Tuesday, June 24, 2008

DO WE BLAME SPECULATORS?

With the increase in commodity prices, including agricultural and energy futures, many critics have come down hard on speculators. Some are calling for more regulation including increased margin requirements, or requirements for players to actually take delivery of the products.

These critics seem to forget that the role of futures markets is to provide risk management tools to suppliers and producers of commodities. Speculators provide the liquidity to make this possible.

Futures prices, like any other price, have an important social function in transmitting information, providing incentives, and allocating resources. It is in the interest of speculators to search out information related to the relative scarcity ( now and in the future) of commodities. The potential for profit provides the incentive to do so. Further, as ‘speculation’ drives up the price of scarce commodities, it provides incentives for producers to increase supply and for consumers to find substitutes or reduce consumption. As a result we get an optimal allocation of commodities over time, as opposed to catastrophic shortages or surpluses.

The proposed regulations on commodities markets will likely reduce this consumption and production smoothing process, and increase the volatility of commodity prices. Most importantly, the information transmission function of commodity prices would be inhibited. As a result, knowledge about the relative scarcity of commodities may not be as complete or timely making things much worse than we can imagine today.

see also: Scapegoating the Speculatorsby Alan Reynolds

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