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Do You Still Believe it Wasn't Speculation?

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With crude oil prices now twenty percent below their levels of just a month ago, and other commodities down as much or more, it's time for the countless economists who told us the rapid prices increases had little to do with speculation to stand up and explain themselves.

Now, anyone writing about or discussing economics is going to make mistakes. But this claim was a whopper. More to the point, and the reason it brings out this writer's passionate anger, is that the rapid rise in prices has caused so much pain for the world's poor.

The simple fact is that prices for any commodity can be moved by speculation about the future. When they are financialized, as is crude oil, it means non-users can make easy bets on future prices that require only a small down payment.

It's just like the stock market. Do stock prices reflect only rational projections of corporate earnings and dividends? We've had enough of irrational exuberance and its opposite to know better now. Then why should oil futures prices reflect only genuine shifts in supply and demand?

The fascinating question is why all these economists were so anxious to deny speculation an important role.

There are two answers. One is the persistence of a view that financial markets are efficient and mostly rational. Many economists, not only Friedmanite conservatives, like to believe that. It makes doing economics a lot easier to assume most of the time that prices accurately reflect the real world supplies and demands of goods and services, including financial assets, and that market participants always have their wits about them.

The second answer is that if the financial community admitted oil price speculation was a major problem, regulation of trading might likely follow. Many economists work for Wall Street firms, or might someday like to, even those staffers at the Fed.

What is really galling is when economists make such claims implying that anyone who disagrees is simply ignorant of the basic laws of economics or just not bright enough to understand all the nuances.

Oil is a financial asset now. It attracts hundreds of billions of dollars of institutional investment. It is a hedge against inflation and against a falling dollar. And like all financial assets throughout time, it is given to fashion and fad.

Demand for oil in the US is down only a couple of percentage points, crude down twenty percent. Quite a swing, Try to explain it rationally.

Then tell us how the Federal Reserve and other central banks can dare make monetary policy based on assumptions that such prices have genuine roots in supply and demand. Not to say that there may not be a long-term shortage over time in oil. Fortunately, Ben Bernanke has thus far resisted. But tough guys at central banks were wiling to cause people to lose jobs without sufficient sensitivity to the wobbly foundation of these oil prices.

Why do so many smart people believe such things?