« Exposing Hypocrisy | Main | Skepticism about prices» Russell Roberts
July 21, 2008
Nonsense on Speculation
Don Boudreaux
An especially clear example of the confusion that economically illiterate people suffer when thinking about speculation is this column today by Dick Morris and Eileen Mc Gann. The core offending passage is here:
If there is any doubt that it is speculation, not the supply and demand for oil, that is driving up the price, look at this week's history of oil prices. After Bush announced that he was rescinding his father's executive order and permitting off shore drilling and after OPEC announced a weakening of oil demand, the futures market price dropped $15 per barrel. No new oil gushed through the system. The speculators just switched their bets from up to down.
Market prices reflect
future as well as current conditions. Just as, say, General Motor's share price
would rise today if that company announced a major breakthrough in
fuel-conservation technology - rise even though this technology might
not find its way into GM's engines until years from now - so too does
new information on greater supplies of oil tomorrow push today's oil
prices down.
And it's good that this price adjustment happens today because such information
means that oil is less scarce than previously thought. Because there's more oil than previously thought available in the future, people need not
be as careful today in consuming it. "Speculators" play a vital role
in causing today's prices to reflect future conditions and, hence, in
causing consumers and producers today to act in ways that are
consistent with future reality.
Morris's and Mc Gann's supposition that the price of oil should be determined only by today's physical flows of oil -- and that supply and demand reflect only such immediate-run realities -- is wholly mistaken.
(HT Rudy Schober)
Posted by Don Boudreaux in Current Affairs, Energy, Myths and Fallacies, Prices, Regulation | Permalink
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Comments
I think I got it:
http://tinyurl.com/6pbopn
If not, please let me know.
.
Posted by: OregonGuy | Jul 21, 2008 12:00:16 PM
In fact, the more speculators, the more liquid the market and the faster the price adjustment.
Posted by: Methinks | Jul 21, 2008 12:28:23 PM
Dick Morris. You could have just written "ignorant" instead of "economically ignorant." Dick is to conservativism what Paul Krugman is to liberalism--that guy we all wish wasn't one of us.
Posted by: US Grant | Jul 21, 2008 1:13:46 PM
But if i you had actually watched the oil market you would know that the markets were reacting to the EIA data release showing that US oil inventories were much larger than expected, not anything that Bush said.
So as seems typical, you are drawing all kinds of conclusions because you think you know something you do not really know.
Posted by: spencer | Jul 21, 2008 1:17:52 PM
He should try to answer the question of why they switched their bets to 'down'.
Why would they, if they could, want to drive the price down instead of up?
Posted by: Sam Grove | Jul 21, 2008 1:20:41 PM
Spencer,
I didn't say that the markets reacted to what Bush said; that was said by Dick Morris and Eileen Mc Gann. My point stands regardless of the source of information about higher-than-expected oil supplies.
Posted by: Don Boudreaux | Jul 21, 2008 1:25:00 PM
I am surprised that no one has made an analogy to property values. If I am in the process of trying to sell my house and the city announces a plan to take it in 10 years via eminent domain, I going to be very upset. The market value will drop immediately, even though nothing is happening now to the supply and demand for housing in my area.
Posted by: Acad Ronin | Jul 21, 2008 1:28:41 PM
Just to clarify and take this one step further, 1) the futures market is a futures market – it is an estimate of future price, not instantaneous stock or flow (so no new oil flowing is a particularly asinine observation), 2) threats to crack down on so-called “speculators” will create an exodus from any market, as nearly anyone could be deemed a speculator, and a self-fulfilling price movement (see? Those evil speculators left, and the price went down), 3) truly dangerous and disingenuous people like George Soros know both of the above, and use it to their advantage, especially when they are invited to testify in front of Congress about evil speculators, which they are.
Posted by: Mesa Econoguy | Jul 21, 2008 6:54:20 PM
Maybe a name change would help: instead of "oil futures market"
we should switch to "market in allocation of risk regarding the inherent uncertainty of future quantities of supply and demand of a well-known black oleaginous substance that is currently an important part of everyone's life".
Posted by: Unit | Jul 21, 2008 7:47:04 PM
we should switch to "market in allocation of risk regarding the inherent uncertainty of future quantities of supply and demand of a well-known black oleaginous substance that is currently an important part of everyone's life".
By golly, Unit, I think you have something there! I can't imagine Barney Frank trying to slur his way through all that!
Posted by: Methinks | Jul 21, 2008 9:26:06 PM
Methinks,
well ok we could use an acronym then:
The MARIUFuQuSuDeWeBOSCIPEL index.
Posted by: Unit | Jul 21, 2008 10:31:02 PM
Even better idea, Unit! Nobody in congress can wrap their forked tongues around that acronym. If they can't say it, they'll be too embarrassed to talk about it and maybe even leave it alone. Instead, they'll turn their attention back to figuring out if they're addressing Bernanke or "the other one".
You are a genius, possibly deserving of a Nobel prize (not the Peace Prize, one of the ones that's still meaningful).
Posted by: Methinks | Jul 21, 2008 10:50:35 PM
Over the years I have had countless discussions with liberals regarding whether free markets prices adequately reflect the long-term. Their arguments have been along the lines that free markets reflect only short-term, immediate influences on prices.
I have always argued that this was bunk and pointed out that speculators make certain that current prices reflect long-term influences on prices. If they did not, speculators could make alot of money buying long-term options for a good.
Now it is odd to watch many people who once complained about the shortsightedness of markets are now complaining about the role of speculation in incorporating future events into the current price of oil.
Posted by: PaulD | Jul 22, 2008 10:16:19 AM
The core offending passage is here:
I see nothing offensive or incorrect in this passage, except the attribution of recent price fluctuations entirely to speculation over offshore drilling. Opening more areas to offshore drilling could not much affect the market for oil over the term of these contracts, so I don't attribute recent speculation to this event. The recent speculation seems more related to the prospects of war with Iran; however, when Morris says that speculation accounts for the price fluctuations, he's clearly right about that.
I agree that limiting access to the oil futures market is a mistake, and I have no problem with speculators. They're right to bid up the price of oil when the prospects of war with Iran seem so dire. I have a serious problem with the prospects of war. All of this talk about "speculation" is clearly camouflage for the guys generating all of the speculation, like all the cosponsors of the Congressional resolution advocating unprovoked acts of war (including a blockade) against Iran. They are responsible for the price movements, not the speculators.
Posted by: Martin Brock | Jul 22, 2008 11:27:50 AM
Thx Don, great response.
Rudy
Posted by: Rudy | Jul 22, 2008 2:09:23 PM
martinduck,
First you say:
"however, when Morris says that speculation accounts for the price fluctuations, he's clearly right about that."
then you say this:
"They are responsible for the price movements, not the speculators."
Posted by: Martin Brock | Jul 22, 2008 11:27:50 AM
Either the speculators are responsible for the price fluctuations or they are not.
Which is it martinduck, me bucko? Chose a side, pick a partner, get off the fence, one or t'other ya know?
Posted by: vidyohs | Jul 22, 2008 4:31:35 PM
"... speculation accounts for the price fluctuations ..."
"... the guys generating all of the speculation ... are responsible for the price movements, not the speculators."
These statements are consistent. If I credibly threaten to nuke all the oil refineries in Saudi Arabia, people will immediately begin offering more for credible promises of future oil delivery, fearing a sudden cessation of oil deliveries from a major supplier. This rise in the price of oil is simply inevitable. If you didn't bid up the price, someone else surely would. Blaming these bidders for the rising price is absurd. Obviously, I'm to blame, because I've generated the speculation.
Posted by: Martin Brock | Jul 22, 2008 8:33:29 PM
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