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Obama North American version of a banana-republic Generalisimo

President Obama Lashes Out at the Bogeyman



Earlier this week President Obama announced his Administration's redoubled efforts to crack down on oil speculators. The only problem is, he failed to explain a single thing that these people are doing wrong. The President's pronouncement is impossible to analyze, since it was devoid of content.
Successful speculation in the commodities markets serves a useful role in reducing price volatility and providing liquidity. By jacking up the penalties on ill-defined crimes, the Administration will actually make oil prices move more erratically. The president's finger-wagging at the big bad speculators is just a rhetorical ploy to distract attention from his nonsensical energy policies.

President to Congress: Let's Make Illegal Behavior a Crime

The following excerpts from the president's remarks show the vacuity of his position:

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[W]e still need to work extra hard to protect consumers from factors that should not affect the price of a barrel of oil. That includes doing everything we can to ensure that an irresponsible few aren't able to hurt consumers by illegally manipulating or rigging the energy markets for their own gain. We can't afford a situation where speculators artificially manipulate markets by buying up oil, creating the perception of a shortage, and driving prices higher--only to flip the oil for a quick profit.... ... I've asked Attorney General Holder to work with Chairman Leibowitz of the Federal Trade Commission, Chairman Gensler of the Commodity Futures Trading Commission, and other enforcement agencies to make sure that acts of manipulation, fraud or other illegal activity are not behind increases in the price that consumers pay at the pump. So today, we're announcing new steps to strengthen oversight of energy markets. Things that we can do administratively, we are doing. And I call on Congress to pass a package of measures to crack down on illegal activity and hold accountable those who manipulate the market for private gain at the expense of millions of working families. And be specific. [Bold added.]
As the passages in bold make clear, President Obama is coming down hard against...activity that is already illegal. He is proudly telling Americans that he is opposed to crime. Read at face value, the president's remarks suggest that anytime the price of oil goes up, the people who are trading that day should be prosecuted. Presumably that's not what the president means, since that would effectively be a price control on oil at the current price. But if the president isn't saying, "Anytime the price of oil goes up, someone is going to jail," then his remarks are completely ambiguous. It's not even that they are wrong; in order to be wrong, he would have to actually offer a statement about how these speculators are allegedly hurting consumers.

Successful Speculation Serves a Social Function

As I explained in a previous post, blaming speculators for rising oil prices is like blaming thermometers for a heat wave. If some people have a strong view that oil prices do not adequately reflect (say) the danger of a supply disruption from the Middle East, they will enter the oil futures market and bid up the price. This ultimately causes oil producers with excess capacity to ramp up current output, and it causes users of oil to reduce current consumption. This allows for the physical stockpiling of inventory (perhaps on oil tankers) which is exactly what we want the market to do, in the face of an interruption of Iranian exports. Remember the motto of the speculator is to "buy low, sell high." By definition, successful speculation makes prices less volatile speculators push up prices that are too low, and push down prices that are too high. By cracking down on speculation, the president will ironically make oil prices more volatile. Speaking of speculators, didn't they push down the price of oil $9 per barrel when President Bush lifted the Executive moratorium on offshore drilling? Wasn't it speculators who pushed down the average price of oil from $133 per barrel in July 2008 to $41 by December? Buoyed by an expected inventory report, speculators have pushed natural gas prices lower than they've been in a decade, and I bet some of them make a nice living too. Does the president consider this "artificial manipulation" for personal profit?

People Trade Oil Derivatives to Reduce Risk

Beyond actual speculation, derivatives in the oil market are also useful for hedging purposes. This is obvious in the case of the airline and trucking industries, which are hurt by rising oil prices. These companies can reduce their exposure by "going long" on oil futures (or related derivatives such as call options), so that they experience a gain on these contracts when oil goes up, which helps to offset their higher operating costs. Yet there are other groups that might want to trade in oil derivatives for hedging purposes, that don't fit the traditional mold. For example, a retiree who manages his own savings might be fearful of coming inflation, and want to gain exposure to commodities as a way of protecting his assets. It is precisely this type of "little guy" who is going to be excluded by the Obama Administration's new rules on electronic trading‚ this is what they have called closing the "Enron loophole," as if only giant corporations used electronic trading platforms.

Conclusion

GMU economics chairman Don Boudreaux nailed it when he wrote that the president "behaved very much like a North American version of a banana-republic Generalisimo: posing as a tribune of a People besieged by nebulous devils, he blames those devils for the ill-consequences of his own bad policies." Cracking down on speculators for high prices at the gas pump is a classic example of blaming the messenger. Both theory and history show how to harness speculators in the cause of pushing down oil prices: Simply implement policies that will allow the greater development of American energy resources.

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Institute for Energy Research -- Bio and Archives

The Institute for Energy Research (IER) is a not-for-profit organization that conducts intensive research and analysis on the functions, operations, and government regulation of global energy markets. IER maintains that freely-functioning energy markets provide the most efficient and effective solutions to today’s global energy and environmental challenges and, as such, are critical to the well-being of individuals and society.


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