A Digital Magazine by American University's Kogod School of Business
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Does Speculation Really Affect Food Prices?
    Attention shoppers: milk and meat prices are on the rise. Early this year, the UN Food and Agricultural Organization (FAO) issued the final verdict on global food prices for 2013. While meat and dairy prices were sharply higher than the year before, those increases were offset by a steep decline for sugar prices and lower cereal and vegetable oil prices.Over the full year, the FAO’s Food Price Index, a monthly measure of international prices for a basket of food commodities, was down 1.6 percent from 2012.

    Despite the slight decline, global food prices have seen a sharp increase in recent years. FAO says 2013 was marked by the third-highest food prices on record; the first- and second-place finishers were 2011 and 2012, respectively. Average prices more than doubled over the decade from 2003 to 2013.

    “People depend on being able to go to the market and afford that loaf of bread made with grain or that piece of meat that comes from a cow,” said Associate Professor Michel Robe. “Steep price increases and price volatility in these products can cause serious problems around the world.”

    Robe and Assistant Professor Valentina Bruno have been taking a closer look at the reasons behind the rise.

    Speculation in financial markets often is blamed for driving up food prices worldwide, but without irrefutable proof. “[We need] to have a better understanding of what drives prices in this new financial world we are in,” Robe said.

    Robe and Bruno have devoted the past year to researching the question, “Are speculators truly to blame for rising food prices?”

    Put another way, has the “financialization of food” brought added volatility and higher prices to global food markets? Or are there other factors—such as growing demand in China—that are having more pronounced effects?

    The answer has important implications for policy makers, investors, and consumers across the globe.

    AN INFLUX OF “NON-COMMERCIAL” TRADERS

    The “new financial world” Robe referred to is one where global commodities markets, including agricultural futures, saw an influx of new traders starting around 2003.

    In the old days, the futures markets for things like grain, corn, soybeans, and cattle were dominated by commercial interests in the agricultural sector—for example, grain traders—who used futures or option strategies for hedging purposes.

    But early in the 2000s, financial traders came onto the scene in force. Dubbed “noncommercial traders,” these new market participants were primarily hedge funds and index traders. Investing in grain, livestock, and other commodities increasingly was seen as a way to diversify one’s holdings and hedge against risk.

    Then, in the years immediately after these new traders entered the picture, something startling happened: world food prices began to shoot up.

    Between 2003 and 2008, the FAO Food Price Index jumped from 97.7 to 201.4, prompting wide-spread concern that the “financialization of food” was wreaking havoc on global food markets.

    In a March 2009 letter to President Obama, the leaders of 183 organizations working on international development, hunger, and human rights decried the effects on food prices of “excessive speculation in the commodities markets.” The letter stated that a sharp rise in prices for corn and other food commodities between 2007 and 2008 had caused rising levels of hunger among 200 million people in the developing world.

    In their research paper, Robe and Bruno, along with co-author Bahattin Buyuksahin from the Bank of Canada’s research department, take a detailed look at the degree to which financialization has—or has not—contributed to fluctuations in agricultural prices. Their approach was to measure “cross-market linkages” in grain, livestock, and equities markets.

    Based on earlier research, the researchers knew that financialization is generally associated with an increase in “co-movements” among various commodities and between commodity and equity markets.

    If financialization were indeed a factor in food price fluctuations, the researchers expected that they would see some of the same co-movements among agricultural and equities markets. Essentially, the markets would appear to move in tandem.

    Robe, Bruno, and Buyuksahin decided to separate their research into two distinct periods of time:

    1. 2003–2008, the time period preceding the September 2008 bankruptcy of Lehman Brothers;
    2. Late 2008–2011, the post-Lehman period.

    This was necessary due to the onset of the financial crisis in September 2008, which created clear “structural breaks” in the data on equity and food prices. Between 2008 and 2009, for example, FAO’s Food Price Index dropped by 20 percent, while the S&P 500’s 38.5-percent drop during 2008 was the biggest since the Great Depression.

    WHAT DRIVES PRICES?

    The researchers faced a significant challenge in trying to separate fundamental drivers of food prices (such as macroeconomic conditions, drought, flooding, swine flu, oil prices, and more) from the “financial” drivers. In other words, how do you account for the effects of something like Hurricane Irene versus those of the hedge fund speculators on Wall Street?

    As the research got underway in 2012, Robe was on sabbatical at the University of Illinois, which is home base for some of the country’s top experts on agricultural markets. He was able to consult with the Illinois faculty about how to account for weather and other fundamentals affecting grain and livestock prices.

    Using this feedback, he developed proxy measures for the condition of various crops throughout the survey period. Robe even took advantage of a trip to Europe to visit the International Energy Agency in Paris, where he talked to IEA researchers about how to control for conditions in the crude oil market, which has a significant influence on food production and costs.

    A SURPRISING CONCLUSION

    Speculative activity, the researchers found, does not alone affect the extent to which grain markets move in sync with the stock market. Rather, before the financial crisis, financial speculators’ futures positions simply facilitated the transmission of economic shocks into grain markets.
    “What you see is what an economist would call normal: that financial traders transmitted information related to market fundamentals into the paper markets, but they did not per se drive prices,” Robe said.

    In the post-Lehman period, however, this “transmission channel” between financial and paper markers became significantly weaker.

    Furthermore, the researchers found that the role of speculative activity is even less of a factor when it comes to livestock prices. In the livestock case, only macroeconomic conditions affected the correlation of equity and agricultural prices in a statistically significant way.

    In other words, the results suggest that, for grains as well as livestock, the intensity of participation by financial speculators such as hedge funds in paper markets is not the main factor in any co-movements among or between agricultural futures and equity prices.

    “In that sense,” the researchers conclude, “our results cast doubt on the popular claim that the last decade witnessed the ‘financialization of food.’”

    Robe said he would like to be able to use more detailed, private data on trader positions to take another pass at the work. However, he and his colleagues are convinced that the work they have done raises important questions about the extent to which speculation can be blamed for fluctuations in global food prices over the last decade.

    “The bottom line is that the fundamentals do matter,” Bruno said. “The physical conditions in the market are absolutely key to how prices play out.” She added a few words of advice for policy makers seeking to keep food prices in check: “Never lose sight of long-term strategies to increase the stability of the world’s food supply.” KN mark


    The Financialization of Food?,” Valentina G. Bruno, Bahattin Buyuksahin, and Michel Robe, Bank of Canada Working Paper No. 2013-39, has been presented in seminars at several conferences, universities, and governmental organizations.



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