I never got around to finishing what was intended to be a thoughtful commentary on this Harper’s article, but since John posted about this earlier, I’m going to give you all the link, at least. Frederick Kaufman, “The Food Bubble: How Wall Street starved millions and got away with it”:
Agriculture, rooted as it is in the rhythms of reaping and sowing, had not traditionally engaged the attention of Wall Street bankers, whose riches did not come from the sale of real things like wheat or bread but from the manipulation of ethereal concepts like risk and collateralized debt. But in 1991 nearly everything else that could be recast as a financial abstraction had already been considered. Food was pretty much all that was left. And so with accustomed care and precision, Goldman’s analysts went about transforming food into a concept. They selected eighteen commodifiable ingredients and contrived a financial elixir that included cattle, coffee, cocoa, corn, hogs, and a variety or two of wheat. They weighted the investment value of each element, blended and commingled the parts into sums, then reduced what had been a complicated collection of real things into a mathematical formula that could be expressed as a single manifestation, to be known thenceforward as the Goldman Sachs Commodity Index. Then they began to offer shares.
As was usually the case, Goldman’s product flourished. The prices of cattle, coffee, cocoa, corn, and wheat began to rise, slowly at first, and then rapidly. And as more people sank money into Goldman’s food index, other bankers took note and created their own food indexes for their own clients. Investors were delighted to see the value of their venture increase, but the rising price of breakfast, lunch, and dinner did not align with the interests of those of us who eat. And so the commodity index funds began to cause problems.
Wheat was a case in point. North America, the Saudi Arabia of cereal, sends nearly half its wheat production overseas, and an obscure syndicate known as the Minneapolis Grain Exchange remains the supreme price-setter for the continent’s most widely exported wheat, a high-protein variety called hard red spring. Other varieties of wheat make cake and cookies, but only hard red spring makes bread. Its price informs the cost of virtually every loaf on earth.
As far as most people who eat bread were concerned, the Minneapolis Grain Exchange had done a pretty good job: for more than a century the real price of wheat had steadily declined. Then, in 2005, that price began to rise, along with the prices of rice and corn and soy and oats and cooking oil. Hard red spring had long traded between $3 and $6 per sixty-pound bushel, but for three years Minneapolis wheat broke record after record as its price doubled and then doubled again. No one was surprised when in the first quarter of 2008 transnational wheat giant Cargill attributed its 86 percent jump in annual profits to commodity trading. And no one was surprised when packaged-food maker ConAgra sold its trading arm to a hedge fund for $2.8 billion. Nor when The Economist announced that the real price of food had reached its highest level since 1845, the year the magazine first calculated the number.
Nothing had changed about the wheat, but something had changed about the wheat market. Since Goldman’s innovation, hundreds of billions of new dollars had overwhelmed the actual supply of and actual demand for wheat, and rumors began to emerge that someone, somewhere, had cornered the market. Robber barons, gold bugs, and financiers of every stripe had long dreamed of controlling all of something everybody needed or desired, then holding back the supply as demand drove up prices. But there was plenty of real wheat, and American farmers were delivering it as fast as they always had, if not even a bit faster. It was as if the price itself had begun to generate its own demand—the more hard red spring cost, the more investors wanted to pay for it…
By all means, read the whole thing (and if you can spare a few bucks, subscribe to Harpers). Goldman Sachs, and its imitators, are playing with real people’s lives and the global food supply as if those were the markers for their all-important Monopoly money “finance”.
And if anyone wants a few dozen pounds of old Harper’s issues – and wants to pay for the shipping – let me know
Discouragement. That’s all I can feel about this.
For this they get paid?
One of the things I do admire about the Medieval Catholic church was that it had the power to make the rich and powerful perform public penance. It may not have made the rich and powerful behave any better, but I do feel that shame and guilt have a place in enforcing at least the semblance of morality in the high and mighty.
Let them walk to Rome on foot and pay for the building of an almshouse in every city they travel through.
@beltane: Especially if they have to walk all the way from Wall Street.
Yeah, that underwater stretch is a bitch.
@Omnes Omnibus: Since they can’t walk on water, as pope I would grant them permission to paddle a kayak across the Atlantic.
@beltane: How decent of you, your Holiness.
Ugh. This is just so scary and depressing. My husband wonders why I read horror novels, and love truly scary (not just gory) movies. Because real life is much, much worse.
Goldman’s CEO, Lloyd Blankfein, tells us he is doing God’s work.
His God is Sauron.
Well, that’s simply not true. For example, hard red winter wheat is predominately used in bread. Even Wikipedia knows that! And as a citizen of the wheat-growing state of Kansas, and a biologist at the land-grant university in that state, I know it too.
So if that easily verifiable fact is wrong, it makes me very suspicious about the other parts of that article…
There was a similar ‘cornering’ of the market on cocoa not too long ago. It was described as odd and mysterious. Wonder if it really was just another GS scheme–corrupt and manipulative?
Is there anything Goldman doesn’t have its sticky mitts into and thereby destroy? Anything?
Wait a second. Even to my very limited knowledge, agriculture has been noticed by finance since the beginning of time. The term ‘futures’ comes from speculating on coming harvests, doesn’t it? And this isn’t neccessarily this eeeeeeevil practice, either. After all, if Joe farmer can’t afford seed and fertilizer, aren’t futures essentially the organized way that somebody somewhere decides if he’s worth investing in? Finally, though high prices aren’t great news for allof us, they’re at least sort of good news fro farmers. And keep in mind that in the third world, that includes non insubstantial percentages of the population.
@Violet: I think they have so far steered clear of the used K-car futures market, but it’s only a matter of time.
Kdaug, for all that I prefer reading the paper copy, I think that your back issues might not be so desirable to many people because a subscription includes online access to the archives. Still, you might try sites such as Freecycle and Craigslist to see if anyone local can take them off your hands with no shipping hassle.
Centuries from now historians will wonder why we didn’t just shoot them.
eat the rich
Anne, I always enjoy the topics of your post, and what you have to say, but you have a serious problem of over-quoting. There is absolutely no incentive to click through to the link, and each and every six-, seven-, eight-paragraph blockquote you provide is a flagrant violation of copyrights.
I’m not trying to be an ass, but please, respect the work you cite by quoting a reasonable amount and sending us over for the rest. It’s only fair.
My 2 cents. Thanks.
Because they cornered the market on bullets?
That's Master of Accountancy to You, Pal (JMN)
As well you should.
That’s one of the reasons you should be suspicious. Based solely upon what Anne Laurie has excerpted, I smell a piece of crap. However, I don’t plan on paying for a subscription to find out for sure.
The quoted section doesn’t provide any evidence for shenanigans. Maybe it’s in the rest of the article, but not here. The closest it comes is:
And that’s true, but this still doesn’t mean manipulation. There are several things that changed that have absolutely nothing to do with commodities trading. One was cited in the thread on the subject earlier: there is a lot less wheat planted than there used to be. This has several causes, but one of them is the increasing subsidies paid to corn, which causes farmers to grow more corn and less wheat. Another is the increase in extreme weather that has accompanied global warming. Both of these not only will tend to increase price, they will also drive up the volatility of prices, so you get crazier swings, and agriculture was already volatile.
As for the 2005 date, which of these two things do you think is more likely to drive a spike in prices: speculators manipulating the markets, or a 21% drop in wheat production from the previous year? I know which of the two I’d blame first, and it’s not the traders.
There’s a bigger problem with the whole idea of this sort of market manipulation, namely that no one has come up with a plausible way for it to work. Trading wheat contracts, and those of other agricultural products, involve someone taking physical delivery of trainloads of the stuff. In the end, any price manipulation that does not involve taking actual possession of the wheat, has to be short term. Of course, the excerpt says:
That’s not short term. You can’t just buy up contracts and sit on them. You have to remove actual wheat from the supply chain. In order to that, you either have to have huge warehouses of it just sitting around eating up overhead, or you have to destroy it, in which case you don’t have any way to profit off of the higher prices.
As I said, maybe the rest of the article has some indication of how someone was able to make a profit off of manipulating the market. It would sure as hell have to involve something more than Goldman putting together a bunch of different commodities into a basket and trading the basket on an exchange. What we have here is weak.
No, the sales of futures contracts can’t overwhelm the actual supply of wheat. At some point, that wheat needs to be sold if anyone is going to make money, and the supply is what it is.
Aside from the fact that Wall Street rumors aren’t reliable, this sentence indicates that the author doesn’t understand what cornering the market means. I explained it in the other thread, but it’s primarily a way of extracting bogus profits from other traders, not from consumers. It could lead to short term price disruptions as the contracts are repurchased or settled, but all of that wheat will come back on the market pretty soon. If it were something like gold, then I can see how it might work (though not where someone would come up with the capital to do it; trying to corner the smaller silver market laid waste to the Hunt brothers), but not wheat.
American farmers were, but that’s utterly irrelevant. Wheat trades as a global market, and global supply crashed.
And then from Anne Laurie:
The subject of finance brings out the credulity in a lot of people. All anyone has to do is claim that Goldman has screwed us all for everyone to take it as faith. Application of critical thinking goes right out the window. This excerpt indicates that the article is complete bullshit, but only two of the first 15 distinct posters bothered to ask any questions.
Goldman found plenty of real ways to screw people that we don’t have to make them up. Most of them are arcane, and involved making a very small amount of profit on each trade and just doing it a lot of times. Most of the rest involved lying to their own customers, not manipulating prices to screw with the general public. With housing, the general public was overwhelmingly complicit in the acts that drove up house prices by buying them in the first place. None of that is breathlessly exciting, though, I admit.
If I may recommend…A Deal in Wheat, by Frank Norris. Talk about fucking depressing….
Jeez, even the Mortimers fucked up when they tried to corner the orange market.
@That’s Master of Accountancy to You, Pal (JMN): My condolences that you are trying to use the actual realities of supply and demand (that you have to divert, hold, or destroy the supply to drive prices up in the long term) when there is a dead horse to flog.
If I remember right, India and China were having rice shortages and banning exports. Russia had some problems too (this is in 2007-2008 I believe), I wonder if that had anything to do with global grain prices?
@That’s Master of Accountancy to You, Pal (JMN)
Isn’t the whole point of the Goldman index (and similar financially engineered products) that you don’t have to ever take delivery of any real goods? Over at the Goldman website they have a pretty detailed explanation of how they continuously roll over the various futures…
More fundamentally, it seems like the problem with these sorts of commodity index products is that they make commodities as easy to trade as stocks–wheat futures become just another item in your e-trade account. That enables big institutional investors and hedge funds to invest in commodities, making their prices much more volatile. People aren’t buying or selling oil/wheat/porkbellies to cover their supply needs, they’re buying and selling to try and make a quick buck. The problem is that commodity production is too inflexible to respond to weekly or monthly price signals- most crops get planted twice a year at most and don’t come to market for months.
So, the problem is not so much that Goldman is cornering the market or somehow profiting on high prices; the problem is that Goldman has basically set up a casino based on food prices, skimming fees from the players while disrupting farmers’ ability to plan.
Am I missing something here?
I don’t see what’s the problem with trading commodities. After all, they are already traded. As JMN said, in order to do smth with prices long term (as in for more than a few months) you need to do smth to actual wheat. How is this index dramatically different from trading wheat and pork belly futures? CME has been doing that for decades. Goldman does make a commission from creating an index but it’s usually around 1% or less.
That’s pretty much it – there was a great Nova recently about the meltdown and experimental economists who have been doing studies in how people behave in financial bubbles. I think it explains a lot of what happened here – I don’t think Goldman is evil – I think bubble behavior is an unanticipated consequence of turning markets into casinos. The only thing that amazes me is how we keep doing the same damn thing!
That's Master of Accountancy to You, Pal (JMN)
Rolling a contract over simply means that you sell the front month and buy the second month. Typically the position holds the front month, except for a few days before expiration after they’ve rolled over. This isn’t any different than what people, both speculators and hedgers, do with non-indexed futures.
The only real difference of a basket is that it allows you to buy a small amount of a bunch of different commodities rather than having to buy them in huge chunks. Futures contracts are big, typically in the tens or hundreds of thousands of dollars. Breaking them up makes it easier to speculate, but it also makes it easier for a number of hedgers.
By rolling the position over, it means that the basket never holds positions in the spot market. The amount of wheat, or any other product, available for delivery right now is not affected. The actual buying and selling of the commodity is done either in the spot market or when futures that aren’t rolled over mature, requiring delivery.
If there’s no position in the spot market, and no actual wheat being withdrawn from the market, it’s very hard to affect the buying and selling of the actual product. If you have publicly announced that you are going to sell, and the market believes you, it doesn’t think that you’re ever going to take delivery. The GS Commodities basket is contractually required to avoid taking purchase.
It is possible to have a basket that matures but never takes delivery. In fact, there are plenty of them, though I’m only directly familiar with the ones on stock indexes. The thing is, these are cash settled. Rather than requiring delivery, these contracts just involve the two parties (or a market participant and an exchange) transferring cash equal to the difference between the contract price and the spot price. With these, it’s impossible for the contract to affect actual supply. It can’t happen. No matter how many of them trade, the same amount of wheat is going to be available for sale and the same amount of wheat is going to be wanted for purchase.
The entire concept of cornering the market depends upon having the counterparties really, truly believe that you are going to demand delivery. It works in theory because the seller enters into the contract thinking that he isn’t going to have to deliver, or that he can buy on the spot market if he does. It’s only when he realizes that you are going to demand delivery and that there are you, yourself, have so many open contracts that you control the market that it becomes possible to make money through cornering. That’s when you get panic buying, supply dries up, and the counterparty has to come to you and pay whatever you want to buy back the contract so he doesn’t have to deliver. If there’s no possibility of delivery, it can’t work.
In the end, the amount of wheat there actually is is what determines the spot market. The only non-speculators who get squeezed by market manipulation are those who have to buy futures (and not the spot commodity) in a specific expiration during which the market is led to believe that there is going to be a shortage of supply relative to demand, and only during the period that the market believes this. Particularly with grains, it becomes pretty clear what the supply is going to be in advance of the expiration. To make a profit from market manipulation, the speculator’s timing has to be exquisite. This is because he’s going to buy up a bunch of his contracts after the price has started moving up, and he’s going to have to sell a bunch of them after the price has started going back down. Most of the times it’s tried, the manipulator gets whipsawed by his own scheme, and ends up selling for less, on average, than he bought for.
There is some evidence that someone, or someones, tried it with oil a couple of years ago. They tried to take advantage of the start of the recession and some really cheap rates for renting tankers when demand declined, and bought oil and just stored it in the tankers which floated around not going anywhere. They hoped to take advantage of an increase in price. This is a case of a party actually taking delivery and trying to manipulate the amount of supply available.
Unfortunately for them, and fortunately for those of us who like to laugh at people, the evidence suggests that they got absolutely hammered. When you start piecing together the timing, of both the oil market and the tanker rental market, it’s almost impossible for it to have worked. They bought the oil when it was still relatively expensive, and contrary to their expectations, it continued to fall. The likely had to sell it for somewhere between 50% and 75% of what they bought it for, plus the cost of renting the tankers, which while cheap, wasn’t free, and the carrying cost of the oil. No one knows for sure, because if it happened, it wasn’t anyone that had to disclose their trades, and no one went bust holding a bunch of oil. That’s probably what went down, though.
Market manipulation, at least of liquid markets, isn’t as easy as it sounds, even if you’re Goldman. I have a hard time seeing Goldman even wanting to try. One of the things that’s become apparent over the last year, as things unwind and more information comes out, is that Goldman’s reputation as a swashbuckling rogue that took risks in order to make big profits was as much of a fraud as a lot of other things in the last decade. They made money acting as a middleman more than anything else, and just taking a slice of the action without ever holding on to the stuff that was risky.
Where they did manipulate prices, it wasn’t in anything like commodities. It was in the CDO and CDS markets, where things were thinly traded without any publicly available prices. It technically isn’t even “market manipulation.” It’s “setting the bid/ask spread,” except doing so while the person trading with your left hand has no idea what your right hand is trading the other side of the deal at. It’s basically the trading equivalent of forbidding your employees from discussing their salaries, so that no one has any idea what the product (their own labor, in the latter case) is really worth. It’s sleazy. It’s why people who trade in the OTC market with someone that is just a middleman is begging to have their head handed to them. But it’s legal.
And I was wondering why a loaf of bread now costs $3.50.
It’s a good thing CEOs think they can walk on water, then!
Yves Smith in “Econned” does a good job of breaking out what Goldman’s and other hedge fund speculators did to the price of oil in the Spring and Summer of 2008. In that case, an actual demand rise and supply ceiling was taken advantage of to by speculators to drive the price of oil up to near $150.00 a barrel, and again last year, a carry trade of oil drove up the price in expectation of much stronger economic recovery than we actually have had. In both cases those who went long, got burnt.
I also must admit that the artilcle does create some bullshit alarms since food has been a play ground of financial speculation since the mid-19th century. The Chicago Board of Trade invented the futures contract, perhaps the original “derivative,” and it has spun many scams (see the Frank Norris reference in the comments). Goldman may have brought its own brand of evil to the game, but it is not the root of the evil.
I would actualy argue that “cheap food” that this country has had, accept for a brief period from FDR to LBJ, accelerated the destruction of small family farms and the small towns whose economies were based on small farmers, and led to their replacement by large, corporate farms, with some severe environmental side affects along the way. (Read about Nixon’s and Earl Butz’s agricultural policies, and the consequences of creating a boom-bust cycle in agriculture since the 1970s.)
Food and oil costs will probably increase relative to other prices and wages in the coming years. A billion Chinese, Indians, Southeast Asians, South Africans, and Latin Americans rising into middle class status as the world’s population grows to the 9 billion people people will insure greater demand for food and meat. And there will be speculative bubbles and crashes along the way, but the straight lines on the graph touching the peaks and valleys of cycles will likely point up for the next 40 years just based on the demographics.
If you have the wherewithall, the skills, and hopefully the luck, farming might be the one area of America that could be a growth center for the next 30 years. But the essential problem small and middling farmers have had both before the New Deal and since Butz is that that they basically they tend to borrow during the up cycles against the appreciating asset of their crops and farm land. But when the crashes come. those assets, and their cash income, decline while the debts remain (sound familiar?), with the consequenctial foreclosures and liquidation. A further risk that the farmer has of course his that he or she is playing dice with the gods of weather and pests, with the farmer bearing most of that risk, the bank not so much (the bank gets the land and equipment). The New Deal was certainly not economically efficient in that it placed both floors and ceilings on prices (the Government would buy up grain in years of oversupply to support the price and sell grain in years of scaricity to keep the price down), but both farmers and banks had some certainity and it sustained a social structure and a way of life. As Yves Smith points out we have worshipped the god of Economic Efficiency the last thirty years and slaughtered all other values such as stability and equity before it.
It is worth noting that while a remarkable rise in prices occurred across all commodities during 2007-08, these prices reverted back during the latter part of 2008. Recall also that during 2007-08, there was a lot of talk about peak oil, peak steel, etc., along with the increased attention and investment in biofuels. Whatever the positive impacts, increased use of biofuels is sure to increase the price of food over the long term as energy production competes with food production in the agriculture sector.
Having said that, the dramatic spike in commodity prices during 2007-08 was to a large degree due to speculation, as buying simply fed on itself. The thing is, given the opportunity, people are going to speculate. It’s probably more worthwhile to examine what aspects of our financial system encourage market distortions and asset bubbles (e.g., Federal Reserve policies).
@That’s Master of Accountancy to You, Pal (JMN):
Thank you. I’m not usually the credulous type, but this one got me until your comments brought me back to the real world.
@That’s Master of Accountancy to You, Pal (JMN):
You just described a Manipulation Bubble almost perfectly. These guys uncouple the price of the thing from the supply of the thing, and make large piles of money trading the idea of the thing.
It has precious little to do with the realities of Supply & Demand you’re trying to impose on it. That’s why speculation based on these exotic derivative instruments is so dangerous.
Of the Goldman Sachs commodities brokers we may say as Osip Mandelstam said of Stalin: “Each death, a strawberry in his mouth.”
The Kaufman article was excellent and opened a door onto new horrors of empire of which I was not aware before. It was followed by an excellent article about the deplorable state of affairs in Arizona, which I also highly recommend.
But only if they make the kayak themselves. After all, many of these guys probably consider themselves “self-made” men, with all their success attributable solely to their own talent.
@TheNickronomicon: Didn’t read the book, but I did see the movie.
@ThresherK: That’s marvelous. Thanks for the link!
“A Deal in Wheat” is probably a 20 minute read. I’m in the midst of Norris’s novel, The Octopus, right now.
@TheNickronomicon: Yep. You can almost see the language of the cinema growing up with Griffith.
Couple this with a majority of viewers being farmers or one generation removed, and the impact at the time, ~a century ago, is hard to overestimate.
@TheNickronomicon: Yep. You can almost see the language of the cinema growing up with Griffith.
Couple this with a majority of viewers being farmers or living rurally, or at most one generation removed, and the impact at the time, ~a century ago, is hard to overestimate.
Ugh. I thought there was some built-in way to keep me from double-posting.