Letter 2 America for February 7, 2014

Dear America,

By now you have probably realized that my solution to the problem of economic inequality relies in large part on regulating or outlawing the things rich people do to get richer without actually working or producing anything.  And among those things is trading in "derivatives."  That term covers a lot of ground, some of which is legitimate, but some of which is just institutionalized gambling for people who have too much money to use.  Among derivatives are the kind that got our economy into the mess it is still in five years after the collapse of the housing market, but more on that another time.  Another part of the derivatives market is in the area of commodities.  You can buy large quantities of almost anything in advance of its production, and in many cases that is useful.  An orange grower may need money for maintenance of his orchard now so that his crop will be fulsome when it comes in in a year, so he can sell orange juice futures on the commodities market to finance its that maintenance.  But then there is the use of the market by speculators, which has an impact on all of us in that it leaves the farmer with his obligation to sell the juice of his crop at one price while driving the price we pay in the supermarket relentlessly upward.

Orange juice futures seem almost frivolous in light of the fact that the price seems relatively stable, though trending ever upward in subtle ways; a half-gallon of orange juice is no longer a 64 ounce half-gallon, but now is rather what passes for a half-gallon: 59 ounces.  But there are other commodities that are more essential and that are caused to fluctuate wildly because of speculation...oil in particular.  It is not unusual for the price of a barrel of oil on one of the oil futures exchanges to go up by 20% in a month, or even quicker, because someone in the middle east is angry at someone else there.  That isn't a function of scarcity, because even when Libya was in a state of revolutionary chaos, the world's supply, which runs at about 83 million barrels of oil per day, went down by only about 1%, which the Saudi's made up effortlessly along with ever increasing American production, which continually decreases American demand in the world market.  But the price of a barrel of oil changed dramatically during that period, and we paid for it at the pump when we bought gasoline.  The reason was neither a significant change in supply, nor was it demand, which has been declining lately because of slow economies in Europe and Asia.  So what was it then; it was speculators who bought oil futures in the market.  My solution to the problem of the market being moved by people who think that time will increase the value of a commodity--or of any derivative including mortgage based ones like credit default swaps, the kind of derivatives that were the main cause of the worldwide economic crash at the end of 2007 and the beginning of 2008--is to bar from those markets anyone who cannot take delivery of the commodity.  In the case of oil in particular, individuals and companies that do not deal in oil, or use it in volume like airlines, would be effectively barred from trading in it because they would not have the storage or shipping capacity under their control to allow them to accept delivery of any significant amount of oil, and thus, they would be eliminated from the trading process that now allows the price to swing wildly because someone thinks there might not be enough soon.  It's simple really, even though we don't control all of the markets in which oil is traded because we use more foreign oil than any other nation, and what we do affects the market worldwide.

If that kind of market regulation were combined with a nationalized portion of the oil industry--just enough to supply the federal government with the 10% of total American consumption that the military and government agencies use each day--there would be that much less demand, and since the law of supply and demand would control oil prices rather than the ability of oil speculators to intervene, we would have a rational market for petroleum, which would be to the advantage of everyone who uses petroleum based products.

Then there is the unfair trading practices of participants in the world market in general, including that of American companies.  There has been a taboo in economics in that regard for decades.  It is called protectionism and it is the scourge of international, macro-economic theory, but we now have a problem not just with foreign competitors.  We also have one with American companies that exploit foreign advantages like obscenely low labor costs on account of the weakness of labor in some other countries like Bangladesh and China.  More on that next Tuesday.

Your friend,

Mike