Saturday, July 5, 2008

Supply and Demand - Not Speculation

There is a great amount of frustration and anger about the current price of gas. Everybody is looking for someone to blame. Currently the blame is being placed on Speculators. But Speculators are not the problem. Our CONGRESS is the problem. They deserve our ire and anger for our gas woes. It is Congress who is keeping supply low. Low supply and high demand equals high prices.

John Stossel accurately describes the roll of Speculators in his article, Bless the Speculators.
In fact, the hated speculator is a good guy because his buying and selling reduce volatility and uncertainty in an unpredictable world. He may only be out for his own profit, but that doesn't matter. As Adam Smith wrote, "It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner but from their regard to their own interest".
We all speculate to some degree. For instance, if you fill your tank today, even though it is only half empty, because you expect the price to be higher when your tank is empty, YOU are Speculating. When the farmer decides what to plant in the Spring, he relies on the Speculator to give him an indication of what the harvest price will be. He does not have to wait until he harvests the crop to find out what his income will be from the crops he produces.
The prices of commodities often change unexpectedly, making business risky. The speculator brings a degree of certainty to otherwise risky ventures. When supplies of a commodity are plentiful and prices low -- but speculators expect the price to rise later -- they buy -- cushioning the collapse of prices. When supplies become scarcer and prices rise, they sell -- easing the shortage and lowering the price. Also, speculators may agree to buy a commodity in the future for a price locked in today. This reduces the risk for an oil producer or farmer who fears investing because he doesn't know what price his product will sell for next year.
Airlines are a good example for the benefits of Speculation. They know because of the Speculators, what their fuel prices will be 6 months or more in the future. Therefore, your ticket price can be set, and remain stable, in the future. If not for Speculators future Contracts for Fuel, Ticket prices would become very unstable. Fluctuations in fuel costs for the Airlines, would be passed on to passengers. That could mean DAILY changes.
As a result of these activities, volatile supplies and prices are evened out over time. Occasionally, speculators increase volatility. Markets are never perfect. (Although they are better than government regulation.) But in general, speculators increase liquidity and keep the market on a more even keel. This makes long-term planning easier for everyone.
Unfortunately neither John McCain or Barack Obama have shown any grasp of basic economics. The fact remains that if supply were higher, prices would be lower. Basic economics 101 states that when Demand out paces Supply, Price increases. Our Congress is contributing to the low supply by not allowing Domestic Production in Coastal Waters, Alaska and the Rockies. Some of the Proven Domestic Reserves could be producing by next year, some not for 5-10 years. But the announcement of these Domestic Reserves would cause the Speculators to bid the Crude price down, because the Future Supply is Going UP.

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