Why blame 'speculators' for oil price run-up?

Business Times - 25 Jul 2008

Their upward pressure on prices drives down demand; falling demand leads to lower prices


DEMOCRATIC and Republican lawmakers in Washington, led by the two presumptive presidential candidates, have been blaming 'speculators' for some of America's current economic problems.

They indict these people for rising energy prices and the housing market mess. And they want the government to take action against energy traders, short-sellers and other evil-doers.

Senator Barack Obama has promised voters that as president he would strengthen government oversight of energy traders. He has blamed them for the skyrocketing oil prices.

Senator John McCain has called for a 'thorough and complete investigation of speculators' to see if they have been driving up energy prices.

At the same time, responding to pressure from Capitol Hill where lawmakers have placed the responsibility for some of the turmoil in financial shares on short-selling investors, the US Securities and Exchange Commission (SEC) is promoting its effort to curb speculation in financial services stocks, most notably hedge funds. Among other moves, it has introduced new short-selling rules, listing 19 banks and investment banks which cannot be shorted.

The reason for the current obsession in Washington with speculators is simple. Americans - aka voters - are angry about the rising oil prices and shocked by the mayhem in the financial and housing markets.

Since the average American is economically illiterate and is certainly not familiar with the intricacies of global financial and energy markets, he or she will search for simple explanations for their current misery: the federal government - the President and Congress. In this age of the nanny State with its power of regulation, they were supposed to ensure that such bad things don't happen.

Lawmakers and officials, on the other hand, encourage Americans to shift the blame to other targets against which they could vent their rage.

Hence the tendency in Washington to bash the Chinese and the greedy CEOs when American manufacturing jobs disappear, or to scapegoat the oil companies and energy speculators when oil prices rise or to fault hedge funds and short-sellers when stock prices fall.

After all, as they used to ask in Rome: 'Cui bono?' Who Benefits? Since those who invested in commodities in recent years seem to have profited from the commodity price boom which they had predicted, doesn't it make sense to blame them for causing the price hikes?

And aren't short-sellers hoping for bad things to happen to stock prices, suggesting that there is perhaps a direct connection between short-selling and falling stock prices?

It's not surprising, therefore, that these speculators are being depicted in the media, which echoes the spin of the politicians in Washington, as evil geniuses, who through the power of their perfect foresight and flawless investment strategy, have succeeded in exploiting the misery experienced by the rest of us.

For example, I was watching investor and short-seller Jim Rogers being interviewed on CNBC business news programme recently, during which he was accused by a reporter of 'talking down' the stocks of Fannie Mae and Freddie Mac and making them insolvent.

Forget the decades of mismanagement and waste by these two Washington behemoths, privileged through government cronyism. It's Mr Rogers and his fellow short-sellers who are responsible for their disastrous performance.

That short-sellers are not popular with investors who have a stake in seeing certain stock prices go up is understandable. But to say Mr Rogers is responsible for the troubles afflicting America's two mortgage giants is the equivalent of blaming medical researchers who predict a rise in the rate of cancer, as causing the spread of that disease.

And the fact that those medial researchers would benefit from the flow of more grants to help them find cure for cancer won't lead us to malign them as 'profiteers' either.

Indeed, not unlike a medical doctor who discovers that his patient is sick (and will therefore be required to visit the doctor - and pay for his services - several more times) or an investigative reporter who uncovers government corruption (and wins fame and fortune), short-sellers also 'benefit' from the problems faced by others.

Short-selling - very much like hostile takeovers - provides a critical source of accurate information for the players in the market by discovering problems confronting certain firms, suggesting that the current high prices are an over-estimation of their real value.

That kind of information should be valuable to other market participants who could take advantage of it and correct their mistakes. The short-seller will continue to make huge profits if these participants dismiss his information and insist on listening to the optimistic information provided by the cheer-leaders who are interested in continuing to boost the stock prices of the troubled firm. But even the most successful short-seller cannot force prices for a long time if other market participants discover that his information doesn't correspond with reality,

Restricting short-selling is akin to shooting the messenger if he happens to be a bearer of bad news. It assumes that deflating false expectations is a process that should be prohibited by society while cheer-leading should be encouraged.

As the current mess in Fannie Mae and Freddie Mac demonstrates, the short-sellers seem to have played the role that should have been performed a long time ago by the respective government regulators - detecting the problems facing these two companies.

Similarly, contrary to their perception as malevolent speculators who are driving oil prices up, energy traders are actually helping make the market more efficient. Indeed, challenging a 'fundamental misperception' about 'so-called speculators' driving oil prices to 'supposedly unjustified levels', a 'super-spike' report issued by Goldman Sachs earlier this year concluded that it was just the other way around.

Energy traders were helping to 'solve the energy crisis' by providing incentives for more capital spending on alternative energy. And the Goldman Sachs report questioned the economic logic behind the plans proposed by the administration and Congress to place restrictions on energy trading.

'It is not speculators moving the market, it is the information on forward supply and demand fundamentals that they are conveying,' the Goldman Sachs report said. The removal of speculators from commodity markets would force the market 'to function with less informed views, degrading the price discovery mechanism,' the report said.

New York Mayor Michael Bloomberg is one of the public figures who have been insisting that it would be a mistake to blame the global run-up in energy prices on speculators.

'The big run-up is not because of speculators,' Mr Bloomberg told WNYC television in New York. 'The big run-up is because more and more people are using energy.'

Indeed, the rise in energy prices is being driven by structural factors, including the increasing demand sparked by the growth of China, India and other emerging markets. At the same time, supply of oil has fallen in the US, Mexico and Venezuela and other oil-producing countries. There was also a political factor in the price: traders expected US attack on Iran - with all its implications for the flow of oil down the Gulf. Now that there are hints of a shift in US policy, the oil price is coming down.

In any event, speculators help drive down demand when they put upward pressure on prices. And falling demand leads eventually to lower oil prices. In that case, commodity speculators could take short positions and contribute to falling oil prices.

One wonders if American officials, lawmakers and the media would then praise the speculators for the falling energy prices or accuse them of short-selling.

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.


Anonymous said…
Dr. H.,

Explain this to me:

Why should a man be able to buy something he cannot physically accept?

My problem with commodity-trades in agricultural products and oil is this: I can buy tons of this stuff......warehouses of it in fact, while not owning a refinery or having a deal with a refinery or even a warehouse to store it in. Im not even a player in that market to turn this raw resource into a finished product, but IM ALLOWED TO INTERFERE IN THE MARKET ANYWAY.

To me, if you cannot accept delivery of a commodity (like having a very large storage facility in which you can store that oil or soybeans or whatever), then you dont have any business being able to buy any of it in bulk.

Aren't you afraid that in the future other countries that wanted to inflict some damage on the USA, would be willing to try and buy up some things we need in order to drive prices through the roof here? It seems to me that we could be asking for foreign meddling in our economy by allowing this.

One can leverage 16 times what they can buy in some hedge funds, allowing them to buy much more of a commoditiy than they could ever really afford right there from their keyboard.

Whether they are doing anyone favors by pointing out that company A or B is 'overvalued' is something that looking at the P/E ratio alone should let people know. Anyone who trusts company-men for a square analysis of a compainy's future prospects alone is asking to be mislead IMO.

Have we suffered ridiculously high oil prices (28 bucks a barrel vs. 150+ per barrel) because of fears of wars in the middle east or is there a real shortage in the ground? We both know there is plenty of oil under the land and oceans of this planet, and that we are nowhere near running out of it in the aggregate...............therefore one would seemingly conclude that 'fear' of political and terror considerations are driving the price up alone.

I cannot fathom the price of milk going up by a factor of 5 in a few years because some people were mad at each other somewhere. Only in oil do things get so far out of sorts-----to the real detriment of our economy. Petroleum is in tons of stuff you never think about....packaging, tires, etc. Its slowing everything down and inhibiting the recovery, it really is "sand in the gears" when its high like this.
Your criticism of the futures market can also apply to much of the activities taking place in the financial market and that in some level is not "real." And certainly in terms of my own personal sentiments all my admiration goes to the entrepreneur that creates industries and jobs and not to the financial speculator. But if you accept the notion that the free market is the most effective way to create wealth and sustain individual liberty, there is no justification for the restrictions on most forms of financial exchange. Re oil. I've written quite a lot anout this in my recent book, Sandstorm: Policy Failure in the Middle East. In general, I think that the price of oil is an outcome of a complex forces involving the working of the energy markets and the policies of national governments. What's happening in the Mideast including terrorism is clearly a factor in all of this, although I think the rising denand for oil in China and other emerging economies is the most important reason for the rising prices.
globetrader said…
You’re observation about the economic illiteracy of the average American is right on. It is probably accurate to say the same about most American politicians. Sadly, even economically literate politicians are still probably willing to pander to this nonsense.

To those who insist that energy prices are artificially inflated because speculators are driving up crude prices or that mortgage lenders are artificially devalued by short-selling speculators, my response is simple: if they are so certain then they should stop complaining and seize these OUTRAGEOUS, risk-free business opportunities. They should short crude, buy mortgage lenders, and (as a handsome reward for their shrewd market analysis) make a PILE of money at the expense of those unpatriotic/pessimistic/evil/idiotic speculators. What better way to teach those speculators a lesson, right? ;-}

Great piece. It is a shame that the bulk of its audience will not be American. You’re preaching to a Singaporean choir.
OdorlessPainThinner said…
You seem to have missed a major piece of the news. The proposed regulations are directed at NAKED short selling, where the shares are not even located, as opposed to ordinary short selling, where the shares must be borrowed and then only from accounts that have purchased on margin and do not own the stocks outright.
Chester said…
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Jacob said…
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