Deutsche Bank Returns to 'Speculation in Food'

Much to the consternation of the economically illiterate left in Germany, Deutsche Bank has decided to engage in investment activities in commodities again (no 'Dodd Frank' restraint exists for euro-land bank prop trading, so they are now apparently jumping into the breach). The big worry of the leftists is that “speculation in commodities is driving up food prices”.


Der Spiegel reports (beginning its report by repeating the utterly false allegation leveled by various organizations and people regarding speculation, but later on noting that alternative views exist):


“Many financial institutions and multinational organizations view speculating on food commodities as a dangerous game and a contributor to global hunger. Despite its bruised reputation, Deutsche Bank is leaping back into the business.

In May 2012, shortly before ending his term as CEO of Deutsche Bank, Josef Ackermann realized with some remorse that "no deal is worth risking the good reputation of Deutsche Bank."

But, by then, the reputation of Germany's largest bank was already somewhat battered — and it's suffered even more since. The latest scratch came on Thursday, when the bank reported a surprise net loss of €2.2 billion ($3 billion), for the fourth quarter of 2012, citing numerous lawsuits and official investigations among the reasons.

This makes it all the more surprising that Jürgen Fitschen, who succeeded Ackermann along with co-CEO Anshu Jain, is now returning to the type of business that could further damage the bank's image: speculation in agricultural commodities.

This is precisely the business that organizations such as Foodwatch and Oxfam, and even United Nations institutions such as the Conference on Trade and Development (UNCTAD), hold partially responsible for hunger in the world.

The fact is that, in recent years, an enormous market has developed for financial products used to speculate on fluctuations in food prices. Critics say that these deals drive up the prices of corn, rice, wheat and other commodities, making food unaffordable for many in the Third World.

The accusations have been so vehement that Deutsche Bank suspended its business in agricultural commodities until it could be proven that speculation didn't harm anyone. Such proof has apparently now been supplied, at least in the bank's view.”


(emphasis added)


OXFAM and all other critics of speculation in commodity futures are all wet (unless of course their objections are motivated by selfish reasons, which is definitely possible). Leaving aside the basic fact and pretty obvious objection that in futures, there must be a seller for every buyer, they simply do not understand the basic laws of economics. Speculators  cannot 'drive up the prices of food' and thereby 'cause hunger' willy nilly. Unless a speculators' views on the future state of the market are correct, he will soon suffer grievous losses. If he drives up the market price of a commodity and the fundamental market data fail to confirm his views, he won't be a speculator for very long.


Speculation is Beneficial

As Murray Rothbard writes on the topic in 'Man Economy and State':


“Entrepreneurship is also the dominant characteristic of buyers and sellers who act speculatively, who specialize in anticipating higher or lower prices in the future. Their entire action consists in attempts to anticipate future market prices, and their success depends on how accurate or erroneous their forecasts are. Since, as was seen above, correct speculation quickens the movement toward equilibrium, and erroneous speculation tends to correct itself, the activity of these speculators tends to hasten the arrival of an equilibrium position.


There can be a reserve demand for a depletable resource, just as there is speculative reserve demand for any other stock of goods on the market. This speculation is not simple wickedness, however; it has a definite function, namely, that of allocating the

scarce depletable resource to those uses at those times when consumer demand for them will be greatest. The speculator, waiting to use the resources until a future date, benefits consumers by shifting their use to a time when they will be more in demand than at present.


(emphasis added)

We can therefore summarize: correct speculation will hasten the arrival of the price at which market supply and demand reach equilibrium; incorrect speculation is self-correcting; and finally, by holding back stock for a time when  it will be needed more urgently, speculators benefit consumers.

We would add to this that by hastening the arrival of equilibrium prices, speculators also benefit consumers, as producers of the commodity concerned get the price information that is crucial for their production decisions faster than would otherwise be the case. This will therefore hasten the required expansion in production that in turn will over time expand supply and bring prices down again.

Agricultural prices have not risen in recent years because speculators are somehow 'evil'; they have risen because speculators have become aware of the fact that the world's stock of agricultural commodities was too low. Rising prices serve to both ration the existing stock, as well as giving an incentive to  producers to increase production.

Speculation is entirely beneficial; in fact, it is crucial for the smooth functioning of the market economy. There can in fact not be a market economy without speculation: all entrepreneurial activity is at its core 'speculation', as it is concerned with correctly appraising the future.

Speculators do not cause hunger – instead they ensure that it will be alleviated as soon as possible.

So what would happen if we were to curtail speculation in agricultural commodities? The market would become inefficient; producers no longer would be able to smoothly hedge their output, as market liquidity would evaporate. Price signals would be transmitted more slowly and would be less accurate. If  prices were artificially suppressed by additional measures in order to 'alleviate hunger', the typical effect of price controls would soon appear on the scene: supply would disappear and hunger would increase to a truly catastrophic extent. Of course, this would benefit absolutely no-one.

Actually, that is perhaps not quite true – there is one exception: namely OXFAM and similar organizations, that would have more hungry people to look after and whose activities and clout would expand as a result.


'Der Spiegel Reports on Contrary Views

Der Spiegel notes that Deutsche Bank is citing a study in support of its decision (citing common sense may have sufficed actually) that supports the ideas outlined above.


Deutsche Bank can now cite a study by Ingo Pies, an expert in business ethics from the eastern German city of Halle. After reviewing selected publications, he concluded that the agricultural markets would function worse, not better, if speculation were curtailed. "Trying to ban it would torpedo the moral concern for sustainably fighting worldwide hunger," says Pies. He concludes that putting more rather than less emphasis on the free market is the key to achieving this objective.

The study's findings didn't surprise Fitschen. He believes that the discussion over food speculation is headed in the wrong direction. As the son of a farmer, he saw firsthand how price fluctuations could cause problems for farmers. When harvests were bad and the price of hog feed went up, a farmer could quickly be driven to the brink of ruin. Today, Fitschen argues, so-called derivatives enable farmers to hedge against price fluctuations.

Through futures transactions, banks give farmers, exporters and other business owners the ability to set the price at which they will buy or sell commodities, such as wheat, pork or coffee beans, in six or 12 months' time. Soybean producers in Brazil, for example, are often unable to receive loans for production unless they can ensure that they'll be able to sell a certain amount of soybeans at guaranteed prices.

Even conservative managers in the finance industry admit that there are risks involved. But, they add, the true villains in the markets are completely different. They include, for example, global commodities giants such as Switzerland-based Glencore, which, unlike Deutsche Bank, is relatively unknown to the general public.

Companies like Glencore own mines and large tracts of land, which allows them to exert considerable influence on prices. Commodities giants based in Switzerland alone, a center of the industry, control 15 to 25 percent of the global ore, oil and agricultural trade. Industry revenues went up fivefold between 1998 and 2010.

Proponents of the business even believe that restricting it is wrong. They point out that it's impossible to monitor who buys the futures contracts. You don't even know who is sitting at the other end, Alexander Dibelius, head of the German operations of the investment bank Goldman Sachs, said in a recent SPIEGEL interview. It could be "the good farmer or the evil speculator, or perhaps both in one person, because the farmer could also be speculating on what the weather holds, couldn't he?"

What's more, for every risk that food producers sell, there also have to be buyers — that is, speculators betting that this risk will become reality. In these transactions, the bank is generally merely an intermediary between seller and buyer.”


(emphasis added)

Even Glencore, with all its economic might, cannot alter the fundamental data of the market. This charge falls flat as well. We have seen that the mighty OPEC cartel – which controls a far greater proportion of crude oil output than Glencore can ever hope to achieve in agricultural commodities –  failed miserably in its attempts to control the oil price for several decades running. What Glencore is doing is that it creates economies of scale – its activities help to lower rather than push up prices. The attempts to find a villain, some 'evil controller' of food prices, lurking in the dark somewhere are totally misguided. They play into the Left's false notion of capitalism's alleged evils, but they are simply incorrect from the perspective of economic theory. They are also contradicted by economic history, i.e., empirical evidence. Attempts to 'corner' commodities markets have spectacularly failed numerous times in history. The 'manipulators' have invariably come to grief (the late 19th century Hutchinson corner in wheat is one example specifically involving an agricultural commodity).

It should also be mentioned that apart from the communists, who banned speculation and all entrepreneurial activity to the great detriment of the people they caged in their 'socialist paradises' for decades, the other political force that banned speculation were the fascists. Hitler and Mussolini both deemed speculation evil and in some European countries (like e.g. in Austria) their laws banning futures and options trading only came off the statute books in the early 1990s.

So the modern-day political left is indeed in 'good company' with its attacks on speculators.


Other Modern Studies: Dimitri Speck

We should also mention a recent study by German commodities expert Dimitri Speck. The German publication 'Handelsblatt' reported on it recently. Instead of translating the article, we will briefly summarize Mr. Speck's arguments here, with which we were familiar even before the German press reported on his study.

Mr. Speck has specifically examined the effect of index investors on the commodities futures curve. Whereas in the past there was a tendency for agricultural futures contracts to trade in backwardation, as the hedging activities of farmers in the further out months tended to suppress prices, the arrival of index investors has altered the futures curve and produced a strong contango.

Mr Speck notes that index investors can not have any influence on the spot market, except perhaps a psychological one: after all, they don't buy spot commodities, but only buy futures contracts. Of course the futures price won't move a whole lot higher than the spot price, as commercial sellers will soon correct any large-scale deviations, but the higher contango once again actually has beneficial effects.

The reason is that it increases the profits of producers, who can now hedge at higher prices than they would be able to do otherwise. While the contango is not excessively large, in terms of percentages the advantage adds up to quite a bit over time due to the compounding effect. This is all the more relevant in times when interests rates are extremely low. And what happens when producers are able to get higher prices? Right, they expand production.

In other words, Mr. Speck shows that not only the activities of active speculators in the market are beneficial, but also those of 'mindless asset allocators' who simply engage in index investing.


To sum up: speculation in agricultural commodities helps to alleviate hunger. Suppressing it would be a grievous mistake indeed.




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2 Responses to “Is Speculation in Agricultural Commodities ‘Evil’?”

  • Keith Weiner:

    Pater: futures buyers do have an effect on spot. There are arbitrageurs between spot and futures markets. And this segues to my answer to MC. The grain elevator operator does not typically speculate but arbitrage. he can simultaneously buy spot and sell future. He is interested in making a consistent spread rather than speculating on a rising price.

  • mc:

    Even more fundamentally, this type of criticism is an attack on the whole nature of a supply chain. By this logic, all food should be purchased directly from the farmer, labor from the individual, and all enterprises are one-person self-financed. In each case, the ideal outcome is that the highest price is paid between producer and consumer because there is no ‘middle-man’. However, in practice, the coincidence of wants (which makes the farmer’s job harder), inflexibility of labor (making specialization valuable), and the value of accumulating capital (enabling one enterprise to grow large and exploit efficiencies of scale) makes it impossible to realize the highest price WITHOUT the inter-mediation of ‘speculation’ ie predicting the future state of the market to best solve the wishes of consumers. Wheat is harvested in a narrow time frame, yet is most valuable when other foods are scarce in winter since it is storeable – and to exploit that I could purchase wheat in the fall and store it to sell later. That assertion alone (and any economic behavior associated with it) is speculative by definition because it may not be true (and if wrong, cost the speculator). It is no different with labor if I were to hire and train plumbers – I am predicting the need of plumbers and will suffer if wrong, nor capital to build a factory – a worthless building if those products aren’t needed. Just because a farmer can capture 100% of the retail value of his tomatoes at a farmers’ market, doesnt mean that the exact economic behavior would scale to all society or that some inter-mediation would make us poorer or increase food prices. It is unfortunately assumed that any middle man between the producer consumer endpoints is collecting an economic rent (“leech on society”), but if that process adapts between differences in preferences (quantity, time, quality, location, etc) then it is economically valuable. If there was an army of trucks at the farm willing to haul off the crop and pay the top price in cash, then certainly the farmer is going to sell and bypass DB and speculators. Precisely because that isnt the case is why the farmer is happy to sell to a middle man who will store and sell the crop at the ideal price and thus pay the farmer more to start.

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