An August 2009 paper by Jayati Ghosh, professor at the Centre for Economic Studies and Planning at Jawaharlal Nehru University in New Delhi, compared food staples traded on futures markets with staples that were not. She found that the price of food staples not traded on futures markets, such as millet, cassava and potatoes, rose only a fraction as much as staples subject to speculation, such as wheat.
Excerpted from Ellen Brown, who first explains the general mechanism:
“The cause of the recent jump in global food prices remains a matter of debate. Some analysts blame the Federal Reserve’s “quantitative easing” program (increasing the money supply with credit created with accounting entries), which they warn is sparking hyperinflation. Too much money chasing too few goods is the classic explanation for rising prices.
The problem with that theory is that the global money supply has actually shrunk since 2006, when food prices began their dramatic rise. Virtually all money today is created on the books of banks as “credit” or “debt,” and overall lending has shrunk. This has occurred in an accelerating process of deleveraging (paying down or writing off loans and not making new ones), as the subprime housing market has collapsed and bank capital requirements have been raised. Although it seems counterintuitive, the more debt there is, the more money there is in the system. As debt shrinks, the money supply shrinks in tandem.
That is why government debt today is not actually the bugaboo it is being made out to be by the deficit terrorists. The flipside of debt is credit, and businesses run on it. When credit collapses, trade collapses. When private debt shrinks, public debt must therefore step in to replace it. The “good” credit or debt is the kind used for building infrastructure and other productive capacity, increasing the Gross Domestic Product (GDP) and wages; and this is the kind governments are in a position to employ. The parasitic forms of credit or debt are the gamblers’ money-making-money schemes, which add nothing to GDP.
Prices have been driven up by too much money chasing too few goods, but the money is chasing only certain selected goods. Food and fuel prices are up, but housing prices are down. The net result is that overall price inflation remains low.
While quantitative easing may not be the culprit, Fed action has driven the rush into commodities. In response to the banking crisis of 2008, the Federal Reserve dropped the Fed funds rate (the rate at which banks borrow from each other) nearly to zero. This has allowed banks and their customers to borrow in the US at very low rates and invest abroad for higher returns, creating a dollar “carry trade.”
Meanwhile, interest rates on federal securities were also driven to very low levels, leaving investors without that safe, stable option for funding their retirements. “Hot money” – investment seeking higher returns – fled from the collapsed housing market into anything but the dollar, which generally meant fleeing into commodities.”
She cites Frederick Kaufman, for the specific mechanism, the commodity fund index:
“Goldman … came up with this idea of the commodity index fund, which really was a way for them to accumulate huge piles of cash for themselves…. Instead of a buy-and-sell order, like everybody does in these markets, they just started buying. It’s called “going long.” They started going long on wheat futures…. And every time one of these contracts came due, they would do something called “rolling it over” into the next contract…. And they kept on buying and buying and buying and buying and accumulating this historically unprecedented pile of long-only wheat futures. And this accumulation created a very odd phenomenon in the market. It’s called a “demand shock.” Usually prices go up because supply is low…. In this case, Goldman and the other banks had introduced this completely unnatural and artificial demand to buy wheat, and that then set the price up…. [H]ard red wheat generally trades between $3 and $6 per sixty-pound bushel. It went up to $12, then $15, then $18. Then it broke $20. And on February 25th, 2008, hard red spring futures settled at $25 per bushel…. [T]he irony here is that in 2008, it was the greatest wheat-producing year in world history.
… [T]he other outrage … is that at the time that Goldman and these other banks are completely messing up the structure of this market, they’ve protected themselves outside the market, through this really almost diabolical idea called “replication”…. Let’s say, … you want me to invest for you in the wheat market. You give me a hundred bucks…. [W]hat I should be doing is putting a hundred bucks in the wheat markets. But I don’t have to do that. All I have to do is put $5 in…. And with that $5, I can hold your hundred-dollar position. Well, now I’ve got ninety-five of your dollars…. [W]hat Goldman did with hundreds of billions of dollars, and what all these banks did with hundreds of billions of dollars, is they put them in the most conservative investments conceivable. They put it in T-bills…. [N]ow that you have hundreds of billions of dollars in T-bills, you can leverage that into trillions of dollars…. And then they take that trillion dollars, they give it to their day traders, and they say, “Go at it, guys. Do whatever is most lucrative today.” And so, as billions of people starve, they use that money to make billions of dollars for themselves.”