Financial WMDs and Hunger Games
Artificially high food prices are the new normal and cloud the developing world in a pall of misery
The writer is a postdoctoral researcher in the UK, working on cybersecurity, next-generation voting systems and virtual currencies
This is a quick introduction to the concept of financial weapons of mass destruction (WMDs) by way of an example.
In 1991, Goldman Sachs had an epiphany: let’s financialise food markets. They selected 18 ingredients, including cattle, coffee, corn, soy and wheat, and launched the Goldman Sachs Commodity Index. Folks who had no interest in the ground realities of buying food could now speculate as they would with normal stocks, buying low and selling high. Commodity indexes proved popular and other banks soon launched similar indexes. Activity picked up significantly after massive deregulation in the US in 1999. Earlier, bankers were limited in how much they could dabble in these markets but now they could take arbitrarily large positions.
The dynamics of this set-up are fascinating. The food market traditionally dealt in futures, aka forward contracts, i.e., buyers and sellers would negotiate the price of a commodity far in advance of delivery. In the case of grains, this would often happen before the crop had even been grown. The logic was that a predetermined price would buffer the market from short-term fluctuations in times of stress, prevent the wealthy from gaming the market and protect farmers in hard times.
However, to attract investors, bankers had to transform this new market, with its hard cycles of food growth, harvest and consumption into a ‘stock-like market’, where gambling on growth was a given, and investors could sink in money for the long run, as they might into Apple or IBM stock. The strategy for this was to go ‘long only’, that is, buy, buy, and only buy. When the due date of the contract approached, they would simply roll it over into new futures with a later date. The bankers would purchase these futures in bulk, thereby driving up their prices. Investors would notice the price surge and clamour for a piece of the action. The bank would profit selling the futures they owned and also charge clients hefty transaction fees for brokering the sales.
However, food prices can still be notoriously fickle and the bankers needed a way to assure investors that commodities were a bulletproof investment. They innovated by exploiting loopholes in the system. Typically, when a future is bought, a small amount, or margin, of about 5%, needs to be paid up front to demonstrate the buyer’s good faith. The bankers started heavily pouring the leftover 95% into other investments like Treasury bills or stocks. Now, if food prices rose, they’d make money. If food prices crashed, they’d still make money on the original investment thanks to the diversification. It was a magic formula, win win win.
But how does any of this relate to us?
Since 2005, these commodity indexes have created some of the largest food bubbles in history, triggered violent riots in some 30 countries, overthrowing governments, and pushed 250 million people to the brink of food insecurity and starvation. And we know next to nothing about it.
This saga was first documented in painful detail by Frederick Kaufman, writing for the prestigious Harper’s magazine in a prominent story titled, “How Wall Street Starved Millions and Got Away With It”. In short, after the dot-com bubble popped in 2000 and the housing market imploded in 2006, buyers eagerly sought a safe haven, and mountains of money poured into commodities. After all, what could be a safer bet than food? The farmers, millers, and food industry who traditionally dominated this market were dwarfed by the speculators. Commodity index holdings went up from $13 billion in 2003 to $317 billion in 2008. Lehman Brothers estimated that the volume of index fund speculation went up by a staggering 1,900%. This netted the banks hundreds of millions of dollars in fees but drove global food prices into the stratosphere.
"What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets," hedge fund maverick Michael Masters testified before Congress in 2008. Olivier De Schutter, the UN Special Rapporteur on the Right to Food, concurred in a briefing note: “The promotion of biofuels and other supply shocks were relatively minor catalysts, but they set off a giant speculative bubble in a strained and desperate global financial environment. These factors were then blown out of all proportion by large institutional investors who, faced with the drying up of other financial markets, entered commodity futures markets on a massive scale.”
From 2005 to 2008, the price of food worldwide surged by 83%. Wheat prices went up by 127%, rice rose by 170%. Dairy products in 2006-07 went up by 157%. The brunt of this was borne by poor communities. The average American spends an estimated 6.6% of his income on food. The average Pakistani spends 47.7%.
Many of us remember in vivid detail how this played out on the ground, day-to-day, at home. Prices for staples like rice, onions, milk and sugar soared. Politicians and cartels started hoarding sugarcane and grains. We started rationing dessert. The Supreme Court opened investigations. A Rs100 note very soon had the purchasing power of a Rs10 note. And there began a steady trickle of heart-rending stories of people driven to begging and desperate parents killing their children before committing suicide.
Some scratched their heads: how in the world can agricultural countries have a food crisis in times of bumper crops and record harvests? According to the International Grain Council, global wheat production actually went up in this period and Professor Ghosh of the Center of Economic Studies demonstrated that real demand actually decreased.
Food prices were a big factor that intensified Pervez Musharraf’s confrontation with then chief justice Iftikhar Chaudhry. In Thailand, rice farmers guarded their crops in shifts. Russia froze food prices, several countries instituted tariffs or bans on grain export. In Egypt, the army began baking bread to prevent riots. In Peru, the military switched to baking bread with potato flour instead of wheat. Food truck hijackings in Africa went up. The prime minister of Haiti was unseated amid food riots. Riots and demonstrations resulted in violence and actual deaths in scores of countries. In Ethiopia, journalist Johann Hari compares the crisis to a “tsunami”, quoting a woman, Abiba Getaneh: “My children stopped growing. I felt like battery acid had been poured into my stomach as I starved.” And in Tunisia, a food seller immolated himself, triggering the Arab Spring.
Indeed, prominently cited research by the New England Complex Systems Institute correlates the Arab Spring riots and protests with these very same speculation-induced price spikes. The authors identify a base threshold for food prices after which rioting is likely.
The bubbles may have popped for the moment but artificially high food prices are the new normal and cloud the developing world in a pall of misery. Over the 2010-2012 period, the World Development Movement estimates the top five banks made about $3.5 billion dealing in commodities. In 2012, Goldman Sachs alone made $400 million at it. Commentators warn that nothing has changed and we are a heartbeat away from a repeat performance of the crisis.
This ghastly saga has been covered in papers of record (including Time, The Guardian, The Independent, Foreign Policy, Scientific American, Der Spiegel, etc.), confirmed by scores of studies (by the likes of the UN, the FAO and Harvard University), but has yet to penetrate mainstream consciousness. We fret and fuss about daily injustices at home, but our entire reality is fundamentally warped and twisted by a multitude of invisible forces which we have yet to even fathom. This is the moral crisis of our generation.
Published in The Express Tribune, September 9th, 2015.
In 1991, Goldman Sachs had an epiphany: let’s financialise food markets. They selected 18 ingredients, including cattle, coffee, corn, soy and wheat, and launched the Goldman Sachs Commodity Index. Folks who had no interest in the ground realities of buying food could now speculate as they would with normal stocks, buying low and selling high. Commodity indexes proved popular and other banks soon launched similar indexes. Activity picked up significantly after massive deregulation in the US in 1999. Earlier, bankers were limited in how much they could dabble in these markets but now they could take arbitrarily large positions.
The dynamics of this set-up are fascinating. The food market traditionally dealt in futures, aka forward contracts, i.e., buyers and sellers would negotiate the price of a commodity far in advance of delivery. In the case of grains, this would often happen before the crop had even been grown. The logic was that a predetermined price would buffer the market from short-term fluctuations in times of stress, prevent the wealthy from gaming the market and protect farmers in hard times.
However, to attract investors, bankers had to transform this new market, with its hard cycles of food growth, harvest and consumption into a ‘stock-like market’, where gambling on growth was a given, and investors could sink in money for the long run, as they might into Apple or IBM stock. The strategy for this was to go ‘long only’, that is, buy, buy, and only buy. When the due date of the contract approached, they would simply roll it over into new futures with a later date. The bankers would purchase these futures in bulk, thereby driving up their prices. Investors would notice the price surge and clamour for a piece of the action. The bank would profit selling the futures they owned and also charge clients hefty transaction fees for brokering the sales.
However, food prices can still be notoriously fickle and the bankers needed a way to assure investors that commodities were a bulletproof investment. They innovated by exploiting loopholes in the system. Typically, when a future is bought, a small amount, or margin, of about 5%, needs to be paid up front to demonstrate the buyer’s good faith. The bankers started heavily pouring the leftover 95% into other investments like Treasury bills or stocks. Now, if food prices rose, they’d make money. If food prices crashed, they’d still make money on the original investment thanks to the diversification. It was a magic formula, win win win.
But how does any of this relate to us?
Since 2005, these commodity indexes have created some of the largest food bubbles in history, triggered violent riots in some 30 countries, overthrowing governments, and pushed 250 million people to the brink of food insecurity and starvation. And we know next to nothing about it.
This saga was first documented in painful detail by Frederick Kaufman, writing for the prestigious Harper’s magazine in a prominent story titled, “How Wall Street Starved Millions and Got Away With It”. In short, after the dot-com bubble popped in 2000 and the housing market imploded in 2006, buyers eagerly sought a safe haven, and mountains of money poured into commodities. After all, what could be a safer bet than food? The farmers, millers, and food industry who traditionally dominated this market were dwarfed by the speculators. Commodity index holdings went up from $13 billion in 2003 to $317 billion in 2008. Lehman Brothers estimated that the volume of index fund speculation went up by a staggering 1,900%. This netted the banks hundreds of millions of dollars in fees but drove global food prices into the stratosphere.
"What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets," hedge fund maverick Michael Masters testified before Congress in 2008. Olivier De Schutter, the UN Special Rapporteur on the Right to Food, concurred in a briefing note: “The promotion of biofuels and other supply shocks were relatively minor catalysts, but they set off a giant speculative bubble in a strained and desperate global financial environment. These factors were then blown out of all proportion by large institutional investors who, faced with the drying up of other financial markets, entered commodity futures markets on a massive scale.”
From 2005 to 2008, the price of food worldwide surged by 83%. Wheat prices went up by 127%, rice rose by 170%. Dairy products in 2006-07 went up by 157%. The brunt of this was borne by poor communities. The average American spends an estimated 6.6% of his income on food. The average Pakistani spends 47.7%.
Many of us remember in vivid detail how this played out on the ground, day-to-day, at home. Prices for staples like rice, onions, milk and sugar soared. Politicians and cartels started hoarding sugarcane and grains. We started rationing dessert. The Supreme Court opened investigations. A Rs100 note very soon had the purchasing power of a Rs10 note. And there began a steady trickle of heart-rending stories of people driven to begging and desperate parents killing their children before committing suicide.
Some scratched their heads: how in the world can agricultural countries have a food crisis in times of bumper crops and record harvests? According to the International Grain Council, global wheat production actually went up in this period and Professor Ghosh of the Center of Economic Studies demonstrated that real demand actually decreased.
Food prices were a big factor that intensified Pervez Musharraf’s confrontation with then chief justice Iftikhar Chaudhry. In Thailand, rice farmers guarded their crops in shifts. Russia froze food prices, several countries instituted tariffs or bans on grain export. In Egypt, the army began baking bread to prevent riots. In Peru, the military switched to baking bread with potato flour instead of wheat. Food truck hijackings in Africa went up. The prime minister of Haiti was unseated amid food riots. Riots and demonstrations resulted in violence and actual deaths in scores of countries. In Ethiopia, journalist Johann Hari compares the crisis to a “tsunami”, quoting a woman, Abiba Getaneh: “My children stopped growing. I felt like battery acid had been poured into my stomach as I starved.” And in Tunisia, a food seller immolated himself, triggering the Arab Spring.
Indeed, prominently cited research by the New England Complex Systems Institute correlates the Arab Spring riots and protests with these very same speculation-induced price spikes. The authors identify a base threshold for food prices after which rioting is likely.
The bubbles may have popped for the moment but artificially high food prices are the new normal and cloud the developing world in a pall of misery. Over the 2010-2012 period, the World Development Movement estimates the top five banks made about $3.5 billion dealing in commodities. In 2012, Goldman Sachs alone made $400 million at it. Commentators warn that nothing has changed and we are a heartbeat away from a repeat performance of the crisis.
This ghastly saga has been covered in papers of record (including Time, The Guardian, The Independent, Foreign Policy, Scientific American, Der Spiegel, etc.), confirmed by scores of studies (by the likes of the UN, the FAO and Harvard University), but has yet to penetrate mainstream consciousness. We fret and fuss about daily injustices at home, but our entire reality is fundamentally warped and twisted by a multitude of invisible forces which we have yet to even fathom. This is the moral crisis of our generation.
Published in The Express Tribune, September 9th, 2015.