Two years ago, there was a major surge in food prices, which led to food shortages and riots in many parts of the world, amid soaring prices for industry and consumers – and many have claimed that excessive market speculation helped fuel price spikes. Prices of maize, rice and wheat, for example, reached their highest levels in 30 years.
Speculation on the futures market can perform an important function, helping the price discovery mechanism by highlighting any emerging imbalances between supply and demand – in the case of food crops, by encouraging planting when supply is tight and prices are high and discouraging it when supply is good and prices are low.
But the FAO said on Wednesday: “Apart from actual changes in supply and demand of some commodities, the upward swing might also have been amplified by speculation in organized futures markets.”
However, the FAO said that too much regulation to prevent the recurrence of such a scenario could be risky.
“Limiting or banning speculative trading might do more harm than good,” it said.
Market transparency
In terms of the type of regulation that could be appropriate, the FAO said that efforts should focus on improving the functioning of the market. Measures should include more transparency of futures trading and closer investigation of suspicious behavior, such as traders requesting permission to invest above their speculative position limits, the FAO said.
Proposed efforts to reduce speculation in futures markets could “have unintended consequences”, the organization said, as speculators could be put off trading if the futures price is deemed to have diverged too far from the equilibrium level determined by market fundamentals. This could lower the liquidity in the market available for hedging purposes.
Senate recommendations
A Senate probe from the Permanent Subcommittee on Investigations reported a year ago that wheat price spikes had been caused by excessive speculation in the futures market, noting an increase in daily outstanding contracts from 30,000 in 2004 to 220,000 by mid-2008 on the Chicago Mercantile Exchange (CME) – the world’s largest wheat futures market.
It recommended phasing out the waivers that allow traders to exceed the 6,500 wheat contract limit, to consider further restrictions, and to analyze and strengthen other commodity data.
The FAO’s policy brief concluded: “Commodity futures have become an integral part of food markets, and they perform an important role for many market participants. Adequate regulation should improve, not ban, speculative trading in order to foster market performance.”
The organization also pointed out that speculation was not solely responsible for soaring food prices, citing high oil prices, strong demand for crops from the bio-fuel sector, falling stockpiles of food and lower cereal production as other contributing factors. In addition, strong economic growth, low interest rates and export restrictions also played a role.