Speculation Frenzy: Is it Simple Ignorance or Something Else?


I must admit that I think most members of Congress are economic dunces who would be lucky to pass one of my introductory courses in economics. Time and again, we see the typical Congressman (or woman) making statements that boggle the mind, and so I find myself concluding that perhaps they simply are stupid and in need of education.

However, the older I become, the more I realize that the political classes really are not interested in economic education. They have had Ron Paul giving them almost daily lessons that would rival any good content from a Harvard doctorate in the subject, but he always is seen as a fringe character. Thus, I finally have come to realize that these are people who really couldn’t care less about the economic damage that they do.

The latest frenzy about oil speculation is a good case in point. As Robert Novak recently pointed out in the Washington Post, Congress seems to be trying to convince everyone that the fundamental price (governed by supply and demand) actually would be about half of what it is if it were not for those darn speculators:

Senate Majority Leader Harry Reid, back from the Fourth of July break last week, delivered a typical harangue on Republican obstructionism and Democratic virtue that included a promise: By week’s end, he would show Republicans his proposal to deal with “this speculation thing” that he calls the root cause of $4-a-gallon gasoline. It would attempt “to end speculation on the oil markets.”

Novak later writes:

A current embodiment can be found in Rep. Bart Stupak, a former Michigan state trooper now in his 16th year of representing his state’s Upper Peninsula. A centrist Democrat, he is what Speaker Sam Rayburn once referred to as a “workhorse” rather than a “show horse.” As chairman of the Energy and Commerce Committee’s oversight and investigations subcommittee, he has made “excessive speculation in the energy markets” his signature issue the past three years.

Stupak has introduced bills tilting at the speculative windmill with all manner of tight federal regulation over commodities markets. Testifying last Wednesday before the House Agriculture Committee about this need, he rejected supply and demand as having pushed up oil prices.

The star witness before Stupak’s committee two weeks earlier was Michael W. Masters, a hedge fund operator headquartered in Christiansted, Virgin Islands. Hardly anybody had heard of him prior to his appearance before Congress beginning May 20 to sing songs Democrats wanted to hear. He said at Stupak’s subcommittee’s June 23 hearing that federal regulation would drop the price of oil $65 to $70 a barrel in a month — a claim viewed as preposterous by economists I consulted. While Masters swore that his firm does not deal in oil futures, BusinessWeek reported June 27 that he “has a keen financial interest in lower oil prices” because of his portfolio’s heavy stakes in airlines and autos.

Given that the airlines recently were repeating this mantra, one thinks that it could be a situation in which a falsehood is repeated enough times until people believe it. However, most airline executives are not as stupid as members of Congress, and most members of Congress, while not exactly near the top in intelligence, nonetheless are extremely cunning characters, and I believe that this latest assault on speculation is something that needs to be more closely examined.

First, as Robert Murphy has demolished that argument, as well as other economists, the notion that traders suddenly have decided that they can make the big bucks selling oil futures back and forth like a hot potato is pretty silly. (Granted, it is paraded as truth in the halls of Congress, which is even more proof that it is a silly idea, as good ideas generally get traction on Capitol Hill.)

Second, turning Congress loose on commodities traders is going to step on the turf of Sen. Dick Durban of Illinois, who is seen as a guardian of the Chicago Board of Trade. However, it is that point that is relevant here. We have to look at an alternative argument, and Fred McChesney provides it.

In the January 1998 edition of The Freeman, McChesney wrote in "High Plains Drifters: Politicians’ Lucrative Protection Racket" that what we think we are seeing might not be the case. We believe we are watching an orgy of economic illiteracy, and certainly what comes out of recent congressional hearings on oil prices qualifies for that category.

However, even members of Congress can see that they are strangling domestic production and refining of oil at every turn and the U.S. Government’s "war on terror" has spooked the markets, since a huge percentage of the world’s oil is transported through the Persian Gulf. Furthermore, the Federal Reserve has turned loose the dogs of inflation, and with the housing and stock markets moribund, the new money is moving (surprise, surprise) into commodities and consumer prices.

Yet, why would Congress now be blaming the speculators? Yes, blaming speculators has been a favorite sport ever since the Middle Ages, but I always thought that the modern political classes believed themselves to be more intelligent and sophisticated than decision makers of yore. McChesney points to a different reason: extortion.

Exploitative behavior need not involve stealth, as typifies theft. Take blackmail, where Person A agrees to forbear from some perfectly legal action in exchange for payment from Person B. For example, A may know of B’s extramarital affair and threaten to reveal it to B’s spouse and the rest of the world (as A is perfectly free to do), but agrees not to tattle in exchange for money. Superficially, the transaction resembles a contract, but there is a crucial difference. Commercial contracts between A and B would leave both better off than they were before A came on the scene. But B agrees to a blackmail deal to avoid being made worse off by A’s intrusion. When Bill Cosby contracts with a production company or television network, he gains; had he acceded to the demands of his alleged daughter, he would have been paying protection money to avoid her attempts to make him worse off. Had model Elle Macpherson agreed to the alleged demands for money in exchange for a promise not to post nude photos of her on the Internet, she likewise would have been paying to avoid being made worse off, not to gain. So, too, with politicians. They may well take payments to make private parties better off, such as providing tariffs or subsidies. Occasionally, these payments cross the legal line and are actionable as bribery. Prosecutions are few and far between. They largely target not the true substance of the transaction — payment for special favors — but some failure to follow the prescribed legal methods of payment for the favors. Campaign-spending laws provide the blueprint for perfectly legal bribery. But a politician has an alternative for raising money: selling protection. (emphasis mine) He can agree not to do something that otherwise he says he would do, something that would reduce the wealth of the potential donor. The most obvious burden that can be threatened is a tax, but there are any number of others that a politician can propose and then withdraw for a price. A private citizen will be just as willing to pay for a special favor worth $1 million as he will to avoid a $1 million tax. (This assumes constant marginal utility of wealth; with declining marginal utility of wealth, a citizen will pay more to avoid the $1 million loss than for the $1 million gain.) This, then, is the essence of the political protection racket. Superficially, selling special favors and selling protection do look the same: payment is made to the politician in both cases. But in the extortion racket, citizens are made to pay, not for special favors from Uncle Sugar, but to protect private wealth that they have earned the old-fashioned way, outside the political process.

He goes on to point out that legislators around the country have special names for bills that are designed to damage specific industries or organizations — if they actually are passed. I say "if" because there is a way that these organizations can stop or slow down the legislative juggernaut, and that is to pay up. McChesney writes:

One observes this sort of protection being sold routinely, at all levels of government. Legislative extortion is commonly practiced through so-called "milker bills," to use a term popular in California. A bill is drafted and submitted, not because there is any legitimate need for it, but because it threatens some private person or group that predictably will pay to have the bill withdrawn. "Juice bills" is another term for those legislative proposals intended to squeeze private interests for cash. In Illinois, the name "fetcher bill" is apparently the more common designation for legislative proposals intended purely as shakedowns of monied interests.

Indeed, one notices that the current attempts by Congress to place blame upon the speculators via actual legislation is lacking. Writes Novak:

The dominant figure of Stupak’s hearing, however, was his mentor and model in paranoid politics: the chairman of the full Energy and Commerce Committee, Rep. John Dingell, now in his 27th term in the House from the Detroit area. Just shy of his 82nd birthday, Dingell showed that he had lost none of his legendary sarcasm and invective in questioning Republican officials.

Dingell told his cross-examination target, Walter Lukken, a former Republican Senate aide who is acting chairman of the Commodity Futures Trading Commission, that he was “twiddling your thumbs” in not regulating “those good-hearted folks up there in New York who are running this wonderful, speculated enterprise.” He concluded: “Now we find that these good-hearted folks in the futures market have figured how . . . to screw the farmers and the consumers in the city . . . on a whole new product: oil.”

Why did Lukken, who surely knows better, not rebut that? For the reason that the kid kicked around in the schoolyard by a bully does not hit back: for fear of inviting more abuse. But Harry Reid has not yet achieved Democratic agreement on a bill, and Bart Stupak’s legislative panacea for cutting oil prices by $30 a barrel remains stalled in committee. The paranoid style is hard to turn into action.

One can bet that Dick Durban is receiving lots and lots of campaign cash from the commodities futures organizations, and Dingell most likely is a beneficiary as well. Right now, the only people making money are the traders, something that is not lost to members of Congress who would like to squeeze some of those profits for themselves.

However, this brinksmanship does have its setbacks. First, it reduces private enterprise to little more than a campaign cash cow for money-starved legislators. The effects on business are obvious, as it makes everyone a villain. Second, there are times when it is hard to stop the train. Take the October, 1987, stock market crash, as Jennifer Itskevich points out:

In the days between October 14 and October 19, 1987, major indexes of market valuation in the United States dropped 30 percent or more. On October 19, 1987, a date that subsequently became known as “Black Monday,” the Dow Jones Industrial Average plummeted 508 points, losing 22.6% of its total value. The S&P 500 dropped 20.4%, falling from 282.7 to 225.06. This was the greatest loss Wall Street had ever suffered on a single day.

Members of Congress soon blamed the "speculators," or to be more specific, "program trading" in which institutions would sell large blocks of stock whenever the prices reached certain points. They also blamed the sale of stock options and derivatives, not surprisingly, as they would fall under the "speculation" category.

However, real culprit turned out to be Congress itself, as Itskevich points out:

While structural problems within markets may have played a role in the magnitude of the market crash, they could not have caused it. That would require some action outside the market that caused traders to dramatically lower their estimates of stock market values. The main culprit here seems to have been legislation that passed the House Ways & Means Committee on October 15 eliminating the deductibility of interest on debt used for corporate takeovers.

Two economists from the Securities and Exchange Commission, Mark Mitchell and Jeffry Netter, published a study in 1989 concluding that the anti-takeover legislation did trigger the crash. They note that as the legislation began to move through Congress, the market reacted almost instantaneously to news of its progress. Between Tuesday, October 13, when the legislation was first introduced, and Friday, October 16, when the market closed for the weekend, stock prices fell more than 10 percent — the largest 3-day drop in almost 50 years. In addition, those stocks that led the market downward were precisely those most affected by the legislation.

Ultimately, Congress would strip the anti-takeover provisions from its bill, and the market recovered. Yet, while this crash was a financial disaster, nonetheless it strengthened the hand of Congress, as members were able to hold hearings, berate witnesses, blame speculators, and hold themselves out as the white knights, despite the fact that they were the real culprits.