Something seems wrong with this story. I understand how speculation can push the price up but if the price goes too far above the true value for too long there has to be a drop - the bubble needs to burst at some point. Has there been a drop in price since this article came out? Have farmers adjusted to grow unusual amounts of wheat? Are there parties to the events who have been shielded (bailed out) from any downturns?
There's a lot wrong with this story. I'm amazed that most people here are just eating it up. Compare to the reaction to science news: if an article claims that X causes Y but the data only shows a correlation but not causation, people will always point it out. Why not be a little more critical here too?
For instance, how do we know the commodity index prices caused an increase in the price of the actual commodities, or if something else caused the price increase and the commodity index price was merely reflecting it?
Other things the article gets wrong or doesn't explain:
* the Goldman Sachs Commodity Index is just an index (and it's not even owned by GS anymore, it's owned by S&P). It's not a fund. There are funds that track it, but just
creating an index doesn't do much to the market.
* he says that bankers started making financial products out of food products in the early 1990s, only to contradict (and correct) himself later but without explaining that contradiction.
* "the bankers had figured out how to extract profit from the commodities market without taking on any of the risks they themselves had introduced by flooding that same market with long orders". This is exactly what every mutual fund manager does, whether it's stocks or commodities. There's nothing new here. The fund manager will only flood the market with orders to the extent that his clients are putting money into the fund.
* "By the time the normal buying season began, drought had hit Australia, floods had inundated northern Europe, and a vogue for biofuels had enticed U.S. farmers to grow less wheat and more corn". How in the world does that support the claim in the title? Droughts and floods decrease the supply, prices go up.
I'll stop here, but there's more data about this in the Economist:
Goldman and other banks profited because they were selling the financial products, not buying them. The sellers always make money.
Investors who bought the Goldman products did eventually lose money, however not soon enough to stop millions of people from starving.
For me, the takeaway here is that tremendous wealth and power inequality creates conditions where the stupidity and inattention of a wealthy elite can easily cause the starvation, death, and suffering of the people they financially dominate.
This story has repeated over and over throughout history. Usually, it happens when a powerful person like a King or Emperor behaves irresponsibly and causes terrible suffering.
I'm reminded of Nero watching Rome burn or Stalin starving the Ukrainians.
Concentrating power and wealth in the hands of the few is a bad idea because their slightest indiscretion causes mass suffering.
According to the article, the bubble did indeed burst:
> Then, like all speculative bubbles, the food bubble popped. By late 2008, the price of Minneapolis hard red spring had toppled back to normal levels, and trading volume quickly followed. Of course, the prices world consumers pay for food have not come down so fast, as manufacturers and retailers continue to make up for their own heavy losses.
The same people who always take the losses - speculators. Some of them are the same people who bid the market up; some of them are people who foolishly bought at the top.
Speaking as a farmer, these are the prices required to remain profitable. I'm sure it wasn't covered here, but prior to 2008 we were seeing numerous farmer protests against the destabilization of our food sector. And then, all of a sudden, the prices rose. Maybe it was purely coincidence with investor actions, but I have always felt it was something else.
Though it raises some interesting ethical questions. Is it better to have the farmer subsidize the poor by not turning a profit, or is it better to have the farmer turn a profit (the goal of the business) at the cost of starvation of others?
At some point the farmers have to turn a profit. Maybe not every year, but most years. Otherwise some percentage of farmers will get out of the business and do something else. The price will rise until it becomes profitable.
Over the last few decades the real problem has been food is too cheap. First world governments are subsidizing food production to the point that a farmer trying to grow rice in southeast Asia can't compete with imported rice shipped from California. So that farmer moves to the city and gets a job making Nikes.
When there's some disruption in food production thousands of miles away all of the sudden people are starving because everybody is making shoes instead of growing food.
Good point, and of course there are the government farm subsidies too, which could go to the poor instead if the farmers were profitable, certainly here in Europe the subsidies have not necessarily achieved the right goals, as there is still extensive poverty in agriculture. There are also buy side issues, such as concentration of buyers. And in the UK I see farm land prices are rising fast, which will reduce much of the potential profitability long term.
The key seems to be the way in which the accumulated long positions were periodically rolled over, but the article doesn't seem to explain how this was done.
capnrefsmmat covered the bursting of the bubble, but the positions were rolled over simply by converting the futures to their equivalent holdings in actual wheat, selling the rights to that wheat for the actual spot price, and using the proceeds to buy more futures for the next term.
This doesn't actually protect the buyer. Rather, the buyer was protected (for a while) by the continuing influx of new capital into commodity indices which led to a continuing rise in prices -- in other words, it was effectively a distributed Ponzi scheme.
I think I understand. The profit is determined by how much the spot price has increased during the term, since the futures are bought for the spot price at the beginning of the term and sold for the spot price at the end. Put that way, this looks much more like all the other bubbles we've read about.
I get the feeling that there's really only one bubble, but it moves from one sector of the economy to the next, leaving destruction in its wake, kind of like Bugs Bunny used to tear up the ground as he burrowed through it.
Given Ponzi schemes tend to end in prosecution,(this is probably a forlorn hope) could we eventually see prosecutions for this sort of behaviour? Or maybe as a next best investors slowly beginning to realise that these odd price spikes keep ending with a few investment banks winning and all else losing?
