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.""

Are We Seeing a Healthcare Cost Bubble?

Jeffrey Sachs' "Entitlements Hysteria" discusses the rising healthcare cost obsession common among politicians as well as the "punditariat". Their beliefs remind me of the folks who thought housing prices would always rise. Haven't we had enough reason to learn it's folly to bet on prices always rising? It makes no difference whether it's housing or healthcare, just because it rose over some past years doesn't mean it necessarily will over all the years to come.

Past price increases beyond inflation don't guarantee future price increases beyond inflation any more than past performance guarantees future earnings. In fact, if we do implement a public option or a single payer system with price negotiation, we could very well see a drop in prices! So why do so many people seem to be so convinced healthcare prices couldn't possibly stop skyrocketing? After all, everything else that goes up out of step with the rest of the economy eventually stops rising faster and usually falls back down.

Deregulation, Bubbles, And The Myth That Our Two Major Parties Are The Same

Many people point the blame for our recent financial crisis towards deregulation. While there's something to that, deregulation did not cause the housing bubble to exist. All deregulation did was let it get more out of hand and have bigger consequences. While that's plenty of reason to push for strong financial regulations, we shouldn't let ourselves believe that regulations could have prevented there from being any more bubbles. Bubbles can happen without any govt interference. And they can happen despite the wisest govt efforts to prevent them. Psychology, markets, information failures, and irrational exuberance build bubbles. And those are also the factors that usually burst them.

Bubbles can form simply from too few people remembering the last time something happened ... such as a major drop in real estate prices. Then people may -- as they did -- start to think it can only go up and they need to get in now and if they get in now they can easily sell higher later. As long as people start to believe that about anything -- and I knew many people who believed that about housing -- then we will get a bubble.

That said, deregulation did arguably make the housing bubble bigger and played a part in how it popped, the impact, and the aftermath. It would have happened anyway, but it wouldn't necessarily have happened the same. It probably wouldn't have been as bad if we'd had better regulation of sub-prime mortgages, securitization, and derivatives as well as better established procedures for the orderly liquidation of large failed banks in a way that protects their customers but not the banks themselves.

Many have rightly pointed out that the Republicans championed deregulation. In response, some try to claim, "but the Democrats did some too," as if all were equal and as if it were a bipartisan failure.

Did the Democrats occasionally go along with some of those policies? Sure, at least many of their blue dogs did. But the Democrats didn't make those policies central to their platform. They didn't push that recent Republican recipe as the right answer for every situation. By contrast, the Republicans did fully, enthusiastically, thoroughly embrace and push all those bad ideas (see below). Some of the Democrats occasionally went along with the insanity and maybe some even bought parts of it -- which was bad -- but it shouldn't earn their party as much blame as the folks who were seriously pushing all those bad ideas as a central and widespread basis of their party policy.

And worst of all, the Republicans are still pushing deregulation as if it hadn't seriously messed us up in recent memory. The party used to be able to claim a proud history with folks like Ike and Lincoln. Now? They would benefit greatly from an effort to transform themselves away from all they've become. It could be back towards the Grand Old Party they used to be. Or it could be something entirely new. Just please, Republicans, get your party to stop pushing every insane position that's been demonstrated to be wrong and bad for us by recent history.

For more of the "bad ideas" referenced above, see "Republicans undiscover fire" by Mark Sumner.


Full disclosure: I'm an independent, a member of no political party. (And I'm well aware both major parties have their own flaws. ...but that doesn't make their flaws equal.)