Why the ‘Financialisation of Nature’ is a very bad idea indeed

The six minute video, below, argues against the ‘financialisation’ of nature — it says it is wrong to apply the logic of finance to pay for forests, biodversity, and ecosystems.

The film by itself doesn’t quite convince me.

Logically, getting people to pay for the ‘ecosystem services’ provided by forests, biodiversity, and ecosystems seems like a good idea: it would get people to value nature. But my gut instinct tells me that this is a very bad idea indeed.

Which should I trust? My brain or my heart?

The recent ‘financialisation’ of the market for iron ore provides a suitable case study.

In 2010, buyers and sellers agreed to change the way they bought and sold iron ore, a commodity that is used in the making of steel, which in turn is used in building roads, bridges, buildings and so on. Instead of iron ore prices being fixed for a year, they would now be set to cover only a three month period.

The trigger for this change was (ironically) the 2008 financial crisis. After that crisis, and the slowdown in the world economy that followed, several major buyers of iron ore failed to honour their contracts. This naturally angered the iron ore producers, and in a market where supply is now less than demand, they eventually decided (after months of renegotiations) to shift to a new price-setting system: one where prices would be set only for three months, not a year. Coincidentally, this new system would also increase the profits of the three largest producers of iron ore by $5bn in the first year alone.

That is the background. What are the consequences?

This “financialisation” of the iron ore markets seems ‘fairer’ to the producers, since it enables prices to fluctuate more readily in response to market demand.

But these larger fluctuations also encourage speculators to make money by gambling on future prices. As a result, bankers and brokers have been developing a multibillion-dollar derivatives market similar to the ones that exist for commodities such as oil, aluminium and coal.

Within ten years, trade in iron ore derivatives (by weight) is expected to exceed the size of the physical market.

When that happens, the price of iron ore will be driven more by supply and demand in the financial markets than by supply and demand in the physical markets.

Supply and demand in the financial markets, in turn, is driven by whether speculators think they can make more money that day by holding iron ore, gold, pork bellies, dollars, yen, stock in ‘XYZ Corp’, or any other financial instrument.

The inevitable result is that the price of iron ore will become more volatile. It will be driven up and down not by the number of people wanting to build bridges or roads, but by the comparative price movements of pork bellies in Chicago, the Libor/GBPound/Euro rate in London, or the gold price in Hong Kong.

This in turn means that some real life projects to build bridges and roads will fail, hit by unexpected price spikes. And/or, we will all pay more for our buildings, bridges and roads, to cover the cost of financial hedging that engineering companies will have to pay to cover against those price spikes — spikes which will only be there because we changed the way ran the market.

The effect of “financialising” any sector is to increase cost, and risk, and volatility.

That might be appropriate for foreign exchange rates, pork bellies and even iron ore.

But it is not appropriate for the ‘services’ we get from nature.

Financial markets, as we know from 2008, can and do crash.

Applying financial logic to the natural world would benefit the owners of the financial markets, but for the rest of us would be at our extreme peril.

http://vimeo.com/43398910


Sources:

Financial Times, “Steel prices set to soar after iron ore deal”, 30-31 March 2010:
http://www.ft.com/cms/s/0/d15d7758-3bad-11df-a4c0-00144feabdc0.html

Financial Times, “Iron ore swaps could grow to $200bn”, 30 March 2010:
http://www.ft.com/cms/s/0/c6dd3ada-3c1a-11df-b40c-00144feabdc0.html

Financial Times, Lex, “Iron ore pricing”, 30 March 2010:
http://www.ft.com/cms/s/3/a49ed476-3c04-11df-9412-00144feabdc0.html


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