Don’t Blame Goldman Sachs for the Food Crisis

Frederick Kaufman’s article "How Goldman Sachs Created the Food Crisis," ignores a number of important facts about the underlying economic, social, and political factors that have driven the rise in food prices.

The assertion that Goldman Sachs introduced speculation into commodity markets is incorrect. The Commodity Research Bureau (CRB) Index has been investible since the early 1970s, and futures on the CRB Index have been traded since 1986, five years before the creation of the Goldman Sachs Commodities Index (GSCI). Gary Cohn, the president of Goldman Sachs, was not involved in the creation of the index, contrary to the article’s assertion. The GSCI was purchased by Standard and Poor’s in 2007 and retains a connection to Goldman Sachs in name only.

More importantly, the article does not present any credible evidence that commodity index investing is responsible for the rise in food prices. Serious inquires, such as one conducted by the OECD in the wake of the 2008 price spike, have concluded that "index funds did not cause a bubble in commodity futures prices." Rather than destabilizing futures markets, commodity index funds provide them with a stable pool of capital, improving farmers’ ability to insure themselves against the risks inherent in agricultural prices. This, in turn, can allow farmers to produce more food at a lower cost. The pension and endowment funds providing this vital capital are investing the savings of individuals. They are not faceless "speculators." They represent people, often pensioners, who seek to protect the value of their savings against inflation and rising food prices.

Finally, the article suggests that because commodity indices are "long-only" they, therefore, inflate prices. This is not the case. Futures contracts expire on a set date, meaning that "rolling" them over simply involves a re-investment of the original funds by selling one contract and buying another. This "roll-over" is akin to renewing home-owners insurance from year to year and is not like purchasing a second or third home, which could inflate prices.

The real drivers of food inflation and food shortages are long-term trends, like increased meat consumption by the growing middle class in emerging markets and greater use of biofuels in the developed markets. Monetary policy, climate change, and protectionism also play key roles. Historical facts and demonstrable economic trends cannot be disregarded if there is to be a productive discussion about this vital issue.

Sincerely,

Lucas van Praag
Managing Director
Goldman, Sachs & Co.

Frederick Kaufman replies:

Instead of working to undo the damage Goldman Sachs and other banks have done by transforming our daily bread into nothing but a financial product, and instead of elucidating the murky world of over-the-counter swaps and baroque derivatives, Lucas van Praag has chosen to offer up yet another example of the fact-twisting and blindness that have unfortunately become the 21st century banking industry’s norm.

My article "How Goldman Sachs Created the Food Crisis" did not accuse Goldman of introducing speculation to the commodity markets. To the contrary, the editors at Foreign Policy allowed a great deal of space for the history of American commodity markets, including an explanation of the traditional role of bona-fide hedgers and speculators. Of course, it is not traditional speculation that has sparked the historically unprecedented rise in the price of food, but the demand-shock Goldman and their industry followers introduced to the markets with their long-only Goldman Sachs Commodity Index fund — the two-decades-old food, energy, and precious metals derivative that has come to be widely imitated throughout the financial industry.

Regarding the role of Gary Cohn, we need only review his testimony to Congress in September of 2008, in which Goldman’s president articulated the ideas and concepts that lay behind the birth of the GSCI: "There was no natural long in the market," Cohn explained to the Senate. "The consumers are so fragmented that they don’t amalgamate to a big enough position. So we actually, as a firm, came up with the idea in the early 1990s to create a long only, static investor in the commodity markets." In other words — and contrary to van Praag’s assertion — the traditional buy/sell or sell/buy activity of the commodities futures market did not satisfy Goldman, nor allow them nor their largest clients (in this case, multinational oil firms) the market position they desired, a position which had little to do with the long-standing price discovery function of the futures market. Long-only indexes subsequently hijacked this role from this market.

Van Praag’s assertion that the index funds were created to help "pensioners, who seek to protect the value of their savings against inflation and rising food prices" is a classic case of Wall Street posing as Main Street. Spurred by the institutional sales force of Goldman and other banks, the weight of hundreds of billions of dollars of new money from hedge, pension, and sovereign wealth funds has pushed up the slope of the agricultural price curve. Meanwhile, the contango markets caused by the demand shock the long-only indexes themselves introduced have created a negative yield for investors — who lose money five times a year as commodity prices surge and the price-insensitive funds buy. The regular, 5-times-a-year "roll" of long futures has given commodity insiders the opportunity for immense profit at the expense of investors, and it is simply misleading for van Praag to compare the unnatural, subversive market behavior of the banks to a responsible property owner who regularly renews her home insurance policy.

While the OECD study has turned a blind eye, both the United Nations and the Senate Committee on Homeland Security and Government Affairs — in their investigation of the role of long-only index funds as a threat to interstate commerce — concluded that these funds must bear some of the blame for the rising cost of food. Of course, supply and demand matter, as do monetary policy, climate change, and nationalistic policies of protectionism. But despite all protestations of innocence, the long-only index funds have added regular doses of kerosene to the commodity conflagration that has come to mark the new millennium. No surprise, then, that both the U.S. Commodities Future Trading Commission and the G-20 agricultural ministers have put long-only index fund speculation near the top of their lists of the most egregious financial abuses.

Frederick Kaufman is the author of A Short History of the American Stomach.