The prices of many staple foods increased dramatically during 2007 and 2008, creating a food crisis for many poor and developing countries. International prices of maize, rice and wheat, for example, reached their highest levels in 30 years, causing political and economic instability — and leading to food riots — in many countries.
Several factors contributed to the crisis, including high oil prices, high demand for crops from the bio-fuel sector, falling global stockpiles of food commodities and lower cereal production. Strong economic growth and expansive monetary policies further boosted the trend, as did protectionist measures, such as export restrictions.
While these factors undoubtedly placed upward pressure on food prices, they alone cannot explain the steep hikes. Some believe the crisis was amplified by speculative trading in commodity futures, which have become an integral part of food markets.
Commodity futures are formal agreements to buy or sell a specified amount of a commodity at a specified future date for a specified price. They provide an important instrument for hedging price risks in commodity markets. By entering into a futures contract, both buyer and seller gain certainty as to the price of their subsequent transaction, independent of actual developments in the market.
Commodity futures are generally traded before their expiration date. Indeed, only 2 percent of contracts end in the delivery of the physical commodity. Thus, the market also attracts investors who are not interested in the commodity, but in speculative gain. In fact, commodity futures have become increasingly appealing to non-commercial investors, as their returns seem to be negatively correlated with returns on equities and bonds.
The growing presence of non-commercial investors has provided important liquidity to the market, as speculators assume risks related to commodity prices that hedgers wish to avoid, but their presence has also raised concerns that speculation could result in higher price volatility.
Economists argue that traders of commodity futures merely react to price signals that ultimately depend on market fundamentals. In this way, speculation accelerates the process of finding an equilibrium price and stabilizing the physical market.
But what about trend-following investors, or those with market power? In fact, in the short term, an investor might be attracted by the increasing price of a commodity, although the price is not based on any fundamental data. These speculative investments can further strengthen the trend and push futures price further away from market equilibrium, especially if many investors follow suit or those who invest have sufficient funds to influence the market.
Index funds have become key players in the market, holding about 25 percent to 35 percent of all agricultural futures contracts. Besides investing large amounts of money, they hold futures contracts for a long time, which might make them less likely to react to changes in market fundamentals.
Empirical evidence yields no clear answer concerning which hypothesis is correct. For each study that finds a significant connection between speculative trading and market volatility, there is at least one that claims the contrary. There are three main reasons to believe that speculation was not the main driver of the recent food-price surge.
Although index-fund investments are important compared to the positions of other futures participants, their behavior is predictable, as they publicly announce both their commodity portfolio and the timing of their transactions.
Price volatility has also been high for commodities that are not traded in futures markets (copper, iron, and ore), or for which these markets are not important (steel and rice).
As excess demand in well-functioning futures markets can easily be met by sufficient supply (by issuing new futures contracts), the effect of speculation on the equilibrium price is relatively small and short-lived compared with price swings of a physical asset.
Given these findings, trading in futures markets seems to have amplified price volatility in the short term only. Longer-term equilibrium prices, however, are ultimately determined in cash markets where buying and selling physical commodities reflect the fundamental forces.
Futures markets have evolved historically in response to market participants’ need to manage price risks and they are an indispensable marketing tool for many commodities. Limiting or even banning speculation in futures markets might therefore be costly and have unintended consequences.
Proposals to create an international fund to counteract price hikes in futures markets, for example, might divert speculators from trading and thus lower the market liquidity available for hedging purposes. Moreover, such a fund would require exorbitant resources to be operational, not to mention the tremendous challenges in determining a price level that would trigger its intervention.
Given the important role that commodity futures play for many market participants, regulatory measures should aim at enhancing confidence in the functioning of the market. This can be achieved by increasing transparency and the amount of available information on futures trading. Recent initiatives by the US Commodity Futures Trading Commission point in the right direction.
In order to counteract suspicious behavior — such as traders requesting permission to invest amounts that are above their speculative-position limits — the commission lifted exemptions for two firms trading in maize, wheat and soybean futures. Such measures will contribute to shaping a more stable market environment and ensure that commodity futures reduce risks and volatility.
Denis Drechsler is a policy analyst at the UN Food and Agriculture Organization (FAO). George Rapsomanikis is an economist with the FAO’s Trade and Markets division and Alexander Sarris is director of the division.
COPYRIGHT: PROJECT SYNDICATE
Could Asia be on the verge of a new wave of nuclear proliferation? A look back at the early history of the North Atlantic Treaty Organization (NATO), which recently celebrated its 75th anniversary, illuminates some reasons for concern in the Indo-Pacific today. US Secretary of Defense Lloyd Austin recently described NATO as “the most powerful and successful alliance in history,” but the organization’s early years were not without challenges. At its inception, the signing of the North Atlantic Treaty marked a sea change in American strategic thinking. The United States had been intent on withdrawing from Europe in the years following
My wife and I spent the week in the interior of Taiwan where Shuyuan spent her childhood. In that town there is a street that functions as an open farmer’s market. Walk along that street, as Shuyuan did yesterday, and it is next to impossible to come home empty-handed. Some mangoes that looked vaguely like others we had seen around here ended up on our table. Shuyuan told how she had bought them from a little old farmer woman from the countryside who said the mangoes were from a very old tree she had on her property. The big surprise
The issue of China’s overcapacity has drawn greater global attention recently, with US Secretary of the Treasury Janet Yellen urging Beijing to address its excess production in key industries during her visit to China last week. Meanwhile in Brussels, European Commission President Ursula von der Leyen last week said that Europe must have a tough talk with China on its perceived overcapacity and unfair trade practices. The remarks by Yellen and Von der Leyen come as China’s economy is undergoing a painful transition. Beijing is trying to steer the world’s second-largest economy out of a COVID-19 slump, the property crisis and
Ursula K. le Guin in The Ones Who Walked Away from Omelas proposed a thought experiment of a utopian city whose existence depended on one child held captive in a dungeon. When taken to extremes, Le Guin suggests, utilitarian logic violates some of our deepest moral intuitions. Even the greatest social goods — peace, harmony and prosperity — are not worth the sacrifice of an innocent person. Former president Chen Shui-bian (陳水扁), since leaving office, has lived an odyssey that has brought him to lows like Le Guin’s dungeon. From late 2008 to 2015 he was imprisoned, much of this