MERCHANDISER Broken Markets How financial market regulation can help prevent another global food crisis
THE INCREASE IN financial speculation in commodity markets over the last ten years is clear, however the effects that this has had are hotly debated. Proponents of efficient market theory have argued that speculation is inherently stabilising. Speculators are believed to help smooth volatility in the
market. In practice this has not been the case, according to a new report from the World Development Movement (WDM) who contend that financial speculation has in fact:
• Distorted prices away from expectations of supply and demand.
• Increased price volatility.
• Caused the prices of unrelated commodities to move together.
• Increased costs for traditional hedgers, forcing them out of the market.
The effect of the increasing presence of financial speculators in agricultural derivative markets has been to undermine their basic functions of risk hedging and supporting price discovery. “These markets are now barely fit for purpose both for those who rely on these markets directly and in terms of their devastating impact on food prices around the world,” according to the report’s author Murray Worthy. In 2008 food prices reached record levels, rising 80%
in 18 months, pushing the total number of people going hungry to over 1 billion. Following this peak food prices rapidly declined. However, since 2009 the cost of food has been climbing
again on global markets, with food prices reaching record highs once again in early 2011. Many commentators expect food prices to continue to rise. This huge increase in the cost of food and a sharp increase in food price volatility over recent years have triggered a global debate on the causes and solutions to this crisis. Some factors are widely agreed to have had an impact
on food prices, such as declining crop yields as a result of climate change, the impact of growing demand for biofuels and the long-term neglect of investment in agriculture by governments around the world. The role financial speculation in contributing to this crisis has been much more controversial. Many have argued that the huge increase in financial
participation in commodity derivative markets has played a central role, fuelling price inflation and increasing price volatility. WDM’s 2010 report The Great Hunger Lottery highlighted the role of banks and other financial speculators in pushing up the price of food during the last food crisis, prompting significant debate. Some commentators have questioned the very premise
that financial speculation can affect the price of food. Others, proponents of ‘efficient market theory’, have argued that rather than contributing to food price rises, financial speculation stabilises food prices. “This debate is not just one of abstract financial market theory. In the wake of the financial crisis and in the context
of a looming global food crisis we are faced with a unique political opportunity,” says Worthy. The US, EU and the G-20 are all considering rules to
regulate commodity markets, to ensure their effective functioning and curb excessive speculation. Broken Markets argues that these reforms are urgently needed to prevent a global food price crisis driving millions more into hunger and poverty throughout the global south. Broken Markets shows how financial speculation has boomed, turning commodity derivatives into just another asset class for investors, distorting and undermining the effective functioning of agricultural markets. It shows how these changes in the financial markets translate into changes in the price of food, and the devastating impact this has had on the world’s poorest people.
Financial Holdings in Agricultural Derivatives
140 120 100 80 60 40 20 0
2006 2007 2008 Source: Barclays Capital; The Commodity Investor According to some estimates, as many as 1.3 billion
people currently go hungry. And its not just the poor who are feeling the effects say WDM. Richer countries are also being hit hard by rising food prices. In the UK, for example, food price inflation in June 2011 reached 6.9%. Broken Markets calls on regulators to introduce:
• Market Transparency – Moving trading of derivatives from deregulated OTC markets onto properly regulated
public exchanges, and introducing position reporting so that regulators and analysts can properly assess the functioning of the markets.
• Position Limits – Strict limits are needed on the amount of the market that can be held by individual traders and
by financial speculators as a whole, to prevent them from overwhelming the markets. Based on analysis of data from US markets, financial speculation could be limited to as little as 25% of the market.
Clear, hard rules are required say WDM to control
financial speculation and to help prevent another global food crisis. “Regulators should seize this unique opportunity to tackle the dominance of financial speculators and contribute to ensuring fairer and more stable food prices for consumers throughout the world.”
You can download Broken Markets from WDM at:
www.wdm.org.uk
September 2011 25 2009 2010 2011
US$ Billion
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