Marian Spiral Fractal by Bryan Evans

Marian Spiral Fractal by Bryan Evans

On Friday Republicans blocked a bill in the Senate meant to give regulators more ability to reign in oil speculation (h/t The Zoo). While there's some dispute how much if any of the price of oil is based on speculation, there's reason to think it could be a lot. And current law means that a lot of oil futures trading is done in such a way that we don't even know how much is being done, let alone if it's having any effect. At this point the current law is effectively "we don't even look to see if a crime could be occuring."

Hugh lays this out (365):

3. The Enron exception. Through its political pull with politicians like then Senator Phil Gramm (R-TX), Enron was able to insert language into the Commodity Futures Modernization Act of 2000 exempting energy trading companies from oversight by the Commodities Futures Trading Commission (CFTC), the government watchdog agency, in the over-the-counter (OTC) market for “futures-like” instruments. 4. London-Dubai loophole. In January 2006, the Intercontinental Exchange (ICE) with the blessing of the CFTC (via no-action letters) began allowing American traders to trade futures contracts on oil produced and consumed in this country on foreign terminals in the UK thus circumventing reporting requirements to the CFTC regarding large trader activity and speculation caps. (ICE also has an OTC component.) NYMEX joined with the Dubai Mercantile Exchange to launch a similar venture in May 2007.

5. Swaps dealer loophole. Under a 1993 CFTC rule, swaps dealers, investment banks like Goldman Sachs and Morgan Stanley, were given the same status as traditional futures traders like oil companies and airlines as long as they were considered to be hedging a “legitimate” risk. This allowed large financial funds to enter into swaps contracts with investment banks. A swap contract is essentially an agreement between two parties in which the first party agrees to pay the second a fixed rate of interest on an agreed upon amount, and the second party agrees to pay the first a variable rate on the same amount. The actual principals offset each other so it’s really a mechanism to convert a fixed rate into a variable rate. The trick is that the investment banks use the money they receive to buy something that has a variable value, in this case crude oil futures which they have access to and the funds do not. This has been yet another way for large amounts of outside capital to enter into and distort the operation of the futures market in crude.

6. An ineffectual CFTC. This agency is supposed to regulate futures markets, but in this most anti-regulatory of Administrations, it has given away so much of its authority that it has no idea what is going on in the “dark markets” created by ICE and the Enron exception and no real interest in doing anything about it.

So, the Senate bill, while it doesn't go far enough (I'd slap a percentage tax on all futures and options commodity trading, probably of 1% and I'd increase margin requirements significantly), it's certainly a good basic idea. Even if you don't think futures are doing a thing to oil prices, no liberal can be for all that trading going on in the dark—nor should any markets believer, since transparency in markets is generally considered necessary for them to operate properly, and this is clearly not a transparent market without information asymmetries.

But the real problem is liquidity slop, as has been the case with all bubbles in the past ten years ever since Greenspan slammed the pedal to the metal back in the late nineties and produced far more money stock than there are good investment opportunities. First money went into stocks, and caused the Nasdaq to go from a bull market to a bubble. When that burst, the money went into two places—housing and commodities (not just oil, but commodities as a group). The housing bubble finally burst last year and even more money then flooded into the commodity markets in general, and specifically into oil. Since there is a mechanical link between futures markets and oil prices, the already significant price increases began to bubble over.


Illegal Immigration

Illegal Immigration

While there are different stages to this increase in commodity prices, it should be emphasized that commodity prices began their long increase when Greenspan first released liquidity to end the Asian currency crisis. That has had a wide variety of effects, the first one of which was actually an increase in illegal immigration to the United States. As the prices of staples rose for the poor in Latin American countries, it hurt people on the margins, people barely making it, the most. When you're living on pennies a day and the price of food goes up, you're screwed. So those people headed north and you can see it very clearly on charts of illegal immigration numbers, where the numbers explode in the late 90's.

Another consequence is military. Oil money, the most important form of commodity money, goes in large amounts to the Muslim world. Not to put too fine a line on it, but the richer they are, the more support they are able to give various groups the US doesn't like. Saudi support for Sunni insurgents in Iraq (and Saudi Arabia is where most of their money comes from), for example, is made much more feasible by high oil prices. Subsidies to Palestinian fighters against Israel is made more possible. And so, frankly, is money for folks like al-Qaeda and the Taliban.

In the 90's and the first few years of the 2000's really the Muslim world could only afford to subsidize one war against the West. For a long time that was the Palestinians, but when the US invaded Iraq, the money shifted there. The Saudis and other Sunnis sure as heck weren't going to let an Iranian controlled Shia majority take over without putting up a fight. That left the Palestinians, deprived of both Iraqi support and much Sunni support at the same time, in a bad spot and Ariel Sharon used this period to really put the pressure on, with an eye to enforcing a unilateral two-state solution during the last and probably greatest window of Israeli strength and Palestinian weakness.

Sharon's collapse put an end to that, and his successor horribly bungled the plan, then picked a fight with Hezbollah Israel couldn't win, shattering the myth of Israeli military superiority in the process. And all during this time the price of oil increased and the time came when the Muslim world could support more than one war against the West—could subsidize Iraqi resistance, Palestinian resistance and Afghani resistance all at the same time. Methods honed in Iraq were moved to Afghanistan and insurgent effectiveness soared along with NATO casualties. To be sure this wasn't the only factor, but it is a significant one and often overlooked. A poor Muslim world, one at $20/barrel, simply cannot afford to subsidize multiple wars. Heck, after the oil price collapse in the eighties, it could barely subsidize one, even though that subsidization was done directly by the Saudi government rather than through private individuals, mosques and non-profits.

In the old world, in the Clintonian world before Greenspan broke it, the idea was to keep the periphery poor. Make sure no one has as many dollars as they want for everything they need it for, and they won't do things you don't want them doing, or if they do, they won't be all that effective at it. People had to have dollars to buy the best weapons, if not an oil producing country, to buy oil, and also to buy the future. Wanted to be in on the newest hottest technology? It was happening in the US and if you wanted to play, you had to play in dollars.

Printing too many dollars meant an end to that. It meant that the discipline enforced on countries without hard currencies mostly went away, especially if they had oil. Countries like Venezuela started getting seriously uppity, indeed most of Latin America did. Why not? They had money again; they had resources the US needed more than they needed what the US dollar could buy.

The price, then, of loose monetary policy by the world's hegemonic power with the world's primary currency is the loss of power, the encouragement of its enemies and the flow of immigrants across borders as they seek to go where they can afford to live.

The result, oddly, has been that America has lost pricing power in the things it sells (other than food) and suffered inflation in the thing it must absolutely import: oil. That's an inflation riptide - prices of what you sell not rising as fast as prices of what you have to buy. And since what the US sold most was really paper assets backed by things like housing and since that market is actually in a deflationary spiral, really the US is caught between deflation in what it sells and inflation in what it must buy.

Not a pretty place to be. Add on top of that increased immigration and the fact that its enemies have lots of American cash with which to fight the US, and America is in a world of hurt.

At the end of the day, power doesn't just come from the barrel of a gun, it comes from the economic foundations which make supporting power in all its varieties possible. America is finding out that prosperity bought with fake money is likewise fake, and that fake prosperity leads to hollow power.