Speculators ‘R’ Us: The G8 And Energy Prices

The G8 summit was obviously disappointing, even for those with low expectations.  Usually, the substance is lacking but the public relations are well managed.  This year even the messaging was messed up – they said some new things on climate change but not what we were told they could say, the food aid/development package was lamer than advertized, etc.  So the whole thing looks like an expensive flop.

But actually it was much worse.

I’ve written elsewhere this week about the G8’s broad decline in legitimacy and appeal relative to the G20 , and the specific pressing issue of cross-border resolution authority for failed banks – which is a matter of pressing urgency, yet not something taken up in or around this summit.

Think now about the macro/financial angle.  Writing in the WSJ on Wednesday, Gordon Brown and Nicolas Sarkozy argued that speculation in financial markets lies behind the fluctuations in oil prices.  The G8 went along with this message.

On any given Friday, I’m perfectly willing to believe that there are either specific manipulations or broader structural issues with regard to trading in oil futures.  I welcome the CFTC’s moves to (finally) regulate markets more effectively.

But, more generally, the G8 – and its members this week – are disingenuous when they speak about energy prices, in three ways.

1) They are trying hard to talk up the market, with regard to global growth.  At the same time, the hard data continue to disappoint.  Naturally, this causes volatility in oil prices.

2) They claim to see no link between their failure to converge on climate change/environmental policies and what happens to energy prices.  The extent to which industrialized countries’ effectively control carbon emissions will have a big impact on the longer-run demand for oil.  Flip-flopping on this issue discourages investment in the energy sector (regular and alternative), and thus directly and indirectly contributes to oil price volatility.

3) The very cheap money policies of leading central banks, including the Fed, the Bank of England and arguably also the European Central Bank, lower the funding costs for big players who want to take large positions in commodities markets.  Essentially, we are providing the credit that makes big speculative positions possible.  Add to this mix a “too big to fail” attitude and a “yes we can, recapitalize through trading profits” deal with policymakers, and you see why major financial firms are likely to place huge commodity bets in the months ahead.

The G8, separately and jointly, destabilizes energy prices and refuses to even talk about this reality – taking the view that being more candid would just upset consumer, business, and investor confidence.  They gamble, on energy and more broadly, that the road to recovery runs parallel with pretending there are no problems.

The true speculators here are your elected representatives.

By Simon Johnson

21 thoughts on “Speculators ‘R’ Us: The G8 And Energy Prices”

  1. Don’t be such a cynic Simon!!! I’m sure all the call girls working at the L’Aquila hotels had big windfall profits!!! Try to see the sunny side of life would you Simon?!?!?!

  2. Please, Simon, grow up. Don’t blame the politicians for your disappointment. If you want change, denounce their corruption and forget about hope.

  3. Well the G8 did promise to reduce carbon emissions by 50% by 2050 (if I have my facts right here). Thats 1.2% each year. Let’s see if they meet this target by next year’s meeting.

    Certainly, innovation to deal climate change, should keep serious stimulus money busy.

    Ted K, as for sunny side of life, maybe not too sunny when it comes to global warming would we hope.

  4. This brings us to Taibbi’s article about Goldman Sachs. I wish Simon or James would explain to us how the CFTC can justify granting GS the license to trade commodity futures (the now famous letter of 1991).

    The increase in oil price is just equivalent to a tax levied on all of us. This will probably have the effect of inhibiting consumption and prolong the depression.

    Thanks to government support (i.e. our money) financial institutions will be able to survive a crisis of any length.

    Speculators aren’t us because our elective representative aren’t us.

  5. “The very cheap money policies of leading central banks, including the Fed, the Bank of England and arguably also the European Central Bank, lower the funding costs for big players who want to take large positions in commodities markets. Essentially, we are providing the credit that makes big speculative positions possible.”

    This is not just true for commodity positions, but also for currency positions, the carry trade, foreign assets… Even so, we still have 5-year disinflationary expectations (and 15 year expectations of a run on the dollar). So, are you suggesting raising short term rates? (Or some other measures to curb speculation-driven leverage?) Would such a move be countered by other targeted Fed credit easing programs (e.g. reopening/expanding the direct credit facilities?) Should we raise taxes (gasp!) to close the deficit, thereby closing expectations of default/monetization in 10-15 years, and perhaps allowing a more aggressive short term Fed policy, or would cheap Fed rates just be sucked away through capital flight and foreign investment?

    Some productive suggestions (other than reiterating the too-big-to-fail mantra) would be helpful…

  6. Interesting piece, but I don’t see how, except for door #3, doors #1 and #2 explain the doubling and halving of oil prices over a period of six months, if I remember correctly.
    For example, Mr. Johnson, are you saying that if the world really did something so foolish as to implement the Kyoto protocols in a consistent way then we wouldn’t have had these extreme changes in the price of oil?(And yes, I’m a skeptic a la Bjorn Lomborg, about the Kyoto protocol-style solutions to climate change).
    I just don’t see how doors #1 and #2 really explain away the likelihood that mostly it’s financial speculation that drives these wild price swings. But not very much gets into the press about this, as far as I can tell anyway.

  7. Shame, shame Simon.
    You should know that everything you mentioned is irrelevant to the increase in oil prices. You know, for example, that lower interest rates don’t guarantee increased demand.
    Commodity prices were well in hand for decades until the CFTC foreswore regulation and allowed speculators to increase their share of the futures market from 25% to 75%.
    Do you truly not know this?

  8. There were two ways to play the cheap money/gov’t guarantee angle over the last several months. The presumed proper way was to bail risk and take on ballast. But a couple of astute parties observed that the no-lose move was to ship risk by the boatload and unfurl all the canvas clear to the sky sails. Watch Goldman’s earnings on Tuesday.

  9. Tippy Golden: “Well the G8 did promise to reduce carbon emissions by 50% by 2050 (if I have my facts right here). Thats 1.2% each year. Let’s see if they meet this target by next year’s meeting.”

    Actually, it’s more like 1.8% per year. Rots o ruck!

  12. I think they ought to have been more ambitious, and solemnly vowed to cut emissions by 99% by the year 3009.

  13. A recent Newsy.com video analyzed media coverage on the progress (or lack thereof) made on carbon emissions at the G8 summit. One cited international source, Xinhua News from China, had this to say about what they saw as a double standard:
    “While being vague about targets for themselves, the G8 leaders took a tougher position against emerging economies.”

    Obviously, China, along with India and Brazil, is one of the strongest emerging economies, if not the strongest, in the world.

  14. Financial agitation and speculation ruins economic reflection and constructive action.

    Beyond what Sarkozy and Brown suggested (and no doubt Merkel agrees), direct measures ought to be taken to reduce the leverage of non commercial operators in the futures’ markets and the velocity of transactions (by introducing a tiny transaction tax; one could not accuse that to reduce liquidity, it would just reduce velocity).

    The coffin corner model suggests that the economy is losing lift from the shocks associated to the velocity of money, not just simply the oversize of finance (although that is of course a problem).

    Patrice Ayme
    http://patriceayme.wordpress.com/

  15. Something else: a carbon tax will bring every body, including China, to heel. And it will be good for employement and real GDP.

    France, tired of waiting, is thinking about unilateral action in 2010. The ecological minster was made third in command to prepare this.

    France will drag the EU with her, and so forth. Since it is France which led the entire crack down on CO2 in Europe, this will happen. No choice.

  16. Great points, Simon.

    Point #3 really dovetails into not just oil but the rest of the bubble economy that has burst from equities to housing. There’s the strong undercurrents of Austrian Business Cycle Theory underpinning what you’ve written there.

    At a minimum, the Fed needs to bring back the Taylor Rule ASAP. Even better: freeze the monetary base and let the banking system operate more freely to react to real money demand regulated by fear of failure.

    Ideally, snuff out the Fed and FDIC.

  18. Min, rounding off 1.2% seems right. But I get your point. However, serious stimulus money for innovation to reduce carbon emissions would make for an interesting blog discussion.

  20. yes, good points as usual.

    it’s clear that mr johnson has one worthwhile narrative to tell — the narrative of regulatory capture — and we should all be glad he has put that forward. however, step outside that sphere and there’s not much to what he says.

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