Are Banks to Blame for Your High Prices?

As another thorn in Wall Street banks' paws, many, including MSNBC host Dylan Ratigan, claim banks increase the cost of everyday living:

Next came the government's attempts to hide the costs of the bailout by printing extra money ... the lucky banks that received this free money had to put it somewhere, and now that the real estate market no longer seemed safe, they bought commodities, driving up the price of gold and oil and food.

Are banks truly to blame for soaring commodity prices?

Commodities 101
Traditionally, commodities are affected by supply and demand of the underlying product. If a drought hurts crops, supply falls and prices rise given unchanging demand. If growing global populations demand more crops, prices rise given a constant supply. To protect from unexpected droughts or other shocks to prices, futures contracts can be bought that guarantee a certain price at a time in the future.

A regular investor can trade in commodities easily through commodity ETFs or ETNs, from commodity specific funds such as United States Natural Gas Fund (NYS: UNG) , iShares Silver Trust (NYS: SLV) , ELEMENTS Rogers Agriculture (NYS: RJA) , and iPath Crude Oil (NYS: OIL) , or an entire commodity market fund like United States Commodity Index Fund (NYS: USCI) .

Soaring prices
Just how much have prices soared?


The run-up of gold is well documented. And along with gold, as Dylan Ratigan points out in Greedy Bastards, "in 2010 alone ... the price of coffee rose 77 percent; wheat, 47 percent; and cotton for clothes, 84 percent."

Is it the banks' fault?
There's definitely more money floating around in commodities. Index fund investments in commodities more than doubled to $200 billion from early 2006 to the end of 2007. These funds typically invest in futures contracts, as buying actual commodities would create the logistical difficulties of having to store cattle and tons of grain in the banks. Is this great influx of trading in commodities pushing prices higher? Or are higher commodity prices attracting more investment?

The answer lies in whether the futures market affects the true price. Some argue that by trading solely in the futures market, any effects of increased speculation are not felt in the spot, or immediate, market, as the true supply and demand remains the same regardless of how many participate in futures. Even so, others claim that contracts today are based on future prices that are bid up by speculators. Additionally, more volatile prices increase the margins, or cost of participating, in the futures market. For a business that hedges commodities in the futures market, increased margin costs could potentially be passed on to the customer.

An enormous amount of research on the topic has been done. In the end, the authors of an OECD report concluded, "the weight of the evidence at this point in time clearly tilts in favor of the argument that index funds did not cause a bubble in commodity futures prices." A report by the St. Louis Fed similarly notes that "commodity prices rose in markets with and without index funds," and "price impacts across markets were not consistent for the same level of index fund activity."

A commodity market for scapegoats?
As much as Wall Street deserves a few thorns in its paw, it should have this specific thorn pulled out. Higher prices are much more likely a result of increased demands from developing countries -- the Fed reports "more than 90 percent of the increased demand for agricultural commodities over recent years has originated in developing countries." And higher demand for energy like oil compounds the upward pressure on agricultural prices, as the more fuel costs, the more expensive it is to farm the crops to feed both mouths and biofuels.

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At the time thisarticle was published

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