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 (NYSE: UNG  ) , iShares Silver Trust (NYSE: SLV  ) , ELEMENTS Rogers Agriculture (NYSE: RJA  ) , and iPath Crude Oil (NYSE: OIL  ) , or an entire commodity market fund like United States Commodity Index Fund (NYSE: 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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Fool contributor Dan Newman does not own any of the companies mentioned above. Follow him @TMFHelloNewman. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (5)

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  • Report this Comment On February 18, 2012, at 1:46 PM, gkirkmf wrote:

    OCED..... isn't this the same government organization that failed to regulate derivatives? I give their reports a lot of cred....

    As for one agricultural commodities, CORN , as I understand it, the price of corn is high because of the subsidy it receives for being used in the alcohol fuel business. I have seen several articles documenting Goldman Sachs oil trading which was blamed for pushing oil prices over $100 a barrel between 2004 and 2007. I am really not sure why you bothered to write this. Who is to blame? Folks with lots of money on their hands. Who has lots of money on their hands? ( besides Wall Street of course)

  • Report this Comment On February 18, 2012, at 1:59 PM, Crookedpauper wrote:

    Since 2008 results are more and more attributed to big banks moves and their success(!) in the profits games I do not agree with your article which does not insist enough upon the relation

    between the many selfconscious bank managers

    who came out of their crisis with extra millions in their pockets: fatty commissions to smaller banks in credit lines were eventualy paid for by us voters when not covered by "short' options or government help later(after the fan hit it !)

    Crookedpauper.

  • Report this Comment On February 18, 2012, at 11:24 PM, riketz wrote:

    Would somebody please explain the precipitous drop in gasoline prices when the credit crunch occurred. Within two weeks the price of gasoline dropped from over $4/gal to $2.80/gal and remained low unit credit became available again. Actual demand, meaning the real demand for gallons of gasoline at the pump, did not change yet the line that we were fed was that the price drop was driven by drop in demand. The only demand that ceased was the demand created by speculators who could no longer afford to speculate because credit was not available. Who benefits from artificial demand created by speculators and who is damaged by the rise in costs? Industry will pass the cost increase along when they can in the form of increased prices. The individual consumer will simply have to absorb it which causes a shift in consumer spending habits which affects other aspects of the economy.

    Another thing that I would like explained is the pricing volatility that all of us see at the pump. It does not make sense and who benefits from it?

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