Food Prices and Commodity Speculation

Michael Niemann, 15.04.2008 16:02

The wheat flour I use to bake bread has increased by thirty-eight percent in just one months. What happened? In addition to all the other factors, the increased number of speculators in commodity markets are driving prices up.

Wheat Field (USDA picture)

Chicago Board of Trade in 1970 (USDA picture)

I bake my own bread. It's one of these habits that may seem quaint or silly, but I do it anyway. I know what goes into it and I know its good for me. And it's a lot cheaper than buying good bread in the store. One of my loafs takes about a cup and a half of water, a little oil and honey, four cups of flour (I use a mix (3:1) of whole wheat and white organic flour), a couple teaspoons of yeast and a few spoonfuls of whatever seeds I have lying around.

Obviously, the key ingredient is flour which I buy regularly. So imagine my sticker shock when the last batch of flour I bought cost $1.08 per pound. That's 30 cents more than I paid only a month ago! That's a thirty-eight percent increase in only one month! What's going on here?

Well, if you haven't paid attention to the news about food prices lately, you are in for a nasty surprise. They are going up and rapidly so. The World Bank just released a report showing that wheat prices have more than doubled since 2004. The other key grains are not far behind. Rice has doubled in price, corn is up 80% and soybeans 56%. And since these grains are key ingredients for almost anything we eat, all food prices have increased quite a bit. The poorer you are, the more this will hit you in the pocket book.

What has happened?

Here are a few explanations for these increases. Some blame it on the increase in oil prices that makes everything related to agriculture - transport, fertilizers and pesticides - more expensive. Then there is the weather. A drought in Australia and the Ukraine has reduced those countries' output significantly and they are important global suppliers. How about the increasing standards of living for some in China and India. Sure that number is still a small fraction of their total population, but if even ten percent of India's population adopt a Western diet (wheat bread, more meat, etc.) that's 100 million more consumers right there.

We've all heard about the wonders of biofuels. Well, it seems as if the ill-advised rush towards biofuels is also to blame. With governments subsidizing the production of ethanol and other oil substitutes in the U.S., Europe and Brazil, farmers have switched land use from food crop production to fuel crop production. The IMF estimates that fully half of the increase in global food prices in 2007 can be explained by the switch to biofuel production in Europe and the U.S.

But there is another factor that affects the price of my flour in Ashland and it turns out to be by-product of financial globalization. Speculation on commodity markets. Wheat, like most other agricultural commodities it traded on commodity exchanges. In the U.S., the Chicago Board of Trade (CBOT) is that place but there are similar commodity exchanges in other parts of the world.

Commodity exchanges trade in futures and options. Futures are simply standardized contracts for a particular commodity. There's a lot to futures trading and that's better left for another article, but for this one let's just say that there are two kinds of futures traders - those who want to hedge against a price risk and those who want to make a quick buck.

The hedgers use the commodity markets to protect themselves against future price decreases for wheat they have already contracted to buy. If they locked in a price for next year and the price goes down between now and then, the profit they make in the futures market next year will offset the loss they incurred from having contracted for a higher price now. The speculators just want to make a buck by betting against the future.

It looks like there has been a big increase in speculators in the commodity markets in the recent past and that has driven commodity prices higher than they would have been otherwise. Even though futures prices are about the future, they do influence current prices. Anticipation of higher prices in the future quickly leads to higher prices now. We see that at the gas pump all the time.

How did we get here? When the dot.com stock market bubble of the 1990s popped, the people with money were desperately looking for another way to make big bucks fast. With interest rate low, the mortgage market was the next speculative thing. Well, we all know where that got us. Now that the stock market is down and the mortgage speculation is busted what else is there to make a quick buck? Commodities! In 2004, the number of open interests, an indicator of how many parties participate in the market hovered around 100,000. By 2007, that had doubled to over 200,000. Hedge funds and other entities have been pouring money into commodity futures in search of higher returns.

But these newcomers may not know what they are doing. As the New York Times reported, economists have been puzzled by a strange phenomenon in the commodity markets recently. Normally, futures prices and cash prices converge when the delivery month arrives. A contract for May 2008 can go through all kinds of price gyrations but come May 2008, its price will be the same as the cash price. Or so the accepted logic goes. Well in recent months, it has turned out that the futures price for wheat has been higher than the cash price in the settlement month. Apparently, those speculators, don't sell when they should.

So in this world, where financial markets are interconnected 24/7 and events in one region instantly affect developments in another, a number of separate developments that might influence wheat prices locally is exacerbated by the speculations of hedge funds and commodity funds into a global wheat crisis. And that's why my bread is so much more expensive. So buy locally produced food, it's the only way to get out of this globalized treadmill that serves the interests of the few but ignores the needs of the many.

e-mail:: mniemann2@gmail.com
Homepage:: http://michael-niemann.com

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Local Buyer 16.04.2008 - 11:40 Helpful explanation about who buys on commodity exchange, thank you! I like to support local stores and producers. Still I don't understand how buying local affects the commodity trading in Chicago. World Food Crisis> Why Buying Local Helps 16.04.2008 - 16:19 Yes, the link between buying local and the CBOT in Chicago seems far fetched and it is a long-term solution. Once farmers know that they can sell their products locally, they become less dependent on selling in bulk to Cargill or ADM. That in turn can insulate local markets from the global gyrations. But that's not going to happen very soon. At the moment, I don't even know where they flour in the Coop or at Shop 'n Kart comes from. So this requires some patience. Michael Niemann> e-mail:: mniemann2@gmail.com