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What Are Futures and Derivatives

A ‘Future’ is an agreed contract for the sale or purchase of an asset, currency or commodity at a future date. This financial instrument came about to provide a kind of insurance to the producers so that they did not go out of business when there might be a poor harvest, for example.

After intense lobbying, the US Commodity Futures Trading Commission relaxed the rules surrounding the market in 1999. Banks such as Barclays, Deutsche Bank and JP Morgan, could now hold as large a ‘position’ in food futures as they liked. Previously they could not. A traders ‘position’ is the balance of (long futures contracts) ‘promises to buy’ minus ‘promises to sell (short contracts).

food futures

A derivative is a financial contract whose value is derived from the performance of underlying market factors, such as interest rates, currency exchange rates, and commodity, credit, and equity prices. Derivative transactions include an assortment of financial contracts, including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards, and various combinations thereof.

Each quarter, based on information from the Reports of Condition and Income (call reports) filed by all insured U.S. commercial banks and trust companies as well as other published financial data, the OCC prepares the Quarterly Report on Bank Derivatives Activities. [Office of the Comptroller of the Currency, U.S. Department of the Treasury, Taken from the internet 28.04.2014: http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/index-derivatives.html]

So, looking at the financial markets and the trade in derivatives, it would be fair to say that the price of futures are based upon the economics of scarcity.  The price of futures determines the price of various products including that of staple foods.

 

Hazel Healy wrote a journalistic article in New Internationalist called “The Food Rush” on these issues. [New Internationalist; NI 447 November 2011; Taken from Internet 27.10.2013 – http://newint.org/features/2011/11/01/food-speculation-commodities-trading]

She reports on how banks have designed financial products to get consumers and pension funds to ‘bet on’ products as diverse as aduki beans, greasy wool and ‘leveraged soya beans’. Traders across the world stare into screens looking for products to invest their money in, and essentially are trading on food scarcity to gain a financial dividend. Scarcity is, of course, a concept central to economics thinking.

In a well known essay, Lionel Robbins gave a popular definition to economics in saying ‘the unity of subject of Economic Science are the forms assumed by human behaviour in disposing of scarce means’ (page 15, An Essay on the Nature and Significance of Economic Science, Lionel Robbins, copyright 1945, Retreived from web 14/08/2013, http://mises.org/books/robbinsessay2.pdf).

As we encounter value in a relationship with scarcity, the next question which arises in this exploration of the subject of food speculation is whether scarcity is being created to influence the value of futures prices…

This study is about realising the economics of the speculation on food markets and an attempt to rationalize my day to day experience of changing costs of basic living with that of the world view; using the technical language of economics, I am attempting to contextualise the microeconomic view (perspective from the bottom up) to the macroeconomic view (perspective from the top down) [Professor Tim Taylor, 3rd Edition Economics, The Teaching Company lectures].

We have to ask whether confidence is being eroded in the perceived utility of the subject of political economy (i.e. economics) as non-transparent, unaccountable and badly managed financial industries have driven people to abandon any attempt to understand the systems which influence and govern our lives.  What value does the study of economics have ?  Is economics simply the building of a language sufficient to allow the development of articulate thought ?

 

Question 1: Using the Office of the Comptroller of the Currency, U.S. Department of the Treasury resource [http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/derivatives-quarterly-report.html] download at least two reports, extract and compare a specific value (for example Notional derivatives) making a comment on the relationship. For example…

According to the Office of the Comptroller of the Currency, U.S. Department of the Treasury, in the first quarter of 2003, the Notional derivatives in insured commercial bank portfolios was $61.4 trillion. In the first quarter of 2013, the Notional derivatives was $231.6 trillion.  This shows that Notional derivatives increased by $170.2 trillion or an increase of 377% over 10 years.

This is an exercise in being able to locate similar values in different documents and make a comparison. Explain why you think  being able to do this task is important in the context of this study of food futures.

Question 2: Write a reason why you think the amount of food futures that any one institution or investor was allowed to hold, was regulated before 1999. Discuss whether regulation or deregulation of this area would be a positive or negative thing to do.

 

 

This is part of a series of articles and exercises exploring food speculation and its relation to famine:

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