Separating the wheat from the chaff


by Ben Lilliston | June 24, 2009 • Remember when the cost of a loaf of bread rose rapidly last year due to skyrocketing wheat prices? A new Senate report says excess speculation by financial investors with no connection to actual wheat markets drove up prices for profit. These speculators were aided by lax enforcement from government regulators. The findings by Senate investigators are consistent with what we found in our report last year on the role of commodity speculation in the global food crisis.

Think Forward is a blog written by staff of the Institute for Agriculture and Trade Policy covering sustainability as it intersects with food, rural development, international trade, the environment and public health. The Institute for Agriculture and Trade Policy promotes resilient family farms, rural communities and ecosystems around the world through research and education, science and technology, and advocacy.

Commodity futures markets have traditionally brought together buyers and sellers in a market, like the Chicago Board of Trade (CBOT), to bid, offer and finally settle on a price for the delivery of a certain quantity of a commodity (say, wheat) at an agreed time and place. The contract enables commodity sellers, such as grain elevator operators, to avoid sudden price drops and commodity users or traders to avoid sudden price increases, e.g., due to tight supplies, crops failures or logistical bottlenecks. Both buyers and sellers use futures contracts to “hedge” their price risk.

The report, by the Senate Permanent Subcommittee on Investigations, focused on the disruptive role of commodity index traders who have no connection to the real-world wheat market. Instead, these speculators were interested in buying low, driving up prices, and selling high for a spectacular profit. The Senate report found that commodity index traders increased their holdings from 30,000 wheat contracts in 2004 to 220,000 contracts in 2008. In each year since 2006, these commodity index traders held between 35-50 percent of wheat futures contracts.

What was the effect of all this new outside money entering the wheat market? The gap between prices on the CBOT and actual cash prices paid at grain elevators grew from about 13 cents per bushel in 2005 to $1.53 in 2008—a ten-fold increase. In other words, what was happening on the CBOT had little connection with actual supply and demand.

The Commodity Futures Trade Commission (CFTC) is supposed to prevent excess speculation by restricting traders to no more than 6,500 wheat contracts at a time. But the Senate report found that the CFTC allowed some commodity index traders to hold up to 10,000, 26,000 and even 53,000 contracts at a time.

Let’s hope the Senate report spurs action. It makes a number of strong recommendations for reform, including limiting commodity index traders to 6,500 contracts (and potentially decreasing the number to 5,000). House Agriculture Committee Chair Collin Peterson has already introduced legislation to toughen regulations on commodity markets.

The United Nations is holding a summit on the global financial crisis this week in New York. IATP’s Steve Suppan is attending and will address attendees today to call for international regulation of commodity exchanges. The chaos caused by big commodity index funds on the Chicago exchange reverberated around the world with higher food and energy prices. Tougher regulations in the U.S. will help global markets, but to ensure that speculators don’t simply jump to commodity markets in London or elsewhere with weaker controls, a global approach is needed.

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