The Rich Get Richer Off the Backs of the Poor

The world appears to have come through another harrowing episode of skyrocketing commodities prices. Analysts are forecasting that at least in the short run, they are likely to moderate if not actually fall, which should be a relief – some, but not much -- to the hundreds of millions of the world’s starving.

“The long-term commodity rally is losing steam, indeed it may already have peaked though we do not rule out last hurrahs,” according to a report last week by Research-Works, a Shanghai-based research firm that specializes in commodities. ”What we can say is that annual commodity prices look much closer to their tops than to their averages.”

Behind the story is a series of disparate elements including long-term decisions in the Eurozone and the US to produce biofuels as well as food from corn, driving grains prices to skyrocketing levels; climate change, which is cutting into some annual harvest yields while increasing them elsewhere; and finally the Malthusian proposition that population appears to be increasing faster than available food supplies.

But in discussions of the factors that drive prices, consultants and others largely don’t mention a relatively new one. That is “financialization,” an unwieldy word for the discovery by the boys in yellow suspenders -- investment bankers, hedge fund and money market managers -- of the profit to be made in commodities trading. Over the past decade a flood of speculative money has overwhelmed the quantity of goods for sale, with the result that prices have gyrated.

As the world downturn has continued, however, and the need to cover financial problems has escalated in Greece, Spain, Italy and other parts of the world, the speculative money has begun to wash back out.

Research-Works notes that "funds invested in commodities fell by 22 percent from April to the end of September after having risen 195 percent from the fourth quarter of 2001 to their 2011 peak, thus acting as a catalyst for commodity prices rising to record levels, investment in futures could well be the needle that pops the commodity balloon. Whether it has happened for this long-term cycle is not clear as uncertainty about liquidity, debt, quantitative easing, inflation or industrial output will determine the short to medium trend.”

A new book and disturbing book, “Endless Appetites: How the Commodities Casino creates Hunger and Unrest,” by Alan Bjerga, a prize-winning Bloomberg News Service reporter, tells part of the story. It began in Chicago at the Commodities Futures Trading Commission during the administration of George H W Bush, when free-market acolytes including CFTC Chairwoman Wendy Lee Gramm, the wife of US Sen. Phil Gramm, argued to keep over-the-counter trading exempt from regulation.

Prior to that point, futures trading was the province of people in the industry who were actually active in the buying, selling and delivery of commodities like wheat or corn, etc. But in 1991, according to Bjerga, “Goldman Sachs had an idea that changed commodity trading forever. A Goldman trader got the idea to do a swap with a pension fund to add commodities to its portfolio. Eventually, Goldman created an index to track prices on selected commodities, allowing index fund buyers a way to speculate on them.”

But it wasn’t until 2000, when Bill Clinton signed a measure largely exempting over-the-counter derivatives from regulation as he was leaving office, followed by George W. Bush, that things began to take off.

“For free market advocates, the creative power of modern markets would be unleashed – just as crops, energy and metals were about to look better than ever as an investment,.”

That kicked off Bjerga’s commodities casino.

“Unburdened by regulations and with a motivation to move money elsewhere, index funds created by Goldman, Deutsche Bank, Pacific Investment Management Co. (PIMCO) Prudential Bache Commodities and others began pouring money into energy, metal, food and fiber,” Bjerga writes. “Assets handled by money management firms, hedge funds, or other financial services companies started the decade at US$6 billion in value. They jumped to US$10 billion in 2001, fell back with the recession, then started to rocket once the economy recovered: more than $25 billion in 2003, $54 billion in 2004, S145 billion by 2006.”

With a flood of money behind them, the big banks got into commodities ownership in a big way. Goldman, Bjerga noted, created a global network of warehouses to hold aluminum. Morgan Stanley began chartering more oil tankers than Chevron Oil. JP Morgan hired a supertanker to store heating oil off Malta.

Ultimately, investment in the indexes tied to commodity prices -- energy, food and metals -- by early 2011were 55 times larger than in 2000, directly connecting rich-world investors to volatile food costs, Bjerga continued. While certainly there are other factors at work, this chart clearly shows the influence of the index funds.

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The effect on poor-nation consumers and the farmers struggling to feed them was devastating. From the middle of 2007 to mid 2008, when the World Bank, the United Nations Food and Agriculture Association and other world bodies began to be concerned, world food prices rose by 46 percent, then plunged 34 percent in the second half of that year, Bjerga writes, bottoming out in February 2009. Then they took off again in June 2010 to 2011, rising another 39 percent.

Then, nearly 8,000 km. across the world from Chicago, on Dec. 17 a vegetable seller name d Mohammed Bouazizi, discouraged by a variety of problems, poured a can of fuel over his head and lit himself afire. He died on Jan. 4, having set off a revolution.

“Mohammad Bouazizi’s self immolation alerted the world that a new crisis, fueled by food, had begun,” Bjerga writes. That, of course, turned into the Arab Spring.

“Demand by developing countries is unlikely to have put additional pressure on the prices of food commodities, although it may have created such pressure indirectly through energy prices,” authors John Baffes and Tassos Haniotis wrote in a July 2010 report for the World Bank. “We also conclude that the effect of biofuels on food prices has not been as large as originally thought, but that the use of commodities by investment funds may have been partly responsible for the 2007/08 spike.”

Today, according to Research-Works, analyzing US investments in individual commodities paints a clearer picture of what has happened. Investments in 14 of them fell during the second and third quarters of this year, were flat in one, and up in just one – gold.

“Even copper, which we consider to be one of the strongest commodities fundamentally, has fallen out of favour with the values of index holdings falling 35.9% to $5 billion. The fall in value of cotton indices was the most severe, almost halving from $5.9 billion in Q1 2011 to $3.1bn in Q3. West Texas Intermediate, wheat, soyabean oil and silver also saw values fall sharply. Livestock commodities, however, outperformed other sectors, with index values in hogs and live down just 12.5% and 7.2% respectively.”

Futures trading, which began hundreds of years ago as a method to smooth out price swings, has thus come into favor as a speculative tool by people whose only connection to food or energy is at the dinner table or the petrol pump. Instead of acting as a hedge against volatility, as Bjerga writes, futures trading has become a way to add fuel to the fire.

“The effects of commodities trading on food prices is controversial,” he continues. “Regardless of cause, the price swings of global crop and energy markets have turned a quarter century of stable food costs into a marketplace casino where demand pushes prices higher – and drought drives them higher still -- while a cooling economy or an unexpected gain in supplies cascades them down faster than any changes in how much people actually eat.”