The biggest bubble of all time: commodities market speculation

Photo by Lars Plougmann via flickr

By: L. Randall Wray

Back in the fall of 2008, I wrote a piece examining what was then the biggest bubble in human history.

Say what? You thought that was tulip bulb mania? Or, maybe the NASDAQ hi-tech hysteria?

No, folks, those were child’s play. From 2004 to 2008, we experienced the biggest commodities bubble the world had ever seen. In 2008, I wrote:

“According to an analysis by market strategist Frank Veneroso, over the course of the 20th century, there were only 13 instances in which the price of a single commodity rose by 500 percent or more…Now, if we look at the current commodities boom, there are already eight commodities whose price rise had reached 500 percent or more by the end of June: heating oil (1,313 percent), nickel (1,273 percent), crude oil (1,205 percent), lead (870 percent), copper (606 percent), zinc (616 percent), tin (510 percent), and wheat (500 percent)…There is no evidence of any other commodities price boom to match the current one in terms of scope.”

Over the spring and summer of 2008, the Congressional staffs of Senator Joe Lieberman and Representative Bart Stupak held a series of hearings to look into whether the bubble could be blamed on normal “supply and demand.” But upon examination there was no doubt this speculative bubble was driven by pension funds.

When this came out, pension funds panicked, realizing that their members would hold them responsible for exploding prices of gasoline at the pump. Pension funds withdrew one-third of their funds and oil prices fell from about $150 per barrel to $50, and this bubble popped in the fall of 2008.

But the investigation got sidelined as the financial crisis wiped out real estate markets and the economy, and sent America spiraling into the recession. As the crisis atmosphere cooled, managed money needed another bubble to recover. And so, Wall Street whipped up irrational fears of hyperinflation that supposedly would be caused by Helicopter Ben’s (Bernanke) QE1, QE2, and the newly announced QE3. Better run to good “inflation hedges” like gold and other commodities. That did the trick. The commodities speculative bubble resumed.

And boy, oh boy, what a boom it was.

Quite simply, this boom is unprecedented in any market; nothing (including hi tech bubbles and real estate bubbles) can even come close.

Yes, commodity bubbles happen, but usually the truth sets in and brings the price back down to reality. But this time, the boom just kept on going.

But wait a minute. The standard deviation of price rises for iron coal, copper, corn and silver sorghum, palladium, and rubber, flaxseed, palm oil, soybeans, coconut oil, and nickel, and so on down through jute, cotton, uranium, tin, zinc, potosh and wool are so unlikely that they quite simply could not have happened individually. The likelihood that we’ve got a boom in almost all of the top 33 globally traded commodities is so unlikely as to be impossible.

But happen it did.

The reason for this was financialization. Just as homes became financialized (in many ways, including serving as the collateral for the deadly “ATM” cash-out home equity loans), commodities became thoroughly financialized.

Believe it or not, commodities markets are tiny; except for soy, oil, and corn they are smaller than tiny. Managed money is huge—tens of trillions of dollars floating around the world looking for high returns. US pension funds alone are three-fourths of US GDP–$10 trillion give or take. If you put even a fraction of managed money into commodities index funds, you blow up the prices.

Now, what do we have to look forward to as a result of this huge bubble? An epic explosion, or what Frank Veneroso calls a commodities nuclear winter.

As prices rise, consumption of the commodities falls (as we are already observing) both through substitution and through conservation. At the same time, additional supplies come on line. Real world suppliers feel the imperative to slash prices to have some actual real world sales. They cannot forever live in never-never land with rising prices and collapsing sales.

The pieces of this nuclear winter we can look forward to are a commodities crash, a default or two by a periphery European nation, the failure of a European bank, or the closure of Bank of America or Citi. That will generate the return of the Global Financial Crisis with a vengeance. All of these are likely events; and probably all of them will happen within the next year.

No matter what the triggering event is, the bubble will pop and a commodities nuclear winter will happen; at this point sadly, the only question is when…

The original version of this post can be read at http://www.economonitor.com/lrwray/2011/09/22/the-biggest-bubble-of-all-time-commodities-market-speculation/

L. Randall Wray is a Senior Scholar at the Levy Economics Institute of Bard College and Director of the Center for Full Employment and Price Stability at the University of Missouri, Kansas City.