Farmers have sold their food grains in markets for millennia. For almost as long, traders, bankers, and moneylenders have been involved in financing and shaping those markets. Over time, financial players have tried to control those markets so as to pay the farmer less, or to charge the consumer more. The oldest market regulations in the world were created to protect farmers and consumers from such “cornered” markets. In recent decades, U.S. government regulation of many agricultural markets was severely weakened for long periods of time, clearing the way for speculators and grain traders to make the markets more volatile and to capture windfall profits.
In the United States today, the prices for commodity food grains such as wheat, corn, and soybeans are established in specialized markets such as the Chicago Mercantile Exchange or the Kansas City Board of Trade (which was bought by CME in 2012). In these markets, farmers, traders, and other middlemen buy and sell the actual or physical grains. They also buy and sell various forms of “futures” contracts that commit the farmer and trader to deliver or accept a particular amount of physical grain at some particular moment for a particular price, at a date sometimes long in the future.
Futures contracts are designed to stabilize markets and the production and distribution of food grains. They serve as a way for farmers, traders, and food processors to protect themselves—or “hedge”—against sudden spikes or plunges in prices, as well as against pests, flooding, and other vagaries particular to agriculture. They do so by enabling traders to lend to farmers the money they require to plant, harvest, and deliver their crops. Futures allow both the farmer and buyer to plan ahead and to manage their businesses more effectively.
Futures contracts date back as far as 17th century Japan. In the United States, the Chicago Board of Trade established the first commodity futures market in 1864. Futures markets have been federally regulated since 1922. In today’s world, where grain trading is international in scope, the Commodity Futures Trading Commission and the Securities and Exchange Commission regulate U.S. grain markets.
Despite the immense size of these markets, and despite the numerous regulatory checks, well-capitalized traders over the last two decades have found ways both to destabilize and to corner these markets. More volatile markets serve the trader by increasing the number of trades that take place each day, which in turn increases the fees that traders collect and the number of hedges they can sell. Cornering markets can enable traders and other speculators to sell both the physical grains and futures contracts for much higher prices.
The greater volatility in today’s markets is largely a function of the deregulation of commodity markets between the 1980s and the early 2000s. For most of the 20th Century, the U.S. government carefully regulated commodity markets. Key pieces of federal legislation, including the Grain Futures Act of 1922 and the US Commodity Exchange Act of 1936, empowered regulators to closely limit the participation of those traders, such as speculators and banks, who do not deal with the physical commodity. The Commodity Exchange Act also empowered regulators to set position limits, a ceiling on how many futures contracts a single investor can hold.
But beginning in the 1980s Congress and the Executive, under both Republican and Democratic control, relaxed the restrictions on non-commercial traders and position limits. They also allowed more trades to occur outside of the marketplace, in unregulated venues. One of the main outcomes of these changes was to make it possible for Wall Street traders to use commodity crops as investment tools.
Beginning in the 1990s, many futures markets for food grains – as well as for commodities like energy and metals – were flooded with money from investment firms that had until then played a small role in the agricultural supply chain. This flood was facilitated by the creation of the Goldman Sachs Commodity Index, which allowed bankers and traders to make money off commodities markets without absorbing much of the risk associated with such trading. Several other such commodity indexes followed. By the late 2000s, hundreds of billions of dollars had been invested in these new commodity indexes. Between 2006 and 2010, financial speculators held 70% of the Chicago Board of Trade’s wheat contracts.
The huge leap in trading from speculators contributed to a boom in commodity prices. Between January 2005 and March 2008, the value of commodity futures contracts controlled by investors doubled to around $400 billion. In 2008, grocery prices in the U.S. shot up 6.6%, the biggest spike since the oil crisis of 1980. The price of a bushel of wheat, which had held at $3 for years, hit nearly $13. Internationally, the average price of food, including commodities like soy, rice, and wheat, rose 80%. Unrest and riots related to high food prices broke out in several countries, including Egypt, Pakistan, and Indonesia.
Other factors played a role in the rising cost of food. Rapidly growing demand in China for livestock, which tend to eat a lot of grain, contributed to the price increases. Droughts in Australia and California devastated wheat and rice crops. But many analysts agree that speculation contributed greatly to the rising prices. In a 2010 report, Olivier De Schutter, the United Nations Special Rapporteur on the Right to Food, stated that “a significant portion of the increases in price and volatility of essential food commodities [during the 2008 crisis] can only be explained by the emergence of a speculative bubble.”
In 2013, the Financial Times reported that the top 20 traders had made over $250 billion from commodities trading in the prior decade. The top four traders in profits were Mitsubishi, Glencore, Mitsui, and Cargill. Since the financial crisis of 2008 and greater scrutiny of bank speculation in commodities markets, players like Morgan Stanley and Goldman Sachs have scaled back on their commodities holdings.
The four largest grain companies – Archer-Daniels Midland, Bunge, Cargill, and Louis Dreyfus – have extensive operations on the commodity exchanges. Some of these companies and others have been found to use the information they glean from their wide-reaching commodity-handling operations to inform their commodity hedging strategies. The European Union has taken steps to limit or even criminalize such use of private information in commodity market trades. The exchanges themselves have also become more concentrated. For instance, the CME Group controls the Chicago Board of Trade, New York Mercantile Exchange, and Kansas City Board of Trade.
Since the beginning of the financial crisis, attempts have been made in the U.S. to rein in the power of hedge funds and investment banks in commodity market trading. The Dodd-Frank Act of 2010 included rulemaking that instituted stronger position limits for 28 commodities. But in 2016, top advisors at the CFTC challenged the necessity of such limits.
Between 2009 and 2014, under the leadership of Gary Gensler, the CFTC overhauled its oversight of derivatives markets. During that time period, the agency brought high profile cases against Barclays, Citigroup, JP Morgan Chase, UBS, and Goldman Sachs, some of which involved commodity speculation. The resulting fines levied against those companies were among the highest in the agency’s history.