April 9, 2012

Can banks manipulate food prices?

Speculations in food commodities, such as wheat and corn, by banks and hedge funds have risen from $65 billion to $126 billion in the past five years. The problem seems to be that the banks are not interested in the physical commodity - they just want to make money. One example is the wheat-market where 61 percent of the buying or selling are made by banks. This could create a fake price which is higher (or lower) compared to if banks were not allowed to speculate in wheat.

If the price of wheat increases, poor people may not afford to buy enough wheat to feed themselves. The country of Armenia has been affected by these higher food prices. The poor in Armenia did reduce their food consumption with 14 percent and the middle income group reduced their food consumption with 5 percent.

In theory since we are living in a market economy, a higher price should result in a larger supply of wheat. Farmers are more motivated to supply the market since they get a higher price and new farmers should start growing wheat. This may however not always be the case.

Food prices reached a 30-year high in 2008 and the result was that "food riots" occurred in various countries. After the crash of 2008 where food prices fell, they have now recovered. This has resulted in a "silent tsunami of hunger", according to the UN World Food Programme. High prices combined with the global economic crisis has increased the number of poor people with 115 million, to a total of 925 million.

The experts disagree whether speculation actually increases food prices. Other factors that may affect food prices are:
  • Climate shocks such as the large forest fire in Russia a couple of years ago and the great flooding in Australia. Post-election violence and drought affected food prices in Kenya
  • The world population increases each year and a higher demand for food results in higher prices
  • High oil prices are resulting in higher costs of supplying food. Some farmers are using their crops to create bio-fuels and not food for people to eat
  • When speculating in food prices, you can actually sell something short that you think is overvalued and make money if the price is moving lower. The article from The Independent says "investment" in food commodities when a better word is speculation - or trading. If a bank thinks the price is overvalued, it may sell the commodity short, and the price may move lower again. It is hard to manipulate a price long-term since we are living in a market economy where a higher price results in a higher supply
  • Goldman Sachs made a profit of about $950 million from food speculation in 2009. But who lost $950 million - was it individual farmers or other banks?  

Conclusion: It is still hard to determine whether banks are actually affecting the price of food commodities. They may affect it short-term, but when the price is overvalued, the banks may sell the commodities short which will drive the price lower again.
The big question here is if banks should be allowed to speculate in commodities when they are not interested in the physical commodity? The main point of being able to speculate in commodities used to be a way for farmers to decrease their risk of future price changes - not a way for banks to make money.

If you would like to learn more about the commodities market, please watch this video:

Source: The Independent