The increased liquidity that speculators provide has to be weighed against the price hikes that their activities cause.
The huge profits and bonuses in Goldman Sachs, referred to in the last article, continue to attract political / economic criticism. For example, Christine Lagarde, the French Finance Minister, recently said, “I think it is an absolute disgrace … that some people are thinking of reinstating the old ways of compensating with insufficient relationship between compensation and lasting performance and risk-management.” France is likely to take up the issue in the G-20 summit next month, as she believes that effective action cannot be taken by any one country. The UK’s Financial Services Authority has warned banks of heavy penalties if they agree to guaranteed multi-year bonuses, as several global banks like Citi, Deutsche and Nomura seem to be doing. The only change is that there has been a shift from politically-sensitive bonuses to basic salaries.
There are, of course, those who defend the compensation and bonuses on the argument that there is nothing wrong with people who work long hours and under great stress getting large compensation: After all, if shareholders can get outsize profits for doing nothing, can’t bankers have the same? There is, of course, a basic difference between the two: Shareholders run a lot more risk than the traders or fund managers do.
In a recent column, Paul Krugman, the Nobel Laureate, criticised Goldman Sachs from another angle — that it made a lot of money selling securities backed by sub-prime mortgages to its clients over the last couple of years, and even more by shorting the same securities! One article in the Rolling Stone magazine is, as is to be expected, far more scathing in its criticism of Goldman Sachs calling it ‘the great American bubble machine’.
Besides , I had argued last week that speculators provide a needed input to markets — namely liquidity. The question is whether the price being paid by society for this is too high considering the volatility of exchange rates, commodity prices, etc arising from speculative activity — prices to which the real economy is forced to adjust.
Take the price of crude oil, the world’s most-traded commodity, and also the one which is used by practically everybody in the world. The price per barrel went up from around $50 in January 2007, to nearly $150 by mid-2008, only to drop to less than a fourth of that level by earlier this year, and then more than double in the next few months! The demand-supply data suggest that the changes were minimal; in fact, in the first half of 2008, the supply increased and the demand fell, if only marginally. And yet the price jumped by $50 per barrel thanks to speculative activity. In fact, commodities have become a new ‘asset class’ for the super-rich who have invested something like $300 billion in commodity funds. The actual speculative positions would, of course, be much higher because the fund corpus is typically used as margin money.
UK Prime Minister Gordon Brown and French President Nicolas Sarkozy — neither a leftist — wrote in an article in The Wall Street Journal in mid-July 2009, that “First (the oil price) rose by more than $80 a barrel, then fell rapidly by more than $100, before doubling to its current level of around $70. In that time, however, there has been no serious interruption of supply ... such erratic price movement in one of the world’s most crucial commodities is a growing cause for alarm. The surge in prices last year gravely damaged the global economy and contributed to the downturn…..Those who rely on oil and have no substitutes readily available have been the victims of extreme price fluctuations beyond their control — and apparently beyond reason. Importing countries, especially in the developing world, find themselves committed to big subsidies to shield domestic consumers from potentially devastating price shifts….We therefore call upon (regulators) to consider improving transparency and supervision of futures markets to reduce damaging speculation….
This would serve the interests of orderly and adequate investment in future supplies. Volatility and opacity are the enemies of growth”. Strong words, those!
Before the mid-1990s, commodity markets were dominated by entities that had physical exposures to the price of the commodity, as producers or buyers. To be sure, speculators were present but, in recent years, a new type of ‘investor’ has zeroed in on commodities as an asset class. A report expected later this month from the Commodity Futures Trading Commission is expected to blame speculators for the sharp swings in the price of oil in the last couple of years. To be sure, commodities are not the only new asset class. In addition to the more traditional equities, bonds and currencies, the new speculative assets include weather, human longevity, natural disasters — and even the prices of loans. But more on this next week.
Tailpiece: In last Thursday’s election, the Democratic Party of Japan campaigned on a pledge to end the ‘politics of the bureaucrats’. We surely need a party which reduces the stronghold of the bureaucracy, even more than the Japanese.
