Speculation Leads to Bubbles, Right? So ... Food and Oil?

Bubbles yield unqualified delight when you're a kid and bathing in them or chasing them around a yard. Sadly, bring them over to the dismal science, and they usually just reinforce the dismal reputation. On the other hand...

We know from bubble after bubble that they thrive on speculation. The peak of the housing bubble swelled on speculators buying houses with the assumption that the price would keep going up so they could flip them for a profit. The process was nothing new. It was the same old recipe. No govt involvement was required. All that was needed was for speculators to get a bit too exuberant from success after success and throw caution to the wind. Whatever the market, strong profits draws speculators to try their hand. Get enough speculators and they enter a feedback loop pushing the prices up further ... until the Minsky Moment when for whatever reason the buyers stop buying higher and the bubble pops on the weight of speculators who can't stay in without rising prices.

We also know there are quite a lot of speculators in food and oil futures. Some claim speculators in the food futures market outnumber hedgers 4 to 1. And it's been said the speculative part of the oil futures market dwarfs the producer/consumer part by about 5 to 1. Can there really be that much speculation in a market without a bubble in progress? I'm far from certain, but there's at least enough appearance of bubbles in these markets to start digging into that question further.

Pondering the idea of a bursting of food and oil bubbles almost makes one tempted to hope. Lower food and oil prices sure sound appealing to the vast majority of us. Of course, America produces a lot of food and reports say we've recently become a net oil exporter, but still most of us would see more good than harm from a massive drop in those prices.

Update 03/8/2012: from the March 7, 2012 article, "Oil Speculators Must Be Stopped and the CFTC “Needs to Obey the Law”: Sen. Bernie Sanders" by Morgan Korn:

"Blaming the speculators may seem like scapegoating to some (namely, oil traders) but speculators control more than 80 percent of the energy futures market, up from 30 percent a decade ago, and there is mounting evidence that speculation contributes to higher prices:

• At a Senate hearing last June, Rex Tillerson, the CEO of ExxonMobil, said speculation was driving up the price of a barrel of oil by as much as 40 percent.

• A study conducted by the nonpartisan consumer advocacy group Consumer Federation of America found that speculation caused the average American household to spend an additional $600 on gasoline expenditures in 2011. Moreover, the report concluded that excessive speculation (which the organization estimated added about $30 per barrel to the cost of oil in 2011) drained the U.S. economy of more than $200 billion in consumer spending in 2011.

• The St. Louis Federal Reserve has also recommended that the CFTC do more to prevent oil speculators from driving up the price of oil. Fed officials studied the effect of oil traders on the price oil over five years and determined that "speculation contributed to around 15 percent to oil prices increases."

• CFTC Chair Gary Gensler declared last year that "huge inflows of speculative money create a self-fulfilling prophecy that drives up commodity prices.""