After this, therefore because of this.
Students of Latin (and devotees of the The West Wing TV show) know that the phrase above describes a common logical fallacy. One thing does not (and can not be said to) cause another simply because it came first.
The current debate over rising commodity prices brings this thought to mind.
As several recent articles have noted (including these from The Independent and the Financial Times), there has in recent years been an increased flow of investment funds into commodities. Commodity prices have experienced volatility and price changes during this time.
This has raised concerns that the “financialization” of and increased financial speculation in these markets are adversely impacting them. One thing (increased investment) leads to the other (higher prices), at least in the minds of some.
Given its importance, there have in recent years been a number of research studies conducted by leading academics and government institutions into this issue. What does the research show?
As Professor Craig Pirrong of The University of Houston has written, “As yet there is no serious theory, and certainly no serious evidence that speculators have distorted commodity prices.” In addition, a US CFTC Commissioner — Michael Dunn — stated in 2011, “To date, CFTC staff has been unable to find any reliable economic analysis to support either the contention that excessive speculation is affecting the markets we regulate or that position limits will prevent excessive speculation.”
In fact, there is today abundant evidence that supports the view that speculation makes little, if any, difference to food prices and price volatility:
- A report prepared by the G20 Study Group Commodities in November 2011 indicates that the main factor behind rising commodity prices is not speculators but rising global consumer demand that is outstripping supply.
- A technical report prepared by Professors Irwin and Sanders for the Organization on Economic Development and Cooperation (OECD) in June 2010 states that “the weight of the existing evidence clearly tilts in favor of the argument that index funds did not cause a bubble in commodity futures prices…There is no convincing evidence that positions held by index traders or swap dealers impact market returns…”
- The Task Force on Commodity Futures Markets of the International Organization of Securities Commissions (IOSCO), co-chaired by the CFTC and the UK’s Financial Services Authority, determined that market fundamentals, not speculation, caused the price volatility in physical commodities markets in 2008.
- The International Monetary Fund’s World Economic Outlook, published in October 2008, found that “there is little discernible evidence that the buildup of related financial positions [in commodity markets] has systematically driven either prices for individual commodities or price formation more broadly.” Similar conclusions were reached by the CFTC Inter-Agency Task Force on Commodity Markets, the European Commission, and the Government Accountability Office.
- A January 2009 memo prepared by the Government Accountability Office found, based on both public and non-public data, “limited evidence” that speculation causes changes in commodity prices. The GAO Memo reviewed numerous empirical studies, all of which “generally employed statistical techniques that were designed to detect a very weak or even spurious causal relationship between futures speculators and commodity prices,” and concluded that “the fact that the studies generally did not find statistical evidence of such a relationship appears to suggest that such trading is not significantly affecting commodity prices at the weekly or daily frequency.”
Criticism of “speculation” and “financialization” might be timely and trendy, but it’s important to base policy decisions on the facts. As ISDA has written:
“Although speculation is often blamed for causing problems in markets, the economic evidence shows that it is in fact a necessary activity that makes markets more liquid and efficient, which in turn benefits hedgers, investors, and other market participants. Speculation increases market liquidity by reducing bid-offer spreads, by making it possible to transact more quickly at a given size, and by making markets more resilient. Speculators make markets more efficient by helping move prices closer to fundamental values: short sellers, for example, provide discipline against overpricing while speculative buyers counteract unjustified drops in price. Without speculation, markets would be less complete in that there would be fewer opportunities for other market participants, especially hedgers, wishing to manage the risks they encounter in their financial activities.”
The potential adverse impact is echoed in the academic literature. An EDHEC-Risk Institute paper notes that “proposals to restrict speculation fall somewhere in the continuum of being a placebo to actually being harmful to the goals to which they aspire.”
In addition, the Irwin-Sanders paper states: “the policy implication of the available evidence on the market impact of commodity index funds is straightforward: current regulatory proposals to limit speculation — especially on the part of index funds — are not justified and likely will do more harm than good…. The net result is that moves to tighten regulations on index funds are likely to make commodity futures markets less efficient mechanisms for transferring risk from parties who don’t want to bear it to those that do, creating added costs that ultimately are passed back to producers in the form of lower prices and to consumers as higher prices.”
All of this brings to mind another Latin phrase that’s worth keeping in mind the next time someone tries to sell you a story about the financialization of commodities markets: