Supply, demand, oil, and deregulation!

So Chris Byrne linked to a very interesting article from 60 Minutes on oil futures, speculation, and how they caused the price of oil to skyrocket even as the demand for it didn’t go up and the supply didn’t go down. Economics is a fascinating field to me, but only in spurts, so I know entirely too little about the subject. But it’s interesting that the system put in play to allow commodities traders to more easily exchange their goods is now being sucked into the theoretical trading market that’s been the source of most of our recent economic woes. It’s notable that the deregulation of the futures market that allowed for these sort of trades to happen came under the Clinton administration, just like the housing regulations that forced banks into making bad loans – oh, Bill, is there anything you can’t screw up?

The comments section of his site also highlighted a few good points. Mike suggests that the problem wasn’t so much that speculation occurred, as the article indicates, but that it increased suddenly and to a very large degree. Gun Blobber adds the timing of it coincided with the housing crisis, so the money had to be moved somewhere else. Additionally, it’s also escalated by the fact that there is something like 20 times more money invested into futures than the actual value of the underlying securities. Chris also wrote a very extensive post touching on this and other issues a few months back when discussing the problems with Wall Street. I said then and I’ll say it now, the more I realize how our market is propped up, the more I wonder how it’s lasted this long.

As I understand it, the root problem comes from how we have more money in the investment “pool” than we have stuff to actually invest in – or rather, stuff that is deemed worthy of investing in (startup companies may be considered too risky, etc). This causes more money to be bound to an item – like oil, or real estate, or whatever – than what it is actually valued at on the supply/demand scale, which artificially inflates prices. When things get bad for investors, or the value rises so artificially high that the market “crashes,” then that money has to shift somewhere else. That’s why we saw oil rise so high, and then suddenly fall when the money moved.

This sort of thing makes me agree with Chris that we’d be better off if we banned equities trading in, and securities based on, synthetic instruments, and made companies actually invest money into “real” things – or at least put regulations in place to strongly “encourage” this behavior. The massive amount of money floating around would become available to all the garage geniuses out there trying to start the next Google, or just your average joe wanting to start a bookstore down the street. By allowing small businesses to grow, we would help the economy to grow, which would give us yet more opportunities for investment. Of course, as Chris points out, this would kill off the big investment banks and brokerage houses, but they’re little more than bookies at this point anyway. They are, however, getting massive bailouts from the government for running a risky business that finally crashed on them, and that is A Bad Thing.

Take everything I’ve said with a grain of salt, as I’m certainly nothing remotely close to an expert here. I’d love to hear feedback on this issue.

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