Gambling on food prices was a driver of the 2007-08 crisis and it’s time to take action against this practice, says Julian Oram.

Julian Oram

I don’t consider myself to be an especially intuitive person and I’m pretty sure I’d make a lousy detective. But a few years ago something happened on an international scale which roused my suspicions: the price of food was rising fast.
Between January 2007 and June 2008, maize prices shot up by 74%, wheat prices by 124%, and rice by 224%. In Britain, this led to grumblings about the rising cost of a loaf of bread. But across Asia, Africa and Latin America, riots erupted as the price of basic foodstuffs became unaffordable to poor households and millions went hungry. It was, without doubt, a major world crisis.

On the surface, there was a convincing ‘perfect storm’ of circumstances behind the rising costs: a combination of poor wheat harvests in Australia, rising demand or bio-fuels, high oil prices, changing farming conditions in the face of global climate change, and a surge in demand for grains from India and China.

But what bugged me was that the sudden and dramatic nature of the price rises just didn’t seem explicable by these factors. As I searched for clues, I picked up on a theory that the spike in food prices had as much to do with financial markets as it did with  food markets.

The big bang theory

The theory goes something like this. Since around 2000, deregulation in the US and Europe along with changes in the financial services industry had greatly expanded the role of banks in trading in commodity ‘derivatives’. 

Commodity derivatives were invented over a hundred years ago in the US to provide a means of risk protection for farmers and food buyers. Producers could take out a contract to sell their crops in the future for a pre-arranged price. For decades, regulations had been in place which ensured that the trade in these ‘futures’ contracts were largely the preserve of those involved in trading physical commodities.

But since 2000, commodity derivatives had become increasingly popular as an ‘asset class’ for investment banks and hedge funds, who were now treated by regulators as no different to farmers or flour millers. In the early part of the last decade, the number of commodity-based index funds as well as ‘over the counter’ (bank-to-bank) swaps in commodity futures jumped dramatically; to the extent that financial speculators became the dominant presence in these markets.

The problem was that commodity markets are relatively small beer in global financial markets terms, say, in comparison to stock markets. As the US sub-prime mortgage market began to unravel in late 2006 and early 2007, banks began to redirect large amounts of capital into the relatively safe haven of commodity futures. Because of the vast amounts of money flooding into these markets, demand for futures contracts soared, leading to massive inflationary pressure on both the future and immediate ‘spot’ price of commodities, including food and oil (PDF).

But in summer 2008, with the jury still out on this theory as the finger was pointed at other factors such as biofuels, the credit crunch suddenly hit the world’s richest countries. Food and oil prices nosedived. For the global media, the issue of food prices and hunger suddenly ceased to matter. Now it was serious. Now it was about money.

But in much of the developing world, the impacts of the food crisis continued to hit the poorest people again and again like the aftershocks of an earthquake. In 2009, the UN Food and Agriculture Organisation reported that the number of chronically hungry people globally had crossed the inauspicious 1 billion mark.

For a number food economists, activists and market analysts the issue was by no means put to bed. It became like an unsolved crime.

On the case

One of the principal investigators on the case has been the Indian economist Professor Jayati Ghosh. She examined the evidence and concluded that financial speculation was indeed one of the main culprits for the 2007-08 food crisis.

Her arguments are varied, but for me two key things stand out. First, that activity in the over-the-counter commodity derivatives market in the period from late 2006 to mid 2007 went into overdrive, corresponding almost exactly with the price in food prices. Second, that none of the explanatory factors put forward by those arguing that the 2007-08 crisis was down to the ‘fundamentals’ of supply and demand can account for the dramatic peaks and troughs of food price movements over recent years, and in particular for the price crash in the late summer of 2008.

Since 2008, studies by various international institutions, academics, hedge fund managers (PDF) and former commodity traders (PDF) have all identified financial speculation on food commodities as causal factor in the increased cost and volatility of food prices. Gary Gensler, the head of the US Commodities Futures Trading Commission (CFTC), and Commissioner Michel Barnier, the head of the European Union’s Directorate for Internal Markets, have reached the same conclusion. So too has Olivier de Shutter, the UN’s own Special Rapporteur on the right to food, in his briefing note of September 2010 (PDF).

Although there are those who still dispute this, I believe the weight of evidence now sits firmly on the side of those who would declare the financial services industry as guilty as charged.

The path to progress

A verdict needs a court and judge, and in the real world this means a political opportunity and a government willing to take action. In the US, the recent Dodd-Frank ‘Wall Street Reform’ Act has introduced strong laws making commodity derivatives trading more transparent, and limiting the role of purely financial speculators.

Meanwhile, Commissioner Barnier has instigated a review of the main EU regulatory instrument government commodity derivatives, the Markets in Financial Instruments Directive (MiFID). These reforms have the potential to toughen up Europe’s regulatory oversight of the commodity speculators and harmonise the rules here with those in the US legislation. The French government are strongly backing this, and the German Chancellor Angela Merkel is also onside.

Less clear is the UK government’s commitment to tackling the issue. Correspondence sent to the World Development Movement from government ministers and the Financial Services Authority has indicated a lack of concern over the role of financial speculation in increasing volatility and level of food prices. With the City of London keen to maintain the status quo, Britain has thus far adopted a resistant stance on most areas of potential new financial regulation across Europe, including derivatives.

Which is where we come in. Over the coming months, the World Development Movement will be campaigning hard in the UK to ensure that the voices of millions of ordinary people who suffer from food price inflation – and particularly those living in chronic food insecurity in the global south – are heard louder by our government than those from the City of London. By taking action with us to support new regulations in the UK and Europe, we can help make gambling on hunger what it should be: a genuine crime.

About Julian Oram

Dr Julian Oram is Head of Policy and Campaigns at the World Development Movement and leads their advocacy work on global justice issues, including food commodity speculation. Prior to this role, Julian was head of the trade and corporate team at ActionAid, specialising on international trade, food rights and corporate accountability. Julian previously headed the ‘transforming markets’ programme at the New Economics Foundation, and developed practical proposals for delivering a more sustainable economic system. Before that he led a research programme on globalisation and food security at the International Famine Centre, in Ireland. Julian has a doctorate in Geography from University College Cork, and has lived and worked in the UK, Ireland, the Philippines and the US.

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