“I believe there needs to be a thorough and complete investigation of speculators to find out whether speculation has been going on and, if so, how much it has affected the price of a barrel of oil.
“There's a lot of things out there that need a lot more transparency and, consequently, oversight.”
Those are the words of presidential candidate John McCain. This man is the Republican?
There's more.
“I am very angry, frankly, at the oil companies not only because of the obscene profits they've made but at their failure to invest in alternate energy to help us eliminate our dependence on foreign oil.
“They're making huge profits and that happens, but not to say, 'We're in this so we can over time eliminate America's dependence on foreign oil,' I think is an abrogation of their responsibilities as citizens.”
Let me get this straight. A potential president of a putatively free country scolds companies for “obscene profits,” failure to invest in competing products, and therefore irresponsible citizenship. Why? Is McCain running for national economic commissar?
This is not the first time McCain has displayed what I would call an anti-capitalist mentality. In an early presidential debate he countered former businessman Mitt Romney's claim to superior executive experience by saying, “I led the largest squadron in the U.S. Navy, not for profit but for patriotism.”
Why the put down of profit?
It's clear McCain does not understand how markets work or why they are good. He certainly doesn't understand the role of speculators and other middlemen.
He's not alone. Speculators are among the most reviled people in history. When they were members of ethnic minorities, they have been easy targets for economically illiterate people who were jealous of their success.
McCain wonders “whether speculation has been going on.” He needn't wonder. Speculation always goes on. Speculation means to take a risk on what the future holds in hopes of making a profit.
The world's stock and commodities markets are based on this principle. Sen. McCain must have meant it when he said, “I know a lot less about economics than I do about military and foreign policy issues.”
I doubt that speculators are responsible for much of the run-up of oil prices. Why didn't they run them up sooner? Besides, there are too many other explanations: increased demand from China and India, the declining dollar and Middle East tensions.
Even if speculators did play a role, what McCain apparently doesn't understand is that speculators perform a valuable service. Most people don't realize this because on the surface speculators don't seem productive. They buy what already exists and resell it. How does that help society?
In fact, the hated speculator is a good guy because his buying and selling reduce volatility and uncertainty in an unpredictable world.
He may only be out for his own profit, but that doesn't matter. As Adam Smith wrote, "It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own interest."
The prices of commodities often change unexpectedly, making business risky. The speculator brings a degree of certainty to otherwise risky ventures.
When supplies of a commodity are plentiful and prices low — but speculators expect the price to rise later — they buy — cushioning the collapse of prices.
When supplies become scarcer and prices rise, they sell — easing the shortage and lowering the price.
Also, speculators may agree to buy a commodity in the future for a price locked in today. This reduces the risk for an oil producer or farmer who fears investing because he doesn't know what price his product will sell for next year.
As a result of these activities, volatile supplies and prices are evened out over time.
Occasionally, speculators increase volatility. Markets are never perfect. (Although they are better than government regulation.) But in general, speculators increase liquidity and keep the market on a more even keel. This makes long-term planning easier for everyone.
It would be nice if McCain would finally learn some economics.
9 comments from readers
Any ways very good post, thanks.
A succinct explanation of Eco 101 for the economically illiterate (read "people 'educated' in America").
While increasing the capital requirements isn't the best solution since it will eliminate some of the smaller investors, the fact that the remaining speculators will not be able to control as much of the market individually, I believe, makes up for that loss. Another possibility would be to reduce the ratio on commodity futures to cover a smaller proportion of the commodity for each futures contract.
There is some suspicion that the "Enron loophole" has removed a significant amount of regulation from the energy futures market. While this is debatable, what is not debatable is that facts and knowledge in an open market make for a more efficient market where prices are more related to facts than to guesses and gut-feelings.
Keep in mind that the crash of 1929 was propagated by 2 major factors - short selling and futures. Both of which were subsequently regulated in ways that increase the necessary capital to enter into each of those positions. The uptick rule, and higher margin requirements quelled the short selling problems, while the decrease in the number of shares controlled by an options contracts reduced the effect of speculators.
I don't think that a government regulated market is the solution, but modifying the regulations that are currently in place would be a step in the right direction.
I've continually heard oil company executives blamed for their "shameful windfall profits" -- even being brought in front of Congress to explain themselves. What's there to explain? Demand has gone up, and American consumers are obviously OK with paying $4+ a gallon for gas... because they are. People never pay more for something than it's worth; including oil. Yet consumers themselves are never "blamed" for oil prices, only the suppliers and speculators who meet their oil-thirsty demands are.