The President’s Rose Garden press conference last week on speculative trading and gas prices has induced a flood of editorials that lecture the administration on the law of supply and demand. President Obama pressed for renewed scrutiny of excessive speculation and manipulation in oil commodities and for proper funding of the CFTC to ensure that there will be cops on the beat in these markets. According to some, he is either ignorant of basic economics or spouting populist rhetoric as a cynical election-year tactic.
Being generous, the authors of these editorials are being duped by the big banks that fear losing the goldmine that commodities trading has become. Firms like Morgan Stanley and Goldman Sachs have become dominant in the energy futures and derivatives markets as well as in ownership of physical supplies.
The issues surrounding excessive speculation are complex, and the banking lobby cleverly offers an easy explanation. They argue that speculation is good, a manifestation of the invisible hand that distills the “right” price from the diverse mass of information on future supply and demand. The straw man opponent that they stand up is a Jacobin extremist bent on finding a scapegoat for the uncomfortably high price at the pump. In this view, blaming speculators is no more than an emotional “eat-the-rich” slogan of an ignorant mob. This misleading set of talking points is superficial in the extreme.
It's true that speculation is a necessary and constructive element of both the capital and commodities markets. But the disciples of Ayn Rand fail to point out that the purposes of these two markets are very different. Capital markets exist as a pool of funding for businesses, governments and (through the miracle of securitization) households. In a sense all capital markets participants are speculators.
Commodities markets, however, exist specifically for enterprises to manage price risk. Speculation in the commodities markets is useful when it serves that purpose by providing access to price hedging at a transparent and objectively legitimate price. It is damaging when it distorts the information required for the price formation process and undercuts prices based on objective factors. Speculation that is not required for optimal efficiency serves no socially useful purpose and can be damaging.