How banks cause hunger | World Development Movement

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How banks cause hunger

Without any real supply or demand issues we are witness to the fact that most agricultural food commodities are at record highs at once, and coffee is at a 34-year high. Through financial speculation … the commodities market is in a very unfortunate position."
- Howard Shultz, chief executive of Starbucks

Financial speculation has overwhelmed agricultural derivative markets. It has inflated prices, increased price volatility and created bubbles completely unrelated to supply and demand.

For a simple, visual explanation of food speculation, check out the animation or the infographic – or for more detail, read on!

In a well-functioning market, prices should be affected only by changes in supply and demand. But data from the US Department of Agriculture on global supply and demand for wheat and maize shows that here have been no significant changes that could have caused the large price rises that we have seen in recent years. 

While other factors such as export bans, increased demand for biofuels, climate change and increased food consumption in China and India have contributed to long-term price rises, they cannot explain the short-term price fluctuations that we have seen in recent years. 

Instead, speculation lies at the heart of the problem. But how does it work? To understand it we first need to understand futures contracts and their role in food markets.

Futures contracts

Futures allow farmers to agree a guaranteed price with a buyer for their next harvest well in advance, giving them greater certainty of income when planting crops. In a sense, a futures contract is a form of insurance against price changes. In financial terms, it enables a farmer to hedge their risk.

Futures contracts can then be traded on futures markets, with other farmers, food buyers or speculators. Speculators aim to make money by buying and holding on to the contracts, seeking to profit from changing prices. Having a degree of speculation helps these markets function , making sure that farmers have someone to pass their risk on to.

Until the 1990s futures markets were regulated through position limits (a limit on the amount of the market that can be held by big traders). But following lobbying by banks such as Goldman Sachs these markets were deregulated. As a result, financial speculators flooded the market with over $100 billion. This money wasn’t being traded based on the supply or demand for food, but was largely bet on rising prices, forcing prices to rise higher and faster.

But how do futures contracts affect the physical price (spot price) of commodities? It does so in three main ways:

1) Influencing the expectations of buyers and sellers

Because there aren’t many major central markets for food commodities, it is often difficult for food producers and buyers to know what the physical price of food should be. Instead, the prices of the numerous trades in the futures markets are often used as a benchmark for negotiating real prices for food. If futures prices are high, this changes the expectations of buyers and sellers in the physical markets and physical prices go up. If food producers see that prices will be higher in the future, they will often wait to sell their food, thus reducing supply and increasing prices now. In addition, if food buyers see that prices will be higher in the future they will be more willing to pay more now, also increasing prices.

2) Using futures prices now

Futures prices are often used as the basis for pricing physical market contracts. For example, grain prices on the major Chicago exchanges tend to be incorporated directly into grain contracts the world over. 

By incorporating the futures price directly into physical commodity contracts the prices from the financial markets are translated straight into the prices of food. 

3) Taking advantage of differences between future and spot prices

Traders who are willing (and able) to take physical delivery of a commodity can profit from differences between futures and physical prices. If futures prices are higher than physical prices, traders wanting to buy physical commodities who hold futures contracts near the delivery date will sell them and try to buy (cheaper) physical contracts. This then increases demand for physical commodities now, pushing up physical prices. Traders call this process arbitrage. 

Read frequently asked questions about food speculation.

 



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