Classic Demagoguery

by Don Boudreaux on July 15, 2008

in Current Affairs, Energy, Politics

I just sent this letter to the Wall Street Journal:

Sen. Dick Durbin’s letter
today
is classic demagoguery.  He presumes that his motives are purer
than those of persons who disagree with him; his case for
more-intrusive government is based on zero evidence that the culprits
he demonizes ("speculators") are responsible for the "problem" (high
oil prices) visited upon victims portrayed as helpless but for Sen.
Durbin’s courageous intercession on their behalf; he demands power to
prevent practices defined only with question-begging vagueness
("excessive speculation" and "unfair speculation") – a vagueness that,
once enacted into legislation, greases the path to even more power for
demagogues such as Sen. Durbin.

Sincerely,
Donald J. Boudreaux

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{ 47 comments }

David P. Graf July 15, 2008 at 8:16 am

Until there is a greater transparency in oil futures and the government has the resources to monitor it, then we really can't know if speculators are driving up the cost of oil. Considering the hurt being put on ordinary people and a lot of businesses by the rise in oil prices, it's hard to argue that his requests are demagogic. I thought that supporters of Friedman would be in favor of more informaton being made available in the markets.

Hammer July 15, 2008 at 8:26 am

David, I think you are missing the point. The good Dr. has already demonstrated numerous times in this blog that speculators do not drive up the price in the long term, and very little in the short term. To the contrary, speculation generally smooths out the peaks and valleys of supply and demand fluctuations.

Anyone who seriously claims the price of oil is not predicated on a supply shortage is simply not being honest. There are known reserves of oil that were profitable at 1.50$ a gallon, yet at 4$ they are not being tapped. If you think this is due to anything other than government intervention, you are not being honest with yourself.

Chris July 15, 2008 at 9:13 am

David P. Graf –

I suggest that you are going about it backwards. Let me change your words slightly:

Until there is a greater transparency in pudding ingredients and the government has the resources to monitor it, then we really can't know if pudding is driving up the cost of oil.

In other words, it's up to the people who assert that speculation is affecting oil prices to prove it; it's not up to the speculators to disprove it.

David P. Graf July 15, 2008 at 9:28 am

Hammer,

Knowing from history how markets can be manipulated, I am not as sanguine as you and Don are about the contribution of speculators to rising oil prices. I see no harm from bringing a greater degree of transparency to the oil futures market. In contrast, real people are being harmed by the rise in oil prices.

As an aside, I wonder why you and so many of the posters in this forum feel it necessary to question the honesty of others. It's ironic in that I agree with you that supply and demand probably is the culprit behind the rise in oil prices. However, that does not mean that speculators are not making their own contribution.

David P. Graf July 15, 2008 at 9:40 am

Chris,

I'm not asking that the speculators prove that they are not guilty of contributing to the rise in oil prices. I'm simply asking that we have the information necessary to make that determination. Where's the harm in that? And if the rising cost of pudding proves to be as harmful to the nation as the increase in oil prices, I think that we would want to find out as much as we could about it. Wouldn't you?

John Dewey July 15, 2008 at 9:53 am

David P. Graf: "simply asking that we have the information necessary to make that determination."

And just how are "we" going to determine the cause for the rise in oil prices, David? Who is going to make the determination?

The whole problem for me is that every time the federal government injects itself into free markets, it screws things up far worse than any alleged problem it was trying to fix. "More investigators" into oil futures trading will lead to either higher costs or else the fleeing of futures markets to less intrusive locales.

Nunca July 15, 2008 at 9:57 am

"Knowing from history how markets can be manipulated"

We also know from history that Congress can make extremely bad policy. What assurance would we have that Congress would draw the correct conclusion with all of the pertinent trading info as opposed to drawing some really bad political conclusion. Since we're reviewing history this morning, the amount of government failure dwarfs the amount of market failure, i.e. ethanol, the Great Depression, and the current mess we're in now. All of it courtesy of the demagogues in Congress.

John Dewey July 15, 2008 at 10:02 am

I don't know if Dick Durbin is truly ignorant or if he intentionally misleads with his statements:

"A growing amount of oil futures trading is done by players who never take possession of actual barrels of oil."

What could possibly be wqrong with that? I don't take possession of crude oil, but I am certainly impacted by price changes. nearly every good I purchase has some energy cost component.

Businesses such as trucking companies never take possession of crude oil, but they certainly feel the rise in crude oil prices. So do airlines, railroads, and shipping companies.

If I want to reduce my exposure to higher fuel prices – my exposure to rising prices of goods – what is wrong with me hedging in the oil futures market. Further, if my hedging requirements are far less than that of an airline, what is wrong with my mutual fund doing the hedging for me?

To imply that only crude oil users should be allowed to heddge their exposure to energy prices – which is exactly what Senator Durbin is implying – demonstrates either ignorance or else intentional deception.

Chris July 15, 2008 at 10:05 am

David P. Graf –

When making economic decisions, more information is a good thing. But, when it's the government trying to get information about otherwise private transactions, the government should (at minimum) have to show that it has some need for that information. Otherwise, the government can intrude in anything on a whim.

The government has no more right to know about private oil futures transactions than it does to know about the lemonade stand the neighborhood children run.

So, I suggest that unless there's some sort of reasonable suspicion that oil speculation is "causing" relatively high oil prices today, the government has no business prying. (Even then, I still have my doubts.) I have yet to see a rational theory of why the are affecting anything.

In fact, apart from supply & demand, the biggest contributor to oil prices appears to be the Fed — by keeping the money supply high, it's driven down the exchange rate, making foreign oil dramatically more expensive.

Chris July 15, 2008 at 10:08 am

"either ignorance or intentional deception"

And there, in five words, you have wrapped up the existence of 535 members of the US Congress.

mr.beachbums July 15, 2008 at 11:09 am

Krugman "Speculative nonsense, once again" => trading in oil futures can't really influence the price of physical oil because it doesn't remove any oil from the market.
I don't know what argumennt he made, since in reality worlds never deficit the oil more than 10%, most country have stock for more than 1 months. small schock would be very ease to response(by hedging).
It means speculator drive daily price into targeted price in future.(they did the long contract and tried to secure their betting contract)

Scott Anderson July 15, 2008 at 11:15 am

I think that I am going to say the obvious. Are not the "speculators" who are buying being harmed? They are paying too high a price according to Dick Durbin. It must be the "speculators" who are selling that are the thiefs. They are selling at a much higher price than is their right (according to Dick Durban). If we know that prices are high (do we know that?) isn't that a lot of information for producers to create more? There are always two sides to every transaction.

If some guy wants to own oil at $145 and its worth $35 (how can that be?), why not let him. Maybe its a luxury item in this case. If its worth only $35 then certainly Dick Durban can find some for $35 (strategic reserves?).

Why do we always want to shoot the messenger (the market)?

I am being a little facetious here but clearly if a market this large and liquid is trading at such a high price, somehow supply and demand for the underlying is moving in a direction of scarcity, neccessitating removal of barriers to increasing supply of energy (in whatever form makes most sense).

Sam Grove July 15, 2008 at 1:03 pm

Speculators provide a service in the market, at some risk, by providing early market signals to producers, alerting them to modify production accordingly.

As petroleum production has a certain amount of lead time, it is critical that oil producers, and consumers, get a heads-up from these early signals.

"Speculators" is one of the Marxist bogeymen.

Rudy July 15, 2008 at 1:10 pm

(Part of my posting below is from another posting I made recently, Sorry for the length).

The fact that oil prices are high is mainly due to central bank policy, not speculations in the oil commodity. The increase in the price of oil is the result of inflation (as well as supply/demand issues).

Speculators cannot indefinitely inflate or depress the price of a commodity. This is absurd. If you are speculating in an attempt to prop up the price above the equilibrium, then I need only short my position and wait for my windfall of cash when the price corrects. If speculation worked over the long run then it would only require a sufficiently large pile of money to corner each market. It's not that simple.

Using speculators as the scapegoat isn't anything new. Before President Nixon took the U.S. off the gold standard in 1971, he said that 'speculators' were at the root of the problem too. The problem wasn't due to speculation in the gold commodity at that time either, the underlying true reason was the federal government printing too many dollars to support gold at the fixed exchange rate. (People believed Nixon in the 70's too).

Here in the US the price of oil has more than quadrupled since Bush entered office in January 2001. If you price oil not in USD but in gold, the price is barely changed in that same 7-year span.

For further illustration let's use another currency – the Euro. Both USD (dollar) and Euro were valued equally in 2002, one to one. At that time the cost of a barrel of oil was 20 Euros (or 20 USD). Today, July 15, 2008, Europeans are paying 85 Euros per barrel (or $139 a barrel). Keep in mind, the European Market also speculates in futures too.

Holding to the topic of speculators controlling prices does this mean European speculators are just more considerate about the price of a barrel of oil for their citizens. This is a bunch of gobbly-goop. In reality we've seen the Euro currency holding strong on the world market while the USD lost ground. Plus, if speculation is so powerful, we should just speculate in the USD currency and we could simply make the USD stronger. It's the same logic.

Again, the problem of an ever increasing money supply is the true villain – it’s been a federal action, not a speculating action.

Listen, futures are basically a zero sum game. If I enter into a future contract I have to find someone betting the opposite of what I think a market will do. Once a contract expires I am required to fulfill the contract. If I win, someone else loses. Or if they win, I lose. Also, buying speculative future contracts are expensive. The 'premiums' for big contracts run in the millions (for both parties). So you not only have the risk of trying to hedge the commodity correctly, you also face (even if you win) the price of the premium too.

This is why futures are not a popular 'investment'. It's typically used in the investment world as an 'insurance' contract. The federal government, just by announcing we're opening off-shore drilling, could affect the spot price of oil more than a speculator!!

The other major cause of the price of oil is demand – with globalization and industrialization around the world ( China and India ), demand and supplies haven't stayed static. Some countries that use to be oil providers have even turned into oil importers today, such as Indonesia or Malaysia. With a fixed supply and an increasing demand we would expect the price of any commodity to increase, be it from wheat to oil.

Rudy

mark seery July 15, 2008 at 3:37 pm

John Dewey,

"Further, if my hedging requirements are far less than that of an airline, what is wrong with my mutual fund doing the hedging for me?"

I generally like the stuff you right, but I would have to say that it is my intution that representative hedging is probably about as precise as representative government from an information signaling perspective.

John Dewey July 15, 2008 at 4:57 pm

mark seery: "I would have to say that it is my intution that representative hedging is probably about as precise as representative government from an information signaling perspective."

Not sure if I'm misunderstanding your message or you're misunderstanding my point.

I want my mutual funds and my pension funds to have the freedom to invest in commodities as an inflation hedge. I see no difference between their hedging and that of passenger airlines. I see no reason why the government should discourage or prohibit either just because neither will ever take possession of actual barrels of oil.

Whether "representative hedging is probably about as precise as representative government" seems irrelevant to me. It's the freedom to do so that I want to protect from power-hungry control fanatics such as Senator Durbin.

Perhaps I'm misunderstanding your message. Straighten me out if so.

Mark Seery July 15, 2008 at 5:07 pm

Hi John,

Thanks for the further explanation…

In your explanation you do draw a clarifying line. Oil futures were set up as a hedge against the future cost of oil – that is their proclaimed function (especially by the exchange boards). On the other hand you suggest using them not as a hedge against the future cost of oil which is what you originally stated ("If I want to reduce my exposure to higher fuel prices – my exposure to rising prices of goods – what is wrong with me hedging in the oil futures market") but as a hedge against inflation in general, i.e. as a general investment vehicle.

Now that does not mean I am in favor of Mr Durbin exacting scapegoats in the public square for the sake of gaining votes. It also does mean I don't understand the impact of Asian governments subsidizing the cost of oil and all the other demand and supply side arguments. But it does mean I believe there is a more sophisticated conversation to be had here about the enormous amounts of money looking for investment and the waves that are created as those amounts are concentrated and withdrawn; and also even a good willed debate about whether we think it is good to use commodity futures in that way regardless of our view on regulation.

vidyohs July 15, 2008 at 5:13 pm

"I'm simply asking that we have the information necessary to make that determination. Where's the harm in that?
Posted by: David P. Graf | Jul 15, 2008 9:40:11 AM"

David,
The harm in that is, that your idea might not raise the cost of gas at the pump but it will most assuredly raise the cost to you come tax time. And most probably will
long term make the entire oil industry less profitable which does mean higher prices in the long term.

I'm a dumb-ass country boy and I got that one figured out.

Anyone who invests in what others currently consider valuable is a speculator. He could invest in gold, oil, beans.

The biggest fear a speculator has to have is that after investing a ton of money in something others consider valuable….what happens to his investment if suddenly no one considers his holdings valuable? That might happen in the case of an unanticiapted increase in the supply of what he is holding, or a unexpected change in technology, etc etc, use your imagination and you can see a lot of reasons what an investor holds might lose value before he can unload it.

The Dirty Mac July 15, 2008 at 6:17 pm

So will the major commodities exchange be moving to London or Hong Kong?

Methinks July 15, 2008 at 6:27 pm

"…then we really can't know if speculators are driving up the cost of oil." – David P. Graf

Yes we can and they're not. But please, by all means, employ the colossal ignorance of the yahoos in congress, folks like yourself who vote for them, and the regulators trying hard to justify their existence to restrict who can trade oil and how much. There is nothing like a reduction in liquidity to inject huge amounts of volatility and enormous mispricings into a market – exactly the opposite of what is intended.

I, for one, can't wait for them to initiate restrictions. I want to see the heart attack everyone will have when oil hits $250/bbl. When people want something, I'm all for giving it to them good and hard.

SteveO July 15, 2008 at 6:27 pm

Bush: "Drill"

Market: Oil down $9

Methinks July 15, 2008 at 6:32 pm

Bush: "Drill"

Market: Oil down $9

Supply and demand? Are we still "into" all that "classical economics" mumbo-jumbo? Save it for the oldies. This is a congress of the new millinium and it's taking its cues directly from the proven strategies of Zimbabwenomics.

John Dewey July 15, 2008 at 6:40 pm

Mark Seery: "On the other hand you suggest using them not as a hedge against the future cost of oil … but as a hedge against inflation in general, i.e. as a general investment vehicle."

Does it really make any difference?. I would assume that an institution hedging against general inflation might invest in all varieties of commodity futures, with oil futures perhaps being the most significant.

Again, if passenger airlines can hedge their exposure to energy inflation, then my pension fund should also be able to hedge its/my exposure to energy inflation and to general inflation.

Airline CEO's have asserted that their rights to hedge using crude oil or heating oil futures should be honored but suggested the rights of my pension fund acting on my behalf should not be. Senator Durbin seems to be implying that neither should be able to invest in crude oil futures, unless they actually will take possession of the oil.

Chris July 15, 2008 at 7:00 pm

SteveO:

Interesting. Of course, here's an alternate:

Chris: Give me a pizza with the works

Market: Oil down $9

Just like in my example, there's no reason to believe that Bush's statement had anything to do with the market price. Nevertheless, talking heads are great at "finding" such connections. ("Stocks are up today on rumors that Madonna really is Like a Virgin.")

Methinks July 15, 2008 at 7:02 pm

But it does mean I believe there is a more sophisticated conversation to be had here about the enormous amounts of money looking for investment and the waves that are created as those amounts are concentrated and withdrawn; – Mark Seery

Mark,

That conversation is not as sophisticated as you might expect. There's a relationship between the spot price of oil and the price of the future. Basically, the price of the future is the spot price of oil (the price of a barrel if you're buying it today) plus the carry. The carry consists of costs of storage and an interest rate. Spot plus carry is the fair value. If that relationship is disturbed, arbitrageurs drive it to fair by buying spot and selling the future (if the price of the future goes above spot + carry).

The oil futures market is extremely liquid (what with all those evil speculating arbs around!), so these relationships don't get out of whack for more than a few seconds. In fact, the only ones who can take advantage of these arbitrage opportunities are market makers because they disappear so quickly. So, the deviations from fair value that you you suggest can only happen if…you guessed it…you remove market participants so that their are fewer market participants to keep the spot/futures relationship in line.

In other words, the surest way to achieve what you fear is to implement restrictions on who can trade, how much and how often.

mark seery July 15, 2008 at 9:14 pm

Methinks,

Thanks for the explanation. Sounds like you know more about this subject than most of us.

Are you suggesting that a market that consisted of only actual buyers and sellers of oil would not work? Outside of the world of futures what other markets that consist only of actual buyers and sellers do not work?

Methinks July 15, 2008 at 10:28 pm

Mark,

I trade derivatives (including futures – but financial, not commodity futures), for a living. For this reason, I'm a little closer to the subject than most of the folks who frequent this site. Mesa Econguy, another poster, is also a derivatives trader.

Are you suggesting that a market that consisted of only actual buyers and sellers of oil would not work?

That depends on what you mean by "work". To me, anytime there is a free exchange, there is a working market. However, the more participants in a market, the more efficient it is. So, if you restricted participation, there would still be a market but it would be less efficient.

As each participant wants to do a trade, each participant must either outbid another buyer or offer lower than a competing seller. Each participant has a rough idea of the fair value of the asset they are trading and seek to buy below fair and sell above fair. The difference between the bid and the offer is the spread. To trade you must "cross the spread" and it is a real cost of trading. More market participants means more competition and tighter spreads. Obviously, the tighter the spread, the lower the cost of trading.

To complicate things further, identifying "fair value" itself depends on market participation. Since the real value of a good is what the next guy will pay for it, the more guys bidding, the better the estimate of fair value.

Restricting the number of participants is simply reducing the competition and it has the effect of increasing the cost of buying and selling the asset for everybody. In addition, since airlines and oil exploration and production companies buy futures and options as hedges to reduce the volatility of their P&L, they are not market makers (because they don't also sell the contracts). They rely on market makers – exactly the "speculators" targeted by the Durbins of the world, the traders who never take possession of the physical commodity – to keep the spot/future relationship in line so that they don't overpay for their futures contracts.

One thing to consider is that even those who do take physical possession of the commodity are not compelled to. So, an E&P or airline company can sell the futures contract without taking possession. It's entirely possible that if the futures market is made less efficient through a reduction of participants, E&P companies and airline companies will simply hire traders to make markets because it will be profitable to do so (in fact, I know several oil companies that already do that). So, these market makers will quit working for various commodities trading concerns on Wall Street and start working for oil companies and airlines doing exactly the same thing they were doing before. In the short run, rules that restrict trading will create market inefficiencies which increase the cost for all and in the long run all you change is who employs the traders.

These principles apply to all markets.

Mark Seery July 15, 2008 at 11:38 pm

Methinks,

Thanks. Interesting take on it, and one I appreciated reading. I can except that competition can lead to greater efficiency for the product being traded.

Is it possible in your mind to make a distinction between the demand for oil and the demand for an oil contract (given that the demand has been already stated as a demand for a hedge against inflation as opposed to a demand for the oil itself)?

SteveO July 16, 2008 at 1:22 am

Chris:

Of course you are right. I may be fooled by randomness. I wasn't really making a big point, nor am I making any positive assertions about Bush.

It just seemd like a short and funny punchline that practically wrote itself as I looked at the news crawl today.

Love the Madonna joke.

Methinks July 16, 2008 at 12:02 pm

Mark,

Ultimately, it doesn't matter what you're trying to hedge or if you're trying to hedge anything at all in the futures market. The market is indifferent to your motives. Spot + Carry will be maintained as long as participants are allowed to compete with each other to maintain it. As long as that relationship is maintained, the market will reflect the real value of the commodity.

I think I might be able to provide a better answer if I understood why you think there's a difference in the first place.

You realize, of course, that ultimately it is not the airline companies, etc. that take possession of the oil. It is you. Ultimately, it is you and I who are the end users of the commodity. Ultimately, we are the ones who "take possession". Based on the "take possession" argument, everyone is entitled to trade.

Sam Grove July 16, 2008 at 1:03 pm

'Speculators' provide a valuable function else they would not exist.

Considering comments made here on the function performed by speculators think on this:

Any particular performance is best done by those with an interest and experience. The human brain actually develops neural connections in support such activity.

A good comedian was once not such a good comedian, but with a talent and practice, his brain develops to the enhancement of his talent.

Thus the 'buffering' provided by speculators is best done by those who have a talent and experience. They keep themselves informed on market dynamics and learn to spot trends. If they are good at it, they are rewarded in accordance with their performance.

What they do is deliver price information from the future.

Don't you wish you could do that?

mark seery July 16, 2008 at 3:28 pm

Methinks,

Thanks.

I study systems/networks for a living. I am sensitive to the presence of echo effects, positive loopbacks, and non-linear effects (which are not easily understood).

What if for example the very act of trying to hedge against inflation was itself inflationary for example? These are the kinds of questions that people who look at systems ask. Now it still might be that investors as a group know more than regulators as individuals, but that does not make the questions any less deserving to be asked.

Sam Grove July 16, 2008 at 3:58 pm

Price increases due to increased scarcity or demand does not constitute inflation.

Inflation occurs when the money supply increases more than production.
So we know what causes inflation.

The problem here is that we commonly use official currency as a reference. Unfortunately, currency is a floating reference.

mark seery July 16, 2008 at 4:29 pm

Sam,

"Inflation occurs when the money supply increases more than production."

I like Milton too. Does not mean everything he said encompasses everything there is to be said.

Are you saying the orthodox view of cost push inflation is a complete myth? Care to elaborate why this can never be the case?

Methinks July 16, 2008 at 5:21 pm

Mark,

Thanks for that clarification. It helps a lot to know where you're coming from.

Fortunately for all of us, Sam beat me to the inflation answer. His posts are far more eloquent and to the point and he's nowhere near as long-winded as I am.

I study systems/networks for a living. I am sensitive to the presence of echo effects, positive loopbacks, and non-linear effects (which are not easily understood).

Externalities!

Methinks July 16, 2008 at 5:36 pm

Mark,

I know this was aimed at Sam, but I just posted and saw your new post, so I'll give it a crack.

Friedman is pretty hard to argue with on monetary issues – especially since that was the research for which he received his Nobel Prize.

Assume that money supply does not change and there is no change in productivity. If you buy more of one thing, you have to buy less of another. The demand and the price for one good increases and decreases for the other. The net effect is zero in my uber basic scenario.

If prices increase but so does productivity, then there is no increase in the rate of inflation. If there is no increase in productivity, how can there be an increase in demand for all goods (generally) without an increase in the money supply? Where would would we get the money?

mark seery July 16, 2008 at 5:52 pm

Methinks,

Thanks for taking a crack at it.

Firstly let me say it is a great saddness that the kind of logic you presented is not given in introductory economics courses – does not seem to me to be an harder to understand than what is presented (standard cost push and demand pull inflation). I would love to know why the likes of Friedman and Schumpeter have yet to make it in to orthodox economics in any compelling way (Schumpeter gets the occassional glancing blow).

Let me ask this though. There is an interesting dialog today about all the forms of money in an economy, and not just the forms that we would typically refer to as "the money supply" and not just all the different forms influenced by the fed. Does this combined with all the forms of fractionalized leverage give any reason to think that all forms of money can grow regardless of fed controls (Friedman's focus) and in ways that also have echo and positive loopback effects?

Methinks July 16, 2008 at 6:54 pm

Mark,

I grew up in a college town as a child of academics, surrounded by university professors. My observation, based on that experience, is that most (certainly not all) professors are against anything that would allow the average plebe to make decisions for himself. Locked in an ivory tower, they tend to be so removed from reality that they are under the impression that only they have the ability to make decisions. They fashion themselves the American Nomenklatura and Marx and Keynes naturally appeal to them. It's hardly a surprise that the likes of Friedman are detested. I still have my notes as far back as undergraduate intro macro and micro. They are all (apart from the very technical classes) straight from Keynes.

anyway…

Money is a medium of exchange which can also be viewed as a consumption credit. You can either directly barter for other goods using the goods you produce or you can use a medium of exchange to represent the goods you produce which you are exchanging for the goods someone else produced. Ultimately, it doesn't matter what the medium of exchange is, it still represents your production. And you ultimately cannot consume more than you produce.

Credit can be viewed as a claim against your future production. In a very simple example, you have no saved up consumption credits but you need some to buy the things necessary to start a business. A bank may lend you the start up costs, making a bet on your future production (which can, of course, be expressed as consumption credits).

Credit can have positive and negative externalities. It can both facilitate growth in production (as in the business start up example) and it can fuel temporary bubbles in, say, housing when lenders don't even attempt to adequately assess the borrower's future productivity. However, I don't think credit can raise the rate of inflation in the long run, nor do I think that it can raise the rate of overall inflation. At some point, lenders will stop lending if they suspect that future production will not be adequate to repay the loans. Lenders will only continue to lend more if they think that production will continue to rise. Paper money, in contrast, can just be printed.

The risk of bankruptcy is the motivation for not over-lending. However, when the government forces taxpayers to bear that risk instead of lenders, the incentives to do perform good risk assessments evaporate. Having removed the incentive for good risk assessment (failure), the regulators make a case that lenders are "irresponsible" and require regulation. Unfortunately, a regulator is in no position to assess every Tom, Dick and Harry's individual circumstances and are forced to issue one size fits all regulation. Tom and Dick, it turns out are actually good credit risks but don't meet some arbitrarily set and usually outdated standard because of xyz reasons that the regulator failed to account for because it can't consider every case individually. Tom and Dick can't start their own business. They lose. Harry meets the standards and wins. Really, they're all good credit risks.

So, the regulators try to use vague language like "must be able to pay back the loan" instead of specific standards. But then, that sort of leaves the discretion to the lender – the one for whom the regulator has removed the incentives to control risk….

How's that for echos and positive loopback effects?

In the natural world, there are consequences for our actions. If those natural consequences are distorted, we get a lot more and worse externalities.

ps July 16, 2008 at 8:26 pm

Big Mac: "So will the major commodities exchange be moving to London or Hong Kong?"

I didn't notice any response to Big Mac's comment. Isn't this the bottom line? The trading just moves offshore? Let some other countries becom the haven for free markets – most people here apparently don't like them.

Sam Grove July 16, 2008 at 9:59 pm

I like Milton too. Does not mean everything he said encompasses everything there is to be said.

I don't even think of Friedman in this regard. All the print dictionaries I have possessed referred to 'inflation' in this manner "esp. a rapid increase in the money supply". The most common example given is Germany between WWI and WWII, which is referred to as an example of 'hyper-inflation'.

Perhaps we should be specific and refer to 'monetary' inflation.

Governments have used this device throughout history to make people pay for things without raising direct taxes.

The common use of the term in reference to the economy is caused by the printing of currency beyond the requirements of economic growth. The root cause is the growth of government spending.

Sam Grove July 16, 2008 at 10:05 pm

If prices increase but so does productivity, then there is no increase in the rate of inflation.

I think you mean "If the money supply increases…"

Methinks July 17, 2008 at 8:56 am

Yes, Sam. Thank you.

I think I was thinking about changes in price levels and changes in the rate of change and didn't proof what I actually wrote (as usual).

mark seery July 17, 2008 at 10:43 am

"Perhaps we should be specific and refer to 'monetary' inflation."

Well that may be accurate, but in practice the perception of what is inflation is created by price level indexes (and in some real perceptive sense this is an alternative definition of what inflation is). If these baskets included everything in the economy they may well as methinks suggests show no more increase than the growth of money supply. But even if money supply did not grow, and costs were shifted from non-basket goods/services to basket goods/services that would register with people who measure inflation as inflation. And there in lies a political issue. Is the price of oil, milk, etc some how more important to a politician and an economist than the price of something else and why.

The bottom line on all this for me is not to do with whether there should be regulation or not, but just the abstract question of whether an oil futures contract really represents the markets view of the future price of oil or simply the markets inability to perceive of a better opportunity to be investing its money. In my mind there may be a difference between the fair value of oil and the fair value of an oil contract and once a new investment craze appears that may become more apparent (not discounting the fact that there are many issues impacting the cost of oil).

Methinks July 17, 2008 at 12:18 pm

In my mind there may be a difference between the fair value of oil and the fair value of an oil contract and once a new investment craze appears that may become more apparent

Again, that can only happen in an inefficient market. The spot price of oil is the price of a barrel of oil for use today. If the price of a barrel of oil for use today goes up, the price of a futures contract goes up by more than cost (spot price) plus carry, then traders will short the contracts to take advantage of that "theoretical edge", driving the contract back down to fair value.

Asset bubbles require certain conditions: 1.) short selling is impossible or restricted 2.)fair value is difficult to know 3.) the market is illiquid. It's not really possible to short houses, for example, so the RE market is subject to bubbles. The dot coms were nearly impossible to value because they were so new and there was a lot of disagreement about fair value because their positive cash flows were so far in the future. The SEC is trying to create a bubble in 19 financial stocks right now by restricting short selling in them.

At the moment, none of these conditions exist in the oil futures market. The oil futures market is exceptionally liquid (because of the number of competing participants). The spot price of oil is the price for which users are actually buying barrels for use today and it's also liquid, so there's no question about fair value. Also, shorting is not restricted.

Although, I see your point about money looking for an investment. I think that happened in the housing market. However, the inability to short houses is the condition that allowed that to happen.

Sam Grove July 17, 2008 at 4:00 pm

the markets inability to perceive of a better opportunity to be investing its money.

The market has no ability or inabilty. The are many thousands, likely millions, of market actors looking for worthy investments. Many are followers. However many mistakes are made by these actors, I am fairly certain that they are bettr at it than people who devote their talents to the attainment of political power, and, by the nature of the business, they are less likely to be corrupted than are political agencies.

mark seery July 17, 2008 at 4:39 pm

"Many are followers"

Glad we agree on something ;-)

As for the rest..both politics and business are markets. The major distinction being representative versus direct and the ability to steal money through a monopoly on violence. Now that might be a critical distinction, but outside of that there are many similarities (IMO).

Methinks July 17, 2008 at 5:19 pm

…the ability to steal money through a monopoly on violence.

…but outside of that there are many similarities

Ah, but that makes all the difference, doesn't it? A market is simply the collection of many people trading on thing for another. Every moment of the day we make trade-offs. so, of course, politics are no different in that way. But, nobody can hold a gun to my head and force me to sell them an option at the price they want on the AMEX. Politicians can and do. That's not a market. That's slavery to the political class.

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