Comment by miked | Hacker News Reader

Comment by miked | Hacker News Reader

If you are going to explain a system-wide phenomena, you need a systemic explanation.

Gas isn't expensive today. What's expensive today are almost all commodities. http://www.indexmundi.com/commodities/

This is a systemic problem. Any valid explanation of price increases in a commodity, e.g., oil (gas), has to explain why prices are rising almost across the board.

Global commodity price increases are being driven by two main factors. The first is rapidly rising standards of living in the developing world as many nations, especially China and East Asian countries, have freed up their markets. This has caused a dramatic rise in living standards and a huge decrease in the number of people living in poverty. These people are now buying the things that we in developed take for granted, and that is driving the prices of copper for cars and new homes, steel for buildings, oil for transport, corn for livestock feed, etc.

The other systemic factor is massive currency inflation in almost all OECD coountries. When inflation happens in more normal circumstances, an inflating country's money falls in price relative to those of other countries, and it's easy to see which countries are destroying their currency and which aren't. People sell the increasingly worthless currency and buy the strong ones. What we have today is almost all OECD countries inflating their currencies at once in a (failed) effort to boost their economies. This means that anyone who wants to protect their wealth needs to invest in something that will rise at least as fast as inflation. That means commodities.

BTW: If speculators can somehow control prices in a way largely independent of constraints, then why aren't they always doing it? It's not like human beings just started getting greedy last year. And why have, for instance, prices of natural gas fallen thru the floor (hint: greatly increased supply due to drilling breakthroughs)? Where are the all-powerful speculators on that?

Gas isn't expensive today. What's expensive today are almost all commodities. http://www.indexmundi.com/commodities/

This is a systemic problem. Any valid explanation of price increases in a commodity, e.g., oil (gas), has to explain why prices are rising almost across the board.

This is almost exactly the point the article is trying to explain: commodity prices are rising across the board in line with the commodities index, but why should there be an index at all? In the market you have the supplier, buyer, and consumer. The "speculator" was placed into the mix with a limited role for providing liquidity; this role was intentional and helpful since in the real world there could be a delay between the time a grower/supplier and buyer/cereal producer actually needed what the other had (raw material or cash); with the speculator there was always the opportunity to buy or sell. However, there were intentional, specific limits placed on the speculator. This was to ensure he couldn't corner the market and artificially skew prices. As long as these limits remained intact the market operated as designed, and the actual price of commodities reflected real world supply and demand (since the main players in the market were physical hedgers - people who actually had stake in/cared about the physical commodity). Goldman Sachs was able to get these "speculator handcuffs" removed. This means the actual market price for commodities doesn't necessarily reflect supply and demand. Rather, it also has the component of speculation priced into it. We can see this even within these last few days. The price of a barrel of oil was skyrocketing above $100; this seemed to make sense due to the unrest in the Middle East, then amazingly with the earthquake in Japan it quickly dropped below $100. In such as short time was there really an escalation then de-escalation in the demand for oil!? Of course not. The price was following speculation, people who are only in the market to make money. The end result is that ordinary consumers must pay at the pump what the whims of investors say, never mind progress made whether politically or technologically, or reductions by consumers in a recession to ease pressure on demand and oil prices. Natural gas is not as attractive to speculators as oil.

Don't forget that speculation works both ways. It can also bring down prices very quickly and consumers benefit from that. What speculation really does, in my view, is to insert a component of future expectations in addition to the current supply and demand effects.

It is not entirely clear to me that adding this expectations component is always bad. It can get out of control when it becomes self feeding, but it can also convey valuable information that allows us to react early to fundamental supply and demand issues. We clearly have fundamental supply issues in crude oil and in agricultural products. The blog post is totally wrong on that one. Pointing to falling US demand of crude oil makes no sense in a world where the marginal buyer is in Asia.

Don't forget that speculation works both ways. It can also bring down prices very quickly and consumers benefit from that.

That's like me expecting you to say "thanks" for returning an item I took from you when it's speculation which helped drive up prices in the first place.

What speculation really does, in my view, is to insert a component of future expectations in addition to the current supply and demand effects.

That's exactly what it does. Why do we need that?

It is not entirely clear to me that adding this expectations component is always bad. It can get out of control when it becomes self feeding, but it can also convey valuable information that allows us to react early to fundamental supply and demand issues.

React early and do what? This isn't like hurricane preparedness. Again, the point the article is trying to convey is that prices don't reflect supply and demand. We experience sky rocketing gas prices but no longer see gas shortage or rationing lines. In 2008 we had significantly more people go hungry from food shortages, although nothing has changed about wheat farming except, if anything, farmers producing it more efficiently. The wheat harvest that year was the most bountiful the world had ever seen.

I think we need a component of future expectations in prices because it increases incentives and provides funding for averting real future shortages.

I think we need a component of future expectations in prices because it increases incentives

I'm extremely wary of the term "increased incentives" in light of recent events sparked by this model on Wall St.

and provides funding for averting real future shortages.

We just don't see gas lines to support that argument.

Edit: And what do you mean "provides funding" anyway? Speculative contracts don't raise oil producing levels, nor stockpile oil (as our Strategic Reserve does). The extra money which exists is all used up by the speculators playing the game.

General anti Wall St. sentiment is not a very potent argument. It's difficult to deny that higher prices increase supply and/or destroy demand. Wall St. didn't invent this logic.

General anti Wall St. sentiment is not a very potent argument.

I'm not anti-Wall St. But I am anti-recklessness when it means wreaking havoc on our national (and by extension entire world) economy.

It's difficult to deny that higher prices increase supply and/or destroy demand.

No, it's not. Actually, higher prices usually mean there is decreased supply and increased demand. That's in a normal market. But we don't even have a normal oil market. That's the entire point. When oil prices skyrocketed to record levels above $145/barrel in 2008 it wasn't because of increased demand, and those astronomical prices didn't mean an increased supply of oil either.

He is saying that "higher prices -> lower demand" You say that, "no higher demand -> higher prices"

Both are true

I think our misunderstanding is that you're talking about what has happened and I'm talking about what is resulting from it. Higher prices mean that demand has been growing faster than supply. As a consequence, suppliers now want to supply more and consumers want to consume less. So higher prices incentivise more supply.

Higher prices mean that demand has been growing faster than supply.

But that's not the cause of our higher prices. Listen, I can't keep arguing this. Do me a big favor and just read the first 3 paragraphs here:

http://useconomy.about.com/od/commoditiesmarketfaq/p/high_oi...

As a consequence, suppliers now want to supply more and consumers want to consume less.

Suppliers want to supply more. So, if you're some Saudi Arabian sheik witnessing these astronomical oil prices you really want increase oil production and supply more? What will that do to oil prices? Think about what you're saying.

Exactly. If I'm an owner of an oil field I prefer to sell at higher prices and if prices are high I invest more in exploration.

Of course prices are not just influenced by supply and demand. They are also influenced by speculation. I never denied that. What I'm saying is that speculation changes the timing and increases the volatility, but it cannot decouple from supply and demand indefinitely.

So if we're running out of easily accessible oil in, say 20 years, and speculation increases today's prices in expectation of that, that's a good thing. Of course it is a double edged sword. Sometimes future expectations never materialize and speculation ends up destroying value.

High oil prices make alternatives economically viable so they get funded. It's pretty simple.

Oooh, it's a bit of a slippery slope to try to argue that. A shift in political winds and/or attitude can cancel/limit alternative energy funding in a heartbeat.

The speculation is in commodities indexes which are all long positions. Thus, it won't work both ways - prices won't go down.

I think what actually influences prices is trading of futures contracts. The price in the contract can be above or below the price of a shorter dated contract, i.e the "current" price. So I can speculate on falling prices, thereby depressing prices. That's my understanding, but I don't claim to understand all the details.

Note: That wall o' text makes it hard to pick out your key points.

> The "speculator" was placed into the mix with a limited role for providing liquidity

This makes no sense. Who did the placing? Every market has speculators, and even end-user-buyers base their decisions in some part on speculation.

The speculator has no altruistic diktat to provide liquidity. The speculator is there to make money, and providing liquidity is a side-effect. i.e. the speculator wants to take on a position, but can only do this if someone else wants to exit a position -- thus making a trade. The seller's interests are served just as much as the buyer's.

Now, there is a clear issue with cornering the market. However, there is a natural check to this behavior, in that taking delivery of millions of barrels of oil is expensive. And if you have no intrinsic need to consume a commodity, then it is very expensive to sit on. If supply is indeed artificially constricted by hoarding speculators, they will need to sell off their supply at some point.

>This makes no sense. Who did the placing? Every market has speculators, and even end-user-buyers base their decisions in some part on speculation.

Did you read the article?

These buyers and sellers of real stuff are the physical hedgers. The FDR administration recognized, however, that in order for the market to properly function, there needed to exist another kind of player - the speculator. The entire purpose of the speculator, as originally envisioned by the people who designed this market, was to guarantee that the physical hedgers, the real players, could always have a place to buy and/or sell their products.

>The speculator is there to make money, and providing liquidity is a side-effect.

Yes, speculators making money is fine. The liquidity side-effect is the reason to allow for some speculation in regulations.

> If supply is indeed artificially constricted by hoarding speculators, they will need to sell off their supply at some point.

Yes, that's why, as I said, consumers are subject to volatile price swings from investors, rather than steadier prices which would more accurately reflect supply and demand.

> The FDR administration recognized, however, that in order for the market to properly function, there needed to exist another kind of player - the speculator. The entire purpose of the speculator, as originally envisioned ...

My point is that free and open markets attract participants who exercise their self-interest. There is no central authority saying "you are the buyer", "you are the seller", and "you are the speculator". Speculation is an inherent property in any market participant. So-called "speculators" are merely those having no larger interests (i.e. taking delivery and consumption).

In a split-second, a "real player" can become a speculator, if he sees a market opportunity and takes on a position for which he never intends to take delivery. The point is, identifying who is a speculator and attempting to limit those activities is extremely difficult, because speculation is all about internal motivation, and central authorities have no real insight as to an individual's motivation.

I applaud FDR for not trying to prevent speculation, but I seriously doubt any capability for injecting speculation via "placement".

>but I seriously doubt any capability for injecting speculation via "placement".

You're reading my text too literally. I don't mean to an arm from the sky put speculators in the middle of the wheat market. As you correctly mention, an open market will attract those who exercise self-interest. Speculators are thereby effectively "placed" in a designed market by not regulating them out.

The article states that the regulation changes that allowed unlimited commodity speculation only started in 1991 and then only for 16 institutions who were given exemption.

I agree that speculation isn't the sole cause of the price increase in oil since there are other buyers besides speculators and the post's long quote from Matt Taibbi’s Griftopia acknowledges this. The quote gives facts to show the increase in speculative demand for oil was more or less equal to the increase in China's demand. If China makes up a substantial amount of the change in demand that drives up the price of oil then speculation does as well.

I agree with you about the effect of inflation and the post only covers 15 foods and oil in detail so an argument that speculation is the sole cause of price increases would be false. An argument that speculation is a driver in the prices of all commodities would be an extrapolation that requires more evidence. However, breakthroughs in drilling for natural gas gives a reason for natural gas to be an exception, not for all commodities to be devoid of speculation's influence.

Reply on news.ycombinator.com