What distinguishes a speculator from a hedger? Here's the New York Times:
Unlike hedgers — the farmers, miners, refineries and other commercial interests that actually make or use the commodities themselves — the speculators, like day traders in the stock market, are simply trying to profit from changing prices.
But that's not really right. Conceptually, a hedger is a party trying to shed risk, usually accepting some cost to do so, while a speculator willingly takes on risk, hoping to profit.
If we take nominal dollars as investors' unit-of-account, then all noncommercial interest in commodities is "speculation", as the Times implies. People are pouring money into commodities because they believe commodity prices will rise in US dollar terms. Since holding cash is risk-free (in nominal dollar terms), all investment is speculation unless it's offsetting some commercial risk.
But if we more realistically view investors' planned consumption bundles as their unit-of-account, the recent interest in commodities is better characterized as hedging than speculation. Investors perceive the value of currency to be more volatile than stored commodities, relative to the goods and services they hope to consume. It would be inefficient for investors to store commodities directly, so they hire professionals to store on their behalf by purchasing financial futures. (In properly functioning futures markets, when more money wants to go long than short, an invisible hand seeks out those capable of efficient storage, and compels them to fill warehouses in order to meet the excess demand.)
What Joe Lieberman proposes to do, then, is best understood not as barring speculation by institutional investors, but as barring hedging, as forcing investors to accept risks that they would prefer to shed.
Yves Smith writes that Senator Lieberman's proposal is "a Nixon-goes-to-China moment". I am wrong far more often than Yves Smith is, but I'm gonna go out on a limb here and say she's mistaken. The Senator fron Hedgefundistan is acting very much on behalf of his constituents. Smith writes:
Opponents may argue that this will simply drive investing in commodities overseas. Perhaps, but funds regulated under the Investment Company Act of 1940 (most US fund managers) don't have that sort of latitude, and ERISA investments could similarly be reined in quite easily. And it's US investors, plagued by (until recently) an ever falling dollar who have had particularly strong reasons to look to a hedge like commodities.
As a move to drive any speculative froth out of commodities, this one isn't bad (but one wonders how all those commodities index funds get unwound). Although some have called for increases on margins at commodities exchanges, that hurts commercial actors as well as speculators. A move like this focuses on the underlying issue more directly.
Goldman in particular would suffer, since as the biggest manager of commodities funds based on its index, GSCI, it not only earns fees, but as we have discussed elsewhere, earns even more from an unsavory but hugely profitable practice called "date rape" around the monthly futures contract roll.
Now before the wealth-holding class howls that they've just been done a dirty by being deprived of inflation protection, there is an asset class that, unlike commodities, supports productive investment. and provides inflation protection, namely, infrastructure investments. The cash flow from infrastructure projects (toll roads, airports) goes up over time, as do the payouts, so they have fairly secure cash flow that increases over time. Although there is some debate about how to view them, they seem closest to an inflation-indexed bond (although any investor would need to study the ability of the enterprise to increase charges versus the drivers of operating expenses).
Many investment funds may be prohibited by charter or regulation from participating in overseas commodity markets, but Senator Lieberman's hedge fund constituents and their wealthy accredited investors are not. The "wealth-holding class" would evade these restrictions quite easily, by funneling money through Connecticut businesses. This would be a growth-enhancing regulation for Stamford.
Meanwhile, retirement funds and retail ETF investors would be stuck with currency-denominated securities, and forced to bear any loss of purchasing power. Infrastructure as an asset class might or might not be a reasonable inflation hedge, as might stock (in the long run, equities are said to pass through inflation), TIPS, or any number of other assets. But that's fundamentally a decision for individuals to make. If infrastructure is a good choice, let the hedge funds buy it. But so long accredited investors (and savvy individuals with direct futures market accounts) have access to commodity exposure, it is inequitable to prevent the beneficiaries of ordinary investment funds from enjoying the same.
The United States economy is suffering the aftermath of poor aggregate investment decisions over a period of many years. Losses will have to be taken on those investments. The "wealth-holding class" responsible for the misdirection of capital will do what it can to shift losses to dispersed and relatively powerless little guys. I'd be glad to see the government take a more active role in addressing America's economic crisis. But most of the proposals out of Washington so far, including this idea from Senator Lieberman, give options to banks and wealthy investors while shoving costs and constraints onto everyone else. Trying to address the "commodity bubble" by restricting so-called speculation is a fool's game. If it's a bubble pop it, if it's a response to real risks, address those. Blaming speculators is like combating global warming by banning thermometers.
FD: I'm an evil speculator, but as an individual who trades futures directly, Senator Lieberman's proposal wouldn't prevent me from escaping the little people's inflation. That said, the only commodities I'm long are precious metals. I'm short Ag comodities via a retail ETF. I lose money all the time, so taking anything I say as investment advice is just dumb.
|Steve Randy Waldman — Friday June 13, 2008 at 2:50am||permalink|