The Price of Speculation Makes the Case for Regulation

One of the most visible signs of climate change was last summer’s prolonged extreme drought. Over eighty percent of the corn and soybean crops were impacted. Not surprisingly, we saw record food prices globally. Price increases due to drought are easy to understand given the reduction in crop supply that accompanies drought. Yet, even before this summer’s drought, food prices have been increasing and record high prices were seen in 2008 and again in 2011.

Part of the increase in prices can be attributed to the increase in global population, and therefore, increased demand. Part of the increase, however, is artificially manufactured and not a result of increased demand or decreased supply. Financial speculation destabilizes the commodities market and increased speculative action correlates with increased food prices. In other words, financial manipulations are causing food prices to increase when there is no other reason why they should be increasing.

After food prices increased 165 percent between April 2007 and April 2008, the UN Special Rapporteur on the Right to Food analyzed why the prices spike had occurred. The resulting report found supply and demand issues did not explain the full extent of the increases and volatility in food prices. Any crises that may have occurred from changes in supply or demand were exacerbated by excessive and insufficiently regulated speculation. This problem was further exacerbated by large institutional investors entering the commodity futures markets on a massive scale. Barclays, for instance, has made 500 million pounds (about $800 million US) profit in two years speculating on food staples.

Speculation doesn’t just increase food prices, it also increases gas prices and is one of the main reasons prices were so high this summer and continue to stay high. Limiting speculation to decrease its impact on prices was one of the strongest pieces to come out of the Dodd-Frank Wall Street reform bill. Ideally, commodity markets would contain only 30 percent speculators, which is substantially less than the 85 percent in current markets.

To start to minimize the damage caused by speculation, the Commodities Futures Trading Commission, created by Dodd-Frank, issued draft rules last year, otherwise known as position limits. Even though the limits were quite modest, a federal judge struck them down and ruled it was not clear that position limits could be imposed without determining whether they were necessary and appropriate. As a result, no limits will be implemented and the CFTC is back to the drawing board.

The clear winner in all of this is Wall Street where banks continually boast record profits while their bad behavior remains unchecked. The loser, of course, is everyone else who will see price increases in staples like food and gas. Some increase in food and gas is expected because the population is expanding and demand for these staples will increase. What should end, however, is artificial market manipulation that benefits banks and traders but falsely increases the cost of staples, hurting average families.

Limiting speculation would stabilize commodity prices and prevent violent price spikes. Other, more fundamental market changes, like regulating derivatives, provide further protection against market instability. At the end of the day, Wall Street has proven time and again that when it comes to their practices, we need more- not less- regulation.

This entry is part of the series New Rules for Wall Street, where Demos analysts and members of the Coalition for Sensible Safeguards make the case for what should be on the financial-reform agenda in the next four years. Read all the entries here.