Published: June 30, 2008 11:44 pm            

Arthur Foulkes: Speculators important in free markets

TERRE HAUTE — Speculators in energy markets are taking a lot of heat lately as oil prices reach record highs.

Yet there is nothing new about attacking speculators. In 1974, Hillsdale College economist John Sparks wrote “once again the guns of public criticism are trained upon speculators.” Sparks quoted fellow economist Hans F. Sennholz, who wrote, “What the witch was to medieval man … the speculator is to most politicians and statesmen: the embodiment of evil.”

Despite their lack of popularity, speculators play an important role in free markets. They assume risks others want to avoid, and they contribute to price stability for consumers.

Imagine an orange grower who worries that the price of his crop will fall by the time he is ready to bring it to market. To lock in a price today, he may sell his future crop to a speculator for an agreed-to price. The speculator accepts the risk that the price of oranges will fall. He also accepts any reward if the price rises. Either way, because of the speculator, the grower can focus on growing and worry less about market fluctuations.

Speculators also help consumers avoid wild price swings. For example, if coffee is currently selling at a low price because of a strong growing season, a speculator may purchase coffee and conserve it on the chance that bad weather or a surge in demand will increase prices down the road.



If the speculator is correct and prices rise, he will sell his coffee and make a profit. However, by selling when supplies are low and prices are high, the speculator adds to the available supply and helps bring prices back down. In this way, speculators provide scarce resources when supplies are tight and contribute to price stability.

Politicians from both major parties are pointing their fingers at speculators as oil prices continue to rise and it’s true — as our coffee example shows — that present purchases by speculators can temporarily cause prices to be higher than they otherwise would be; however, it is far from clear that this is even happening in the oil market today.

As economist Robert Murphy recently has written, if speculators were truly pushing the price of oil higher than its natural market level, world oil output would be exceeding world consumption. Yet there is no evidence this is happening. As Murphy writes, “consumers are purchasing every barrel [of oil] that producers bring to market … [therefore] the world price is justified by the fundamentals.”

Restricted oil supplies, booming global demand and loose monetary policies in America and abroad are the main causes of today’s rocketing oil prices. Two of these three causes are the fault of politicians and governments, themselves.

People who act as speculators are probably closer than you think, including perhaps some of your friends and neighbors. Anyone who buys a commodity in the hope of re-selling at a profit is a speculator. Yet speculators in commodity markets (when commodity prices are rising) make convenient scapegoats for politicians and pundits. Very few people probably realize what speculators really do.

But, the truth is, speculators play a useful and stabilizing role in a free market. Demonizing and outlawing speculative oil trading might be smart — if cynical — politics, but it does nothing to make oil more plentiful or reduce prices in the long run.

Arthur Foulkes is a Terre Haute native and long-time resident. The Tribune-Star reporter writes a column on business and economics. He can be reached at (812) 231-4232 or arthur.foulkes@tribstar.com.

        

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