[OPE] Mr Bernanke on the oil price

From: Jurriaan Bendien (adsl675281@tiscali.nl)
Date: Thu Jul 24 2008 - 16:23:24 EDT

Actually, the IMF analysis seems to be just a take-off from Mr Bernanke's report, presenting an ideological "united front" as it were. Mr Bernanke states:

"Another concern that has been raised is that financial speculation has added markedly to upward pressures on oil prices.  Certainly, investor interest in oil and other commodities has increased substantially of late.  However, if financial speculation were pushing oil prices above the levels consistent with the fundamentals of supply and demand, we would expect inventories of crude oil and petroleum products to increase as supply rose and demand fell.  But in fact, available data on oil inventories show notable declines over the past year." http://www.federalreserve.gov/newsevents/testimony/bernanke20080715a.htm

I suppose that following Economics 101 theory, if the price for a good rises, this must mean that demand exceeds supply, and then supply should rise in response, causing the price to fall. That is how markets are supposed to work. Effectively Mr Bernanke says speculation cannot be the cause of high prices, because in that case, oil inventories available for sale would have increased in response (the law of supply and demand) - therefore, it must be the case that, in reality, physical oil supply is incapable of meeting physical oil demand, i.e. there is an absolute scarcity of physical oil inventory available for sale, as proved by "notable declines" in oil inventory for sale (a "market rigidity" of sorts). 

But this interpretation is a bit difficult to believe given deliberate cartel decisions made about "global oil inventory management", and especially if  it is true that - as Prospect magazine claimed - there are now up to three times as many "paper barrels" traded in New York and London as there are physical barrels of oil supplied to the world each day. That is, it is possible to drive up the average oil price beyond "fundamentals of supply and demand" without this however leading to an rapid increase of physical supply, and in fact an increase in the oil price does not automatically cause an increase in supply; the price-level is to a significant extent dislodged (semi-autonomous) from supply and demand conditions. And this of course puts political pressure on Western governments; oil supplies become a directly political matter. In brief, the oil market just does not seem to function according to the Economics 101 explanation.

But why deny the role of speculation of various kinds (including hoarding) in commodity price formation anyway? Presumably the answer is that, doctrinally speaking, financial intermediation must always play a progressive role in markets, facilitating the mutual adjustment of supply and demand, and insuring capital values against risk. Thus, rather than causing mischief in markets, speculators are viewed as aiding the market's functioning. But why should this always necessarily be the case? It seems more a market dogma, than a realistic portrayal of what actually happens. 

You might indeed well argue that, if this really described the role of financial intermediation correctly, then the gigantic global expansion of financial intermediation would rule out the very possibility of supply bottlenecks; the futures market was supposed to help remove gluts and shortages causing price volatility. Given ample capital liquidity, in fact bottlenecks simply could not happen, since capital would flow to where it's needed. But if they do happen, then you have to explain why. The main reason, I would think, is that the original purpose of the financial markets has changed: the "underlying value" which was supposed to be insured is nowadays merely a "collateral asset" for a burgeoning and profitable derivative trade staked on it, involving an amount of capital which is a multiple of the "underlying value". 

Mr Bernanke's story however just leaves us with the simple (and really rather vulgar) idea that "people are just not doing the things that make the markets work properly". But that is precisely what capital finance and abundant liquidity were supposed to resolve!

What I think is really missing in this whole controversy is the distribution of actual risks among the population of economic actors, and the ability to shift risks to someone else. In reality, few investors other than governments invest specifically and explicitly to "absorb risk". That is only the ideological or moral rationalization of what they do. They invest instead to make money, based on a perception that the probability of making money is greater than the probability of losing money. But this gambit has the ultimate outcome that the burdens of risk are shifted to ordinary producers and consumers, who have to battle with price hikes eroding their income.  In the end, the costs of the speculator's net capital gains and losses obviously have to be paid by "someone" in the trading circuit. That "someone" happens to be you and me, i.e. the ordinary producers, consumers and taxpayers in the world.

Seems to me like the more capital values are insured against risk, and the more that a profitable trade in derivatives substitutes for longterm investments in real production, the more the risks for the ordinary working population of the world proliferate. Food and energy supplies are among the most basic, elementary requirements of the human race, yet the burgeoning financial intermediation of markets is unable to secure these requirements adequately, and what is worse, in many cases actually becomes an obstacle to meeting them. In Marx's phrase, "the ultimate barrier to capital is capital itself" (although he could hardly foresee the sheer magnitude of the problem in modern times). If bankers nowadays often perceive too much risk even to lend to each other, why would they lend, at even greater risk and with more organizational difficulties, to poor people just trying to make a living - particularly if nothing compels them to do so? 


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