Speculators Move the Markets: How Much Movement Do We Need?


Perhaps it is fitting that on the anniversary of the Flash Crash on the NYSE  last May when the Dow Jones Index fell by  nearly 1000 points, the markets got a reminder of how speculation still rules the roost. The day before oil prices fell by 10%, silver by another 8%, and commodity prices across the board – corn, natural gas, copper, … you name a commodity and prices fell substantially on May 5th. Marketwatch came clean after Bloomberg, Reuters, and other Financial Talking Heads reported the rollercoster downswing in commodity prices but attributed the causes effectively to some butterflies in Brazil. Here is what Marketwatch said:

Analysts offered a wide variety of reasons for Thursday’s plunge in commodities, but some agreed the main force behind the drop might simply be a matter of stampeding speculators.
“It all began with silver, which started falling sharply late last week when CME Group increased margin requirements on trades,” said BMO Financial Group Chief Economist Sherry Cooper, in a note Thursday.
Indeed, the CME’s repeated hikes to the silver-margin requirements sent the metal, which as of April 29 had risen nearly 60% for the year, tumbling, with benchmark silver futures losing more than 25% since then.
But a variety of other news, including a Wall Street Journal report that billionaire financier George Soros was selling off his holdings, helped the losses snowball, and on Thursday, silver fell 8% on the Comex division of the New York Mercantile Exchange, its largest one-day percentage drop since Dec. 1, 2008. This touched off massive selling across all commodities….

Wikipedia sets the record straight saying – Financial speculation can involve the buying, holding, selling, and short-selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives, or any valuable financial instrument to profit from fluctuations in its price, irrespective of its underlying value. Many speculative trades are naked – neither the buyer nor the seller has any interest in using the underlying commodity. As such, these naked trades are not only zero-sum – what  one sides gains over time means the other sides real or opportunity losses; but also are really gambling. Now financial market theory argues that speculators are necessary because they a)make markets more liquid and b)make prices more efficient and true to the underlying demand. This party would disagree with the latter statement when speculators become the a significant % of the overall market trading. The proof is in yesterdays and today’s trading – markets stuffed with speculators not only became more volatile and risky but also no longer reflected the fundamental usage supply and demand. Worsening this speculative volatility and decoupling of markets from natural demand is the fact that much trading [as much as 50-70% in some markets] is done solely by computing algorithms.  Thus financial markets can be thought of as a high stakes, zeros-sum, computer-automated gambling casino. A place where efficiency and transparency get lost as deception and opaqueness become paramount for the large, speculative trades. The situation has become so dire that many traders have been driven  from the markets according to the WSJ.

So it is no surprise that there is great interest in the following two questions. First, how can one control the speculator produced volatility in the markets. Second, is there an effective  way to limit the size of speculative trading in markets [here is one novel proposal published in BusinessWeek]. But the real question is whether the government and the bulk of financial traders have lost control of the financial regulatory and control processes to  very wealthy hedge funds and other special interests and their encompassing lobbying influence.  If the latest reports are indicative [see here], ye Editor would be betting on the superwealthy speculators. So it looks like John Q. Public is still set to endure more not less Flash Crashes and/or Bubble Collapses. And hey the SuperWealthy are big into  Trickle Down Job Creation for the Masses -” you, John Q., get to be  first-in-line as our financial-mess pooper scoopers – and we promise a gargantuan load this next time”.

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