A popular theory floated around Washington in 2011, suggesting Commodity Index Traders, including Wall Street’s biggest banks, hedge funds, and retirement funds were responsible for driving up the global price of food. That price spike would lead to riots the world over, from Libya to Syria, and push millions around the globe to starvation.
Since then the so-called Masters’ theory has been widely debunked as a root cause of rising food prices, but the economists who cleared investors from the guilt of causing starvation did only that. The data shows that though they did not cause rising food prices, they did profit from it.
A Second Look at 2008 Commodity Investment
First, if you’re at all interested in understanding how commodity markets work, and how ag products are bought and sold, get yourself a copy of Endless Appetites: How the Commodities Casino Creates Hunger and Unrest by Alan Bjerga. Though it’s approaching 10 years old, it’s insight into food and ag during the 2008 financial crisis is invaluable.
The Master’s theory was a simple one, that between 2000 and 2010, food prices rose steeply, and so did the amount of speculation in ag commodity markets by major index funds. Index fund trading in commodities like energy, metal, food, and fiber jumped from $6 billion in 2000 to $375 billion in 2010.
“From 2006–08, CITs on the long side of the market held between one-fifth and one-half of all outstanding wheat contracts at the Chicago and Kansas City exchanges.”
(Adjemian, M., P. Garcia, S. Irwin and A. Smith. “Solving the Commodity Markets’ Non-Convergence Puzzle.” farmdoc daily (3):159,Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, August 21, 2013.)
The unique things about ag commodity markets is that they’re not just a piece of paper— when you buy a corn future, someone must eventually receive some corn. Farmers use futures to control risk, and so do businesses that need to purchase ag products like bakers or grocers (these groups were who commodity markets were set up for).
But the physicality of ag commodities is what attracts index funds too, because during times of inflation, nervousness in the market tends to cause prices of physical goods to rise while stock prices fall. That makes investing in ag commodities a way to limit risk and balance a portfolio. They can make that investment without ever having to pay for grain silos or cattle pens by buying future contracts and rolling over their position, or continuously shifting dollars to contracts that are further in the future. Master believed that this activity made it appear that there was a lot of demand for farm products in the future, encouraging farmers to store their produce, and hold out for those higher future prices, causing today’s prices to rise.
“Investment banks could buy crop contracts, just like a wheat merchant. Food no longer made for just a balanced diet. It balanced portfolios too, opening the doors for millions of investors to have a personal stake in food and energy markets beyond their groceries and gas tanks.” — Endless Appetites
But since Masters testified before the Senate Ag Committee and the CFTC in 2009, the phenomenon his theory explained has been ascribed to other factors, and no substantial link has been made that would suggest causality between increase in index fund investment and food prices.
And yet, that the passive investments of hedge funds in agricultural commodities didn’t actively lead to global hunger-inducing price levels isn’t the only relevant question.
Here is a particularly telling passage;
“Chicago crop contracts…seemed to have potential as a long-term investment for all rather than as a short-term way for farmers to hedge against bad weather of for bakeries to make sure they have flour. Buying and selling crops… could do a lot more than feed people: It could help people save for their retirements, survive economic turmoil, and create greater wealth for all. Even a shopper paying more for bread would at least benefit from higher prices at the investment side, even if the consumers pocketbook got hit when prices rose. Positive returns over the years would be practically guaranteed as demand increased. Big banks could provide the money and electronic trading of future anywhere, anyplace, anytime could provide the scale.” — Endless Appetites
It’s so obvious it bears repeating. “…A shopper paying more for bread would at least benefit from higher prices at the investment side…” It’s obvious because that’s exactly why there are fees for a 401k, to pay a smart broker on Wall Street to make sure that when the economy is not doing well, our money is still secure and growing. To ensure that even when the market is faltering due to inflation and economic outlooks are grim, we don’t totally lose out financially. Investing in stocks and commodities is like investing in boats and life jackets — no matter how things are going, at least one of your investments is going to be doing well.
Bjerga’s passage suggests it’s essentially just a shift. You pay a dollar more for a gallon of milk, and you see it as growth in your investment account. But what does that mean for people who don’t have formal, market-driven investments, as most Americans don’t?
To be clear, I’m not describing a tradeoff. It’s not that, if there were no index funds to benefit from rising prices, they would decline. Food prices are going up for other reasons. Nor am I saying that hedge funds and others are making kingly fortunes this way — it’s more a strategy to soften steep stock losses during tough times than it is a cash cow.
But it does not change the reality that, because of the way the market is set up, when prices are on the rise, for whatever reason — geopolitical crisis, weather, energy shortage, etc. — the long-term stability of the wealthy grows while the poor get poorer. When poor American’s give up medicine or clothes to buy a $5 gallon of milk (let alone poor Brazilians or poor Tunisians), the investments of the wealthy grow, or at the very least, decline less dramatically, because they, in a way, own that gallon of milk.
Since the poor, at home and abroad, spend a much larger percentage of their income on basic commodities (be it food, oil, natural gas, or fiber), when prices increase, they feel an out-sized impact, and it’s not being “made up for” in their investment accounts. Plus, these commodities tend to feed back on each other. The UN World Food Price Index looks extraordinarily similar to oil prices, because of both transportation and fertilizer made with natural gas.
It’s worth noting too that we already grow more than enough calories than we need to feed the world. But hunger is far from being a thing of the past, and as long as food supplies can be limited, the free market will lead some to profit from the lack. It’s easy to forget when the economy is plugging along to prepare for the next possible catastrophe, but if 2008 taught us anything, it’s that tragedy could be waiting around any corner.
“To feed everyone, we need everyone. To make famine a memory, we first must stop forgetting about it.”
Thanks for reading! I look forward to some spirited debate. In the meantime, you might enjoy exploring more about AgTech, the watering hole on the Serengeti of Farming. @sarah_k_mock