Saturday, July 5, 2008

The flaws in blaming oil "speculators"

From CNBC, Vince Farrell defends commodity futures traders from the politicians' attacks:
I would like one of our fine, financially knowledgeable, market savvy politicians to define "oil speculator" for me. I know, there is no politician that fits the aforementioned description, but I would like someone to tell me who "they" are. I suppose Morgan Stanley would qualify since they are not in the oil business and trade oil futures.

So "they" are evil and to blame for the high price of oil. Except Morgan handles all the hedging business for United Airlines. The trades appear as Morgan trades but they are for an airline that critically needs to try to hedge its exposure to the volatile price of oil. Who gets outlawed?

Those being called "speculators" are players in the futures market. If they were to be the drivers of the price of oil, they would have to take possession of the commodity and hoard it. As it is they buy a piece of paper and for every buy decision there is going to have to eventually be a close out sell decision. They do not buy the physical product. When a "speculator" buys a futures contract, there has to be a seller and that's what free markets are all about.

Congress should know the price of oil has been driven primarily by the fact that more than 2 billion people in the Far East have been rushing into a more modern world and are demanding their share of the good life that is powered by oil. Demand is up, therefore the price is up. Also, since oil is priced in dollars, the precipitous decline in the value of the dollar due to the twin budget and trade deficits, has raised the price of oil. In 2002 one euro equaled one dollar. Today it costs about $1.55 to buy one euro. If the one-to-one ratio was still true, oil would be around $80.

Institutional investors that now consider commodities to be an asset class to invest in don't hoard the commodity and should have every right to be buying at the top of a bubble like they did in the internet boom. If investors like these were creating a bubble by buying futures contracts, how then to explain the soaring prices of potash and iron ore. These commodities don't have futures to trade!

But it's so easy to blame people, especially during an election year. Don't try to figure a solution. Just assign the blame and maybe get re-elected.
Farrell echoes the argument of Bush-bashing economist Paul Krugman. This is not a left–right issue. This is a fact vs. fiction issue.

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