theme 4

• WEED - Weltwirtschaft, Ökologie & Entwicklung
• World Economy, Ecology & Development
• This paper has been financially supported by the Ford Foundation. The views expressed in the paper are those of the author.
• Food Speculation - The Main Factor of the Price Bubble in 2008
• Briefing Paper by Peter Wahl
• This paper argues that speculation on food prices has played the decisive role in the price bubble in 2007/2008.
• Given that other factors which influence food prices, such as increasing demand of emerging markets countries, stagnation in production or the use of agrofuels are long term factors, they cannot explain that the FAO food price index increased by 71% during only 15 months between the end of 2006 and March 2008 and fell back after July 2008 within few months to the level of 2006.
• This hike can only be understood by looking at the mechanisms of food speculation.
• Speculation


  The main cause of the sharp increase in food prices
• Factors governing the pricing of agricultural commodities

  • Long-term factors (increasing demand, agricultural productivity, production of agrofuels, reduction of food stocks)
  • Short-term factors (increase in oil price, bad harvests, exchange rate fluctuations, export restrictions)
• Mainstream economists initially ignored the role of speculation in the food price increases.
• It has become clear since the decrease in food prices from July 2008 that neither increasing demand in the emerging economies nor agrofuel production caused the food price trend.
• Speculation in connection with the financial crisis is the decisive factor.
• We are dealing with the classic case of a speculative bubble which was built up in the second half of 2007.
• The crisis in the mortgage sector in the US, which was also the result of a huge speculative bubble, started to spread across the whole financial sector.
• People in the financial market sought alternatives in the commodity sector and the bubble started to form.
• The bubble reached its maximum in Summer 2008 and then burst.
• Mainstream economists no longer deny that speculation at least contributed to this bubble.
• The U.S. supervisory authority (CFTC) observes that the commodity markets have begun to set the price of commodities as an asset instead of setting the price solely according to factors of supply and demand, causing price distortions and a speculative bubble.
• A complex package of countermeasures is necessary to deal with all the factors causing the price increases, including measures against speculation.
• The industrial countries carry a special responsibility for measures to counter speculation as speculation is occurring in the commodities markets of the industrial countries and the instruments for regulation exist there.
• A complex package of countermeasures is necessary in view of the threat to the livelihood of millions and millions of people who can no longer afford their daily bread, and this package should deal with all the factors causing the price increases
• The industrial countries carry a special responsibility for measures to counter speculation
• There are scarcely any opportunities to act against the cultivation of agrofuels in Brazil or the long term increasing demand for agrofuels, but direct measures can be taken against speculation
• Speculation is occurring in the commodities markets of the industrial countries and the instruments for regulation exist there as well
• On September 18th, 2008, both Great Britain and the US have banned a certain type of speculative business, so-called short selling, as part of the crisis management in view of the financial crash
• If the financial crisis is a reason to use this set of instruments, then the threat to the livelihoods of millions of people in the developing countries is a reason any time
• Speculation


  (in mainstream economics, neo-classical theory) an obsolete category, everything is considered as investment for which assets are used on the basis of a future expectation of achieving profit at a later date
• Speculation


  (in heterodox positions like Keynesian, Marxist) an anticipatory action taken in relation to the future with the aim of forestalling future developments in one's own dispositions and achieving an (economic) profit
• There is a fundamental difference between investment and speculation - investment creates real added value, while speculation aims to profit from a future difference in the prices of assets
• Speculation


  • No real, additional value is created, there is merely speculation on a higher price
  • Profits are not sustainable or self-supporting, but can only be repetitively achieved through new speculation activities
  • When speculation fails, the assets dissolve into nothing
• Speculation creates macroeconomic instability - even in times when there is no crisis, volatility has a structural impact
• Futures


  Derivative contracts where a farmer negotiates with a speculator to buy the harvest at a fixed price in the future
• Commercial trading


  Futures trading by established experts who possess expertise and information to provide relatively reliable forecasts on price trends, closely linked to the fundamentals of the real economy
• Index fund speculation


  Speculation on a basket of commodities, primarily oil and metals but also agricultural commodities, by funds that exclusively follow the trends of stock exchange indices and have automated, pro-cyclical trading strategies
• The volume of index fund speculation increased by 1,900% from 2003 to March 2008, from 13 billion US$ to 260 billion US$
• Index fund speculation contributed to the food price bubble not only from 2003 to 2007, but also to the rapid increase in 2007 due to the flight of hedge funds and other institutional investors from the crisis-ridden financial markets into the commodity markets
• When institutional investors turned to the commodity markets, the demand for futures suddenly increased, affecting the price trends
• Leveraged speculation


  Acquiring borrowed capital that exceeds their equity by 30 or 40 times in their operations
• When credit resources dried up, the possibilities for leveraged speculation diminished