SPECULATORS are never popular. We associate such people with naked greed. They profit from our misery. No one wants to be known as a speculator.
An alternative word is investor or risk manager. To be an investor is to have confidence in the future. To be a risk manager is to be prudent and wary.
These two words can be two faces of the same activity. When I buy life insurance, I am managing risk. I don’t often think about how the insurance company that sells me the policy is speculating on the chances of my death, even though they are.
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Farmers invest in the future with every spring planting. They manage their risk by pre-selling their crop. Investors purchase those contracts for future delivery because they are speculating that the price will be higher on the delivery date than the price they have paid ahead of time.
For this market to work properly, farmers need investors prepared to speculate and investors need farmers prepared to speculate too. When the environment stays stable, this market works, and adds to the stability overall.
The market for managing risk in food commodities has started to become dysfunctional. The futures market for wheat on the Chicago Board of Trade is twice as volatile in 2008 as it was in 2007. How volatile is that? Well, that’s six times as volatile as the price of gold or the Dow Jones Industrial Average.
What is the explanation? Some people blame the drought in Australia or the low level of wheat stocks worldwide. After all, world wheat consumption has exceeded production in six of the last eight years.
Some blame a general increased demand from China and some blame a spill over effect of tight rice supplies and transferred demand. Some even blame increased ethanol use since 30 percent of the U.S. corn crop is now going to ethanol production and farmers are switching out of wheat and into corn.
Probably all of these factors contribute but drought and changes to supply and demand are factors we have seen before and they haven’t had this level of impact.
One new feature is the dramatic increase in investments made by Wall Street pension and hedge funds. According to the New York Times, as much as $300 billion of new money has been invested in these speculative plays. Although the Chicago Board of Trade has offered futures contracts since 1959, only recently have they also offered options on those contracts.
Where have we seen this before? In 1971, when president Richard Nixon took the American dollar off the gold standard, a market was created for foreign exchange. Such a market always existed but the volatility was low since most currencies were related officially or unofficially to the American dollar and it was pegged to the price of gold at $35 per ounce.
The market was considered so insignificant that the Swiss based Bank of International Settlements didn’t start measuring it until the 1980s, and then only on an experimental basis. That same institution now estimates that market to handle more than $3 trillion daily. The danger of this market is that it is bigger than all of its regulatory bodies. When the market was only a third of its current size it was already larger than all of the reserves of all of the central banks of all of the industrialized nations put together.
There is not yet a consensus on the causes of increased volatility in the commodities markets, but, if I had to speculate (!) I’d say the unregulated increase in speculative investments has destabilized longstanding relationships between producers and consumers, increased costs to farmers and increased risks to us all.
Christopher Lind has published widely in the area of ethics and economics. He is a Senior Fellow at Massey College, University of Toronto.
