By Nader Habibi
Payvand.com - The latest economic indicators in the United States and other industrial countries suggest that economic decline might finally be coming to an end and a recovery can begin by late 2009. Once it starts, however, the global recovery can face a new potential threat from rapidly rising commodity prices, particularly for oil, food and industrial metals. It is inevitable that global recovery will itself contribute to this price increase by raising the demand for all types of commodities. But upward pressure can also come from a second source: speculation. Speculative investment in commodity markets can put an even larger upward pressure on commodity prices and make them more volatile.
The governments of leading industrial economies are well advised to carefully consider the potential threat of speculative investments in essential commodities such as oil. Otherwise the sharp price rises of the first half of 2008 might be repeated again.
Recent investigations into the rapid increase in price of oil during 2007 and first half of 2008 suggest that speculative investment by major institutional investors played an important role in pushing the price to $150 per barrel in June 2008. Once the investors realized that the market was tight and supply was not able to keep up with demand, they invested billions of dollars in oil futures contracts.
By early 2008 the list of speculators in commodity futures market (oil in particular) included California Pension Fund, Harvard Endowment and many hedge funds. The volume of speculation in commodities rose from $13 billion in 2003 to $260 billion in March 2008. Speculation became so prevalent that in 2008, for every barrel of oil that was actually consumed in the United States 27 barrels were traded in the New York Mercantile Exchange.
The rapid increase in food and energy prices raised some political concerns in 2008 as it led to higher costs for many goods and services. The transport and tourism industries launched a campaign for regulations that would have constrained financial speculation in commodity markets. This campaign was also supported by agriculture and food industry. In June 2008 Representative Bart Stupak of Michigan introduced the Prevent Unfair Manipulation of Prices Act (PUMP or H.R. 6330) to limit speculation in oil and gas markets. Unfortunately this proposal did not receive enough support and was quickly forgotten after the sharp decline in price of oil in September and October.
The massive commodity speculation of 2007-08 was made possible by a number of regulatory weaknesses in the U.S. and European financial systems. In the United States the speculators took advantage of a regulatory loophole in the Commodity Futures Modernization Act of 2000 which allowed the commodity futures to be traded in the unregulated Over-the-Counter market. This law, which was strongly supported by large investment firms, reduced the government's ability to monitor the financial markets for excessive speculation.
Unfortunately the U.S. and other major governments are so preoccupied with the financial crisis and the global economic recession at present, that there is little appetite for proactive regulatory reforms for prevention of speculation in commodity markets. Yet the time to act is now. Large groups of investors are eagerly waiting for the economic recovery to improve the demand for basic commodities before jumping in.
The next round of speculation in commodity markets might be even more powerful than 2008. After suffering severe losses in real estate and stock markets many investors worldwide are looking favorably at commodity markets as less risky alternatives. Even the sovereign wealth funds of oil exporting countries, which lost billions of dollars in U.S. and European real estate and equity markets, are likely to invest in commodities in the next round. No one can blame the private investors for trying to profit from speculation. But it is up to governments to determine which markets are open to speculation and which ones are off limit. It is better to shield some essential commodities such as oil, basic metals and agricultural products against speculation. Affordability of these commodities is essential for a global economic recovery and as experience has shown excessive speculation can put excessive upward pressure on prices of these commodities.
Speculation in commodity markets is a global phenomenon and major economies must act in coordination to make these markets less vulnerable to speculative activity. Now that the commodity markets are calm, is the best time for the major industrial governments to strengthen their oversight on commodity markets and impose limits on financial speculation in these markets. Failure to act now will force the governments worldwide to react after a new round of speculation has pushed up the commodity prices and derailed the economic recovery that everyone is so eagerly waiting for.
About the author: Nader Habibi teaches economics at Brandeis University (email@example.com)
... Payvand News - 05/22/09 ... --