San José, Costa Rica, since 1956

A Matter of Speculation

A conspiracy theorist is a person who, because of inherent character defect or unfortunate experience, accounts for any unexplained event as the work of conspirators. Pearl Harbor, JFK’s assassination, Roswell and Princess Di’s death all provided rich pickings for us conspiracy buffs, and the mere suggestion of a cover-up gets our antennae twitching. For example:

The world-average price of crude oil increased, for a multitude of legitimate reasons, from about $10 a barrel in January 1999 to some $50 a barrel in January 2007.

A fivefold increase in eight years was bad enough, though manageable, but then it really took off, rising to $147 a barrel last month, threatening millions with starvation and the collapse of many unstable economies. So now we have something new and extremely frightening: an apparently unrestrained rise in the price of an essential commodity, having no relation either to the cost of production or the familiar struggle between demand and supply.

Obviously, something had to be done, and quickly, to uncover the reasons and roll back the increase. Trying to be helpful, in mid-2008, the major TV networks fielded panels of experts to explain the phenomenon and offer solutions to a generally uninformed public who naturally assumed, as we all do when prices rise inexplicably, that speculators were at work. I watched one such panel in June, impressively manned by the head of a major oil company, the financial editors of a prestigious magazine and a national daily, a market analyst and the mayor of an oil country city.

I watched with mounting incredulity as these eminent gentlemen pinpointed dollar devaluation, inadequate crude oil supply, rising demand by developing countries and our love affair with the automobile, without once mentioning even the possibility of speculation. And their unanimous conclusion was that we should generate more crude, consume fewer products and generally straighten up and fly right.

My amazement was because, firstly, the sudden price acceleration in 2008 could not possibly be the result of any of the reasons given. Secondly, the proposed solutions did not address the real causes and anyway could not possibly have any effect in time to repair the damage. And thirdly, because I had in my hand a copy of the testimony given before the U.S. Senate on May 5, 2008, by investment professional Michael J. Masters, demonstrating conclusively that irresponsible index speculation was the real reason for the runaway prices of commodities in general.

Index speculation is the automatic investment of funds based only on rising price.

There is absolutely nothing illegal about it; however, like water, where a cupful is fine but a bath-full fatal, huge investment in the stock or bond markets can be easily absorbed, but huge investment in the relatively small commodity market promptly drives up prices, inviting the waiting computers to pour in more funds, thus further increasing the price – a classic case of positive feedback. Commodity market regulations place caps on the permissible rate of investment by fund managers, but not on commercial banks, so the former simply do swaps with the latter to achieve their objectives.

Consequently, there is no foreseeable limit to the price rise. And, even worse, index speculators do not take delivery of their selected product and sell it on the open market, which is the purpose of the commodity exchanges, but simply roll over their positions. This reduces the public availability of the commodity and further drives up the price whenever supply and demand are barely in balance.

So who are the villains in this terrible business? They are the big institutional investors: the industrial and government pension funds, the college endowment funds and the commercial banks – the holy cows of the financial system, to question whom is sacrilege. It’s all strongly reminiscent of cartoonist Walt Kelly’s Pogo, who famously proclaimed, “We have met the enemy and he is us.”

But these are simply organizations; who are the responsible individuals? They are the financial advisers who, around the middle of the decade, recommended abandonment of the stock and bond markets in favor of commodities, without regard to the predictable effect. And to these people, we may add the exchange regulators and the investment analysts who failed to spot what was going on, or even joined in the fray. These gentlemen, as a class, let us down once before in 1929, when they recommended tightening rather than relaxing credit, provoking a decadelong depression that needed a world war to reverse it. They obviously don’t understand the magnificent machine that sustains us all.

But from the point of view of the general public throughout the world who must literally pay dearly for these antics, the most egregious villains are the TV talking heads who have deliberately misled a public that does not regularly read the Congressional Record, long after the truth has been revealed to Congress.

So to return to our theme, we may require a new definition of conspirators for those who, like sheep, act in concert if not in direct communication to destroy the very system that nurtures them. At all events, Mr. Masters deserves a medal for blowing the whistle, and the villains deserve no less than permanent removal from the financial scene before they do any more damage.

So what of the future? Unrestrained index speculation can be stopped virtually overnight by prohibiting or capping bank swap transactions. But even simpler, while Congress fiddles, the mere threat of legislative action may be sufficient to persuade index speculators to liquidate their positions before they sustain losses, whereupon commodity prices will automatically start to fall and indexed funds will return to the stock and bond markets where they belong. Then we can return to normality, possibly, so far as oil is concerned, back to $50 a barrel, where it all started. Insha’Allah.


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