Lesson From History: How to stop speculators driving up commodity prices

[Pab Sungenis]

Back in the late 1970's, Nelson and William Hunt, commonly and collectively known as the "Hunt Brothers" had an audacious scheme: they wanted to corner the market on the world's silver.

The actual mechanics of the process are confusing to people who don't understand investment strategies, but here's the "For Dummies" version: It was a common practice back then (and to a lesser degree still is now) for speculators to buy futures contracts, agreeing to purchase a commodity on a certain date at a certain price, then sell them to others later on. If the price had gone up, then they could sell the right to buy to someone else for a profit. If the price dropped, they would have to buy at the higher price.

The Hunt Brothers, however, had an idea. Instead of just re-selling the contracts, they decided to actually purchase all the silver that they had contracted for, and demanded delivery. Funny thing: almost none of the people who had written the contracts actually had the silver in their possession; they had just been trading paper back and forth. They had to go onto the open market and buy silver at any price to meet their contractual obligations. Increased demand drove prices higher and higher. Before long, the Hunts actually owned nearly a third of the world's silver supply and prices were at an all time high of almost $50.00 an ounce.

So what happened? It was a combination of things. First, the ridiculously high buy prices for silver brought a lot of the metal out of hiding, letting people sell old silver coins for around 40 times their face value for example. This increased supply started putting pressure on the high prices. Then the markets intervened, changing some of the rules on speculators. Finally, the Fed dumped a lot of silver from government stockpiles onto the market driving the prices through the floor. On Silver Thursday (March 27, 1980) the Hunts were unable to meet a $100 million margin call on their contracts, and were financially ruined. The whole scheme fell apart, and silver finally plunged back to $10.00 an ounce. The speculators who had banked on the price continuing to rise were ruined.

Now, almost thirty years later, the speculators are at it again, but this time the economic effects are much more devastating. When the Hunts drove precious metals through the roof (since gold also skyrocketed to record highs as speculators bought up gold futures in conjunction with silver futures) the hardest hit parts of the economy were mainly the electronics, jewelry, and photography industries. Speculation in petroleum, however, has sent economic spikes into every sector since we are so dependent on oil and gasoline. Food prices are jumping like monkeys because of shipping costs and petroleum based fertilizers. Electricity costs are rising, which will impact all sectors of manufacturing driving all other prices higher. And let's not even dream about what heating oil prices will do this winter.

The time to act is now, and we have a precedent to follow. The Hunt Brothers fiasco showed us the way. Here's how we should smash these speculators once and for all.

1: Give speculators less incentive

The main cause of the speculation spike is the whole question of stability in the oil fields. Our invasion of Iraq and constant threats of invading Iran have disrupted delivery of oil and threaten to make the situation worse. This makes prices more likely to rise in the future, so the speculators are encouraged to buy oil futures at what they hope will be a lower price than the actual price when they are called in. Drastic changes in our foreign policy and stabilizing the situation in Iraq and Iran will reduce the threat of delivery disruptions, lowering the price somewhat.

2: Decrease demand

We're wasting billions of dollars' worth of oil in Iraq right now. Curtailing our military activities, even if we don't pull out completely, will conserve a lot of oil and decrease demand, putting less pressure on prices. At the same time, the government has been buying petroleum at these inflated prices to pump into the Strategic Petroleum Reserve (SPR). If the Bush Administration carries through on its promise to stop filling the SPR to the brim, that will also help reduce artificial demand and lower prices a little bit.

3: Smash the speculators

In 1980, Paul Volcker and the Fed dumped so much silver on the market that there was way too much out there to meet demand, and prices plunged. We need to do the same thing now. President Bush should go on television and announce that the government will immediately start selling half of the petroleum in the SPR, dumping the oil at the maximum withdrawal rate of 4 million barrels a day for the next 90 days. The sudden guaranteed availability of petroleum will drive prices through the floor as the supply-to-demand ratio is turned upside down, and smart speculators bailing out of the market as fast as they can will further reduce prices. If we're joined by other major nations with large petroleum reserves (like Japan), the effect will be even more widespread. Then we will be able to take the money the government gets from selling at higher rates, and once again rebuild the SPR as prices stabilize back at actual market levels.

Of course, the long term answer is to wean ourselves off of the teat of petroleum through renewable resources and alternative energy sources, but we don't have time to wait. While we need to increase investment and research, we have to stop the damage that speculators are doing to our economy now.

[Fumesucker]

1. Interesting analysis..

Probably correct, IMO..

Too bad Bush would never do such a thing, it would upset his base.

[Pab Sungenis]

2. If that's the case

then this will have to be item #1 on the new President's desk in January.

[truedelphi]

3. I remember those high priced silver days

I bought several relatives some silver coins that were guaranteed to keep going up in value.

Not long after that...

[BeFree]

4. Good idea

Teach those pirates a lesson.

Of course we will have to wait till next year, and in the meantime...ouch.

Funny how bushco went to Saudi Arabia and appeased them on their oil price gouging, eh? And what did they do? Sent him home without anything to show for his appeasement.