I Spoke Too Soon

A while ago I disparaged the Indian government’s backwardness (as I saw it) in considering a ban on futures trading. But now, not a few American pols, journalists and bloggers are sounding like the Indian finance minister, making similarly foolish suggestions in favor of restricting oil speculation.

Everybody always wants to punish speculators. But speculators, by following their self-interest, provide the rest of us with market liquidity, price information and generally lower costs of doing business.

Also, if you believe in freedom, free markets are good in and of themselves. Restricting speculation when prices are unusually high or low is like restricting unpopular speech: there’s generally an expedient argument for it, and it’s generally a bad idea because the long-term harm it does far outweighs any short-term benefits.

8 thoughts on “I Spoke Too Soon”

  1. People forget that speculators only make money when they accurately predict the future price of oil. Speculators may drive a bubble to some extent but they also suffer the most when the bubble pops. Sure some individuals may guess the correct time to exit a market but viewed as a population, most speculators won’t profit long term from a bubble. During the big oil boom of ’81-’83 we saw a lot of speculation and a lot of speculators big and small lost their shirts.

    The belief that speculators could drive up the price of a rapidly consumed commodity like oil more than a percent or two is laughable. It’s not as if pumped oil can be stored in vast amounts and sold only at the moment of highest price. It takes 30 plus days for oil in the ground to make it to market. The basic parameters for someone to drive up the market by “cornering the market” simply don’t exist.

  2. Yes. The classic example is the Hunt brothers, who attempted to corner the gold and silver markets and instead frittered away their entire personal fortune, perhaps almost one billion dollars. Speculators only make money when they are right. They do not move markets to any substantial or sustained degree.

  3. Perhaps a question for a number of bloggers/posters here – isn’t a futures contract a zero sum game except for the cut that the entity that issues the contract takes (such as the CBOT or Merc)? In other words, for every “speculator” that wins, isn’t there one that has taken it in the shorts on the bet?

  4. Dan:

    isn’t a futures contract a zero sum game except for the cut that the entity that issues the contract takes (such as the CBOT or Merc)? In other words, for every “speculator” that wins, isn’t there one that has taken it in the shorts on the bet?

    Luckily, futures aren’t a zero-sum game:

    Farmers thus sought to lock in a value on their crop and were willing to pay a price for certainty. They gave up the chance of very high prices in return for protection against abysmally low prices. This practice of removing risk from business plans is called hedging. As a rule of thumb, about half of the participants in the futures markets are hedgers who come to market to remove or reduce their risk.

    The difference between speculation in futures and casino gambling is that futures market speculation provides an important social good, namely liquidity. If it were not for the presence of speculators in the market, farmers, bankers, and business executives would have no easy and economical way to eliminate the risk of volatile prices, interest rates, and exchange rates from their business plans. Speculators, however, provide a ready and liquid market for these risks—at a price.

  5. Dan from Madison,

    If you just look at the monetary exchange then yes one party in a futures contract must come out ahead relative to the other. The person with the most accurate prediction of future prices wins.

    But profits are merely the mechanism by which the markets function. Their greater function is to remove uncertainty i.e. they control information and allow people to make long term plans. People surrender the chance at a future superior profit for a lower but more certain profit.

    It’s a neat system.

  6. No problem till good o’boyism kicks in and speculators are not held to full payment on bid. Work arounds and escape clauses, paper fronts and creative reorganizing not only cheat the system but stick the rest of us with the consequences that should be borne by the players. If we are to bear the negative consequences of manipulation of others, then we are also entitled to protect our own interests in the game.

  7. Interesting how most ppl react to the term “speculator”.

    Did you buy your house with the anticipation that the value would rise? Did you get angry when housing prices began to fall this year? If so, then you too are a speculator; the difference between most Americans with a mortgage and an oil trader is scale of risk and velocity of transactions.

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