Politicians can influence oil markets over the short term and long term in many ways

Politicians can move markets by talking about how they want to change markets and by enacting legislation that drastically distorts them.

Think ethanol. Politicians decided that corn-based ethanol would be a great subsidy program for farmers, that it would reduce America’s dependence on foreign oil producers, and most important for most presidential candidates over the last 15 to 20 years, that supporting government subsidies for corn based ethanol would help them win Iowa primaries.

So we have the very flawed ethanol subsidies, and of this year’s presidential candidates, only Sen. John McCain opposes those subsidies today.

But the politicians forgot that corn is used to feed livestock and poultry, and that diverting 25% to 30% of American corn production to ethanol would reduced supplies of corn needed to produce food. As a result, food prices are soaring around the world.

As a result, voters, and therefore,  politicians, are changing their minds about ethanol. After this year’s elections, the backlash against ethanol may result in reduced government subsidies for ethanol and corn prices. The long-term outlook for corn prices is not as bright as it was only a few months ago.

Politicians have had a big impact on agricultural markets for decades, and when they talk about those markets, they move them.

Barron’s apparently doesn’t get it.

In his urgency to defend oil speculators, Barron’s Randall Forsyth mocks politicians who think they can talk down the oil markets.

In Washington, the Democrats are talking about reducing the impact of institutional speculation on the oil and other commodities futures markets. And they’re trying to enact legislation that would do just that. The markets are responding as if the legislation were a sure thing, which it’s not, because President Bush may veto it. But the Democrats’ power seems to out weight the president’s at the moment, and the market psychology is that they could win their way ad take 10%, 20% or even 40% off the price of oil.

Is this the only reason oil prices have plunged recently? No, but it’s having an impact. Whether that impact will be short term or long term depends on what happens with the anti-speculator bill as well as on changes in supply and demand created by recent high prices and politicians around the world.

In defending oil futures speculators, Forsyth clearly doesn’t understand how the futures markets are inflated by institutional speculators, which I’ve explained here and here.

In his online column, “Deluded pols think they run markets,” Forsyth’s impact graphs are:

“Undoubtedly, Congress will take credit for scaring bulls out of the crude-oil pits. They don’t deserve it,” writes Ed Yardeni, chief strategist at Yardeni & Co. “The (relatively) free market is working. Record high oil prices have depressed demand, which is bringing the price of oil down to a level that consumers can live with.”

Yes, supply and demand have a huge impact on prices. But speculators also have a big impact as outlined in the articles that I’ve linked to. And when politicians talk about curbing institutional speculators, authorizing offshore drilling, promoting $8 a gallon gasoline, increasing or lowering taxes or subsidies, they can affect markets.

During the last few weeks we’ve seen the politicians in Washington and around the world trying and in many cases succeeding in manipulating currency, money, credit and commodities markets, which have reacted and are reacting accordingly. Certainly, politicians don’t always get what they want, but the mere fact that some of them have the ability to create mischief gives them power over market psychology.

Yardeni and Forsyth need to do their home work. They need to read some of the testimony from commercial hedgers who are seeing the futures markets distorted by pension funds, hedge funds and index funds, most of which only buy futures. And they need to review the histories of so many markets that have been distorted by politicians in America and abroad.

They should talk to people who don’t work for the Wall Street funds, pension funds, index funds and other organizations that make billions helping institutional speculators inflate and distort the futures markets.

Should politicians be manipulating markets?

No. But they do and that reality has to be recognized along with the impact of prices on the supply of demand for oil, agricultural products and about anything else that’s traded.

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