Global Policy Forum

In Grip of Financial Markets


The Role of the Speculation Factor

By Rainer Falk

World Economy and Development in Brief
May-June 2008

"Speculators may do no harm as bubbles on a steady stream of enterprise", John Maynard Keynes wrote in his famous book The General Theory of Employment, Interest and Money, "But the position is serious when enterprise becomes the bubble on a whirlpool of speculation." The current food crisis shows that global agrobusiness is about to become "the bubble on a whirlpool of speculation".

Strengthening a trend

Increasing demand, for example caused by changing consumption patterns in the emerging economies, by increasing consumption of meat or by booming biofuels, has been a steady development which triggered the price increase. Food speculation, looking for investment options beyond the crisis-ridden asset classes, has immensely fuelled the trend. Thus food became more and more from a basic human need to an economic "commodity".

It is impossible to measure exactly the significance of speculation in agflation as the inflationary trend of agro-products has been dubbed. Economists such as Paul Krugman argue that speculation is pushing above all futures prices, e.g. the wagering of speculators how much commodities, be it corn or rice, will cost the moment they hit the market. The spot prices would only follow suit if the exploding futures prices were to reduce the available quantities. In reality, however, as Heiner Flassbeck, chief economist at the UN Conference on Trade and Development (UNCTAD), explains, whole harvests are being bought up before they are even brought in from the fields. That increases consumer prices too.

Facts and figures

No doubt, speculative trade with commodities derivatives has been booming during the last few years as the figures clearly indicate:

  • In the past five years the trade with commodities futures and options virtually exploded. According to the Futures Industry Association contracts rose from US$6.2bn in 2002 to US$15.2bn in 2007. In the past year alone, the increase was 28%.

  • At the Chicago Mercantile Exchange, the traditional hub of commodities speculation, commodities investment funds accounted for 40% of the trade with futures and options – the highest percentage ever.

  • According to investment bank Morgan Stanley in the last few years the number of corn contracts has risen from 500,000 to 2.5 million.

  • So-called exchange-traded funds (ETFs) participate in the commodities trade via swaps, futures and other derivatives. Although these investment products have been available only for a few years they are immensely successful: In January 2008 net investments in the amount of US$32.4bn were recorded compared to US44.8bn in 2005.

    Three drivers

    What is driving the current interest in speculation with commodities? Analysts usually see three drivers:

    Firstly, financial returns: They come into play when the return on investment in the commodities sectors exceeds that in other investment sectors – as is currently the case. According to The New York Times, the hedge funds, commercial banks and brokerages who turned their backs on the crisis-ridden securities, real estate and loan markets due to low returns are now the big players on the commodities markets.

    Secondly, the physical aspect: Here the longer-term developments of supply and demand are taken into consideration. They can trigger medium-term boom and bust cycles which attract and may indeed strengthen speculation.

    Thirdly, financial and physical factors can combine and trigger an interactive panic. In this situation – a self-propelling run – speculation and self-defending measures by private and public actors spur each other. This happened last weeks when stockpiling rice and export moratoriums – albeit understandable measures – exacerbated the problems on the food markets.

    Source: Ocampo/Parra

    From excess to normalisation?

    Recently, public attention has focused on the threat of a global food crisis. Analysts, however, tend to forget that agro-prices have just recovered from their dramatic decrease in the 1980s as José Antonio Ocampo and Maria Angela Parra convincingly show (see graph). That means the wave of speculation of the recent months in fact only contributed to a normalisation of price levels.

    Ocampo's and Parra's figures indicate that the real boom is happening in mineral commodities: their prices are now twice that of the post-war average. A look at the long-term price developments of agricultural products provides a rather uneven picture (see table): palm oil, wheat and bananas, for example, are booming, corn and rice are still below the 1945-1980 average and tropical products such as cocoa, tea, coffee or cotton are still in depression.

    Real commodity prices, March 2008 (Index: 1945-1980 = 100)

    Palm oil : 260.1
    Wheat : 189.7
    Bananas : 185.0
    India rubber : 162.8

    Below the index:

    Corn : 95.7
    Rice : 78.8


    Cocoa : 60.9
    Tea : 58.7
    Coffee : 58.0
    Cotton : 43.5
    Sugar : 41.0

    The continuation of these trends allows an interesting conclusion: While the Singer-Prebish theory of secular deterioration of commodities prices compared to manufactured goods may indeed be disproven with regard to metals, it may keep some importance for agricultural products. In any case, no development policy strategy can be based on peak prices that are artificially created by speculation. The hopes recently spread by the OECD (see references) that high food prices may hold development opportunities for poor countries may be built on sand – once again.


    * OECD et al., African Economic Outlook 2008, OECD: Paris 2008 (
    * Jose Antonio Ocampo/Maria Angela Parra, This is a Boom of Mineral, Not Agricultural Prices, RGE Monitor, New York, 6 May 2008 (

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