Greece and the sugar market may appear to have little in common but in the past couple of months both have been subjected to the attentions of speculators and both have suffered as a result. In the case of Greece, hedge funds have bet against the country's ability to keep paying its debts by buying credit default swaps and making it more expensive for banks to insure their Greek debt. This in turn has helped push up the cost of Greece's borrowing, making a default more likely.
The actions of the speculators has exaggerated and inflamed an already bad situation, creating a vicious spiral that will enrich those betting against Greece. This risks throwing the country into turmoil, putting people out of work and impoverishing a nation. Not surprisingly, Greek leaders and other European politicians have denounced the speculators and one possible outcome is a ban on this type of short selling.
The hedge funds have defended their actions claiming they are merely helping the market discover the true price of Greece's debt. They argue that Greece is being punished for its lax attitude to fiscal control - and this is a fair point. However, there is now so much money being gambled by speculators that the supply-demand balance has been fundamentally altered and this presents serious economic dangers.
Take, for example, the sugar market. There is usually sufficient supply to meet demand for sugar except when the crop is hit by an external shock such as poor weather, which causes a sharp fall in production. That happened last year and the sugar market is currently in deficit, meaning that some producing countries are now importing sugar.
This fall in supply resulted in gradually rising prices throughout the second half of last year. Then, towards the end of 2009 and start of 2010, prices suddenly shot up as speculative money spotted an opportunity. Prices in that period rose by about 50 per cent to 30 cents (Dh1.7) per pound.
But a number of factors then led to an easing of the supply crunch. These included better than expected production from India and stockpile reductions in the EU. This was enough to dampen the price rise and the hot money fled, turning an ordered withdrawal into a rout. Since mid February, the price of sugar has fallen by nearly half, to 17 cents per pound.
Analysts now fear that farmers will be put off by the low price. The production shortfall will be made worse, creating the conditions for an even steeper price rise later in the year.
Two years ago, a similar cycle hit other crops and led to food riots in some countries as people went hungry because the cost of staple foods had shot up. The price of oil was also driven to a level that defied common sense by excessive flows of hot money.
When oil hit $100 a barrel at the start of 2008 there were good underlying reasons for it reaching that level but the surge towards a peak of $148 was the result of hot money coming into the market. The result was that companies in the real world were squeezed because their costs shot through the roof.
When everyone realised that the global economy was not as robust as previously thought the hot money fled and oil plunged well beyond sensible levels to under $30 a barrel. But the damage had already been done to the balance sheets of large oil consumers and many companies were short of cash just when they needed reserves to see them through the downturn.
Somehow we have ended up with commodity markets that are driven primarily by financial instruments, not real supply and demand. Derivatives designed to even out fluctuations in the real world are being used to dictate market conditions. The fundamentals have lost out to speculation and the result is increased volatility, not less.
There is now so much speculative money that we do not have price discovery but price irresponsibility as the value of commodities is driven up and then abandoned creating huge peaks and troughs.
In such an environment businessmen in the real economy cannot invest in future production or efficiencies because prices have become too uncertain. Surely the lesson of the past two years is that what masquerades as clever financial wizardry one day can become a curse the next. Investment funds should encourage growth, not feed on markets like locusts.
- The writer is the Business Correspondent with The Times of London
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