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Bubble machines still going strong

business Updated: Nov 07, 2011 21:40 IST

The markets are a-changing. It is no longer the supply and demand that sets prices. More likely it’s supply and demand for the futures, swaps and derivative instruments linked to those things.

In the past decade, hundreds of billions of dollars have flooded into the commodities market, largely through swaps contracts and commodities index funds, ETFs and mutual funds.

These markets have long outgrown their original function of providing producers and consumers of these commodities with a way to hedge their risks by guaranteeing supply and locking in prices.

All futures markets require a certain number of “speculators” to take the other side of the contracts from commercial users and producers. Typically, speculators would represent 30% of market.

But today, because of a sudden desire to earn higher returns and diversify investment portfolios, there are more people wanting to invest in corn and copper and oil than there is corn and copper and natural gas produced and consumed. And speculators typically account for 70% or more of the market.

The strong demand for commodities futures has put upward pressure on the actual prices paid for those commodities as many private sales contracts are settled at a price linked directly or indirectly to futures prices.

Earlier this year, the chief executive of ExxonMobil, Rex Tillerson, estimated that speculation was then contributing an extra $30 a barrel to the price of oil.

What’s clear from this tale is how little the financial services industry has really changed since the crisis of 2008. The financialisation of the economy continues undeterred, creating a bubble in commodities just as it did with houses and office buildings. The industry is still engaged in clever games to circumvent regulation. And when regulators step in, they inevitably run into a political buzzsaw created by the industry and its Republican allies.

(In Exclusive Partnership with The Washington Post)