Why the Krugman “I See No Commodities Speculation” Analysis is Flawed (rerun)

[girl gone mad]

This is an Yves Smith post from February. After this week's crash, I think we have a clear ideological winner.

Why the Krugman “I See No Commodities Speculation” Analysis is Flawed
http://www.nakedcapitalism.com/2011/02/why-the-krugman-i-see-no-commodities-speculation-analysis-is-flawed.html

Paul Krugman correctly anticipated that I would be unable to resist taking issue with him again regarding his view that the recent increase in commodities prices are warranted by the fundamentals.

Note that I am not saying in this post that “commodities prices have increased as a result of speculation.” That takes more granular analysis of conditions in various markets; we’ll be looking at some that look suspect in the coming days and weeks.

I intend to accomplish something much simpler in this post: to dispute the logic of Krugman’s overarching argument. He professes to be empirical, but as we will show, he is looking at dangerously incomplete data, so his conclusions rest on what comes close to a garbage in, garbage out analysis. And that’s been a source of frustration given his considerable reputation and reach.

Here is the guts of Krugman’s reasoning, from a recent post, “Signatures of Speculation“:

OK, how can speculation affect this picture? The answer is, it has to work through accumulation of inventories — physical inventories. If high futures prices induce increased storage, this reduces the quantity available to consumers, and it can raise the price. And you can, in fact, argue that something like this has been happening for cotton and copper, where there are apparently large and growing inventories.

http://www.nakedcapitalism.com/2011/02/why-the-krugman-i-see-no-commodities-speculation-analysis-is-flawed.html">more...

[Jim__]

1. Krugman's column was not on the price of commodities in general, but on the price of food.

As in: But for food, it’s just not happening: stocks are low and falling. The very next sentence after the ones you quoted:

OK, how can speculation affect this picture? The answer is, it has to work through accumulation of inventories — physical inventories. If high futures prices induce increased storage, this reduces the quantity available to consumers, and it can raise the price. And you can, in fact, argue that something like this has been happening for cotton and copper, where there are apparently large and growing inventories.

But for food, it’s just not happening: stocks are low and falling.

Here is Krugman's column that is referenced from naked capitalism. The column is about the price of food. If oil drops will food drop? Probably. But that will not be evidence of speculation in food, only evidence that the price of oil affects other prices which Krugman is not denying.

Here's a news article from today on the price of food. And here's a news article from yesterday on world food production. Speculation in some commodities does not imply speculation in all commodities.

[girl gone mad]

4. Krugman was pushing the same line about oil in 2008.

He was wrong then, too.

[happyslug]

5. I agreed with Krugman in 2008, and I agree with him now

The problem with Oil (The biggest issue of "Speculation") is that the market for oil is tight, to damn tight. The market HAS to loosen up, and that can only occur if there is an increase in Supply of oil (Unlikely) OR a decrease in the demand for oil (Equally unlikely). Whenever you have a tight market, it is an market subject to rapid increase and decreases in price. The price of oil increasing is driven (as in was in 2008 and is driven today) by the market wanting to reach some sort of Equilibrium between demand and supply. The real problem is, when that point is reached it is generally a product of a sudden introduction of supply OR (as was the case in the Summer and Fall of 2008) a sudden and unexpected drop in demand (The US, for only the second time in History saw a reduction in oil usage, the first time had been in 2007, but it was only marginal, in late summer and fall of 2008 it was almost 5%).

Thus you saw a steady drive up of prices, and then a sudden and rapid decline in prices. Speculators were involved in both, but as true speculators i.e. betting the price of oil would go up or down. Speculators ALWAYS do that, it is the role of Speculators in the Market Place. When that is all Speculators are doing, placing bets, it is causing minimal harm as far as economists are concerned. It is hard for such speculators to drive up the price (or drive DOWN the Price) unless there is some fundamental force driving the price up and down. Up till late summer of 2008, it was the increase demand for oil from India and China more then any increase in the US and Europe. The 5% Drop in US oil consumption starting in late summer 2008 and into the Fall of 2008 (Given, the 5% figure is a year to year figure, so actual US usage dropped about 10% or more starting in August 2008) lead to an excess of oil and thus the pressure came to sell as oppose to buy. With more oil to sell then people were willing to buy, the price of oil dropped (The rapid decline in ocean traffic do to the recession was also a major factor in the subsequent drop in the price of oil).

Krugman pointed out the in 2008 there was NO storage of oil being reported by any oil agency unlike 1979 when such storage of oil was known and reported (I do NOT mean people CLAIMING oil was being stockpiled, but actual reports of the people doing the actual stockpiling of oil, we had such reports in 1979, we had none in 2008). The speculators keeping oil out of the market (as they did in 1979) is the speculators Economists (and that include Krugman) dislike and are the only speculators truly capable of manipulating the price of oil (or any other item they are stockpiling). It is speculators of this school the Krugman could NOT find any evidence of in 2008 and can not find any today. There appears to be no excess stock piles anywhere in the world. Oil is pumped, refined and shipped. None is being held for higher prices later on. Thus no evidence of any illegal market manipulation as to the price of oil

As to "Norma" speculators, such speculators are buying oil and selling it as the price goes up. Are such speculators driving up the price of oil or are they just going along for the ride? Some commentators are saying such speculators are driving up the price, others are saying they are just riding an already climb in the price of oil. Such Speculators can NOT drive up the price more then three or four months (the time for a shipment of oil to go from the pump overseas to be sold in the US). Speculators can NOT hold onto the oil, they must sell after the tanker docks and unloads its cargo. Whatever is the price for oil that day is all such speculators get for they must sell. If there is no buyer, the price will drop till a buyer buys. What has been happening is when the tankers, unloads its cargo, the price is higher then when the speculators purchased the oil.

One more comment:
The recent drop in price have been given various causes, but the most likely cause is the Mississippi River flood. Most of the oil between the Appalachians and Rocky Mountains come up the Mississippi River by barge. The ongoing flood has slowed down river traffic, thus the recent drop may be caused by the refineries in Texas and Louisiana refusing to buy new oil till after the flood had run its course. Thus no buyers and with no buyers the price of oil will drop. This may NOT be undone till the flood runs its course which appears to be about two weeks from now. Then those refineries will want oil to refine and ship up the River. Remember when the tankers left the Persian Gulf, it was six weeks ago, while before the rains that produced this flood. The refiners probably shipped as much up river as the rain fell to empty their storage tanks (Thus driving prices down at the pump, the refiners wanted the oil OUT at any price). Today many of those tanks are empty waiting for this flood to run its course (or full, waiting for this flood to run its course). Most farmers already have their fuel for Spring plowing so not a major concern at that level, but I suspect everyone is waiting for this flood to runs it course and then the price of oil will start its upward drive once again.

[Warpy]

2. It was one of the few times I've read his column

and had a WTF? moment. Of course, there has been massive commodities speculation. It's far easier to create bubbles in a commodities market than it is in the massive stock exchange.

Now that he's seeing the speculative money withdrawn from petroleum and heard the loud "SSSSSSS!" of air being let out of that bubble, perhaps he'll notice the other commodities bubbles out there, many of them in foodstuffs.

If you're wondering why bubbles are being created, it's a bleedoff scheme to extract the last remaining money from the middle class. Joe middle class sees the price of something going up and up and figures the days of cheap whatsis are over and buys his futures. As more and more Joes get into the market, the big money that created the bubble starts taking their profit by selling Joe those shares. Joe is left holding the bag when the bubble deflates while the big money that created them counts the profit.

[pscot]

3. Commodities trading is inherently speculative

You're betting on the come. Most commodities are tied pretty closely to fundamentals. When frost hits the oranges, the price of concentrate goes up. But it's not that hard for farmers to shift production, especially in grains or livestock, which leads prices to correct in a single crop cycle. This tends to limit the growth of bubbles. Reality impinges on speculation. Of course, that's less true in precious metals, where demand is artificial.