Frederick Kaufmann spoke last week at Harvard about his Harper’s Magazine article, The Food Bubble: How Wall Street starved millions and got away with it (pdf here), for an event sponsored by the HLS Food Society. Kaufmann has described, in scrupulous detail, how the creation of the Commodity Index Fundsin 1991 opened the door to speculation in commodity food markets and how this speculation is wreaking havoc around the world.
Despite record yields in recent years, the price of of cattle, coffee, cocoa, corn, wheat, and other foods has skyrocketed. The price of food might be an inconvenience to middle class shoppers in the U.S. with domestic food prices expected to rise by 3-4% this year. But internationally, rising food prices can mean starvation. In fact, Spiking food prices have also been cited as a major force behind the recent popular uprisings in Egypt and elsewhere in the Middle East.
Obviously, crop prices are affected by seasonal fluctuations in yield. But, that hardly accounts for the record increases in food prices during the late 2000s (particularly since output continued to rise). Oil costs play a part, but Kaufmann has persuasively argued that the long-term commodity index fund, a financial innovation, has thrown food prices out of wack. It has done so by removing them from a world of supply-and-demand and turning food into another sphere of financial speculation. Beyond anything we saw in the housing market, a bubble in food prices could fuel continual political upheaval and produce incalculable human costs.
So how did food become an arena for speculators? Commodity grain futures are possibly the oldest derivative product on earth. For over a century-and-a-half, they helped stabilize food prices by allowing farmers to set the price of their grain before the harvest and offset some of the seasonal risks. Speculation was uncommon, nonetheless, due to purchase limits and because, five times per year, the major U.S. grain exchanges forced all these futures contracts to be executed.
According to Kaufmann’s account, this is where Goldman’s commodity index fund came in and threw things off. By designing a way to rollover these products that were supposed to clear five times per year, Goldman created a long-only fund that allowed investors to hold commodity grain investments for far longer periods of time. This meant that it was now possible to continue buying grain futures, driving up the price, and thus disrupting the process through which these commodity markets are cleared. Other banks and financial institutions, of course, followed suit.
Two aspects of this are troubling. First, this market is long-only, meaning it is engineered for investors to buy and push the price up. It’s a bet that food prices will keep rising, and in light of the growing middle class in China and India, that’s a safe bet–until, of course, it’s not. Secondly, and perhaps more nefariously, Kaufmann argues that Goldman and other banks have insulated themselves (through hedging and a per-transaction fee model) from the bubble they’ve helped to blow.