Tags: commodities, exxon, forward contracts, gasoline, goldman sachs, money, politics, poverty, prices, Wall Street
As an out-of-state college student living near central campus and without a car, I rarely, if ever, come into contact with gas stations. However, over this fall break I had the opportunity to travel to New York, and as a result, I witnessed firsthand the price of a gallon of gasoline; I was in utter disbelief. Never in my life have I seen the price of gasoline exceed four dollars a gallon.
So what is pushing gasoline prices to these astronomically high levels? Two words: Wall Street. If you haven’t already been introduced, then please allow me the honor of presenting to you the world Wall Street has created.
People often reminisce about the simplicity and security of the past, and in the realm of commodity markets, I do too. For about 150 years, producers of commodities would engage with manufacturers in what is known as “forward contracts,” or contracts between two parties to buy or sell an asset at a specified future time at a price agreed upon today. The benefit offered by a “forward contract” is the elimination of price risk for both parties which, in effect, promotes both parties to invest appropriately in their businesses.
A simple example would be that of a wheat farmer and a bread producer. Since both the wheat farmer and the bread producer would like to know today the price of a bushel of wheat in the future, they engage in a forward contract.
Nevertheless, investment firms during the late 1990′s wanted to gain exposure to commodity markets as well. Thus, a lobbying effort spearheaded by yours truly, Goldman Sachs, pressed Congress to pass the Commodities Futures Modernization Act in 2000 which essentially deregulated what is known as “futures markets,” or the existing markets for “forward contracts” which I described above. The result of this legislation was the influx of nearly $300 billion dollars into commodity markets.
However, the new players, with their $300 billion in cash, are not interested in physically attaining or selling the underlying commodities. As a UN report about the issue of rising commodity prices explains, “[commodity] markets have deviated massively with the arrival of new speculators who are purely interested in short-term monetary gain and are not really interested in obtaining physical commodities – they never actually buy a ton of wheat, corn, or coffee; they only promise to buy or sell it.” So what happens when a bunch of people merely want to bet on the prices of different commodities? Well, that UN report goes on to explain how prices have “moved far from levels justified by the fundamentals for extended periods of time, leading to price bubbles … due to these distortions, commodity prices do not always provide correct signals about relative scarcity.”
So who wins and who loses?
Well, we don’t need to look very far to find the winners. Investment firms have reported hefty profits in their sales and trading divisions that focus on commodity markets. According to Britain’s Independent Magazine,
“Goldman Sachs, the largest player in the agricultural commodities market, earned £600 million from food speculation in 2009, and Barclays Capital, the world’s third-largest player and Britain’s largest bank, earned up to £340 million in 2010.”
On the other hand, in only the last four years, we have seen over 115 million people enter the ranks of poverty due to exorbitant food prices. And as people become impoverished, they begin to get really pissed off. Thus, many people have come to understand that the driving force of social unrest around the world is high food prices; the endless rioting you witness in areas such as South America, North Africa, and the Middle East can be somewhat, if not directly, attributed to Wall Street’s presence in commodities markets.
Furthermore, we at home are also affected. We continue to witness an ever-increasing percentage of our disposable income going towards the purchase of gasoline and food for literally no pragmatic reason! These price increases serve no purpose other than to enrich the coffers of those who engage in speculation in commodity markets.
So what needs to be done about this?
For starters, there must be a restriction on the number of speculators who can engage in commodity markets. If there isn’t, then the primary function of these markets will be entirely undermined. Secondly, we as a society need to stop looking at certain assets as investments. For instance, the belief that a home is an investment instead of a “place to live” caused the 2008 financial crisis which we are still recovering from today. This applies to commodities as well, as they should not be viewed as an investment. If we continue to do so, then we will merely repeat the same traps of the past and drive up the prices of these commodities all over again.
By: Jeremy Lash
(Photo by futureatlas.com under a Creative Commons License)
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3 Comments
Hey Jeremy,
Wow, thanks so much for writing about this issue–I really appreciate the concise way you explain the cause of higher gas prices and the effects on the commodities market. I’m curious as to how you interpret each Presidential candidates comments on the rising gas prices and how (or if!) their economic plans address this regulation problem? It’s a tough subject that I don’t really know anything about but it seems you might…
Hey Rachel,
Thanks for the comment.
The problems that I find with this issue emanate from the discourse surrounding it. Most people attribute the rise of oil and food prices to issues which hardly make an impact. For instance, an article released today on this same issue by The Advertiser Magazine argued that the rise in oil prices are from “economic sanctions on Iran, spare oil capacity in Saudi Arabia and auto use in China.” In essence, this is a load of crap. A report composed by Matt Taibbi of The Rolling Stone Magazine points out how “thanks to Wikileaks, we now know that when the Bush administration reached out to the Saudis in the summer of ’08 to ask them to increase oil production to lower prices, the Saudis responded by saying they were having a hard time finding buyers for their oil as it was, and instead asked the Bush administration to rein in Wall Street speculators.” Thus, Wall Street speculators have effectively disrupted oil markets while our politicians fail to either understand or tackle the true issue.
Furthermore, recent rhetoric from both President Obama and Mr. Romney doesn’t suggest that they plan to implement any more regulation of Wall Street. Although the Dodd-Frank Financial Regulatory Act was passed in 2010, Wall Street lobbied heavily and stripped the bill of a lot of it’s beneficial features (like reigning in on the derivative markets that allow people to speculate on commodities). Given that Wall Street banks have nearly paid back all of the money they had accepted from the government during the 2008 Financial Crises, I don’t see Washington as having much leverage to reign in on Wall Street’s parade. I really think that this nonsense will merely continue for the coming years.
But there is a greater issue to confront, American Culture. It really seems as if the predominant culture of America has turned from one that promotes equal opportunity to one that views this country as a means for extraction and nothing else. If you look at practically any industry (especially Finance, Insurance, and Health Care), you will find cases of incredible theft and dishonesty. It makes me feel as if our countries leaders, businessmen and politicians alike, have adopted a looting mentality. Until that changes, I really think that we will only see repetitions of past events.
I’ll try and tackle many more of these issues in later blog posts.
Read more: http://www.rollingstone.com/politics/blogs/taibblog/wikileaks-cables-show-speculators-behind-oil-bubble-20110526#ixzz29lWWCKs3
Fantastic insight, Jeremy.