Nonsense on Speculation

by Don Boudreaux on July 21, 2008

in Current Affairs, Energy, Myths and Fallacies, Prices, Regulation

An especially clear example of the confusion that economically illiterate people suffer when thinking about speculation is this column today by Dick Morris and Eileen Mc Gann.  The core offending passage is here:


If there is any doubt that it is speculation, not the supply and demand for oil, that is driving up the price, look at this week’s history of oil prices. After Bush announced that he was rescinding his father’s executive order and permitting off shore drilling and after OPEC announced a weakening of oil demand, the futures market price dropped $15 per barrel. No new oil gushed through the system. The speculators just switched their bets from up to down.

Market prices reflect future as well as current conditions.  Just as, say, General Motor’s share price would rise today if that company announced a major breakthrough in fuel-conservation technology – rise even though this technology might not find its way into GM’s engines until years from now – so too does new information on greater supplies of oil tomorrow push today’s oil prices down.

And it’s good that this price adjustment happens today because such information means that oil is less scarce than previously thought.  Because there’s more oil than previously thought available in the future, people need not be as careful today in consuming it. “Speculators” play a vital role in causing today’s prices to reflect future conditions and, hence, in causing consumers and producers today to act in ways that are consistent with future reality.

Morris’s and Mc Gann’s supposition that the price of oil should be determined only by today’s physical flows of oil — and that supply and demand reflect only such immediate-run realities — is wholly mistaken.

(HT Rudy Schober)

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