imported goods should be treated no less favorably than domestically produced goods (at least after the foreign goods have entered the market) and was introduced to tackle non-tariff barriers to trade (e.g. technical standards, security standards et al. discriminating against imported goods).[34]
  2. Reciprocity. It reflects both a desire to limit the scope of free-riding that may arise because of the MFN rule, and a desire to obtain better access to foreign markets. A related point is that for a nation to negotiate, it is necessary that the gain from doing so be greater than the gain available from unilateral liberalization; reciprocal concessions intend to ensure that such gains will materialise.[36]
  3. Binding and enforceable commitments. The tariff commitments made by WTO members in a multilateral trade negotiation and on accession are enumerated in a schedule (list) of concessions. These schedules establish \”ceiling bindings\”: a country can change its bindings, but only after negotiating with its trading partners, which could mean compensating them for loss of trade. If satisfaction is not obtained, the complaining country may invoke the WTO dispute settlement procedures.[35][36]
  4. Transparency. The WTO members are required to publish their trade regulations, to maintain institutions allowing for the review of administrative decisions affecting trade, to respond to requests for information by other members, and to notify changes in trade policies to the WTO. These internal transparency requirements are supplemented and facilitated by periodic country-specific reports (trade policy reviews) through the Trade Policy Review Mechanism (TPRM).[37] The WTO system tries also to improve predictability and stability, discouraging the use of quotas and other measures used to set limits on quantities of imports.[35]

The mind boggles, truly.

  • Safety valves. In specific circumstances, governments are able to restrict trade. There are three types of provisions in this direction: articles allowing for the use of trade measures to attain noneconomic objectives; articles aimed at ensuring \”fair competition\”; and provisions permitting intervention in trade for economic reasons.[37] Exceptions to the MFN principle also allow for preferential treatment of developing countries, regional free trade areas and customs unions.[citation needed]
  • 3 thoughts on “The UN on speculation in food futures”

    1. I’m not sure your point about short positions equalling long positions has much weight.

      The point is that the long interest pushed the price up. The short interest responded to this price rise. It would initially have come from the ‘usual’ market participants and then diversified commodity traders and hedge funds, and then up the financial food chain (so to speak) until those first-mover mutuals sold out to the last man in. At which point the price stopped going up but had reached a point way above where it would have been if it was being driven mostly by the dynamics of the physical market and the derivative markets which work off it.

      The problem was one of excess liquidity looking for a speculative story. Some real world people – buyers in physical markets – got burnt as a consequence.

    2. No it is arguable, and has been argued, by many people over the last few years with little free market/anti-free market/left/right split (e.g. Krugman’s on your side).

      Let me try to give some background. It seems clear the impetus for the large rise in positions has been from the long side, not the short side. The markets contain dealers who will take the other side of any trade so the short side has risen as well. Those dealers however need to offset their risk. How they did that, and whether it impacted on the spot market, is the key.

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