June 10, 2008 — iancjclarke

Just listening to CNN, one of the talking heads listed speculation in the oil markets as one of the reasons for high oil prices, the implication being that the situation would be better without speculation.

Let’s be clear about what speculation is, it’s people buying oil today, betting that its price will increase in the future, and in doing so they make the price increase today.

I would argue that speculation is generally a good thing, because it tends to make the future happen sooner than it otherwise would. In other words, speculation is capitalism’s foresight, it makes the markets try to predict the future, and adapt accordingly.

Of course, sometimes it can get out of control, where people start to speculate based on predictions that are themselves the result of speculation – as with various bubbles over the years, causing behavior that may be rational at the individual level be irrational at the group level.

In this case though, I think the high oil prices are likely to do what no amount of regulation would ever do in the US – which is to force people to find ways to use less oil, to force them to change their behavior.

Most people don’t like to be forced to do anything. A change of career can mean retraining, and sometimes a pay-cut. A change of location means a lot of effort and money to move your stuff, not to mention waving goodbye to your social circle (something I’m painfully familiar with). A change in your company’s expenses can mean lower revenues until you figure out a way to compensate, and that may cost money.

Nonetheless, change is often necessary. The alternative, which often involves protectionism or other forms of government manipulation of the market, tends to delay rather than prevent change and exaggerate the eventual trauma when it happens. Look at the British miner’s strikes in the 80s for an example of this.

Speculation, on the other hand, will tend to force change earlier than it might otherwise occur, and often make it occur more gently. In the US, the high oil prices already have the automobile manufacturers scramling to catch up with their Japanese and European counterparts in-terms of fuel efficiency, something that can only be a good thing for our long-term future.