Playing the Commodity Game

Imagine this – a man sits comfortably by his fireplace with a glass of whisky and a cigar, musing on life and wondering what to do now he’s got all this money and nowhere he really wants to spend it. So why not play a game, he thinks. Why not invest it and see what it’ll do? Ah, but it’s not just any old investment, with any ordinary amount of money. He decides to take millions of dollars and buy commodities on the market, to see what that’ll do to the global price mechanism. After all, if it boosted the production of commodities like food, and brought down price as a consequence, the world would thank him. The hungry would get fed, producers would get a fair wage, and the agricultural industry would benefit from this injection of money. Everything would be rosy and lovely.

But what do we do if that doesn’t happen? What if, after millions of dollars is invested, we get hungrier, lands get drier and the price just keeps going up? And what if, after all of that, we have some rich men and women to blame? Did they consider these consequences, and do they even care?
There’s been lots of talk about the recent financial disasters across the world, and people are turning their attention to the actions of speculators, and rightly so. What I’m interested in though, is how these shifts in food prices are affecting the most vulnerable in our world – the poorest in developing nations. A barrel of oil is now around $125, and such rises in commodity prices are being attributed to sharp increases in the aggregate demand of growing nations like India and China. Certainly, that increase is boosting global consumption, maybe even supply. But if nations like China and India could control global commodities prices, wouldn’t it make sense that they would try and manoeuvre it to their advantage?

A loaf of bread in Ghana today costs 2 cedis, the equivalent of a week’s salary. People are actually buying bread by the slice rather than as a loaf. This doesn’t sound out of the ordinary because for a country with a consumer price index of 332 last year (data from UN Country Profile), it would seem like a natural result of market functions. But this rise in the price of a basic good was a result of speculation. The effects don’t just stop at the market in Accra though, the echo is heard throughout the world. An increase in price as a result of these movements, the aggregate demand decreases, leading to a loss. Several of these mills around Ghana are owned by foreign companies and investors; this in turn leads to a loss for them, affecting their own businesses and those that interact with them globally. In the second quarter, the Jordanian company that owns one of Accra’s mills reported a $5 million loss compared to the previous year. “God knows where it will finish, and where is the end of it?”, an unnamed source commented.

Wheat prices have increased to $800 a tonne, way beyond any justifiable, market-related reasons – it should be between $350 and $450. So why is the market at $800? “Because a few people like to speculate”, a mill owner in Ghana responds. “Countries in Sub Saharan Africa are suffering. I think it’s quite disgusting, to be honest.”

Cut to the Chicago Mercantile Exchange, one of the largest in the world dealing in agricultural commodities. 500 traders decide “how prices are made” – they deal in commodity futures, ie. deciding what the price of a certain commodity will be at a future date, through the stock market.

Playing the stock market to your personal advantage – through investments – is common practice, and thousands do it everyday. Speculating with billions of dollars means that you can manipulate the market to your advantage, if you know what to do when and where to invest it all. And yes, this is a simplified model of what speculation really is about; in the right hands it can go very well, but as we’re seeing now, the right hands aren’t doing anything.

Here’s another example. A bushel of corn is now $621. This time last year, it was $3.70.

There’s been a growth in flows of over $5 bn a month, says Richard Brock, who heads a commodity consultancy and advises buyers in the Chicago Futures Exchange. He attributes this flow of money to the Commodity Index Funds, which track the value of certain commodity baskets. Any money they receive goes straight to commodities; in the last year, these funds have doubled to $250 bn.

Naturally, the wheat market would have hit brand new highs, which it did last year – the price of wheat and related commodities were tripled, distorting market signals and seriously affecting prices in the short-run (for the forseeable future).

This has also affected the production of a fuel substitute, ethanol – corn is used in its production. There has been no shortage of supply, and nearly half the takings of corn are sitting in silos in the American Mid-West, like this one. They’re 95 feet tall and holds nearly four trainloads of corn; farmers see it as a “sign of the times; we now now there are a lot of speculators in the market right now now.”

Terry Duffy’s market, of the Chicago Mercantile Exchange, sets the price of 80% of the world’s grain production; he insists the prices are just a reflection of basic economics and based off equations of supply and demand. He claims that the true reasons crop prices are so grossly affected, are within the industry himself – he blames crop failure and supply freezes. The price movement however, is much larger than these effects would have justified.

Index funds have been hindering any benefits of production to the producer, consumer and trader; the market has become much more volatile as a result of speculation. When idea was floated that maybe we should curtail the activities of speculators, Duffy replied with, “But that’s communism at its best, right?”

“Once everyone knows it, the game is pretty close to over. The speculative bubble is gonna hurt everyone in the long term”, Brock observes. Hedge funds and index funds are causing much more damage than they should, and such games with the stock market won’t lead to any positive economic outcomes anytime soon.

Hearings on Capitol Hill are trying to determine who’s behind these games, and whether the activities of speculators need to be curtailed or not. It’s now $4 for a gallon of petrol, which is forcing people to look for alternatives to driving. Once again this is a price hike driven by speculation, and once again, the ramifications outside the US are much more severe than within.

Fingers crossed, we’ll be able to curtail and control the activities of speculators. It’s all very well to put faith in the free market and it’s power. But when this faith backfires on us, and speculators rule the global economy, we can’t not act. No one should be able to control the economy to their advantage, and play games with it like they’re 5-year olds with Legos. And when the consequences are this severe, with poverty getting worse by the minute, jobs and industries collapsing and lives being ruined; it’s very hard to argue from a moralistic point, that the activities of the perpetrators shouldn’t be monitored and controlled.

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