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Starving and speculating

October 27, 2011

The World Bank and the UN are warning of a new wave of famine. But poor harvests and Western subsidies are not to blame, rather market speculators who are driving the prices of staple foods through the roof.

A villager harvests wheat on the outskirt of Islamabad, Pakistan
The world 'buys' and 'sells' far more wheat than it producesImage: AP

In 2007 and 2008 more than 30 countries faced famine. 115 million people were driven into extreme poverty by exorbitant increases in the prices of staple foods. The cost of rice and grain more than doubled in that period. In the meantime, partly because of the recent recession, prices have normalized.

Even so, the UN and World Bank are sounding the alarm again: Prices for most foodstuffs are now back at 2008 levels.

There are manifold reasons for prices are rising, says Joachim von Braun of the University of Bonn, one of the world's leading agricultural economists and a former head of the International Food Policy Research Institute in Washington.

"There hasn't been enough investment in the agricultural sector; agriculture has been overlooked in international development work; warehouse stock has been reduced; trade barriers have been bolstered; and bio-fuel subsidies have taken a toll," von Braun told Deutsche Welle. "This whole litany underlies the problem, and it all needs to be addressed."

Professor Joachim von Braun
Food expert von Braun says futures trading has Jekyll and Hyde sidesImage: ZEF

If a product becomes scarce, its price rises. Where staple foods are concerned, the consequences of this are particularly pronounced. While the average household in an industrialized country spends an average of 10 to 20 percent of its income on food, that figure is closer to 60 or 80 percent in developing countries.

If the cost of rice and corn doubles, it can price the world's poorest 3 billion people out of the market. Agricultural produce is traded on so-called commodity futures exchanges.

"Two different groups of market traders reside there," von Braun said. "There are those who want to buy grain in order to use or sell it - these are the traditional commercial traders."

Most of these commercial traders operate as go-betweens for the grain producers and companies that process the food.

Two kinds of futures

Producers and purchasers alike have a genuine interest in protecting themselves from future price fluctuations. The grain grower worries about falling prices while the operator of a grain mill is concerned by rising costs. This is why both sides often agree to set rates for future deals - hence the name "futures."

A hand holding grains of corn
A staple food, and a speculator's bread and butterImage: DW-TV

Commercial traders demand a fee from both sides for this service, but promise in return to cover the farmers' losses if prices drop and the purchasers' extra costs if they rise. These commercial futures traders are widely considered to have a stabilizing influence on prices and the market as whole - their work is based on tangible deliveries of the product in question.

The next group of financial investors and speculators, however, is an entirely different kettle of fish. They also deal in futures but have no interest in the physical product. Instead, they are interested in the profits that can be made with a successful "bet" on rising or falling prices. Global banks, insurance firms and other funds have started using the raw materials markets as a speculation playground over the past decade, motivated by the bursting of the "dot-com bubble" and the real-estate market downturn in 2008, which left speculators seeking fresh pastures.

Gambling with a harsh reality

The financial sector often argues that betting on the future cost of a product cannot influence the real price, a contention that Professor von Braun disputes.

"These actors' activities most definitely influence the price-setting processes. That's because they tie up huge amounts of grain and food, thus influencing levels of supply across the marketplace," he said. "Financial investors influence the real market considerably nowadays."

If anything, that's something of an understatement.

According to calculations by UK bank Barclays, the finance sector had invested over $120 billion in securities speculating on rising foodstuff prices by the end of March 2011. These assets increase by between $5 and 10 billion every month.

The NASDAQ 100 Futures trading pit at the Chicago Mercantile Exchange
All the world's grain - and more - is traded at this exchange aloneImage: AP

On the raw materials market in Chicago alone, grain contracts are penned each year whose value exceeds the annual global production of real grain by 800 percent.

Calls for a ban

Considering these figures, it's little wonder that NGOs like Foodwatch have repeatedly appealed for a ban on such trading on food commodities by financial institutions - saying that products like food and energy should be out of bounds for hedge funds and other similar investment models.

That's going a bit too far for Joachim von Braun: "I would appeal for us not to touch the group of commercial traders dealing with food producers and purchasers, because their business helps stabilize the market. However, there should be clear rules to promote transparency and to reduce the financial rewards for the speculation from the second group, index funds, which have absolutely no interest in the product itself."

Deceleration, transparency and financial impediments are the order of the day, in von Braun's view. For instance, the trade would be slowed considerable if speculators were obliged to hang on to their futures deals for a few days; they can currently resell them seconds after purchasing.

The trade could be made more transparent if investors were forced to publish their transactions, perhaps by bringing this form of "sideline" trading back onto the mainstream financial markets, where they would have to be documented.

Plugging loopholes

Von Braun also says that trading, and therefore speculation, would be less financially appealing if investors were required to underwrite their futures deals with more real capital than is currently the case.

A man's hand pulling a wad of euro banknotes out of a wallet
One way to limit speculation would be to make traders back up their deals with real moneyImage: picture-alliance/dpa

"Since the global financial crisis of 2008 and 2009 our banks have become much more strictly regulated," von Braun said. "But the commodity futures markets were largely spared; the loopholes offering high risk and high profits were never properly plugged. That process is just beginning, with the US leading the way."

The Securities and Exchange Commission, which oversees the US financial markets, published a draft document on possible regulation of trade in oil, metals and grain, proposing a limit to the number of contracts traders can pen.

The EU's commissioner for internal markets and services, Michel Barnier, has also put forward a package of laws to reform financial market guidelines. According to this draft, traders on commodity futures markets would have to make their deals public, so regulators would have an easier time intervening and imposing trading limits in times of market volatility.

Author: Rolf Wenkel / msh
Editor: Nancy Isenson