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Fed Has Power To Pop Commodity Bubble

Oil refinery#Anacortes Refinery (Tesoro Corpor...

Crude oil down almost 15% last week

As pub­lished on

I don’t know about you, but I’m fed up with being a vic­tim of Wall Street spec­u­la­tors who are dri­ving food and fuel prices up through the roof. The recent plunge in com­modi­ties prices con­firms what every­one knew all the time — infla­tion is being dri­ven by com­modi­ties spec­u­la­tors who are prof­it­ing from every­one else’s col­lec­tive misery.

Last week the mar­gin require­ments for sil­ver — a rel­a­tively minor com­mod­ity — were changed and trig­gered a wide­spread sell off. The evi­dence of a spec­u­la­tor dri­ven bub­ble was unmis­tak­able by the end of the week — crude oil was down almost 15%, corn down about 10% and wheat down almost 8%.

If mar­gin rule changes for a minor com­mod­ity can trig­ger a gen­eral price run, imag­ine what would hap­pen if a series of broad based rule changes were implemented.

Well I have a sug­ges­tion for our eco­nomic lead­er­ship in Wash­ing­ton — go crazy — change the rules for all com­modi­ties. I guar­an­tee that the com­modi­ties price bub­ble will instantly pop.

The Fed has the reg­u­la­tory author­ity to imme­di­ately imple­ment this pol­icy by order­ing banks to stop fund­ing, invest­ing, clear­ing or facil­i­tat­ing deriv­a­tives com­mod­ity trading.

The prob­lem that the Fed needs to fix is that the com­modi­ties mar­kets have been “finan­cial­ized” by Wall Street. Prices that used to be deter­mined by pro­duc­ers and users of com­modi­ties are now set by finan­cial spec­u­la­tors mak­ing naked bets on how much price pain con­sumers can endure with­out break­ing by buy­ing and sell­ing deriv­a­tives com­mod­ity con­tracts. These spec­u­la­tors don’t own, or oth­er­wise have a long term inter­est, in the com­modi­ties that they bet on, they are just in the mar­ket for the quick finan­cial kill.

Over the past decade, com­modi­ties mar­kets have become a large book­mak­ing oper­a­tion where bets are placed on the amount of eco­nomic tor­ture con­sumers can take before cry­ing “uncle.” In the last 12 months when oil at $100 per bar­rel didn’t destroy Amer­i­can fam­i­lies, spec­u­la­tors raised the stakes and tried $110. When oil at $110 didn’t break us, spec­u­la­tors were will­ing to go to $115.

Despite the rapidly ris­ing prices, there was no short­age of crude oil to jus­tify the run up of price in the com­modi­ties pits. In fact, oil spot prices have con­sis­tently been far below reported “mar­ket” prices.

If you think the com­modi­ties mar­kets seem like a Las Vegas casino oper­a­tion that isn’t a coin­ci­dence. Com­modi­ties spec­u­la­tion enjoys a spe­cial exemp­tion from crim­i­nal gam­ing laws and only exists because Con­gress says that wager­ing on oil, corn and wheat isn’t the same as gam­bling and that the peo­ple that run the mar­kets aren’t the same as gangsters.

Las Vegas Strip

Com­modi­ties trad­ing is a form of legal­ized gambling

If he wants to, Bernanke can fight back at com­modi­ties wager­ing by stop­ping banks from fund­ing or sup­port­ing naked com­modi­ties bets. That action won’t hurt pro­duc­ers or users of com­modi­ties or the com­modi­ties trad­ing mar­kets that actu­ally have some­thing to do with the pur­chase and sale of the under­ly­ing goods. Nev­er­the­less, it will stop finan­cial spec­u­la­tors from using liq­uid­ity that was actu­ally intended as eco­nomic stim­u­lus from being diverted into legal­ized com­modi­ties gambling.

Thirty years ago Paul Vol­cker attacked a sim­i­lar liq­uid­ity fueled com­modi­ties bub­ble by declar­ing banks couldn’t fund com­modi­ties spec­u­la­tion. Prices plunged and the bub­ble was popped. Bernanke can learn a thing or two from Volcker.

US Federal Reserve Chairman Ben Bernanke speak...

Bernanke can learn a thing or two from Volcker

Put sim­ply, the Fed has the reg­u­la­tory author­ity to stop bank hold­ing com­pa­nies, and their sub­sidiaries, from being the “house” at the com­modi­ties casino.

Unfor­tu­nately, in recent years the Fed has been at best a reluc­tant reg­u­la­tor. The Fed needs to ditch its pol­icy of reg­u­la­tory non-intervention, at least when its own mon­e­tary pol­icy is cre­at­ing unin­tended eco­nomic distortions.

Fed action doesn’t have to be broad based to be effec­tive — in fact, nar­rower is bet­ter. Lend­ing and cap­i­tal rules only need to change for the financ­ing and clear­ing of non-delivery deriv­a­tive com­modi­ties con­tracts. Fed pol­icy shouldn’t change for phys­i­cal deliv­ery con­tracts that are used by pro­duc­ers and users of commodities.

Bernanke needs to get some back­bone and stand up to com­modi­ties spec­u­la­tors, and the sooner the bet­ter. He should remem­ber that there was a time when the Fed Chair­man wasn’t afraid of Wall Street and didn’t hes­i­tate to use all of the reg­u­la­tory tools at his disposal.

Pun­ish­ing every­one by rais­ing inter­est rates, or wait­ing until infla­tion over­takes the econ­omy, isn’t a ratio­nal choice. Bernanke has the power to pop the com­modi­ties bub­ble right now with­out hurt­ing the rest of us. Let’s hope he uses it.

Posted in: commodities, economy, Finance, Inflation, Public Policy, REGULATION

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