From the August & September AD
Our Lady of the Rosary
NOTE: This is an advanced
and may be modified after the Parish Bulletin is printed in final form
On the Morality of Economic Speculation
Question: I am still a bit skeptical of your
claim that the gas stations aren’t pricing in an immoral manner-but the
financial commentators on TV now seem to be blaming the “speculators.” What
precisely does a speculator do, and is whatever he does moral?
Answer: It will
help to distinguish those who participate in the forward commodity
markets from those who participate in the commodity futures markets,
which we will explain later in this article.
● By the “forward market” we mean the
market in which a contract is negotiated by the buyer and seller, containing
terms, including price, agreeable to both, with the transfer of goods at some
specified date in the future. If the transfer is within a day or two it is
called a spot transaction rather than forward. All such contracts
must be carried to completion unless both parties agree to modify or extinguish
them. The essence of forward and spot contracts is the actual transfer of goods.
In this market, speculation, mixed with an attempt to protect one’s assets,
can take one of three major forms.
● If the average person speculates that goods will
soon be more expensive or difficult to obtain, he will stock up in advance. The
prudent man stocks his pantry before the bad weather season in his locale-those
batteries, bottles of water, and cans of food may be (literally or figuratively)
worth their weight in gold when the power is out after the hurricane or snow
storm. He may also speculate that gasoline will be more expensive next week, and
therefore fill his car’s tank and all of his little red utility cans this
week. Note that it costs the prudent man something to do this. He pays for the
gas and the groceries with money he has now, giving up that opportunity to use
that money for something he would like to have now-he does so, even though he
knows that he will not use what he buys for weeks or even months, and may not
particularly like canned green beans or wieners. He is simply being prudent, not
● The owner of a business (or a government, or a
charity) may speculate that petroleum products he needs to run his machinery and
vehicles will become more expensive or difficult to obtain. Shutting down or
cutting back will probably not be an option. His product may be important or
even essential to the people he serves-the electric company, for example, or the
water works, or the companies which make or deliver food, gasoline, and
materials needed in the aftermath of a disaster. Shutting down means laying off
workers at one of the worst possible times. Shutting down may mean defaulting on
loans and mortgage payments and going out of business permanently-producing
nothing and employing no one ever again. Like the prudent average person, the
prudent business man will spend money now to provide for the future, even though
he has other uses for his money, or even though he may have to borrow that
money. He is simply being prudent, not immoral.
● The idea of buying a large lot of a commodity like
oil and taking delivery on it, now or in months yet to come, suggests someone
who is already in the oil business. Very few others are likely to have the
storage capacity and the ability to comply with safety and environmental
requirements. The utility companies might have such facilities, but they will
need the oil for their own purposes, and will not want to sell it, even at a
good profit, if they will have to turn around and buy it back at a higher price.
The oil company may purchase oil for storage because it is obligated
contractually or morally to furnish product to its wholesale and retail
affiliates-if Exxon, Shell, Sunoco, or other such companies failed to supply
their gas stations, the results could be catastrophic. The oil company buying
above current needs will have to spend money or make contracts now for future
returns. Again, it is being prudent, not immoral.
● Does buying now on the assumption that goods will
soon be more expensive or difficult to obtain contribute to the current rises in
price? Of course it does!-an imperceptible amount when the householder buys
batteries, beans, and a tank of gas-a barely measurable amount when Exxon and
its competitors fill up their huge tanks (we are talking about marginal
purchases not total consumption).
But all of these speculations-small, medium, and
large-contribute to the general well being in several ways. Perhaps most
importantly, they serve to guarantee that life will go on more or less as
normal: with enough to eat and a flashlight to see the food; without bankrupt
businesses, unemployed workers, and no goods on the shelves; and without the
nation running on “Empty.” This guarantee is bought with the carrying
charges actually or hypothetically required to finance these purchases.
If it is perceptible, the initial price rise will
discourage further immediate increases in demand, and the future demand will be
offset by the reserved goods as they are used up.
Free-market entrepreneurs know that they will do best in
an economy that is operating at full production-one in which all factors of
production are optimally utilized-land, labor, capital, and entrepreneurial
ability. Extreme conditions benefit no one in the long run. A rapid movement to
either high or low prices will destabilize the economy, putting people out of
work and destroying businesses. The only people who thrive on chaotic markets
are those who view martial law as an opportunity to show off their new uniforms
and boots, and those who make their living financing both sides of the wars they
expect the chaos to start. The widget maker selling at $4 might be happy to see
$5 or even $6, but would be terrified to wake up one morning to see in the paper
that it was $17. Such a rapid up-tick would probably signal a market collapse or
extreme government intervention.
In the spot and forward (not futures) market
examples we gave above, it is difficult to distinguish a profit motive from a
self protection motive. Even the householder might describe his actions as “profitable”
if they get him through a difficult time in relative comfort. Things are a
little different in the futures market.
● ● ●
The reader may have noticed that we kept
referring to goods that are “more expensive or difficult to obtain.”
Of concern to prudent householders and businessmen is the possibility that
government may intervene in the market with price regulations or rationing.
Price regulation will cause shortages by lowering supplier incentives to produce
and bring goods to market. Rationing may make required quantities of goods
unavailable at any price.
Recall the odd and even days for getting on
line to buy gas in 1973 under Richard Nixon, and in 1979 under Jimmy Carter. The
ration coupons (above) were printed but, thankfully, never issued.
Economic ignorance is bipartisan.
“As the average vehicle of the time consumed between 2-3
liters (about 0.5-0.8 gallons) of gasoline (petrol) an hour while idling, it was
estimated that Americans wasted up to 150,000 barrels (24,000 m³) of oil per
day idling their engines in the lines at gas stations.” (Wikipedia s.v.
“1979 Energy Crisis”)
● ● ●
Morality of the Futures Market
The “futures market” deals
exclusively with exchanges of goods that will take place are some specified date
in the future-no contracts are made for the immediate present (no “spot”
contracts), and contracts cannot be called ahead of time. The futures market is
primarily concerned with the management of risk to buyers and sellers, both of
which are called “hedgers”-the buyers being assured an adequately
low price, and the sellers being assured an adequately high price-both
sacrifice the possibility of great profit for adequate profit and low risk.
Futures contracts are set in standard terms specified by the exchange-things
like how many items per contract, their quality, place of delivery, last day to
complete the contract, and so forth.
It is important to note that while
there is the appearance of sellers selling to buyers, all contracts are between
the exchange and individual buyers or sellers, and may be extinguished by either
buyer or seller by obtaining an offsetting contract at the exchange. (If
I have a contract to buy 10,000 rutabagas, and I make a contract to sell
10,000 rutabagas, one contract offsets the other, and I have no contract any
more.) As the primary reason for the futures market is obtaining a predictable
price at the end of the period, most hedgers offset their contracts, and then
buy or sell on the spot market, rather than take or make delivery of the futures
All participants in a futures market must
cover their contracts with a percentage of the total value of the contact. This
performance bond, a demonstration of their ability to pay what is expected of
them, is called “margin.” As the value of a contract increases relative to
the market price, the difference is added to the margin account, or taken away
if the contract decreases in relative value. Margin accounts must always be
maintained above an amount set by the exchange, investors will be “called”
to add to their margin accounts if they fall below the specified values.
No participant in the market-hedger or
speculator-may make a contract farther from the market price than a daily limit
set by the exchange. Remember that the purpose of the exchange is to keep prices
relatively stable. For example, if a commodity future is trading around 20,
nobody will be able to make a contract on the exchange at 7 or at 38. This
allows the market several days to adjust to real changes in the availability of
goods, and keeps anyone from bidding the market very far above average prices.
Limits are also set on the quantity of commodity that any one hedger or
speculator may control-it is not possible to “corner the market.”
There may be brokerage and exchange fees
to contend with, government taxes on transactions in certain markets, and other
incidental expenses that must go into the process. The investors known as “speculators”
enter the market, not to hedge trades, but to profit on changes in market
● The speculator may offer a
contract to sell goods he does not yet own. If the price is down at the end of
the contract he offsets this contract with one bought at the lower price, and
receives a profit; if the price goes up he offsets with a more expensive
contract and looses the difference. If selling what one does not yet own seems
strange, consider that the farmer sells a contract for crops that he has not yet
grown-this is a futures market.
● The speculator may buy a
contract to acquire goods at a fixed price with the hope that the market price
will go up by the end of the contract, allowing him a profit. He loses the
difference if the market price goes down. Even during the period of the
contract, he will be “called” to pay additional margin if the price drops
and decreases his margin account below the exchange limit, probably causing him
to offset the contract immediately, losing the amount of the decrease.
● The speculators serve the useful
purpose of bringing liquidity to the market-In markets with few trades, a trade
or two can move the market price to the limit-the speculators add a few more
trades to the mix so that no one trade is overly significant.
● The speculators’ position is the
same as that of the hedgers, with a substantial possibility of loss as well as
gain. The losses of the speculators can be viewed as the way in which market
liquidity is financed.
An Example of a Hedger
All of this will make a little more sense
if we describe a typical hedger. He is someone with business to run and a
concern that the business will be hurt or fail if some necessary commodity
suddenly becomes too expensive. He might be concerned about the cost of some
necessary major material: wood, gold, plastic, cement. He may be concerned with
labor costs (not normally thought of as a “commodity,” but a contract with a
labor union to provide labor is similar to a forward commodity contract). He may
be concerned with the ability to exchange one currency for another, foreign or
domestic. He may be concerned with the cost of powering his business with water,
coal, electricity, or, in our case, petroleum. The operative idea is that the
hedger wants to make futures contracts with people for the things he needs but
believes to be risks beyond his control. He is willing to pay for such contracts
as the cost of doing business, and as insurance against damage or failure. He
takes most of the risks himself, letting contracts only on those things better
managed by other people. Again, in our case, the hedger is worried about the
availability of petroleum products, and their availability at a price that is no
more than his specified percentage above the current market price.
By way of illustration, our hedger
operates a widget factory. He employs a thousand workers who are happy with
their jobs. The factory requires three pallets of copper plated zirconium widget
blanks each day, which he is sure his brother-in-law will supply. The employees
are paid in Italian lire which he is sure will be available at or below the
current dollar exchange rate. Sales are in euros, which seem to be rising
relative to the dollar. Our man’s biggest concern is that the plant needs
five-hundred gallons of No. 2 diesel fuel each day, six days a week. His
operation will run and prosper at the $4.75 per gallon he is currently paying,
will have to lay off about half of his workers at $7.75, and will have to shut
down completely at $9.35. Market analysts predict prices around $6.50 or lower
for the next six months, but he doesn’t feel comfortable with their
predictions. What our hedger will do is buy futures contracts (perhaps several
contracts with staggered dates) for No. 2 diesel. In the six month window he
will probably get the ≤$6.50 price predicted, and when the contracts come
due, he may or may not wish to take delivery, but will be assured of having
adequate diesel fuel to run his business.
The businessmen producing oil products are
in much the same position as our widget manufacturer. They too are dependant on
regular shipments of oil or partially refined products from those who actually
produce these commodities.
The fellow who actually has the oil well
may have different but similar concerns. He is not so concerned with the demand
of the market for his product, but may be very worried about the value of the
currencies in which he is paid. He may be looking for a contract to guarantee
that his euros and dollars are actually worth something in gold a few months
down the road.
● ● ●
It is difficult to impossible to find
anything unjust in any of the examples we have examined. No one is expected to
participate without knowing the risks or the general expectations of the market.
Research is encouraged. No one is forced to do anything. What we do find is the
hope that life for everyone involved will go on pretty much as normal-that
employment will be stable, that businesses won’t fail, and investors will be
Even if nothing goes wrong-even if prices
remain stable and goods remain obtainable-the money spent to protect the home or
the enterprise was as moral as buying automobile insurance. The fellow who buys
the commodity outright gets some return for his money, for he will use what he
purchased eventually. The hedger who bought a futures contract bought peace of
mind if nothing else. The speculator pays a lot of the insurance premium on
stability. We all hate paying for insurance, but we hate it a lot more when we
have the “opportunity” to collect on a claim!
● ● ●
So What is Wrong With the Speculators
As the futures markets are traditionally
conducted, the speculator plays a useful role, as we have seen. But a few things
have taken place, changing the character of the market.
No longer completely self regulating, the
US futures exchanges are now regulated by the Commodity Futures Trading
Commission (CFTC), an agency of the federal government.
In addition to its role in debasing the
dollar and thus inflating the price of oil and everything else, the Federal
Reserve System (Fed) has been pursuing a policy of abnormally low interest rates
in order to make credit easily available. Doing so has lowered the rate of
return on the traditional stock and bond markets, prompting investors to seek
higher yields elsewhere. Large
banks and hedge funds have entered the futures market as speculators, and have
been give permission by the CFTC to hold oil contracts in numbers above the
normal market limits, in competition with the traditional large oil buyers like
airlines, shipping and delivery firms.
The futures market is intended to
stabilize prices to allow continuity of industry-exempting transportation
companies from the exchange limit makes sense, but introducing an enormous
volume of speculation beyond the usual limits does not. In view of their special
relationship with the Fed, there is also the question of the propriety of
exempting the large commercial and investment banks. And in light of the Bear
Stearns bailout, it is questionable that they should be given free rein in a
The CFTC has also lifted large contract
restrictions on those who trade in foreign markets, allowing additional
speculation on the lesser regulated and sometimes secretive exchanges of foreign
countries. The New York Mercantile Exchange (Nymex) is now doing business in
Dubai, where it will be under foreign regulation exclusively. The New York based
Intercontinental Exchange (ICE) does business in London, beyond US authority,
but with an information sharing agreement with the British government
Congress is considering a “slew” of
bills to limit speculation and to demand greater information from foreign
“In two days, the price of
oil rose $16,” said Sen. Richard Durbin, D-Ill., at a joint hearing of two
Senate panels on oil speculation Tuesday. “Did I miss something, was there
some war in the Middle East?”
In fact, the $16 rise came over two days,
with $11 being attributed to a “loose cannon” Israeli official, threatening
to obliterate Iran, the world’s fourth largest oil producer.
When one thinks of the way the Administration, Congress and the Fed mismanaged
the Great Depression, perhaps we ought to begin gathering firewood to run the
furnaces of family, industry, and society.
Hargreaves, CNNMoney.com , "Oil Prices: Wall Street's Game, May 16, 2008 http://money.cnn.com/2008/05/16/news/economy/oil_speculator/index.htm?postversion=2008051615
 David Cho,
Washington Post, "Investors' Growing Appetite for Oil Evades Market Limits:
Trading Loophole for Wall Street Speculators Is Driving Up Prices, Critics
Say" June 6, 2008 http://www.washingtonpost.com/wp-dyn/content/article/2008/06/05/AR2008060504322.html
 David Cho,
Washington Post, ibid.
Hargreaves, CNNMoney.com , "Congress takes aim at oil speculators. June 17,
Lindorff: "Oil, Israel, Iran, America and the High Cost of a Single
War-Like Remark" http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=389x3403819
and Reuters, June 10 2008 http://uk.reuters.com/article/stocksNews/idUKHOL02445120080610