Goldman Sachs and all the other nasty speculators made a fortune out of starving people.
There are so many things wrong with this it’s unbelievable.
Then, through the 1990s, Goldman Sachs and others lobbied hard and the regulations were abolished. Suddenly, these contracts were turned into “derivatives” that could be bought and sold among traders who had nothing to do with agriculture. A market in “food speculation” was born.
No, you never did have to prove that you were either a farmer or a baker in order to trade in wheat futures. The whole point of any form of futures market (which in itself is a derivative) is to allow speculators, those not directly involved in the market, to buy and sell. For it is they that take the risk off the shoulders of the farmer or the baker.
But much, much, worse is that he’s got the entire process of speculation wrong.
At the end of 2006, food prices across the world started to rise, suddenly and stratospherically. Within a year, the price of wheat had shot up by 80 per cent, maize by 90 per cent, rice by 320 per cent. In a global jolt of hunger, 200 million people – mostly children – couldn’t afford to get food any more, and sank into malnutrition or starvation. There were riots in more than 30 countries, and at least one government was violently overthrown. Then, in spring 2008, prices just as mysteriously fell back to their previous level.
Let’s agree that this is what happened.
Now, let us also consider what we would like to have happen.
Back in 2006 there were concerns that biofuels were going to take a huge chunk out of the market: what could feed people was going to fuel cars. Thus food in the future was going to be in short supply. Let us stick with wheat.
What we want is some method of reducing the future demand for wheat while also increasing the amount of wheat that will be planted. We want both consumers and producers to react rationally to this mooted future shortage. We want consumers to substitute for wheat: eat rice, cassava, teff, rye, oats, instead. We want producers to change their production processes: it’s a standard of farming that you can go for extensive or intensive methods and there’s a spectrum between them. You can add a little more fertiliser for example, but you’ll only do so if the rise in price is great enough for the marginal production to cover the cost of your marginal fertiliser use. And of course we’re all making predictions, something which is difficult about the future.
What might we use as a transmission method for this message? Use less wheat and grow more please because it’s going to be much more expensive in a year or two?
Well, actually, what we did use to do this is the futures market. The price of wheat for delivery later that year, for delivery next year, went up as all those speculators saw an opportunity to make a profit. Even the price of wheat now went up as people saw that you could buy now, store, and then sell when the price had risen (so both spot and futures markets contributed to the price rise). They could give a shit about the starving and less than two shits for for the farmers’ profits of course. But their very actions, piling into wheat futures, sent the message humming along the wires that wheat’s gonna be in short supply soon and it’s gonna get more expensive!
And what was the result of this message? Yes, demand fell and supply rose:
Most of the explanations we were given at the time have turned out to be false. It didn’t happen because supply fell: the International Grain Council says global production of wheat actually increased during that period, for example. It isn’t because demand grew either: as Professor Jayati Ghosh of the Centre for Economic Studies in New Delhi has shown, demand actually fell by 3 per cent.
Riiiight, we’ve got our higher prices leading to lower demand, good. Oh, and supply rose did it? That’s the other thing we’re looking for, isn’t it? Excellent. So, our filthy, lucre seeking, bastard speculators have actually managed, purely through the application of their own greed, to do exactly what we wanted to happen.
They’ve reduced demand, increased supply and thus solved the looming shortage of wheat.
We should also remember something else. Derivatives markets (futures, options etc) are by definition zero sum for the speculators in them. For every £ that Goldman Sachs made in that market, someone else lost a £.
This doesn’t apply to the system as a whole though: the transfer of risk from farmer and baker to the speculators is of value, as are the price signals that the system as a whole produces. But for the speculators within it, it’s zero sum. So, just as many people have lost money (or rather the amount of money lost is the same as the money made) as made it in bringing us these two useful things: risk transfer and price information, a prediction about the future.
Now the thing is there’s no mystery to any of this at all. It’s laid out (in his usual exhaustive manner) in page after page of Adam Smith’s Wealth of Nations. Here in fact.
The interest of the inland dealer, and that of the great body of the people, how opposite soever they may at first sight appear, are, even in years of the greatest scarcity, exactly the same. It is his interest to raise the price of his corn as high as the real scarcity of the season requires, and it can never be his interest to raise it higher. By raising the price he discourages the consumption, and puts everybody more or less, but particularly the inferior ranks of people, upon thrift and good management. If, by raising it too high, he discourages the consumption so much that the supply of the season is likely to go beyond the consumption of the season, and to last for some time after the next crop begins to come in, he runs the hazard, not only of losing a considerable part of his corn by natural causes, but of being obliged to sell what remains of it for much less than what he might have had for it several months before. If by not raising the price high enough he discourages the consumption so little that the supply of the season is likely to fall short of the consumption of the season, he not only loses a part of the profit which he might otherwise have made, but he exposes the people to suffer before the end of the season, instead of the hardships of a dearth, the dreadful horrors of a famine. It is the interest of the people that their daily, weekly, and monthly consumption should be proportioned as exactly as possible to the supply of the season. The interest of the inland corn dealer is the same. By supplying them, as nearly as he can judge, in this proportion, he is likely to sell all his corn for the highest price, and with the greatest profit; and his knowledge of the state of the crop, and of his daily, weekly, and monthly sales, enable*70 him to judge, with more or less accuracy, how far they really are supplied in this manner. Without intending the interest of the people, he is necessarily led, by a regard to his own interest, to treat them, even in years of scarcity, pretty much in the same manner as the prudent master of a vessel is sometimes obliged to treat his crew. When he foresees that provisions are likely to run short, he puts them upon short allowance. Though from excess of caution he should sometimes do this without any real necessity, yet all the inconveniences which his crew can thereby suffer are inconsiderable in comparison of the danger, misery, and ruin to which they might sometimes be exposed by a less provident conduct. Though from excess of avarice, in the same manner, the inland corn merchant should sometimes raise the price of his corn somewhat higher than the scarcity of the season requires, yet all the inconveniences which the people can suffer from this conduct, which effectually secures them from a famine in the end of the season, are inconsiderable in comparison of what they might have been exposed to by a more liberal way of dealing in the beginning of it. The corn merchant himself is likely to suffer the most by this excess of avarice; not only from the indignation which it generally excites against him, but, though he should escape the effects of this indignation, from the quantity of corn which it necessarily leaves upon his hands in the end of the season, and which, if the next season happens to prove favourable, he must always sell for a much lower price than he might otherwise have had.
What Hari has got wrong, because he doesn’t understand even the most basic points about economics, is that this greed for profit produces exactly the outcome we desire. The high prices which would accompany the coming shortage are brought forward in time and thus influence both consumption and production now and into the future. Meaning that the highly undesired famine doesn’t happen as consumption falls and production rises.
Or, in short, futures allow speculation upon the future: which is why we have them, for speculation upon the future allows us to sidestep the very things which we do not desire to happen in that future.
Now, of course, you could design an alternative method of doing this. The wise, omniscient and altruistic politicians and bureaucrats could send a fax to all farmers telling them to plant more. Signs could appear in every breadshop telling us all to eat our crusts.
Except, of course, those wise, omniscient and altruistic politicians and bureaucrats are precisely the fuckers that got us into the mess in the first place by insisting that we should put wheat into cars rather than people.