The commodities bubble

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:

Silly you.

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.

via Steven Pearlstein: You bet it’s another bubble – The Washington Post.

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?

About Gene Veith

Professor of Literature at Patrick Henry College, the Director of the Cranach Institute at Concordia Theological Seminary, a columnist for World Magazine and TableTalk, and the author of 18 books on different facets of Christianity & Culture.

  • Dennis Peskey

    free market economics?
    Free? – I think not where money is involved; the only two things which are truly free are bad advice and God’s grace. Bad advice is in abundance; grace is free only for us – it did cost God his Son.

    Market? Not very consumer friendly but it is a financial market, a financial market with insufficient controls to avoid abuse. As is the case with all bubbles – these too will burst eventually. My only hope is I’m not required to bail out these investors as well (equality does have limits primarily dictated by the size of my wallet).

    Economics – Here’s the beef (no bun intended). I read many wonderful theories of economic systems but I’ve yet to find one which addresses reality. Money has no morality and will distort and thwart all markets, but money does have limits as well. A healthy commodities market can be a blessing to a democratic nation but we must never forget the people involved are all sinners and in all probability do not function with Luther’s explanation of the seventh commandment as a trading guide. I would encourage our government to focus on the speculation aspect of this market; this is where the greatest abuse will occur and affect the entire country.
    Pax,
    Dennis

  • Dennis Peskey

    free market economics?
    Free? – I think not where money is involved; the only two things which are truly free are bad advice and God’s grace. Bad advice is in abundance; grace is free only for us – it did cost God his Son.

    Market? Not very consumer friendly but it is a financial market, a financial market with insufficient controls to avoid abuse. As is the case with all bubbles – these too will burst eventually. My only hope is I’m not required to bail out these investors as well (equality does have limits primarily dictated by the size of my wallet).

    Economics – Here’s the beef (no bun intended). I read many wonderful theories of economic systems but I’ve yet to find one which addresses reality. Money has no morality and will distort and thwart all markets, but money does have limits as well. A healthy commodities market can be a blessing to a democratic nation but we must never forget the people involved are all sinners and in all probability do not function with Luther’s explanation of the seventh commandment as a trading guide. I would encourage our government to focus on the speculation aspect of this market; this is where the greatest abuse will occur and affect the entire country.
    Pax,
    Dennis

  • SKPeterson

    Speculation is a vital part of our economy and placing restrictions on speculative activity, as well as short-selling, are likely to have more negative consequences than positive. That being said, what is missing in this article is the source of all these funds flowing into various asset classes – cheap money. Trillions up trillions of ever cheaper electronic dollars generated by the Federal Reserve, and trillions of dollars of other currencies being created by other central banks around the world. The money itself has become disconnected from reality and from a real economic commodity or factor like gold or silver. Switching away from fiat money towards a stable commodity money would go a long ways to solving the problems outlined in the article and restraining the emergence of new asset bubbles. The only problem is there are two huge constituencies who stand to benefit from the current system: 1) the financial institutions that Pearlstein notes, who rely on the cheap money, siphon it off, command resources with it, and direct it into bubble after bubble, and 2) the governments of the world, especially our own precocious little one right here, who rely on cheap money to pay their burgeoning debt bills. I suppose there is a third – the central banks that exist in the spaces in between group 1 and group 2 and serve as the financial drug dealers allowing both to get their monetary fix.

  • SKPeterson

    Speculation is a vital part of our economy and placing restrictions on speculative activity, as well as short-selling, are likely to have more negative consequences than positive. That being said, what is missing in this article is the source of all these funds flowing into various asset classes – cheap money. Trillions up trillions of ever cheaper electronic dollars generated by the Federal Reserve, and trillions of dollars of other currencies being created by other central banks around the world. The money itself has become disconnected from reality and from a real economic commodity or factor like gold or silver. Switching away from fiat money towards a stable commodity money would go a long ways to solving the problems outlined in the article and restraining the emergence of new asset bubbles. The only problem is there are two huge constituencies who stand to benefit from the current system: 1) the financial institutions that Pearlstein notes, who rely on the cheap money, siphon it off, command resources with it, and direct it into bubble after bubble, and 2) the governments of the world, especially our own precocious little one right here, who rely on cheap money to pay their burgeoning debt bills. I suppose there is a third – the central banks that exist in the spaces in between group 1 and group 2 and serve as the financial drug dealers allowing both to get their monetary fix.

  • Joe

    Well said SKP.

  • Joe

    Well said SKP.

  • Dennis Peskey

    SKP (#2) “cheap money” I almost thought you were arguing for a return to the gold standard! Almost. (But I did appreciate the “financial drug dealers” reference.)
    Pax,
    Dennis

  • Dennis Peskey

    SKP (#2) “cheap money” I almost thought you were arguing for a return to the gold standard! Almost. (But I did appreciate the “financial drug dealers” reference.)
    Pax,
    Dennis

  • SKPeterson

    Dennis – I would advocate a return to the gold standard in place of the monetary chaos we have now. Ideally, we’d just let currencies and methods of payment operate in a free market, and let people decide on single commodity currencies, commodity basket currencies, or trust to some fiat standard. Eventually, something globally accepted would emerge and my gut is that it would be some mix of gold and silver, with maybe oil used in some currencies as well. Further, I’d point out that these asset bubbles are coming more and more frequently in tandem with ever more fiat currency being put into circulation and as we become ever more temporally removed from the closing of the gold window.

    The parallels between the currency crises in Greece and now Italy are eerily reminiscent of the chaos of the early 1930′s when countries began to devalue their currencies, suspend specie payments, and even suspend payments in gold (or seize it outright per FDR). At least then we maintained the pretense of a commodity standard; today we don’t even have that.

  • SKPeterson

    Dennis – I would advocate a return to the gold standard in place of the monetary chaos we have now. Ideally, we’d just let currencies and methods of payment operate in a free market, and let people decide on single commodity currencies, commodity basket currencies, or trust to some fiat standard. Eventually, something globally accepted would emerge and my gut is that it would be some mix of gold and silver, with maybe oil used in some currencies as well. Further, I’d point out that these asset bubbles are coming more and more frequently in tandem with ever more fiat currency being put into circulation and as we become ever more temporally removed from the closing of the gold window.

    The parallels between the currency crises in Greece and now Italy are eerily reminiscent of the chaos of the early 1930′s when countries began to devalue their currencies, suspend specie payments, and even suspend payments in gold (or seize it outright per FDR). At least then we maintained the pretense of a commodity standard; today we don’t even have that.

  • DonS

    The distortion in pricing of a lot of our commodities now has much more to do with government intervention than financial speculation. Speculators traffic in commodities where supply is uncertain — typically being consumed at close to full production capacity so that the margin between adequate supply and shortage is razor thin. In the case of grain, think ethanol, which government mandates and subsidizes and which consumes huge quantities of our former food sources. In energy, restrictions on domestic production, and even on means of efficiently transporting energy from the field to refinement and delivery sites create these conditions ripe for speculation.

    The ability to trade futures is essential to businesses such as airlines, who require predictable fuel prices to operate. If government were to choose to hyper-regulate speculation, on top of its hyper-regulation of commodity supply, we would be doubling down on the problem, certainly not solving it.

    A government that really cared about jobs and the health of the economy would do everything it could to ensure an adequate and reasonably-priced supply of commodities. We don’t have that government.

    Ultimately, the market is still driven by supply and demand.

  • DonS

    The distortion in pricing of a lot of our commodities now has much more to do with government intervention than financial speculation. Speculators traffic in commodities where supply is uncertain — typically being consumed at close to full production capacity so that the margin between adequate supply and shortage is razor thin. In the case of grain, think ethanol, which government mandates and subsidizes and which consumes huge quantities of our former food sources. In energy, restrictions on domestic production, and even on means of efficiently transporting energy from the field to refinement and delivery sites create these conditions ripe for speculation.

    The ability to trade futures is essential to businesses such as airlines, who require predictable fuel prices to operate. If government were to choose to hyper-regulate speculation, on top of its hyper-regulation of commodity supply, we would be doubling down on the problem, certainly not solving it.

    A government that really cared about jobs and the health of the economy would do everything it could to ensure an adequate and reasonably-priced supply of commodities. We don’t have that government.

    Ultimately, the market is still driven by supply and demand.

  • http://www.facebook.com/mesamike Mike Westfall

    Sounds more like the Ponzification of the economy.
    If things keep going the way they are, we may just see more barter/trade type transactions coming down the road as people get skittish about accepting and holding money.

  • http://www.facebook.com/mesamike Mike Westfall

    Sounds more like the Ponzification of the economy.
    If things keep going the way they are, we may just see more barter/trade type transactions coming down the road as people get skittish about accepting and holding money.

  • Pete

    It’s over my head. But it seems like those with wealth use the market artificially inflate the value of commodities, playing musical chairs. Throw your money in too play and You don’t wan to be the last guy in the particular market because you’ll be left without a chair. And you certainly con;t want to be a person that actually needs one of the chairs.

  • Pete

    It’s over my head. But it seems like those with wealth use the market artificially inflate the value of commodities, playing musical chairs. Throw your money in too play and You don’t wan to be the last guy in the particular market because you’ll be left without a chair. And you certainly con;t want to be a person that actually needs one of the chairs.

  • Dust

    Mike at 7…..good point, that would be a solution until the government tries to tax those transactions too. And it’s more possible if folks try to use computers to organize and conduct their bartering arrangements?

    Have always thought that if things keep going the way they are, that is, in particular, the seemingly widening gap between the haves and have nots, we may see something along the lines of what took place in the French Revolution?

    Hope not, and the country has been thru very bad cycles throughout it’s history and always came out better, so maybe this is just another one of those? Trouble for a while, but then things get sorted out and back on track….well, until the next bunch of clever and greedy folks figure out a way to exploit the system and ruin it again?

    Nothing new under the sun….

  • Dust

    Mike at 7…..good point, that would be a solution until the government tries to tax those transactions too. And it’s more possible if folks try to use computers to organize and conduct their bartering arrangements?

    Have always thought that if things keep going the way they are, that is, in particular, the seemingly widening gap between the haves and have nots, we may see something along the lines of what took place in the French Revolution?

    Hope not, and the country has been thru very bad cycles throughout it’s history and always came out better, so maybe this is just another one of those? Trouble for a while, but then things get sorted out and back on track….well, until the next bunch of clever and greedy folks figure out a way to exploit the system and ruin it again?

    Nothing new under the sun….

  • http://www.bikebubba.blogspot.com bike bubba

    OK,in commodities, we’ve got the government driving up corn supplies and prices through massive ethanol subsidies, as well as government driving up oil prices by restricting oil drilling needlessly. Now tell me again how, exactly, the “commodities bubble” is anything but a creation of the government, OK?

  • http://www.bikebubba.blogspot.com bike bubba

    OK,in commodities, we’ve got the government driving up corn supplies and prices through massive ethanol subsidies, as well as government driving up oil prices by restricting oil drilling needlessly. Now tell me again how, exactly, the “commodities bubble” is anything but a creation of the government, OK?

  • Dust

    bike…consider diamonds. supposedly there are lots of them and if they entered the market it would drive down prices considerably. but since just one company (or a few) owns most of the diamonds and mines, they control the circulation and thus artificially drive up the cost. This could happen with other commodities, theoretically at least, but looking more like reality everyday, including some of the ones considered necessities of life.

    Also just the natural flux of the demand levels will influence the values without government intervention. Just consider if the number of customers (population) exceeds supply (production) that will drive up prices, and all without any political help. The same is true in a disruption of supply lines, as in a war, at worst, or for any other reason. Hard to believe that it could be in the interests of certain commodity traders to help bring about such kind of circumstances? If so, then again, with no need for government assistance, that is, at least without them being aware of a the role they play?

    Like any system in which ethics and morals are important, the economy needs honest and good people controlling it, especially at the top, and then making choices that benefit everyone, not just a few disproportionally well…sadly, it seems to me, these are the qualities missing from the current generation running the show. but, perhaps they are just responding to the general levels of corruption and decadence they see at every level of society and culture? well, that’s getting off the topic…..

  • Dust

    bike…consider diamonds. supposedly there are lots of them and if they entered the market it would drive down prices considerably. but since just one company (or a few) owns most of the diamonds and mines, they control the circulation and thus artificially drive up the cost. This could happen with other commodities, theoretically at least, but looking more like reality everyday, including some of the ones considered necessities of life.

    Also just the natural flux of the demand levels will influence the values without government intervention. Just consider if the number of customers (population) exceeds supply (production) that will drive up prices, and all without any political help. The same is true in a disruption of supply lines, as in a war, at worst, or for any other reason. Hard to believe that it could be in the interests of certain commodity traders to help bring about such kind of circumstances? If so, then again, with no need for government assistance, that is, at least without them being aware of a the role they play?

    Like any system in which ethics and morals are important, the economy needs honest and good people controlling it, especially at the top, and then making choices that benefit everyone, not just a few disproportionally well…sadly, it seems to me, these are the qualities missing from the current generation running the show. but, perhaps they are just responding to the general levels of corruption and decadence they see at every level of society and culture? well, that’s getting off the topic…..

  • Julia Bickel

    it’s all just a game like monopoly—————-

  • Julia Bickel

    it’s all just a game like monopoly—————-


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