Droughts in Russia, monsoons in Pakistan. Weather once again is being blamed for lowering expected global food production. But by focusing on the weather, a more significant factor behind high prices escapes scrutiny: a massive amount of financial speculation in food commodities. This was a key cause of the 2008 food crisis.
And it's returned. In short, the agriculture bubble is back for an encore. It needs to be kicked off the stage once and for all.
As in 2008, food prices on world markets have been soaring. In 2010, wheat climbed 47 per cent, soybeans were up more than 34 per cent, and corn rose 52 per cent. Until recently, 2011 has seen little meaningful reprieve for consumers.
Social unrest has resulted from these high prices, with food riots erupting in many African countries, most notably Tunisia and Egypt. These demonstrations are perfectly understandable given the misery caused by skyrocketing prices: In February, the World Bank estimated that 44 million people have been pushed into poverty by food price spikes since June, 2010.
We know one thing for sure: perhaps with some exceptions, genuine shortages do not appear to be responsible for skyrocketing food prices.
Take wheat as an example. On July 12, the U.S. Department of Agriculture projected global inventories as a percentage of consumption to be a healthy 27.18 per cent for the 2011/2012 crop year. Historically this is a more than adequate buffer against supply shortfalls.
Is there evidence investors are once again responsible for these price spikes? Yes.
U.S. Commodity Futures Trading Commission official Bart Chilton stated on March 15 that commodity speculation has never been higher, referring to data showing agriculture market bets 20 per cent greater than the frenzied levels of June 2008.
Excessive speculation in food commodities affects everyone. But higher costs for coffee and chocolate in rich countries are mere nuisances compared to increased hunger and malnutrition in the developing world. (This is not to ignore the serious hardship experienced by low-income citizens in wealthier countries.)
Developing nations' households spend a much larger percentage of their income on food than those of developed countries. In fact, food comprises 50-90 per cent of household expenditures among the poorest in developing countries. This leaves very little financial cushion in the event of price spikes. Citing recent studies, a paper presented at a World Bank conference last year estimated that between 100 and 200 million people were thrown into poverty by the 2008 food crisis.
The most effective way of curbing excessive speculation in food commodities is through regulation.
Good regulation requires two basic elements:
First, it must be comprehensive. All trading in food derivatives (such as futures contracts, forward contracts and options) should be disclosed to national regulators, and where possible, such contracts ought to be traded through existing exchanges. In addition, well-enforced position limits must be applied so that speculation does not overwhelm markets.
Regulation must not just be stringent; it also needs to be global. This will require significant international agreement and cooperation. In this regard, the G20 should back France's call for stricter rules about food speculation. Agreement spanning many countries is a must, because good regulation in one jurisdiction can be spoiled by little oversight in other key financial centers. Even as the U.S. moves to further regulate agricultural commodity markets, the U.K. still won't admit that speculators played a significant role in the 2008 episode. Achieving a G20 consensus will not be easy: the recent meeting of agriculture ministers in June ended with only lip-service to the issue of speculation. More must, and can, be done.
Second, there needs to be a general prohibition on speculators physically storing food items. In the rush to regulate commodity derivatives, U.S. regulators have not meaningfully addressed the issue of commodity hoarding. This is troubling given reports in the last few years of hedge funds storing food in grain elevators.
The developed world has a great opportunity to reign in its wayward markets and show the world that it is willing to get tough with the food casino when it infringes on basic humanitarian needs. In 2008, it passed up one such chance. There does not have to be a third shot.
Andrew Hepburn comments on business issues. He researched commodity markets at Sprott Asset Management in Toronto from 2006 to 2009