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How Goldman Sachs Created the Food Crisis

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PostPosted: Fri Jun 17, 2011 11:50 am    Post subject: How Goldman Sachs Created the Food Crisis Reply with quote

How Goldman Sachs Created the Food Crisis

Don't blame American appetites, rising oil prices, or
genetically modified crops for rising food prices.
Wall Street's at fault for the spiraling cost of food.


The Food Issue

Demand and supply certainly matter. But there's another
reason why food across the world has become so
expensive: Wall Street greed.

It took the brilliant minds of Goldman Sachs to realize
the simple truth that nothing is more valuable than our
daily bread. And where there's value, there's money to
be made. In 1991, Goldman bankers, led by their
prescient president Gary Cohn, came up with a new kind
of investment product, a derivative that tracked 24 raw
materials, from precious metals and energy to coffee,
cocoa, cattle, corn, hogs, soy, and 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 henceforth as the
Goldman Sachs Commodity Index (GSCI).

For just under a decade, the GSCI remained a relatively
static investment vehicle, as bankers remained more
interested in risk and collateralized debt than in
anything that could be literally sowed or reaped. Then,
in 1999, the Commodities Futures Trading Commission
deregulated futures markets. All of a sudden, bankers
could take as large a position in grains as they liked,
an opportunity that had, since the Great Depression,
only been available to those who actually had something
to do with the production of our food.

Change was coming to the great grain exchanges of
Chicago, Minneapolis, and Kansas City -- which for 150
years had helped to moderate the peaks and valleys of
global food prices. Farming may seem bucolic, but it is
an inherently volatile industry, subject to the
vicissitudes of weather, disease, and disaster. The
grain futures trading system pioneered after the
American Civil War by the founders of Archer Daniels
Midland, General Mills, and Pillsbury helped to
establish America as a financial juggernaut to rival
and eventually surpass Europe. The grain markets also
insulated American farmers and millers from the
inherent risks of their profession. The basic idea was
the "forward contract," an agreement between sellers
and buyers of wheat for a reasonable bushel price --
even before that bushel had been grown. Not only did a
grain "future" help to keep the price of a loaf of
bread at the bakery -- or later, the supermarket --
stable, but the market allowed farmers to hedge against
lean times, and to invest in their farms and
businesses. The result: Over the course of the 20th
century, the real price of wheat decreased (despite a
hiccup or two, particularly during the 1970s
inflationary spiral), spurring the development of
American agribusiness. After World War II, the United
States was routinely producing a grain surplus, which
became an essential element of its Cold War political,
economic, and humanitarian strategies -- not to mention
the fact that American grain fed millions of hungry
people across the world.

Futures markets traditionally included two kinds of
players. On one side were the farmers, the millers, and
the warehousemen, market players who have a real,
physical stake in wheat. This group not only includes
corn growers in Iowa or wheat farmers in Nebraska, but
major multinational corporations like Pizza Hut, Kraft,
Nestle, Sara Lee, Tyson Foods, and McDonald's -- whose
New York Stock Exchange shares rise and fall on their
ability to bring food to peoples' car windows,
doorsteps, and supermarket shelves at competitive
prices. These market participants are called "bona
fide" hedgers, because they actually need to buy and
sell cereals.

On the other side is the speculator. The speculator
neither produces nor consumes corn or soy or wheat, and
wouldn't have a place to put the 20 tons of cereal he
might buy at any given moment if ever it were
delivered. Speculators make money through traditional
market behavior, the arbitrage of buying low and
selling high. And the physical stakeholders in grain
futures have as a general rule welcomed traditional
speculators to their market, for their endless stream
of buy and sell orders gives the market its liquidity
and provides bona fide hedgers a way to manage risk by
allowing them to sell and buy just as they pleased.

But Goldman's index perverted the symmetry of this
system. The structure of the GSCI paid no heed to the
centuries-old buy-sell/sell-buy patterns. This
newfangled derivative product was "long only," which
meant the product was constructed to buy commodities,
and only buy. At the bottom of this "long-only"
strategy lay an intent to transform an investment in
commodities (previously the purview of specialists)
into something that looked a great deal like an
investment in a stock -- the kind of asset class
wherein anyone could park their money and let it accrue
for decades (along the lines of General Electric or
Apple). Once the commodity market had been made to look
more like the stock market, bankers could expect new
influxes of ready cash. But the long-only strategy
possessed a flaw, at least for those of us who eat. The
GSCI did not include a mechanism to sell or "short" a

This imbalance undermined the innate structure of the
commodities markets, requiring bankers to buy and keep
buying -- no matter what the price. Every time the due
date of a long-only commodity index futures contract
neared, bankers were required to "roll" their
multi-billion dollar backlog of buy orders over into
the next futures contract, two or three months down the
line. And since the deflationary impact of shorting a
position simply wasn't part of the GSCI, professional
grain traders could make a killing by anticipating the
market fluctuations these "rolls" would inevitably
cause. "I make a living off the dumb money," commodity
trader Emil van Essen told Businessweek last year.
Commodity traders employed by the banks that had
created the commodity index funds in the first place
rode the tides of profit.

Bankers recognized a good system when they saw it, and
dozens of speculative non-physical hedgers followed
Goldman's lead and joined the commodities index game,
including Barclays, Deutsche Bank, Pimco, JP Morgan
Chase, AIG, Bear Stearns, and Lehman Brothers, to name
but a few purveyors of commodity index funds. The scene
had been set for food inflation that would eventually
catch unawares some of the largest milling, processing,
and retailing corporations in the United States, and
send shockwaves throughout the world.

The money tells the story. Since the bursting of the
tech bubble in 2000, there has been a 50-fold increase
in dollars invested in commodity index funds. To put
the phenomenon in real terms: In 2003, the commodities
futures market still totaled a sleepy $13 billion. But
when the global financial crisis sent investors running
scared in early 2008, and as dollars, pounds, and euros
evaded investor confidence, commodities -- including
food -- seemed like the last, best place for hedge,
pension, and sovereign wealth funds to park their cash.
"You had people who had no clue what commodities were
all about suddenly buying commodities," an analyst from
the United States Department of Agriculture told me. In
the first 55 days of 2008, speculators poured $55
billion into commodity markets, and by July, $318
billion was roiling the markets. Food inflation has
remained steady since.

The money flowed, and the bankers were ready with a
sparkling new casino of food derivatives. Spearheaded
by oil and gas prices (the dominant commodities of the
index funds) the new investment products ignited the
markets of all the other indexed commodities, which led
to a problem familiar to those versed in the history of
tulips, dot-coms, and cheap real estate: a food bubble.
Hard red spring wheat, which usually trades in the $4
to $6 dollar range per 60-pound bushel, broke all
previous records as the futures contract climbed into
the teens and kept on going until it topped $25. And
so, from 2005 to 2008, the worldwide price of food rose
80 percent -- and has kept rising. "It's unprecedented
how much investment capital we've seen in commodity
markets," Kendell Keith, president of the National
Grain and Feed Association, told me. "There's no
question there's been speculation." In a recently
published briefing note, Olivier De Schutter, the U.N.
Special Rapporteur on the Right to Food, concluded that
in 2008 "a significant portion of the price spike was
due to the emergence of a speculative bubble."

What was happening to the grain markets was not the
result of "speculation" in the traditional sense of
buying low and selling high. Today, along with the
cumulative index, the Standard & Poors GSCI provides
219 distinct index "tickers," so investors can boot up
their Bloomberg system and bet on everything from
palladium to soybean oil, biofuels to feeder cattle.
But the boom in new speculative opportunities in global
grain, edible oil, and livestock markets has created a
vicious cycle. The more the price of food commodities
increases, the more money pours into the sector, and
the higher prices rise. Indeed, from 2003 to 2008, the
volume of index fund speculation increased by 1,900
percent. "What we are experiencing is a demand shock
coming from a new category of participant in the
commodities futures markets," hedge fund Michael
Masters testified before Congress in the midst of the
2008 food crisis.

The result of Wall Street's venture into grain and feed
and livestock has been a shock to the global food
production and delivery system. Not only does the
world's food supply have to contend with constricted
supply and increased demand for real grain, but
investment bankers have engineered an artificial upward
pull on the price of grain futures. The result:
Imaginary wheat dominates the price of real wheat, as
speculators (traditionally one-fifth of the market) now
outnumber bona-fide hedgers four-to-one.

Today, bankers and traders sit at the top of the food
chain -- the carnivores of the system, devouring
everyone and everything below. Near the bottom toils
the farmer. For him, the rising price of grain should
have been a windfall, but speculation has also created
spikes in everything the farmer must buy to grow his
grain -- from seed to fertilizer to diesel fuel. At the
very bottom lies the consumer. The average American,
who spends roughly 8 to 12 percent of her weekly
paycheck on food, did not immediately feel the crunch
of rising costs. But for the roughly 2-billion people
across the world who spend more than 50 percent of
their income on food, the effects have been staggering:
250 million people joined the ranks of the hungry in
2008, bringing the total of the world's "food insecure"
to a peak of 1 billion -- a number never seen before.

What's the solution? The last time I visited the
Minneapolis Grain Exchange, I asked a handful of wheat
brokers what would happen if the U.S. government simply
outlawed long-only trading in food commodities for
investment banks. Their reaction: laughter. One phone
call to a bona-fide hedger like Cargill or Archer
Daniels Midland and one secret swap of assets, and a
bank's stake in the futures market is indistinguishable
from that of an international wheat buyer. What if the
government outlawed all long-only derivative products,
I asked? Once again, laughter. Problem solved with
another phone call, this time to a trading office in
London or Hong Kong; the new food derivative markets
have reached supranational proportions, beyond the
reach of sovereign law.

Volatility in the food markets has also trashed what
might have been a great opportunity for global
cooperation. The higher the cost of corn, soy, rice,
and wheat, the more the grain producing-nations of the
world should cooperate in order to ensure that panicked
(and generally poorer) grain-importing nations do not
spark ever more dramatic contagions of food inflation
and political upheaval. Instead, nervous countries have
responded instead with me-first policies, from export
bans to grain hoarding to neo-mercantilist land grabs
in Africa. And efforts by concerned activists or
international agencies to curb grain speculation have
gone nowhere. All the while, the index funds continue
to prosper, the bankers pocket the profits, and the
world's poor teeter on the brink of starvation.


Portside aims to provide material of interest to people
on the left that will help them to interpret the world
and to change it.

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