Page 1 of 5 CREDIT BUBBLE BULLETIN
A new inflationary epoch
Commentary and weekly watch by Doug Noland
Crude oil closed on Friday above US$126. The most vitally important commodity
in the world has now posted a stunning year-to-date rise of better than 30% and
has now doubled in the past year. It is worth noting that during the 10-year
period 1996 through 2005 crude averaged about $29 a barrel. It's now at four
times this level - and running.
I don't believe it is mere coincidence that crude has posted about a 30%
year-to-date price surge at the same time as international reserve positions
have expanded at about a 30% annualized rate - to a stunning $6.769 trillion.
Over the past four-and-a-half years, official international currency reserves
have ballooned an
unprecedented $3.921 trillion, or 138%.
During this period, crude prices surged almost 300%. Chinese reserves ballooned
more than four-fold over this period to $1.68 trillion; India's reserve
position tripled to $303 billion; and Brazil enjoyed a four-fold increase to
$189 billion. After beginning 2004 at $73 billion, Russian reserves have almost
reached the half trillion mark ($493 billion). And in just the past year,
reserves of Organization of Petroleum Exporting Countries reserves have
inflated 42% to $490 billion. To be sure, the world is awash like never before
in excess "liquidity" for which to bid up prices of critical tradable
resources.
Especially since the US Federal Reserve's credit system bailout, anticipating
heightened global monetary disorder has been a key Credit Bubble Bulletin
theme. The ongoing relevant question: how much would (in particular) China,
India, Russia and Asia be willing to pay to procure adequate supplies of food
and energy for their populations and economies? The obvious answer is "we have
no way of knowing", but the market is becoming increasingly cognizant of the
reality that today's massive international reserve positions provide virtually
unlimited purchasing power. The bidding war has begun in earnest, in what
increasingly appears a new inflationary epoch.
The CRB Commodities index closed on Friday at an all-time high, sporting a
year-to-date gain of 19% and one-year rise of 37%. The Goldman Sachs
Commodities index, also ending at a record high, has gained 28% so far this
year and 68% over the past 12 months. During the past year, soybeans have
gained 85%, corn 72%, and wheat 68%. Prices for iron ore, steel and hard
commodities have experienced similar price inflation. Gasoline prices are up
almost 40%, natural gas about 50%, and heating oil about 90% over the past
year.
A second important theme also emanated from the Fed and administration's
desperate measures to sustain the US bubble economy: one upshot of this gambit
would be stubborn current account deficits and resulting ongoing growth in the
increasingly destabilizing global pool of speculative finance. Not only do
China, India, Russia, OPEC and others today enjoy ample reserves to bid up the
price of global necessities, the leveraged speculator and sovereign wealth fund
communities remain awash in financial resources that embolden huge speculative
positions in various energy and commodities markets - essentially
"front-running" real-economy purchases. It's turning into a battle royal - and
a prime dynamic of a new inflationary epoch.
Perhaps others recall the commercials that seemed to run nonstop on CNBC during
the 1996/97 Asian crisis: Make easy currency trading profits from the collapse
in the Thai baht, Indonesian rupiah, the Malaysian ringgit, and the South
Korean won. I remember thinking at the time how repulsed Asian policymakers
must be at the thought of retail US speculators shorting their currencies,
while their citizens and economies suffered through such devastating financial,
economic and social upheaval. Some leaders did spew vitriol and point blame at
the hedge fund speculators. Yet the bottom line was that these policymakers and
their broken systems were basically powerless to mount any response against
speculation or other forces unleashed on them, not to mention the International
Monetary Fund and other Western policy strongmen.
Powerless no more
The Asian and emerging economies "block" are anything but powerless today. To
be sure, surging food and energy prices these days spur the most serious social
unrest since the "Asian contagion" of the late 1990s. The head of the Asian
Development Bank last week warned that "soaring food prices" were hitting a
billion poor Asians "very hard". The so-called "silent famine" became louder
this week after a catastrophic cyclone ravaged Myanmar. Rice prices (in
Chicago) jumped another 7% and have more than doubled over the past year.
Throughout Asia, nervous policymakers are wasting little time in reacting to
surging prices, hoarding and supply constraints for rice and other basic
foodstuffs. As this crisis unfolds, the various policy responses and courses
adopted by countries throughout this region will have a decisive influence on
the general global economic and inflationary outlook. One might think in terms
of polar-opposite effects to the "disinflationary" forces that arose from this
same region during much of the nineties.
Responding to public outrage over the perceived role commodities speculation is
having on food prices and heightened general inflationary pressures, the
government of Indian Prime Minister Manmohan Singh has suspended futures
trading in soybean and cooking oil, sugar, rubber and other commodities. India
has scrapped import tariffs on many commodities, while banning the export of
rice, wheat, edible oils and cement. The government is also pressuring steel
and other industries to limit price increases. Politicians in India and
throughout Asia will come under only more intense pressure to deal with rapidly
mounting inflation pressures. Various forms of intrusive government prices
controls are gaining in popularity.
China, the Philippines, Thailand, Malaysia and Vietnam have all over the past
several weeks moved aggressively to secure additional food supplies. China, in
particular, appears to have significantly bolstered its global efforts to
procure agricultural and energy resources. It's a fair bet that spiking prices
for food, energy and commodities in general will have major trade and
geopolitical ramifications - while our policymakers' attention is fixated on
problem mortgages.
Wealth redistribution is an inherent facet of credit and asset bubbles. And I
would argue that this inequitable wealth-transfer gains momentum progressively
throughout the life of an inflationary boom. As such, various degrees of angst,
contempt, unrest and "blowback" are inevitable. I've had particular disdain for
former US Federal Reserve Board chairman Alan Greenspan warning us of the risks
of trade frictions and "protectionism". These are, after all, the predictable
consequences of a bursting US credit bubble.
It would now appear that spiking prices, hording, and supply shocks (emerging
most acutely in the Asian inflationary tinderbox) throughout the agricultural,
energy, and commodities markets have the potential for initiating a period of
problematic trade tensions, dislocations and acute geopolitical uncertainty.
And it is not only government policymakers grappling with today's new reality:
the extreme uncertainty with regard to pricing and availability of critical
resources. Industries throughout the US and global economies now confront a
fundamentally altered environment, where the future prices and supply of scores
of key inputs can no longer be taken for granted.
For many, the whole idea of "just-in-time" inventory management has become a
luxury no longer affordable. Moreover, recent media accounts have illuminated
the problems suffered by farmers and grain elevator operators due to recent
dislocations in commodities derivative trading. Financial derivatives markets,
having functioned well in the commodities arena for the most part for years
now, will play a destabilizing role in a new era of acute supply/demand
imbalances and disruptions.
In particular, one can expect today's unfolding dislocations in energy trading
to inflict bloody havoc on scores of businesses, industries and derivative
players alike. Many (such as the airlines) that have previously been somewhat
hedged against future energy price gains were more recently left largely
unprotected because of the perceived exorbitant cost of hedging programs. And
those derivative players on the wrong side of runaway price gains are today
scrambling to hedge exposures and mitigate mounting losses.
Changed psychology
Importantly, whether it is in derivatives or in contracts for the future
delivery of actual resources, those in a position to provide supply are today
much less willing to lock themselves into future commitments. Psychology has
changed and changed profoundly. The entire market landscape has been radically
altered for key commodities and resource markets, and the ramifications for
general inflationary trends are significant.
I am compelled to again contrast today's inflationary forces to other recent
bouts of acute pricing pressures. When emerging credit bubble forces fueled the
NASDAQ and technology bubbles, inflationary effects were largely isolated in
technology stocks, high-yielding telecom/tech-related junk bonds and leveraged
loans, and a booming tech industry. This bubble incited huge increases in
demand for technology products, yet this demand
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
