Category Archives: Macro Economics

Govt. Legislation in Free Markets

By David Goldman,
staff writer

NEW YORK ( — Some of the Democratic lawmakers leading the campaign to crack down on oil traders appeared Wednesday
before the House Committee on Agriculture to explain their proposals.

A dozen or so bills have been introduced on the subject of oil speculators,
and Democratic leaders in the House have promised to address the issue by
tackling what they call “excessive” speculation.

But some Congressmen are skeptical that the legislation will do any good –
and could even cost consumers more by driving up the price of other commodities
such as corn and soybeans.

“Given that charges against speculators have historically been more wrong
than right, it is important that we have the facts, data and analysis that
demonstrate the validity of this contention before we take action,” said
committee chairman Collin Peterson, D-Minn. “Any legislative remedy that seeks
to remove speculative interests from futures markets could result in more
volatile markets, as the role of speculators has always been vital for price
discovery and liquidity.”

The slew of speculation-tackling bills that have not yet faced a vote address
a variety of issues.

Some have bipartisan support, such as one increasing the Commodity Futures
Trading Commission’s (CFTC) budget, and some are more contentious, such as
limiting over-the-counter trades to producers and boosting traders’ margin

If applied to all commodity traders, some lawmakers say the propositions may
have unintended consequences on other markets.

“Increasing margin requirements, for example, would be very problematic, as
volatility in the futures prices of the grains … has already made it tough for
elevators in farm country to meet margin calls,” Peterson said. “Such
instability can have serious effects on the prices we pay at the

Legislation necessary to combat high oil prices

But other lawmakers are convinced that curbing excessive speculation by
expanding the role of CFTC will help reduce oil and fuel prices for

“While some have advocated for doing nothing and others believe that we
should simply bar index investors and others from the energy commodity markets
altogether, I believe what we really need is a level playing field that is
transparent and accountable,” said Rep. Jim Matheson, D-Utah. “Our goal should
be to make sure that the regulator – the CFTC – has the ability to ensure undue
manipulation isn’t taking place in the markets.”

Though many lawmakers are still unconvinced that speculation plays a role in
higher gas prices due to a lack of concrete evidence, other Congressmen say the
circumstantial evidence is enough reason to act.

“In light of the dramatically increased speculative inflows into the energy
futures markets … coinciding with a staggering 1,000% jump in the price of a
barrel of oil, I believe the burden is on those who would argue for maintaining
the status quo,” said Rep. Chris Van Hollen, D-Md.

“Proponents of maintaining current law must definitively demonstrate that the
exceptions we have thus far permitted to persist in the Commodities Exchange Act
do in fact support the primary functions of price discovery and offsetting price
risk necessary for a healthy energy futures marketplace,” Van Hollen added.

Speculation debate continues

Since 2003, the volume of investment funds in commodity markets – especially
oil – has risen from about $15 billion to $260 billion, according to the
International Energy Agency (IEA), an influential oil-policy group.

But the IEA released a report last week arguing that the increase in
oil-market speculation is not driving up crude prices.

“There is little evidence that large investment flows into the futures market
are causing an imbalance between supply and demand, and are therefore
contributing to high oil prices,” the report said.

But the study far from ends the debate.

“A growing chorus of congressional testimony and market commentary from a
wide range of credible and authoritative sources has concluded that the run-up
in today’s price of oil cannot be explained by the forces of supply and demand
alone,” said Van Hollen.

Even analysts who concede that the laws of supply and demand are the main
contributors to record oil prices say that speculation can make price swings
more volatile.

The House Agriculture panel has planned hearings Thursday and Friday to
further discuss the issue of amending the Commodity Exchange Act. To top of page

Commodity Index Funds & Investment Banks

This is from John Mauldin at http://www.frontlinethoughts.comI think he does a wonderful job of explaining how the Commodity Index Funds stay off of the CFTC’s radar in their weekly Commitment of Traders reports.

Swapping out Commodities

The Commodity Futures Trading Commission announced yesterday that they are
looking very hard at possibly closing a regulatory loophole that allowed some
extremely large commodity index funds to get around position limits. For those
not familiar with the concept of limits, it basically works like this. No trader
or fund is allowed to own more than a specific amount of a commodity traded on
the futures exchange. This limit varies from commodity to commodity and exchange
to exchange. The point is to keep one group from manipulating the price of a
commodity, as the Hunts did with silver in the early 80s.

The loophole is one where large investment banks can sell a “swap” for a
specific commodity like corn and then hedge their position in the futures
markets. There is no limit on the amount of the commodity that can be hedged.
So, a fund can accumulate sizeable positions far in excess of what they could do
directly by working with an investment bank. In essence, the swap is a
derivative issued by a bank which acts just like a futures trade, but it is with
the bank as guarantor and not an exchange. Swaps are not regulated as such. And
up until now, the banks were seen as legitimate hedgers so there were no limits
on what they could buy in the futures markets.

This works for very large commodity index funds which try to mirror a
particular commodity index and need to be able to buy very large positions in
excess of the normal limits (and there are scores of them), and for the banks
that make the commissions and profits on the swaps. Remember, the fund gets a
management fee, so growing the size of the fund grows their fees.

These indexes typically have about 26 commodities, with the largest
allocation to oil, but almost anything that is traded has some small portion of
the allocation. As I noted last week, there are some who believe this is working
to drive up the price of commodities beyond the simply supply and demand
principles. Whether or not you believe this to be the case, the CFTC is looking
at the loophole.

The key word in the announcement yesterday was the word “classification.” Their classification can be tracked in the Commitment of Traders Report classified as hedgers and as such have no limits. But
they are not rea lly hedging the actual physical commodity as a farmer or
General Mills might do, but the hedge is their financial position.