Last week, an article by Fred Kaufman in Foreign Policy magazine ripped off a gangrenous scab: the topic of Goldman manipulating markets, a theme extensively dissected over the past two years, only in this case a rather sensitive one: that of food prices. Since the topic of Goldman being involved in market manipulation is nothing new to Zero Hedge, which first exposed the firm's prop trading shenanigans in 2009, a trope that was merely validated when Lucas van Praag responded to our allegations, to be promptly followed by Volcker making prop trading by banks semi-illegal, we were not surprised to read this piece. What did surprises is that Goldman once again exhibited horrendous PR sense by issuing yet another Lucas van Praag response, literally minutes ago, in the same venue. While van Praag does touch upon some valid points, the overall response is beyond weak and along the lines of the traditional excuse: "we generously provide liquidity/markets/capital, etc." which merely exacerbates the overarching theme: Goldman's relentless condescension, and assumption that it always is dealing with idiots who have no idea how the firm operates. As Goldman is about to find out, this will do nothing but generate a firestorm of angry responses by the "non-faceless" crowd which will now have a scapegoat to blame, since by taking he defensive, Goldman once again validates the allegation. What happens next to Goldman, and the GSCI, is unclear but will likely not be favorable in light of Obama's recent witchhunt against "speculators." Yet at the end of the day what can one expect from a firm that will always have to live with the following classical example of shooting itself in the foot: "When asked about these emails, Mr. Swenson also denied that Goldman had attempted to squeeze the CDS short market. He claimed that the cost of single name CDS shorts had gone too high, and the purpose behind Goldman’s actions was to restore balance to the market. Mr. Swenson could not explain, however, why in an effort to restore balance to the market, he used the phrases “cause maximum pain,” and “this will have people totally demoralized".”
From Lucas van Praag, Foreign Policy
Don't Blame Goldman Sachs for the Food Crisis
Blame the meat-loving middle class.
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
involves a re-investment of the original funds by selling one contract
buying another. This "roll-over" is akin to renewing home-owners
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.
Lucas van Praag
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
Van Praag's assertion that the index funds were created to help
"pensioners, who seek to protect the value of their savings against
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
the weight of hundreds of billions of dollars of new money from hedge,
and sovereign wealth funds has pushed up the slope of the agricultural
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.