Vitaly Timkiv/AP Photo
Farmers harvest wheat near the village of Tbilisskaya, Russia, July 21, 2021. That nation’s farmers produce nearly a fifth of world wheat exports.
Price Wars: How the Commodities Markets Made Our Chaotic World
By Rupert Russell
Doubleday
Media coverage of Russia’s invasion of Ukraine has focused on Vladimir Putin’s desire to patch the Soviet Union back together into some semblance of empire, and his outrage at NATO creep. Putin may look increasingly like a mad king, and his attack like a scattershot and ego-driven blunder. But the Kremlin had been planning the invasion (if not their own military readiness) for months, and the timing coincides with a run-up in energy prices and tight commodity markets that gave Putin major strategic leverage.
Putin wanted to strike at a time when it would hurt. Oil and gas prices have soared over the last year, driving a global gas shortage. Windfalls from fossil fuels not only padded Putin’s war chest and foreign-exchange reserves to act as what he assumed would be a partial buffer against sanctions; they also made Europe acutely dependent on its eastern neighbor in the winter leading up to the attack. And while Putin has committed a series of strategic blunders—like underestimating the United States’ willingness to expel it from the global dollar order—his wager on the primacy of energy has been borne out so far. Russia was once derided by John McCain as a “gas station masquerading as a country,” but Europe is reluctant to impose sanctions on the gas station. Politicians rightly fear popular rebellions under higher inflation and shortages.
Renewed calls for energy independence in the U.S. and Europe partly register that reality. But the push for energy self-sufficiency only tells half the story. What emboldened Putin was not only petroleum flows, but the herd behavior in financial markets that drives price fluctuations. His attempt to bloodily redraw the map of Europe is only the latest instance of a pattern beautifully documented by the sociologist and filmmaker Rupert Russell in Price Wars, a new book exposing how financialized commodity markets sow political chaos.
Following Bill Clinton’s deregulation of commodity markets in the late 1990s—amid a charged political debate that Russell charts in a vivid chapter—commodity prices became unstuck from fundamentals. It may seem unbelievable today, but until the Commodity Futures Modernization Act of 2000, retail investors couldn’t bet on the direction of commodity prices. The index funds simply didn’t exist yet. Investment banks and oil companies pushed provisions into the act in the waning hours of the 106th Congress exempting the trading of futures contracts and swaps for energy and metals from regulation. Most commodities derivatives are traded in unregulated over-the-counter markets run by dealer banks in the United States and Britain.
By the early 2000s, firms like PIMCO and Credit Suisse were launching commodity-tracking mutual funds at a dizzying pace. They were marketed to investors as helping diversify portfolio risk, but instead, they compounded it. Previously uncorrelated, oil, food, and metals became increasingly linked as a volatile new asset class. As commodity index funds proliferated, local disturbances in crop yields, amplified by leveraged bets of traders, gained the power to rip through global markets, destabilizing prices in far-flung areas with cascading knock-on effects.
High energy prices also brought off an incredible transfer of wealth from oil-importing countries to oil-exporting countries, and from consumers to private oil companies. Russell cites an estimate that between 2002 and 2012, speculative finance delivered excess windfalls of up to $820 billion for Saudi Arabia, $580 billion for Russia, and $290 billion for Iran. In a similar repeat, the run-up of oil and gas prices last year fattened Russian dollar reserves. Its Finance Ministry announced an unexpected 2021 budgetary windfall weeks before the invasion.
What emboldened Putin was not only petroleum flows, but the herd behavior in financial markets that drives price fluctuations.
The oil price–conflict relationship is not unique to Russia. Russell draws on political scientist Cullen Hendrix’s discovery that as oil prices increase, oil exporters are more likely to engage in military adventurism.
The last oil peak, in 2014, didn’t just send skyscrapers soaring in the Gulf. It enabled Saudi leader Mohammed bin Salman’s murderous siege of Yemen, and spurred Putin’s annexation of Crimea. Before that, high oil prices in 2008—when oil traded at its all-time high of $143—emboldened Russia into sending tanks into Georgia, and sent Venezuelan tanks into Colombia. While long-running geopolitical factors set the stage for those invasions, high oil prices sent them over the edge.
In Russell’s clear-cut breakdown, three key dynamics cause high oil prices to generate conflict.
First, petrostates get a windfall of dollars to spend on their military, and foreign-exchange reserves to insulate themselves from sanctions. During the years of more oil income, petrostate rulers can buy off domestic opponents, giving themselves more autonomy in foreign policy. Unlike checks and balances from domestic taxation, commodity windfalls from internationally determined prices empower leaders—whether in Russia, Saudi Arabia, or the UAE—directly.
Next, limited supply acts as a shield protecting oil exports, discouraging powerful importers from sanctioning energy. Countries importing oil are loath to risk even higher import bills and rebellion from drivers. Europe’s dependence on Russian fossil fuels protected the sector from sanctions following the Crimean invasion in 2014 and is doing so again following the invasion of Ukraine.
The third, and most potent in Russia’s case, is the gas weapon. Unlike oil, which is easily transportable on the seas, most of the world’s gas is piped over land with high fixed investment and a lack of easy substitutes. Belarus, Georgia, and Ukraine enjoyed generous subsidized gas from Putin until supply was yanked away in the 2000s to enforce compliance.
In addition, the West’s financial centers inflated an oil bubble that, in turn, inflated Putin’s “chestiness.” That’s the fourth element, and the most irreducibly political one, which can cause a price bubble to “jump” from markets to the government into the minds of political leaders. “This psychological inflation is what turns opportunity into action,” Russell writes.
COMPLEXITY SYSTEM SCIENTIST Yaneer Bar-Yam has analyzed the causes and consequences of the “polycrisis” induced by the 2008 crash. The Arab Spring, a concurrent emergence of riots and revolutions across multiple countries, is widely believed to have resulted from a mix of bad food harvests and bad governance.
But Arab dictators had run oppressive regimes for decades, so that can’t explain the rapid breakdown of political legitimacy. Food prices were the trigger, Bar-Yam found in a complexity analysis.
The costs of grains such as wheat and corn increased dramatically, doubling in 2007–2008 just after the financial crisis. Then they crashed and soared again in 2010–2011. Four days before Mohamed Bouazizi’s notorious self-immolation in Tunisia, Bar-Yam sent a warning to the government: High food prices were at risk of triggering social unrest and political instability.
That rising food prices could trigger riots is unsurprising; the food share in household budgets can be more than 50 percent in developing countries. But what caused bread prices to soar? The consensus view points to a lot of supply-and-demand factors, from droughts in Australia to demand from China. But, as Russell argues, most weather-driven/seasonal supply shocks were not big enough to cause such a large effect. In fact, global food production had never been as high in human history as it had been in 2007.
When markets are deregulated, it enables many investors to speculate on commodities who would otherwise not be able to do so, from small investors to “massive passives” institutional investors like BlackRock. There are really only four markets: housing, bonds, equities, and commodities. After the housing crash in 2007, the behavior of investors changed. Institutional money fled housing and equities, and flowed into commodities and bonds. Commodities are a small market in the hundreds of billions, compared to the trillions whooshing down from housing. It was that flow of money, not a supply-and-demand “fundamentals” effect, that caused prices to spike, triggering food riots in 2008. In 2010, investors rotated again to commodities to hedge against perceived inflation risk after the second round of quantitative easing by the Fed. The ensuing second food-price peak in 2010 triggered the Arab Spring, and the disruption of four dozen governments.
Russell’s reportage tracks the cascade of this global crisis, from the change of rules in the markets in 2000 to the mortgage bubble and crash in 2008 that created a flow of money into comparatively smaller commodity markets. Another supply factor—ethanol production targets in the U.S. at the behest of agribusiness—caused a massive amount of corn to be directed from animal feed to gasoline. Bar-Yam’s modeling shows corn ethanol mandates in 2005 were responsible for rising prices after accounting for speculative bubbles. The rules on ethanol were created by George W. Bush, and Bill Clinton presided over the deregulation of commodity markets.
The “China demand” story cannot explain the commodity price collapse of 2008 and 2011, even though Chinese demand boomed as Beijing embarked on a domestic investment binge. Instead, as hedge fund manager Michael Masters testified before Congress, “What we are experiencing is a demand shock coming from a new category of participant in the commodities futures markets.”
At times, Russell can tip over into a conspiratorial style, as when in a well-argued chapter tracing al-Shabaab’s use of financial speculation he overdraws the similarity. “Hedge funds and al-Shabaab did not just share similar tactics, they were working together to create one of the worst human catastrophes of the century. The hedge funds were operating at a global scale by driving up the price of food everywhere,” he writes.
The acrobatics through which Russell posits hedge funds to be sort of like terrorists really point to some of the limits of the argument. Volatility and exploiting chaos are lucrative for disaster capitalists. There’s no conspiracy here. But the power of Russell’s larger argument shines through, illuminating the hidden dangers of throwing open commodity trading to speculators.
TEN YEARS ON from the commodity chaos that Russell recounts, investors are once again pouring into commodities markets to hedge against inflation. Soaring prices of oil, gas, and coal are again emboldening commodity producers. If a single senator empowered by a gas boom in Appalachia can hold up President Biden’s infrastructure bill, Russia’s invasion is a foretaste of how petrostates threaten grand energy transition plans. Governments, not BlackRock, must decide green investment “off-ramps” for stranded states and stranded countries.
In the short term, governments can increase subsidies to support people struggling with food and energy prices, and invest in clean energy to permanently reduce families’ bills. But to prevent speculation-amplified price shocks, Congress’s Dodd-Frank commodity markets reform agenda, parts of which were shot down in the courts, must be brought back.
Banks and hedge funds had furiously stalled the implementation of Commodity Futures Trading Commission rules curbing speculation such as position limits and cross-border regulations. In 2022, Democrats will regain control of the CFTC. The post-crash agenda to bring dark over-the-counter derivatives markets into lit markets must not be wasted.
Two scholars have proposed more direct regulation of systemically important commodity prices through the Fed’s (or commodity regulators’) open-market operations to stabilize prices of essentials, much in the way that sales of the Strategic Petroleum Reserve are used to limit volatility of oil. That would be a wise step. Right now, we’re headed for more market pandemonium. Just look at the recent blowup of nickel markets and commodity traders pleading for central banks to provide liquidity.
And if active interventions to forestall commodity-market-driven chaos aren’t taken, as Russell warns, “a financial implosion threatens to make a tsunami of human suffering not a passing wave but a decade-long deluge.”
