First, Kill All the Speculators!
The price of everything has been on an epic rise – but we don’t have to tell you that. You notice every time you fill up your tank, or pay your electricity bill. American politicians are looking for someone to blame – and they have found their mark. Kevin Kerr explores…
The price of almost everything on the planet has been rising. And so has the inevitable talk of a commodities bubble and price manipulation. The discussion has become front and center in global markets around the world as economies reel under the heavy weight of soaring prices.
It’s simple for a senator to blame high oil prices on speculators. But don’t hold your breath to hear a long discussion of the taxes on every gallon of gasoline and heating oil that the government collects each time we fill up our tanks. Perish the thought.
So who are these speculators, and why and how could the high prices of commodities be their fault? Of course, those are the real questions. But the conversation never really gets that far. The cameras are turned off before the detectives hit that crime scene.
To say we are in a crisis is a massive understatement. It’s like saying there was a little fire on the Hindenburg. As oil prices surge and the ebb and flow of trading begins to catch up with the world’s growing population, we can expect to see these prices continue to climb – maybe exponentially.
Meanwhile, the fools in Washington, and those political candidates hoping to get into that asylum, continue to talk the same smack they have for years. Essentially, they’ll say whatever they need to in order to get elected. What else is new?
The problem this time, however, is that the situation is simply too dire. We should not waste time trying to find scapegoats. That won’t solve the problem. It will just distract attention while politicians hope for answers.
But let’s face it. The blame game works. The politicians have an easy target in speculators. After all, the average American imagines Gordon Gekko-type characters slashing and burning their way through Wall Street and making the everyday man’s life more expensive while they water-ski behind their yachts.
So for senators and other politicians, it’s not a tough putt to get the general public to latch on and want to lynch every speculator out there.
But Gordon Gekko was not a speculator. He was a manipulator. He used information he should not have had to do things he should not have done.
That does not matter to the politicians, however. They want to paint every speculator with a broad brush. To the politicians, every legitimate speculator is an unlawful manipulator.
The problem is this: If the politicians restrict legitimate speculation, they will cripple the free market and actually cause prices to surge even higher. Politicians have confused things pretty badly.
Speculation shapes the margins of the markets. Many markets cannot function correctly without some element of speculation at the margins. Few politicians seem to understand that. Or they do, but won’t acknowledge it. Either way, it’s a critical mistake to be focusing on witch hunts, rather than real answers.
In real estate, it’s location, location, location. In trading, it’s liquidity, liquidity, liquidity.
In case a number of U.S. senators don’t know, one of the most important elements in a free market is a provision of liquidity. It is possible to discover an "active price" only when the market is free and open. This is the job that speculators perform. Without speculators, there cannot be free market capitalism.
Yet even in the face of clear evidence that speculators perform this vital service, all we hear about is how speculators are causing the run-up in energy prices. And then we hear how speculators need to be more "regulated." It’s absurd and dangerous.
As Richard Rahn of the Cato Institute writes in a great article for The Washington Times, "Many members of Congress make up ‘solutions’ to things they do not understand and cause problems where there are none or make real problems worse, which explains the current run-up in gasoline prices."
You may be reading this and saying, "Of course you’re saying this. You’re a speculator!"
Very true, but I am also a consumer who has to buy gasoline and heating oil, just as you do. I also know the risks of assuming any position in these volatile markets. And that risk is calculated each time I trade. There are no guarantees. (How I wish there WERE some guarantees when I lay my cash on the line!)
The other very important factor here is to realize that speculators are not beholden to one side of the market. They are married to movement, not direction.
As far as my trading portfolio goes, I couldn’t care less if oil were moving higher or lower. As long as there is movement, we have trading opportunities.
The problem with blaming speculators is the damage done to the free market can be irreversible.
Richard Rahn goes on to say, "Speculators are not the problem; they are part of the solution, by reducing the risk for producers, refiners and other oil market participants. This risk reduction results in more production of oil, other fuel, food and metals where futures markets exist."
Once again, he has hit the nail on the head. Reducing the number of speculators in the free market actually has the reverse impact. It drives prices much, much higher.
Let me just say that I am one of the biggest advocates of free, open, transparent markets. So are almost all speculators. The integrity of any market is only as good as its participants. And in some cases, I can see the need for more regulation. But the best regulator of the commodity market is usually the market itself. Markets punish unwarranted excesses.
Did you notice that back in July – when oil prices slipped from record highs and even had their biggest one-week drop in history – nobody was calling for speculators’ heads? There were no congressional hearings into the matter, just silence.
The fact of the matter is that speculators were just as active on the way down as they were on the way up, providing the service they do. With or without speculators, prices will continue to climb. The solutions, however, will be much harder to come by without speculators. The speculators are the ones who add liquidity and discover the best free market prices every day.
We must set aside all of the election-year rhetoric and demand better from our politicians, energy producers and even ourselves. We all have to take some responsibility if we hope to find solutions. Simply blaming one group of people is not going to work. The challenges of Peak Oil – if not Peak Everything – remain. Banning speculation means just losing a critical piece of the early warning system.
for The Daily Reckoning
August 5, 2008
Kevin Kerr is the editor of two highly successful and acclaimed financial advisory newsletters, Resource Trader Alert and Outstanding Investments. A veteran commodities trader, Kevin uses his irreplaceable experience to advise his readers on a variety of commodities investments on a daily basis. Widely considered one of the nation’s top commodities gurus, Kevin’s expert opinions are routinely featured in the country’s premier media outlets.
The above essay was excerpted from the latest issue of Oustanding Investment’s.
Let us keep looking through our binoculars…
We are trying to see the big picture, trying to understand what is really going on. We can imagine ourselves like Caesar – watching the action at Alesia from a nearby hill – or like Lee looking at Cemetery Ridge as the Confederates tried to push back the Yankees. Which way is the battle going? Who’s going to sweep the field…who’s going to carry the day? Caesar won at Alesia with a combination of strategy, planning, and discipline. But Lee lost at Gettysburg for lack of resources…bad luck…and bad tactics. And now…General Bernanke is losing too.
Yesterday’s news described another day of deflation. The Dow lost 42 points. Oil fell almost $4, to $121. The commodity index, the CRB, dropped 18 points. And gold lost nearly $10, ending the day at $907.
What to make of it?
Banking has always been a boom and bust business. Bankers tend to act like retail investors who just happen to have a lot of money. They lend to whatever is fashionable…then, when the go-go businesses go bust, the bankers look for the next opportunity to lose money.
The retail investor doesn’t know anything about investing or economics either. Instead, he watches television or reads the papers. Gradually, he forms the opinions that turn him into a chump for Wall Street – ready to buy financial products because he’s heard someone say they make good "investments."
From 1997 to 2007, the retail lumpenhouseholder developed an extraordinary hallucination; he came to believe that he could make money simply by buying a house and living in it. Of course, the little guys are always susceptible to delusions – especially those that flatter them or offer them something-for-nothing; that’s how democracy works. But what was really remarkable, in the ’97-’07 period, was that sophisticated bankers and brokers came to believe the same thing – that they could get rich by buying and trading the mortgage contracts of people who thought they’d never have to pay back their mortgages.
Of course, the whole thing blew up last year. The marginal homeowner is in trouble – with more mortgage than house. And the marginal banker is in trouble too – he owns the mortgage! So far, houses have fallen about 20%, with another 10% to 30% left to go. And the banks have written off about $476 billion worth of bad credits – according to the Int’l Institute of Finance – with maybe another half a trillion in mortgage-related losses.
So far, the subprime mortgages have been the focus of losses. But now the Alt-A and Prime mortgages are getting into trouble too – with delinquency rates in both categories on the rise.
Nothing astonishing about this picture. A correction is always equal and opposite to the claptrap that preceded it. The housing hallucination was a whopper. So is the correction. The housing bubble caused big increases in nominal GDP, retail spending, and corporate profits (from the financial sector). Now, the GDP is flattening out, retail spending is softening and corporate profits have been crushed.
Taken altogether, guess how much money the Dow stocks are making? These are the companies that form the backbone of American commerce and industry. Guess again. Because if you put them all together, says Barron’s, you’d have a loss of more than $80 billion. The last time there was such a loss in the Dow was 75 years ago – in the Great Depression.
This is an encouraging word to many observers. They note that the last time Dow earnings went negative proved to be a very good time to buy stocks. After ’32, stocks in the United States went up 373%.
But wait, they went up AFTER having lost about 85%. The Dow in ’32 rose from a low of 41…with stocks trading at only 5 to 8 times trailing earnings (in terms of current negative earnings, the P/Es were meaningless). In other words, the stock-market had been crushed before it rose again.
Today’s stock-market has not yet been crushed. In fact, the Dow itself is only a bit lower than its all-time high.
The correction has taken the wind out of Wall Street’s sales. But, so far, it has done very limited damage to U.S. stocks. Most likely, more pain lies ahead…before another upswing.
Hey, don’t take our word for it. No less an authority than Alan Greenspan himself says there is more suffering ahead…and there is no less an authority than Alan Greenspan.
The auto business is being corrected – severely. One of the biggest losers on the Dow was – no surprise – General Motors. It lost $11 a share in the second quarter- which is almost unbelievable, for a share that sells for $10. And Chrysler’s latest attempt to raise money fell $6 billion short. The auto industry will probably go broke – and be nationalized, like housing.
*** A correction is always equal and opposite to the deception that preceded it. You can quote us on that, dear reader.
A correction is always deflationary too. Delusions and hopes push up asset prices. Reality and despair pull them back down. The latest figures show M2 – a measure of the money supply – no longer growing. True, the feds are desperately trying to increase the money supply with bailouts and tax rebates. But the bankers are running scared. They get their hands on some hard cash…and they want to hold onto it as long as possible. They figure they might need it.
This is the phenomenon that Keynes described as "pushing on a string." The feds push. But the string bends.
Of course, it’s not just the bankers. Remember, bankers act like retail investors – and householders. And right now, they’re all feeling a bit under stress and looking for stray coins under the seat cushions.
Unemployment is rising. It is projected to hit more than 6% before the end of the year. In the last major recession – of the early ’90s – unemployment hit 7.8%. It could well reach up to 7% or 8%…or higher…this time too.
The combination of falling employment (including overtime and so forth) and falling house prices makes it almost impossible for the consumer to continue consuming in the manner to which he has become accustomed. We are watching the retail sales figures closely for proof. Broadly, from our great distance, the figures show little sign of a let-up in consumer spending. But when you look more closely, the picture is more interesting.
Consumer spending continued to rise in the last quarter, for example. But there were three important nuances:
First, most of the growth in consumption spending is no longer coming from the consumer. It is the government that is doing the spending. The feds are stepping up to the plate to try to compensate for weakening consumer spending (they don’t know they are doing this…they are just doing what comes naturally). Federal government spending rose at a real rate of 6.7% in the last quarter, while personal consumption rose only 1.5%.
Second, consumer spending is not even keeping up with consumer incomes. The feds handed out billions in tax rebates, which boosted incomes by 4% – more than twice the level of consumer spending increases. This tells us that consumers are trying to cut back.
But third, they’re finding it especially hard to cut back because prices are still rising. Ah, here’s the real complication. It’s a deflationary correction – we see that clearly, through our binoculars. But consumer prices are still going up. In June, consumer prices rose 0.8%. Doesn’t seem like much, but multiply that times twelve and you have an annual rate of nearly 10%. Prices for the essentials – food and fuel – have risen so much that the consumer has to spend all his money just to keep up. The broad figures show consumer spending rising…but the consumer is actually consuming less. He’s eating out less – so the restaurants are failing. He’s buying less – so the retailers are hurting. And he’s driving less – so gasoline sales, in gallons, are actually going down.
And pity the poor baby boomers! They’ve lived their whole lives with a pot of honey in their hands. Save money? Why bother? Na na na na live for today! The economy was always expanding…they were always getting richer…jobs were always plentiful…and so were credit cards. Now though, the tables are turning against the boomers. When companies lay off employees – they get rid of the middle-aged, expensive workers – the baby boomers. And since the poor boomers never bothered to save money – and since their houses are losing value – they now face retirement with no money in their pockets and no way to get more.
And now, even when they save money, they get kicked in the derriere. Interest rates are so low, they make almost nothing.
What are the poor baby boomers to do? D-O-W-N-S-I-Z-E in a hurry…
*** Zimbabwe with oil…
That’s today’s Venezuela…more tomorrow…
The Daily Reckoning