

There are many obstacles to taking action on climate change. Most of those obstacles have deep roots: there are powerful interest groups that don’t want market prices to reflect true costs, and there are ideologues — financially supported by these interest groups — who don’t want to admit that sometimes the government has to intervene.

But there’s also, it seems, growing opposition to cap-and-trade from people who should be on the side of progress — but whose reaction is basically “Eek! Markets!Wall Street! Speculation! Bad!”

We don’t need this.

So let me talk a bit about why this reaction is 99% wrong, and bad for the planet.

Any time you have a market, there’s some opportunity for speculation. Even if the good being traded isn’t storable, there may be a futures market, so you can bet on the future price. If the good is storable, the spot price may be moved by the futures market, since high futures prices may provide an incentive for stockpiling.

For example, the fact that wheat is traded means that there’s also a wheat futures market; and because wheat can be stored, futures prices affect spot prices.

So, should fear of speculation lead us to ban trading in wheat? Nobody would say that. Yes, sometimes speculators will get it wrong — but the advantages of having a wheat market vastly overshadow the possible harm that may sometimes come from speculation.

Now substitute “emission permits” for wheat. It’s exactly the same story. Why should you address it any differently? Yet as Joe Romm tells us, Sen. Byron Dorgan — who I suspect kind of favors allowing the market in wheat to operate — warns against cap and trade because it would offer too many opportunities to the “Wall Street crowd.” And that same line is, unfortunately, being echoed by a number of progressives.

This is really bad — it’s not a case of the perfect being the enemy of the good, it’s a case of the perfect being an enemy of the planet.

But wait — don’t we have examples of energy markets being manipulated by speculators? Yes — but the proposed cap-and-trade system would NOT reproduce the conditions of those markets.

The prime example of an energy market gone bad is the western electricity market in 2000-2001; and let me say that I have some moral authority here, since I called it when it was happening. That was the real thing — but what made it possible was a combination of at least two factors. First, the demand for electricity was highly unresponsive to prices; second, the relevant markets were fairly small (northern and southern California were isolated both from the outside world and from each other by transmission bottlenecks).

In the case of emission permits, demand will probably be quite responsive to prices — and the market will, as Joe Romm says, be huge.

What about the 2008 surge in commodity prices? Actually, I’m still of the view that speculation didn’t drive that episode — a view backed by serious research. But even if you think that there was a speculative bubble, would that lead you to propose shutting down the market for crude oil?

By all means keep a watchful eye on speculators and regulate derivatives — and make market manipulation illegal, as Waxman-Markey does. But don’t apply standards to emissions trading that you don’t apply to any other market.


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While people claim to be afraid of the “Wall Street crowd”, I would bet that they are really afraid of an open market and enviornmental groups. I mean, what would prevent environmental groups from buying credits and not using them? I’m sure that scares a lot of big industry folks.

Is it possible, despite the legality of it, that some ideologically driven person or group might attempt to manipulate the market to “prove” a point? I think a very close eye would need to be kept on this.

Re: Cap and trade and other democrat dilemmas, David Brooks describes Krugman perfectly:


Prof. Krugman refuses to meet the many challenges that have been posed by his bloggers who know that no science at all support the hypothesis that human CO2 emission will have a significant impact on global temperature. Further, he refuses to admit that EVEN IF the CO2 hypotheses were correct, that the cap-and-trade bill does absolutely nothing to mitigate the problem. Krugman has instead corrupted the public discourse on science policy by disseminating junk science as if it were fact (no, computer models that ignore cloud formation and biosphere fixation of CO2 cannot predict global temperature in 50 years), using ad hominems as the basis of his attacks against those who understand climate science (calling them traitors, fanatics, and deniers), and refusing to post blogs that outline the facts. This is shameful, for Krugman and the New York Times.

This is one of your best blog entries in a while, and I hope you expand it into a full column. The financial crisis tells us to scrap our blind “free-market” ideology. It does not tell us to scrap markets entirely.

Matthew G. Saroff July 21, 2009 · 10:33 am

Actually, the worry is not about speculation, but about speculation swallowing up the original purpose of the market.

Look at the CDS market for that.

A simple solution is a tax, on the order of 2% or so, on all transactions but the initial purchase of a carbon permit, and on ALL FINANCIAL INSTRUMENTS WHICH ARE DERIVED FROM THOSE PERMITS.

For the people who need the permits, it’s a minor cost, but for heavy speculators, it’s a killer.

What happens when speculative financial markets buy these up, hoard them so they’ll become scarce, artificially grow them in value and sell them off to the highest bidder. It becomes an expensive cost of doing business for the big polluter and drives the smaller business out of the market and out of business.
When do we stop creating opportunities for bubbles to occur?

The problem with speculation on this issue is basically the same as the one on Healthcare.
Profits and Wall Street interests drive the policies,
now Mr Krugman, do you want to leave the future of this planet in the hands of traders or would scientists driving the policies be a better deal?
Every issue seems to be too complex for command and control these days; could it be that we don’t really have anybody at the controls, and using the complexity argument is risible Paul, we are talking about a crowd that created a system they don’t really understand anymore.
Listening to Congress discuss global warming, their pockets full of lobbying money, is also funny; same kind of red/blue speculation that leads nowhere.
We need leadership.

How well does this important story reflect recent behaviors? Let’s see . . .

So-called free-market advocates being completely hypocritical? Check.

Main-stream-media parroting these sudden anti-market sentiments without noting the hypocrisy, or even irony? Check.

Powerful interests “guiding” the story with lobbying and advertising? Check.

Professor Krugman (and a couple others) blowing the story wide open, and yet being ignored? Check.

We’ll be lucky if the story gets as far as Ira Glass on “This American Life” or Jon Stewart’s “The Daily Show”.

Sounds like Paul read the Taibbi article in Rolling Stone. I agree that a market-based cap and trade approach is likely the bst approach. At the end of the day the ‘cap’ part is really the more important piece. It is a little frustrating however when it seems like nothing good can hapen unless the invisible hand gets it’s 10%.

Market manipulation is already illegal. But it is almost impossible to prove in a court of law.

Excellent post; two thoughts. What about the fact that this market (unlike all others?) will begin with a finite amount of carbon credits to trade which will decrease over time by law? Doesn’t that make it much more likely that it will be subject to all sorts of non-illegal manipulation, i.e., buying and selling for profit maximization to the detriment of industries needing the credits?

Also, do you really believe that a market created from whole cloth is better than just taxing carbon directly and using the proceeds to help those consumers and industries that are hurt the most while also financing new technologies? Isn’t it just the fear of raising taxes that prevents doing directly what the created market mechanism will do indirectly? And, hasn’t the last year or so properly caused us to be highly skeptical of the markets’ ability to properly allocate resources and capital to any end other than enriching the few well positioned financial intermediaries?

I fully agree what’s at stake demands action and the fact someone somewhere will make money off a regulation system isn’t in and of itself an intolerable side effect, however, I’m still confused as to why a cap and trade system to deal with carbon emissions is a superior solution to a carbon tax given the risks of regulatory capture. Is this purely a case of trying to avoid the ire of those who cry foul whenever taxes or tax increases are mentioned?

What about reducing carbon in a manner which is not prone to speculation, i.e. higher prices at the pump through gas taxes?

I would guess that many economist,myself included, would support a “pure” bill that truly represented what cap and trade is.

The problem is after it passes through the house and senate the bill does not do what it was intended to do. Large corporations will have lobbied for much larger pollution allotments and politicians will have bloated it up with a bunch of “add ins”.

At the end of the day it will allow large corporations to pollute more, penalize small and medium size buisness and put alot more money into the hands of our “leaders”.

I would guess that most of us do not disagree with you on the fundamentals just the actual application of the fundamentals through our goverment processes.

The RGGI market here in the Northeast seems to be behaving ratinonally – CO2 emissions will likely be below the cap in 2009-2011, and the clearnace price has fallen.

Besides the possibility of speculation, there is a danger that with the right to emit suddenly becoming a scarce resource, the wealthy will be in the best position to pay for (directly or indirectly) emissions permits and so the less well-to-do will face a bit of a dirty energy shortage while the wealthy can afford to keep using the same amount of the stuff. Of course, this is not likely to begin happening for years after the program starts four years from now, and there are predictions that by then solar will be at grid parity anyway so a big part of the “cheap, clean energy” worry will be resolved, but it’s still something to keep in mind. In any case, auctioning all the permits and using the revenue to reduce payroll taxes or otherwise benefit the lower and middle class would probably help mitigate this inequity.

The bottom line is that emissions need to be capped, and cap-and-trade obviously does that. The trade part is simply a way to distribute this newly-scarce resource. It’s not perfect, but it’s exactly the way the rest of our imperfect economy works–even for life-or-death things like medical care–so those who support the existing marketplace shouldn’t have any reason to oppose the trade part of cap-and-trade.

It is a specious argument that preventing a derivatives market on carbon will prevent a cap on carbon. Carbon can be capped and traded amongst actual carbon “consumers” without ever involving speculators and without the creation of a derivatives market. The United States can auction off carbon credits for multiple future years the same way they auction Treasury bonds. Then we will have “the market” telling us what their best estimate for future carbon prices will be, leading to the change in behavior necessary today.

It is a fallacy to believe that Wall Street must be involved in order for a true market to be created. Their involvement is not necessary (and probably counterproductive) when it comes to the actual reduction of carbon emissions.

On the off chance that Krugman isn’t just being disingenuous with his claim that well-intentioned opponents of cap and trade systems are motivated by fear of speculation (and/or a penchant for ‘command-and-control’) , I’ll just mention a couple of things he didn’t:

First: It’s a well-documented fact that existing (and proposed) cap and trade systems are riddled with (political) games (and corruption) [ Bali climate conference reaffirms carbon trading scam // Cap-and-trade bill is no solution //
] .

Second: There is a better way, a (‘fossil’) carbon tax [ Club Pigou: James Hansen and Carbon Tax Aficionados // ] .

It’s not the speculation that has me miffed, it’s the prospect of seeing cap & trade converted into CDO – or CDS sleights of hand, as the heroes of the last twenty years trade possibly fraudulent (at worst) or opaque (at best) stuff, and they drive the whole mess over a cliff again, taking us with them.

Maybe the initial phase will be properly regulated, but the reaction to the last collapse does not give much basis to hope that there will be a rigorous regimen in place for long, if at all.

I completely agree with you Dr. Krugman. However, I still am very warry of the influence that firms like Goldman have on the political establishment. The similarities to oil speculation are very relavent. The supply will only decrease in the long term, the firms who get in early and out early made a killing off private citizens, and the speculation is likely to reach fevor pitches whenever the amount of the commodity ratches downward. If the large cororations are involved in this legislation, which they will be, then it is likely that the main objective will be to funnel monies to them, not curb emissions. In fact, i find it very likely that the rules will state that having a single windmill attached to a coal plant will totally exempt the plant from redutions, but not the ability to procure credits.

I am very suspicious of this plan, mostly beacuse it is untested (if I am wrong, PLEASE tell me). Implementing yet another large beaurarcy is likely to mean a lot of smoke-filled rooms where the ordinary citizen is not allowed or cannot fly through the maze.

I am also suspicious of the claim to urgency you profess. I believe you, yes. But to the layman, the claim that we have to save the planet or the sky is going to fall, sounds like the 2003 run up to the Iraq war. I’m not saying that things are not dire, I am just saying that we have heard this argument before.


With all due respect, there is a nice tool between command&control and markets, called taxation. Taxation creates identical incentives to cap and trade, thus there is no need for command or control, even if issue is complex. The difference lies in “efficiency”, which would require that we would know how much we actually need to reduce emissions. Of course, we do not know that, so there is no way one can argue that a $25 tax would be somehow less efficien than a market whose average price happens to be $24, $25 or $26.

Further, I am afraid that the cap in cap&trade is not set by a scientific analysis (there is none for required accuracy), but based on a guess how much we can afford to reduce. This means that cap&trade will be de facto reduced to a tax scheme that is difficult to adjust and predict.

Unfortunately the interest groups have seen the possibilities to make a killing in this market (especially if they manage to persuade a need of free allowances as in Europe) and no-one wants to hear anything about new taxes, so there is practically zero chance of carbon tax, even if it is in all (other than political) ways superior to cap&trade.

Paul you’re right on every point, yet people become stubborn, ignorant and fearful of what they half understand. How did progressive liberals ever catch that flu?!

Speculation is one of a number of such villains that get trotted out whenever the stupid try to make a point against reason and fact. Boo!

Speculators are the ONLY reason that secondary markets work (being the stock market, futures, options, etc.) and they create incredible value for all participants and society as a whole:

1. price discovery
2. liquidity, and (contrary to the conclusions hammered by the idiots that comprise the Permanent Subcommittee on Investigations regarding Excessive Speculation in the Wheat Market Majority and Minority Staff Report)
3. LESS price volatility (by the demanding of excess supply and the supplying to excess demand)

It would be nice if we had a vaccination against stupidity instead of swine flu for the masses, but then where would we find the speculators to trade against?

I think the argument about the impact of cap and trade on the weak economy is far better than the argument that speculation might take place.

“it’s too complex an issue to deal with using command-and-control”

Lovely, I hope you have the same enthusiasm for a market based health care system.