Friday, October 14, 2011

Federal Reserve Bank of Dallas Clearly Explains Why Speculation Didn't Drive Oil Prices in 2008

And that applies similarly to food....
This past week there have been a couple of news items announcing that a large petition by "450 economists" wants to limit global food commodity speculation which is causing high food prices for the world's poor food consumer. Since I just posted, Round Two. Does Speculation Cause High Food Prices? on this blog ten days ago, I wanted to follow-up by connecting a few dots.

Just my luck, the Federal Reserve Bank of Dallas has just produced a new report which clearly states and illustrates why the oil price peak of 2008 was not caused by speculators but by the fundamentals of supply and demand. (The dynamics for oil are very similar to the food commodities.)

First, about this news item that the world's "economists" are going after the food speculators:

Economists demand curbs on food speculators
More than 450 economists from some 40 countries, and at institutions including Berkeley, Cambridge and Oxford universities, urged this week's meeting of finance ministers from the G20 group of leading industrialised countries to "curb excessive speculation" in agriculture futures. The letter, which blamed speculators for "contributing to increasing volatility and record high food prices", and so "exacerbating global hunger", demand caps on their positions.

"Limits could be set at a level that would maintain sufficient liquidity in the markets while preventing an excessive concentration of purely financial actors," the letter said. "Clear limits would provide regulatory certainty, promoting stable and sustainable derivatives markets to the benefit of food producers, consumers and broader economic stability."

... "On balance, we see more potential upside than downside to ag prices as speculators look to reposition on any sustained risk-on rally," Mr Deane said.

G20 urged to help end world hunger by stopping commodity speculation
The economists said that proposals to increase market transparency were vital, but would not go far enough to tackle excessive financial speculation. Instead, they urged finance ministers to support a move to cap the proportion of agricultural commodity derivatives markets that can be held by traders. ... Deborah Doane, director of the World Development Movement, said that "excessive" lobbying from the finance sector seemed to be delaying political action, both in the UK and elsewhere.

What does the Federal Reserve Bank of Dallas have to do with it?

Those concerned need pointed to this new report out from the Federal Reserve Bank of Dallas by Michael D. Plante and Mine K. YĆ¼cel which so clearly demonstrates and concludes that that market fundamentals, and not speculation, were behind the dramatic rise and fall in oil prices, the dynamics of which, are similar to food prices.
In the explanation, after going through hoarding possibilities, and comparisons to a few commodity movements not having futures markets that mirrored oil's move, they conclude that the commodity movements were "consistent with a pure demand story, rather than a speculation one."

This chart demonstrates the dynamics of the price movement quite well:

I hope this helps the doubters out there. I have been occasionally visiting a TED sponsored
discussion thread about this that is attempting to convince readers that speculation is causing dangerous food price movements and many assume and believe this because it seems right to them (faith-based). I am grateful to Scott Irwin and a few other key economists such as Paul Krugman, Andy Harless, Michael J Roberts, James Hamilton, Mark Thoma, and Parke Wilde, who have helped educate me on this issue, along with others rjs, jjb, and Nevil Speer. And, lastly, if people want to go after something causing global high food prices, they need to go after the corn ethanol policy here in the U.S.
——Kay McDonald

UPDATE: 5 minutes after posting this I've seen the Bloomberg article “For those who say no evidence exists linking excessive speculation and prices, they just aren’t looking,” CFTC Commissioner Bart Chilton said today in a statement. “Scores of studies and papers exist which document the linkage.”

See: Businessweek article here


  1. Don't most of those 450 economists also assume that ~3% growth is infinitely possible?

  2. Great post Kay. I think all of this speculation business is coming from the generally volatile times, and possibly from people projecting from home prices and the Wall Street shenanigans in the mortgage-backed-securities market. But many of the people connecting this stuff to commodities really should know better.

    Anyway, really great blog. Yours is by far the best thing going in this area. It's now my first stop for all things ag. I wish I discovered it sooner.

  3. Michael, I'm humbled and flattered by your note, but its a nice reward for my insane toiling day after day for no real sane reason. Thanks for having this blog on your sidebar btw.

  4. I think Chilton was referring to some of these 88 studies from respected universities and institutions that say excessive speculation is a problem:

    Also, a recently released study that shows what should be obvious - that the massive rolls from commodity index trading messes up markets, adding to volatility and price:

  5. Retail speculators don't affect futures markets but over-leveraged hedge or sovereign funds could if they exploit rules that grant them the lower margin rates enjoyed by true producers or consumers. So long as margin requirements are fairly set and enforced speculators help liquidity and create more stable prices. Look at historical prices of onions (no futures market) with exchanged traded ags like corn or beans and you'll see 20:1 price swings in onions compared with 5:1 for grains.

  6. I understand commodity markets to be finely tuned with traditional speculators helping by going long and short depending on their opinions of supply and demand conditions.

    But investments in these new commodity indexes and ETFs are almost exclusively long and those investment decisions are not made on the basis of supply and demand conditions in each commodity market, but on portfolio allocation reasons.

    So my question is how can hundreds of billions of dollars, almost exclusively betting long for long periods of time, NOT mess up the functioning of these markets?

    I think they should be banned.

    This study shows how commodity index rolls mess up markets: