How Goldman Sachs Created the Food Crisis (this really is a MUST READ article)

[Bill USA]

from Sept 2007 to June 2008 the price of oil and food (and many other commodities) rose rapidly. Everybody was, understandably, angry about the situation. Voices were raised and many articles were written seeking a cause, a culprit. Some of the loudest voices declared America's modest effort at producing biofuels was the villain. But mainly confusion reigned and no clear understanding of the situation was ever gained. Among all the clamor, some voices were calling out Wall Street and deregulation of financial markets - including speculation in commodities - as the cause of the crisis. In the four or five months after June 2008 the prices dropped almost as fast as they had risen and our ardent anger gradually dissipated into mute disconsolance.

Now that most of the noise has died down perhaps some clarity can be gained as to what really caused the spike in commodity prices. A very good article on this subject, an excerpt from which appears below, appeared in Foreign Policy magazine at that time. ....

.. this just may be most important article you will ever read on the factors affecting the price of food and.... our economy.



[font size="+1"] "...Imaginary wheat dominates the price of real wheat, as speculators (traditionally one-fifth of the market) now outnumber bona-fide hedgers four-to-one." [/font]


http://www.foreignpolicy.com/articles/2011/04/27/how_goldman_sachs_created_the_food_crisis?wp_login_redirect=0

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[font size="3"]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.[/font] 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).

[font size="3"]
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. [font color="red"]Then, in 1999, the Commodities Futures Trading Commission deregulated futures markets [/font]{i.e. The Commodities Futures Modernization Act => see Who Wrecked the Economy - Foreclosure Phil - Mother Jones_BU}[font color="red"]. 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.[/font][/font]

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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 commodity.

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.
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Michael Masters, Hedge Fund owner manager, written testimony to Senate Committee on Homeland Security and Governmental Affairs - May 2008

There is a crucial distinction between Traditional Speculators and Index Speculators:
Traditional Speculators provide liquidity by both buying and selling futures. Index
Speculators buy futures and then roll their positions by buying calendar spreads. They
never sell. Therefore, they consume liquidity and provide zero benefit to the futures
markets.20

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The CFTC Has Invited Increased Speculation

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When Congress passed the Commodity Exchange Act in 1936, they did so with the
understanding that speculators should not be allowed to dominate the commodities
futures markets. Unfortunately, the CFTC has taken deliberate steps to allow certain
speculators virtually unlimited access to the commodities futures markets.

The CFTC has granted Wall Street banks an exemption from speculative position limits
when these banks hedge over-the-counter swaps transactions.21 This has effectively
opened a loophole for unlimited speculation. When Index Speculators enter into
commodity index swaps, which 85-90% of them do, they face no speculative position
limits.22[/font]

The really shocking thing about the Swaps Loophole is that Speculators of all stripes
can use it to access the futures markets. So if a hedge fund wants a $500 million
position in Wheat, which is way beyond position limits, they can enter into swap with a
Wall Street bank and then the bank buys $500 million worth of Wheat futures.23
In the CFTC’s classification scheme all Speculators accessing the futures markets
through the Swaps Loophole are categorized as “Commercial” rather than “Non-
Commercial.” The result is a gross distortion in data that effectively hides the full impact
of Index Speculation.

Additionally, the CFTC has recently proposed that Index Speculators be exempt from all
position limits, thereby throwing the door open for unlimited Index Speculator
“investment.”24 The CFTC has even gone so far as to issue press releases on their
website touting studies they commissioned showing that commodities futures make
good additions to Institutional Investors’ portfolios.25
Is this what Congress expected when it created the CFTC?

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Index Speculator Demand Is Driving Prices Higher

Today, Index Speculators are pouring billions of dollars into the commodities futures
markets, speculating that commodity prices will increase. Chart One shows [font size="3"]Assets
allocated to commodity index trading strategies have risen from $13 billion at the end of
2003 to $260 billion as of March 2008 {that is, 20 times more invested in 2008 than 5 yrs
earlier_B USA} ,5 and the prices of the 25 commodities that compose these indices
have risen by an average of 183% in those five years!6[/font]

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Commodities: Who's Behind the Boom - Barrons - Mar 2008

The speculators, now so bullish, are mainly the index funds. To see how their influence on the market has become outsized, just look at how they operate. Nearly $9 out of every $10 of index-fund money is not traded directly on the commodity exchanges, but instead goes through dealers that belong to the International Swaps and Derivatives Association (ISDA). These swaps dealers lay off their speculative risk on the organized commodity markets, while effectively serving as market makers for the index funds. By using the ISDA as a conduit, the index funds get an exemption from position limits that are normally imposed on any other speculator, including the $1 in every $10 of index-fund money that does not go through the swaps dealers.


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Position limits on speculators, in some commodities specified by CFTC rules and in others by the exchanges, are generally quite liberal. For example, the position limit on wheat traded on the Chicago Board of Trade is set at 6,500 contracts. At an approximate value of $60,000 worth of wheat per contract, a speculator could command as much as $390 million of wheat and still not exceed the limit.

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No such information is available from individual swaps dealers. But based on CFTC data on their total position in a commodity like wheat, together with the fact that only four dealers account for 70% of all the trading from the ISDA, it is quite clear that if the exemption were ever rescinded, the dealers' trading in these markets would no longer be viable.

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[font size="+1"]
The CFTC provides these figures on index trading for only 10 commodities. Why are such major commodities as crude oil, gold, and copper excluded? The agency's rationale, which even certain insiders question, is that[font color="red"] it would be hard to get reliable information on these other commodities from the swaps dealers.[/font]
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[Leme]

1. I sort of get parts of this

how they were let into futures market and how always going long would affect prices... the rest not sure, will look again at full link maybe later

[Uncle Joe]

2. Kicked and recommended.

Thanks for the thread, Bill USA.

[blkmusclmachine]

3. ,

,

[underpants]

4. Marking for later read

[bananas]

5. Imaginary wheat dominates the price of real wheat as speculators outnumber hedgers four-to-one

"...Imaginary wheat dominates the price of real wheat, as speculators (traditionally one-fifth of the market) now outnumber bona-fide hedgers four-to-one."

k&r, important stuff.