Monday, August 04, 2008

Congress' Lack of Comprehension of Derivatives

Friday's Wall Street Journal featured an article entitled "The New Chemistry of Speculation" in its Money & Investing section.

For everyone's good, the Journal chose to focus on how mobile and unstoppable global commodities speculation is.

Responding to investor demand, investment and commercial banks are ramping up derivative instruments to cover one of the last un-hedgeable commodities: iron ore. Like other commodity derivatives before it, this provides a more efficient way for producers and/or consumers of iron ore to directly lock in forward prices without clumsily buying, or selling equity positions in iron ore producers.

True, as the article reports, hedge funds have increased their assets allocated to commodities from $13B five years ago to roughly $260B now. But is this not simply investors taking advantage of rising, and volatile prices of 'an' asset? Nobody complains when investors pile into, say, internet stocks. Or tech issues.

Why are commodities special?

And, as the Journal's interviewed source for the article, Kamal Naqvi, points out, these contracts are really for taking positions regarding prices of commodities. They don't allow market squeezes, because no physical delivery is ever taken.

Much like agricultural commodity derivatives allow farmers and food processors to take positions which lock in prices they will receive or pay for the commodities in question, so, too, do these new instruments. They have no effect on the supply.

If only we had legislators who actually understood economics, we might get a decent policy on financial sector and overall economic issues in the US.

Until that happens, we'll have to continue to watch Washington look foolish on the global economic stage while investors move to the exchanges and markets that fulfill their demands for investments.

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