June 3 (Bloomberg) -- The U.S. Congress is taking time out from whatever it does in an election year to look into soaring food and energy prices. Just the thought is scary.

One hearing last month featured the public parade of Big Oil executives, a favorite ritual whenever Congress needs someone to blame for sky-high oil prices (there are no mirrors to hold up on Capitol Hill). Another looked at the effect of ethanol subsidies on food prices, one of those `good' government ideas with disastrous consequences, not to mention the inconvenient truth that ethanol is more polluting than gasoline.

A third hearing examined the role speculators are playing in commodities markets, which is pressuring U.S. regulators into action.

It's one thing to identify a problem; it's quite another to legislate or regulate a solution. History is replete with examples of the unintended consequences of government interference in the market. Capping gasoline prices in the 1970s, for example, led to long lines and fuel shortages.

The Senate Committee on Homeland Security and Government Affairs (HSGAC), chaired by Connecticut independent Joe Lieberman, is intent on doing something to curtail speculation by commodity index traders who, unlike hedgers, have no interest in physical commodities and unlike normal speculators, only buy. Possible fixes range from the mild -- closing the swaps loophole, an over-the-counter way to invest in commodities without being subject to speculative position limits -- to the draconian -- limiting pension-fund investment in commodities. Lieberman plans to hold a second hearing in late June to learn more and get feedback on legislative proposals.

One-Way Bets

What, if anything, should be done to curtail the growing dominance of commodity index traders?

This is a thorny issue for libertarians and other free- market advocates. If commodity markets are declared off limits to public pensions, what's next? Currency markets? Maybe it's not in the public's best interest for the dollar to weaken further.

``Commodity futures markets were designed for three things,'' said Howard Simons, a strategist at Bianco Research in Chicago. ``Price discovery, risk transfer and commerce facilitation. They were never designed to accommodate speculative inflows from one side.''

Commodity index traders currently account for about 40 percent of the open interest, or outstanding contracts, in the 12 agricultural commodities for which the Commodity Futures Trading Commission reports data, according to Bianco Research. Some $260 billion was allocated to commodity index trading strategies in March 2008, up from $13 billion at the end of 2003, according to Mike Masters, president and founder of Masters Capital, a hedge fund in St. Croix, who testified at the May 20 HSGAC hearing.

CFTC Budges

``Commodity futures markets were set up for physical producers and consumers,'' Masters said in a phone interview last week. ``If commodities are an asset class, they should be regulated like capital markets.''

If the CFTC were to enforce existing speculative position limits on index traders, what's to stop those investors from migrating overseas? The CFTC is expected to introduce additional regulatory initiatives this week following last week's announcement of steps to improve oversight of the energy futures markets.

Masters says he thinks Congress should modify ERISA (Employee Retirement Income Security Act), the 1974 law that sets minimum standards for public pension plans, and prohibit them from investing in commodities because of the damage it's doing to the country. Simons, a self-described libertarian, agrees and says non-public funds would follow.

``The government has clearly signaled, `you either cease and desist on your own, or we'll do it for you,''' he said.

`Social Service'

Today's soaring food prices are causing riots and unrest in developing nations. For the 1 billion people who live on $1 a day and spend half that on food, a doubling of food prices is the difference between eating and starving. Surely the government has to do something about speculation.

To the contrary, speculators ``are performing a social service,'' said Paul DeRosa, a partner at Mt. Lucas Management Co. ``The thought of conservation without higher prices is ridiculous and logically inconsistent.''

For whatever reason, ``a broad spectrum of people has come to the conclusion that we will have commodity shortages some time in the future,'' he said.

If their instinct is correct, then ``conservation is necessary,'' he said. ``You can't have conservation without higher prices.''

Price Signals

Higher prices send a message to allocate more acreage to crop production. Whether the current fixation on agricultural commodities and ``peak oil'' is one of those recurrent Malthusian scares or the real thing, it's hard to see how Congress will be able to fix it. Wall Street is famous for devising new-fangled derivatives to circumvent regulations.

``I don't have concerns with speculation,'' said Michael Aronstein, president of Marketfield Asset Management in New York. ``It's the allocation of public funds to the ownership of something on a long-term basis that can't support the flows.''

Aha! Now that's a slightly different matter.

``No one volunteers to have his money in a public pension fund,'' he said. ``Should the New York State public employees fund be buying mountains of cotton swabs or propane? What if the Social Security System had decided to buy condos'' during the housing boom?

Return on Forecast

Aronstein, who describes himself as a ``19th-century liberal,'' has another issue with today's commodity index investor.

``There is no embedded expectation of return in owning a pile of inventory in a business you have no interest in,'' he said. ``The only return is from a presumed ability to forecast prices. It's not like owning a hot dog cart, where the expectation is that every day you'll make a profit.''

At some point, commodities will enter a bear market, pension funds will decide the stuff they own isn't an asset class after all, and their one-way long bets will turn to one-way sales.

And who but the producers will complain about falling prices?

(Caroline Baum, author of ``Just What I Said,'' is a Bloomberg News columnist. The opinions expressed are her own.)

To contact the writer of this column: Caroline Baum in New York at cabaum@bloomberg.net.

Last Updated: June 3, 2008 00:05 EDT