Re: Martin Feldstein — The Fed Should Stop Helping Commodity Speculators?

In The Wall Street Journal on April 15, Martin Feldstein of Harvard took a position between Makin and Chapman, saying the Fed should have left the federal funds rate at 2 1/4%, because a lower rate would cause “rising food and energy prices.” Feldstein told The Guardian the dollar had to fall further on April 11, so the link he envisions between Fed policy and commodity markets is not through exchange rates (I’ll discuss that in a later post), but just upside speculation alone:

Lower interest rates induce investors to add commodities to their portfolios. When rates are low, portfolio investors will bid up the prices of oil and other commodities to levels at which the expected future returns are in line with the lower rates.

But investors go short as well as long–betting the price will fall– and they can use credit for that too.

The only reason to make a leveraged bet that the price of oil, gold or corn will go higher is if you expect the prices to rise by enough (during the holding period) to exceed the interest expense.

Ignoring trading costs, if you can borrow at 5% to invest in something whose price is expected to rise by 8% that may look like easy money. Yet oil futures are cheaper than near-term spot prices, and gold has recently fallen by about 13%, so momentum trading is dangerous. It is properly called “greater fool investing” – just like paying too much for a Las Vegas condo on the assumption that some greater fool will later pay even more.

It seems unlikely that today’s quarter-point cut in the fed funds rate will result in lower margin rates for commodity traders. But even if it did that is not nearly enough to make a significant difference for more than a day or two.

U.S. politicians seem equally angry with upside “speculators” and downside “shorts,” but it is the contest between the two that constantly gropes for the right price.

I am shorting oil through an exchange-traded fund (DUG), and shorting precious metals through a mutual fund (SPPIX). I’m also slightly long the dollar (UUP). Don’t try this at home without a net. But if I win those bets, the world economy wins too.