Posted on 04/27/2012 4:55:28 AM PDT by SeekAndFind
Lately, speculators have come under attack by Barack Obama. The president blames them for raising prices on oil and gasoline, and he has proposed new restrictions on oil traders. But this is a wrong turn on the road to a healthy economy.
Back in 1958, onion farmers were concerned that speculators were taking advantage of them. They were especially concerned about the extreme volatility of onion prices, which could often double in a short period of time and then drop to a level below the cost of production. Farmers aimed their ire at the Chicago Mercantile Exchange, the principal futures market for commodities. They thought if futures trading in onions was banned then speculators would not create so much price volatility and farmers would benefit. At the behest of Congressman Gerald Ford (R-Mich.), Congress banned futures trading in onions—the only commodity for which trading is prohibited by law.
Four years after the ban, Stanford agricultural economist Roger Gray examined the impact on onion prices. He found that, contrary to the farmers’ expectations, onion price volatility had actually increased. Gray compared onion price volatility into four periods: 1922-41, a period in which there was no futures trading; 1942-49, when futures trading was only developing; 1949-58, an era when futures trading was robust; and 1958-62 when futures trading was banned.
GRAY'S ANALYSIS Gray’s analysis showed conclusively that onion price volatility was far greater during the period when futures trading was undeveloped or nonexistent than during the period when it was robust. This is exactly the result predicted by economic theory. As Gray put it, “An organized futures market widens the opportunity to buy a commodity during the harvest surplus and sell it for later delivery, hence the diminution of in seasonal price range was to be expected on a priori grounds.”
This stands to reason. Speculators make their money by anticipating price changes. If they anticipate future shortages, they will buy now and bid up prices. If they anticipate a future surplus, they will sell now and put downward pressure on prices. Thus the whole purpose of commodity speculation is to moderate volatility—raising prices when they would otherwise be lower and reducing them when they would naturally be higher.
As the famous economist Milton Friedman once explained, the only way speculators could possibly increase commodity price volatility is if they are systematically wrong—buying high and selling low, which is the opposite of how they try to behave and make a profit. If they were wrong too often they would lose money and go out of business.
Said Friedman, “Speculation is stabilizing rather than the reverse…. People who argue that speculation is generally destabilizing seldom realize that this is largely equivalent to saying that speculators lose money.”
HEDGING PRICES It’s also worth remembering that those who produce commodities have a legitimate interest in wanting to hedge their prices. They may want to lock in a sale well before harvest so that they are guaranteed a profit. For hedging to work, however, there have to be speculators on the other side of the trade who are willing to buy without knowing for sure what the price will be when the commodities are available for delivery. In some cases, the speculator is also hedging; a manufacturer may wish to lock in the price of a key commodity used in production so that he can estimate his future costs with precision.
Another benefit of futures markets is guiding production. If a farmer wants to know whether to plant one crop or another, he can look to futures markets to see which offers the greater profit. He can even sell his output before it is planted and thus know with certainty whether he will have a profit or loss. Thus futures markets help moderate price volatility by telling producers to bring more or less of a given commodity to market.
high gas prices regulating oil speculationRose Garden event We can't afford a situation where speculators artificially manipulate markets by buying up oil, creating the perception of a shortage, and driving prices higher -- only to flip the oil for a quick profit. We can’t afford a situation where some speculators can reap millions, while millions of American families get the short end of the stick. That’s not the way the market should work. And for anyone who thinks this cannot happen, just think back to how Enron traders manipulated the price of electricity to reap huge profits at everybody else’s expense.
While it is certainly true that at any given moment in time speculators may cause market prices to vary from fundamental values—on either the high side or low side—it is hard to see how they could do so for any extended period without controlling supply. That is, they would have to physically hold commodity stocks off the market to raise the price above fundamentals for any length of time or bring additional stocks to market to hold it down. There is no evidence that speculators do so or even have the capacity for doing so.
BASIC SUPPLY AND DEMAND Many studies by reputable academics have looked at whether speculators are responsible for volatility in commodities markets and found that this is not the case; price swings have overwhelmingly been driven by economic fundamentals. That is, changes in supply and demand. (See, for example, the January paper by University of Muenster economists Martin Bohl and Patrick Stephan; and a just published paper by Oxford economists Bassam Fattough and Levan Mahadeva and University of Michigan economist Lutz Kilian.)
Nevertheless, there is likely to be continuing pressure to restrict or even ban futures trading. This would be a terrible mistake, as the lesson of the onion market proves. Proof can be found in a recent study by University of Michigan economist Mark Perry, who compared the price volatility of onions to crude oil. Although we think of oil as being especially volatile, the fact that it is widely traded on futures markets actually makes its price swings quite modest compared to the price for onions, for which futures trading is still banned.
It’s human nature to look for easy fixes to complex problems. Banning or restricting energy speculation, however, is a terrible idea that will likely make the problem worse.
Speculators have an easy bet with Democrats in charge of any of the 3 parts of the legislative branch of government, gas supply will be down, making prices go up.
I think you need to go back to square one and learn how speculation works. Here’s a good start:
http://money.howstuffworks.com/oil-speculation-raise-gas-price.htm
People who deny that speculation raises the price of oil beyond its actual worth are basically living under a rock.
That's funny. Beyond it's actual worth? That's even funnier.
The CFTC was established by Congress in 1974 specifically to prevent speculation from artificially inflating the price of commodities.
No it wasn't.
The CFTC's mission is to protect market users and the public from fraud, manipulation, abusive practices and systemic risk related to derivatives that are subject to the Commodity Exchange Act, and to foster open, competitive, and financially sound markets.
Source
In fact, at that source, the words inflate, artificially and inflating aren't even there.
But a speculator with the capital to purchase a sizeable number of futures derivatives at one price can actually sway the market.
But a speculator with the capital to sell a sizeable number of futures derivatives at one price can actually sway the market.
A speculator purchasing vast futures at higher than the current market price can cause oil producers to horde their commodity in the hopes they'll be able to sell it later on at the future price.
Or it can cause oil producers to sell their commodity now in the fear they'll have to sell it later on at a lower price.
If they want to sell it in the future, at the "futures price", all they have to do is sell a future.
As a result of speculation among these and other major players, an estimated 60 percent of the price of oil per barrel was added; a $100 barrel of oil, in reality, should cost $40 [source: Engdahl].
I don't know about you, but if I have a product that is "only worth $40" and it's selling for $100, I'm going to go all out to produce more now and I'll be selling those ridiculously priced futures contracts by the tankerful. In reality, I'd clean up.
Thanks, I needed a good laugh.
I’m sorry, are you under the impression that there are an equal number of long and short positions being held in the oil futures market? The reason speculation has such an effect is because closed long positions, which should theoretically drop the price of oil, are immediately replaced with new long positions.
Yes, it is theoretically possible that speculators could drive the price down. The problem is that history does not show that speculators have ever done this. The speculation market by definition is a zero-sum game. Its effect on the spot price of oil, however, is *not* a zero-sum game.
Global oil demand and global oil supply have mirrored each other for more than 30 years. The oil-producing nations now are as unstable as they have been. The instability, in other words, is nothing new. Yet we have seen massive fluctuations in the price of oil despite this. If speculation has no role, how do you explain this?
I’m sorry, are you under the impression that you can be long a futures contract without a short on the other side? LOL!
“People who deny that speculation raises the price of oil beyond its actual worth are basically living under a rock.”
I would rather see the price of gas go up because of speculation. Then by leftist aka progressive epa laws.
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