Record Food Prices: Bubble or Here to Stay? Part 1

Maybe you noticed it... maybe you didn´t ...but food prices worldwide are at all time highs and seem to be staying there.  By some measures, prices are at their highest point in more than 150 years.  You can cut-back and economize on a lot of things but food is usually the last on your list.  For the next few weeks, I´d like to look into this issue, as much to explain it to myself as anything else.  If this kind of thing interests you, send some loving comments my way and encourage me to share what I find out.  I´ll bring my perspective as a rancher and farmer ...you bring your appetite.

Are Wall Street Speculators Driving-up the Price of Food?

This is a hot topic ...that's only getting hotter.  Food prices worldwide are holding at record levels and the subject of outside speculators will be getting your attention in the media.  I follow this closely ...but I don´t have the answer yet.  So let´s explore the subject together:

First, what´s the difference between an investor and a speculator?

Answer:  Not much ...but generally speaking investors have a longer-term outlook for the businesses they sink their money into.  For example, if you are a brewer, you like to buy or contract your barley purchases as much in advance as possible.  That way, your brewery knows how much it will be paying for your crucial ingredient and can plan your pricing and production.  Same for any other food commodity that is crucial to business: corn flakes/corn, wonder bread/wheat, etc.  That´s just business as usual and it also gives farmers an idea as to how much to produce ...and buyers an idea as to what to what prices to expect.  Investors buy their commodities in advance by signing a futures contract (more on that later.)

A speculator (sometimes called an "outside speculator"), on the other hand, doesn´t produce food commodities and doesn´t consume them in his business.  For example, the speculator might notice that prices for those commodities seem to have a good possiblility of going up ...so he buys a futures contract ...and hopes that he can later sell that contract for more than what he paid for it.

So, is there anything wrong with being a speculator?

It´s hard to say.  It´s certainly not illegal and there are very few restrictions against it.  In fact, there have been many years in which speculators have been universally praised.  Conventional economics sees speculators as bringing buyers and sellers together, bidding-up prices when they are too low for the producer, and causing high consumer prices to fall when they sell their contracts.  Speculators also can boost production in some cases because the futures contracts they buy provide "an insurance policy" for farmers who might otherwise not plant for fear of too low a price come harvest time.

Opponents of speculation in food commodities, on the other hand, point out that there is no need for speculators to bring barley farmers and beer brewers together.  They say that there is no shortage of futures contracts between food producers and their industrial customers.  Opponents go on to say that, instead of keeping a balance between high and low prices, speculators deliberately cause prices to swing wildly so that they can profit from the rise and fall.  As to boosting production, critics of food commodity speculators point out that driving up prices to record levels puts pressure to slash and burn environmentally sensitive lands so that they can be planted or grazed.

They also point out that perhaps most alarming of all is Wall Street´s development of new financial instruments that have unforseen consequences in food commidity markets with no benefit to producers or consumers.

Full disclosure: as a rancher and farmer, if speculators are driving prices up ...they are putting money in my pocket.

However, I didn´t get into the food production business in order to see people go hungry.  If speculators are causing prices to hurt my industrial consumers or my end-consumers, these high prices will eventually hurt me and make it even more difficult for me to plan what to produce from year to year.

Coming-up... Part 2: The Goldman Sachs Commodity Index