Question/Comment: Do you believe that some of the run up in oil prices is based on speculation in the commodities markets? My understanding is that the amount of funds et al. playing in oil futures has risen more than 70 percent in the last several years and that this is the true reason that the price of oil has doubled in the past year?
Paul Solman: Yes, I do, but there’s a great debate about this, as I mentioned before. Paul Krugman, the New York Times columnist and a formidable economist, says the futures market doesn’t set the price in the so-called “spot” market — the market for oil you actually buy. Actual supply and demand does, he argues — as does another person who presumably knows more about this than I do, Leo Melamed, whose biography identifies him, rightly, as “the founder of financial futures markets.” On June 25, he wrote:
“Accusing futures market speculators as the main source of the problem for high oil prices is the modern equivalent of beheading the messenger of bad tidings….
Speculation, such as occurs on the futures markets, can only effect underlying prices in a temporary fashion, for a day or two, and then only on the margin. There are speculators who believe oil price[s] are going up and who buy futures contracts. An equal number of speculators believe that prices will fall and they sell. The idea of blaming those who anticipate that prices will rise for the subsequent time period is not rational. To achieve a long-term or permanent effect in underlying prices, such as has occurred in oil, has to be based on either supply demand fundamentals, an unusual natural dislocation, government action, or manipulation.
In the case at hand, the oil rise is a consequence of both fundamentals and government action: A global increase in demand, and the debasing of the U.S. dollar. That, coupled with government inaction: A failure over many years to institute a coherent and comprehensive national energy policy.
If the price rise is the result of manipulative activity then someone is intentionally buying and hoarding the underlying physical supply in question….”
As I e-mailed a finance professor friend who sent me this quote, the literal eminence grise Zvi Bodie (he has a grey beard):
“Melamed is understandably defensive (given his legacy) and
thoroughly wrong. The fact that for every seller, there’s a buyer
would, by the same logic, suggest that a stock market crash (or boom)
is not caused by speculators. Sure, fundamentals will prevail over
time, in some utterly un-pin-downable but theoretically airtight way.
In any market, presumably. But as Keynes remarked (in 1923, no less),
in the long run, we’re all dead. And anyone who thinks buyers and
sellers aren’t setting the price in the indefinite interim — with
their fears, hopes and prognostications — is talking nonsense. Anyone
try to sell a house lately?”
Upon re-reading Melamed, I’d further point out that his argument is
circular. “A long-term or permanent effect in underlying prices, such
as has occurred in oil,” he writes. If it is “permanent,” then sure,
the fundamentals of supply and demand are bound to be setting the
price. But the “permanence” of today’s price is just what we’re
debating. And how can he possibly know whether it’s permanent or not?
But don’t go betting your nest egg on my say-so. I certainly
wouldn’t (and haven’t). Keep John Kenneth Galbraith’s quote in mind, as I should.
And even if I’m right and speculators have driven up prices, it could
be years before they come back down. When the NASDAQ composite
index (the Dow Jones industrial average of high tech, you could say)
starting rising in the ’90s, I thought I detected a bubble forming at a
price of around 1,200 (1996). Imagine my surprise when it rose to
2,000, 3,000, 4,000 and 5,000. It took six years for the price to dip
briefly below 1,200, and even now, in the slough of market despond,
it’s around 2,200. Fair warning.