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Food speculation – 450 economists tell the G20 to take action, now

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The World Development Movement has been bringing to public attention, and to policymakers in Britain, the effects of financial market speculation in food. Recently, a WDM campaign group circulated a letter amongst economists in all countries addressed to the finance ministers of the countries that make up the G20. They met in Paris, France, on 15 October.

I am honoured to be amongst the 450 who have signed the statement. Those who have lent their names to the statement are amongst a group of economists, social scientists, academics and activists who are witnessing – every day no matter where they live – the impacts of relentless food inflation on the lives of poor households whether urban or rural. This statement is one way to remind the G20 powers of their social responsibilities.

Here follows the text of the letter, which is available on the original site here:

11 October 2011

Dear G20 Finance Ministers,

We write to you ahead of the October meeting of the G20 Finance Ministers to urge you to commit with your counterparts to take effective action to curb excessive speculation on food commodities. Excessive financial speculation is contributing to increasing volatility and record high food prices, exacerbating global hunger and poverty.

While there are many pressures on food prices, fundamental changes in supply and demand cannot fully account for the dramatic price fluctuations that have occurred in recent years.

In June, a report for the G20 by international organisations including the IMF and the OECD noted that “too much speculation can cause frequent and erratic price changes” in futures markets.

Evidence suggests that financial speculators are less likely to make trading decisions based on information regarding supply and demand and are more prone to herding behaviours than commercial traders. Excessive speculation undermines the price discovery function of futures markets, driving real prices away from levels determined by supply and demand.

The High Level Panel of Experts on food security for the Committee on World Food Security at the FAO reported in July that “tighter regulation of speculation is necessary.” The panel suggested that “Increasing transparency, by requiring exchange trading and clearing of most agricultural commodity contracts, and setting lower limits for noncommercial actors could be the first set of measures taken by the countries that house major commodity exchanges.”

Increasing market transparency is vital, but will not go far enough to tackle excessive financial speculation. We therefore urge you to support the establishment of position limits to cap the proportion of agricultural commodity derivatives markets that can be  held by financial speculators.

Limits could be set at a level that would maintain sufficient liquidity in the markets while preventing an excessive concentration of purely financial actors. The US has already passed legislation including provisions to introduce such limits and the G20 should act to prevent regulatory arbitrage between exchanges.

Position limits would be more effective in tackling excessive speculation than position management powers, which rely on the use of judgement by exchanges and provide little assurance that powers will be exercised effectively. Clear limits would provide regulatory certainty, promoting stable and sustainable derivatives markets to the benefit of food producers, consumers and broader economic stability.

With around 1 billion people enduring chronic hunger worldwide, action is urgently needed to curb excessive speculation and its effects on global food prices.

Yours sincerely,


Economics is not physics

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From ‘India and the Global Financial Crisis What Have We Learnt?’, by Dr Duvvuri Subbarao, Governor, Reserve Bank of India, as the K R Narayanan Oration, at the South Asia Research Centre of the Australian National University, Canberra on June 23, 2011.

A few months into the crisis [the 2008-09 financial crisis], the Queen happened to be at the London School of Economics and asked a perfectly sensible question: ‘how come none of the economists saw the crisis coming’. The Queen’s question resonated with people around the world who felt that they had been let down by economics and economists. As economists saw their profession discredited and their reputations dented, the economic crisis soon turned into a crisis in economics.

What went wrong with economics? It now seems that by far the most egregious fault of economics, one that led it astray, has been to project it like an exact science. The charge is that economists suffered from ‘physics envy’ which led them to formulate elegant theories and models – using sophisticated mathematics with impressive quantitative finesse –  deluding themselves and the world at large that their models have more exactitude than they actually did.

Admittedly, in a limited sense there may be some parallels between economics and physics. But similarity in a few laws does not mean similarity in the basic nature of the academic discipline. The fundamental difference between physics and economics is that physics deals with the physical universe which is governed by immutable laws, beyond the pale of human behaviour. Economics, in contrast, is a social science whose laws are influenced by human behaviour. Simply put, I cannot change the mass of an electron no matter how I behave but I can change the price of a derivative by my behaviour.

The laws of physics are universal in space and time. The laws of economics are very much a function of the context. Going back to the earlier example, the mass of an electron does not change whether we are in the world of Newton or of Einstein. But in the world of economics, how firms, households and governments behave is altered by the reigning economic ideology of the time. To give another example, there is nothing absolute, for example, about savings being equal to investment or supply equalling demand as maintained by classical economics but there is something absolute about energy lost being equal to energy gained as enunciated by classical physics.

In natural sciences, progress is a two way street. It can run from empirical findings to theory or the other way round. The famous Michelson-Morley experiment that found that the velocity of light is constant led to the theory of relativity – an example of progression from practice to theory. In the reverse direction, the ferocious search now under way for the Higgs Boson – the God particle – which has been predicted by quantum theory is an example of traversing from theory to practice. In economics, on the other hand, where the human dimension is paramount, the progression has necessarily to be one way, from empirical finding to theory. There is a joke that if something works in practice, economists run to see if it works in theory. Actually, I don’t see the joke; that is indeed the way it should be.

Karl Popper, by far the most influential philosopher of science of the twentieth century, propounded that a good theory is one that gives rise to falsifiable hypotheses. By this measure, Einstein’s General Theory was a good theory as it led to the hypothesis about the curvature of space under the force of gravity which indeed was verified by scientists from observations made during a solar eclipse from the West African islands of Sao Tome and Principe. Economics on the other hand cannot stand the scrutiny of the falsifiable hypothesis test since empirical results in economics are a function of the context.

The short point is that economics cannot lay claim to the immutability, universality, precision and exactitude of physics. Take the recent financial crisis. It is not as if no one saw the pressures building up. There were a respectable number of economists who warned of the perilous consequences of the build-up of global imbalances, said that this was simply unsustainable and predicted a currency collapse. In the event, we did have the system imploding but not as a currency collapse but as a melt down of the financial system.

We will be better able to safeguard financial stability both at global and national levels if we remember that economics is a social science and real world outcomes are influenced at a fundamental level by human behaviour.

[The entire oration is here.]

In an extraordinary meeting, FAO sizes up the turmoil in world cereal markets

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The FAO’s Committee on Commodity Problems has just concluded its Extraordinary Joint Intersessional Meeting of the Intergovernmental Group on Grains and the Intergovernmental Group on Rice (held in Rome, 24 September 2010). The Food and Agriculture Organization of the UN does not, it appears, want to cause any alarm bells to be rung in countries already worried by food inflation, and that is why its overall advise is at odds with the details highlighted during the day-long consultations.

Here are the main points of an advisory titled ‘Turmoil in Global Cereal Markets: Outlook for 2010-11, Short-Term Risks & Uncertainties’:

La Nina (colder-than-normal sea-surface temperatures in the Pacific Ocean) often results in drier periods in Argentina and southern Brazil but wetter weather in Asia. It may strengthen through January
Any downgrading of wheat crops in southern hemisphere countries before harvest this year- Western Australia not so good
The final maize harvest in the USA (and China) – production may end up lower
Adverse growing conditions affecting secondary rice crops in Asia and main crops in southern hemisphere
Drought in Russia and delayed winter grain sowing (down 20%) – but some rains have arrived
Crop damage in Pakistan: implications for next season
Faster/slower economic recovery influencing demand prospects for feed and fuel: tightening maize supplies in the US if demand for ethanol rise faster than predicted
Larger than currently expected import purchases, maize by China for example
Trade measures, in particular further exports restrictions
Developments in outside markets such as currency (US Dollar), equity, energy and other commodity markets

UN Millennium Development Goals Report 2010 / UNICEF Photo

UN Millennium Development Goals Report 2010 / UNICEF Photo

The rhetorical question is asked – “Are we ready?” – and the points supplied are: (1) We are not in a food crisis and grain prices may even come down a bit, (2) But all indications point to still high prices and volatile markets with many uncertainties lying ahead, (3) Food security under growing market instability and price volatility: Are we ready?

The extraordinary joint meeting briefly explained what it meant by “Increased volatility & speculation” with the following points: Markets liberalisation, decline of price supports; Deregulation of the financial service sectorl Declining margins in securities tradingl Rising demand for food in emerging marketsl Under-investment in agriculture; Lack of price transmission to producers; Sudden governmental interventions in export marketl Ease of access to electronic market place; Exchanges restructured today as for-profit corporations.

The dangers, current and expected, are set out in the briefing paper on ‘Agricultural Futures: Strengthening market signals for global price discovery’. This said:

Volatility in commodity foodstuffs is a result of both fundamental factors and speculative inflows of managed money. Sharply differing opinions exist on how institutional money flows have changed the nature of the markets, particularly since the expansion of limits. While financial firms argue that they add volume and liquidity to the market, others maintain that large order size creates volatility and jagged price swings. In the August 2010 price hike of wheat, the CME wheat price moved up limit and down limit within two consecutive days. High frequency trading is also a controversial issue – one that a CFTC editorial recently stated needed “reining in,” commenting that “parasitical trading does not truly contribute to fundamental market functions.”

Global undernourishment (image: Nature)Much debated also is the effect of passive fund money (index funds and swaps dealers), with experts on both sides arguing whether they have caused chronic price elevation and steep contango in some futures contracts. In its 2009 Trade and Development Report, UNCTAD contends that the massive inflow of fund money has caused commodity futures markets to fail the “efficient market” hypothesis, since the purchase and sale of commodity futures by swap dealers and index funds is entirely unrelated to market supply and demand fundamentals, but depends rather on the funds’ ability to attract subscribers. Despite the risk transfer nature of futures trading, in which gains and losses are equally offset, passive funds have successfully packaged and sold futures contracts as an alternative investment class to institutional investors. However, most would agree that these passive funds do not affect volatility levels since their only trading activity is a forward “roll” of their positions and the timings of these rolls are announced in their prospectus.

This is worrying because the FAO is now being a great deal clearer about the same problem it tried to describe in 2007-08,

Finally, Olivier de Schutter, the United Nations Special Rapporteur on the Right To Food, has released a briefing paper entitled ‘Food Commodities Speculation and Food Price Crises: Regulation to reduce the risks of price volatility’. His recommendations:

1. Given the numerous linkages between agriculture, oil, and other financial markets demonstrated above, comprehensive reform of all derivatives trading is necessary. The very first step would be to require registration, as well as clearing to the maximum extent possible of OTC derivatives, so that there is real time reporting of all transactions made, without information privileges for OTC traders, and in order to allow for effective supervision. The small minority of derivatives that cannot be cleared must nevertheless be reported without a time lag.

Islamabad Water Carrier

Islamabad Water Carrier: World Water Day was just another Monday for Nasir Ali, who was photographed on March 22 hauling water to his home in an Islamabad slum. Water shortages have become common for many people in the capital who must gather their daily water from government tankers or private trucks—when the precious resource is available at all. The nation’s acute rainfall shortage has also cut water supplies at hydroelectric dams, exacerbating disruptive power shortages and forcing officials to implement some rather dramatic solutions. Photograph by Aamir Qureshi, AFP/Getty Images

2. Regulatory bodies should carefully study and acquire expertise in commodity markets, instead of regulating commodity derivatives and financial derivatives as if they were the same class of assets. It may be appropriate to assign the task of regulating commodity derivatives to a specific institution staffed with experts in commodity regulation, rather than have a single body regulating both financial and commodity derivatives.

3. Access to commodities futures markets should be restricted as far as possible to qualified and knowledgeable investors and traders who are genuinely concerned about the underlying agricultural commodities. A significant contributory cause of the price spike was speculation by institutional investors who did not have any expertise or interest in agricultural commodities, and who invested in commodities index funds because other financial markets had dried up, or in order to hedge speculative bets made on those markets.

4. Spot markets should be strengthened in order to reduce the uncertainty about future prices that creates the need for speculation. However, these markets must also be regulated in order to prevent hoarding. Spot markets must be transparent, and holdings should be subject to strict limits in order to prevent market manipulation.

5. Physical grain reserves should be established for the purpose of countering extreme fluctuations in food price, managing risk in agricultural derivatives contracts, and discouraging excess speculation, as well as meeting emergency needs. Such measures and the abovementioned reform of commodity derivatives markets should be seen as complementary.