Speculators

They are bad. They are evil. They are no good. Who has this awful reputation? Speculators, of course. They are greedy, self indulgent with an insatiable lust for money. At least that is what politicians want us to think. As gasoline prices in the United States head toward $6 a gallon ($1.60 per liter), President Obama has promised to do something about these wicked, wicked people. He said that he was setting up the team “to root out any cases of fraud or manipulation in the oil markets that might affect gas prices – and that includes the role of traders and speculators.” There is one problem. He has to start with himself, US government, and governments around the world.

In the past few years the world has been subject to politicians castigating markets for high prices. Sometimes it is food. Other times it is energy. Whatever the commodity and whatever the price they seem to believe that the reason has something to do with the market. The reality is that it always gets back to the government and its policies. It is also not just one government. It is all of them. In recent years governments around the world have followed policies to stimulate growth in their economies that have had unintended consequences to others.

The high price of oil is generally ascribed to several factors. The first is the unrest in the Middle East, specifically the lack of shipments from Libya. Another factor is the dollar. Since oil is quoted in dollars, its devaluation has caused oil to become less expensive. Third, economists like to point to demand from emerging markets whose red hot economies require ever more oil. All of these are good points, but how did they happen?

The lack of supply from Libya is certainly a valid reason, but I cannot remember a time when the Middle East wasn’t volatile. At the beginning of the Iraq war the price of oil “spiked” to $37 a barrel. Although Iraqi oil had already been subject to an embargo, a substantial amount was leaking onto the world markets. This ceased after the war started, but the price of oil was soon down to $30 a barrel.

The low dollar is an excellent cause for the high price of oil, but who exactly is responsible for that? The central bank of the United States government. The Federal Reserve in order to stimulate the economy has embarked on a program of ultra low interest rates and since last summer, quantitative easing. The program has had the intended effect. US interest rates are very low, but so is the value of the dollar.

The monetary easing has leaked out of the US and into emerging markets. Capital flows into the Asian and Latin American blocs have exceeded the last peak in 2006/07 and Asian inflows are 60 per cent above that level. According to IMF research monetary easing by the US, Japan and the EU has in the past transferred itself completely to emerging markets. This has pushed up the demand for subsidised oil as well as inflation in those markets to dangerous levels.

It is not only the G4. The Chinese bank lending programs over the past two years have pumped close to $3 trillion into their economy. This not only stimulated a housing bubble, but additional demand. China’s currency manipulation has resulted in a foreign reserve pile which has helped keep US interest rates low.

As for the speculators themselves, we have to ask where did they get all the money to fuel their rampant speculation? Well, the loose monetary policies have created an environment that has encouraged cheap loans either directly or through the carry trade. US banks are flush with money, but with the economy still weak and the demand for loans is low. In contrast, speculators are happy to put this cheap cash to work raising the price of cotton, metals, coking coal, sugar, oil, coffee, copper, rice, corn, heating oil and gold to new highs. Free money always finds an outlet. Since the cost of capital does not reflect its true value, its allocation ceases to be efficient.

The Federal Reserve’s job according to the former Chairman William Martin was "to take away the punch bowl just as the party gets going," The present central bankers gave the punch bowl to the worst alcoholics and are then surprised when they trash the place.

According to a US senate committee, the 2008 crash was caused by low policy interest rates in rich countries and recycled trade deficit dollars out of poor export financing foreign countries and exacerbated by not understanding that markets need fair and enforced rules to thrive. Sound familiar? So world leaders shouldn’t blame the speculators, if they want the culprit they only need to look in a mirror.

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