Wednesday, March 2, 2011

Futures, speculation, spot prices

There's been a lot of talk lately in all sorts of circles, especially the ones closet to me, about futures, speculation, and spot prices, so I figured I ought to lay out my thoughts somewhat carefully.

1) I focus most on food.  Because food is crucial, volatile, and somewhat more simple than other products.
2) With respect to food, we care about the spot price. Because just about everybody who matters buys food on the spot market—they take their money, hand it over, and get grain.
3) Speculation, even only on a futures market, can impact the spot price. This matters, since most speculation is on the futures market.
4) This works by people buying up goods on the spot market in anticipation of a spot price rise foretold by the futures market.
5) Sometimes this is a good thing. If the fundamentals of the market are going to drive up the price soon (for instance, there's going to be an uptick in demand) it is a good thing to stockpile goods, driving up the price now to drop it in the future, making the change more smooth.
6) The key thing to understand is that there is a natural fundamentals based price—the price at which the producers and the consumers match their supply and demand exactly.
7) The stereotype of economists squeaking "supply, demand; supply, demand!" is because it's just that important.
8) If the price is above this fundamentals-based price, suppliers will make more than consumers consume, so the overall stockpiles of the good will expand.

All of which leads to:
9) If the price of a good is continually elevated (eg by speculators, but really for any reason), we will see a growth in supply stockpiles.

10) We don't see that happening, not on any huge scale at least, and not beyond what is reasonable given expected growth in demand in the developing world combined with climate change induced yield uncertainty.

11) So, baring evidence that somewhere, somehow, grain is being added to vast scale reserves, or that somehow the supply curve or demand curve has been reversed (ie, higher prices leading to lower production or higher consumption), I'm not going to be convinced that food price increases are caused by anything but simple supply and demand.

12) This does not mean that it is virtuous or not screwed up. For instance, a huge portion of the corn grown by the US is made into ethanol and put into cars to burn, in a process that is, overall, carbon positive. Hurts the environment, and drives up food prices. WTF?

In sum, I don't put it past banks to artificially create a food-price bubble to make a profit, I just don't think they're doing it here.


  1. Excellent post. Here are some thoughts on that subject and others wrt academic vs real world pricing and the science(?) of economics and food prices:

  2. I don't know if I ever gave a list of blogs that are timely and top ten for applicability to economics both academic and, more importantly, real world. If you would like them, assuming I have not left them somewhere for you already, please request that I do so.