Commentary—

Commodity Speculation: It’s The Bankers Again

 By Ben Lilliston

Public outcry over giant AIG bonuses has members of Congress and the White House falling over themselves to demonstrate their anger at Wall Street abuses. Less publicized, but equally worthy of outrage, is deregulated or unregulated commodity futures trading that contributed to huge price hikes in food and gas prices, and chaos on our country’s farms when the commodities bubble burst.

Commodity speculation by well-known Wall Street players, such as Merrill Lynch, and the lesser known, such as AIG, affected more than US supermarket aisles and gas pumps. In 2008, the world’s hungry increased by an estimated 75 million people, while more than 60 countries experienced riots when food and energy prices shot up.  

Commodities exchanges, such as the Chicago Board of Trade (CBOT), are perhaps the least regulated of all financial markets. Traditionally, trading in agriculture commodities has been tied to real world supply and demand, and has been used by grain traders and county elevators to manage price risks.  

But a series of deregulatory changes by Congress and the Securities and Exchange Commission (SEC) over the last ten years opened the door for well-heeled players. They entered these markets and transformed how commodity exchanges had historically worked. Instead of managing price risks, these speculators, who don’t use or trade actual agriculture or energy commodities, were out to drive prices up and profit from their investment.  

A decision in 2000 allowed companies like Goldman Sachs to enter commodity markets and buy and sell without limits. Then in 2004, Henry Paulson, the chief executive officer at Goldman Sachs and later Treasury Secretary, successfully petitioned the SEC to exempt the big banks — Lehman Brothers, Morgan Stanley, Bear Stearns and J.P. Morgan — from keeping large enough money reserves to cover their trades. Soon after, these big name banks released billions of dollars of their reserves onto commodity markets for speculation.  

The financial giants then set up and bet hundreds of billions of dollars on commodity index funds that undermined traditional price risk management tools, such as those used by country grain elevators. For example, the most-traded index fund, set up by Goldman Sachs/Standard & Poor’s, bundled together up to 24 commodities, including agriculture, oil and gold. That fund rose 238 percent from 2003 to 2007. From 2003 to July 2008, money invested in commodities index funds increased from $13 billion to $317 billion.  

The commodity bubble acted much like the housing bubble. Suddenly in 2007 through mid-2008, prices for agricultural commodities like corn, soybeans and wheat shot up. Though not entirely attributable to speculation, from 2006 to 2007 corn prices were up 50 percent, soybean prices 60 percent and wheat prices 50 percent. A marketing consultant estimated in 2008 that approximately 31 percent of the CBOT price of corn was due to financial speculation — having nothing to do with supply and demand. The UN’s Food and Agriculture Organization estimates that price volatility for corn was 30 percent, soybeans 40 percent and wheat 60 percent beyond what could be accounted for by supply and demand.  

While companies like Cargill and Archer Daniels Midland saw their profits skyrocket, farmers struggled because their costs for fuel, fertilizer, seed and equipment also rose. Researchers from Tufts University found that for midsized farmers, increases in costs wiped out gains from farm sales.

The spike in oil prices mirrored agricultural commodities and high gas prices sent shockwaves throughout our economy. In January, 60 Minutes documented how the price of oil shot up $25 a barrel in one day — without any change in physical supply and demand.  

Fortunately, not all of Congress is ignoring the damage caused by excessive speculation in commodity markets. Representative Collin Peterson (D-Minn.), the Chair of the House Agriculture Committee, has introduced legislation to limit how much speculators can trade, require greater reporting of private contracts, and demand separate agriculture and nonagricultural trading data. Peterson’s efforts for tougher regulation are stalled in a current fight with the House Banking Committee over who has jurisdiction over commodity exchanges.

If we want to prevent the type of runaway speculation that drives up prices at the supermarket or at the gas pump, we need to focus some of our AIG outrage toward policy change and strengthen regulation of commodity exchanges.  

(Ben Lilliston is the communications director at the Minneapolis-based Institute for Agriculture and Trade Policy.)