How Goldman Sachs created the food crisis

Frederick Kaufman's piece for Foreign Policy examines how the Goldman Sachs Commodity Index (GSCI) is responsible for the increase in food prices.

[T]he boom in new speculative opportunities in global grain, edible oil, and livestock markets has created a vicious cycle. The more the price of food commodities increases, the more money pours into the sector, and the higher prices rise. Indeed, from 2003 to 2008, the volume of index fund speculation increased by 1,900 percent. "What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets," hedge fund Michael Masters testified before Congress in the midst of the 2008 food crisis.

The result of Wall Street's venture into grain and feed and livestock has been a shock to the global food production and delivery system. Not only does the world's food supply have to contend with constricted supply and increased demand for real grain, but investment bankers have engineered an artificial upward pull on the price of grain futures. The result: Imaginary wheat dominates the price of real wheat, as speculators (traditionally one-fifth of the market) now outnumber bona-fide hedgers four-to-one.

Today, bankers and traders sit at the top of the food chain -- the carnivores of the system, devouring everyone and everything below. Near the bottom toils the farmer. For him, the rising price of grain should have been a windfall, but speculation has also created spikes in everything the farmer must buy to grow his grain -- from seed to fertilizer to diesel fuel. At the very bottom lies the consumer. The average American, who spends roughly 8 to 12 percent of her weekly paycheck on food, did not immediately feel the crunch of rising costs. But for the roughly 2-billion people across the world who spend more than 50 percent of their income on food, the effects have been staggering: 250 million people joined the ranks of the hungry in 2008, bringing the total of the world's "food insecure" to a peak of 1 billion -- a number never seen before.

At least the Goldman Sachs vampires have plenty of money to buy guns to shoot starving peasants who will be trying to steal heirloom tomatoes from their manor gardens. Don't blame American appetites, rising oil prices, or genetically modified crops for rising food prices. Wall Street's at fault for the spiraling cost of food.


  1. Could anyone explain why the balance of supply and demand doesn’t kick in here, so eventually the price goes back down to a reasonable level?

    Why dont’t suppliers undercut the world market prices? If the price is unrealistically inflated by speculation, I’m sure one would find a supplier who will still happily sell 20% below the “world market price”?

    Why isn’t production following increased demand here?

    1. A couple of reasons, Anon. For one, agricultural production’s not something you can increase quickly. This year’s fields are already planted, and they can’t be changed now and still have them ripen before they run out of growing season. Changes to what’s being grown have a one-year lag: it’ll be next year before farmers can change crops based on this year’s demand. And adding more fields takes at least that long, assuming the farmer can find unowned land to buy up which they usually won’t be able to.

      For another, even if production increased the speculators would just absorb it too. Remember that the speculators aren’t playing with real money, and they don’t plan on actually having to pay for their positions. They’re leveraging, buying $10 or $20 or more worth of commodity for every $1 they have on the table, betting (along with the people loaning them the money) that they’ll be able to sell their position for more than they paid for it long before it comes due for delivery. And they’re in the comfortable position of knowing that their customers *have* to buy the product. People can’t just not eat, and when it comes right down to it somebody somewhere will have to buy that load of crops if they don’t want to starve. The worst that happens is the speculators break even, not a big risk considering the potential profits.

      1. Different Anonymous here, but a similar question to Anonymous #1. Are speculators actually stockpiling food–putting it in warehouses and all?

        The reason I ask is this: if they aren’t buying the actual commodity, but only contracts relating to the commodity, how can they increase demand? I can see how a lot of screwing around with futures and options and so on would increase price volatility and allow for short-term run-ups, but unless consumption is actually increasing or unless the product is being taken out of circulation, the demand for the product isn’t changing, and the long term price of the commodity ought to be governed by demand.

        Is there some trick to this that makes laws of supply and demand go away?


      2. I just love when non farmers discuss farming.

        No, much of this years crops have NOT been planted, while some have. It’s very very early in the season. Some areas still have snow, you know. And some crops only take a few weeks to mature.

  2. The dude writing the article simply ignored the most important factor in the commodities boom which lead to unintended consequences like higher food and gas prices: The commodities market used to be very well regulated to prevent wild price swings which the article itself were removed in 1999. Chalk one up for another failed attempt at deregulation.

    1. And quantitative easing by the Fed (pumping printed, worthless paper money into the economy) has nothing to do with rising food/commodity prices?

  3. I’ve always been amazed at the idea of the stock market.

    It’s not like a bond or cd, which gives a defined period of monetary loss to a defined gain. Like a 1 year CD at a fixed 3.0% APR. I mean that makes logical sense in a way. You gain money for the loss of time you could be doing something else with it.

    But in the stock market you can just jump in and then jump out. Sometimes with a fairly large gain. And who has your money benefited? Who actually paid you that extra money you made? And was that a wise investment on their part….

    1. Theoretically, selling stocks makes sense. Say someone has a business that they wish to expand, but don’t have any money (it’s all tied up in the assets of the business, like premises and machinery). If they just sold their building or one of their machines to get the money, they’d lose capacity so couldn’t expand. So they sell stock- i.e. they give you a certificate that says you own some proportion of the business as a whole in exchange for money.

      If you invested wisely, the value of the business (and therefore of your share in it) increased. The money came from the profits (and hence from the customers) of the company you bought stock in.

      That’s the basic idea behind a stock market- it’s a way for businesses to raise capital. Of course, trading in stocks between people who don’t actually own any of the business adds onto that, and therefore some of the increase in the value of the stock will come from what people think it is worth rather than what it actually is worth. But that’s the same with almost any non-centrally-planned market (say that in used cars, or baseball cards, or land).

      1. Correct. I understand that as the original intent and idea, and in that respect it works well. But look at what it is today. Billions, if not trillions of dollars are moving in and out of the market everyday, all with the purpose of making more money.

        My example would be something along these lines: On the 1st of the month you buy 1,000 shares of a Company for $45 each. You know that they seem to have done well for the past quarter, and they are due to release their earnings report soon. Two weeks later they release said earnings report, which shows an excellent quarter. Their stock rises by $2 a share. You now sell your 1,000 shares and have made $2,000 dollars. The Company has had your assets for a little over two weeks….

        Sure that’s over simplifying it (taxes, trading fees, and penalties), but that is it in a nut shell.

        Or take that example, scale down the amount the Company’s stock increased and magnify the amount invested. Now have a computer do it and you have high frequency trading:

        Again, the investors are using the market just to make money. Not to actually invest in the growth of companies.

        1. “Again, the investors are using the market just to make money. Not to actually invest in the growth of companies.”
          Yes, that what everyone does, both speculators and long-term shareholders.

          Stock market makes sense, and all the speculation that you are talking about are on the secondary markets (between trades), therefore company may not get affected unless they want to issue new shares.

          In theory stock prices, which has nothing to do with the futures market were commodities are traded, represents all available information about the company. That’s the basic idea of finance. HFT allow markets to work by providing liquidity.

      2. Good answer.

        In the stock market, a rising tide can (in theory) lift all boats. If it doesn’t, an investor can choose to hang on for the long haul until the market as a whole picks up again. In comparison, options are a zero-sum game: there is a specific date in the contract, and for each investor who makes money off the deal there’s an investor who lost money. Used as an insurance policy for things like currency fluctuation, it can be an acceptable and in fact prudent choice, but the risk in commodities and options is that there is a specific deadline, a moment of reckoning. Take that mechanism away, and you get the worst of both worlds: higher risk with no reckoning.

      3. “That’s the basic idea behind a stock market- it’s a way for businesses to raise capital. Of course, trading in stocks between people who don’t actually own any of the business adds onto that, and therefore some of the increase in the value of the stock will come from what people think it is worth rather than what it actually is worth. But that’s the same with almost any non-centrally-planned market (say that in used cars, or baseball cards, or land).”

        It’s all a question about the nature and the motivations of the *most powerful* and the *most common* market participants.

        If any given market (stocks, used cars, baseball cards, land, tulips…) is dominated (either through power, or through number, or through a combination of the two) by ‘initial producers’ and ‘ultimate consumers’, then the market laws we all know and love work pretty damn well. With inbuilt intrinsic valuation limits (the bulk of consumers will never be able to afford a sudden 100x price increase, and the bulk of producers will never be able to effect a sudden 100x cost drop), supply and demand will balance nicely, providing no one is in a position to abuse market dominance.

        On the other hand, allow a market to be dominated by speculators (i.e. parties for whom the product traded has neither intrinsic cost, nor intrinsic value, and the only relevant dynamic is an ability to sell the traded good for a higher price than it was purchased for), and supply and demand balance goes out of the window. If you are only concerned about resale potential, and, moreover, are trading almost exclusively with people who share the SAME single concern, then supply, demand (and therefore pricing) become part of a massive feedback loop (and, therefore, self-referntial). So you get bubbles, busts, self-fulfilling predictions, a profound reliance on ‘confidence’ for market functioning, and arbitrary market prices that are unanchored to reality.

      4. Thanks for that explanation. I never worked out how stock works before.

        (World) economics often seems so complex, that as soon as I tend to grasp a concept, it seems to slip away again.

  4. Sam, the same guy wrote a much more detailed piece for Harper’s called “The Food Bubble” that goes into much more detail:

    You’re right though, the CFTC quietly issued exemptions on position limits for commodities to sixteen firms and ever since they have been driving up prices in a crazy scheme of commodity indexes and futures contracts. They have been doing EXACTLY the same thing with oil, which I keep trying to explain to people who are convinced that gas prices are high because of Libya (which would be tough since it only produces like 1.5 million barrels a day) or because OBAMA BANNED DRILLING IN THE GULF (which did not, in reality, actually happen)

  5. The GSCI is a measurement. Nothing more. It measures price movements more usefully than other, previously used measurements.

    Blaming the GSCI for the “food crisis” is like blaming an improved tide gauge for a tsunami.

  6. Eat the bankers? Why just the bankers? Fuck that.

    Eat the rich. Every last one of the useless motherfuckers.

    1. That sounds like something my pool boy would say. Is that you Steve? If you can’t act like an adult, I’m cutting the wi-fi in the servants house.

  7. Of course all of this originates with the unprecedented money supply inflation by the fed. With cheep credit and a falling dollar value it is only natural that speculators will abound and focus on commodities.

    Once again our benevolent overloads are handing our food and savings to their corporate masters.

  8. Every year there are global food shortages and price fluctuations. This has happened under every US president, and it has never been much of an issue, or rather, a conspiracy. But the second we elect an American-American President, then suddenly his top campaign donor is accused of plotting nefarious schemes in order to raise profits. That is pure racism.

  9. It’s terrifying that we can have a “food bubble”. Why does greed have to run everything?

    1. The investors don’t really care what they’re investing in, as it all boils down to educated gambling on future value. Whether it’s commodities (theoretically buying other people’s capital investments in growing food, which may reap returns on the market later), or stock (buying partial ownership in companies from previous investors whose workers and sales will hopefully increase the value of the company), or even currency (expressing faith that one state’s economic output per printed currency unit will outstrip that of other states), it all boils down gambling on increase in value. Any value. Of anything.

      Anything you care about that can be traded with another human being is fair game, based on pretty much the same rules. Which means it’s all subject to investment, and over-investment, and bubbles, and eventually crashes when enough people realize there’s no way in hell their gamble can possibly pay off.

  10. The most profitable purchase Goldman Sachs has ever made was when they bought the US Government. From that point forward, it would have been difficult for them have NOT made money. They haven’t had that problem.

  11. bcsizemo: stocks have the benefit that they pay dividends to shareholders. now, obviously a lot of the trading action has nothing to do with that, but that’s where their value comes from. if the company’s profitable, you still get paid even if the stock price has gone down from your purchasing price.

  12. This is a good motivation for a socialist or even communist revolution, cause then we could hang the bankers!

  13. Hedges and other derivatives for those not insuring against losses in commodities or equities actually owned should be illegal.

    This would have prevented the worst of the underlying losses in 2008 (which taxpayers made good on, for no good reason).

  14. Look further north. Two blocks in fact. On Liberty St lies the offices of the New York Federal Reserve. And southwest. On Pennsylvania Ave. While Goldman Sachs and the rest of the vampire squid squad have certainly compounded the misery through fictional reserve lending, the penultimate blame must lie at the feet of the institution that is licensed to counterfeit fiat money, and hence reduce it’s purchasing power by monetary inflation. Of course the Fed is a creation of the bankstas in the first instance, and this round of monetary inflation only kicked off because of a need to finance an illegitimate and unnecessary war. The Vietnam war that is. Nixon’s abolition of the gold standard is the ultimate cause of this out of control Keynesian nightmare. Unfortunately, the TeaBag Partiers have only bits of it right, and are therefore not tackling the ultimate cause; the problem of being a nation that wants to invade-for-oil, but then have other countries pick up the cheque.

    1. You are right on, and therefore, the only one that “gets” what’s happening. The author fell way short of the mark. The blame belongs to a mix of rich bankers, corrupt government, and a broke Fed.

    2. Dear TheAntipodean

      What you are trying to say in theory makes sense, however in practice it sucks.

      I disagree with article also, it misses the point and isolates single company, as sinister as Goldman is, it doesn’t control the world of finance as everyone believes.

      As many mentioned, including TheAntipodean, fiat money added to the problem, but that’s not unique to US, I can’t think of any modern monetary system which is gold standard (not 100% sure). Price of fuel affected food prices also, but predominantly, it is due to prosperity. If you listen to Trump, he will tell us that Asia is rising against us. They stole our jobs and they want their cars painted red. In reality they just want to live on same level as us, which means same consumption, which in effect means higher demand. End of story.

    3. “Look further north. Two blocks in fact. On Liberty St lies the offices of the New York Federal Reserve. And southwest. On Pennsylvania Ave. While Goldman Sachs and the rest of the vampire squid squad have certainly compounded the misery through fictional reserve lending, the penultimate blame must lie at the feet of the institution that is licensed to counterfeit fiat money, and hence reduce it’s purchasing power by monetary inflation.”

      Government policy, especially *highly technical* government policy is set almost exclusively by the most powerful interested parties. The vampire squid squad is almost never caught doing anything illegal (and can almost always claim “We’re just playing the game by the rules that exist!” excuse) because they make sure to redefine the necessary technical laws between the time they *identify* a new opportunity and the time they start to *exploit* it.

      You can never lose at a game if you have a lot more leeway for modifying the rules than do all the other competitors…

  15. Take it easy!

    Most crops are not commoditised and standardised, which is necessary for it to be traded on this kind of trade markets. Almost all meat and live stock produced do not fit into the system either.

    Most of the food they trade with is only abstract numbers on a paper anyway. Most of it don’t exist in the real world. In the case of futures, most of these are never intended to be used to buy real commodities (the buyers of the futures could not afford or have the knowledge to buy the real stuff, nor store, refine, distribute or sell it). If nobody is interested in realising the papers into real physical products, then the farmers are free to sell their products to someone else. It is mostly a transfer of money from US pension funds to traders and US farmers, with almost no physical foodstuff involved.

    Most of the commoditised foodstuff is grown in USA and the small effect there is, will mostly effect USA, as a lowered demand from the rest of the world and inside USA for those physical goods in respond to the artificially increased prices. The only exceptions that will effect the rest of the world, that I can think of, is bananas, coffee beans, tea, cacao (this one is actually traded in 100% real physical products, stored in Belgium, I believe), cacao butter, palm-oil (very unhealthy anyway), pork (most of it is produced in Denmark), some kinds of beef (South Americas), soft wheat (small parts of Russia & Eastern Europe), condensed milk (Northern Europe) and sugar. Almost all rice and soy on the international trade markets is from USA, not Asia as some might believe.

    Interestingly, this is all low quality foodstuff, high quality foodstuff won’t be effected at all.

    1. I loved that piece. Especially the part where they say FDR took us off the gold standard and ended the Depression in 1933. There as apparently no second dip in 1936, leading right into a war that killed a couple million people and reduced all but the U.S. & Canada’s industrial capacity to rubble.

      The truth is, FDR didn’t even take us off the gold standard. He devalued the dollar, and closed the gold settlement window for individuals, but the U.S. dollar was still backed by gold at a fixed rate, and settled in gold for international exchange until 1971.

      I guess they figured that the truth – that it was Tricky Dick Nixon who took us off the gold standard, leading right into the economic shocks and stagflation of the ’70s – wouldn’t sound so impressive.

  16. Johann Hari wrote about this 9 months ago. I remember reading it in the paper and thinking the article sounded a little unbelievable. I hadn’t read anything like this before, and here was Mr Hari basically accusing Goldman, Deutsche Bank and traders at Merrill Lynch of having a direct hand in the starvation of millions.

    I don’t see this as conspiracy theory.

    1. Neither do I. I see it as a pure nonsense from unqualified journalist.

      Future prices do not affect current prices and are not even viable indicator of a future price. It is there just for hedging, and that’s what it is predominately used for. Future market existed for more that 100 years now, therefore don’t see why people see is as some sort of nuisance.

      1. Unfortunately, you’re wrong. There’s this thing called speculation which is a big fucking deal in finance and you’re being obtuse if you deny it.

        1. I’m not denying speculation, nor am I obtuse, however it is less of a deal that most of us make of it. Speculators do not drive the long term price.

          1. I said in long term. In short and mid terms there are speculations, or so called naked trades. But in reality majority of volume(besides HFT) is done by hedgers, who try to reduce risks of volatility.

            Quite a few new posts appeared by anons which worth reading.

            BTW I am no spokesman for bankers, on contrary, but this article was just ridiculous.

  17. “They don’t really want the thing!” That’s true. Ticket scalpers aren’t interested in going to see the show either. But when the night of the show arrives, if they paid more than those who do, they’re going to lose money as they try to unload their inventory. That’s exactly what happened after the last oil spike. Americans cut back driving 8-12% on driving and oil consumption, and prices plummeted, creating huge losses for speculators who assumed they would continue even higher. Oil, food, concert tickets, house flipping. The middle men can trade back and forth between each other for higher and higher prices for a while, but they’re ultimately at the mercy of the final customer.

  18. This is like blaming the hundred years war on William the duke of Normandy. If the problem is a system error, don’t blame the user – blame the system.

    1. Not really.
      They ARE the system. The people that are behind the speculation and the deregulation of the commodities markets are the same people. They are the ones that flooded DC with cash to change the game and then demanded bailouts when the financial world exploded.
      Then you have their apologists all over CNBC and elsewhere trying to explain it all away as part of the so-called “free market” – of which there is no such thing. There never has been, there never will be and there cannot be a free market. Such an animal does not exist. Maybe Craiglist..
      Tell me it’s the free market at work while a barrel of oil changes hands 50 times before it’s actually delivered and consumed, driving the price of gas up even when demand for gas/oil is flat or dropping like in 2008.

          1. Well it is serious question. I just wonder how you as a consumer get affected buy the changes in the futures market.

      1. No they are not. They are individuals within a system who are acting at what they consider to be, the best way. Just like you do, just like I do.

        By claiming there is a section of “evil” people on whom we can blame all our problems and if only, oh only, they could be replaced by others, better people, the problem would magicly disappear. Its like when fascists these days say things like “if we could find a perfect human for a leader, fascism would be great” and then ignore the fact that they have disproven their entire political agenda since there are no perfect people. Or when during the prison riots in the 70’s where the demands was to change the people in charge instead of the system in itself. Or the Russian Revolution that kept the factories and the work system but just replaced the people, the titles and the wording.

        To change something like this, you need to change the system in itself. Pretending that all you need to do is find the guilty party and smartly kick their asses is just comic book quality political theory.

        A “free market” exists because those in a position of power perceives it to be free, because from their perspective, it is. If you dont like your job, you can switch according to those who are used to a constant and large cash flow. Its not true, but their the bosses. But saying this and being this, doesn’t make you “evil”. Replacing them will only recreate the problem because the system that we live in is the system that creates the problem that affect individuals to act in a certain way.

        Like I said, don’t blame the user, blame the system. The individual in this case is irrelevant.

        1. Remember, though, it’s a system developed over time by people who operate within it and benefit from having it function in a certain way. It’s not an EITHER individuals OR system question, there’s interdependence between them, so what you do to one (or allow them to do) affects the other.

  19. Frederick Kaufman, I want you to know that China is at fault. Those greedy bastards ripping of USA. They send us all that cheap crap which we buy and than they demand food. How could they demand food and oil and other crap we take for granted?

  20. I consider this utter economic nonsense. By what mechanism does the increase in volume of futures speculation increase the prices over several years?
    The speculators don’t hold any actual product, only papers with a promise to deliver the product on a given date. (Which never actually gets realized, only monetarily cleared.) Since the speculators don’t and can’t store the actual perishable product, once the harvest is over, the prices default to what the consumers were actually willing to pay.
    The only way speculation can have any impact on longterm prices is stockpiling. So unless somebody is amassing and storing huge (and I mean huge) quantities of actual walking, breathing and defecating livestock or rotting and germinating grain in hopes they will be able to sell it later at a higher price, speculation will have zero effect on season to season prices. (To be absolutely clear, I do not deny the possibility of a short-term price manipulation.)

    1. My intuition is not that demand is increasing, but that the supply of money in the market is increasing. There’s a good deal of evidence that some of the ridiculous fall of oil prices during the panic of 2008 was due to the sudden reduction in the amount of money in the arena.

      Way I think of it would be to imagine a room full of people who aren’t told what’s going to happen, and offer to sell them a bar of gold. The maximum price they can offer is going to be restricted by how much cash they have on them combined. Now bring more people in, or tell them ahead of time, and the supply of cash to offer increases. Obviously, the price will increase as well, because people have more to bid with. Poor analogy, but you get the point.

  21. I’m still shocked at how the masses believe that the stock market is a tool for ‘investing’ in companies. The best analogy to this day (I believe it was actually Keynes) likens it to a beauty contest – you’re not trying to pick the winner, you’re trying to pick the one everyone else will pick as the winner. It’s not a pure mathematical equation of discounting cash flows and finding ‘undervalued’ companies, rather it’s a socioeconomic organism. As with anything involving human emotion, it’s is prone to overshoot in both directions. Buying a company’s stock isn’t as much an investment in that company as it is an investment in the confidence of others in that company.

    I still don’t buy the argument for speculators being responsible for anything. There are two sides to every trade. For every contract that is purchased, there was a seller. Both are speculating.

    As for the GSCI, as tylerh correctly posted above, that is like blaming the radar gun for the fact you were speeding. All it is doing is tracking what is happening.

  22. Really disappointed in Foreign Policy. I’m shocked at how stupid this is. (The comments are hilarious, though, as always.)

  23. The rise in food prices is and has been totally predictable. When G. Bush started subsidizing Ethanol production for use in cars/trucks circa 2008, most notably through corn fermentation, then, as we are seeing now, it was clear there would be an impact on food prices. Check it out.

  24. I find it difficult to believe the nay-sayers, even though I have no background in economics, due to the fact that a few years ago gas prices were ridiculously high a few years ago with no apparent reason. This was attributed to Goldman Sachs, as is the current economic crisis brought on by the financial industry and Goldman Sachs. I guess we will know for sure if the bubble breaks again.

  25. Food commodity pricing basically follows the price of corn, which is heavily subsidized by the government. So who is really driving up the price here? The lobbyists for the corn syrup industry, who don’t mind getting rich at the expense of the health of millions. Demand for ethanol is not doing it alone.

    True also that the number of speculators has drastically increased in the last 10 years due to the extinction of physical trading floors. There’s too may vultures sitting in their pajamas at home in front of their computers.

  26. Okay, so what specific kinds of trades should be banned?

    Besides the kind where they “only want to make money”, that is.

  27. ITT: People who know nothing about economics, yet feel the urge to share their opinions. A little like me vehemently arguing in a thread about the latest genetic therapy for cancer.

    I’ll put it in simple terms: Market prices are the function of supply and demand. Speculation through derivatives – swapping pieces of paper between banks, individuals and companies – does not affect either. The speculators are not actually buying the product (increasing demand), nor are they withholding the product from the market (decreasing supply). They are just issuing, buying and selling promises with no intention of having the object of the promise physically delivered. All that happens is that the difference in prices gets cleared.
    (Example – I buy a corn future with the promise of the issuer to sell me a bushel of corn for $1000 on a given date. I do this hoping the price will be higher on that date, allowing me to buy for $1000 and sell it on the open market for, say, $1200. But if that happens, we won’t be actually buying or selling any real corn. I’ll call on the issuer to fulfill his obligation. He would have to go to the open market and buy a bushel for $1200 and sell it to me for $1000, only to see me sell it right back for the $1200 to cash in my $200 of profit. Why would we do that? That would be an enormous waste of time and money for both of us. So instead he pays me the $200 price difference right away and we are done with it.)
    The futures market could as well be taking place on a different planet, without the producers, distributors and consumers even being aware of its existence. Where does the money and profit in the futures market come from? From other participants. It’s a zero sum game, for each long speculation there has to be a short one and only one of those can be right. Essentially it’s an elaborate betting system between the investors, with no effect on the actual market.

    Speculation can affect real prices if it induces people to manipulate the actual physical commodities, i.e. buy and stockpile the product, increasing the actual demand and decreasing the immediately available supply. This can and does happen, but it cannot create a trend in prices over the long term; for that you would have to cut and permanently stockpile larger and larger chunks of the market every year.
    Moreover stockpiling anything physically is expensive and in case of some products (livestock, fruits and vegetables come to mind) it’s practically impossible.

    The GSCI is not responsible for the long-term growth of the prices of commodities. It’s the result of a growing demand, mainly driven by China and India (predominantly caused by a dietary shift to more meat – the livestock consumes a large share of the grain production) and a stagnating or a decreasing supply (climatic events ruining crops, e.g. Russia still hasn’t lifted its ban on the export of grain, as far is I know.)

    Oh – and why do large price swings occur even when only a small part of the supply gets knocked out? (e.g. Libyan oil) Because the demand for some goods (like oil and food) is inelastic. Even though there is less oil available now, (some 97% of the original amount I think) almost 100% of the people still have to commute to work and products need to be transported. It takes a large price hike to convince the marginal 3% of people to stop using oil.

    1. Actually, I have to correct one thing – what I wrote about speculation in general (the real, non derivative kind) pertains to consumable goods. In case of speculations in non-consumable goods, the predicate that speculation cannot create a price trend does not hold; very much in the spirit of what andrei.timoschenko wrote. Houses and securities can be effectively stockpiled and hoarded for extended periods, resulting in long-term supply and demand distortions.

    2. I don’t claim to know a great deal about economics other than the few courses I completed with my MBA. I disagree with your post when you say that huge amounts of products are not stockpiled to artificially regulate the price. Our government does this with subsidies and other regulations. For example, ethanol production is currently subsidized at $0.51/gallon. This incentive has an impact on the price of all commodities required. IMHO, if the government would stay out of the people’s business the supply/demand economy would thrive. Of course many would say that “evil” big business would exploit the proletariats. Possibly but, if we don’t buy their products and reduce demand, they would be forced to go into another line of work.

      1. This is a not far from a valid point. Ethanol subsidies distort the markets by motivating farmers to grow super-optimal amounts of fuel crops. Since the total arable land is limited, this is accomplished by growing sub-optimal amounts of food crops. This is one of the factors decreasing supply and driving prices up, though not through stockpiling.

        It has, however, nothing to do with speculation, futures or the GSCI.

    3. Gloster, I would argue that the real world is slightly more complicated than economic theory, and that these complications can actually sometimes result in rather significant differences between the real results and the predicted (or ‘logical’) ones.

      Can the stable presence of speculators in a market for consumable goods significantly distort prices over a long period of time? No, of course not – and you give an excellent explanation as to why in your post.

      But let us consider the commodity markets specifically. Up until some years ago, speculators had only a back-seat role in the markets, if one judged by total dollar value of trades. As such, most of the transactions took place between big farmers and big food companies, with both being quite active participants, due to the desire of both to level out the vagaries inherent to commodity production (i.e. supply is quite dependent on factors beyond human control). The system worked decently well – despite the aforementioned inherent supply instability and despite a mismatch in elasticities of supply and demand (commodity consumption levels can change pretty quickly, but only within a narrow range, while commodity production levels can change within a pretty wide range, but only slowly, since commodity production is highly capital intensive), commodity prices have not historically been very volatile.

      At one point in time, however, investment bank trading desks start finding themselves with more money than they know where to profitably park. They figure that with a growing world population, fast economic growth in some very large emerging economies, and seemingly peaking production capacities for some key commodities, they can make some fancy-enough graphs to convince their non-expert investors that commodities are going to be ‘the next big thing’. Since, behaviourally, human rationality is pretty bounded, and since the underlying market dynamics are pretty complex, no one really bothers to dig deeper – the story sounds plausible enough.

      So they successfully lobby to get commodity market regulations changed to allow for easier speculation, and quickly pile into them. The amount of money in the market explodes. All of a sudden, the traditional market players find themselves totally dominated by this new breed of market participants, whose interests and behaviours they (the traditional players) do not really understand.

      Since speculative losses are much more distributed and short term (make a few market-destroyingly bad bets, and you can pass a large part of your losses to your investors before moving all your funds into some different market), the appetite for risk of these speculative investors is much higher, so they decide to test just how inelastic demand for commodities really is, so prices shoot up (suddenly much more money is chasing after the same production volumes). Since production volumes cannot be quickly expanded, and since their expansion is highly capital intensive (so you better be sure that the sudden apparent explosion in demand is here to stay) production levels remain stable for a few years despite soaring prices. Given the strong psychological effect of anchoring (just look at how the oil market re-anchored itself around a new price level!), and the decent story told to explain the trends, the distorted prices are gradually accepted as a new reality (even though they move so much faster than historic precedent as to be inexplicable by market fundamentals). After all, the theory tells us market should never be too crazy, right? So if we cannot understand why markets are valuing things the way they are, it must be some ignorance and deficiency on our part, no? So reason the traditional market participants, especially since no single one among them has the financial power to move against and short the speculators…

      The prices soar past the breaking point in some world regions. Some poor people riot. Some poor people starve. It’s a pretty big problem for some governments and food companies, but speculators are relatively unaffected.

      What of the future? Keep prices artificially high enough for long enough and commodity producers will start to make massive investments in economically questionable expansions of supply (e.g. see Canadian tar sands). Once the supply expands massively enough, speculators begin to see dwindling margins so they quickly move to greener pastures (again, because they are the only players that can move quickly). Money flows out, demand collapses, a massive over-supply of capacity is revealed, capital turns out to be wasted, and the unluckier producers go bankrupt, get some government support (due to their systemic importance), and are sold off for pennies on the dollar, perhaps to different divisions of the same investment banks whose traders just killed the market. Look, for instance at what happened to all of the fibre laid in response to the apparent telecommunications boom at the end of the 1990s…

      Oh, and after a few decades, during which the real market painfully settles again into being less crazy, speculators get tired of playing in other areas, figure the market is again ripe to be ‘rationalised’ by them, and re-enter. Rinse, repeat… So theory is right – unable to effect a significant long-term impact, speculators settle for effecting a series of intermittent but massive short-term shocks.

      1. Yes, but again, for this scenario to take place, speculators must be buying the actual commodity, not securities. Are they?

      2. I hope everyone reading this thread reads your post in its entirety. That was an excellent explanation.

      3. Again, I just don’t buy this. Canadian tar sands are not a misplaced investment, driven by a broken regulatory system. The only way one can believe this is if one has no knowledge of what’s going on with energy: the scale of the situation, the limits dictated by the laws of physics, the limits imposed by the capricious history of Earth. Energy is not something that is interchangeable, readily substitutable with something else when the price goes up (And yes: it’s everywhere, but not all forms are equally available to us). We go after the easiest stuff first, and it’s not just habit or some form of social inertia that is driving this — the laws of thermodynamics are.

        If we put the cart before the horse, if we believe that moral turpitude, or corruption, or some other human failing is driving the instability we see in markets now, we’ve missed an opportunity to deal with a serious problem because of simple ignorance. It is tragic.

  28. Insulated America where everything is priced in dollars and exchange rates are an unknown vocabulary word outside of forex traders. The price is rising rapidly because the US and everyone else is inflating their currency. Free magical new money for the rich to invest in stimulus, bad old weaker money for the trickle down serfs. Cant wait for a billion dollar/euro pizza myself.

  29. Try this exercise: draw, to scale, a drilling ship, 30 meters from bridge to waterline, 2-3000 meters to sea floor, 2-3-4000 meters to get to a formation, and maybe a few thousand more km horizontally. See that little speck, dangling a steel straw? That’s a little metaphor for the difference between all energy vs. energy that’s available to us in useful form. There’s a reason we’re doing such desperate things. So, apply Ockham’s razor to the world economy. Are commodities prices soaring because of conspiring cabals of oil companies, libruls, enviros, capitalists, facists, bankstas, the house of Saud, et al.? Or are they soaring because Asia wants in on the industrial game (and “life” style), and we’re running out of the stuff needed to make it go?

    If you want another analogy, how about the assay of copper since 1990, vs. demand plus the cost of the energy to get ore out of the ground, break it up, and extract the good stuff?

    You can redistribute what you don’t have, and sooner or later the invisible hand was bound to start stealing from the visible wallet, thermodynamically speaking.

  30. It seems like there’s a fallacy in here in somewhere. Farmers sell future food to Wall Street. Then Wall Street eventually sells it to supermarkets, etc. right?

    Two points:
    – The supermarkets, etc. decide how much they are willing to pay. If Wall Street could just make up any price they want, they would sell milk for $1 million per gallon. Since we are not seeing milk that expensive, there must be a limit to how much pricing power Wall Street has. The market decides the price. Supply and demand, right?

    – Farmers are not stupid. They are very smart business owners. If there was so much profit in this, then farmers would not sell futures, they would just wait until the last minute and sell food at market prices.

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