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Who's to Blame for High Commodity Prices? It's the Producers, Stupid

Jan. 09, 2011 5:29 AM ETDBC, GSG31 Comments
Chris Cook profile picture
Chris Cook

For some time now the conventional wisdom has been that commodity market 'speculators' are to blame for current high prices across precious and base metals, in most energy markets, and, of course, in the sensitive agricultural commodity markets where high prices are, in many countries, a matter of life and death.

This has been propagated by lurid and ill-informed articles in the press - most notably 'Daily Mail' images of tankers full of oil moored off the UK coast. This greedy speculator myth has been taken up by politicians who have driven almost entirely useless action by US regulators in particular.

While the blame for high prices correlated across commodity markets is being firmly ascribed to greedy speculators intent on making transaction profits, I do not believe that they are to blame.

QE and the Zero Bound

The US government has reduced interest rates to zero, and for good reason as the credit markets collapsed. They have also been assiduously pouring in money in order to save the US financial system through Quantitative Easing (QE) and other monetary strategies.

QE is the creation of credit (eg dollars) by Central Banks, and in the US this means the Federal Reserve Bank. This was necessary to replace the money draining out of the financial system as legions of US borrowers were unable to perform in respect of the unsustainable loans they had taken on, and had QE not happened there would have been massive defaults, and a Depression.

But a side-effect has been a huge pool of dollars roaming the global financial economy looking for a safe home, and this has reduced short term dollar interest rates on US government debt to zero.

Anything but Dollars

Investors see the Fed flooding the US financial economy with freshly created dollars and they conclude

This article was written by

Chris Cook profile picture
Chris Cook's background is in UK market regulation, latterly as a Director of the International Petroleum Exchange. In recent years, he has been a strategic market consultant and commentator, and has also been actively developing new partnership-based legal and financial structures or "enterprise models". Since 2011 Chris has been a Senior Research Fellow at the Institute for Strategy, Resilience & Security at University College London.

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Comments (31)

This is a great analysis, but the conclusion that financial markets no longer work overlooks that there is no such thing as real money. If you cannot see that the pretend money, that can be lent at 0% interest is not at the root of the problem, you are all frighteningly stupid. Fiat money is death to all financial, economic and now you finally see even human life! Fiat currency is the root and sole and exclusive source and cause of all and every economic problem.
Chris Cook profile picture

Totally agree that fiat money is a key part of the problem.
"that the majority of the population has an excess of income available to save, when the truth is that a large and increasing proportion of the population is one paycheck away from insolvency."

This maybe true but only due to lack of fiscal discipline on their part. Most people, at least in the USA, who do not belong to the wealthy class, live beyond their means. A frugal person with a full time job can save money no matter what their income level. I personally know people who made very little in wages yet though controlling their spending and not giving in to every whim and desire have amassed savings that individuals who make 5 times as much would be jealous of.
The QE, low interest rates and overall policies of the government and central banks are destroying these types of people's future by creating this ugly scenario where there is real inflation (or fiat currency devaluation if you will).
I think there is a serious semantics issue. You say speculators aren't the problem, rather it's financialization of commodities and investors flowing in.
I say financialization of commodities has allowed investors to speculate in commodities.

Investors buy stocks of resource producing companies. They should not be allowed to buy the underlying commodities.
Chris Cook profile picture
@ TiPs

It does come down to definitions, I agree.

In my view a 'speculator' is motivated by transaction profit - ie the Greed is Good approach - and this may be achieved irrespective of which way markets are moving.

But many investors - particularly at the moment - are risk averse and motivated by Fear, not Greed. I don't see their motives - or actions - as 'speculative', but they ruin markets based on consumption and production just the same.

The jargon of 'Risk On' and 'Risk Off' investment addresses this same distinction in investor motivation.

Add the investors' herd instinct; the existence of massive funds; and ingenious and avaricious middlemen, and the outcome is the terminally dysfunctional markets we now see.
You are right to a certain extent, but the powers that be have otherr ideas as Henry Kissinger observed.
''If you control the food supply, you control a country, If you control the oil supply you control a continent, but if you control the Money Supply you control the world''
As for his fellow Jews' 'It wouldn't be U.S. concern if U.S.S.R sent Jews to gas chambers', Kissinger told Nixon --Former American president can also be heard making many disparaging comments about 'abrasive and obnoxious' Jews on the 1973 recording, including: 'I don't want any Jew at that [state] dinner who didn't support us in that campaign'. 12 Dec 2010 Former U.S. Secretary of State Henry Kissinger told President Richard Nixon that if the Soviet Union sent its Jews to the gas chambers, this would not be an American concern, the New York Times reported Saturday. The 1973 conversation, recorded on a newly released batch of White House tapes from the final months before Nixon's presidency became consumed by the Watergate affair, took place shortly after the U.S. president had met with Israeli Prime Minister Golda Meir. [A**wipe/war criminal Henry Kissinger actually won the Nobel Peace Prize. His resume reads like 'The Making of an Unsub.' --LRP]
The rich and power full Jews couldn't care less about the poor Jews.
True in any society..
Unless we take control of the issue of Money Supply (interest free) we will all remain ENSLAVED.
It has been done before, by Abraham Lincoln, and by the 1945 Labour Government to a certain extent.
In recent years, by one country, as I recall.
I might have played a insignificant part in it.
Margaret Thatcher would have taken the bold step too, when the IMF was menacing,but chickened out.
She was saved by a U$550 interest free loan.The Muslims do not charge interest.
Again I may have played a passive role, as I cannot work out for my invite to No 10 and the Lord Mayors banquet and serenaded to the top but one table.
I was so incensed when I found out the the secrete services have had to pry into my personal life, and once you are in their radar one is never out of it.
This is for my sins in the Anti Vietnam Anti Apartheid Anti Nazi non violent struggles.
Time wasters.
The present crisis is insurmountable, so each country will be forced to, by design and necessity to address it's own money supply independent of unelected un accountable stooges of American Plutocracy; the IMF and W.B
I am hoping UK may be the first European Nation (Old World) to do so.
I doubt whether both parties in the UK have the bottle to carry it out, but no other way out of the crisis.
I am rather surprised at the following comments by Chris
''Who gains from high prices? The answer is obvious: producers gain from high prices, and if there is one thing that the history of commodity markets tells us it is that producers can and will attempt to maintain prices at high levels wherever possible ---''.
It's well accepted fact and in practise, that producers always loose out as the cartels are not the innovation of producers.
So much so when Ghana, a coco producer of substance sued a dealer of systematic for mal practise, which deprived the producers, the British Government put pressure on Ghanaian Government to drop the case.
The independent milk producers in the UK are going bust as they haven't got muscle to take on the middleman and the buying power of the supermarkets
I will not comment on QE1,2, and possible three, except to say the US is bankrupt and any amount of helocpter Ben is not going to solve it.
According to Professor Laurence Kotlikoff's estimate, total US off-budget and on-budget debt comes in at more than $200 trillion. We'll leave you to do the math on everyone's share of that one.
I am sending it out to others too on my list they too will add their observations

dirtyharry profile picture
"The US government has reduced interest rates to zero, and for good reason as the credit markets collapsed. They have also been assiduously pouring in money in order to and other monetary strategies."

For good reason? It was Greenspan's rate reduction to 1% for an extended period of time that helped create the real estate asset bubble in the first place. The prices reached in the real estate save the US financial system through Quantitative Easing (QE)market never should have been so high, therefore there is no need to "reinflate" prices that should have remained lower in the first place.

A zero-interest rate policy discourages people from saving, which is what they should have been doing, while at the same time encouraging fiscal irresponsibility once again! I know everyone here who has a mortgage that they refinanced for under 5% is happy with that fact, but that's missing the macro picture.

You also mention they will "save the US financial system through Quantitative Easing (QE)". I'm sorry - creating inflation and leading up to the destruction of the U.S. dollar is NOT saving the financial system in my book. Perhaps our definition of "financial system" is different. If you meant the financial system as being the collection of banks that are receiving a de facto bailout through intentional asset inflation, then it's good for them. If you're talking about the financial system as the system in which Americans entrust their financial well-being, their wealth is being destroyed and quite intentionally so.

I don't like high prices as much as the next consumer, but blaming producers for something as simple as a supply and demand issue is baseless. If your only point is that speculators aren't at fault, I agree with that. You barely address the supply and demand issues, with natural gas as an exception. Even then, you mention that the natural gas market is not being "financially inflated" like other commodities due to it's large supply. Only in that moment are you actually addressing what's really happening. Supply and demand dictate prices, and also, the commodities markets are being "financially inflated." Financially inflated by WHOM? The producers? Of course not. They are being financially inflated by bad monetary policy which you referred to as "good reason" to counterbalance credit collapse.
Chris Cook profile picture
@ dirtyharry

Firstly, the QE acted to prevent the collapse of the banking system, and acted to prevent deflation and depression. You may be a liquidationist: I am not.

I agree that zero interest rates discourage saving, which is undesirable, but you assume - which is understandable from the point of view of an investor - that the majority of the population has an excess of income available to save, when the truth is that a large and increasing proportion of the population is one paycheck away from insolvency.

I have written extensively on supply and demand issues.

My view is that in a finite world, with a growing population, the medium and long term trend of commodities is upwards.

But I think that market prices will - at the zero bound - oscillate between an upper bound 'sellers' market' price, where demand destruction sets in, and a lower bound 'buyer's market' price where the lowest cost producer is the last man standing.

The commodity markets are being inflated by risk averse financial buyers awash with dollars.

I frankly don't see the problem as bad monetary policy - the Fed is, as I said above - as much use at the zero bound as a chocolate teapot: I see the problem as Bad Money - ie the deficit basis of the monetary system itself.
LKofEnglish profile picture
define "future consumption." it's an interesting concept "to the ETF that owns the good." i define it as "now you pay...and ideally more." how about you? the fact is "we're not talking dollars" which if we are to believe The Bernank (and in this case i most definitely do) we have in fact "a shortage of dollars." What we don't have of course "is a shortage of all those other worthless dollars" which are "flooding into ETF's in order to control every commodity on earth" when "not bailing out everybody but especially their brother." These ETF's are a very effective tool i might add--although i doubt "Seeking Alpha Certified" since "being long markets is considered so impoverishing for said individuals." And hence "the hilarious sanity of advocating the US default." Only a true lunatic sees "exporting all we have" as "the way to reduce the budget deficit." Indeed "doesn't that in fact make it impossible to pay said debt and deficit"? But, hey--"thank God Wall Street has finally arrived in the White House to save the day." Perhaps our morphing into a nation of Irwin Fletchers really was pre-ordained? Could be worse....we could have been forced to morph into a nation of Lindsay Lohans.
flash9 profile picture
We have found the enemy and it is us'
Ben Gee profile picture
If you befriend your enemy, he may become your friend, that include ourselves.
jlmanfred profile picture
Thanks for a well thought out article. I tend to agree with Albertarocks and am also an optimist. The problem as I see it is structural on a global basis and therefore the solution with be global in nature. Growth and productivity has shifted, not surprisingly, to China, India, Chile, Brazil, and even hints of same in Russia. The U.S. unfortunately, although not necessarily, will have a declining standard of living due to lack of good leadership and policies. The U.S. is at a critical inflection point. There are ways to correct the U.S. situation, so in this sense I am optimistic that salvageable strategies are available. My basic very optimistic outlook is at the global level.
Chris Cook profile picture
@ jlmanfred

"My basic very optimistic outlook is at the global level."

I am a great admirer of the US, and believe that your sheer scale of human and natural resources is crucial.

Once the US realises that it is necessary to collaborate with other nations - particularly China, who are in the same boat as far as natural resources go - rather than to compete with them, then everything else will follow.
You either compete or die.
Ben Gee profile picture
But the US does not know how to compromise. For over 100 years, the US dictated all the terms, it is incapable on bending a little in order to compromise. In Asia, there is a saying: A great man is one capable of extending or bending.
john s. gordon profile picture
as we learned in 2008-early 2009, the 'greedy speculator myth' is more than just a myth.
> jack
Chris Cook profile picture
@John S Gordon

'Greedy' speculators exist all right, and are responsible for short term volatility and spikes.

But my point is that since speculators are neither consumers nor producers they can have no effect on physical market prices in the medium and long term, and the myth/meme I am debunking is that it is greedy speculators who are responsible for correlated cross-commodity high prices.

For speculators, the market is a less than zero-sum game. Only the casino operators consistently make money.
Roy Mark profile picture
Greedy-Speculators is a term that can get your blood boiling, but what exactly is a greedy speculator. First we know that a speculator, in the business sense is a futures market participant who attempts to gain from anticipating changes in prices of commodities or financial instruments. Speculators aim primarily at quick profit from a short-term acquisition of assets. A “greedy” speculator would presumably be a speculator with a desire to acquire more material wealth than they need or deserve.

Are we to restrict speculators to only the material wealth they need? That sounds very communistic to me. Are we to restrict them to only that material wealth they deserve, and just who will make that decision and how? Are speculators less deserving of material wealth than say directors of public corporations or for that matter Air Force officers or oil refinery workers?

My bone is not with the thesis that speculators influence commodity prices and may even be responsible for a bubble but rather with the use of the term “greedy”. There are few among us that would not like to accumulate a little more wealth during our working lives; wealth that can be used to insure the happiness of our families during retirement. Should we then refer to our mail carrier as the “greedy mail man”; to the “greedy secretary” and the “greedy farmer”? I think not!
Gosh, Oh My! profile picture
Please, the problem is much easier then your long winded ideas.

Supply and Demand!

Just look at the World's Population that is expected to be as much as
9 Billion by 2020.

Sure this economic situation exacerbates things now but heed the Future!
Chris Cook profile picture
@ Steve Soden

Thank you for your courteous response.

The only way in which the challenges of population growth can be addressed is through reconfiguring markets and economics.
Gosh, Oh My! profile picture
I'm glad to hear you suggest there's a way out for our future relatives.
Ben Gee profile picture
Supply and demand: If you are poor, have no money to buy food, does that mean you have no demand for food? This was the trouble during the depression, people were starving, because they had no jobs and no money, they had no demand for food. Farmers did not grow for food, because there were no demand.
China replaced balanced supply and demand with unbalanced supply and demand. If you increase demand, supply will follow. You can also increase demand by reducing the prices.
Albertarocks profile picture
"Within two to five years, I think the global market architecture and economy will look very different, and very positively so."

Thanks for the response Chris. I also believe that in a few years the global market architecture and economies will look very different. I'm not so sure it will be positively though, since the potential exists for the implementation of a one world currency as a "solution to the disaster". That would be nothing less that the horrendous NWO dream having become a reality. I pray that isn't the outcome. In that regard I'd rather consider myself a realist than a pessimist. I believe a one world currency "could" happen and that we will face pressures to accept it. But I'm not necessarily pessimistic in that I'm not automatically assuming it would happen.

I like your vision better but even if you're right, and we do indeed emerge on the other side very differently, but positively so, I still loathe the happenings that I see occurring between now and then. The world is in for some very, very hard times... of that I have no doubt. I believe the deflationary scenario could unfold and if it does, I see it lasting for as long as it takes for the European debt crisis to run it's course. I'm not talking about raising the limits on sovereign credit cards as just happened with Ireland, but a "true" resolution which I think pretty much has to be defaults and a severe deflationary phase. Only after that great reckoning has run it's course do I see the American dollar resuming it's course toward its ultimate demise.

What the world will look like once deflation has run its course (if we even get a deflationary phase) could be very, very ugly or it could be something beautiful. Whatever it is, I'm sure we're at an inflection point and have 2-4 years of tough times ahead.

"about as useful as a chocolate teapot"... lol

If you don't mind, I'm going to use that one. All the best. I hope 2011 is the best year for you... ever.
My first thought was that I do not see how the USA would adopt a one world currency where the US Constitution put the power of creating money into the hands of the Congress. Of course that is the argument made by the people who want to eliminate Federal Reserve (Fed is unconstitutional).
Yet somehow, the Fed exists because Congress passed a law giving them the power, so would giving this power to a different international entity be any different? Probably not. It is a sad but a true fact that politicians will pass laws without any regard to their constitutionality. It is also sad but true that many of these kinds of laws have been challenged in the Supreme Court and survived.
Chris Cook profile picture
@ Albertarocks

Thanks for your appreciation, and particularly for your thoughtful response.

I think that the post property bubble problem faced by the US and UK in particular with Ireland and Spain not too dissimilar, is of systemic wealth imbalance with the majority of the population in debt to a small minority which owns substantially all of the unmortgaged wealth.

This is not new: it's happened for thousands of years as a result of the combination of compounding debt and private property in land.

The outcome is that there is no mechanism - whether through increased earned income, or sufficient credit - whereby the purchasing power which might lead to hyper-inflation could reach consumers who are for the most part, illiquid, insolvent or both.

You are quite right about the Fed which is - at the zero bound - about as much use as a chocolate teapot, as we say in the UK.

In terms of Economics, I think that the monetary assumptions of Chartalists and MMT'ers (and I am neither) reflect reality better than those of Keynesians and any other school of Monetarist. But frankly, that doesn't matter a damn since there is no more chance of Chartalist/MMT policies being adopted than there is of Austrian policies going mainstream.

I take a more radical view, believing as I do that the effects of the direct instantaneous connections enabled by the Internet will transform (indeed are already transforming) economic interactions in ways most of us will find difficult to understand.

Within two to five years, I think the global market architecture and economy will look very different, and very positively so.

But then as an optimist, I only ever get unpleasant surprises.... :-)
Albertarocks profile picture
Chris, this is a very interesting article and touches upon a point I've been pondering for a couple of months now.

First of all, if Mish Shedlock, whom I respect, and Peter Schiff, whom I also respect a great deal, are at opposite ends of the spectrum when it comes to defining which path the world will be taking (the deflationary or the inflationary), then I'm certainly not going to declare that I know either.

Having said that, in spite of the incredible amounts of money printing by the Fed (mainly for the purpose of propping up the bond markets and thereby holding interest rates artificially low), I still see very serious reasons why the dollar should surge in the coming weeks and months... but probably not years. Ok, perhaps even as long as two years or however long it takes for the European credit problems to be properly dealt with. And by "properly dealt with", I don't mean raising the limit on their sovereign credit cards. The fact that we're seeing bond markets drop ever since QE2 was announced is showing that the Ben Bernank's great plan has blown up in his face. Obviously, the Fed isn't the 'only' player in the bond market. In fact, they shouldn't be a player at all, but they've opted to monetize the debt... something that politicians and Fed leaders have always vowed they would never do. Liars they are! (I just had to throw that in... couldn't help myself)

But very little, if any, of the vast pools of newly printed money have been loaned out into the global economies. They can't afford to loan it out apparently, because if rates rise... the game is over anyway. That money is earmarked for treasuries and that's all there is to it, it seems. So we aren't seeing inflation truly occurring, at least not to the extent we'd normally be seeing when money is printed out of thin air like this. Via the magic of the fractured reserve banking system, normally that money would expand exponentially... to at least 10x if not 100 times the amount of the original issuances. 95% of all money on the face of the planet was "loaned into existence". But at the present time we aren't seeing any more money being "loaned into existence" and in fact, the past 3 decades worth of "loaning money into existence" have finally reached a level where the piper is now apparently demanding payment. It appears the party just might be over.

When the European sovereign debt issues once again rise to the surface, the deflationary forces will likely re-emerge as the headline grabbers. And I expect to hear a lot more about that as early as this week probably, now that the Santa rally myth and the January effect myth (illusion) have been taken care of. I think the deflationary forces could cause a massive rush back into the USD and back into bonds (US bonds, and very few others).

I think what's been happening with commodities is that although a ton of money has been pushed into the bond markets since QE began, it's also obviously been surging into equities and commodities, creating some of the finest bubbles we've seen since the tech days. But it's phony as a $3 bill. In my view, some of the big players are realizing the equities markets are flat out dangerous, and perceiving future inflation "must be?" the outcome (rightly or wrongly) are simply searching for anything that will rise in value. As you said, "anything but the dollar". So by the shear weight of their own numbers, they have pumped up many commodity markets beyond what is justified.... more bubbles in most cases but probably not all. Food commodities for example, are legitimately higher due to supply disruptions. Even coal will likely explode in value do to the disaster in Australia where their coal delivery infrastructure is severely damaged and can't be repaired 'quickly'.

But I'm quite confident that a surging dollar brought on by the incredibly powerful deflationary forces that I think are just around the corner should put an end to most of this bubble blowing. And I don't think the Fed can do a heck of a lot about it. The Bernank keeps insisting that he wants to see some inflation. Well if the soaring prices of commodities aren't enough to convince him that we "are seeing inflation"... then what exactly is he looking for? I believe he's not even considering commodities because he realizes that it's not an inflation caused by any healthy form of demand but just a bubble... one that isn't likely to last long. I actually believe that the inflation in the commodities markets is one he wasn't expecting. And it's certainly not the category he wanted to see inflating if he truly wants the economy to get going. No... he wanted equities to explode in value with total confidence that the sheep would once again begin to feel wealthy and would thereafter spend us out of trouble. In any event, it's not inflation he's worried about anyway... it's the ultra-uncontrollable deflation monster that scares the ever living hell out of him. You know central bankers... they love to control everything. And deflation is one thing they 'can't' control. I think he knows he's about to lose that battle. We all are!

I think the days of "anything but dollars" as you so aptly put it are about to come to a screaming halt. As John Mauldin said, 'the American dollar is the worst currency in the world, except for all the others". So I'm in Mish's camp I guess... I believe the dollar is about to become king in an ugly deflationary spiral where the mantra will be "nothing but dollars"... probably with the addition of some commodities like foods, but not likely energy commods when the demand might be on the verge of drying up big time. Only after the deflationary phaze has run its course can the US dollar resume it's ultimate path... a permanent retirement on the sunny beaches of Zimbabwe.

Thanks for a great article. I apologize for such a long winded comment, but this is a topic of extreme importance I think. I particularly enjoy articles that not only make sense because they're logical and in enough detail to make it easy to follow the premise, but just flat out well written. Well done!
Chris Cook profile picture

I realise I have not addressed the 'surging dollar' point you raise.

It seems to me that if the - dollar denominated - commodity markets DO collapse then the investors may indeed fly to T-Bill safety, but that would not affect the exchange rate.

I confess my crystal ball is clouded by the $ carry trade and my view that the crucial, but inscrutable, Chinese economy is totally unpredictable because they do not play by our rules.

I do believe, however, that the EU is much more solid than many observers believe, although with an overlay of a currency unsustainable in its current form. Similarly, Japan is a very long way from the economic basket case widely portrayed.
Michael Corley profile picture
I'm glad someone else see's the issue.

I realize it is sort of completely against your point, so I should probably disclaim this with that fact that I believe there is a great deal of money to be made in gap's between efficient and inefficient markets, (if you can understand them).

I maintain that there is always money to be made, not from speculation, but from speculators. So onto the point: how do we make money off of this entire ordeal?

Do you have any possible outcomes and probabilities? Thoughts?
Chris Cook profile picture
@ Michael

Thanks for the response.

I think that there is money is to be made from a having a better understanding of market drivers than others have - assuming that one's assumptions are correct of course. But it's a risky business taking a contrarian view, since as the guy said, markets can stay irrational for longer than we can stay solvent.....

I think that the potential is there for a collapse of markets as happened after the oil spike in 2008. IMHO no spike from these levels is sustainable, since consumers will simply cut buying and in the oil markets at least there is relatively little storeage as a 'cushion'.

But that does not mean that there won't be a spike, just that if there is, there'll be a crash to follow.

It might be an interesting strategy to put on a few waaay out of the money options both above and below the current market prices, but more below than above.
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