Then I found that Jim Hamilton already did a better job than I could hope to do, while skewering Rep. Joseph Kennedy's editorial in the New York Times calling for a ban on speculation.
Jim reminds us that volume numbers are meaningless because most of the trading lasts hours:
Many of the traders who bought a contract on Friday turned around and sold that same contract later in the day. If the purchase in the morning is argued to have driven the price up, one would think that the sale in the afternoon would bring the price back down. It is unclear by what mechanism Representative Kennedy maintains that the combined effect of a purchase and subsequent sale produces any net effect on the price.And what's good for the goose is also good for the gander:
It's also worth noting that on that same day, there were 146,000 May natural gas contracts traded... By what mysterious process can all this within-day buying and selling of "paper" energy be the factor that is responsible for both a price of oil in excess of $100/barrel and a price of natural gas at record lows below $2 per thousand cubic feet?Jim reminds us how futures markets work
But remember that for every buyer of a futures contract, there is a seller. The person who sold the initial contract to me also likely wants to buy out of the contract at some later date. I buy and he sells at the initial contract date, he buys and I sell at a later date. One of us leaves the market with a cash profit, the other with a cash loss, and neither of us ever obtains any physical oil.However, if you read too quickly, you will think that "speculators" in a zero sum game cannot affect prices. This is not true. If speculators collectively think that prices will be higher in the future, more of them want to buy than want to sell, so futures prices rise until there are equal buyers and sellers.
In turn, when futures prices rise, people who actually have some oil hold it off the market (or sell it forward). This is precisely the correct economic function of speculation. As William Tucker, quoted in the Wall Street Journal explains,
What speculators do, however, if they guess right, is smooth out the availability of supplies between the present and the future. By paying a higher price now, they assure that prices will be lower in the future. In effect, they hold supplies off the market today so that they will be available next week or next year when things become even more scarce.If they guess wrong, they lose horrendous amounts of money. There is a lot stronger self-correction mechanism at work here than among politicians.
Adam Smith described this as preventing a "dearth" from becoming a "famine":
When the government, in order to remedy the inconveniences of a dearth, orders all the dealers to sell their corn at what it supposes a reasonable price, it either hinders them from bringing it to market, which may sometimes produce a famine even in the beginning of the season; or if they bring it thither, it enables the people, and thereby encourages them to consume it so fast as must necessarily produce a famine before the end of the season.… No trade deserves more the full protection of the law, and no trade requires it so much, because no trade is so much exposed to popular odium.Adam Smith had seen a few witch hunts. Maybe I should have just started and ended with that one.
Jim Hamilton again. The problem for all attempts to ban "speculators" whose assessments of price we don't like, is that your "speculator" is my "liquidity provider:"
How exactly do we define the "speculators" whose participation in the markets is to be banned? Suppose for example, we stipulate that the only people who are allowed to trade oil futures are those who are actually physically producing or consuming the product. If we do that, what happens if a particular producer wants to hedge his risk by selling a 5-year futures contract, and a particular refiner wants to hedge his risk by buying a 3-month futures contract? Who is supposed to take the other side of those contracts, if all "speculators" are banned?Meanwhile, the New York Times joined the witch-hunt:
Research presented in Congressional testimony, academic papers, government and private studies indicate that excessive speculation, mainly by Wall Street index-fund traders, is needlessly driving up prices,...Speculation by index-fund traders??? I don't have to explain just how silly that is, do I? Next thing you know, Vanguard's S&P500 index fund will be behind bubbles in the stock market.
The Times' links are a fun too, or a bit depressing if you value the ability of "research" to credibly inform public policy, or the Times as an impartial aggregator of consensus among serious academic researchers. The first one, by L. Randall Wray of the Levy Economics Institute of Bard College, starts out stating a fact so obvious it needs no documentation:
"Money manager capitalism has resulted in a series of boom-and-bust cycles in equities, real estate, and commodities.""Money manager capitalism?" You get the idea where it's going from there.