Commodity Speculation: Krugman leaves questions unanswered

Timothy A. Wise

The debate on commodity speculation continues, generating lots of heat but not as much light as I was looking for in my last post. Paul Krugman has responded to those of us bewildered by his position, basically reiterating that because these are physical commodities speculation can only happen if there is evidence of inventory accumulation by, essentially, hoarders. He sees no evidence of that now, except maybe for cotton and copper but not for food commodities. Instead he points to real weather issues that have reduced supplies. Yves Smith, at Naked Capitalism, called his analysis flawed, but took issue not with dismissing financial speculation but rather by pointing to the many flaws in the available data on inventories.

Okay, sure, weather and imperfect information, but please: Are you two really saying that the influx of non-commercial speculative capital into futures markets has no impact on real prices, on the functioning of these markets? If it doesn’t, why bother re-regulating the commodity derivatives market, as Dodd-Frank mandated and the CFTC has proposed?

There seems to be agreement that financial (as opposed to commercial) speculators entered commodities futures markets in a big way. There also seems to be agreement that they did so through largely deregulated financial instruments. The still-unanswered question is whether all that new money simply provided added liquidity to futures markets, with no ill effects. That seems to be Krugman’s argument, because in the end it’s all about the physical commodities.

But doesn’t all that financialization make a mess of price discovery? After all, why are some of the most vocal groups that are demanding re-regulation and strict derivatives reforms the commercial hedgers themselves? Check out the Commodity Markets Oversight Coalition. To listen to Krugman, they should be thrilled that Wall Street is throwing money into their markets. From what I can tell, they’re not thrilled at all. And that makes a whole lot of sense if futures markets actually affect the decisions of economic actors in the real world. Guess what: they do, from farmers deciding what to plant to governments deciding what to buy.

Mexico recently locked in a contract on corn futures in fear of another round of tortilla riots from a future price bubble. A “panic buy?” Maybe, maybe not. Sure, Yves, it depends on whether they’re reading the inventories numbers right, and when China considers its inventories a state secret that’s a tough read. But it also depends on how reliable the price signals are in the futures market, whether rising corn futures are indeed a reliable indicator of tight supplies. Financialization can make a mess of that critical process of price discovery. And all indications are it did just that in 2008 when prices spiked and then crashed in a way quite disconnected from supply and demand.

Those were speculative, overheated markets, and I’m still waiting for some light from all that heat. Hopefully, the CFTC won’t wait and will use the available light to enact prompt derivatives reforms, as some US Senators recently urged.