[R-G] [BillTottenWeblog] How To Burn the Speculators

[Bill Totten]

Why is the price of oil so high?

Because the Bush administration did to the commodities market what it
did to housing.

by James K Galbraith

MotherJones.com (August 15 2008)


Whenever economies sour, politicians blame speculators. But on occasion,
they are right to do so. Speculators did wreak havoc in 1630s Holland,
1720s France, and in the American stock market in 1929. That crash led
to the Great Depression and sixty years of tight controls on
speculation. Now, thanks to our thirty-year infatuation with free
markets, the controls are off, and the mad gamblers are at it again.
Yesterday's burst bubble was housing; today's expanding ones are energy
and food. True, we have major long-term energy problems that cannot be
laid at the feet of speculators. To avoid catastrophic global warming,
we will be obliged to reengineer the country, from housing to transport
to forests, and also to develop and export the technologies required for
the rest of the world to do likewise. Eight years of George W Bush's
policies have made this much harder, and during that time the world may
have passed "peak oil" - that moment when half the recoverable reserves
of conventional oil have been drained and burned - so that from now on
short supplies will be endemic. Meanwhile, demand grows, notably from
China and India, which account for nearly forty percent of the world's
population.

But do supply and demand explain oil prices at $140 per barrel, with
voices from Goldman Sachs projecting $200 for next year (a figure that
would push gas prices above $5 per gallon) and Russia's Gazprom saying
$250, despite a likely US recession? Do they explain the historic price
hikes in rice, corn, and wheat, leading to hunger in the developing
world? Do they explain the absolutely stratospheric price of copper? No
they do not.

Yes, Virginia, speculators can affect the price - if they are large and
relentless enough to dominate a market, and especially if they can store
the commodity and keep it off the market as the price rises.

Futures markets exist to permit commercial interests to hedge their
business risks. For a fee, a farmer (or oil producer) can put a floor
under the price at which his product will sell. The forward price is
normally a bit lower than the current price, but the contract protects
the farmer from a catastrophic price slump - such as may occur in (for
instance) bumper years. Speculators buy the futures on the chance that
the market price will be substantially higher. They make a respectable
profit on what is in effect an insurance function, and a killing in
years of drought, flood, and war.

This system works reasonably well so long as speculators do not actually
control or manipulate prices. For if they can drive prices way up, they
can obviously cash in while the farmer (who has presold his crop)
cannot. Strict regulation by the Commodity Futures Trading Commission
(cftc) is supposed to prevent that.

But thanks to Phil "nation of whiners" Gramm - the former Texas senator
who was until recently John McCain's top economic adviser {1} - futures
market regulation went to hell. Under the "Enron loophole" pushed
through by Gramm in 2000, energy futures were allowed to escape all
federal and state regulation. Gramm embedded that loophole in a surprise
262-page rider, drafted at the behest of Wall Street and Enron, in an
11,000-page appropriations bill on a Friday evening two days after the
Supreme Court handed down its Bush vs Gore ruling and as Congress was
rushing home for Christmas. In a separate bit of absurdity, in January
2006, the Intercontinental Exchange (ice) of Atlanta, which trades
benchmark US oil futures (West Texas Intermediate or wti), came to be
treated by the cftc as a British market (the "London loophole") so that
US regulators do not even track what is going on. (Even more surreal,
the cftc was going to allow trades of US oil futures on terminals
located in America to be "regulated" in Dubai; political pressure put an
end to that idea in July.)

{1} See "Foreclosure Phil" at
http://www.motherjones.com/news/feature/2008/07/foreclosure-phil.html

Worse still, Gramm's Commodity Futures Modernization Act of 2000 also
opened the way for growth in deregulated "credit default swaps" - a way
in which financial institutions "insured" that bad loans would not cause
them losses. This, combined with other deregulatory moves by the cftc,
broadened the "swaps loophole", an enormous backdoor into the
commodities markets, basically permitting speculators making bets off
the commodities exchanges to be treated as "commercial interests" - like
say, farmers - and hence avoid the scrutiny (including limits on the
size of their bets) normally applied to financial players. Thus today,
when officials like Treasury Secretary Henry Paulson say that
speculation is not a factor in the commodity markets, they're not
counting hedge funds and investment banks as speculators - even though
that's what they really are.

According to Senate testimony on June 3 by Michael Greenberger, who used
to head the cftc's division of trading and markets, if swaps were
properly labeled, about seventy percent of the oil futures now traded on
the New York exchanges would be deemed speculative, not commercial, and
subjected to a high degree of regulatory scrutiny.

Okay, let's think this through. First, vast sums of money are flowing
through regulatory loopholes into the commodities markets, particularly
for oil. Second, spot prices (those charged for immediate sale) in all
commodity markets have been soaring. In particular, Americans now pay an
average of $4 per gallon for gas. Is it possible that these two events
are unconnected? Is it possible that Paulson - former ceo of Goldman
Sachs - is right when he says that the price of oil is being driven
mainly by supply and demand?

No, and Senate testimony in May by Michael W Masters, a hedge fund
manager, illustrates why not. Masters points to the spectacular rise of
"index speculation", in which pension funds and other investors invest
in the commodities futures markets according to formulas created by,
among others, (guess who?) Goldman Sachs. Index speculation investments
have risen from $13 billion to more than $250 billion since 2003.
Masters calculates that the speculative demand for Texas oil futures
from this source is now five times the actual 2003 stockpile (the
baseline he used); for corn and aluminum the figure is about nine times;
for silver it's a phenomenal fourteen times. There is of course no way
that the orders represented by all those futures contracts could be met.

So the futures price goes up. As it does, supplies actually disappear.
For instance, copper expert Frank Veneroso believes that 800,000 tons of
copper has been hidden away in China, waiting to emerge closer to the
market top. For Saudi Arabia and perhaps Russia the matter is simpler:
Oil stays in the ground, and the oil not sold boosts the price of the
oil that is. As current prices soar, the index speculators obey their
computer programs, which tell them to pour still more money into the
commodity markets.

There may be a further element at play, according to an April speech by
Attorney General Michael Mukasey: "International organized criminals
control significant positions in the global energy and
strategic-materials markets. They are expanding their holdings in these
sectors, which corrupts the normal functioning of these markets and may
have a destabilizing effect on US geopolitical interests." To whom
exactly Mukasey is referring, he does not say. But that organized
criminal interests have the motive, means, and opportunity - handed to
them by Phil Gramm - to destabilize the world energy markets seems quite
clear.

On these matters, there is a quick fix. Under pressure, the cftc is
closing the London loophole. Early in the next administration, Congress
must slam shut the Enron and swaps loopholes. Index speculation should
be curtailed by making such strategies illegal for regulated pension
funds and by imposing limits for all traders on how much they can buy or
sell. Investment banks using credit default swaps to enter the
commodities markets should be regulated to the standards that apply to
speculators, not as if they were heating-oil vendors hedging against a
warm winter. Investigations now under way at the Federal Trade
Commission, the Federal Energy Regulatory Commission, and the Department
of Justice should be intensified, and criminal manipulation of the
markets, if detected, should be punished.

Finally, the federal government should burn the oil speculators by
selling up to four million barrels a day from the Strategic Petroleum
Reserve. And as economist Tom Palley has pointed out, consumers can help
too. An awful lot of gas is stored in cars. If people stop topping off
and make do with half a tank, they'll back up supply and lower demand.
It's a brilliant suggestion and definitely worth a try.

And while this is being done, and especially if all this smoke leads to
fire, someone should ask, "What did Henry Paulson know, and when did he
know it?"

_____

James K Galbraith is a contributing writer for Mother Jones.

This article has been made possible by the Foundation for National
Progress, the Investigative Fund of Mother Jones, and gifts from
generous readers like you.

(c) 2008 The Foundation for National Progress

http://www.motherjones.com/news/feature/2008/09/exit-strategy-how-to-burn-the-speculators.html


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