Frequently asked questions | World Development Movement

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Frequently asked questions

How does betting on food prices in financial markets work? How does that affect the price?

‘Futures contracts’ were first created in the United States in the 19th century to help farmers deal with the uncertainties involved in growing crops, such as unforeseen weather conditions.  A ‘futures contract’ enables farmers to sell their crops at a future date, at a guaranteed price. This gives farmers greater certainty when choosing which crops to grow.  

To buy a futures contract you do not need to buy or sell actual food and so financial players entered the market to make money from these contracts. Following the Wall Street Crash in the 1930s, regulations were introduced by the US government to limit speculation on food prices. But these regulations were weakened in the 1990s through corporate lobbying which allowed rampant betting on the price of staple foods by bankers. 

Complex contracts were created called ‘derivatives’. This just means that the value of the contract is ‘derived’ from the commodity being traded. But no actual trading of the physical commodity needs to take place. Derivatives are based on the concept of a ‘futures’ contract but have become more complex.

The price of derivatives in food is affected by demand and supply. As more derivatives in a food are bought, the more the price of a derivative contract rises. This causes the ‘future’ price of food to rise. As mentioned above, this rising price of food in the future has a knock-on effect on the real price of food now.

How do futures prices affect today’s food prices? 

To buy a futures contract you do not need to buy or sell actual food. However, the price of food in a futures contract helps to determine the real price of food. If futures prices rise, it is likely to cause the real price of food to rise. 

For example, if a tonne of wheat is selling for £100 today but through a futures contract the farmer can sell that same tonne of wheat for £200 in three months then the farmer may choose to hold back the sale of wheat until then. This reduces the quantity of wheat being sold and with less wheat being sold, today’s prices will be pushed up. Alternatively, the farmer may demand £200 now from buyers, in which case the price today will also be pushed up. 

Rising prices can also increase demand as buyers look to make purchases sooner to avoid future price increases. This increase in demand then pushes up the price of food.

How is speculation on food prices done and who does it?

The main way that investors speculate on food commodities is through ‘commodity index funds’. These indexes put money into derivatives across a range of commodities (such as oil, metals and food). They were mainly created by banks such as Goldman Sachs and Deutsche Bank. It is estimated the total money in such index funds increased from US$46 billion in 2005 to US$250 billion by early 2008. Money began to be taken out of the index funds in the months before food prices began to fall dramatically in mid-2008.

Commodity indexes are open for anyone to invest in, just like the FTSE 100 index for shares. However, they are rarely marketed at ‘ordinary’ people, and instead tend to be used by institutional investors such as pension funds, insurance companies and mutual funds (a professionally managed fund which pools money from individual investors).

Banks play an important part in the working of index funds. Banks tend to arrange the buying of derivatives contracts for their clients as well as act as the seller of contracts the index fund is buying. This effectively means banks are trading against their own clients. 

The banks at the centre of commodity speculation include Goldman Sachs, Morgan Stanley, Barclays Capital, Citibank, Deutsche Bank, HSBC and JP Morgan. 

Doesn’t speculation simply follow market trends, not create them? 

Some speculation does follow market trends. This has the potential to amplify market changes, making them more extreme. However, speculation by index funds in particular does not pay attention to demand and supply in a particular commodity market. In addition financial speculators as a whole are less likely to pay attention to supply and demand than commercial traders.

Financial traders who put money into commodity speculation do so to diversify the kinds of things they have money in, in addition to more traditional places to put money such as shares, currencies and government bonds. Money therefore comes and goes into and out of commodities for reasons unrelated to the supply and demand of that commodity. This can create price trends, increasing price inflation and volatility.  

But isn’t speculation supposed to help stabilise markets?

Defenders of speculation argue that the extra cash (or liquidity) that it brings helps to smooth the process of buying and selling, stabilising the market. They claim that because speculators are believed to buy when prices are low and sell when prices are high they even out price volatility. 

However, once speculators dominate the market, they can end up creating and following price trends to form bubbles that distort prices – at least in the short and medium term. 

Even temporary spikes in food prices can have devastating effects on consumers in poorer countries. 

How do high food prices affect poor people?

High food prices means buying less food, or having less money to spend on other things. Higher food prices are causing more people to go hungry. The 2007-8 food crisis pushed another 115 million people into hunger. Food price rises forced 44 million people into extreme poverty in the last six months of 2010 alone. Nearly 1 billion people are now chronically malnourished. 

But the impact of high prices goes well beyond not getting enough to eat. Poor households in developing countries tend to spend between 50 and 90 per cent of their income on food, compared to an average of 10-15 per cent in developed countries. As well as eating less food, households have been forced to: 

  • Eat less fruit, vegetables, dairy and meat in order to afford staple foods such as wheat. This can have drastic impacts on protein and vitamin intake. Nutritional deficiencies particularly affect children, pregnant women and unborn children.

  • Reduce any savings or take out loans. This can include selling off assets vital to future income such as land or cattle. 

  • Reduce spending on healthcare, education or family planning.

  • Women tend to manage the food budget and often bear much of the suffering. Women may also try to increase income through taking on insecure and risky employment as domestic workers, mail-order brides and sex workers.

Even in countries such as the UK, low-income households are badly hit by food price inflation, with prices 6.9 per cent higher in June 2011 than a year earlier. 

Is it the high price of food or the fluctuations in food price which are the problem? 

Both. The extreme increase in the price of food caused  major problems for households in developing countries as mentioned above. But increased fluctuations also create problems.

In recent years, there have been greater fluctuations in food prices. These price swings make it difficult for both producers and consumers of food. For instance, farmers may choose to plant a certain crop on the basis of its high price, but find that the price has collapsed by the time they harvest.

Extreme variations in food and oil prices also make it more difficult for governments to plan how to run their economies. Whether they are net importers or exporters of food and oil, big price changes can play havoc with growth rates, tax revenues, debt and inflation. All of which make it more difficult to manage the economy in a sustainable way.

For instance, the FAO says: “At the national level, many developing countries are still highly dependent on primary  commodities, either in their exports or imports. While sharp price spikes can be a temporary boon to an exporter’s economy, they can also heighten the cost of importing foodstuffs and agricultural inputs. At the same time, large fluctuations in prices can have a destabilizing effect on real exchange rates of countries, putting a severe strain on their economy and hampering their efforts to reduce poverty.”

Aren’t high prices good for poor farmers in developing countries as they’ll get better prices for their produce?

No, high food prices affect poor farmers as well as the urban poor. Very few poor farmers produce a significant surplus to sell and a high percentage of rural households are net  buyers of staple foods. In Kenya and Mozambique, around 60 per cent of rural householders are net buyers of maize. 

In Zambia, 80 per cent of farm households grow maize, but fewer than 30 per cent sell any. Any farmers who do have a surplus to sell may see little benefit of higher prices. The FAO says that consumers in urban areas are more likely to see the effects of higher prices than producers in rural areas. Moreover, large producers which are part of large (sometimes multinational) companies are most able to benefit from high prices. 

Africa has gone from being a net exporter of food in 1970 to a massive net importer. Around 55 per cent of developing countries are net food importers and almost all countries in Africa are now net importers of cereals. This means they are hugely reliant on the world food prices of their staple foods and higher prices have a direct impact on their ability to feed themselves. 

We buy Fairtrade products because it guarantees a high price. Aren’t high prices a good thing?

Fairtrade products guarantee a fairer, higher price for farmers growing crops in developing countries which are exported to countries like the UK. Typical Fairtrade crops are ‘cash crops’ like cocoa, coffee and sugar. Higher prices received for such products are good for farmers and  communities growing such crops.

One key aspect of Fairtrade is that it guarantees stable prices. Therefore farmers do not suffer from the wild fluctuations in prices (see above) which are partly caused by financial speculation. However, even farmers benefiting from stable higher prices for their cash crops due to Fairtrade still have to buy staple crops for their own consumption, which continue to fluctuate wildly in price. 

The Fairtrade Foundation states that the majority of its “farmers like most smallholders, are net food buyers and as such only a minority have gained from increased commodity prices”.

Aren’t low commodity prices also a problem for developing countries, surely high prices are a good thing?

Through the 1980s and 1990s many developing countries suffered from low commodity prices, particularly for  tropical commodities such as sugar, cocoa, coffee, tea, jute, cotton and rubber. One estimate is that by 2002, developing countries were losing $240 billion a year from the fall in price of then top ten tropical commodity exports since the 1980s. The price of commodities was due to rise.

Whether or not a country’s economy has been helped or hindered by high commodity prices in recent years depends on how much the price of commodities it exports increases compared to those it imports. During 2007 and 2008 the price of oil and staple foods, such as wheat and maize, tended to increase a lot more than that of cash crop exports such as cotton, coffee and cocoa. This meant that the amount they were paying to buy the food they ate outweighed the income received from selling cash crops. 

More fundamentally, what is most important for developing countries as a whole is to receive stable prices on which they can plan their economic development. One of the reasons low prices for crops such as coffee were so damaging in the 1990s is that the World Bank had made countries start growing a small number of popular crops assuming that the price would be higher. 

Speculation destabilises countries because it makes prices more volatile as they fluctuate more. Pedro Paez, former Ecuadorian minister for economic policy coordination, says that both high and low prices “are bad because both are the result of a distortion in the market. For example, the oil price because of speculation on futures went as high as $150 per barrel, and then due to short-selling dropped in four weeks to less than $40. How as an importer or exporter can you plan a sustainable economy under those conditions? If you export just three basic commodities but don’t have any idea what the future price will be, your food security is very vulnerable. The lives of millions of people come to depend on the activities of a handful of financial speculators.”  

Did the price of all foods rise in 2007 and 2008?

No, there were differences in how food prices changed between commodities. There were changes in supply and demand which would have caused price changes without speculation. However speculation amplified the impacts of these price changes. For example, Brazil has rapidly increased production and exports of sugar, with a higher quantity available in the world market, there has been little scope for speculation to amplify a price change. 

Consequently, there is evidence that there was no increase in financial speculation in sugar futures in 2007 and 2008. Some important staple foods such as sorghum, millet and cassava are not traded on futures markets – because they aren’t produced or consumed in the main trading centres.  Prices for such crops rose in 2007/08, though by nowhere near as much as for wheat and, maize and rice.

This is evidence of the role of financial speculation in driving up prices of crops such as wheat and maize. Specifically in reference to the potato, research for the FAO says: “being absent in the major commodity exchanges, there is no risk of potato bearing the ill-effects of speculative activity, which cannot be said of cereal commodities”. 

However, if the price of imported food such as wheat and maize has risen, this is likely to have a knock-on impact on locally produced crops such as sorghum as demand for them increases to replace more expensive foods. 

Very little rice is traded on international commodity exchanges or in futures contracts. Yet the price of rice increased far more than that of wheat in 2007 and 2008. Does this mean that speculation was not the problem?

The international market for rice is very small; about 6-7 per cent of global production. As the rice price rose, key rice exporters such as India, Vietnam and Thailand introduced export bans to protect rice availability for their own people, making the international market even smaller. The rising price also probably prompted households to buy and store more rice, in anticipation of rising prices, which caused prices to rise further.

Some commentators point to rice to show that financial speculation was not a problem. It is undoubtedly the case that the reason the rice price went so high was due to the factors listed above. However, there is strong evidence that the extreme increase in the price of wheat triggered the increase in the price of rice.

In some countries, most importantly India, rice and wheat are substitutes for each other. India is a large net importer of wheat. The average cost of India’s net wheat imports rose from $220 a tonne in 2006 to $255 a tonne in 2007 and $370 a tonne in 2008. As well as causing the local wheat price to rise, this also led to India importing far less wheat in 2008. 

Net imports fell from 5 million tonnes in 2007 to just over 700,000 tonnes in 2008. This rise in the price of wheat and fall in wheat imports had knock-on impacts on rice price and demand.

The global price of wheat increased particularly in late 2007, whilst the rice price increase began in early 2008. Statistical tests show that at times the price of rice is ‘caused’ by the price of wheat. There was a crucial period at the start of 2008 when statistical tests by a researcher for the FAO have shown that the rise in the price of rice was ‘caused’ by the rise in the price of wheat. 

Prices of rice, wheat and maize 2001-2009, IMF Similarly, a research paper for the World Bank says that there was little change in production or stocks of rice, and the initial increase in world rice price was caused by the increases in wheat prices in 2007. An FAO food outlook  report says: “The shock to demand for rice was largely generated by demand to make up shortfalls in wheat available to consumers.”

Financial speculation can be said to have had an impact on the rice price by amplifying the increase in the price of wheat, which in turn triggered the dramatic increase in the price of rice.

What has happened to food prices since the food crisis of 2008? Are food prices stable now or are they still volatile?

The prices of key staples wheat, maize and rice fell sharply after the spike in 2007 and 2008, but generally remained above pre-2006 levels. Food prices have risen again since mid-2010, setting new records for three consecutive months from December and remaining high. Moreover, the volatility of food prices – how much they move around – seems to still be higher than before 2006.

These recent increases have not yet produced a global food crisis thanks to good 2010 harvests in many African countries that kept prices stable. Rice has also avoided drastic price increases. However high prices are one factor in the food crisis experienced in the Horn of Africa in 2011.

Chocolate producers have identified speculation as a key reason why cocoa prices reached an all time high in April 2010. As long as speculators are not regulated they will be able to cause big increases and changes in price, with disastrous consequences for people across the world.

Wasn’t it the high oil price which caused high food prices in 2007 and 2008?

Oil definitely has an impact on food price by affecting the cost of transport fuel and fossil-fuel based fertiliser. But the oil price rise was due in part to speculation as well. The price of a barrel of oil increased from $60 in 2006 to almost $150 in mid-2008, before falling rapidly to $40 in a matter of weeks. Whilst there are underlying reasons for a rising oil price, these extreme swings can only be explained by speculation.

An April 2010 survey of banks, traders and oil companies found that 70 per cent say speculation is currently increasing the price of oil, on average by $10 to $30 a barrel. 

Isn’t it a good thing that oil price is high to deter people from using it?  

If high oil prices are sustained several things are likely:

  • Investing in alternative and more energy efficient technologies becomes more attractive. 

  • But investing in increasing oil extraction, particularly from the dirtiest fuels such as tar sands, also becomes more attractive. A high oil price by itself will do nothing to tackle climate change. Government intervention is needed to ultimately keep oil in the ground.

  • Most developing countries are net oil importers, so higher oil prices add to their import bill. After food, energy is one of the largest expenditures for poorer people. 

  • Whilst net oil exporters benefit from high oil prices, they are affected by the high volatility of the oil price. Whether they are net importers or exporters of food and oil, big price changes can play havoc with growth rates, tax revenues, debt and inflation. All of which makes it more difficult to manage the economy in a sustainable way.

For real demand and supply reasons oil prices are likely to continue rising over the medium-term. This is a reason for all countries to invest in cleaner alternatives. But large swings in oil price, and artificially high prices, are likely to create more problems than they solve.

Surely there are much more important factors driving the movement of food prices – isn’t speculation relatively unimportant? 

There are many factors driving the movement of food prices. Increased use of biofuels diverts food from humans to being fuel for cars. Changes in crop yields from year to year affect food supply, and such changes are likely to get more extreme as climate change increases. Increases in oil and fertiliser prices also make farming more expensive, and so increase the price of food.

No one campaign or policy can tackle all the complexities which cause hunger in our world. Governments need to support smallholder farmers who produce most of the world’s food and should invest in food reserves to help promote stable prices. But excessive speculation is a perversion, amplifying price movements and making them worse.

It can be regulated simply and painlessly. Doing so would also have other benefits.

What regulation is needed to curb speculation on food?

Two key measures are needed to ensure that financial speculation cannot distort food prices and cause hunger:

  • ‘Position limits’ to cap the share of the market held by financial speculators (as opposed to actual food traders  using futures markets to insure themselves against the risk of price changes).

  • Clearing of almost all derivatives on regulated exchanges, instead of secretive, private ‘over-thecounter’ deals (which currently account for 84 per cent of derivatives trading). This would increase transparency, allowing everyone to see what is being traded at what price. It would also ensure that most derivative trading is subject to proper oversight and regulation, which does not currently happen for over-the-counter trading.

The European commission is drawing up proposals to regulate speculation, mainly through the ‘Markets in Financial Instruments Directive’ (MiFID). These will be considered by the European Parliament and member country finance ministers. The UK government could be a major stumbling block to effective regulation.

What’s the problem with the UK government’s plans?

The UK government accepts the need for more transparency but does not want to introduce position limits. Instead ministers are in favour of ‘position management’, which they say gives regulators the flexibility to intervene in the market when necessary. In practice however, they have tended to be so hands-off that position management has amounted to complete deregulation.

Clear position limits are needed to limit the influence of financial speculators and effectively stabilise the futures market. 

What are the other benefits of regulating commodity speculation?

Because the price of commodity futures has been increasingly driven by financial speculation, it has become more difficult for real buyers and sellers of food to use futures to manage their risk. For example, a subcommittee of the US senate has found that in 2007 and 2008 some US farmers were unable to afford future contracts to manage the risks involved in farming. 

Large amounts of money tied up in futures contracts is also a waste of resources. Instead of being used on speculation, resources could be used on genuine assets and investment to increase production. This opportunity cost is particularly pertinent following the credit crunch, as small and medium sized businesses have struggled to secure sufficient capital. 

Limiting speculation on commodities could divert resources to being invested in genuinely productive activities. 

What are the benefits of futures contracts?

Futures contracts are useful to farmers and processors of food to manage the risk of price changes. Some ‘speculation’ is needed for farmers and processors to do this. Speculators are effectively needed to provide insurance. However, there is no reason for the excessive amount of speculation we have seen in recent years. 

Limiting the amount of speculation would prevent excessive speculation, whilst still enabling farmers and processors to use futures as a form of insurance for which they were originally intended. 

What is happening elsewhere on food and speculation?

Since the food and oil price spikes in 2007 and 2008, the US government has expressed concern over the impact of financial speculation. Gary Gensler, appointed by President Obama as Chairman of the US regulator the Commodity Futures Trading Commission (CFTC), says: “I believe that increased speculation in energy and agricultural products has hurt farmers and consumers.”

In 2010 the US passed legislation to re-regulate financial markets. However, implementation of measures to curb commodity speculation is being slowed by political and financial opposition to reforms. There is a strong campaign of over 400 groups in the US campaigning for regulation of commodity speculation, including civil society organisations, farmers and businesses.

Action in Europe would also help the campaign in the US. Food speculation has also been on the G20 agenda in 2011. A strong mandate from G20 leaders to tackle commodity speculation could ensure that food speculation is curbed around the globe.  



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