Tuesday, July 15, 2008

Hanke on Commodities

"Scary rice and oil prices have sent politicians to their bag of tricks. Not surprisingly, they have pulled out one that has been a staple since the Middle Ages: blame the speculators and hoarders. But the politicos should be pointing fingers at themselves. ... A notable proponent of commodity buffer stocks was John Maynard Keynes. ... He recommended that governments use buffer stocks to smooth out price fluctuations by purchasing commodities when prices were thought to be low and selling them when prices were thought to be high. Not suprisingly, this buffer-stock variant of 'Father knows best' has not worked. For one thing it assumes that government bureaucrats possess the same knowledge of market fundamentals and face the same incentives as well-financed, farsighted private traders. It also assumes that politics will not raise its ugly head. ... Now that Japan wants to unload some of its rice, opposition is flaring up in Washington and other capitals, claiming that re-exports are not allowed under the [WTO] agreement. When it comes to filling or releasing government stockpiles, politics clearly rules the roost. ... How would an oil (or rice) bank work? The government would sell out-of-the-money call options on its stockpiles. It might, say, sell December 2008 call options with a strike price of $200 a barrel", my emphasis, Steve Hanke (SH) at Forbes, 30 June 2008.

I agree with SH's analysis and apply it to the credit markets. Don't Fed traders buy and sell bonds? Don't traders at Goldman, Merrill, etc., do that too? Why believe Fed traders are smarter than private traders? Uncle Miltie said this over 30 years ago. In 1978 I read a book (I know, last one) by Adam Smith (AS), On the Theory of Moral Sentiments, 1759. Unlike Wealth of Nations, 1776, this book is obscure. After reading it I became curious about AS's life. AS was a Presbyterian. Some sources say he was a minister. When I discovered this I realized whose "invisible hand" AS wrote of. It was AS's way of saying the market, was God's way of organizing human activity. We don't need to sell call options on oil. We need the government to reduce its interference with the markets.

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