With oil seemingly headed straight for Goldman Sachs’ $150 new price target, there is lively debate going on right now whether or not commodities as a whole are in a speculative bubble. We may very well be at the beginning stages of a bubble much like the U.S. housing market was in a bubble during the early 2000’s but that is still open for debate. If so, who is responsible? Is it the greedy speculators? Is it the billions of consumers in Asia? Is it those corrupt OPEC ministers? While it might be overly simplistic to point the finger in any one direction, in this case, I find it much more logical to blame the past and present actions of government officials. More often than not they try to correct things only to exacerbate the problem or create an entirely new “problem.” A majority of the time, governments overspend, ignore the long term implications of their actions, and generally do not have the slightest clue about economics. As an investor, what I do like about them is that they are predictably foolish. The current debate should not be whether the commodities market is in a speculative bubble but rather, if it is in a bubble, how much and how long will government officials expand it.

In my last commentary, I laid out the basic arguments for why I thought commodity prices would continue their assent. Most people I hear commenting on the matter complain that speculators are the main culprits behind the recent price trends. That is almost the equivalent of complaining that commuters are responsible for all the traffic during rush hour when there is no access to public transportation and the roads are falling apart. Others point the finger at OPEC saying that they have not done enough to increase supply or find new sources of oil. The truth is that OPEC countries are producing at or near full capacity and if they could find more oil they most certainly would. If anything, it has primarily been the actions of the world’s governments that have been the reason behind the seemingly unstoppable rise in commodity prices. Without a supply and demand imbalance, investors would have no reason to speculate dramatic changes in price over the long run. Government actions have distorted the marketplace, creating significant supply and demand imbalances. For one, energy and food subsidies in many emerging markets have not allowed the higher prices to naturally reduce consumption. Long standing agricultural production subsidies in the US and Europe have prevented many emerging markets from taking advantage of their natural comparative advantages and produce more commodities for the world market. The rapid growth in the world’s money supply caused by the actions of central banks and fiscally irresponsible governments alike have created a lack of confidence in currencies, especially the dollar and those with formal and informal pegs to it. This lack of confidence tends to result in a flight to hard assets such as commodities. Commodities merchants have been complaining that commodity supply levels did not justify the large increase in prices for certain commodities but fail to realize that a large part if not a majority of the increase is due to the depreciating currency and anticipation of further weakness.

These factors have been the main causes of the inflation. How will the brilliant politicians “solve” the problem “caused” by those nefarious speculators? More price controls, export regulations/taxes, consumption subsidies, and more trading restrictions on the futures markets themselves. What will be the impact of all of this? Unfortunately, it will result in higher global prices and more distortions that encourage rational speculators. It is not difficult to see how government intervention in commodities markets has done more harm than good.

Rice became “victim” to politics this year through a series of export bans and restrictions from major producers such as India, Egypt, Vietnam, Brazil, and Indonesia. These restrictions only helped fuel the panic and fears that other major producers may also ban exports. Yet somehow politicians and market commentators manage to place the blame on speculators for the price increases. Argentina has imposed heavy export taxes on its soy products in an effort to keep prices lower at home and force farmers to plant other goods. This has not only dramatically increased the global price for soy products but also put Argentinean farmers, the engine of growth for the country, in a very difficult situation and prompted significant protests and strikes.

Policy makers in India have come to the conclusion that in order to more aggressively combat inflation they need to exclude certain commodities from trading on its exchanges. This kind of backward logic is typical of politicians. By making it more difficult to trade something only increases the transaction cost and, ultimately, the price consumers have to pay. The demand does not go away just because the government decides to make it difficult to trade. If speculators want to buy it, they will find a way, either directly or indirectly. India is not alone, in this new trend.

Even U.S. politicians are proposing measures to limit trading of commodities only to certain individuals and companies. Congress has also put renewed pressure on the Commodities Futures Trading Commission (CFTC) to increase oversight and prevent speculative trading. The CFTC will reclassify major investment banks as speculators which would subject them to certain trading limits. The CFTC also announced a new information sharing agreement with London’s commodities regulator, the Financial Services Authority to gather information about large positions. I guess they will figure out what to do with that information once they obtain it.

China is now the second largest importer of oil behind the United States. Unfortunately for the world, the oil consumption in China, like many rapidly growing emerging economies, is heavily subsidized by the government. Bernard Picchi, a senior managing director at Wall Street Access, believes there is “ample evidence of oil-market manipulation, but not by oil companies or hedge funds, but by governments who subsidize consumption with below-market oil prices. Nine of the ten countries with the highest oil consumption growth have below-market oil prices.” According to Picchi’s estimates, oil price subsidies in China alone now run $125-150 billion a year. Higher world prices will put added strain on the governments’ finances as subsides become more expensive. I do not expect the Chinese oil subsidies to be cut back significantly in the near future considering its strong fiscal position and its enormous currency reserves. There are signs that some governments are having problems sustaining their subsidies and will have to remove or lessen them significantly. India recently lowered its subsidies because they were too costly. What they really should be doing is lower their import taxes. The sharp rise of oil prices has also forced Malaysia to significantly reduce its energy subsidies increasing the price of gas overnight by 40% sending shock-waves to consumers. Eventually, more governments will follow but not soon enough.

$135 oil will certainly curb demand in some areas such as air travel and the U.S. and European economies. However, growth in China, India, and other markets will likely more than offset this. I would not be surprised to see oil pull back significantly but I would be very surprised if it stayed lower. High commodity prices finally have the attention of Mr. Bernanke, who has increased his rhetoric against inflation expectations suggesting that he is done with interest rate cuts and might have to raise them. However, he is rather late to this revelation and any interest rate hikes to support the dollar against commodities will not be as effective due to the weakening U.S. economy, out of control spending, and future government liabilities.

One of the interesting aspects of this debate is that people do not usually complain as much when other asset classes are in the bubble phase. They usually just see it as another quick way to get rich. If we were experiencing another 1999 type stock bubble would people really be complaining about the speculators when their 401ks are going through the roof? I heard very few objections when real estate was being valued at ridiculous levels allowing people to continuously withdraw equity from their homes. Part of the reason is because, in general, the U.S. consumes more commodities than it produces and retail investors typically do not have much investment exposure to commodities. Voters are starting to wave the pitchforks and politicians are sure to see this as an opportunity to play the blame game with anyone but themselves. Prices are trying to adjust to correct the past mistakes of politicians. The real prices must be felt directly by the consumers and producers in order for a balance to be met. Until governments are forced to limit their interference and subsidies in commodities markets, I do not expect world prices to come down and remain down anytime soon.