The Commodities Bubble

Sameer Dossani, Foreign Policy in Focus - June 28, 2008

Editor: Emily Schwartz Greco

For those following economic trends, the past 18 months are notable primarily for two reasons. First, the U.S. housing market, long seen as overvalued by alternative economists and even powerful economic institutions including the International Monetary Fund (IMF), finally went from boom to bust. Over the span of a few months, housing in some markets depreciated by as much as 30%, and some economists estimate that losses may ultimately reduce value by as much as 50% in some cities.

Second, the market for commodities, especially food and oil has been growing at an alarming rate. While the per-barrel price of crude oil has been rising since about 2005, the upsurge in food prices has been even more rapid. Rice, the world’s largest staple crop, has more than doubled in value since January of this year alone, with wheat prices not far behind.

Economists are citing many reasons for the upsurge in grain prices, including increased demand in developing countries, especially India and China, as well as poor harvest due to adverse weather conditions in some places.

While changing consumption and production patterns due to things like global warming and the wasteful consumption patterns (particularly in the developed world) may be a worry, in most of the world grain stores are still more than sufficient to handle these fluctuations. With the exception of East Africa, where there are genuine shortages and a genuine danger of famine, the rise in global food prices can’t be explained solely in terms of supply and demand.

Economists also agree that speculation is playing a role in pushing up global food prices. They argue that many investors are engaging in hoarding or other kinds of speculation, anticipating that they will receive bigger returns on their investments in the future than what they could make now. According to this mainstream argument, speculation is a secondary or less important reason for the price boom, with supply and demand factors and rising fuel costs being the primary factors.

While the story of rising food costs is no doubt a complicated one, the sudden rise of commodities prices and the simultaneous collapse in many financial markets is unlikely to be a coincidence.

Markets in Crisis

While many economists maintain that speculation can be a way to increase demand to keep markets flexible, the global economy depends on speculation to a dangerous extent. In the past two decades, we have seen two examples of that dependence on speculation crashing around us, first with the “dot com bubble” of the 1990s and more recently with the housing bubble.

In each of these cases, speculation bred more speculation as investors sought to cash in on seemingly endless growth – until the bubble burst and they dumped their holdings. In the case of the housing bubble, deregulation meant that mortgages could be broken up, sold and resold to small and large companies, making it difficult for investors to track sound loans from unsound loans.

In this case, some of the worst disasters could have been averted or at least detected earlier if analysts had been interested in asking the right questions. Those who did ask those questions, including many progressive economists, were ignored. As Chuck Prince, head of Citigroup at the time, famously stated, “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance.”

That’s a deeply troubling attitude. The willingness of investors and companies to go along with speculative bubbles and the prevalence of a huge amount of speculative capital in the global economy generally may have grave implications. These conditions suggest that the bubbles may not be the disease in themselves, but the symptoms of something much deeper. The market may be so based on speculation, and speculative investors have such a tendency to “herd” together, that we are in a chronic bubble economy. The economic bubble of the day may change – “emerging markets” bonds one day, tech stocks the next, and home mortgages the day after that – but the presence of a bubble may be ubiquitous.

Using this hypothesis, the food crisis becomes a little easier to understand. Commodities, including food, are seen as relatively safe investments. One can imagine situations where most of the world’s population stop buying houses or computers, but it’s hard to stop buying food. The World Bank and the IMF have pushed for the deregulation of trade in agriculture, and therefore it is much easier today for the private sector to invest in a global food market. Once big investors and analysts begin to act as though food commodities are a safe bet, the herd mentality kicks in, more and more investors join the fray and eventually you have an over-inflated food market in the same way as you had an over-inflated mortgage market.

The Real and the Imagined Food Crises

So to what extent can we blame the current state of affairs on a chronic and collective bubble of the financial markets? While speculation has almost certainly been underplayed by mainstream analysts, it’s far from the whole story.

The so-called demand side arguments for increases in food prices – that consumption, especially consumption of meat and dairy has gone up in China and India – ignore a crucial point. While it’s true that changes, sometimes significant changes, have occurred in the diets of the middle class of both of those countries, the middle class constitutes a small minority in each country. Other segments of the population, especially in India, often consume less than they have historically and suffer from chronic malnutrition. According to the Indian economist Jayati Ghosh, both China’s and India’s per capita grain consumption have been more or less constant for the last 20 years. With this in mind, it seems unlikely that the dramatic rise in prices has anything to do with increased demand.

There are other factors not directly related to speculation that have no doubt played a role. For developing countries, these factors include IMF policy “advice” to reduce or eliminate grain reserves, the elimination of tariffs on food coming from Europe and the United States and the removal of subsidies for fertilizer and other agricultural inputs, and at the behest of the IMF and World Bank.

Since about 1980, international financial institutions have attempted to eliminate the mechanisms whereby governments can control food supplies. In their absence, national and international private companies have stepped in and have been dictating food policy in the interests of their profit margins. In times of stress, the mechanisms whereby governments could protect their citizens from the impacts of fluctuating prices often no longer exist.

While this analysis is absolutely correct and the IFIs do deserve their share of the blame for the current crisis in that they have limited the possibility of remedial measures, the analysis does not satisfactorily account for the sharp increase in food prices in such a short time. The liberalization measures of the IMF and World Bank have been applied since about 1980, and for much of this period the only visible effect has been a decrease in global commodity prices, including food prices.

Other real factors, especially the rise in oil prices and related rises in transportation and fertilizer costs, have certainly played a role in the spike in food prices. But these increases to the cost of some inputs cannot account for the whole picture.

Beyond the Bubble: Reforming Global Agriculture

Though speculation may be the main driving factor behind the current surge in prices, all was not well prior to the current crisis. Since about 1960, global food production has been transformed from a primarily local activity, albeit with the import and export of luxury foods, to a primarily global business. International trade rules reward those who produce their goods for export over those who produce for local consumption. Though farmers in British Colombia and California both grow tomatoes in the summer, it is more profitable for them to ship those tomatoes over the border than to sell them domestically. Aside from the obvious ludicrousness of the situation, the increased transportation costs of shipping goods by truck across vast distances adds even more expense.

In Asia, Latin America, North America and some parts of Europe, small farmers are becoming increasingly rare. The industrialization of agriculture through monocropping and over reliance on chemical fertilizer and pesticides has effectively created economies of scale such that it is almost impossible for small farmers to succeed. Genetic modification of seeds adds yet another layer to that industrialization, ensuring that large agribusiness companies including Monsanto, Archer Daniels Midland, and Cargill continue to post record profits.

A solution that some countries have already begun implementing is to de-liberalize their agricultural sectors. So far this has mostly been done in a knee-jerk and unplanned way, which is understandable given the circumstances. So India has banned the export of certain crops, while eliminating some export tariffs; China has introduced some price controls and increased its tariffs on some grains to discourage exports. More than 25 countries and the European Union, which has temporarily suspended import duties, have taken similar measures.

These measures are necessary, but they are not solutions. They may lessen the impact of soaring food prices, but they will do nothing to reverse the trend.

Real solutions will involve the remaking and “de-globalizing” of the global agriculture market. Some steps may include the following:

1. Food sovereignty is food security. Countries that are serious about food security should take measures to increase their production for domestic purposes. In cases where it is not feasible or desirable to be 100% self-sufficient in staple crops, trading deals should be negotiated within the region. If more trade were regional, it would not only cut down on transportation costs, it would help promote regional growth and development.
2. Undo Trade Agreements. Food sovereignty will not be possible unless all talk about agriculture agreements at the World Trade Organization or through bi-lateral trade agreements is suspended. Such trade deals are designed in the context of a global agricultural market, where one country should fine tune its agricultural sector based on comparative advantage and market need. Such a strategy makes no sense when people in countries all over the world are demanding better and cheaper access to staple foods.
3. Increase taxes on speculation. In order to promote domestic production, subsidies and other government-sponsored programs are a must. But many governments are already having difficulty raising money for basic infrastructure and other essential services. There’s no easy answer here, but one possibility may be to find ways to impose taxes on speculation. If this were to be done along the “Tobin tax” model – with a small tax on every transaction made and administered globally – this could generate a lot of money and could be administered by the UN Food and Agriculture Organization. Alternatively countries could tax their own futures and other commodity markets where they exist.

In the final analysis, the food crisis is actually a convergence of two crises. The first is the crisis of speculation, characterized by a chronic “bubble economy.” Increased regulation and taxation of speculation of all kinds is the only long-term solution to this crisis.

The second is a crisis that has been a long time coming – the crisis of global agriculture which has been in many ways been a planned and calculated crisis. When agricultural policy is not made by citizens and their elected representatives but rather by international financial institutions and their market fundamentalist policies and by big agribusiness whose primary concern is their own bottom line, it is a recipe for disaster.

Sameer Dossani, a Foreign Policy In Focus contributor, is the director of 50 Years is Enough and blogs at shirinandsameer.blogspot.com. This commentary is adapted from a article soon to be published in Spanish by "América Latina en Movimiento," a monthly magazine edited by the Latin American Information Agency (ALAI).

Copyright © 2008, Institute for Policy Studies

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