A moral evaluation of speculation on agricultural commodities. Consideration of the greatest happiness principle by Jeremy Bentham

Inhaltsverzeichnis

Table of Figures

Table of abbreviations

Acknowledgement

1. Introduction

2. Definitions
2.1 Greatest Happiness Principle by Jeremy Bentham
2.2 Agricultural Commodities
2.3 Commodity Futures and the Futures Market
2.4 Speculation

3. Analyzing the Consequences of Speculation on Agricultural Commodities for all Concerned Parties
3.1 Analyzing the Consequences of Speculation in Commodity Trading Firms
3.2 Analyzing the Consequences of Speculation on Banks and Investors
3.3 What impact does speculation have on the price development of agricultural commodities

4. Application of the greatest happiness principle

5. Advice for policy makers

6. Conclusion

Bibliography

Table of Figures

Figure 1: A Futures Trade

Figure 2: 5-year annual return of agricultural ETFs

Figure 3: 5-year average annual return of s&p 500 and MSCI World ETFs

Table of abbreviations

Abbildung in dieser Leseprobe nicht enthalten

Acknowledgement

First of all, I want to thank my loving and supporting family. My parents built the cornerstones for my curiosity and the pursuit to achieve more. Without them, I wouldn’t be sitting here at Harvard University today. My sister always supported me morally and gave me love. I am grateful to have this family.

To the best friends in the world: Hannes Poritz, Jakob Malte Schrader, Jan Hinrich Kempfert, Lars Henske and my childhood friend Niklas Suckut. I am glad to have you as my second family.

A special gratitude goes out to Rue Shetty, who spend plenty of hours in the library with me, proof­read my paper and fixed my language mistakes. I am very happy that I got to know you.

1. Introduction

More than 787 million people suffer from malnourishment today. This is about 10.7 % of the whole world population.^[1] Especially in developing regions like Sub-Saharan Africa undernourishment is a big problem: More than 20 % of the whole population is undernourished.^[2]

Concurrently, the quantity of commodity derivatives contracts is rising. By comparing the amount of commodity derivatives contracts from January 2011 to January 2017, it is evident that there was a total rise of approximately 250 million or about 267 %.^[3]

My thesis statement is, that it’s ethical to speculate on agricultural commodities. While the scientific community is unclear about the question about if speculation cause higher food prices, it has a consensus that speculation on agricultural commodities also has positive effects. Through this statement, I disagree with the majority of the civil society.

The British NGO Oxfam said 2012 in its campaign video “Speculation with agricultural commodities is causing maize, wheat and rice prices to skyrocket. This pushes millions of people in poor countries into poverty and hunger.”^[4] The Swiss sociologist and vice-president of the Advisory Committee to the United Nations Human Rights Council Jean Ziegler agreed by saying “Futures [...] and other financial instruments may be legal, but still constitute a crime against humanity. [...] They aren't speculating in order to kill people, rather in the name of profit. If you put it like that, it's not murder, it's manslaughter.”^[5] The church joins the criticism: The Head of the Council of the Evangelical Church in Germany, Dr. h. c. Nikolaus Schneider said that agricultural commodity speculators are “speculating with people’s life”.^[6] Pope Benedict XVI agreed by stating that speculation and volatility (up and down of prices) on the financial markets has “disastrous effects on food and energy prices”, thus the poorest “are more at risk than ever before”.^[7]

These Statements take effect; 84 % of the German population refuse to speculate on rising commodity prices due to moral reasons.^[8] So, the public opinion seems to be clear: Greedy speculators are making profits at the expense of the poorest. But, could this possibly be the truth?

Indeed, there are economists who dissent the public opinion. Among them is Harald von Witzke from the Humboldt university in Berlin who is a professor of agricultural economics. He stated that "only charlatans believe that bets at the firtures markets increase the prices permanently'’.^[9]

So, who is right? The question arises, which consequences do the speculation on agricultural commodities have on food prices? Is it morally wrong to speculate on agricultural commodities? Are policy makers ethically obligated to regulate the speculation of agricultural commodities? The following paper will face these issues.

First of all, I will define the greatest happiness principle by Jeremy Bentham, agricultural commodities, commodity futures and futures markets as well as speculation. Afterwards, I will analyze the consequences of speculation on agricultural commodities for all concerned parties. Doing this, I will examine effects of the speculation on commodity trading firms, banks, investors and the price development of agricultural commodities. On the basis of the results of my examination, I will apply the greatest happiness principle. Given this analysis, I will state my advice for policy makers.

2. Definitions

In the following, I will explain the greatest happiness principle by Jeremy Bentham, agricultural commodities, commodity futures and futures markets as well as speculation.

2.1 Greatest Happiness Principle by Jeremy Bentham

Jeremy Bentham was an English philosopher, and social reformer. He is the founder of modem utilitarianism.^[10]

In 1789 he proposed a new moral principle. Bentham stated that the goodness of an action should be judged by the utility of its consequences rather than the decency of its intentions. He considered utility to be a measure of defined human happiness.^[11] His fundamental principle was that "the greatest happiness of the greatest number that is the measure of right and wrong".^[12] He defined happiness as the "sum of pleasure and paim’; a psychological experience. Bentham stated that the mankind has "two masters'’; pain and pleasure. These two masters decide about the difference between wrong and right.

If an action causes more pain than pleasure, it is morally wrong. If an action causes more pleasure than pain, it is morally right. This philosophy is called "Utilitarianism", since its utility regards behavioral consequences.^[13]

I chose this theory, because I want to analyze the various effects of speculation of agricultural commodities on every involved party. Therefore, if the sum of pleasures will be greater than the sum of pain resulting from speculation, then it would be morally right to speculate on agricultural commodities due to Bentham. But if the sum of pain will be greater than the sum of pleasure, it would be morally reprehensible.

In fact, many policy makers are utilitarian. Barack Obama is considered as utilitarian, as well.^[14]

2.2 Agricultural Commodities

Agricultural commodities consist of staple crops and livestock. Most agricultural commodities are a source of food for people and animals across the globe. Some agricultural commodities have only industrial applications. Manufacturers in different sectors use latex from rubber trees, while the building and furniture industries use lumber from trees. There are agricultural commodities which serve as a source of food, as well as an industrial input. For example, com is consumed by humans and animals but is also an important ingredient in fuel production.^[15]

The reason why agricultural commodities are extremely important is that every living being is dependent on them. We eat the fmits, vegetables, grains and livestock that farmers produce, make clothes from cotton and wool, and buy cars with tires made from mbber. Furthermore, over 1.3 billion people work in farming. In regions such as South Asia and Sub-Saharan Africa, the farming industry is the largest employer;^[16] 65% of poor working adults made a living through agriculture globally in 2016.^[17]

2.3 Commodity Futures and the Futures Market

A very popular way to invest in commodities is through a commodity future. A commodity future is a derivative. A derivative is a financial instrument whose value depends on (or derives from) the values of other underlying values, for instance stocks. Consequently, a commodity firture is derivative whose value is dependent on the price of a commodity.^[18]

A commodity future is a contract which is used to trade a defined commodity on a listed exchange. The delivery date, delivery location as well as the quality and quantity are specified. The seller is required to deliver the specified physical commodity while the buyer has to pay for receiving the commodity. When a buyer and seller agree on a price, a future trade occurs. The exchange takes the role as a counterparty for the buyer and the seller. Thus, every futures trade includes two transactions, a short position for the seller and a long position for the buyer.^[19]

The following illustrates a simplified commodity futures trade through this diagram:

Abbildung in dieser Leseprobe nicht enthalten

Figure 1: A Futures Trade (source: own diagram)

For each contract they own, futures traders maintain a cash buffer, called a margin. This serves as a protection for the exchange against the risk of credit default. Traders have to ensure they have sufficient margin. Furthermore, the seller and the buyer of the commodity has to pay a fee to the exchange.^[20]

So, why do people or companies trade commodity futures? There are two different kinds of motivation to trade commodity futures. The first is hedging. The hedger seeks for insurance against the price risks she faces. The futures contract provides a hedge against a change in the price. Thus, it is an important tool for risk management. Hence, the futures market allows companies to insulate the consumer from big price changes without going out of business.^[21] To clarify, here is an example of a hedge through a commodity future:

The com farmer Harold has a harvest of 1000 tons com every year in September. In July, he expects that the price for one tonne com has reached an annual high. The price for one metric tonne is $200 in July. He then estimates that the price will decline up until September, when he can sell his harvest. Therefore, he wants to hedge against the falling price of com. As a consequence, he is searching for an exchange to find a futures contract which allows him to sell his 1000 tons of com in September for $200 per metric tonne. Luckily, he finds it. The French food producer "Bonducllc" wants to buy the 1000 tonnes com for $200,000 in September. But why? Bonduelle has an opposite opinion regarding the development of the com price. The French company thinks that the price of one metric tonne com will rise till September. The deal with farmer Harald is a chance for Bonduelle to get 1000 tons of com for less than its market value in September. This example illustrates that only one of the contracting parties of futures trade can win.

The other incentive to trade a commodity future is speculation. Speculators purchase agricultural futures purely as an investment strategy. So, they do not want hedge price risks, they simply wish to maximize their profit. Speculators are not interested in the use of the commodity. So, instead of waiting until they get the physical commodity, they sell the commodity futures for a profit.^[22]

2.4 Speculation

Speculation, for the purposes of this article, is the purchase (or sale) of goods or financial instruments with the intention to re-sale (re-purchase) at a later date, with the motive to earn money through the difference between the purchase and the re-purchase price. The speculator sees the goods he purchases or sales only as a tool for financial gain. The sole motive of action for speculators is the expectation of an imminent change in the ruling market price; this distinguishes speculative purchases and sales from other kinds of purchases and sales.^[23]

In food markets, two forms of speculation are the most significant:

- the purchase and/ or hoarding of commodities in the hope that their value will continue to rise. - the purchase of agricultural futures and options, purely as an investment strategy (see above in 2.3).

When speculators hold large stocks of commodities within the market during a time of shortage, they have the aim to drive up the prices for the purpose of a higher resale value. One aggressive strategy entails speculators combing hoarding and trading practices to create or aggravate shortages. An example of such an approach is "Cornering'’; the speculator purchases enough of a commodity to effectively control its price.^[24]

3. Analyzing the Consequences of speculation on Agricultural Commodities for all Concerned Parties

In the following section I will analyze the consequences of speculation on agricultural commodities for speculators. Furthermore, I will question if the speculation has any real impacts on commodity prices.

3.1 Analyzing the Consequences of speculation on Commodity Trading Firms

To analyze the effects for the commodity trading firms, it is vital to consider what commodity trading firms, so called CTFs, are. A small number of big commodity trading firms dominate the transportation, production and the trading of commodities.^[25]

Agricultural commodities undertake a variety of processes to transform them into consumer products. These can be grouped into transformations in space, time, and form. The transportation of commodities from regions where they are produced (supply regions) to the places where they are consumed (demand regions) is a spatial transformation. Moreover, temporal mismatches in production and consumption occur, especially by seasonally produced agricultural products. This happens for example when commodities are produced periodically (for instance com) but are consumed continuously. These mismatches in the timing of production and consumption lead to an urge of temporal transformations: the storage of commodities. Additionally, commodities often must undergo transformations in form to be appropriate for the consumer. Soybeans, for example, have to be cmshed to produce oil and meal. As you can see, commodities undergo multiple transformations between the farm, plantation, mine or well, and the consumer. Commodity trading firms are important agents in this transformation process. Firms that are involved in commodity trading try to find the most valuable of these transformations. Besides, they undertake the transactions to accomplish these transformations and engage in the physical and operational actions necessary to carry them out.^[26]

CTFs create value by optimizing these transformations. The main business of CTFs is to profit on the differential between the untransformed and transformed commodity. Thus, commodity traders want to find and exploit arbitrage.^[27] Though, there are a lot of CTFs, which also speculate on the price development of commodities.^[28]

It would be beyond the scope of this paper to measure how high the profits of the CTFs are which derive solely from the speculation.

[...]

^[1] The World Bank, Prevalence of undernourishment (% of population), no date, last visit: 27 July, 2018. https://data.worldbank.org/indicator/SN.ITK.DEFC.ZS, in connection with: The World Bank, Population, total, no date, last visit: 27 July. 2018. https://data.worldbank.org/indicator/SP.POP.TOTL710cationsM W

^[2] The World Bank, Prevalence of undernourishment (ช/0 of population) in Sub-Saharan Africa, no date, last visit: 27 July, 2018.

https://data. worldbank.org/indicato r/SN.ITK.DEFC.ZS?locations=ZG

^[3] World Federation of Exchanges, Trends in commodity derivatives between January and April 2017, May 2017, last visit: 27 July, 2018. https://www.world-exchanges.org/focus/index.php/in-every-issue/statistics/insight- analysis/154-trends-in-commodity-derivatives-between-january-and-apnl-2017

^[4] Oxfam, Mit Essen spielt man nicht (campaign video, "Don't play with food"), 2012.

^[5] Brühl,./.; Ziegler,./.. Jean Ziegler im Gespräch, Süddeutsche Zeitung, September 21, 2016, last visit: 27 July. 2018. https://www.sueddeutsche.de/wirtschaft/jean-ziegler-im-gespraech-nahmngsmittelspekulation-ist-ein- verbrechen-gegen-die-menschlichkeit-1.1469878.

^[6] Schneider, N., Statement at the Rio+20 Dialogue in Berlin, 2012.

^[7] Pope BenedictXVI, Angelus, 6 July 2008, on the G8 summit in Tokyo, Hokkaido. 2008.

^[8] Handelsblatt, Pro und Contra zu Rohstoff-Spekulationen. May 18, 2012, last visit: 27 July, 2018.

^[9] https://www.handelsblatt.co1n/finanzen/maerkte/devisen-rohstoffe/expertenmeinungen-pro-und-contra-zu- rohstoff-spekulationen/6647170.html?ticket=ST-4569967-OV6RUXv4xjpqNToU13WU-ap2 Ibid.

^[10] Sweet, II'.. Jeremy Bentham (1748—1832), Internet Encyclopedia of Philosophy, no date, last visit: 27 July. 2018. http://www.iep.utm.edu/bentl1am/

^[11] Veenhoven, R., Happiness as an Aim in Public Policy The greatest happiness principle. Positive Psychology in Practice, Chapter 39, Hoboken: 2004, pp. 1-2.

^[12] Bentham, J., A Coimnent on the Commentaries and A Fragment on Govermnent, J. H. Bums and H. L. A. Hart, in the Collected Works of Jeremy Bentham, London: 1977, p. 393.

^[13] Ibid., pp. 11-12.

^[14] Maui din, B.. President Obama's Utilitarianism, Liberty Counsel Action, March 26, 2013, last visit: 28 July, 2018. https ://liberty counselaction. org/blog/lca/PresidentObamaUtilitarianism

^[15] Pines, Lawrence, Agricultural Coimnodities - The Essential Guide, no date, last visit: 27 July, 2018. https://co1mnodity.co1n/soft-agricultural/

^[16] Ibid.

^[17] The World Bank, Agriculture and Food, no date, last visit: 27 July. 2018. http://www.worldba11k.org/e11/topic/agriculture/overview

^[18] Hull, John c.. Options, Futures, And Other Derivatives, Upper Saddle River, N.J.: Pearson/Prentice Hall, p. 1.

^[19] Commodities Demystified, Fundamentals of commodities. Trafigura, 2018, p. 8.

^[20] Ibid.

^[21] L. Johnson, Leland, The Theory of Hedging and Speculation in Commodity Futures, The Review of Economic Studies, Volume 27, Issue 3, June 1 1960, pp. 139-140.

^[22] Filier, G. ; Franke, c. ; Oden ing, Aí. ; Schweppe, K; und Xiaoliang Liu, X., Spekulation mit Agrarrohstoffen: Zuviel des Guten?, Berlin: DIW Berlin, April 2012, p. 11.

^[23] Kaldor, N., Speculation and Economic Stability, The Review of Economic Studies, Volume 7, Issue 1, 1 October 1939, p. 1.

^[24] ifpri Forum, Speculation and World Food Markets, July 2008, p. 9.

^[25] Pirrong, c., The Economics of Commodity Trading Firms, Trafigma, 2014, p. 4.

^[26] Ibid, pp. 6-7.

^[27] Ibid, pp. 7-8.

^[28] Ibid, p. 29.