The Ethics of Financial Speculation in Futures Markets2014.innofin.org/public/docs/Proceedings/Will.pdfMARTIN-LUTHER-UNIVERSITY HALLE-WITTENBERG LEIBNIZ INSTITUTE OF AGRICULTURAL DEVELOPMENT

MARTIN-LUTHER-UNIVERSITY

HALLE-WITTENBERG

LEIBNIZ INSTITUTE OF

AGRICULTURAL DEVELOPMENT IN

CENTRAL AND EASTERN EUROPE

The Ethics of Financial Speculation in Futures

Markets

Ingo Pies*, Matthias Georg Will*, Thomas Glauben** Sören Prehn**

* Martin-Luther-University Halle-Wittenberg (MLU), Chair in Economic

Ethics

** Leibniz Institute of Agricultural Development in Central and Eastern

Europe (IAMO), Agricultural Markets, Marketing and World

Agricultural Trade

Innovation for Financial Services

Montréal, October 17, 2014

2

Worldwide Protests after Price Increases for Food Commodities

(2004-2012)

Quellen von links oben an: http://standeyo.com/C2C_090218/India.food.riot.jpg, http://static.guim.co.uk/sys-images/Guardian/Pix/audio/video/2011/11/22/1321962056421/A-protester-throws-a-tear-010.jpg, http://4.bp.blogspot.com/-DzgCnBcBMTY/TbY7TxAbZtI/AAAAAAAAEe8/Gj8b3sVd_68/s1600/high-food-prices-spark-protests-in-india-where-food-inflation-was-1832-percent-last-month.jpg, http://griid.files.wordpress.com/2012/09/44045095_416_4floods_ap.jpg, http://1.bp.blogspot.com/-

c7B1pIgzP3w/TvviRvBhvjI/AAAAAAAAAqI/etgS6gpgU44/s1600/Mohamed+Bouazizi+in+flames.jpg, http://media.treehugger.com/assets/images/2011/10/food20protest20mexico.jpg, http://e-newschannel.de/wp-content/uploads/2011/01/Mohammed-Bouazizi-in-sidi-bouzid-fire.jpg, http://2.bp.blogspot.com/_AIkWSJ039r8/TIMc3fvjNMI/AAAAAAAADRA/Wmn0GDMibjI/s1600/food3.jpg, http://www.3quarksdaily.com/.a/6a00d8341c562c53ef016303964459970d-800wi,

http://cdn.mg.co.za/crop/content/images/2011/10/01/300Xtahrirxap.jpg/300x300/

Martin-Luther-University, Chair in Economic Ethics and

IAMO, Agricultural Markets, Marketing and World Agricultural Trade

http://standeyo.com/C2C_090218/India.food.riot.jpg

http://static.guim.co.uk/sys-images/Guardian/Pix/audio/video/2011/11/22/1321962056421/A-protester-throws-a-tear-010.jpg

http://4.bp.blogspot.com/-DzgCnBcBMTY/TbY7TxAbZtI/AAAAAAAAEe8/Gj8b3sVd_68/s1600/high-food-prices-spark-protests-in-india-where-food-inflation-was-1832-percent-last-month.jpg

http://griid.files.wordpress.com/2012/09/44045095_416_4floods_ap.jpg

http://1.bp.blogspot.com/-c7B1pIgzP3w/TvviRvBhvjI/AAAAAAAAAqI/etgS6gpgU44/s1600/Mohamed+Bouazizi+in+flames.jpg

http://media.treehugger.com/assets/images/2011/10/food20protest20mexico.jpg

http://e-newschannel.de/wp-content/uploads/2011/01/Mohammed-Bouazizi-in-sidi-bouzid-fire.jpg

http://2.bp.blogspot.com/_AIkWSJ039r8/TIMc3fvjNMI/AAAAAAAADRA/Wmn0GDMibjI/s1600/food3.jpg

http://www.3quarksdaily.com/.a/6a00d8341c562c53ef016303964459970d-800wi

http://cdn.mg.co.za/crop/content/images/2011/10/01/300Xtahrirxap.jpg/300x300/

100,0

120,0

140,0

160,0

180,0

200,0

220,0

240,0

260,0

2004 2005 2006 2007 2008 2009 2010 2011 2012

3

Price Developments with Dramatic Consequences

Development of the FAO Food Price Index from 2004 till August 2012. Price increases

correlate with food riots.

Burundi Somalia, India, Mauretania,

Mozambique, Yemen,

Cameroon, Sudan, Côte

d'Ivoire, Haiti, Egypt,

Tunisia

Mozambique, Tunisia, Lybia,

Egypt, Mauretania, Algeria, Saudi

Arabian, Sudan, Yemen, Oman,

Maroco, Iraq, Bahrain, Syria,

Uganda

Food Riots

2004

–

2012

80,0

130,0

180,0

230,0

280,0

1990 1994 1998 2002 2006 2010

Source: Lagi,, Marco Karen Bertrand and Yaneer Bar-Yam (2011) The Food Crises and Political Instability in North Africa and the Middle East und FAO-Food Price Index



4

Campaigning after the Food Riots in Germany



http://www.oxfam.de/sites/www.oxfam.de/files/imagecache/mainimage_

node/mainimage/_dsc7973.jpg http://www.erlassjahr.de/cms/upload/bilder/Startseite/mitessenspielmannic

ht.jpg

https://d1p42fqrbwqdsw.cloudfront.net/campaigns/background

_images/000/002/048/web/Oxfam_Spekulanten-in-die-

Schranken_580x270px.jpg?1366984874

http://m3.paperblog.com/i/66/666548/mit-essen-spielt-man-

nicht-L-q1EDoM.jpeg

http://garbersgazette.de/wp-content/uploads/2012/03/Banner-

Ackermann_422_startseite_ger.jpg

5

Overview of the Argumentation

1. Moralizing ≠ Ethics

2. Economics for a Reconstruction of Moral Concerns

3. Using Economic Insights for Dealing with Moral Concerns



A Bias within the Field of Ethics: The Individual Level

6

On the individual level, scholars argue that speculation may lead to an addictive and self-

destructive behavior.

• "The mental qualities that are most frequently called into play among professional

speculators are those that characterize the activities of the professional gambler."

(Ryan, 1902, p. 345)

• "Gamblers who have lost money may be tempted to ‘‘double down’’ and increase

their bets in attempts to win back their losses. This increases their losses, with

potentially devastating consequences to themselves, their employers, and the

community around them." (Angel and McCabe, 2009, p. 284)



A Bias within the Field of Ethics: The Societal Level

7

Scholars in the field of ethics assume that speculation has negative societal effects.

• "Compulsive gambling disguised as speculation ... can be particularly injurious to

markets because gamblers may be trading based on their compulsion, not their

information. Their trades may distort prices away from their fundamental economic

values and send false price signals to producers and consumers." (Angel and

McCabe, 2009, p. 284)

• "The wagers that underlie futures and options imply a zero-sum game: what the

option buyer gains, the option seller loses, minus the amount retained in option

fees. Such zero-sum games on a grand scale, resulting from the proliferation of

wagers on the same underlying asset, make no sense in macro-economic terms.

Given the fees incurred, only the banks get rich, while no macro-economic value is

added. A zero-sum game after the deduction of fees becomes a negative-sum

game from which everybody ends up losing." (Koslowski, 2009, 2011, p. 123)



The Societal Discourse about (Passive) Index Funds

8

NGOs that criticize passive index funds have gone one step further than the academic

debate and differentiate between “good” and “bad” speculators.



http://www1.pictures.gi.zimbio.com/Elections+Subcommittee+Holds+Hearing+Voter+CEY2k97dx6yl.jpg

„Index Speculators’ trading strategies amount

to virtual hoarding via the commodities futures

markets. Institutional Investors are buying up

essential items that exist in limited quantities for

the sole purpose of reaping speculative profits.“Masters, Michael (2008; S. 6)

„Index Speculators provide no benefit to the

futures markets and they inflict a tremendous

cost upon society.“Masters, Michael (2010): Testimony before the Committee on Commodities Futures Trading Commission

http://www1.pictures.gi.zimbio.com/Elections+Subcommittee+Holds+Hearing+Voter+CEY2k97dx6yl.jpg

„Active and passive speculators are two

very different animals, and to understand

the distinctions between the two is to

appreciate the extent of the threat posed

by passive speculators. Active speculators

add beneficial liquidity to the market by

buying and selling futures contracts with

the goal of turning a profit. In contrast,

passive speculators drain liquidity by

buying and holding large quantities of

futures contracts – basically acting as

consumers who never actually take

delivery of goods.“Masters, Michael (2008): Testimony before the Committee on Homeland Security and Governmental

Affairs United States Senate.

Are We Asking the Right Questions?

9

There are empirical and conceptual doubts that the “speculation-is-bad”-storyline really fits

both for the individual and societal level.

• Today, the most relevant speculators are not individuals. They are big organizations.

Thus, traditional approaches of the field of ethics may be not appropriate.

• The field of economic theory develops its explanatory power not only from analyzing

individual motives but also from the “situational logic” of markets.



• This "situational logic" of markets calls for a moral assessment of the (systematic)

consequences of market activities.

• Concentrating on the empirical output rather than on the intentional input of market

activities requires a shift from asking psycho-logical questions to asking socio-logical

questions.

10







Non-Commercials

• Long and short

• Discretionary (active)

• Partly collaterized

• Information function

• Liquidity function

• Insurance function

(Traditional) Speculation

Index Funds

• Long-only

• Not discretionary (passive)

• Fully collaterized

• No information function

• Liquidity function

• Insurance function

No (Traditional) Speculation

11

Passive Index Funds are Different

Index funds apply a specific trading strategy: They trace the market trend. To receive a

certain risk profile, they mix their index portfolios with constant weights of different

commodities. Therefore, they have to steadily re-balance their portfolios.

During the last years, the investment volume of passive index funds has

enormously increased. However, we neither find theoretical nor empirical

arguments that index funds increase prices or volatility. Furthermore, index

funds have a price stabilizing effect because of their specific trading strategy

(Prehn et al., 2013).



23

1211

21 1 1 1

18

5

1 1 1 1

0

5

10

15

20

25 Results of 35 Econometrical Studies

6 studies that find an

impact on volatility

9 studies that find an

impact on price levels

Results of the studies researching

volatility:

Results of the studies researching

price levels:

12

15 15

10

12

6

32

32 2

0

5

10

15

20

25

Implication of the 35 Studies Regarding the Regulation of Agricultural

Future Markets

Implications of the studies

that warn against

overregulation

13

Passive Index Funds: Transforming Risk in a Productive Factor

14

Passive index funds have developed an interesting business model: They hedge the

inflation risks of their investors by bearing the price risks of traders within the commodity

markets.



„Index Speculators’ trading strategies amount

to virtual hoarding via the commodities futures

markets. Institutional Investors are buying up

essential items that exist in limited quantities for

the sole purpose of reaping speculative profits.“Masters, Michael (2008; S. 6)

„Index Speculators provide no benefit to the

futures markets and they inflict a tremendous

cost upon society.“Masters, Michael (2010): Testimony before the Committee on Commodities Futures Trading Commission

Risk σ

Expected

Income μ

A

Gross Risk

Net Risk

(with Guarantees)

B

1.

μA

=μB

σAσB

C

D

2.

2.

σC σD

3.

μC

=μD

• Passive index funds add liquidity to the

future markets.

• Especially, when traditional speculators

leave the future markets, it is attractive for

passive index funds to get into the market.

• Thus, farmers (and other producers of

commodities) get additional possibilities

for insuring their price risks.

• In the end, farmers (and other producers

of commodities) have an incentive to

increase their productivity because they

have to bear less (price) risks.

15







Ethics can Learn from Economics

16

• Competitive markets can lead private action to promote public welfare.

• In scrutinizing the potential sources of malfunctions in the business sector,

economists have become aware that the institutional framework plays a decisive

role in shaping competitive forces towards good or bad results.

• Thus, economists came to the conclusion that many market problems have their

origin in political problems, especially where politics is responsible for deficits in

the institutional framework of competitive markets.

• The core insight here is that market failure might result from political failure.

Hunger and malnutrition are often not the consequence of poorly working markets.

Moreover, political failures in developing countries often cause hunger and

malnutrition.



Economics can also Learn from Ethics

17

• Ethics can help by pointing to a quite different source of political failure.

• If false beliefs dominate the public perception of a problem or the perception of

possible solutions, this might lead to a "discourse failure" (Pincione/Tesón 2006)

that pressures political actors to take certain measures even if these in fact defy

the common good.

• Claims by civil society organizations to drastically reduce or even prohibit index

fund activity in commodity futures markets, intended to protect agricultural

production against shocks, might instead un-intentionally and even strictly

counter-intentionally! be detrimental to the moral aim of improving global food

security.

• Therefore ethics, specialized in criticizing (erroneous) moral criticisms on moral

grounds, can complement economics. Ethics can provide arguments that guard

against "discourse failures"



18

Back-Up






Real Economy Triggers for Recent Agricultural Crises

19

The dramatic price increases experienced in recent years were caused by shocks and

structural developments in the real economy. They were intensified by political coordination

failures.

• Global population growth combined with a global increase in per capita income

boosted the consumption of meat, which in turn increased the demand for

agricultural commodities, especially animal feedstuff

• The promotion of bio energy led to competition between the use of commodities

as a fuel as opposed to as a food (food vs. fuel dilemma).

• In 2007 and 2010/2011, adverse meteorological events caused significant price

increases that were exacerbated by low stock inventories.

• Many countries reacted to these price increases by initiating policies that, in

retrospect, contradicted the expectation formation of market participants, causing

severe difficulties for the price discovery process. These highly controversial

policies were taken by both exporting and importing countries.



20

Overview of Policy Recommendations

Field 1: Empower Futures Markets

Better transparency (EMIR); avoid overregulation (MiFID)

Field 2: Measures to Increase Global Food Supply

Support R&D and encourage both private and public investment

Field 3: Measures to Solve the Food vs. Fuel Dilemma

Reconsider “greening” strategy in times of hunger

Field 4: Prevent Policy Coordination Failure that Endangers Food Security:

Reform the WTO Uruguay Round Green Box Agreement (Annex 2) that

allows governments to implement protectionism – one important reason

for price explosions!

Field 5: Prevent Market Intervention that Endangers Food Security

Improve Risk Management and Social Security in Developing Countries



Prices for Crude Oil, Debasement of the US-$

Bio fuels

Economic and population growth, increasing

consumption of meat per capita

Weather

Politics

High

production,

global

recession

Weather

Global Economic

Growth

Politics and

declining stocks

Increasing Stocks

Declining global Stocks

Index: January 2002=100

The Impact of the Real Economy on Agricultural Prices

21

The figure summarizes important causes for crises by the real economy. We find: (1) macro

economical shocks, (2) structural trends of an increasing demand, (3) competition in the usage

because of a promotion of bio fuels, (4) decreasing stocks, (5) adverse meteorological events, (6)

political mistakes.

Price index for weighted prices according to the amount of

traded wheat, rice, corn and soya

Source: Trostle et al. (2011; p. 9).Martin-Luther-University, Chair in Economic Ethics and


The Consumption of Meat Increases

22

Source: IFAD WFP FAO (2012; S. 19).

Nigeria

Bangladesh

Indonesia

nChina, Mainland

India

Japan

Brasilia

Mexico

Pakistan

Spain

Italy

Germany

France

USA

Share of animalistic food for diet (in %)

Increasing per capita income changes the diet of former poor peoble. The consumption of meat

increases. That causes an overproportional increase of the demand for agricultural commodities.



23

Exporting countries reduce supply

(beginning in autumn 2007)

Importing countries increase deman

(beginning in January 2008)

China withdraws subventions for export.

China, Argentina, Russia, Kazakhstan, and

Malaysia increase export tariffs.

Argentina, Ukraine, India and Vietnam

introduce quantitative export restrictions for

wheat and rice.

Ukraine, Serbia and India forbid exports of

wheat.

Egypt, Cambodia, Vietnam and Indonesia forbid

exports of rice.

India forbids exports of rice (except Basmati).

These countries reduced import tariffs:

India (for wheat flour)

Indonesia (soya and wheat)

Serbia (wheat)

Thailand (pork)

EU (grain)

These countries increased their stocks for rice

by means of public purchases:

Philippines

Malaysia

Source: Own figure, referring to Trostle (2008; pp. 23-24) and – especially for the rice market – the detailled overview of Dawe and

Slayton (2011; Figure 9.2, p. 175).

Political Reactions during the Crisis in 2007/8

Producing countries applied exceptions of the WTO rules and tried by means of export limitations or

even bans that aimed on holding food commodities within the home countries. That caused panic on

the markets. Furthermore, importing countries tried to react with public policies. These policies

additionally increased the prices.



24

Two years later, politics repeated the same mistakes. This holds especially for importing countries.

Political Reactions on the Crisis in 2010/11

Exporting countries reduce supply

(beginning in August 2010)

Importing countries increase demand

(beginning in December 2010 till March 2011)

Russia bans export of wheat.

Belarus incurs a crop failure of 30% for

canola oil and bans exports.

Turkey suspends tariffs on wheat imports

for the public sector.

China, Jordan and Algeria tremendously

increase their imports of wheat.

Bangladesh, Taiwan and Russia reduce

tariffs for imports of some agricultural

commodities.

Afghanistan, Indonesia, Agypt, Iraq and

Tunesia tremendously increase their

imports of wheat.

The European Union suspends tariffs for

importing barley and wheat for feed.

Turkey suspends tariffs on wheat imports

of the private sector.

Source: Own figure, reffering to Trostle et al. (2011; Table 3, p. 20).



25Martin-Luther-University, Chair in Economic Ethics and


Afr Asi Lat Sum

Countries 33 26 22 81

Foreign Trade Policy

Restrictions on exports (up to prohibition of exports)

Relaxation of import restrictions (Suspense of customs duty)

8

18

13

13

4

12

25

43

Internal Trade Policy

Targeted tax reductions (e.g. reduced VAT rate)

Sale of stocks for low prices

Price ceilings (including prohibition of hoarding)

14

13

10

5

15

6

4

7

5

23

35

21

Support for Supply Side

Input Subsidies (e.g. cheap-rate loans, fuel subsidies)

Subsidies for fertilizers and seeds

Interventions (e.g. state programs for regrating farm produce)

Market support (e.g. public price information)

12

4

6

4

11

2

4

9

12

3

5

2

35

9

15

15

Support for Demand Side

Income policies (public employment programs)

Ear-marked money transfers to poor people

Direct food supply for people in need

4

6

5

8

8

9

4

9

5

19

23

16

Policy Measures in 81 States in Reaction to the Crisis in 2006-2008

Source: Demeke et al. (2009).

If due to low stocks shocks cannot be buffered, even small supply shocks can

cause extreme price increases.

26

Relevance of Stocks for Buffering Shocks

Because of low stocks, quantity adjustments result in extreme price reactions: An inelastic demand

interacts with an inelastic supply.

Source: Own figure referring toWright (2011; Figure 7, p. 38).

Price

Consumption demand

Total demand,

including stock keeping

Quantity



Stock-to-Use-Ratio as an Indicator for Crises (Wheat)

27

The Stock-to-Use-Ratio is an indicator for food crises. If the ratio falls below a critical value (near

20%), massive price increases can emerge (grey areas).

We find high price increases within the periods that are marked grey. Before

these periods (especially before 2008), stocks went down, not up. This indicates

that the food crisis was not caused by speculation.

Worldwide

Worldwide without China

0,15

0,20

0,25

0,30

0,35

0,40

0,45

0,50

19

60

19

62

19

64

19

66

19

68

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

Weltweit

Weltweit ohne China

Source: USDA Foreign Agricultural Service–Production Supply and Distribution Online

World

World without China



The Level of Speculation and Index Fund Investments have Increased

28

The amount of capital employed (Total Commodity Assets under Management in Mrd. US$) has

strongly increased in the period 2003 till 2011.

Barclays Capital (2011) The Commodity Refiner (Autumn 2011)

9,1 1930

45

60 44

65

9499

0

50

100

150

200

250

300

350

400

450

2003 2004 2005 2006 2007 2008 2009 2010 2011

Energie

Agrarrohstoffe

Industriemetalle

Edelmetalle

The aggregate value of all commodities has increased just as the value of

agrigultural commodities.

Energy

Agricultural commodities

Industry metals

Precious metals



Time Lags between Speculation and Price Rises

29

0

100

200

300

400

500

600

700

800

900

0

25000

50000

75000

100000

125000

150000

175000

200000

225000

2004 2005 2006 2007 2008 2009

Long-Positions (Anzahl)

Preis (Cent/Scheffel)

0

100

200

300

400

500

600

0

50000

100000

150000

200000

250000

300000

350000

400000

450000

2004 2005 2006 2007 2008 2009

Long-Positions

(Anzahl)


0

200

400

600

800

1000

1200

1400

0

20000

40000

60000

80000

100000

120000

140000

160000

180000

2004 2005 2006 2007 2008 2009

Long-Positions (Anzahl)


Wheat Soya

Corn

We can find higher prices. However, there are huge time lags between the increase of speculation

volume and price rises. These lags cause doubts if there is causality.

Source: Sanders and Irwin (2011; Table 1, p. 525).

Price (Cent/Bushel) Price (Cent/Bushel)

(Quantity)(Quantity)

Price (Cent/Bushel)

(Quantity)



Real Food Prices Decreased Since 1900 Despite of an Increasing Global

Population

30

Fuglie and Wang (2012; p. 2).

Food-Price-Index 1977-79 = 100

Food-Price-Index

-0,9% p. a.

Global Population

Global Population in Billions



Sources of Growth for the Global Food Production, 1960-2009

31

Fuglie and Wang (2012; Figure 3, p. 4).

Growth p. a. (in %)

Sources of Growth:

Total Factor Productivity Input-Intensification Irrigation Bigger Cropland



What We can Learn from Onions about Speculation

32

The monthly volatility for onions (in percent) is in general higher than the volatility of crude oil

because there is no future market for onions.

Mark Perry (2012): http://www.dailymarkets.com/economy/2012/04/22/what-can-onions-teach-us-about-oil-speculators/

The USA banned a future market for onions in 1958. Therefore, market

participants have no possibilites for inter-temporal balances. That increases

tremendously volatility. Without speculation, volatility increases!

-80%

-40%

0%

40%

80%

120%

160%

200%

2000 2002 2004 2006 2008 2010 2012

Onions: Mean 7,0%, SD 59,4%

Crude Oil: Mean 1,3%, SD 8,6%



http://www.dailymarkets.com/economy/2012/04/22/what-can-onions-teach-us-about-oil-speculators/

Documents

The Ethics of Financial Speculation in Futures Markets2014.innofin.org/public/docs/Proceedings/Will.pdfMARTIN-LUTHER-UNIVERSITY HALLE-WITTENBERG LEIBNIZ INSTITUTE OF AGRICULTURAL DEVELOPMENT