Economics columnist Steven Pearlstein describes how high finance is distorting the commodities market and warns that speculation and “financialization” is blowing up a big bubble:
You actually thought companies existed to make products and profits.
You thought houses were meant to provide a place for people to live and office buildings a place for people to work.
You thought food was meant to be eaten, oil and gas to be turned into energy, and metals to be turned into cars, bridges and downspouts.
You weren’t sophisticated enough to realize that these really are just different “asset classes” meant to give investors around the world something to speculate in and to diversify their portfolios.
Even worse, you actually believed all that stuff about prices being set based on market fundamentals. Little did you know that it’s no longer the supply and demand for companies, houses, office buildings, natural gas or wheat that sets prices. More likely it’s the supply and demand for the futures, swaps and other derivative instruments linked to those things.
Maybe they thought we wouldn’t notice that the financialization of the economy brought with it higher prices and a more volatile economy, along with higher profits for the financial services industry.
The latest example is the market for commodities: corn, wheat, cotton, silver, copper, oil, natural gas. In the past decade, hundreds of billions of dollars have flooded into the market, largely through swaps contracts and commodities index funds, ETFs and mutual funds.
These markets have long since outgrown their original function of providing producers and consumers of these commodities with a way to hedge their risks by guaranteeing supply and locking in prices. All futures markets require a certain number of “speculators” to take the other side of the contracts from commercial users and producers. Typically, these speculators would represent 30 percent of the participants in a healthy futures market.
But today, because of a sudden desire to earn higher returns and diversify investment portfolios, there are more people wanting to invest in corn and copper and oil than there is corn and copper and natural gas produced and consumed. But no problem. The financial wizards on Wall Street have magically conjured up synthetic corn and copper and West Texas oil so that speculators can provide hedging opportunities for other speculators. Instead of 30 percent of the market, these “passive investors” typically account for 70 percent or more. . . .
What’s clear from this tale is how little the financial services industry has really changed since the crisis of 2008. The financialization of the economy continues undeterred, creating a bubble in commodities just as it did with houses and office buildings.
Does this kind of speculation serve an economic purpose? Is it just an example of free market economics? Or does it actually distort and thwart the free market?