How Goldman Sachs started the food speculation frenzy

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  1. hvactec

    hvactec VIP Member

    Jan 17, 2010
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    US Investment bank Goldman Sachs convinced government officials in the early 1990s to allow it to start gambling on the price of food. Alan Bjerga explains how they did it

    In 1991, Goldman Sachs had an idea that changed commodity-trading forever.

    J. Aron & Co., Goldman’s commodities trader, wanted to enter into a swap with a pension fund that wanted to add commodities to its portfolio. Raw goods were looking attractive at the moment. Inflation had risen more than 6 per cent the previous year, and the economy was in the recession that, in 1992, would elect Bill Clinton president.

    The pension fund wanted to buy into commodities to manage its financial risk, which Congress had said it could do. Goldman was willing to do the deal, but as a speculator that didn’t rely on producing or using physical goods for its business, J. Aron could only do so much before it bumped up against Commodity Futures Trading Commission (CFTC) limits on positions - that could be held by a speculator. Position limits, put in place to prevent market corners and manipulation, date to the Commodities Exchange Act of 1936.

    The pension fund didn’t want to invest in a single commodity - corn, or wheat, or natural gas have too many individual quirks, - but it did want to benefit from commodities as an asset class, buying into oil, natural gas, corn, wheat, and other goods. So, Goldman created an index that would track prices of a predetermined selection of commodities, allowing index-fund buyers a way to speculate in physical goods. That let the pension fund manage its risk, often backing that index by buying up the actual futures of the foods, fuels, and metals the index covered.

    To make sure futures holdings matched the investment, Goldman asked the CFTC for an exemption from speculative limits on crop futures under a loophole Congress had opened in the 1980s. The CFTC granted the request.

    Investment banks could buy crop contracts, just like a wheat merchant. Food no longer made for just a balanced diet. It balanced portfolios too, opening the doors for millions of investors to have a personal stake in food and energy markets beyond their groceries and gas tanks.

    Goldman’s innovation didn’t instantly change trading. Shifts in political winds posed a danger to any bank getting overly involved in commodities. Bush’s CFTC could give an exemption, but someone else's could take it away. The stock market was about to begin nine straight years of gains. Corn, thanks to the productivity of U.S. farmers and stable world markets, couldn’t compete with that.

    Stock market collapses: food takes over

    The year 2000 was a turning point. The Commodity Futures Modernization Act, passed by Congress as Clinton was leaving office, largely exempted over-the-counter derivatives from regulation. George W. Bush’s election as president ensured that the CFTC would favour deregulation. For free-market advocates, the creative power of modern markets would be unleashed –just as crops, energy, and metals were about to look better than ever as an investment.

    A quarter-century of stock-market triunph was ending. The Dow Jones Industrial Average reached 11,750 on January 14, 2000, more than 12 times its value 20 years earlier. Corn that day closed at $2.19 a bushel – down exactly 70.25 cents from where it stood at the end of the 1970s.

    The new decade wouldn’t be like the previous two. The dot-com bubble burst, starting a recession that began before September 11, 2001, terror attacks and lingered beyond it. Stock markets bottomed out in 2002 after the Dow lost 39 percent of its value. Real state was the next bubble. The housing boom took markets to new heights – then, as prices collapsed, to another plunge and an even deeper recession – this time a 54 percent drop from October 2007 to March 2009.

    Investors accustomed to scarcely interrupted stock-market gains needed something that could restore a semblance of balance to their financial lives. Low interest rates made parking money in a bank account unattractive. Real estate that was supposed to rise forever, didn’t. But everyone needs to eat. Investors wanted a save haven from a stock-market boom gone bust.

    Can the speculation be stopped?

    read more How Goldman Sachs started the food speculation frenzy - News - The Ecologist

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