By Horand Knaup, Michaela Schiessl and Anne Seith
September 1, 2011
In recent years, the financial markets have discovered the huge opportunities presented by agricultural commodities. The consequences are devastating, as speculators drive up food prices and plunge millions of people into poverty. But investors care little about the effects of their deals in the real world.
The room in which the world's food is distributed looks everything but appetizing. Bits of paper and disposable cups litter the trading floor at the Chicago Board of Trade (CBOT). Sweaty men in bright yellow, blue or red jackets walk around, seemingly oblivious of the debris beneath their feet, waving their hands, shouting and scrapping over futures contracts for soybeans, pork bellies or wheat.
Here, in the trading room of the world's largest commodity futures exchange, decisions are made about the prices of food -- and, by extension, the fates of millions of people. Those decisions affect both hunger on the planet and the wealth of individual investors.
For Alan Knuckman, there is hardly a nicer place than the CBOT trading floor. "This is capitalism in its purest form," the commodities expert raves. "This is where millionaires are made." The 42-year-old's face shines with a boyish glow -- perhaps because he has never stopped playing.
Knuckman arrived here 27 years ago, and quickly advanced from his first job as a runner in the trading room to a trader. He worked for brokerage firms, soon established his own firm and is now an analyst with Agora Financials, a consulting firm specializing in commodities investments. He also writes a newsletter that offers investment tips. "I trade in anything you can get in and out of quickly," he says candidly. "I'm here to make money."
'I Believe in the Market'
How he makes money doesn't make any difference to Knuckman. He draws no distinctions among commodities like petroleum, silver or food products. "I don't believe in politics," he says. "I believe in the market, and the market is always right."
How does he feel about exploding food prices? For Knuckman, they are purely a reflection of supply and demand. And speculators? They're good for the market, because they predict developments early on. Is there excessive speculation? "I don't see it."
It's a surprising comment. Never before has so much cash flowed into financial transactions involving agricultural commodities. In the last quarter of 2010 alone, the amount of money invested in these commodities tripled compared with the previous quarter. There has been a lot of money in the market since the countries of the world tried to overcome the financial crisis with massive economic stimulus programs and bailout packages.
Agricultural commodities attract investors who are no more interested in grain than they were previously in dot-com companies or subprime mortgages. They range from giant pension funds to small private investors searching for new, safer investment options.
Satisfying the Demand
The large index and agriculture funds now being offered by the banks seem to have come along just at the right time to satisfy this demand. All of a sudden, the world's food supplies have become a tradable commodity, as easy to handle as stocks.
The downside is that food prices are rising in parallel to the ravenous demand for agricultural securities. In March, the Food and Agriculture Organization of the United Nations (FAO) reported new record high prices, which even surpassed the prices during the last major food crisis in 2008. According to the FAO's Food Price Index, overall food costs rose by 39 percent within one year. Grain prices went up by 71 percent, as did prices for cooking oil and fat. The index had reached 234 points in July, only four points below its all-time high in February.
"The age of cheap food is over," predicts Knuckman, noting that this can't be such a bad thing for US citizens. "Most Americans eat too much, anyway."
For his fellow Americans, who spend 13 percent of their disposable income on food, the price hike may be an annoyance. But for the world's poor, who are forced to spend 70 percent of their meager budgets on food, it's life-threatening.
Since last June alone, higher food prices have driven another 44 million people below the poverty line, reports the World Bank. These are people who must survive on less than $1.25 (€0.87) a day. More than a billion people are starving worldwide. The current famine in the Horn of Africa is not only the result of drought, civil war and corrupt officials, but is also caused by prohibitively high food prices.
'Side Effects'
Knuckman refers to the fact that the poorest of the poor can no longer pay for their food as "undesirable side effects of the market." Halima Abubakar, a 25-year-old Kenyan woman, is experiencing these supposed side effects at first hand.
She is sitting in her corrugated metal hut in Kibera, Nairobi's biggest slum, wondering what to put on the table this evening for her husband and their two children. Until now, the Abubakars were among the higher earners in Kibera. The family managed to feed itself adequately with the monthly salary of €150 that Halima's husband earns as a prison guard.
But that has suddenly become difficult. The price of corn meal, the most important food staple in Kenya, is now at a record high after increasing by more than 100 percent in only five months. Potato prices went up by a third, milk is also more expensive, and so are vegetables.
Abubakar doesn't know why this is the case. She only knows that she suddenly has to pay close attention to how she spends the family's meager daily food budget of about 300 shillings (€2.30). Her first step was to switch to a cheaper brand of corn meal. It doesn't taste of much, but at least it fills one's stomach. She sometimes goes without her own lunch so that her children can have enough to eat.
List of Possible Reasons
"More poor people are suffering and more people could become poor because of high and volatile food prices," World Bank President Robert Zoellick said in April, describing the brutal effects of price increases on consumers in developing countries. The problem has many experts deeply concerned. The probable reasons for the price explosions are cited again and again at meetings and conferences. They include:
- Climate change, which leads to droughts, floods and storm, and thus to crop failures;
- The cultivation of biofuels, which takes valuable farmland out of food production;
- The global population, which is growing too fast for agricultural production to keep up;
- The emerging economies China and India, whose citizens are consuming greater quantities of higher quality food;
- The rising price of oil, which makes it more expensive to produce and ship food products;
- The rise in meat consumption, which means that more grain is needed for animal feed;
- Decades of neglecting agriculture, especially in hunger-prone regions.
All of these factors sound logical and plausible, and some undoubtedly contribute to the tense food situation. Yet they are not responsible for the excessive price hikes.
Olivier de Schutter, the United Nations special rapporteur on the right to food, is one of the few who is trying to set the record straight. The production of biofuel and other "supply shocks" -- such as crop failures and export bans -- were "relatively minor catalysts," he wrote recently. "But they set off a giant speculative bubble in a strained and desperate global financial environment." He identifies the true culprits as major investors who, as the financial markets have dried up, have invested heavily in the commodities trade, expanding it beyond all proportion. According to de Schutter, excessive speculation is the primary cause of the price increases. Indeed, closer inspection reveals that the reasons cited to date for the price hikes on food products are somewhat dubious.
Part 2: Every Bubble Needs a Story
Of course, plant-based fuels are increasingly competing with food production, but until now they only made up 6 percent of the global grain harvest. According to the World Bank, biofuels play a much smaller role in price increases than generally assumed. Besides, in June the US Congress voted against further subsidies for biofuel production, a vote that is seen as the beginning of a phase-out.
The same holds true for the new demand for meat in emerging economies. Although meat consumption and, along with it, the demand for feed grain is rising, the Washington-based International Food Policy Research Institute (IFPRI) states that countries like China, India and Indonesia can satisfy their additional demand without significantly increasing meat imports. "We find no evidence that alleged stronger demand by emerging economies had any effect on world prices," a World Bank report concludes.
And climate change? It undoubtedly leads to declines in production. Inventories are shrinking. And yet more food is still being produced than consumed.
It is likely, however, that the hysteria over the supposed food emergency is part of a clever investment strategy. After all, every financial bubble needs a story. In the case of the dot-com bubble, it was the narrative of a "New Economy" that seemed to invalidate the traditional economic rules, not to mention common sense. In the case of the US mortgage bubble, it was the myth of home ownership as a supposedly rock-solid investment. And the story, in the case of the food bubble, is the impending shortage of a product everyone needs: food.
The fact that bread and butter are mutating into an object of speculation for Wall Street has much to do with a fundamental shift in the way the food system works, one which the United Nations Conference on Trade and Development (UNCTAD) describes in a recently published study: the metamorphosis of the food market into a financial market.
Distorted Prices
UNCTAD chief economist Heiner Flassbeck, a former senior official in the German Finance Ministry under then Finance Minister Oskar Lafontaine, has long been concerned about speculation. The walls of his Geneva office, with its view of Lake Geneva, are covered with diagrams, while his latest book on the role of speculators sits on the table.
After the 2008 financial crash, Flassbeck began monitoring changes in the prices of currencies, commodities, government bonds and stocks more closely. When he found that the graphs were noticeably similar, Flassbeck assembled a team to study the phenomenon.
The result of the team's efforts bears the innocuous title: "Price Formation in Financialized Commodity Markets: The Role of Information." But the contents are explosive. The UNCTAD experts conclude that the commodities market isn't functioning properly, or at least not the way a market is supposed to function in economic models, where prices are shaped by supply and demand. But the activities of financial participants, according to the study, "drive commodity prices away from levels justified by market fundamentals."
This leads to massively distorted prices, which are not influenced by real factors but by the expectation that economic developments will improve or worsen.
Most investors involved in the commodities business today have little understanding of the actual products. "Market participants also make trading decisions based on factors that are totally unrelated to the respective commodity, such as portfolio considerations, or they may be following a trend," the UNCTAD report concludes, describing the dangerous herd mentality of investors. According to the report, such behavior has nothing to do with objective pricing.
Gambling with the World's Food
But how did the situation arise that hedge funds and investment banks can now influence the costs of bread in Tunisia, corn meal in Kenya and corn in Mexico? What happened to allow large pension funds and small investors to gamble with the world's food supply? And how did the markets in Chicago, New York and London come to play such a decisive role in determining how many people must go without food?
The fault lies with a significant change in the market that remained virtually unnoticed for several years. The world of high finance made a number of adjustments that turned mankind's staple foods into an object of speculation.
The trade in food commodities was long controlled by the traditional forces of supply and demand. Farmers grew the food that distributors and retailers sold as food products.
A publicly traded futures market developed in the interim. To hedge against price fluctuations, producers sold their harvests in advance at a fixed price, which was usually below the current or spot price. The products were delivered on the maturity date of the futures contract. If the current market price was lower than the futures price, the farmer benefited, and if it was higher, the holder of the futures contract benefited. The sole purpose of these futures transactions was to enable farmers and food processors to hedge their risks. Futures dealers supplied the market with cash, and consumers had access to products at all times.
The players permitted to participate in this market were, for the most part, directly involved in the agricultural industry: farmers, grain processors, warehouse owners, food multinationals. Banks played only a minor role. It was a credit industry of sorts, and it worked well as such. The market remained relatively stable for decades -- until it was discovered by the financial industry.
Change in Regulations
But in order for the financial industry to tap this new business area, market access had to first be expanded. It was strictly regulated, and for good reason. The finance industry's lobbyists got to work, and succeeded in 1999, when the US Commodities Futures Trading Commission substantially deregulated the futures markets. Now banks were permitted to hold large positions in commodities securities.
In 2004, the US Securities and Exchange Commission (SEC) expanded the banks' scope for action when it approved a petition by the investment banks Lehman Brothers, Morgan Stanley, Bear Stearns and JP Morgan to relax equity capital rules. From then on, the financial professionals were able to trade with 40 times as much capital as they held in collateral. Even more play money flowed into the market.
But bets on individual commodities are highly risky, which initially deterred many investors. The banks needed a marketing idea, and Goldman Sachs had one, namely to bundle products together -- an idea that seems suspiciously familiar in the wake of the subprime crisis. Index funds were created that contained a wide range of commodities futures, from oil to wheat. This spreads the risk and enables the funds to obtain a high credit rating, thereby heightening the appeal of the construct for major investors.
The trick is that speculators never convert the futures into real goods. The fund companies sell the contracts, which run for about 70 days, shortly before their maturity dates and use the fresh cash to invest in new futures. The system operates like a perpetual motion machine, with investors never coming into contact with the real market prices.
That's precisely the point, say those who question whether speculators are responsible for rising commodity prices. They argue that the laws of supply and demand remain in force on the real, or spot, market, thereby bringing everything into equilibrium. In their view, whatever happens in the futures markets is irrelevant.
'Vicious Cycle'
This is a fallacy. In reality, futures prices do affect real market prices, as Maximo Torero, director of the IFPRI's Markets, Trade, and Institutions Division has learned. After taking a close look at the markets for corn, soybeans and wheat, he found that, in most cases, real prices followed futures prices. The anticipated future began changing the present.
Another factor is that rising futures prices encourage those who actually do own real goods to hoard their reserves, fueling prices even more.
In this manner, the financial industry's involvement has thrown the once predictable food market completely out of balance. "The boom in new speculative opportunities in global grain, edible oil, and livestock markets has created a vicious cycle," wrote Frederick Kaufman in an April 2011 article for Foreign Policy titled "How Goldman Sachs Created the Food Crisis." His conclusion is equally clear: "The more the price of food commodities increases, the more money pours into the sector, and the higher prices rise."
In fact, the volume of index fund speculation increased by a dizzying 2,300 percent between 2003 and 2008 alone. According to the FAO, today only 2 percent of commodity futures contracts result in the delivery of real goods. Before that happens, 98 percent of contracts are sold by investors who are interested in turning a quick profit -- and who are certainly not interested in getting their hands on 1,000 pork bellies.
Part 3: Number of Speculators Will Continue to Grow
The players include companies like Goldman Sachs. In 2009, the US investment bank earned more than $5 billion in commodities speculation -- more than a third of its net earnings.
"What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets," hedge fund manager Michael Masters conceded in testimony before a US Senate committee addressing the food crisis in 2008.
As long as the market is not regulated, the number of speculators making money at the expense of hungry people will continue to grow, fears UNCTAD economist Flassbeck. The consequences would be devastating. According to the World Bank, an increase of only about 10 percent in worldwide food prices results in another 10 million people slipping below the poverty line. Even though there is enough food, many die of hunger simply because they can no longer afford to pay for it.
"To restore the proper functioning of commodity markets, swift political action is required on a global scale," the UNCTAD study concludes. It calls for increasing transparency in commodities markets and tightening regulations on market participants. The experts believe that it would be helpful for governments to introduce their own commodity reserves, which would enable them to inject these reserves into the market to contain sudden price spikes. They also suggest that the introduction of a transactions tax "could generally slow down financial market activities" and curb speculation.
Dying Quietly
For a time, it seemed as if such proposals stood a chance of being addressed by politicians. The images of protesting North Africans struck fear into the hearts of the powerful. There was talk of "hunger uprisings." But that idea too can now be relegated to the realm of myth.
"One could also call them oil uprisings," says Bettina Engels, an expert in peace and conflict studies at the Otto Suhr Institute of Political Science in Berlin. "The struggle is all about political participation and the redistribution of wealth," she adds. The fact that the middle class, and not the poorest of the poor, has been taking to the streets in Tunis, Cairo and Tripoli, reinforces her argument.
"Hungry people have other things to do than demonstrate," says Ralf Südhoff, head of the Berlin office of the United Nations' World Food Programme. Most, according to Südhoff, are small farmers, people who die quietly and inconspicuously in rural areas.
Still, the subject of food prices has gradually made its way up the political agenda. Even the free-market liberal Guido Westerwelle, Germany's foreign minister and the former leader of the Free Democratic Party, is now sharply criticizing "irresponsible speculation" in food products. "Between 2006 and 2009, millions of men, women and children suffered from hunger, because the sale of dubious financial products caused food prices to explode," Westerwelle said during an event at the German Foreign Ministry in May.
Taming the Market
French President Nicolas Sarkozy says that it is in the "nature of a market" to be regulated, or else it would be a "jungle." Sarkozy, who is chairing both the G-8 (the group of the leading industrialized countries) and the G-20 (the community of the 20 major industrialized and emerging economies) this year, has made the problem a major focus of his presidency.
The subject of rising food prices was also at the center of the conference of G-20 agriculture ministers in Paris on June 22-23. The French president energetically argued for tighter controls on agricultural markets, saying: "An unregulated market is not a market, but simply a lottery in which fortune favors the most cynical."
But the politicians only managed to agree on the introduction of a global Agriculture Market Information System, which will allow governments to share data on commodities. It is intended to make it easier to react more quickly to price increases in wheat, corn, rice and soybeans in the future.
But there is still no concrete regulation of financial transactions involving agricultural products. There is too much resistance to the idea, especially in the United States and Great Britain, which are concerned about the potential impact on the health of their financial markets.
Shifting to Over-the-Counter Trading
Brussels, at least, now intends to revise its guidelines in relation to trading in commodities and commodity derivatives. Lawmakers there want to make such trading more transparent, so that everyone knows who is doing what. They are also considering imposing position limits on speculative contracts, which individual traders would not be permitted to exceed for a given product.
The EU is unlikely to reap much praise for the initiative. While there are no legal restrictions on positions in the commodities trade on European futures markets, such limits have long been the standard in the United States. US regulators are currently discussing the imposition of limits for other commodities, like milk, cotton, coffee and cocoa.
But even then, banks, companies and hedge funds will likely shift their business to the over-the-counter market, conducting their trades directly with one another, without middlemen and well removed from any supervision whatsoever. Already only a fraction of the worldwide trade in derivatives is conducted on the official exchanges.
In light of this dangerously uncontrolled growth, it seems only reasonable to strictly regulate the business. Plans to do so are even in the works in the United States, and yet lobbyists for the financial industry have consistently managed to stall legislation.
Even as politicians have been hesitant to address the question of feeding the world, the business community has been eager to get in on the game.
Looking for Opportunities
In early May, hundreds of attendees crowded into the Waldorf Astoria Hotel in New York to learn about the latest agricultural investment opportunities at the third Global AgInvesting conference. Bankers, brokers, producers, traders, asset managers and large investors were there, as were representatives of the Dallas Police and Fire Pension System and the chief investment officers of elite institutions like New York's Columbia University and George Washington University in Washington, DC.
They all wanted to know how best to use rising food prices to turn a profit. Is it better to invest in farmland in the United States, or perhaps Brazil? Is land for biofuel production cheaper in Africa or South America? And how quickly can investors get out of these investments, if necessary?
Financial investors have little interest in the effects of their investments on the countries involved, or in the social and environmental consequences. The organizers of the AgInvesting conference prudently scheduled a presentation on responsible investing in agriculture at the tail end of the event -- when most attendees were already on their way back to the airport.
Critics refer to investors who buy up agricultural land in other countries as "land robbers." Former FAO Director-General Jacques Diouf berated them as "neo-colonialists." But those being chided in this manner are unaware of any culpability. They see their investment as beneficial, arguing that they are helping to feed the rapidly growing global population.
Land Grabs
Although the world population is not growing as fast as it did in the last 40 years, during which it almost doubled, the projected 30 percent increase in population by the year 2050 means that more than 9 billion people will have to be fed.
Under these circumstances, the land grabs did not look like such a bad idea at first. Even the World Bank initially advocated investments in underdeveloped countries, hoping that everyone would benefit once the infrastructure had been developed and jobs had been created.
But the idea of combining the greed of investors with the fight against hunger as a mutually beneficial business venture has failed miserably.
A conference at the University of Sussex and a study by the World Bank both came up with conclusions that are almost entirely devastating. Researchers describe corrupt elites who have sold off the land of farmers deprived of their rights; job promises that are not being kept; irrigation systems that deprive local residents of water; deforestation, destroyed habitats and monocultures contaminated with pesticides; and forced displacement. According to the World Bank, some 80 million hectares of land have fallen into the hands of foreign investors in the last few years.
Part 4: 'It's the Government's Responsibility to Feed People'
The problem is particularly glaring in Ethiopia, a country whose name is associated with starvation for many people. Even though 5.7 million Ethiopians are dependent on international food aid, the government sells or leases large tracts of fertile land to foreign investors. They, in turn, export most of the food they produce to other countries.
Since 2007, the Ethiopian government has approved 815 foreign-funded agricultural projects. Saudi firms, multinational agricultural companies and British pension funds act as investors. Some 3.6 million hectares of land are up for grabs, much of it in the Gambela region, the proposed site of a national park. Now virgin forest is being cleared to produce food for other countries. Fifty kilometers (31 miles) outside the capital Addis Ababa, Jittu Horticulture, a subsidiary of a Spanish agricultural group, produces 180,000 kilograms (396,000 pounds) of vegetables a week. The produce is exported to the Middle East, supplying multinational oil companies and five-star hotels in Dubai, Qatar, Bahrain and Saudi Arabia.
"We bring foreign currency into the country, enabling the government to buy wheat for the hungry," Dutch manager Jans Brins told the Berlin daily newspaper Tagesspiegel. "It's the government's responsibility to feed people who are unable to buy anything for themselves."
Investing in the Wrong Things
That is precisely the problem: There is enough food, but it's unaffordable for many people. Investors do not believe it is their responsibility to produce affordable food. Their job is to turn a lot of money into even more money. The British hedge fund Emergent Asset Management, for example, expects a 25 percent return on harvest profits and increases in the cost of farmland.
This much profit is normally unattainable with fallow land far from roads and water. Investors are usually drawn to developed areas with fertile soil, where they pursue intensive agricultural methods that tend to exacerbate rather than solve the problem of feeding the world in the long term.
As a result, the harm inflicted on the undernourished people of the world by investors and speculators is not limited to price increases. "It isn't just that the wrong people are investing; they are also investing in the wrong things," says Angelika Hilbeck of the Swiss Federal Institute of Technology Zurich.
Hilbeck, an agricultural ecologist, is one of the authors of the UN's International Assessment of Agricultural Knowledge, Science and Technology for Development. In this unique project, hundreds of scientists commissioned by the World Bank and the UN brought together their knowledge about the future of agriculture and its role in reducing hunger and poverty. The report, published in 2009, was a devastating indictment of industrial agriculture, which, as the study concludes, is responsible in large part for climate change, species extinction, poisoning of the environment, water shortages, disease and poverty.
Calls for Change
Given the threat posed by climate change, the authors call for a radical departure from agricultural mass production, as well as an end to large-scale monocultures and the massive use of pesticides. They argue that this type of agriculture contaminates water and dries up the soil, and that the export-oriented agricultural industry destroys markets in developing countries.
According to the UN assessment, what is needed is a reorientation toward a system of agriculture driven by small farmers who grow their crops at the local level, using both sustainable and environmentally compatible methods. The authors argue that through investment, these farmers must be given access to seeds, infrastructure, knowledge and markets -- and thus the opportunity to feed themselves and others. In their view, this is the only way to preserve the natural basis of feeding human beings and fight world hunger.
But the recommendations have fallen on deaf ears. Government incentives for investment in sustainable agriculture are still rare today. "For far too long, governments have placed the interests of corporations and powerful elites ahead of the needs of the 7 billion people who produce and consume food," says Marita Wiggerthale, an agricultural expert with the development organization Oxfam.
But the dawning of a new food age with an environmental and sustainable orientation, as well as more equitable distribution, remains a distant hope. Economies and politicians continue to emphasize a production model with side effects that are largely responsible for the current crisis in agriculture: intensive industrial farming.
Part of the Problem
There is little sign of the trend reversing itself. Today, the portfolios of established commodity funds represent all the key players in agribusiness. For example, Deutsche Bank's DWS Global Agribusiness Fund and the Allianz RCM Global Resources Fund (which uses the advertising slogan "Promoting Yield Opportunities") invest in such agriculture multinationals as ADM and Bunge, fertilizer makers like the Potash Corporation and Mosaic, seed producers like Monsanto and Syngenta, and major retailers like Tesco, Safeway and Tyson Foods.
In the future, anyone who believes his financial adviser's claims that an investment in such funds helps secure the global food supply should at least be clear about one thing: Such financial investments are part of the problem, not the solution.
