Speculation And The Engineering Of The Food Crisis

Speculation And The Engineering Of The Food Crisis

Frederick Kaufman discovers Goldman Sachs' pivotal role in the rising food prices that have led to a global problem.

Timothy Ryan, PSFK Labs
  • 3 may 2011

Among the reasons cited for the increasing cost of food are American appetites, rising oil prices, and genetically modified crops. Frederick Kaufman believes there is just one main culprit: Wall-Street.

Speculation is a sullied term in light of a worldwide recession. But the basic convention of buying low and selling high plays its part in the functioning of any healthy market economy. And it used to play a welcomed role in the commodities market (food, fuel, and labor), insulating farmers from the natural volatility of the industry as the price of grain was agreed upon even before the wheat was grown. The ‘future’ of a commodity allowed farmers to hedge against lean times and at other times invest in their businesses. As a result, the real price of wheat decreased over the course of the 20th century and America became a model for successful agribusiness.

But in 1999, the Commodities Futures Trading Commission deregulated future’s markets. Kaufman notes that all of a sudden, bankers could take as large a position in grains as they liked, an opportunity that had, since the Great Depression, only been available to those who actually had something to do with the production of our food. Meanwhile, investment bank Goldman Sachs had developed a derivative back in 1991 that tracked raw materials including wheat and soy, before reducing what had been a complicated collection of commodities into a single mathematical manifestation known as the Goldman Sachs Commodity Index (GSCI).

Once deregulation came into play, the derivative had real, and ghastly consequences:

But Goldman’s index perverted the symmetry of this system. The structure of the GSCI paid no heed to the centuries-old buy-sell/sell-buy patterns. This newfangled derivative product was “long only,” which meant the product was constructed to buy commodities, and only buy. At the bottom of this “long-only” strategy lay an intent to transform an investment in commodities (previously the purview of specialists) into something that looked a great deal like an investment in a stock — the kind of asset class wherein anyone could park their money and let it accrue for decades (along the lines of General Electric or Apple). Once the commodity market had been made to look more like the stock market, bankers could expect new influxes of ready cash. But the long-only strategy possessed a flaw, at least for those of us who eat. The GSCI did not include a mechanism to sell or “short” a commodity.

This imbalance undermined the innate structure of the commodities markets, requiring bankers to buy and keep buying — no matter what the price. Every time the due date of a long-only commodity index futures contract neared, bankers were required to “roll” their multi-billion dollar backlog of buy orders over into the next futures contract, two or three months down the line. And since the deflationary impact of shorting a position simply wasn’t part of the GSCI, professional grain traders could make a killing by anticipating the market fluctuations these “rolls” would inevitably cause. “I make a living off the dumb money,” commodity trader Emil van Essen told Businessweek last year. Commodity traders employed by the banks that had created the commodity index funds in the first place rode the tides of profit.

Kaufman’s well rounded summary:

Volatility in the food markets has also trashed what might have been a great opportunity for global cooperation. The higher the cost of corn, soy, rice, and wheat, the more the grain producing-nations of the world should cooperate in order to ensure that panicked (and generally poorer) grain-importing nations do not spark ever more dramatic contagions of food inflation and political upheaval. Instead, nervous countries have responded instead with me-first policies, from export bans to grain hoarding to neo-mercantilist land grabs in Africa. And efforts by concerned activists or international agencies to curb grain speculation have gone nowhere. All the while, the index funds continue to prosper, the bankers pocket the profits, and the world’s poor teeter on the brink of starvation.

Foreign Policy: “How Goldman Sachs Created The Food Crisis”

[via BoingBoing]

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