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As a result, Easterbrook and Pirrong argue that it is possible to detect manipulations with very high probability aer the fact, and additionally, that wrongful accusations of manipulation are easily shown. Moreover, since manipulators necessar- ily require large nancial resources to accumulate large derivatives positions, they typically have the wealth required to compensate those harmed by the manipulation. us, the conditions for ex post deterrence are almost optimal for derivatives ma- nipulation.

Indeed, this is true even in the allegedly scary “dark” OTC markets. For example, consider events in the propane market in 2004. Propane was traded almost exclusively OTC and was one of the most obscure, darkest corners of the OTC energy markets. Energy giant BP squeezed the propane market in February 2004 and market participants noticed. Since somebody is harmed by price distortions, somebody always notices a manipulation; as Judge Easterbrook has written, the undetected manipulation is an unsuccessful manipulation. In this case, the government also noticed and prosecuted BP criminally. BP entered into a deferred prosecution agreement under which it admitted guilt and agreed to pay tens of millions in nes and restitution.

Unfortunately, as shown by Pirrong (1996, 1997), courts and regulators in the United States have routinely made mistaken judgments in manipula- tion cases. As a result, they have undermined the ecacy of ex post deterrence, including legal ac- tion by regulators and by private plaintis.

Whereas market manipulation is a source of le- gitimate concern, excessive speculation is the

subject of much thoughtless and misguided analysis. Whenever prices rise or fall dramati- cally, speculators are routinely blamed for causing prices to deviate from the levels justied by mar- ket fundamentals. ese arguments are typically based on severe logical fallacies and usually de- void of evidence. For instance, during and subse- quent to the oil price spike of 2008, it was widely asserted that purchases of derivatives by specula- tors introduced additional, spurious demand into the market, thereby driving prices above the level justied by fundamentals.

Such arguments are predicated on a serious mis- understanding of how derivatives markets work. Most buyers of futures contracts sell without tak- ing delivery, and others who enter into derivatives positions that prot from higher prices utilize contracts that do not permit them to take deliv- ery at all.6 us, these speculators do not typically demand the physical commodity, and indeed are selling claims on the physical commodity as expi- ration nears. us, if their buying prior to expira- tion tended to cause prices to increase, their sell- ing at expiration would tend to have the osetting eect.7

If speculators were indeed to cause prices to rise above the level justied by fundamentals, they would end up owning large amounts of the actual commodity. If they are willing to pay a price that exceeds what other market participants believe is justied, those other participants would be more than willing to sell the actual commodity to them.

  • us, when looking for evidence of speculative

distortion in prices, it is necessary to look not at prices alone, but at speculative holdings of the physical commodity.

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So-called “cash settled” or “nancial” derivatives contracts do not permit the buyer to take delivery. Instead, they make cash payments to buyer and seller based on a formula that utilizes prices from other contracts, usually a delivery settled futures contract. In essence, nancial derivatives are “bets” on prices, although they can be used to hedge other risks.

  • is has long been recognized. For instance, disputing the theory that “speculation in futures is an organized attempt to suppress prices to

producers,” the United States Industrial Commission noted: “First. Because every short seller must become a buyer before he carries out his contract. Second. Because, so far as spot prices are concerned, the short seller appears as a buyer not a seller, and therefore, against his own will is instrumental in raising prices.” United States Industrial Commission (1901).

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