This is a systemic problem. Any valid explanation of price increases in a commodity, e.g., oil (gas), has to explain why prices are rising almost across the board.
Global commodity price increases are being driven by two main factors. The first is rapidly rising standards of living in the developing world as many nations, especially China and East Asian countries, have freed up their markets. This has caused a dramatic rise in living standards and a huge decrease in the number of people living in poverty. These people are now buying the things that we in developed take for granted, and that is driving the prices of copper for cars and new homes, steel for buildings, oil for transport, corn for livestock feed, etc.
The other systemic factor is massive currency inflation in almost all OECD coountries. When inflation happens in more normal circumstances, an inflating country's money falls in price relative to those of other countries, and it's easy to see which countries are destroying their currency and which aren't. People sell the increasingly worthless currency and buy the strong ones. What we have today is almost all OECD countries inflating their currencies at once in a (failed) effort to boost their economies. This means that anyone who wants to protect their wealth needs to invest in something that will rise at least as fast as inflation. That means commodities.
BTW: If speculators can somehow control prices in a way largely independent of constraints, then why aren't they always doing it? It's not like human beings just started getting greedy last year. And why have, for instance, prices of natural gas fallen thru the floor (hint: greatly increased supply due to drilling breakthroughs)? Where are the all-powerful speculators on that?
This is a systemic problem. Any valid explanation of price increases in a commodity, e.g., oil (gas), has to explain why prices are rising almost across the board.
This is almost exactly the point the article is trying to explain: commodity prices are rising across the board in line with the commodities index, but why should there be an index at all? In the market you have the supplier, buyer, and consumer. The "speculator" was placed into the mix with a limited role for providing liquidity; this role was intentional and helpful since in the real world there could be a delay between the time a grower/supplier and buyer/cereal producer actually needed what the other had (raw material or cash); with the speculator there was always the opportunity to buy or sell. However, there were intentional, specific limits placed on the speculator. This was to ensure he couldn't corner the market and artificially skew prices. As long as these limits remained intact the market operated as designed, and the actual price of commodities reflected real world supply and demand (since the main players in the market were physical hedgers - people who actually had stake in/cared about the physical commodity). Goldman Sachs was able to get these "speculator handcuffs" removed. This means the actual market price for commodities doesn't necessarily reflect supply and demand. Rather, it also has the component of speculation priced into it. We can see this even within these last few days. The price of a barrel of oil was skyrocketing above $100; this seemed to make sense due to the unrest in the Middle East, then amazingly with the earthquake in Japan it quickly dropped below $100. In such as short time was there really an escalation then de-escalation in the demand for oil!? Of course not. The price was following speculation, people who are only in the market to make money. The end result is that ordinary consumers must pay at the pump what the whims of investors say, never mind progress made whether politically or technologically, or reductions by consumers in a recession to ease pressure on demand and oil prices. Natural gas is not as attractive to speculators as oil.
Don't forget that speculation works both ways. It can also bring down prices very quickly and consumers benefit from that. What speculation really does, in my view, is to insert a component of future expectations in addition to the current supply and demand effects.
It is not entirely clear to me that adding this expectations component is always bad. It can get out of control when it becomes self feeding, but it can also convey valuable information that allows us to react early to fundamental supply and demand issues. We clearly have fundamental supply issues in crude oil and in agricultural products. The blog post is totally wrong on that one. Pointing to falling US demand of crude oil makes no sense in a world where the marginal buyer is in Asia.
Don't forget that speculation works both ways. It can also bring down prices very quickly and consumers benefit from that.
That's like me expecting you to say "thanks" for returning an item I took from you when it's speculation which helped drive up prices in the first place.
What speculation really does, in my view, is to insert a component of future expectations in addition to the current supply and demand effects.
That's exactly what it does. Why do we need that?
It is not entirely clear to me that adding this expectations component is always bad. It can get out of control when it becomes self feeding, but it can also convey valuable information that allows us to react early to fundamental supply and demand issues.
React early and do what? This isn't like hurricane preparedness. Again, the point the article is trying to convey is that prices don't reflect supply and demand. We experience sky rocketing gas prices but no longer see gas shortage or rationing lines. In 2008 we had significantly more people go hungry from food shortages, although nothing has changed about wheat farming except, if anything, farmers producing it more efficiently. The wheat harvest that year was the most bountiful the world had ever seen.
I think we need a component of future expectations in prices because it increases incentives
I'm extremely wary of the term "increased incentives" in light of recent events sparked by this model on Wall St.
and provides funding for averting real future shortages.
We just don't see gas lines to support that argument.
Edit: And what do you mean "provides funding" anyway? Speculative contracts don't raise oil producing levels, nor stockpile oil (as our Strategic Reserve does). The extra money which exists is all used up by the speculators playing the game.
General anti Wall St. sentiment is not a very potent argument. It's difficult to deny that higher prices increase supply and/or destroy demand. Wall St. didn't invent this logic.
General anti Wall St. sentiment is not a very potent argument.
I'm not anti-Wall St. But I am anti-recklessness when it means wreaking havoc on our national (and by extension entire world) economy.
It's difficult to deny that higher prices increase supply and/or destroy demand.
No, it's not. Actually, higher prices usually mean there is decreased supply and increased demand. That's in a normal market. But we don't even have a normal oil market. That's the entire point. When oil prices skyrocketed to record levels above $145/barrel in 2008 it wasn't because of increased demand, and those astronomical prices didn't mean an increased supply of oil either.
I think our misunderstanding is that you're talking about what has happened and I'm talking about what is resulting from it. Higher prices mean that demand has been growing faster than supply. As a consequence, suppliers now want to supply more and consumers want to consume less. So higher prices incentivise more supply.
As a consequence, suppliers now want to supply more and consumers want to consume less.
Suppliers want to supply more. So, if you're some Saudi Arabian sheik witnessing these astronomical oil prices you really want increase oil production and supply more? What will that do to oil prices? Think about what you're saying.
Exactly. If I'm an owner of an oil field I prefer to sell at higher prices and if prices are high I invest more in exploration.
Of course prices are not just influenced by supply and demand. They are also influenced by speculation. I never denied that. What I'm saying is that speculation changes the timing and increases the volatility, but it cannot decouple from supply and demand indefinitely.
So if we're running out of easily accessible oil in, say 20 years, and speculation increases today's prices in expectation of that, that's a good thing. Of course it is a double edged sword. Sometimes future expectations never materialize and speculation ends up destroying value.
Oooh, it's a bit of a slippery slope to try to argue that. A shift in political winds and/or attitude can cancel/limit alternative energy funding in a heartbeat.
I think what actually influences prices is trading of futures contracts. The price in the contract can be above or below the price of a shorter dated contract, i.e the "current" price. So I can speculate on falling prices, thereby depressing prices. That's my understanding, but I don't claim to understand all the details.
Note: That wall o' text makes it hard to pick out your key points.
> The "speculator" was placed into the mix with a limited role for providing liquidity
This makes no sense. Who did the placing? Every market has speculators, and even end-user-buyers base their decisions in some part on speculation.
The speculator has no altruistic diktat to provide liquidity. The speculator is there to make money, and providing liquidity is a side-effect. i.e. the speculator wants to take on a position, but can only do this if someone else wants to exit a position -- thus making a trade. The seller's interests are served just as much as the buyer's.
Now, there is a clear issue with cornering the market. However, there is a natural check to this behavior, in that taking delivery of millions of barrels of oil is expensive. And if you have no intrinsic need to consume a commodity, then it is very expensive to sit on. If supply is indeed artificially constricted by hoarding speculators, they will need to sell off their supply at some point.
>This makes no sense. Who did the placing? Every market has speculators, and even end-user-buyers base their decisions in some part on speculation.
Did you read the article?
These buyers and sellers of real stuff are the physical hedgers. The FDR administration recognized, however, that in order for the market to properly function, there needed to exist another kind of player - the speculator. The entire purpose of the speculator, as originally envisioned by the people who designed this market, was to guarantee that the physical hedgers, the real players, could always have a place to buy and/or sell their products.
>The speculator is there to make money, and providing liquidity is a side-effect.
Yes, speculators making money is fine. The liquidity side-effect is the reason to allow for some speculation in regulations.
> If supply is indeed artificially constricted by hoarding speculators, they will need to sell off their supply at some point.
Yes, that's why, as I said, consumers are subject to volatile price swings from investors, rather than steadier prices which would more accurately reflect supply and demand.
> The FDR administration recognized, however, that in order for the market to properly function, there needed to exist another kind of player - the speculator. The entire purpose of the speculator, as originally envisioned ...
My point is that free and open markets attract participants who exercise their self-interest. There is no central authority saying "you are the buyer", "you are the seller", and "you are the speculator". Speculation is an inherent property in any market participant. So-called "speculators" are merely those having no larger interests (i.e. taking delivery and consumption).
In a split-second, a "real player" can become a speculator, if he sees a market opportunity and takes on a position for which he never intends to take delivery. The point is, identifying who is a speculator and attempting to limit those activities is extremely difficult, because speculation is all about internal motivation, and central authorities have no real insight as to an individual's motivation.
I applaud FDR for not trying to prevent speculation, but I seriously doubt any capability for injecting speculation via "placement".
>but I seriously doubt any capability for injecting speculation via "placement".
You're reading my text too literally. I don't mean to an arm from the sky put speculators in the middle of the wheat market. As you correctly mention, an open market will attract those who exercise self-interest. Speculators are thereby effectively "placed" in a designed market by not regulating them out.
The article states that the regulation changes that allowed unlimited commodity speculation only started in 1991 and then only for 16 institutions who were given exemption.
I agree that speculation isn't the sole cause of the price increase in oil since there are other buyers besides speculators and the post's long quote from Matt Taibbi’s Griftopia acknowledges this. The quote gives facts to show the increase in speculative demand for oil was more or less equal to the increase in China's demand. If China makes up a substantial amount of the change in demand that drives up the price of oil then speculation does as well.
I agree with you about the effect of inflation and the post only covers 15 foods and oil in detail so an argument that speculation is the sole cause of price increases would be false. An argument that speculation is a driver in the prices of all commodities would be an extrapolation that requires more evidence. However, breakthroughs in drilling for natural gas gives a reason for natural gas to be an exception, not for all commodities to be devoid of speculation's influence.
If oil is priced above demand, there should be large supplies of unsold oil piling up in tankers.
Period, god damn it.
If there is no unsold oil piling up in tankers than oil is currently priced at the level where demand at that price equals the supply. You cannot blame commodity speculators for this!
My understanding is that during the last price speculation bubble, there were oil tankers piling up. If this is not happening now then commodities speculators have got nothing to do with it. Why is this so hard for people to understand?
It's so full that they're building more capacity to store more oil. The situation is the same in other parts of the world.
BTW, this is common knowledge for those who follow the commodities markets. Oil prices are high because of perceived risk of potential supply contraction due to instability in the middle east. It's a risk trade, i.e. speculation.
And if those speculators are right, people will be praising them for having the foresight to save oil for such a situation, which will lower prices compared to the speculation-free scenario.
Speculation could probably have negative effects on markets in theory, but it's so hard to take such claims seriously since they're rarely based on sound economics.
Speculation has had negative effects in practice: The tulip crisis. Sometimes speculation can turn into a pyramid game.
I'm not saying that this is always, or even often the case, but it is sometimes the case.
So somebody is paying nontrivial amounts to store oil that they think will be worth more tomorrow than today. If they're right, they win. If they're wrong, they lose money. If what they believe is true, they help us all and make a profit. If what they believe is wrong, they hinder us all and make money.
Where is the private incentive that is actually at odds with the public one?
Man, you take one microeconomics class and suddenly you have absolute certainty about the forces at play in the global commodities market.
Did it ever occur to you that maybe it's no public knowledge how much oil is piled up where within a month of Libyan hostilities breaking out? Or that the demand for oil may be somewhat inelastic? Or that information in the oil market is not perfect?
I mean I don't know shit about commodities markets, but yelling "god damn it" isn't a very convincing argument.
In simplest terms, the derivative (in this case, futures contracts) is causing the price of the underlying instrument (oil) to increase in price, because the value of the futures contracts themselves have appreciated due to inflation.
Analogy: let's say I'm Big Co and I want to lock in the price of oil at $90 per barrel in the next 6 months, so I buy a futures contract that will do this for me at a price of $5. If the price of oil increases to $100, then I would've saved my company $5 (price of oil at future rate - strike price - cost of contract).
On the surface, this is a good thing if:
a) There is a liquid market for such contracts
b) My company is actually buying and selling oil for the purpose of production of goods and services
Now, consider (a); it's precisely the problem he's describing. Because these banks have large positions in these contracts, it would be in their best interests to see the market value of the oil increase, since it would lead to a corresponding increase in the value of the contract. You can think of it in terms of an insurance "premium". For example, I would pay an insurance premium for my house, car etc because the intrinsic value is high, but an insurance premium for a bottle of water would be negligible in value.
The problem is made worse because the banks are not in the actual business of using oil to produce goods and services of economic value, but in fact have exclusivity to deal in these contracts.
Note that both the demand and supply side of the underlying oil itself has slight bearing on the actual value of these contracts. It's the volatility that determines the prices.
I thought this is only the case with contracts where the payoff is not linear, i.e. limiting the upside or downside. Future contract payoffs are linear f(t) = S(T) − K, so the upside is the same as the downside.
> the banks are not in the actual business of using oil to produce goods and services of economic value, but in fact have exclusivity to deal in these contracts
Can you talk more about the exclusivity here? That seems like a regulatory mistake.
I don't see your point and the authors point being completely contradictory.
The purported role of the commodities futures markets is to 'provide liquidity' to commodities producers and consumers and allow them to sell the production (and buy their needs) forward.
In fact the futures markets are completely dominated by speculation and leverage. Relatively few buyers and sellers of futures contracts either possess the underlying commodity or have a need for it in the future. Almost all futures contracts are rolled forward. There is much more 'paper' trading than actual commodities exist to back. When leverage is this cheap and loose, (i.e. you have more dollars being constantly created through various borrowing mechanisms) futures tend to be very choppy and whip the spot prices around.
The price you pay at the pump is being driven higher by people who neither own nor need oil, but rather have access to cheap leverage and do it because they can and it makes them money. (This is happening in almost every tradable commodity right now)
You seem to think that this is just the way the world works. But please realize that these are synthetic contracts that are being traded around: works of legal fiction. If the reason society allows people to trade in these contracts is supposedly due to help the market function more smoothly, why should we not consider alternatives to the current state of affairs?
Imagine if there was a futures clearing house and futures contracts could only be originated by commodity producers. (and then only in a decaying relationship to their forward production) The set of all futures contracts in existence would actually have some relationship to the forward production of the commodity. Imagine then that in order to purchase a futures contract you had to demonstrate that a) you had facilities available to take delivery of the commodity and b) that your business wasn't just to trade. (Note: the above will never happen) Do you really think commodities prices would be as volatile as they are today?
The poor and middle classes are more affected by rising commodity prices. Even if the bubble will eventually contract (which is what you seem to be saying) Why should they be they be subjected to this just so a hedge fund can make a killing for its customers?
I've read somewhere (yes, this is not a good source; it's more of a hint of where to look) that some markets are seeing longer-term futures, e.g. where previously futures would be sold 6 months in advance of actual delivery, they are now sold 24 months in advance. This is not as physical as oil in tankers, but not all that different.
The Economist disagrees with the conclusion that higher prices are due to speculation: "Studies have shown that commodities that are not traded on exchanges have tended to rise as fast, and be as volatile, as those that are." http://www.economist.com/node/17913011?story_id=17913011
There is definitely a correlation, at least recently, between availability of credit and the increase in commodity prices.
One way to explain this is to look at house prices, and how real-estate agents 'value' these. They will value a property based on the past value of this property, the general increase in price levels since the last sell, and the price of recently sold properties in the area. Properties are not homogeneous, however the 'value' of all properties in a given area will be affected by the price changes of those being bought/sold.
The problem has nothing to do with whether these commodities are traded on exchanges, it's whether an individual or organization is allowed to buy so much of one commodity that it dominates the market and can permanently drive the price up when normal market forces would otherwise gradually and continually bring the price down.
The global speculative frenzy sparked riots in more than thirty countries and drove the number of the world’s “food insecure” to more than a billion.
Sorry, they did no wrong. They live in the USA and they have the right to manage their trading/strategies/prices the way they like. As a Tunisian citizen, I'm looking for the government to secure food and energy for the population. We have enough lands and water. This is actually a good thing: Solve the problem once in a time and stop the dependency to foreign countries.
On a related note, what happened in Tunisia was a bubble and not a revolution. The bubble burst, destroyed the political system as it was intimately related to the economical one. I'll leave that for a longer article I'll be publishing this summer, which explains and reveals many facts TVs and media are unaware about.
Sorry, they did no wrong. They live in the USA and they have the right to manage their trading/strategies/prices the way they like.
I don't think I agree. Let's think about the situation (assuming the posted article is correct): the price of wheat was relatively stable, on the order of $3-$6 per bushel. This system was fine, and stable, for years and years.
Then some financial analysts come into the picture and decide that this is an untapped market where they can make some money. So they do their magic, and -- again let's assume the article is correct and this was actually the cause -- wheat prices jump like crazy.
The result, in real terms, is that a larger portion of the world had to be considered "food insecure," and I'd imagine that some people actually went without food that wouldn't have otherwise.
Is a financial firm's ability to make money (legally, even) more important than people's ability to eat? Or even just more important than people's ability to feel safe and secure in knowing where their next meal is coming from?
From my perspective, that's a resounding no. The ethical and moral obligations easily outstrip the financial benefits.
As you say, maybe it had positive aftereffects, that the Tunisian government stepped back and decided it needed to take local action to make the country self-sufficient. And that's great, but I don't know that that would work everywhere in the world.
I know there are exceptions. Places where there isn't enough water for example. But let's get a closer look, most of the famine is in Africa. Yet, they have enough lands and water to produce what they need.
So the problem isn't in the price; but in the economy and policy of these countries. If the USA wants to do something about these countries, they just need to stop supporting dictatorial systems.
> So they do their magic, and -- again let's assume the article is correct and this was actually the cause -- wheat prices jump like crazy.
If you are not going to explain prices in terms of supply and demand, you need to have clear, compelling alternate explanation. Magic and assumptions don't cut it. If the "natural" (i.e. where supply meets demand) price of wheat is $3, it would be very difficult (and likely expensive) to establish an artificial price of $6. I am curious to know what that story is, exactly.
Food prices are not perfectly elastic when it comes to the basic staples like wheat, especially in the short term. People need a certain amount of food, and their choices come down to eat if you can afford it, or die. Demand by households doesn't change much with price, but they will pay anything from zero up to everything they have.
The price is therefore depends on the suppliers. Normally, competition between suppliers will bring the price down to near the cost of production. However, if there is a futures market filled with overly confident speculators, who buy the grains at a high price and push it even higher, the cost to all the owners of the stock when delivery is due will be far higher than the cost of production; if most of the market paid this same price, there will be no-one with the volume who can afford to compete and push down prices; the final price is likely to strike a balance between the loss of value from throwing away wheat because some people had to starve as they couldn't afford the price, and the revenue from selling the wheat at the highest price.
In effect, against inelastic demand, a futures market and confident speculators have the same effect as rational price fixing by a cartel.
Demand for grains is actually quite elastic. When the price of things like corn and wheat is low, farmers feed them to animals and people consume more meat. When the price increases, people consume less meat and more grain, and in doing so, consume a lot less grain.
In economies where people are too poor to afford meat, fluctuating food prices are a much bigger issue. But in the US, we use more food than we need to in order to enjoy a luxury commodity.
Extremely short & simplified version, because this is complicated stuff: Goldman, among other places, got an exemption to laws limiting how many futures speculators could own. This law was meant to prevent people from buying up tons of futures in order to manipulate the price. With that exemption gone, people who otherwise had little to no interest in the relevant commodity markets would buy tons of them and hang on to them.
The supply actually went up. But because people would repeatedly say things like "give me $N worth of oil," eventually others got wise and started selling oil for $N a barrel.
I've probably skipped important details and garbled something, but that seems like an OK thumbnail sketch.
Life has just returned. And at least in my city, there were particularly no financial damage. Nothing has really changed, except now that we have better police and prosecution. We have got our freedom, and yes, you can criticize the government in public! You can get in here and have full press coverage of any topic. Internet is uncensored, even Wikileaks works.
Politically, we are heading toward democracy, I hope. There will be a constitution of a "Constituent assembly" whose members are elected by the people. This assembly will put the rule of the country, as well as, a temporary government that will prepare for the presidential elections. The election will take place in July, this summer. The delegation rules will be set by the people who made the sit-in of the Kasbah. Aljazeera seems to be following the event: http://english.aljazeera.net/category/organisation/kasbah-go...
"because none of the banks sell what they hold, the price goes up; because the price goes up, more people make money on their positions; because they make more money on their positions they buy more stuff and don’t sell what they hold; and on and on forever"
That is until the bubble pops, those who got in late and can't sell will make a loss. The bid-ask spread widens, in particular there is glut of people wanting to sell at high prices, whilst there are few cautious buyers willing to offer lower prices.
I would say that the main reason prices of commodities are going up is that the FED is printing massive amounts of $ through QE1 and QE2.
If you think that this is a speculative bubble caused by traders then I suggest you just short the commodities and make some money bursting the bubble and bringing prices down again. Put your money where your mouth is.
It's almost becoming taboo to talk about the FED's activities, as though it's some kind of conspiracy but in my opinion this is a very valid point.
It's hard to call it a bubble when all asset classes are inflating.
Edit: Just to be clear i'm not arguing the premise of the article, just that such extreme speculation would not be possible without the enormous concessions made for these banks.
Many countries (for instance the US) currently have massive debt and budget deficits. They have three ways out of it:
1. Increasing taxes.
2. Lowering expenditure.
3. Printing money.
From a political point of view #3 is by far the easiest route. I therefore fear that many countries will "default through inflation". In other words, we will see massive inflation, possible even hyper-inflation. This will be a huge hit to the middle-class. Because people with job but no savings are affected the most by massive inflation.
"Printing money is the last refuge of failed economic empires and banana republics and the Fed doesn't want to admit this is their only idea." Don't worry, it's (partially) tongue-in-cheek.
"In other words, we will see massive inflation, possible even hyper-inflation." Do governments ever learn? This is what happened in the Weimar Republic and is happening today in Zimbabwe.
Where I live (Ireland), the government is trying to do option 1 and 2, without success so far. Austerity measures are hurting the economy short-term by dampening consumer confidence (fortunately, internal consumption isn't everything, as we are an extremely open economy and will pick up as exports grow.) They'd possibly be trying option 3, except the European Central Bank controls our currency and ECB rules state that a country can't run a deficit over 3% of GDP without incurring major penalties.
Austerity measures are painful but necessary. I think that ten years from now you will be better of than the Americans, simply because the austerity measures are stopping all the malinvestment and over-consumption as quickly as possible. I'm Swedish and we went through the same process twenty years ago when our real estate market crashed. Luckily we didn't do like Japan, which still hasn't recovered from their crash from the early 90's (they did what the FED is doing now).
Bankruptcy is never fun but it's the main thing that makes a market driven economy more efficient than a planned economy. You have to stop malinvestments and reallocate resources to something more efficient. This reallocation can be painful but is necessary in the long run. The recession is not the problem, the boom was the problem.
You borrow shares of the index today and sell them immediately. You will need to return those shares at some point, depending on your contract. The day the shares are due, you can buy them at the market price and complete the deal.
That's one way to do it. You can also use things like puts and mini-futures, which have some convenient properties. For instance when selling something short your equity can become negative. When buying puts, the worse-case scenario is zero.
Just wait another year when the oil cartels/speculators have us accepting $4 prices.
The only "good" thing this is making happen is it's slowly taking extra huge/heavy vehicles off the road as people stop replacing them with the same thing every few years. Low 20s mpg for the city isn't worth it anymore.
Oil is expensive because we'll pay that much and use even more.
Did you know the armed forces pay full top price for fuel in Iraq and Afghanistan?
The current spike in gas prices is not primarily a result of anything to do with the freedom fighters in the Arab world...Nor is it a result of OPEC’s production levels...
Rather, the spikes are primarily a result of the speculative market on oil.
The point that he's trying to make all throughout the piece is that, yes, the speculation is partly based on the civil unrest in the Arab world but that the influx in speculatory money is inflating the issue beyond the simple idea of supply/demand.
In essence, the presence of speculators exacerbates the price hikes that normally come of a volatile market. This turns the whole market into one giant feedback loop.
(this is all assuming that I understand correctly, of course)
I always find it difficult to grasp these economic concepts not having studied anything remotely as detailed in my college economics classes. But he's done an excellent job of explaining it in layman's terms. I found myself on an emotional roller coaster whilst reading this piece - at moments I was enraged, then again at moments felt like I could suggest something that would solve the issues, and then felt a little "let's stick it to the man"-ish near the middle. Excellent writing...
Anyways, in terms of the questions my non-economically-inclined-self has to ask,
Who else knows about this? Are politicians aware? Is it something that's not being addressed because they are afraid of losing the support of their wealthy donors? Do the likes of Obama and McCain not address this and place blame elsewhere because it's too complicated to explain to the American public? Has anyone ever tried? I was born and raised here and have never been presented with anything nearly as lucid as this to understand this system over the past 26 years that I have been alive. To those of us who don't study economics outside of the 1-2 required classes as part of college studies, this type of explanation of Wall Street and the commodities market is never really given to us. We don't even cover investment options in school to be honest - most of us don't know what 401k's, IRA's, etc. are when we get out of college.
So back to the original question - who knows about this and what have they done to make the public aware?
Chris repeatedly mentions that commodities trading bets long and they mostly bet on the prices to go up. "But in commodities, where almost all speculative money is betting long, betting on prices to go up, this is not a good thing—unless you’re one of the speculators."
So my question is, would it balance itself out if we required the banks to allow their investors to bet on prices to go down as well as up?
Is this something the banks are abusing their power with - meaning now that they have the letters making them authorized as physical hedgers rather than merely speculators, are they abusing this power by not presenting their investors with the option to bet on prices going down?
Why can't we just revoke these letters given to the banks? What are the downsides? Basically, all these questions are simply my logical brain trying to figure out "Ok, you presented the problem spectacularly well; now what's the solution?" That seems to be my naturally-triggered response to reading your post. I hope he'll oblige with a follow-up or some other readers have answers to these questions.
> But he's done an excellent job of explaining it in layman's terms. I found myself on an emotional roller coaster whilst reading this piece - at moments I was enraged, then again at moments felt like I could suggest something that would solve the issues, and then felt a little "let's stick it to the man"-ish near the middle. Excellent writing...
Sigh... You are responding to rhetoric. That's why it's an emotional rollercoaster. Bad guys are identified and vilified, so you can feel like a righteous victim.
Markets tend to reflect overall sentiment and expectations about the real world. There are a lot of tricks that bad guys can play to defraud markets, but speculation is assuredly not one of them.
Personally, while high oil prices hurt in the short to medium term, hopefully it sends the US economy towards less dependence on oil. To me, this is a good thing. I just hope the US is smart enough to invest in reducing demand rather than increasing supply.
Also, if this type of story is interesting to you, I highly recommend Paul Krugman's blog at http://krugman.blogs.nytimes.com/ . Also NPR's planet money (blog & podcast) has great information and is much less slanted than Krugman's. http://www.npr.org/blogs/money/ .
Isn't the real problem that oil is produced by a cartel that controls prices? Can't the oil-producing countries just put more oil onto the market to decrease prices, if they wanted to?
The issue is that oil producers have no incentive to increase supply: they have a fixed amount of oil under their land, and releasing it slowly makes them more money. Commodities speculators are also tying up some supply (in offshore tankers), but there is more oil in the earth than there is in investment-bank-owned tankers.
OPEC members continuously cheat on each other. The reason oil prices collapsed in the early 1980s and stayed that way for two decades was because OPEC had no teeth. Somebody would always overproduce and reap the lion's share of the rewards, and then everyone had an incentive to overproduce.
OPEC also has an interest in keeping oil prices low over time. When oil prices are higher, people start investing in more efficient technology, reducing their overall need for oil, and consequently, OPEC's potential for political pressure.
The supply increased while demand decreased last year, why then should oil prices be skyrocketing? Has the Libyan oil production slowed down enough to explain the price hike? I don't have any numbers, but the explanation in the article makes a bit more sense than the cartel theory given numbers for the past decade.
Are you referring to the graphs in the article? The data presented by the article is fundamentally flawed because they show U.S. consumption and production, yet oil is traded on a world market. The U.S. is only a tiny part of world oil production (roughly 11% according to Wikipedia - http://en.wikipedia.org/wiki/List_of_countries_by_oil_produc...). It's a somewhat larger part of world oil consumption (a little over 20% - http://en.wikipedia.org/wiki/List_of_oil-consuming_states), but still nowhere near the total world market.
The article's comparison of Chinese oil consumption with speculator purchases was also specious. Without knowing how much speculator oil was then sold back to consumers, we can't draw any conclusions. To see why, imagine a world that consumes 2.5B barrels of oil per month, and where it takes a month for oil to make it from field to refinery. Now imagine that someone invents a way for oil companies to lock in their price at the time they pump the oil, and not have to wait until they can sell it on the market. We'll call it a futures contract, but it's really exactly the same mechanism that your retail store works by. They buy the goods at one point in time, hold on to them as inventory for the time needed to bring them to market, and then sell them on the open market. At no point does the futures contract holder physically take possession of the oil (this is where financial markets differ from retail trade).
At any given time in this model, financial firms own all of the oil on earth - 2.5B barrels of it. As soon as it comes out of the ground, they buy it, and when it's refined, they sell it. Yet the physical industry - the amount of oil produced and consumed, the means of production, and the price of that oil - hasn't changed one bit. The only difference is that financial firms now bear the risk and reward for any change in the price of oil between when it is produced and when it is consumed.
This model isn't all that different from how the industry actually operates (including the numbers), but some details have been simplified.
Anyway, my point isn't that speculators aren't to blame for the price of oil. My personal opinion is that it's a combination of speculation, peak oil, a rise in consumption by China, geopolitical instability, and plain old price inelasticity, with speculation and peak oil being minor factors and the major ones being China and price inelasticity. But the article has presented no useful data - he quotes a bunch of articles and statistics, but the stats he quotes are not relevant to the actual dynamics of how the industry operates.
People didn't believe in 07/08 that much of the price movement was due to the devaluation of the dollar. Perhaps the real bump in prices is due to the devaluation and perceived future devaluation of developed economy currencies. QE/helicoptering money/printing money to stave off deflation ain't free.
A lot of the speculation on comm is because monied people believe that US monetary policy will end with uncontrolled inflation rather than the soft landing the fed is hoping for. To my understanding this is a greater picture case of supply and demand. It's just that the product isn't crude it's insurance.
> the primary culprit is the reinflating of the commodities market that helped drive the Great Financial Crisis.
The author doesn't claim any special knowledge, yet makes a rather vacuous guess: "The primary culprit [for the reinflating of the commodities market] is the reinflating of the commodities market"
He's arguing that the reason commodities (in particular oil) is so expensive now is that commodities are expensive.
There are many domains where I lack any sort of expertise, and I defer to the experts for their analysis and opinions. It doesn't appear that the author maintained the same restraint.
He's saying that commodities are expensive now due to exemptions granted to banks, and only to them, that allows them to rollover perpetually long positions while charging management fees. This is causing inflation because there is a lack of liquidity from a cornered market.
I live in Romania. The price for gas has gone up almost 30% in the last year, a raise that's so high that it's not justified by anything. We have 5-6 big oil companies and they artificially drive the price high. We're one of the few countries that has a decrease in gasoline sales (a decrease of 18%), but they keep raising the price.
We're all going to change our cars for bikes soon. Or we're going to have something similar to what happened in Libya focused on the oil companies.
So what do you pay per gallon currently ? $3.50 ?
That is $0.92 per litre. In Germany we currently pay €1.50 per litre which is $2.1 or $9.25 per gallon.
Consider yourself happy americans!
The article is meaningless because skips over two big points:
First, for all those long only positions, for each of them, there needs to be a corresponding short position. The article never explained where all those short positions will come from.
Second, the article said that when the futures contracts expired and there was settlement, the funds would just "roll over" their positions, that is, by selling their long positions in the expiring contracts and buying long positions in the next contract.
The problem is, just why can the funds be sure not to lose money during this roll over process?
Or, if wheat should sell for $5 a bushel and some fund bought wheat at $100 a bushel and doesn't want to take delivery, then the fund needs to sell the wheat they bought (and would take delivery on), and who's going to pay them $100 a bushel for their wheat (position)?
But prices have gone up. I just suspect that there's more to the system than in the article.
First, for all those long only positions, for each of them, there needs to be a corresponding short position. The article never explained where all those short positions will come from.
You might have glossed over the food section of the article - it discusses exactly that.. basically, that the market has transformed from a balance of long- and short- positions to only long, made possible because regardless of whether the price went up or down, the big names would make money (if prices went up, they make money the normal way, and if prices went down, they make money via their profits gained through replication).
So long as corporations like Goldman Sachs are making this sort of crazy money regardless of whether prices go up or down, you're going to be in a world of hurt.
I get that Goldman Sachs et al are making crazy money whether prices go up or down, but investors in their funds only make money if prices go up, right? They lose money if prices go down, don't they?
So if commodity prices go down in the long run, why does anyone invest in a commodity fund long term?
That's where it gets crazy/wrong - since Goldman is "buying" regardless of whether prices go up or down, it has the effect of artificially providing feedback that triggers higher prices regardless of anything else.
So even if the investors lose a little in day-to-day trading, in the long-run, they're gaining because contrary to what logic says, the prices aren't going down in the long run, they're actually going up (at least until the bubble explodes).
Basically, if we all agree to continue buying something at whatever price it's at regardless of whether we're losing or not, in the long run, we'll drive the prices higher and our own (as investors) profits with them. And then the bubble bursts... only to start over again.
>That's where it gets crazy/wrong - since Goldman
>is "buying" regardless of whether prices go up or down,...
That's not how futures markets work though. If someone else said, you can only go long in a contract if someone else goes short. You can put in a BUY order, but until it matches someone else's SELL it just sits there in the market.
This is because futures don't work like stocks or shares, or even actually buying a commodity now and sitting on it. This is why some banks rent supertankers full of oil - they can't achieve the same hoarding effect on a futures exchange.
Yes, prices go up until the bubble pops, at which point fund investors (but not Goldman) lose lots of money. Was the low point post-bubble above pre-bubble prices?
Wasn't me that downvoted you, mate. But anyway, that's a difficult question to answer and the response could go either way - it all depends on when you officially define the bubble to have started/ended.
What pisses me off the most about the article is that Goldman Sachs seems to have such a large influence on the regulatory body.
They had a subsidiary company sent a letter to the commission asking for exceptions to the rules.
The head person at the commission was someone who actually worked for Goldman Sachs before and after (maybe even during) working at the commission. And they approved this.
When someone inquired about these exceptions they eventually says: ‘We have to clear it with Goldman Sachs.'
No, quite literally and exactly, the exchange does not buy or sell and only connects buyers to sellers. If you buy a wheat contract, then that means that someone sold one. Maybe the Goldman Sachs fund is long only, but the exchange is not. Again, the number long contracts and short contracts are equal. Again, for all those long Goldman Sachs fund contracts, there has to be someone selling a short contract.
You are on the right track. As far as I understand, if you're long for one delivery (e.g. for March) and then "roll over" you're selling the delivery for March to somebody else and that one has to actually take over the oil scheduled for March delivery. The commodity can't just disappear. The only ones who wouldn't have to receive the contracted goods would be the original sellers. If the price raises, that means that the sellers would lose the money by buying the contracts back near the expiration of the contract. As far as I understand, the oil is constantly delivered even when the prices rise and the article author is just confused, so his conclusions are invalid.
You can't see peak oil, really. You'll just observe more and more "unexplained" fluctuations in the oil price, oil reserves, and subsequently the global economy.
I suspect we'll go up and down for many years while it gradually becomes more and more expensive to drill oil all the time. The supply and demand fluctuate due to speculation, unsold reserves, and reactivity of demand of oil, so it will be hard to see the bottom line. It's not going to be cheaper than today in 20 years, and that will inevitable manifest in the global economy.
What time scale are we talking about? If we're asking why oil is more expensive than it was in 1999, I think that's at least partially due to Peak Oil (more due to China and India, though). If we're asking why oil is more expensive than it was in 2009, I'd say it's because of geopolitical instability, speculation, and price inelasticity.
I haven't had a car in roughly three years, so for me, I am thinking in a longer time frame, not a shorter one. Prices will inevitably go up and down some and be influenced by various factors on a day to day basis. But before my divorce forced me out of college, I was an environmental resource management major and went over peak oil in two classes, well before it was some kind of buzz word. One of those classes covered peak oil quite in depth. This is part of why I chose to give up my car when push came to shove for me financially: I believe in the long haul, things will have to change. We will have to walk more, use public transit more, live closer to work, shop closer to home, develop more fuel alternatives and so on. Not everyone will go to the extremes I have gone but the occasional extremist can help make more moderate adaptations look a lot more normal, sane, comfortable, and so on.
(Having given up my car, I do not expect to ever own a car again, having nothing whatsoever to do with peak oil. The short version is that some of the really scary infections that people with my medical condition sometimes get, which doctors don't know how to effectively treat and which 'normal' people don't typically get, are used by environmental scientists for bioremediation of petrochemical spills -- ie they eat petrochemicals. I have come to believe that people like me absorb petrochemicals more than average and that this fact contributes to our seriously negative health outcomes, including picking up infections that think petrochemicals are yummy. I have done much better, health-wise, without a car. Compared to what is supposed to happen to someone with my diagnosis, a little walking is a minor burden.)
Unless you buy everything from local producers who get all their components from local producers, you are indeed affected by oil prices, regardless if you own a car or not.
There are degrees of affectedness, though. I live 2 miles from work, bike in during spring/summer/fall, and my employer provides food on weekdays (technically on weekends as well, if I wanted to go into work then). I tank up on gas about once every 6 weeks, it costs me about $30, and I spend maybe $25-30/week on food. It's well within my budget, and would continue to remain so even if gas went to $10/gallon.
That's a far cry from someone who commutes 20 miles to work in an SUV and spends $60/week just on gas. These people are hurting now. If you have the opportunity to re-arrange your lifestyle so that it's a bit less sensitive to oil prices, it may be a good idea to do so.
I wasn't suggesting otherwise, merely that I am oblivious to what the current price of a gallon of gas is and have been for some time. Since giving up my car, I have been in a gas station twice. I pay zero conscious attention to such things and rarely have the opportunity to just happen to notice it. So, in this longer view, I attribute the general rise in gas prices mostly to peak oil -- which in no way negates the fact that in the shorter run there are many factors which influence the price of any given commodity.
Furthermore, I imagine that even if I did get everything locally grown/made, the price of gas would still have an impact -- unless the farmers were all Amish or something and didn't use gasoline-powered farm equipment.
If Peak Oil even exists. I've read that Russian scientists believe that oil is a renewable source of energy produced through the action of heat and pressure on water and rock. (These conditions can actually be recreated in a lab and do produce oil, at least according to the link that follows).
They do not believe in the whole 'fossil fuel' business.
Simple googling would provide as much as I could and I'm not nearly expert enough to recommend one article over another. However, I believe it boils down to predicting oil reserves--something abiogenic has been unable to find.
I believe I initially gained this knowledge over on theoildrum.com, and those people know their oil.
I like to think i'm open minded enough to accept that... but, it turns out I'm not.
Massive speculation would be curtailed by increased production. Higher prices mean more exploration/drilling. Either we're being screwed over by a massive price fixing scheme, (which seems unlikely to me) or we've used up most of the easy to get oil.
... and since bernanke is printing money and making stockmarkets go up, therefore the oil exporters also are printing what they have, i.e.oil, making their "valuables" go up...
Gas isn't expensive today. What's expensive today are almost all commodities. http://www.indexmundi.com/commodities/
This is a systemic problem. Any valid explanation of price increases in a commodity, e.g., oil (gas), has to explain why prices are rising almost across the board.
Global commodity price increases are being driven by two main factors. The first is rapidly rising standards of living in the developing world as many nations, especially China and East Asian countries, have freed up their markets. This has caused a dramatic rise in living standards and a huge decrease in the number of people living in poverty. These people are now buying the things that we in developed take for granted, and that is driving the prices of copper for cars and new homes, steel for buildings, oil for transport, corn for livestock feed, etc.
The other systemic factor is massive currency inflation in almost all OECD coountries. When inflation happens in more normal circumstances, an inflating country's money falls in price relative to those of other countries, and it's easy to see which countries are destroying their currency and which aren't. People sell the increasingly worthless currency and buy the strong ones. What we have today is almost all OECD countries inflating their currencies at once in a (failed) effort to boost their economies. This means that anyone who wants to protect their wealth needs to invest in something that will rise at least as fast as inflation. That means commodities.
BTW: If speculators can somehow control prices in a way largely independent of constraints, then why aren't they always doing it? It's not like human beings just started getting greedy last year. And why have, for instance, prices of natural gas fallen thru the floor (hint: greatly increased supply due to drilling breakthroughs)? Where are the all-powerful speculators on that?