Friday, October 3, 2008

Back to the Future? Instead, let’s consign futures to the past

Recently, Terry Scruton reported on a Senate hearing where our elected representatives investigated what role that speculation played in this year’s oil price run-up.

Speculation, in this case, pretty much refers to activities on the futures market, which itself is not much more than a legalized, disguised and very dangerous form of gambling.

Here’s the theory: You start by finding a time where you think oil will go up in price over the next three months. You buy a load of oil that’s not scheduled to arrive here for a month to three months in the future. You make the purchase with borrowed money, using virtually none of your own. Then, as the oil is near delivery, you go back to the same market and sell it for the higher amount.

As the stock market and the rest of the economy started to tank, folks thought oil was a good investment. So they started investing in these “futures.”

Remember, over the past year, if you adjust for seasonal variations, the supply of oil and the demand for oil to burn was pretty typical. What there was more demand for was oil futures. And that drove the price of those futures – and eventually, the price of the oil they represented – up.

That’s the case with oil – the very nature of the market encourages further speculation, encourages traders to commit acts likely to drive up the price, so they can take hefty profits and never actually have to possess one ounce of oil (they never take delivery unless the price drops below what they paid for it).

But this problem isn’t limited to oil. Not by far. It’s pretty clear to me that the futures market is at the heart of many of our economic problems over the years.

Ask a farmer how much they were paid for the amount of wheat used in a loaf of bread. It’s pitiful.

Sure, some of the cost of the loaf went to the baker, to the cost of the yeast, to the retail store, and – God willing – to the trucker who brought it there.

But when some brands of bread are running well over $3 a loaf, it’s ridiculous that the person who produced the most important ingredient gets paid the least of anyone involved in the process – in some cases, as little as 5 cents for the wheat that goes into that loaf.

So where did the rest of that money go? A lot of it ends up on the futures market, where a trader who never worked a day on a farm in his life pulls in huge quantities of cash for the wheat in that bread.

That doesn’t even address the ultimate problem: The end consumers – in this case, economically struggling families who have to pay that much more for the food they need – get stuck with the bill.

Here’s a telling statistic: I’ve seen salaries listed for futures traders that run from $80,000 to $300,000 plus – a figure nearly unheard of decades ago. Farmers are often paid no more for wheat now than they were in the early 1920s. Don’t believe me? Check out Kansas History Magazine.

I really do think the same kind of thing is happening with oil. In both cases, the end consumers – truckers or grocery shoppers – are getting screwed.

The only big difference between the oil and wheat situations is that for oil, the producers – in this case, oil companies – aren’t getting paid a pittance like the farmers. They’re getting rich, too.

It’s just one more thing to discuss when you call your representative or your senators.

Only they can pass the laws needed to properly regulate futures trading and prevent this kind of crisis again.