Tuesday, July 28, 2009

Concerns about government regulations from a blog reader

Earlier I received this email from a reader of this blog:


Over the weekend when I first read about Gov limiting the energy trading I felt it was a positive move. I'm now rethinking that it may not be the best option. We're beginning too many Gov controls in the free enterprise system.
Your thoughts?"

Here is what I wrote back:

Gov't controls on activities that provide no real value to the economy are not something to worry about. In my opinion we SHOULD be dis-incentivizing this kind of activity. Too much of our economy and national income comes from paper flipping and/or hoarding of assets. In the long-term this is not productive and it sets us up for a situation down the road where we don't have enough of the real assets that we'll need as a society in order to live quality lives and have a high standard of living.



KmeleAnthony said...
This comment has been removed by the author.
KmeleAnthony said...


The speculative "paper flipping" and "hoarding" you referenced have very real and even productive consequences within an economy.

These speculators (investors) are making an effort to identify undervalued assets. They could lose their shirts, but they may also generate a profit. Their investment activities impact prices, and price are a fundamental mechanism for communicating information about products and service in the market.

Government regulations hinder this process and distort prices. Distorted prices can lead to minor surpluses and shortages or worse.

Its certainly possible that some acts of speculation might turn out badly, but who can claim to know before hand which will fail or succeed ?

All entrepreneurship is a form of speculation. All of it has the capacity to create or destroy wealth. Prices are central to this process - they help communicate the value of all alternative uses (present and future). Speculation is certainly an important aspect of that process.

mike norman said...

No society can exist without the real assets--the goods and services--that define our standard of living. Flipping paper contracts or accumulating real estate neither creates nor contributes to the real assets that the society needs, however, it siphons off otherwise smart and talented people that could be working to produce technology, medical services, new forms of energy, vehicles, structures, educational services, et.

KmeleAnthony said...

In a market economy, production of all of the aforementioned goods and services is coordinated via prices. The price of all goods and service reflect an incalculable range of information vital to the production process.

How do you determine wether the next 5 tons of steel should be devoted to constructing cars or boats? Just producing a lot of stuff is not what makes us better off. Its producing the right stuff, at the right time, in the right quantities. Prices are an essential part of getting that right.

(F.A. Hayek would be instructive here.)

Entrepreneurs and investors alike, use prices to guide their decisions about production. Prices allow them to determine the relative importance of alternative uses. Those prices include both present and future values. Futures Markets and yes, even real estate speculators help to impute that critical information into prevailing prices.

There is a reason you stock up on supplies when a storm is coming - the shortage has not arrived yet - but you suppose it will. That increased demand will ordinarily cause an increase in price. The higher price moderates demand in light of changing expectations. Without the higher price, the person willing to pay twice as much for ice to keep his insulin cold - may lose out to the guy just looking to keep his beer cold. Prices are a relative measure of value - and speculation is a critical component of any effective price system.

mike norman said...

Do you actually believe that only by the action of speculators that price is determined???

Matt Franko said...

I see your sort of Econ 101 supply/demand points, well taken.
But why when the world uses 84M bbl/day of oil does oil futures trade 1 billion barrels a day? That's the tail wagging the dog.

I cant make the point any better than the SVP of Delta Airlines today at the CFTC. Here's a link to his presentation today.

No Commercials support these rampant speculative arrangements. None, I cant find any. And supposedly these markets were set up to help commercials hedge, yet the commercials are saying the volatility is so bad, they cant use these markets anymore.

The investment firms need to be classified as speculators and limited to the original 10% of open interest or less in these markets.


KmeleAnthony said...

Broadly speaking, supply and demand give us prices.

Speculators, consumers and producers all demand resources. The aggregate demand of all parties contribute to the prevailing market price of goods and services.

Government regulations of all kinds can distort market prices and generate harmful unintended consequences. Your commenter is right to be concerned.

mike norman said...

Yes, the whole thing is a sham as Matt points out. We've become a plutocracy of "finance capitalists" and speculators. Say one thing against them and there is this huge outcry about how we are hurting free markets. It's like stealing from the grocery store and when the store owner complains the perpetrators say, "What...you don't want us to eat??" What a sham!!!

KmeleAnthony said...

All investment is speculation.

Delta representatives pleading for special protection from market uncertainty only confirms that they are self interested.

Its difficult to predict the future. Speculators/Investors are not guaranteed a profit, they often lose their shirts. And prices for many production goods are quite volatile. There is certainly no guarantee that a particular market will always work as smoothly as one might like (smooth is not always better anyway). But airlines can (and most do) purchase futures contracts to smooth out consumption costs. The contracts also have options - so the airline can modify the contract if the price is substantially different than they project. Thats paper speculation!

Lets be clear - speculators can't KNOW if the prices of commodities are going to go up or down. They can guess. And sometimes they're wrong. The ATA document you linked to clearly indicates that Delta engages in hedging - and managed to get it wrong. Isn't that speculative?

Delta could advocate for any number of policy alternatives - why not advocate for a loosening of regulations and increased oil production?

Speculation and investment (two ways of saying the same thing) are critical components of wealth creation.