A Rejoinder to President Obama's Views on Oil Speculation

10/22/2013 11:49 am ET | Updated Jan 23, 2014

In the Wall Street Journal of Thursday, May 3, 2012, a statement by President Obama was published, speaking about the influence of speculators in rising gas prices. He stated, "Raising gas prices means a rough ride for a lot of families. We can't afford a situation where speculators artificially manipulate markets by buying up oil, creating the perception of a shortage and driving prices higher, only to flip the oil for a quick profit." Mr. Duffy, the CME Executive Chairman, dismissed the criticism, saying that speculators play an important part in financial markets. He rightfully credits them with the rise in the Dow and the increase in the share price of Google.

What Mr. Duffy missed is the fact that the Dow and Google are not in the same impactful stance as oil. I can say unequivocally that oil is one of if not the only commodity, with a universal effect when its prices change. Everyone uses it, the poor and the rich who must get to work in vehicles that burn gas. The poor man or woman out there does not care whether the Dow has gone up or Google has increased in share prices. He/she worries whether or not there is enough money to buy gas, which continues to rise in price when income is stagnant.

The question is not whether or not speculators assist in the efficient operation of the market but whether or not that type of speculatory behavior should be extended fully to a commodity so vital to the livelihood of nations, especially people in the middle class and poor. I do not gather from Mr. Duffy that it is not speculators who manipulate oil prices but that they do it so that the market's financial sector will continue to operate efficiently. Since that is the case, Mr. Duffy seems to suggest that we should give speculators free reign in manipulating oil and gas prices. Many have argued that speculators have nothing to do with the rising prices of oil. They blame it on everything else, such as China's growth, India's growth, world conflicts, and so on. They argue that oil prices are responding to supply and demand in the market place. As you will see later, this is a bit far from the truth.

As a rejoinder to President Obama's position, I refer the reader to a research-based article entitled "Oil Speculation: The Impact on Prices, Inflation, Interest Rates and the Economy" (Ajuzie et al., 2009), which found that oil speculation causes inflationary pressures or increases in general price level, including oil. In order to appreciate the result of this oil speculation study, we go back to another study entitled "Import Response and Inflationary Pressures in the New Economy: The Quantity Theory of Money Revisited" (Ajuzie et al., 2008). The paper primarily investigated the response of inflation to goods and services (G&S) imported into the U.S. The finding was that importation of goods and services significantly reduces inflationary pressures. As many have stated before, the reason is that the G&S come from places with lower opportunity cost of production and, thus, have comparative advantage in international trade. As a result, they can afford to sell to us at lower prices than the same G&S produced domestically. The competition forces U.S. producers to reduce their prices. The overall impact is a reduction in inflationary pressures and inflation.

When a strong debate arose regarding whether or not oil speculation drives up the price of oil and gas by putting an upward pressure on inflation or general price level, a decision was made to incorporate speculation into the 2008 imports of goods and services formulation. The variable used was the spot oil price (STP) at the New York Mercantile Exchange (Ajuzie et al., 2009). It was astonishing to find that imports of goods and services (IMP), though still negative, became highly statistically insignificant in its ability to reduce or dampen inflationary pressures. Oil speculation, on the other hand, was found to significantly increase inflationary pressures. We also found that the price of crude oil, which was one of the variables in the model, is a derived price. It is derived from speculatory prices of oil. Crude oil price has an insignificant effect on inflation, which is measured by the consumer price index (CPI). The raw data show a notable divergence between speculatory (STP) and crude oil prices, with the latter being lower throughout the period of study, which included the highest STP of $147.45 reached in mid-July 2008.

The middle and lower classes of this country make up the major consumer spending hub that spurs production and economic growth. The higher the percentage of their income is spent on gas, the less they have to purchase goods and services (G&S). As less G&S are purchased, less output is produced, leading to the stagnating employment and jobless recovery we have been experiencing in this recovering economy even as stimulus money was spent to create jobs and even with the flow of $85 billion monthly into the economy through the Quantitative Easing (QE), which is unsustainable as I suggested previously elsewhere. Oil price increases behave as additional taxes, reducing disposable income, on consumers whose gross incomes do not increase to compensate for the rise in pump prices.

What is scary is that oil speculation is occurring throughout the world, from New York to Hong Kong and places in between. If that is the case, there is no doubt why the downturn has had a universal impact? It has been suggested that a limit be placed on spot oil prices. A spread of between $70 and $90 a barrel of oil would be quite appropriate given the introduction of alternative sources, such as renewable energy, liquefied natural gas, and technology in various forms, including better automobile efficiency and electric rail transportation.

In the import paper referred to above, there is an equation (15), which establishes a threshold, indicating that as long as the value of imports of goods and services is above and/or within that threshold, there will hardly be any inflationary pressure in the economy to necessitate rate increases as was done in the late 1990s. For now, it is only speculators' action on commodities of vital and strategic interest, such as oil, that will be driving up general price level, which includes gasoline pump prices.