Wall Street 101 for Progressives, Academics and Career Politicians

April 24th, 2012
in Op Ed

by Michael Haltman, The Political Commentator

President Obama has a proposal on the table to regulate margin requirements in the crude oil market in order to control what he considers speculation-in-the-pits-close-upSMALto be the scourge of "speculation."

Huh? Isn't speculation a critical part of what makes a market a market? Some people betting that prices will go up while others are betting that prices will go down? Winners and losers? Bulls and bears? Providers of market liquidity?

If crude oil prices were heading lower due to hedgers selling and speculators shorting the market would that still present a problem for the President?

Follow up:

Of course not and what needs to be remembered is that in any market there are going to be winners and losers.

For example hedgers and speculators short the crude oil market when prices rise lose money while those who are long make money.

When crude oil prices are dropping hedgers and speculators who are long the crude oil market lose money while those who are short make money.

In other words the futures market is a zero-sum game arena that politicians should stay out of if their sole purpose for being there is political gain!

Instead of pandering to the public with new margin requirements that attempt toscapegoat market participants, the President should instead look in the mirror and understand that it's his unwillingness to allow the country to drill for oil that is one of the major contributing factors leading to higher crude oil prices.

Academics, Progressives and career politicians know so little about how the real world really works, and for the most part they really don't care!

Oh they may know a given financial markets name and possibly some of that markets jargon, but one need only watch a few minutes of a Congressional hearing devoted to some aspect of finance in order to understand that the majority of these people in Washington and the Ivory Tower know little of how the free markets actually operate.

What they do know is some book theory and what they think that the American public wants to hear. For many, Barack Obama included, they have never ventured very far into the "real world" and they know little else.

President Obama, in full campaign mode, is trying to vilify the "speculators" onWall Street as the root cause for the upward spike in the price of crude oil. As the President likes to say these speculators are some of the same "Wall Street folks" who through their greed helped to create our nations financial crisis that is so hurting the "regular folks" around the country.

In the Presidents mind free markets and the concept of supply and demand have nothing to do with creating the condition of higher prices. For him any solution will involve the government stepping in to invoke new regulations on the markets that he believes will solve the problem. Nowhere in his solution, however, is addressing his policies that affect the supply component other than the ones he has that hinder it.

Progressive talking points!

Rarely do I feel sorry for one of the Obama campaign puppets who are forced to come onto a talk show to describe and defend administration policies. To the contrary these people typically infuriate me to a point beyond belief.

But Saturday morning one of them, Jehmu Greene, had to come onto a business show and discuss why government regulation and intervention into financial markets, specifically crude oil, is what the markets need and what the American people expect. Never mind increasing supply through drilling because the answer for Progressives is always about government and never about the free market.

My sympathy for her stemmed from the fact that she had to perform her song and dance on a panel that consisted of people whose livelihoods are made on Wall Street. People who live how markets function and work each and every day!

She used the phrase "at the end of the day" multiple times as a "talking point" for the smoke and mirror technique that Progressives often use.

This was done to try and push expectations for any tangible results from government intervention out to some point in the future (in this case post-election) when people will theoretically have forgotten to remember another failed attempt to intervene into the operation of the free markets.

The market players, hedgers, speculators and prices!

Attempting to sum this all up here are the two major participants in the futures markets, hedgers and speculators.

The government for its part should be seen and not heard in the way in which the free markets work!

Think about the last time the government got involved in the function of business and the end result was actually better than it was before!

"In general, hedgers use futures for protection against adverse future price movements in the underlying cash commodity. The rationale of hedging is based upon the demonstrated tendency of cash prices and futures values to move in tandem.

Hedgers are very often businesses, or individuals, who at one point or another deal in the underlying cash commodity. Take, for instance, a major food processor who cans corn. If corn prices go up. he must pay the farmer or corn dealer more. For protection against higher corn prices, the processor can "hedge" his risk exposure by buying enough corn futures contracts to cover the amount of corn he expects to buy. Since cash and futures prices do tend to move in tandem, the futures position will profit if corn prices rise enough to offset cash corn losses.

Speculators are the second major group of futures players. These participants include independent floor traders and investors. Independent floor traders, also called "locals", trade for their own accounts. Floor brokers handle trades for their personal clients or brokerage firms.

For speculators, futures have important advantages over other investments:
  1. If the trader's judgment is good. he can make more money in the futures market faster because futures prices tend, on average, to change more quickly than real estate or stock prices, for example. On the other hand, bad trading judgment in futures markets can cause greater losses than might be the case with other investments.
  2. Futures are highly leveraged investments. The trader puts up a small fraction of the value of the underlying contract (usually 10%-15% and sometimes less) as margin, yet he can ride on the full value of the contract as it moves up and down. The money he puts up is not a down payment on the underlying contract, but a performance bond. The actual value of the contract is only exchanged on those rare occasions when delivery takes place. (Compare this to the stock investor who generally has to put up at least 50% of the value of his stocks.) Moreover the commodity futures investor is not charged interest on the difference between the margin and the full contract value.
  3. In general, futures are harder to trade on inside information. After all, who can have the inside scoop on the weather or the Chairman of the Federal Reserve's next proclamation on the money supply? The open outcry method of trading - as opposed to a specialist system - insures a very public, fair and efficient market.
  4. Commission charges on futures trades are small compared to other investments, and the investor pays them after the position is liquidated.
  5. Most commodity markets are very broad and liquid. Transactions can be completed quickly, lowering the risk of adverse market moves between the time of the decision to trade and the trade's execution." (Source)

Other Articles by Michael Haltman

Opinion Blog and Investing Blog

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Oil Price Manipulation by James D. Hamilton

Lower Oil Prices by James D. Hamilton

Oil Shocks and Economic Recessions by James D. Hamilton

Demand Elasticity for Gasoline by Doug Short and John Lounsbury


About the Author

is the founder of The Political Commentator,an outlet for conservative insight, economic analysis, and opinions over a variety of political, global and societal topics. The Political Commentator was awarded the title of the top blog in the 2011 Fabulous 50 Blog Awards and was listed in the top 5 of the Top Conservative Blogs on ConservativeBlogs.net. Michael Halman appreciates any thought or feedback, both good and bad. His email address is extertraining@ aol.com.

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1 comment

  1. Derryl Hermanutz says :

    Michael wrote,
    "For example hedgers and speculators short the crude oil market when prices rise lose money while those who are long make money.

    When crude oil prices are dropping hedgers and speculators who are long the crude oil market lose money while those who are short make money.

    In other words the futures market is a zero-sum game arena that politicians should stay out of if their sole purpose for being there is."

    We had this discussion a couple of years ago at Seeking Alpha. It's true that over the long term speculation and hedging are zero sum games with winners taking their gains from losers. But when bets are overweight long for an extended period, and futures contracts are rolled over by speculators who never take delivery, the persistent presence in the market of speculative buy money holds up the price for buyers who do take delivery. So the demand side of the "real" market pays higher prices, and the supply side collects those higher prices. Ultimately, persistent long speculation increases prices for commodities consumers (i.e. "everybody") and increases profits for commodity producers, and this lasts as long as the speculative long bias persists. Eventually the speculative longs will lose some of THEIR money in the zero sum "betting market". But in the meantime the economy pays higher than "real market" prices for commodities because of the demand pressure that is added and maintained by the long speculators.

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