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Stephen Zarlenga

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'Front Running' Against Humanity in the Oil Markets

Posted: 08/26/11 07:24 PM ET

"Front running" is an insiders' term for an often illegal, always immoral practice in commodity and other markets. Here's what happens:

A broker holding a client's order to buy at a certain price instead buys for himself just in "front" of it. The client's order isn't filled, and the broker has an unfair advantage over other traders because he controls the client's order, which will buy the position back from him and protect his trade from a loss.

The client loses the opportunity to gain, where his order is never filled if the market moves away from his order point. If some participants can trade with little or no risk, over time everyone else is hurt.

Because Exchange members' margin requirements are usually about 1 percent or less, the front-running brokers have a possibility of quick, great gain with almost no risk of loss.

Why Is This Important to Public Policy?

"Front running" is one way to view what criminal Enron executives did to California. They had the client's non-cancellable, inelastic "orders" to buy electricity, and they grabbed the available supply in front of that, restricted the delivery process and extorted higher prices, blaming price rises on "market forces."

Enron was bad enough, and Sarbanes-Oxley was passed to hold corporate officers criminally liable -- a good law, as judged by the corporate types screaming for its repeal. But it didn't go far enough, as judged by the present (2007 to 2011), bold attack against humanity in the oil markets.

The manipulation of energy markets has widened from cheating California to a deadly attack on all humanity. That's what allowing speculation in oil futures is doing today. These markets aren't providing "price discovery," as apologists claim. They've driven oil prices to destructive levels and done immense damage.

We saw the devastating effects on airlines, trucking, food delivery and production, families trying to keep up with living costs, and restaurants and hotels Americans can no longer afford. Add your own examples. It's the speculation that does it. Exxon couldn't have grabbed its record-setting, $11.7-billion, second-quarter profits in 2008 if its costs of obtaining oil were rising.

And so I put aside an outline for this piece when it appeared that Congress would do its job to rescue the world economy from this pernicious vandalism, by limiting speculation in oil futures to a few contracts per account, by enacting the Stop Excessive Energy Speculation Act of 2008. That's all it would take to stop the nonsense!

You see, there's no reason to allow wealthy speculators to position themselves between the world's limited oil supplies and those who have to use that oil to keep the world economy functioning. Such speculation leads directly to hardship, starvation, death and warfare. "Congress will finally fulfill its responsibility," I thought, but the bill failed in the Senate with 50 for, 43 against and seven not voting (including Senator Obama!). Sixty votes were needed to enforce cloture.

Why Didn't Congress Act?

How could the Senate refuse to act? Are they some kind of demons? No, but something almost as bad; we're confronted with a bad idea that many people believe in: the sanctity of markets!

The vote exposes a bad methodology, an ideology based on false axioms, a false view of markets that's been strongly promoted and not questioned. With its negative effects not understood, markets are given a sacred character:

  • Omnipotence: Don't try to legislate against the market; market forces will crush your laws.
  • Omniscience: Don't try to instruct market behavior; it has inputs from millions of participants and knows more than your regulators ever could!
  • Benevolence: Do the right things and the market will reward you; misbehave and you will be punished!

Omnipotence, omniscience and benevolence are attributes of a god, and Senators don't often fight with God!

What's sorely missing from these beliefs and assumptions is evidence! Where's the evidence that removing regulation from the airline industry had good effects? Where's the evidence that removing FCC restrictions on media ownership had good effects? Where's the evidence that removing government regulation from any industry has had good effects?

Of course, it's worse than that. It goes beyond a lack of evidence because holding those beliefs requires ignoring loads of evidence: ignoring the damage done to the airline passengers by deregulation, the damage done to society by media concentration, the continuing damage done to America's middle class, etc.

How can proponents of unregulated markets justify ignoring the facts? Its crazy, but it's also a necessary part of their false methodology, which loves theory but avoids experience -- the facts. That's only so long as their paymasters benefit! One of their leading "lights," economist Ludwig von Mises, carries it to extreme levels, actually claiming that facts cannot disprove his theories! So we are dealing with momentous errors of judgment and methodology.

Though these men are in the U.S. Congress, they are thinking like scared children. But such errors belong in children's sand boxes, not our nation's halls of power.

This battle over methodology is an old fight. We've see it since our nation's beginnings. Ben Franklin's 1729 essay "The Nature and Necessity of a Paper Currency" gave the correct methodology when he summarized the ideas used to help Pennsylvania set up its paper money system in 1723, rescuing her from a prolonged usury crisis. Franklin told the world, "EXPERIENCE, (more prevalent than all the Logic in the World) has fully convinced us all, that [paper money] has been, and is now of the greatest Advantage to the Country."

Fortunately section 737 of the Dodd-Frank Act of 2010 required the Commodity Futures Trading Commission to begin enforcing position limits on the market by Jan. 17, 2011. But the CFTC has yet to obey the law and start enforcing position limit rules months after the deadline! Maybe the congressmen who want to allow speculation to continue harming our nation hold a mistaken belief in the utility of unbridled selfishness and greed.

The great senator Bernie Sanders is leading the fight against the oil speculators to put in position limits. Senator Sanders introduced the End Excessive Oil Speculation Now Act of 2011 in June to stop oil speculators from harming our nation. Monetary reforms along the lines of the American Monetary Act would act to limit speculators' access to bank funding, to maintain margin positions.

This piece was edited by Jules Brouillet.

Zarlenga is co-founder and Director of the American Monetary Institute and author of "The Lost Science of Money." Meet him at The 7th Annual AMI Monetary Reform Conference! Brouillet is a researcher for the American Monetary Institute.