The Times' Paul Krugman had a boffo column yesterday on the link between high global food prices and global warming. "Boffo" because it's sure to piss off the global warming deniers and so get lots of traffic and links, while it simultaneously bolsters his sensible centrist credentials. Krugman has centrist credentials, you ask? Yeah. Krugman is a Keynesian standard-bearer who thinks the economic system is pretty good, and can be perfected with just a wee bit of regulatory tinkering. Part of that belief centers on his faith—oft repeated—that crazy price spikes in commodities markets can be explained by supply and demand. The converse—that speculative shenanigans are distorting the market—Krugman bats away as the bleating of conspiracy theorists and French presidents. In Krugman's world, it simply cannot be true that speculative interests regularly bend entire markets. Because if that were true, reform might demand something more muscular than regulatory tinkering. It's unthinkable. So Krugman goes on today (as he has previously here and here and here and here) about how fundamentals rule every market and "what really stands out is the extent to which severe weather events have disrupted agricultural production," then sums up his greenhouse theory succinctly:
As always, you can't attribute any one weather event to greenhouse gases. But the pattern we're seeing, with extreme highs and extreme weather in general becoming much more common, is just what you'd expect from climate change.Hmm. Well, global climate change is almost certainly a fact, but bad weather has not always led to monster global food price disruptions. So I'd like Prof. Krugman to consider this tinfoil hat idea: What if, in addition to global climate change, we are also experiencing a global market change? And what if, just as CO2 is invisibly polluting the climate, the flood of dollars desperately searching for yield, combined with the recent removal of effective financial regulation, plus absurd, short-term incentives linked to supervillain-level compensation, have together produced a certain sort of hedge-fund wanker who has, in turn, radically altered the global commodities markets? In 2003 the total amount invested in commodity price index funds was $13 billion. By early 2008 that figure was $260 billion. (Here's a report that refers to some of the 2008 speculation). Krugman always hedges just enough to protect his left flank, as in his Dec. 26, 2010, "The Finite World" column, where he wrote:
This doesn't necessarily mean that speculation played no role in 2007-2008. Nor should we reject the notion that speculation is playing some role in current prices; for example, who is that mystery investor who has bought up much of the world's copper supply?Indeed, who is that mystery investor? (Turns out, as had been widely reported by the time Krugman speculated, it was J.P. Morgan. And why does Krugman—or anyone—just accept the notion that we're not allowed to know who owns 50-80 percent of the available copper?) Ah! But never mind such trifles, Krugman's larger point is that conservatives are idiots, or thinking that speculators control markets is childish, or that we live in a finite world, or whatever point Krugman is trying to get to. Ever the sensible centrist, Krugman is even on record in favor of taxing speculators, agreeing that today's hyperactive financial markets are "‘socially useless.'" He just can't quite take that next logical step and say that, worse than useless, the hyperactivity is socially harmful. No, Krugman says, the harm we see—Third World people facing starvation, lighting themselves on fire in protest, sad SUV makers unable to fill their showrooms—is all about physical limits and not about malevolent speculation. How does Krugman know? In 2008, Krugman helpfully spelled out his thinking on futures market mechanisms:
Imagine that Joe Shmoe and Harriet Who, neither of whom has any direct involvement in the production of oil, make a bet: Joe says oil is going to $150, Harriet says it won't. What direct effect does this have on the spot price of oil — the actual price people pay to have a barrel of black gunk delivered?
The answer, surely, is none. Who cares what bets people not involved in buying or selling the stuff make? And if there are 10 million Joe Shmoes, it still doesn't make any difference.His Nobel prize in economics notwithstanding, Krugman seems incapable of grasping that commodity speculation is more than Joe Schmoe betting a price will rise while Harriet Who takes the opposite side of the bet. Krugman's illustration is straight out of any classic economics text, which is to say it's a highly oversimplified model that bears little relation to how the game is actually played. Want evidence? If speculation using futures contracts, credit default swaps, and derivatives really had no effect on an underlying commodity, then the U.S. housing market would not have inflated and crashed. And commodities futures—including currency swaps—are a bit more complicated than the CDOs and CDS's that blew up the housing bubble. It's really not news anymore that, during the 2000s, oil pricing moved from transparent markets into a netherworld dominated by hedge funds and other large financial players. Consider this paper (PDF) by Eduard Gracia regarding oil's bubble pricing—in 2006. Or look at the effect of the Commodity Futures Modernization Act and so-called ICE Futures (Intercontinental Exchange), which moved trillions of dollars worth of contracts from transparent open commodities markets to opaque over-the-counter (OTC) markets controlled by a few big banks. Or read Ken Silverstein's long and colorful story "Invisible Hands: The Secret World of the Oil Fixer" in the March 2009 Harper's. Or just think: The amount of money that can be applied at any given minute to a given market—any market, be it corn, soy, copper, silver or AOL stock—is now far beyond the total value of the actual product. The people in control of this money have faster computers than you do. And they work in secret. And they always have a strategy. Big hedge funds will make market-moving plays on any item if they think they can pull dumb money in behind them and then sell their positions while shorting the same commodity. It's a momentum play, and it's illegal, and it is done routinely (as the infamous Jim Cramer explained in this classic video), and to imagine, in the absence of effective regulation, that it's not being done in today's global commodities markets is to endow bond traders and hedge fund assholes with a rectitude bordering on the divine. As Cramer said, "It's a fun game, and it's a lucrative game." They cheat, Dr. Krugman. It's what they do. Factor it in.