Inflationomics

Speculation: Is It to Blame for High Oil Prices?

Last month, in a 402 to 19 vote, the U.S. House of Representatives voted in favor of a bill requiring the Commodity Futures Trading Commission (CFTC) to curb “excessive” speculation in the U.S. crude oil futures markets. In short, the House wants to lay the blame for crude oil price increases on speculators.

This action brings several questions to mind:

  1. Why doesn’t the CFTC act on its own volition; why does the House have to tell them how to do their jobs?

    Answer: I believe the CFTC understands the role of the speculator and the House doesn’t. Or, perhaps the House just wants to be perceived as doing something. It is common knowledge in the futures industry that speculators provide the liquidity that allows the markets to function smoothly. They make it possible for the hedgers to hedge (transfer the risk of price change to someone else). In fact, the more speculators there are, the less volatile the markets are because prices don’t have to move as far to find someone willing to enter into the opposite side of the trade. If the House has its way, and speculators are banished from the U.S. futures markets, crude oil prices will become more volatile, not less so. Oh, and there’s one more thing—those speculators will simply move their money outside the U.S., thus depriving the U.S. futures markets of the capital needed to be competitive. In the long run, if the House has its way, crude oil will not only be traded outside the U.S., but it will also be traded in a currency other than the U.S. dollar, which means less demand for the dollar.
  2. Implied in the House’s mandate is the belief that speculators are manipulating prices; how could they do this?

    Answer: Obviously, much of the answer depends on how one defines price manipulation. If we define it as “causing prices to act in a way not justified by the underlying supply/demand fundamentals,” then we find that manipulation is primarily limited to the spreading of false rumors and the expansion of the money supply, i.e., inflation. Because inflation of the money supply can only be done by the folks who have a monopoly on the creation of the money supply, we must look to the U.S. government, its spending practices, printing practices, and credit expansion for the primary price manipulators. Speculators simply try to predict future price movements and benefit from those changes. In that sense, we are all speculators—looking to profit by selling something for more than we paid for it. If speculators are successful, they make money. If they are unsuccessful (as most are), they lose money. In the futures industry, there is a buyer for every seller and they drum out any market participants who spread false rumors (they give the industry a black eye).
  3. Could it be that the House is really trying to shift the blame for rising prices from themselves to someone else?

    Answer: For many years, Congress has allowed the U.S. Government to spend well more than it takes in and required the monetization of government debt, thus inflating the money supply and causing prices (in general) to rise. Higher prices and an eventual lack of confidence in a currency lead to greater price volatility. In the long run, inflation turns everyone into speculators—they must speculate on what commodity prices will be tomorrow and which commodities will still be available. But then we’ve known this about inflation for some time—see Fiat Money Inflation in France.

Robert Jackson Smith

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