In defense of Goldman Sachs

If that title doesn't catch your eye, I don't know what will. Goldman-bashing is all the rage these days, and rightfully so. They got preferential treatment during the financial crisis, they sold people things that they knew were worthless before the financial crisis, so they could themselves short them. Lloyd Blankfein thinks he is "doing gods work" as he plays crony capitalist of the month, every month. The list goes one.

But there is one thing that Goldman Sachs has been accused of which is not true. It is claimed that they have driven up prices by creating commodity trading vehicles. This is blatantly false, and anyone pushing this theory has no understanding of economics whatever. You cannot push up commodity prices just by making it more widely tradeable through modern financial inventions like ETFs, index options etc. This is a lie thrown out by old commodity traders who are pissed off because regular people have gotten the tools necessary to trade the markets, while they used to be the only ones with access to the futures pits.

To every transaction there is a buyer and a seller. The charge against Goldmans commodities products is that they create "artificial demand", by pulling in people who do not have a commercial interest (hedging) these commodities, but just want to speculate in the prices. We hear the same thing about how "speculators are starving people in poor nations through higher food prices". This is nonsense. While new vehicles to trade commodities do in fact create higher demand for commodities, they simultaneously create higher demand for the opposite transaction, namely SELLING commodities.

People talk about the "goldman roll", when all speculators shift their futures positions (since they do not want to actually take delivery of a truckload of coffee, wheat, or whatever). The claim is that this artificially pushes up the prices of next months futures by everyone piling in at the same time. And while this is true, it simultaneously means that there is an equal amount of SELLING for the month that is being rolled out of.

To put it simple : Speculators may temporarily move prices, but unless they all take delivery of their contracts, they will move prices in the other direction as they are forced to find someone who will take delivery, and is willing to buy their position. In fact - the only reason we have futures trading markets is because they fill an economic purpose - namely evening out market movements. This is the opposite of what you are told, but it is the truth, and the reason it works is simple : The more participants you have that trade in a market, the smoother the moves, since there is never a lack of either seller or buyers. Simultaneously, it creates a "safety valve"-mechanism, because there is always a large number of people either short or long. If a price of for instance an agricultural commodity shoots up because of a bad harvest, bad weather or some other worldly event, there is always a large number of participants that will take profits on their contracts once the price reaches a certain level.

To illustrate why speculators do in fact prevent catastrophic price moves, look at the financial crisis. Short selling was prevented, which meant there were no short-sellers covering their positions (at large profits) on the way down. That meant that buyers of financial stocks completely disappeared, and thus you get the manic 10+% price swings. Of course, the financial stocks would still have gone down to an equal amount, but by including large numbers of speculators, some of which will speculate that the bottom is in, and some that speculate that there is further downside you will even out the curve.

There is an old ZeroHedge joke about Waddell&Reed, because their selling of a minor amount of SP500 shorts during last years "flash crash" became the official explanation of what happened that day. This joke clearly shows the low level of understanding that exists of how markets work. True - if someone pushes a gigantic pile of bets onto the market, this will push it down. But there will always be people that will start speculating where the bottom is, and they will all choose different levels. Whether they are right or wrong decides if they get a profit or a loss, and thus you have a scenario that benefits those that can make correct bets, and punishes those that cannot. This is in essence what makes markets efficient.

So while Goldman Sachs are probably guilty of most things they are charged with, and a billion of other things they haven't been charged with, they are not guilty of pushing up agricultural prices by creating vehicles for investing in commodities (one would have to imagine a vast conspiracy of farmers to even make sense of this claim). The responsibility of higher prices lies solely at the Federal Reserve. And currently, we are experiencing the exact same thing that happened in 07-08 : People are speculating that the FED will destroy the dollar, and thus make everything enormously more expensive. If they are right, they will have prepared regular people for higher prices before it happened. If they are wrong, agricultural prices will collapse and they will take the loss.

Markets work because there are large numbers of participants with different thoughts and ideas regarding the prices of things. Claiming otherwise makes you either an imbecil, a commie or a regular media douche-bag.