Peter Orszag’s Bloomberg op-ed this week argues that Milton Friedman’s principle of stabilizing speculation, in which speculation always acts to facilitate market efficiency, is not always true. Orszag, who is vice chairman of global banking at Citigroup and formerly President Obama’s director of the Office of Management and Budget, uses the Aluminum market to illustrate his point:
The vast bulk of the aluminum price changes can be explained by physical supply-and-demand factors, such as the cost of energy, opening of new supply basins at higher marginal costs and the increase in demand from China. At the same time, however, financial markets have become significantly more interested in aluminum. Over the past five or so years, trading in the material has roughly doubled. Daily volumes on financial markets are now 10 to 20 times the physical consumption of aluminum — and market participants hold contracts that represent about half of world consumption, a large share even compared with other commodities.
A reasonable conclusion from all of this is that fundamental supply and demand drive aluminum prices most of the time, but that financial flows (including index funds) can, over brief periods, exert a noticeable destabilizing effect — especially when inflows change rapidly.
The aluminum market thus suggests a broader conclusion, which other evidence indicates also holds for the price of food and other commodities: The Friedman principle of stabilizing speculation is not always right.
Excessive speculation has increasingly come under fire recently with surging gas prices and their significance for the 2012 Presidential election.
Read the full article here.