Return to mass destruction?

The U.S. Congress last week passed next year’s budget bill just hours before the deadline to avoid a government shutdown. And this week the price of West Texas Intermediate crude oil, a benchmark for oil pricing, dipped below the symbolic threshold of $60.

Both are good news for Korea - but not entirely so. Oil prices, for instance, have been volatile for most of the last 15 years. Oil cost over $140 per barrel before the Wall Street meltdown in 2008, more than 12 times the lows of the late 1990s. After the spread of the financial crisis, prices were slashed by more than a third to reach below $40. When the global economy improved slightly, they jumped three-fold. From late 2010 and the summer of 2014, prices hovered between $80 and $120. They are now half that.

The price swings can’t be explained in the simple terms of demand and supply. Many attributed price rises to China when it was growing by a staggering pace before the financial crisis in 2008. But petroleum demand by China in the 2000s increased from 5 million barrels a day to 8 million barrels - which can’t account for a 10-fold spike in international prices. Oil prices collapsed over the last six months even though the global economy wasn’t doing so badly.

Speculation is blamed for such wide fluctuations in oil prices on top of the supply and demand factor. Advances in the options and derivatives market turned oil into a commodity that relies on investor sentiment as much as real market forces. Such a phenomenon does not apply to oil alone. Grain prices fluctuate as a result of speculative forces, causing food crises in many poor countries.

Price volatility in staple commodities like oil and food from movements in derivatives instead of real markets can cause ill effects throughout the global economy.

Price swings in primary commodities like oil and grains make economic policies difficult for producer countries. As food riots in 2008 demonstrate, price upsurges can roil poor countries and fan inflation in richer ones. Meanwhile, a downward spiral in the prices of those commodities can bring financial squeezes to vulnerable economies like those of Russia and Venezuela and depress oil-money investment by Middle East countries.

What does U.S. congressional approval of next year’s budget have to do with financial speculation? The budget bill was expected to pass in the Republican-led House of Representatives without major hiccups because it was a collaboration between the White House and leaders of the Republican Party. But a wrench was thrown into the process by some Democrats who opposed the easing of some financial regulations in the bill.

The Dodd-Frank Wall Street Reform and Consumer Protection Act had been signed into federal law in 2010 to tighten financial regulations and oversight following the Wall Street meltdown. It contained a provision that forces banks to spin off derivative trading activities into units that are not eligible for federal insurance on bank deposits and emergency loans. The idea was to protect taxpayers from having to bail out banks as they did in 2008.

Wall Street, which kept a discretely low profile after the meltdown, began to lobby to ease the restrictions on banks and succeeded in persuading Republicans to package the change in the bill, which was needed to be passed in order to prevent a government shutdown. The move drew strong opposition from some Democrats. But the government at the end had to compromise in order to get its needed federal funding.

Financial guru and billionaire Warren Buffett likened derivatives to “weapons of mass destruction.” He may be right when we look at the catastrophic subprime mortgage crisis in 2008 and roller-coaster price swings in staple commodities that have followed.

Assets are dangerously overpriced in the global economy because advanced countries like the U.S. have pumped so much money into assets in order to revive their economies after the global meltdown instead of tending to economic fundamentals. We may have to be on the lookout for an unwelcome old specter - crazy speculation in derivates - thanks to a deal in Washington.

Translation by the Korea JoongAng Daily staff.

JoongAng Ilbo, Dec. 18, Page 35

*The author is a professor of economics at the University of Cambridge.

By Chang Ha-joon