Jan 29, 2011

Market-based solutions for food is leading to political upheavals

In the midst of the chaos being witnessed across the Arab world -- Tunisia, Algeria and now Egypt -- what is being missed out is the role food inflation has played in triggering these protests. Earlier, we have seen the collapse of Soviet Union also being triggered from a deep rooted food crisis. More recently, the world has managed to tide over the 2008 food crisis when 37 countries faced food riots. But once again, food inflation is showing its ugly head. According to FAO, the 2011 food index has already surpassed the peak achieved in 2008.

The warning is loud and clear, but is not being well read. At Davos, where the rich and the crooked are meeting this week, there is a talk of the rising global food prices but as usual the industry sees the crisis as a business opportunity. Agribusiness industry is projecting it as if it is because of production shortfall, and so there is immense business possibilities to sell patented seeds, fertiliser, equipment and so on. The supermarkets are stepping in asking for removal of all barriers to FDI in multi-brand retail.

Globally, there is no shortage of food. Against the average requirement fo 2,600 cal a day (you can even take the upper figure of 3,000 cal/day), what is available is 4,600 calories. Why should the world therefore be faced with recurring food crisis? It is only the trade which is creating the crisis, and making a windfall from the inequalities. Those political leaders who have conveniently ignored to read the signs of an impending but artificially created disaster (by the food majors) must get ready to face the public ire. They deserve it.

And who says hunger and poverty does not offer opportunities for business? Ask the Shylocks who have assembled at Davos.         

Behind the chaos lies the volatility in prices. And it is here that the Shylocks remain quiet. Take for instance the steady rise in oil prices. In 2008 it had almost touched $ 140 a barrel, and we were told that it was because of rising demand from the emerging economies. The Indian Prime Minister Manmohan Singh had at one time remarked that he wasn't sure whether the oil price rise was because of rise in demand or because of a shortfall in production. Both his assumptions were incorrect. It was simply because of speculation. By the end of 2008, the prices had began to drop. Ultimately oil prices came down to almost $ 35 a barrel. Did the global demand drop drastically at that time? The answer is no. So why the price volatility? Speculation. As simple as that.

Oil prices are now rising, have already crossed $ 90 a barrel.

I am also baffled at the frenzy being witnessed in gold prices. On a TV show the other day my views were sought on commodity trading. This was a one hour programme on future markets. I told the studio audience (which comprised of commodity traders) that you guys are primarily responsible for gold prices hitting the roof. There is no shortfall in production or a rise in the demand for gold. Just because a few of you are making money by speculating on prices, the masses are being made to pay through their nose.

With food being branded as a commodity, the futures market is exploiting the gullible masses. While people are feeling the heat and pain, the mainline media has very cleverly ignored the fundamental reasons behind the global food crisis. At the global level, neither the G-20 leaders not the World Economic Forum has had the courage to accept where the fault lies. In fact, both the political as well as the business leadership is looking at the business opportunities that the crisis offers. And I blame the mainline economists of actually fuelling the global food crisis with their textbook analysis. They have simply refused to think out of the box, and in my understanding they do not even have the capacity to think beyond the textbooks.

Timothy Wise is among the rare breed of economists who had time and again explained to us what and where have things gone wrong. I admire his analytical ability, and strongly feel that we need to encourage and spread such clear thoughts and analysis for the people in the streets to enable them to come to grips with the realities. I would like to share with you all his latest analysis of the price upheavals that is emerging as a major headache for several governments across the globe.

The day is not far away when India, China,  Brazil, and South Africa too will feel the heat.
Food Price Volatility: Market fundamentals and commodity speculation

Timothy A. Wise

January 27, 2011

As Jayati Ghosh explained in her recent post on the “Frenzy in Food Markets,” high food prices are back and market fundamentals do not adequately explain the price rise. Still, a wide range of analysts and commentators, from Paul Krugman to the International Food Policy Research Institute, dismiss the argument that a significant part of the 2006-8 food price surge was due to speculation. They are more dismissive now, two years further removed from the bursting bubbles of the housing and financial crises.

As Krugman put it in one of several recent blog posts, “I was and remain skeptical about the speculation story in 2007-2008, because of the lack of evidence of inventory accumulation.”

Krugman and others are missing the point, or at least missing the distinction between price manipulation and excessive speculation. If a big market player hoards in a scarce market, that’s manipulation. But you don’t need manipulation to have non-commercial investors overwhelm commodities markets. And it is hard to deny the market fundamentals of our brave new “financialized” – and still-deregulated – commodities markets.

Let’s review the basics. Some $9 trillion in trades take place in commodity derivatives, with 80-90% in over the counter (OTC) trading, outside of public scrutiny. Five banks control 96% of derivatives activity, giving a few players decisive market power. The ratio of non-commercial speculators to commercial hedgers (those with a commercial interest in the traded commodity) is by some estimates 4:1, roughly a reverse of the shares ten years ago when speculators accounted for 20% of the activity. Then, such speculators indeed provided liquidity to the markets without overwhelming them. That is no longer the case.

Commodity index funds are where the market fundamentals of speculation seem unarguable, particularly in relation to agricultural commodities. Index funds, which are typically baskets of twenty or more commodities, were created by Goldman Sachs and other financial players as a hedge against declining returns in other sectors, based on the observed tendency of commodity prices to hold their value as other assets lost theirs. Index funds generally bet “long,” on rising prices, and they hold their investments for a longer time than the typical commercial hedger. This has a tendency to push prices up, which attracts more speculative capital, which adds to the volatility.

Overall, the number of derivatives contracts increased more than six-fold between 2002 and mid-2008, as these investment vehicles became a safe haven from the subprime crisis and financial meltdown. According to Masters and White, index fund purchases from 2003-7 already were higher than the futures market purchases of physical hedgers and traditional speculators combined. Then they doubled in the first half of 2008.

It would be bad enough if speculative capital simply overwhelmed commercial hedging interests in these markets. But the speculation is actually more institutionally entrenched than that. Index funds rarely hold more than 30% of their value in agricultural commodities. In fact, in July 2008 the ratio for the S&P Goldman Sachs Commodity Index, by far the largest index fund with 63% of the market, held 75% energy futures and 10% grains futures, with the rest in minerals.

So the movement of the index funds is driven by the price of oil, itself a highly speculative market with some 70% of futures investments coming from non-commercial speculators. Under such institutionalized structures, the price of oil drives the movement of the index funds and pushes up the prices of agricultural commodities, no matter what is happening to the fundamentals of supply and demand for soybeans or corn. Worse, the index funds are mandated to keep the value of their commodities in strict proportion, so that when the prices and value of energy products go up the funds have to buy more corn and soybean futures to maintain the mandated proportions. This represents yet another institutional impetus to buying agricultural futures regardless of the market fundamentals.

What part of this picture don’t the speculation-deniers see? Finance capital now dominates commercial hedging in futures markets, index funds have become huge investment vehicles in uncertain economic times, and the index funds move with oil and minerals prices, dragging food prices along with them.

Fortunately, France, as the new chair of the G20, has made the issue a priority for 2011, and in May we’ll see the first-ever meeting of G20 agriculture ministers. Meanwhile the U.S. Commodity Futures Trading Commission (CFTC) is now in the process of issuing its proposed rules re-regulating derivatives markets, implementing some of the more promising provisions of the Dodd-Frank financial reform bill. As CFTC chairman Gary Gensler stated, “I believe that increased speculation in energy and agricultural products has hurt farmers and consumers.”

We should certainly study and debate how much of the recent price volatility owes to excessive speculation and what should be done about it. But we should stop debating whether it’s a problem. The market fundamentals of commodity market speculation seem painfully clear.

For some good overviews of the issue, see:

Food Commodities Speculation and Food Price Crises, Olivier de Schutter
Commodities Market Speculation: The Risk to Food Security and Agriculture, IATP
The Great Hunger Lottery, Tim Jones, World Development Movement
How Institutional Investors are Driving up Food and Energy Prices, Masters and White
Index Funds and the 206-8 Run-up in Agricultural Commodities Prices, Ray and Shaeffer
The State of Agricultural Commodities Markets, FAO
Reflections on the Global Food Crisis, IFPRI

1 comment:

Ramesh Dubey said...

आदरणीय देवेंद्र जी आपका यह कहना ठीक है कि ट्यूनिशिया, अल्‍जीरिया और मिस्र में खाद्य पदार्थों की ऊंची कीमतों के चलते भड़के असंतोष की काली छाया कभी भी भारत, चीन जैसे देशों को अपनी चपेट में ले सकती है । वैश्‍विक स्‍तर पर भले ही 4600 कैलोरी प्रतिदिन खपत लायक अनाज उपलब्‍ध हो लेकिन भारतीय स्‍थिति इससे अलग है । गेहूं, चावल को छोड़कर कुछ भी गरीबों की पहुंच में नहीं हैं । फिर भारत सरकार व बहुराष्‍ट्रीय कंपनियां इतनी उदार तो हैं नहीं कि वे अनाजों को गरीबों में बांट दें । आप कह रहे हैं कि एग्रीबिजनेस कंपनियां भुखमरी में भी बिजनेस तलाश रही हैं । भारत में जिम्‍मेदार पदों पर बैठे लोग भी भगवान से मनौती मांगते रहते हैं कि हे भगवान देश में कोई आपदा आए ताकि उन्‍हें झोली भरने का मौका मिले । ऐसे में भुखमरी-गरीबी के लिए केवल बहुराष्‍ट्रीय कंपनियों को दोषी नहीं ठहराया जा सकता । वर्षों से कृषि क्षेत्र की ओर से आंख बंद कर जीडीपी बढ़ाने की जुगत में लगे अर्थशास्‍त्री और नीतिनिर्माता भी भुखमरी बढ़ाने के लिए समान रूप से दोषी हैं ।
रमेश दुबे