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In a June 27, 2008 OpEd Paul Krugman wrote an article arguing that speculation in oil markets was not driving the huge price spike.  He accused congress of only listening to "experts" that said what they wanted to hear and argued that supply and demand where the true drivers of the spike.

Tonight's 60 Minutes piece on oil speculation presents a pretty compelling case that Wall Street speculation was indeed the main driver of the ridiculous $150/barrel prices we saw last summer.  It doesn't take a Nobel price winning economist to realize that there's no way the price roller coaster of the past year had anything to do with supply and demand.  Is Krugman going to argue that there's 2/3 less oil demand than there was 6 months ago and that the precipitous drop in demand started happening exactly at the same time that the Wall Street banks collapsed?

It's pretty obvious that Krugman was wrong.  Krugman's opinions are currently taken as gospel by many of us on the left.  This is a note of caution.

Originally posted to permanentE on Sun Jan 11, 2009 at 09:25 PM PST.

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Comment Preferences

  •  tell him yourself (7+ / 0-)

    krugman@nytimes.com

    tell us the response you get.

    in any case, the CNN's documentary against government spending was compelling as well. i'll withold judgment until i see it. but as far as the stimulus package goes, i dont disagree with krugman, and i'm a conservative

  •  Didn't watch the show, but will.... (2+ / 0-)
    Recommended by:
    Tonedevil, happymisanthropy

    And I agree, Krugman, whom I generally respect can, in fact, be wrong.  

    About a year ago after there were some tremblers in the market that subsided, he wrote that it's a shame that the solution worked, since it masked the endemic problems that will persist.

    Now he is advocating extensive stimuluses (stimuli?) yet he is ignoring the possibility that the cure may be worse than the disease.

    And the term "Moral Hazard" is used only to dismiss it as not being important during a crisis.  But, of course, during radical prosperity such as we had prior to the collapse, talking about "moral hazard," could end the good times.

    So there is never the right time to talk about the interplay between economic policy and the values of the people that are the basis of accepting any economic scheme.

    I was lucky enough to get a letter in the times that clarified and criticized the mega OpEd of two Sundays ago by Lewis and Einhorn.  While the anger was edited out, they preserved this last sentence:

    "Moral hazard" is not an empty phrase. Its avoidance preserves the values of fairness that a government and economic system rest upon. What we really need is a serious discussion of housing policy, now and in the future.

    It was based on a diaryI wrote here.

  •  Maybe I'm nuts (6+ / 0-)

    but this doesn't seem implausible:

    there's 2/3 less oil demand than there was 6 months ago and that the precipitous drop in demand started happening exactly at the same time that the Wall Street banks collapsed?

    no one has been buying houses since then either.  

  •  Krugman argues that oil speculation can (12+ / 0-)

    sometimes be a factor in markets but that there wasn't an empirical reason in this situation to suggest that speculation (the buying of a futures contract) was necessarily the cause in this case. Looking at the spot and futures prices at the EIA, I'd have to agree, since the futures price (speculation) was at or below the spot price through a great deal of last year. If you put this together with what has been happening in other commodity  markets - copper, iron ore etc then you can see the truth of this across the table in commodities markets. So I would say that the speculators thought that prices were going to stay where they were or fall a little bit.  

    As for your argument that the fall in demand in oil hasn't matched the 2/3rds fall in the oil price, as we all know from Greenspan, markets suffer from 'irrational exuberance' not just on the up side but the down side. Equilibrium in real markets is dynamic not static and sometimes disequilibria do occur as a result of all sorts of factors, including expectations. My read of the similar price falls suffered by other commodities and the price falls we've seen in lots of markets, including the housing market, shows me that Krugman is probably right.

  •  It coould be people (1+ / 0-)
    Recommended by:
    neroden

    are getting laid off so less gas to go to work and less places opened up. People taking less trips and being more energy wise to save money.

    There were some hedge funds that were making money off of oil and they may have stopped that.

    •  gassoline demand only dropped 5% (2+ / 0-)
      Recommended by:
      samddobermann, DrFitz

      oil prices dropped 70%

      •  OVERSHOOT. (2+ / 0-)
        Recommended by:
        chrismorgan, Ashaman

        Prices overshoot on the upside and the downside.  Yes, this is due to speculation.  This is an unavoidable part of having markets where it is possible to store oil.  If people think the price will go up, they stockpile, so the price goes up more.  If they think the price will go down, they wait to buy later, so the price goes down more.

        The current drop is due to expectations of global economic collapse reducing demand.  The previous rise was due to expectations of peak oil constricting cheap supply.  The standard effects caused it to overshoot by a lot.

        It's unavoidable and not even bad.  It's not like the sort of speculation where someone tries to corner or manipulate the market (Hunt Brothers, Enron, etc.)  The "speculation" was mainly on the part of businesses which sell and businesses which buy oil -- everyone was just making the same guess, following a herd mentality.

        -5.63, -8.10. Learn about Duverger's Law.

        by neroden on Sun Jan 11, 2009 at 10:56:43 PM PST

        [ Parent ]

      •  Also, prices don't track demand like that (4+ / 0-)
        Recommended by:
        tameszu, relentless, Ashaman, thethinveil

        Prices are based on the cost of the "marginal barrel".  We're at the point where there's a certain amount of cheap oil (per day), and then the next barrel is very expensive-to-produce oil.  Demand crossing that threshhold should, and does, cause a massive shift in the oil price.

        -5.63, -8.10. Learn about Duverger's Law.

        by neroden on Sun Jan 11, 2009 at 10:58:13 PM PST

        [ Parent ]

        •  From the 60 minutes piece: (5+ / 0-)

          "Approximately 60 to 70 percent of the oil contracts in the futures markets are now held by speculative entities. Not by companies that need oil, not by the airlines, not by the oil companies. But by investors that are looking to make money from their speculative positions,"

          These markets need to be regulated because these speculators can drive the price up to the point were it hurts the economy while providing zero benefits in "efficiency", "innovation" or any of the other crap Wall Street likes to point to.  The piece mentions how when Enron got a hold of the deregulated electricity market they were able to increase prices by 300%.

  •  Oil is vulnerable to volitility (0+ / 0-)

    If oil is so easy for speculators to make billions manipulating the oil market, why did they stop manipulating the market? Are they less greedy now than before? Did the Bush administration have a secret crack down?

    By the way, how come Exxon, Chevron, BP, Shell are no longer greedy - why don't they use their power over the market to drive gas prices back to $4.50/ gallon?

    The most important way to protect the environment is not to have more than one child.

    by nextstep on Sun Jan 11, 2009 at 10:29:36 PM PST

    •  margin calls (5+ / 0-)

      When Lehman and AIG collapsed the margin calls forced hedge funds and investment houses out of the market.  $70 billion left the commodity futures market after July.

      •  The rapid decline in oil preceeded their fall. (0+ / 0-)

        Lehman and AIG Fall - Sept 15

        WTIC Oil on July 14 - $147 - the peak price
        WTIC Oil on Sept 15 -  $96

        The big move down in oil prices had already started two months before Lehman and AIG fell.

        Also consider how with oil sales at about 85 million barrels/day - when the average price of oil was $120 the daily sales volume is about $10.2 billion/day.

        Do you really think that a commodity futures position of $70 Billion by speculators - one week's sales can control the market?

        Also, the way commodity futures works - for every contract that is long oil (betting the price of oil goes up) there is always an equal position that is short oil (betting the price of oil goes down).

        Extensive margin calls on AIG and Lehman at hedge funds is doubtful as most hedge funds were very negative on financials - so an explanation that hedge funds were aggressively long on AIG and Lehman does not make sense.

        The most important way to protect the environment is not to have more than one child.

        by nextstep on Mon Jan 12, 2009 at 09:42:51 AM PST

        [ Parent ]

  •  Partly right/Example of need for change (4+ / 0-)

    First, I'm not an insider or expert; I just read stuff. I could be wrong.

    Second: in my opinion genuine supply and demand issues have been at least partly responsible, and should be responsible, for driving prices up.

    The recession may put off peak oil, but it still seems as if peak oil has either arrived or is not that far away.

    The mathematically complicated problems in the credit default swaps market and other derivatives markets are forcing speculators to sell all sorts of good investments to cope with bets that gone wrong. The speculators have to come up with hundreds of billions of dollars in cash all at once. That's hard. They are, essentially, looking under the sofa cushions of the world for every last penny.

    The fake derivatives-fueled boom may have played a role in increasing oil prices and other commodity prices above their true, supply-and-demand-based level this summer, but now the bust is driving prices below the true suply-and-demand based level. Oil probably shouldn't have been selling for more than $150 per gallon this summer, but, even with a recession, it shouldn't be selling for less than $50 per gallon today.

    Third: the real moral of all of this isn't that Krugman was wrong. The real moral is that regulation over and disclosure in the credit default swaps market and similar markets has been so poor that even someone like Paul Krugman has had a hard time gauging its effect on the economy. He couldn't really know what credit default swaps were doing to the prices of just about everything because, apparently, very few people really knew.

    I think that, even now, Republicans can make reasonable arguments about just how much authority government agencies, etc. should have to control investments, securities, etc. But I think any argument for exempting anyone from tough disclosure rules is clearly bogus.

    Hedge funds should have to report on what they're doing a whole lot more.

    Investment advisors should have to do more reporting.

    People involved in the credit default swaps, etc. should have to do a whole lot more reporting.

    In the past few years, a lot of growth has come in types of investments aimed at rich, sophisticated investors who supposedly don't need ordinary public reporting. But we see, from the Madoff scandal as well as the current crisis, that this theory is a bunch of BS. Rich people can be as dorky and ignorant as any other investor. The whole idea of letting companies use freedom from disclosure rules as a competitive advantage is absurd.

  •  According to a Rec Diary, the Dems (7+ / 0-)

    brought down the price of gas by closing the oil speculation loophole.That diary convinced me that the speculation was the key.

    Children in the U.S... detained [against] intl. & domestic standards." --Amnesty Internati

    by doinaheckuvanutjob on Sun Jan 11, 2009 at 10:31:52 PM PST

  •  Oil Speculation v Supply/Demand (2+ / 0-)
    Recommended by:
    tameszu, happymisanthropy

    our oil markets are opaque and volatile.  World politics can move the price dramatically.  That is speculation but it is part of the market.  Supply is controlled by a cartel/monopoly.  Demand is being destroyed by a world wide recession as well as extremely high prices.  Krugman is not a fortune teller he is an economist who looks at trends and past information to try and read the tea leaves and see where things are going.  No one is perfect, no one can get it right all the time.  Just because he made statements that turn out to be on the face wrong doesn't mean he was completely wrong based on the information he had available at the time.

    Remember hind sight is 20/20, fore sight is not.  I am not saying to give Krugman a break but again no one is perfect and he gets a lot of things right.

    Globalization is great, as long as you can afford it!!

    by padeius on Sun Jan 11, 2009 at 11:02:40 PM PST

    •  It doesn't have to be this way. (3+ / 0-)
      Recommended by:
      samddobermann, ThatBritGuy, padeius

      Yes, the oil markets are complicated but there's no need to think that they are so mysterious and magical that they can't be regulated.  The current laws, passed for Enron back in 2000, allow Oil Swaps and other complicated derivatives as well as trading on "private" exchanges.  These are used to allow investors to speculate in these markets without having to take possession of the oil and to avoid oversight.

      These are relatively new "inventions" by Wall Street, it doesn't have to be this way.  The previous regulations should be reinstated.

      As for Krugman, I respect him and I don't have any pretension that I know even a thousandth of what he knows about economics.  I'm just pointing out that it's pretty obvious that he was wrong.  It happens.  I'm not accusing him of anything or making any judgments, just pointing it out.

      •  I totally agree (2+ / 0-)
        Recommended by:
        permanentE, samddobermann

        markets can be complicated but seem to be because of the structural regulations that have been removed or replaced.  The old regulations that were removed did create some of the opaqueness to which I was referring.  I do not think we should just reinstate the old regulations but look at the market and find new and innovative ways to regulate the markets to create transparency.

        I also agree that all pundits should be viewed with a certain amount of skepticism.  Just because someone writes about it doesn't make it true.  Thanks for pointing out the fallibility of each of us.  We sometimes forget that no one is perfect and opinions can be wrong.

        Globalization is great, as long as you can afford it!!

        by padeius on Mon Jan 12, 2009 at 06:04:06 AM PST

        [ Parent ]

  •  It's normal market forces (1+ / 0-)
    Recommended by:
    samddobermann

    It was a commodity bubble. I think Krugman was talking to the idea of manipulation.

    You are right to not take his word as gospel. Economists are notoriously campish, and easily blinded by ideology.

    You should see some of the Libertarian sites such as Mises Institute right now; they don't know which way to run.

    We said we want change, and they gave us a handful.

    by MouseOfSuburbia on Sun Jan 11, 2009 at 11:37:40 PM PST

  •  Hey! Where does this come from? (1+ / 0-)
    Recommended by:
    permanentE

    "Is Krugman going to argue that there's 2/3 less oil demand than there was 6 months ago and that the precipitous drop in demand started happening exactly at the same time that the Wall Street banks collapsed?"

    That statement implies a coefficient of elasticity in the oil markets which is linear and has a value of approximately unity, (1.0).

    The oil market is actually quite inelastic, because there are no substitutes for oil most of the oil that can be utilized within a reasonable time frame within today's global world oil market. A (hypothetically) high inelasticity in the world oil market could see an increase in price by a factor of ten due to an increase in demand of just one percent, once that extra demand is not met by suppliers within the time it takes for the quantities stored in the shipping pipelines are depleted. Vice versa an unmatched decrease in demand by 1% could cause a tenfold decrease in price, under the same conditions.

    Now oil is not THAT inelastic, such that a wild swing of ten-fold in price either way would happen due to just a one percent unmatched change in demand. But the approximately five percent decrease in demand which did happen over the past half year does seem to be a reasonable explanation for the factor of three drop in price over the last few months. Contracts to buy new oil from suppliers would begin to be canceled once storage of excess crude in the pipeline began to approach the limits of the world's oil transport storage infrastructure.

    For example fully loaded oil tankers would eventually be forced to wait, anchored near their destination ports, for their turn to offload; because storage tanks at the port would eventually all be full. This would start to occur after a delay of about two months from the beginning of such a 5% decline in end point demand. That matches the time line between the actual start of our economic decline, a few months before our realization that it was happening. That would cause the concomitant fall in oil prices which we saw shortly after the TARP bailout, along with less severe drops in several other commodities.

  •  His views on NAFTA and GATT (0+ / 0-)

    are also disturbing to me. On more than a couple of occasions I have heard him or read him saying that 'Free Trades' aren't to blame for the loss of manufacturing and it's related engineering jobs.

    I know that when these tarriff breaker deals were set in motion the race was on to find the cheapest Labor and enviromental cost countries to do biz in.

    How he misses the relationhip between the 'Free Trades' and job losses is a puzzle that will take a Noble Winner to figure out.........

    •  Before you knock Krugman on Free Trade, ... (1+ / 0-)
      Recommended by:
      permanentE

      ... please check out just why he won the Nobel Prize this year.

      You'll find out that it was to honor work he did over the last decade and a half on the mechanisms by which Free Trade can result in the movement of jobs from one country to another. He shows that this can happen without that country which is receiving the jobs having been a priori intrinsically better at doing the kind of work being done by those kinds of workers.

      Rather it results from acting upon the desire to specialize in a new field by the benefiting country. That country then benefits over time from the confluence of field-specific knowledge that it has gained and the productivity enhancements that result from their particular specializations.

      The main effect that free trade has in this scenario is to lubricate this process. That allows it to happen more easily and more often and in many places in the world at once. It happens sooner than it used to happen when trade barriers were abundantly common.

      Th United States can benefit in this way as well, but we stubbornly refuse to do so. We hold ourselves back due to the laissez faire attitude we have against any amount of central planning, however small. That which happens to a far greater extent in China, Japan and most other Asian countries is not allowed to happen here.

      In principle, we accept only the Darwinian evolutionary struggle between companies struggling with each other for their own survival, though we often make exceptions to that principle for companies "too large to fail". That used to work. And probably it still works better in the long run. But it happens in a time scale which is far too slow compared to other countries with whom we compete and who can study what we did over the last century and a half. By this they avoid our mistakes and catch up to us in a decade or two, at least in specialized fields of trade.

      Obama's ideas, about spurring the growth of our own "green revolution", are akin to what China and (previously) Japan did over a time scale of about two decades each. They organized countrywide efforts to garner economic superpower status in certain respective trade sectors, (first textiles  in China but now expanding into electronics; first optics in Japan, and then electronics).

      At least in the areas of energy and climate, Obama wants to disregard the Republican ideal that government is always the problem, never the solution. For if we wait for evolution to change us in everything that we do we run the risk of extinction before we achieve our success. The choice of energy and climate are huge and nascent; we have a moment in time during which the economic superpower(s) in those areas have not yet been determined.

      This illustrates the main effect that globalization has had for us: it introduced a new variable into the equation, time. Without global competition we could have afforded to wait for evolution to change our ways for us. For evolutionary processes eventually discovered how to make things as complicated as human beings! But many more species than now exist had to fall by the wayside along that four and a half billion years long path.

      Meanwhile the rest of the world plows ahead, many starting "Manhattan-style" or "NASA-like" "government-industry" projects of their own. China, one of the previously most ideologically driven countries in the world, has irreverently dropped most of the economic aspects of communism, even as it still clings to some of its totalitarian ideals.

      Ideologies have their place. But each has both good and bad elements when viewed from different perspectives. The world is not black and white, except when viewed by those too mentally lazy to walk around and see the world from another side. The optimum is usually achieved by finding a good balance between competing ideologies and reorganizing the way we think about them so that their tenets can be blended with each other rather than always forced to compete.

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