Monday, July 14, 2008

Newsweek: Speculators not causing rising commodity prices

Robert J. Samuelson of Newsweek weighs in to say that financial speculators are not causing the increase in commodity prices. Instead, he properly puts the blame on increased global demand and harmful government policies.
Tired of high gasoline prices and rising food costs? Well, here's a solution. Let's shoot the "speculators." ... Gosh, if only it were that simple. Speculator-bashing is another exercise in scapegoating and grandstanding. Leading politicians either don't understand what's happening or don't want to acknowledge their complicity. ...

A better explanation is basic supply and demand. Despite the U.S. slowdown, the world economy has boomed. ... When unexpectedly high demand strains existing production capacity, prices rise sharply as buyers scramble for scarce supplies. That's what happened.

"We've had a demand shock," says analyst Joel Crane of Deutsche Bank. "No one foresaw that China would grow at a 10 percent annual rate for over a decade. Commodity producers just didn't invest enough." In industry after industry, global buying has bumped up against production limits. ...

But "speculators" played little role in the price run-ups. ... These extra funds might drive up prices if they were invested in stocks or real estate. But commodity investing is different. Investors generally don't buy the physical goods, whether oil or corn. Instead, they trade "futures contracts," which are bets on future prices in, say, six months. ...

Futures contracts enable commercial consumers and producers of commodities to hedge. Airlines can lock in fuel prices by buying oil futures; farmers can lock in a selling price for their grain by selling grain futures. What makes the futures markets work is the large number of purely financial players—"speculators" just in it for the money—who often take the other side of hedgers' trades. But all the frantic trading doesn't directly affect the physical supplies of raw materials. In theory, high futures prices might reduce physical supplies if they inspired hoarding. Commercial inventories would rise. The evidence today contradicts that; inventories are generally low. World wheat stocks, compared with consumption, are near historic lows. ...

Politicians now promise tighter regulation of futures markets, but futures markets are not the main problem. Physical scarcities are. Government subsidies and preferences for corn-based ethanol have increased food prices by diverting more grain into biofuels. ... Restrictions on offshore oil exploration and in Alaska have reduced global oil production and put upward pressures on prices. If politicians wish to point fingers of blame for today's situation, they should start with themselves.
Hat tip to Greg Mankiw.

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