Sunday, June 15, 2008

Debt Rattle, June 15 2008: Free capital flows and instability

How Speculators Are Causing the Cost of Living to Skyrocket
After investing in high-tech stocks and real estate loans for years, legions of speculators have now discovered commodities like oil and gas, wheat and rice. Their billions are pushing prices up to astronomical levels -- with serious consequences for ordinary people's quality of life and the global economy....

....Searching for secure and long-term returns, major investors turned their attention to the commodities indexes, investments that promised substantially higher returns than investing in the stock market. The more the funds invested, the higher the prices went, especially since the market for speculative commodities securities is very small. Even minor shifts in the portfolios of large mutual funds can quickly drive up the price of oil....

...."The flood of money from Wall Street and hedge funds is driving up prices -- and the effects are potentially destructive," says Tom Buis, president of the US National Farmers Union.

As prices become further removed from reality, another risk begins to grow: the development of another bubble similar to the one fueled by overinflated stock prices in the so-called New Economy. A crash would be unavoidable.

It would be good news for drivers in Germany and the people starving in Africa. But it would also send the financial markets into turmoil once again, causing problems for hedge funds and perhaps a few banks. Regardless of whether prices go up or down, speculation results in preposterous exaggerations, with real consequences for the economy.

Once again, it is the excesses of modern financial markets that are sending the world economy into convulsions. Indeed, German President Horst Köhler may have been right when he recently said, in an interview with the German magazine Stern, that the financial markets have developed into a "monster" that needs to be tamed.

"The financial industry," says Heinrich Haasis, president of the German Federation of Savings Banks, "has disconnected itself from the real economy." This is both correct and incorrect.

It's correct because the transactions concluded in this sector no longer have anything to do with real goods. The industry deals in expectations, and in expectations of expectations, often on borrowed money. And it's also correct because it is an industry in which obscene amounts of money are being earned....

....They are all back at the table, the hedge funds and the major investors, the ones who will place their bets on anything that promises to yield a profit. But they're not the only ones. American pension funds, such as the fund that manages the retirement pensions for Californian teachers, have also joined the fray. And then there are the countless small investors putting their money into commodities funds, into index funds that simulate commodities prices, or into certificates, that modern investment instrument that even allows the most ordinary of investors to get a tiny piece of the action.

They all speculate that commodities prices will continue to rise, partly because demand is growing while supply is limited. Oil is a case in point. Without it, the world economy would come to a standstill, and Asia's emerging economies are constantly clamoring for more. And then there is food. In China, for example, more people can now afford meat. But it takes three kilograms of feed to produce one kilo of pork. At the same time, many fields are now devoted to growing crops used to produce biofuel.

The trend is clear, and yet it offers only a partial explanation for the steep rise in prices. Living habits don't change that quickly and, as a result, neither does demand. The only thing that changes that quickly is expectations -- which keep on driving up prices.

Does connectivity in the financial system produce instability?
Some evidence suggests that free capital flows in and of themselves produce instability and crises. A recent paper by Kenneth Rogoff and Carmen Reinhart found that

"Periods of high international capital mobility have repeatedly produced international banking crises, not only famously as they did in the 1990s, but historically."

Yet the focus of policy has been to increase the cross border flow of funds. Indeed, when the post mortems of this era are in, I suspect the carry trade will be found to have been a major culprit.

Another indicator: as the financial services industry has become increasingly deregulated and boundaries between businesses become blurred or meaningless (fund managers versus brokerage accounts, hedge funds versus proprietary trading desks, investment bank versus commercial bank) bank profitability has fallen and the industry has pushed into higher risk activities to try to compensate. Indeed, not only have overall risk measures risen, but the top banks also appear to be following common strategies. Both behaviors increase systemic risk.

The Vigorish of OTC: Interview with Martin Mayer
Mayer: One of the problems I have with the OTC markets and the arguments that we mustn't cramp innovation is that a lot of what is called innovative is simply a way to find new technology to do what has been forbidden with the old technology.

The IRA: Yes, techno-regulatory arbitrage. What a lovely thought; using new technology as a means for committing financial fraud. It's kind of like the affordable housing and innovative financing games.

Mayer: Yes. Innovation allows you to go back to some scam that was prohibited under the old regime. How can you oppose innovation? The fact that the whole purpose of the innovation is to get around the existing regulation never seems to occur to regulators or members of Congress....

....Mayer: In addition to using technical innovation to evade regulatory limits, there was also a confusion of purpose at the Fed. The Fed really never wanted to exam banks. And it really didn't want to be in a admonitory position vis-a-vis the banks. The commercial banks are the mechanism by which monetary policy is conveyed to the world. And the Fed needed them very badly. But beyond just monetary policy, what got forgotten was the reason why we separated commercial banking and investment banking in the 1930s. Obviously it got more and more difficult to enforce that separation as the technology changed. But that didn't mean that there were not good reasons for the continued separation. The way I like to put it is that the commercial banker wants to know how am I going to be repaid, the investment banker asks how am I going to sell the paper. These two attitudes really do not coexist well together.

The IRA: Banks globally have been miserable failures when it comes to combining investment and commercial banking.

Mayer: Correct. It is a very different mindset. And historically, in terms of public policy, we have relied upon the commercial banks to keep the markets and the economy on an even keel. Greenspan's observation was that, after all, the banks are going to protect us because they are lending their own money.

The IRA: Yes, but in a market dominated by investment bankers, no such discipline prevails. The investment bankers rarely create value and, judging by their recent behavior, care nothing about the long-term health of the global markets or the economy.

Mayer: Well, of course that was inaccurate because commercial bankers lend other peoples money. But beyond that, the notion that people who gamble with their own money are more responsible gamblers than those who gamble with their Uncle Joe's money was always very strange to me. People who are gamblers are gamblers and they will run through anybody's money. The difference between their own money and other people's money usually does not mean much to a gambler.

Litterbin of Last Resort
Oh dear, it was not meant to be like this. The European Central Bank (ECB), widely praised for providing banks with ample liquidity during the credit crunch, now has a problem: how to encourage banks to place freshly created asset-backed securities (ABS) with investors, rather than dumping them, like so much radioactive waste, in its vaults.

The ECB accepts a wide range of assets, including those such as ABS for which there is temporarily very little trading, as collateral in its refinancing operations. Provided the tranche of securities is the most senior, and rated A- or above, the ECB will take it. No surprise then that since August a large number of banks have designed ABS tranches, backed mostly by mortgages, purely for ECB consumption. Of €208 billion ($320 billion) of eligible securities created, only about €5.8 billion have been placed with investors, according to calculations by JPMorgan. In one noteworthy deal in December, Rabobank, a Dutch institution, issued €30 billion of mortgage-backed securities, €27 billion of which were designed exclusively for refinancings with the ECB.

On the face of it there is no immediate problem. Only around 16% of the ECB's collateral so far is ABS. Banks are drinking from the liquidity fountain and keeping the cost of high-street mortgages contained at the same time, which they might not be able to do otherwise.

But it is not helping the revival of a publicly traded ABS market, and may be fostering the creation of even murkier securities. Many of today's ABS are even less transparent than those sold before the crisis—the ECB requires a rating by only one agency, not the usual two, and pre-sale reports are often sloppily prepared. That, at least, is the concern of some rival central bankers, although the ECB itself is not panicking, yet. José Manuel González-Páramo, an ECB director, urged bankers earlier this month to make “serious efforts to revive the interest of third-party investors”. Though action is needed, the bank will not do anything in a rush—the markets are still too fragile for that.

The Greatest Value Of Lehman's Loss Lies In Lessons Learned
Lehman reported a $2.8 billion quarterly loss June 9, the same day it said it had raised $6 billion in fresh capital. Investors seemed surprised, judging by the stock's 15 percent decline since then. They shouldn't have been.

Wall Street stock analysts were predicting a much smaller loss. Yet Lehman's market capitalization, at $19.2 billion, is now almost $7 billion less than the company's $26 billion book value, or assets minus liabilities. That suggests the market believes Lehman hasn't fully cleaned up its balance sheet and that the worst is still to come, management's assurances notwithstanding.

Whatever the case, let's focus on what we can take away from this mess.

First Lesson

When a company attacks short-sellers, run.

You didn't need to know much about Lehman's financial statements to see it was in trouble. All you had to know was that the fourth-largest U.S. investment bank was jousting in the media with fund manager David Einhorn, who had bet against Lehman's stock and told a bunch of other investors (and journalists) why.

Good management teams embrace criticism, address it and move on. Lehman attacked the messenger.

"Mr. Einhorn cherry-picks certain specific items from our 10-Q and takes them out of context and distorts them to relay a false impression of the firm's financial condition, which suits him because of his short position in our stock," Lehman said in May.

The smart read on that line, now obvious, was that there were cherries to be picked. And for a guy whose compensation last year was $34.4 million, you would think Lehman's chief executive officer, Richard Fuld, would have known better.

This is the same strategy once embraced by stock-market flameouts like Inc., MBIA Inc., Biovail Corp. and, yes, Enron Corp. Now you can add Lehman's name to that list.

Second Lesson

There's no such thing as an economic hedge.

Linda Richman, the chronically "verklempt" host of Coffee Talk on "Saturday Night Live," would have loved this one. "Economic hedges are neither economic nor hedges. Discuss," she might say, if only Mike Myers hadn't left.

Lots of banks have downplayed their writedowns by stressing net figures that include gains on so-called economic hedges, or as Lehman calls them, "economic risk-mitigation strategies." In fact, the only thing these terms tell you is that the company made some bets that don't qualify as bona fide hedges under the accounting rules. The words mean nothing, because there is no uniform standard.

Witness Lehman's second-quarter results. The company said its gross writedowns were $3.6 billion. Including hedges, its writedowns were $3.7 billion. In other words, some of the hedges, uh, misbehaved. How's that for managing risk?

Third Lesson

Don't eat the Level 3 mystery meat.

Credit ratings storm
Major securities regulators around the world have placed a bull's eye on debt-rating agencies since last summer's market debacle. Once revered prognosticators, agencies' integrity, credibility, quality and independence are at the centre of a series of examinations and investigations into the credit-market collapse which has galvanized international regulators.

The U. S. Securities and Exchange Commission, the only regulator that oversees its industry (worth US$5-billion a year), proposed new rules this week to reshape the way rating agencies operate.

In this country, the Canadian Securities Administrators, the umbrella group representing the 13 provincial and territorial regulators, is still "examining" the agencies' role in the securities market.

On Monday, Julie Dickson, the federal superintendent of financial institutions, will testify in Ottawa before the House of Commons finance committee that DBRS was partly to blame for the commercial-paper collapse. According to briefing notes circulated by her office, Ms. Dickson, who oversees banks in Canada, will argue that the rating agency, among other groups, encouraged the use of the flawed liquidity agreements that sparked the turmoil in the commercial-paper market last August.

Meanwhile, the International Organization of Securities Commissions, which represents more than 100 securities regulators worldwide, also released a list of recommended modifications to its 2003 code of conduct for rating agencies, originally issued after the collapse of Enron Corp....

....In Canada, the troubles were particularly serious. Last August, a$35-billion chunk of the ABCP market froze completely after a group of foreign banks that had agreed to provide emergency liquidity to buy up paper in the event of a market failure declined to honour their agreements. As a result, investors holding what they thought were notes backed by a bank guarantee were left on the hook for massive losses.

Perhaps most surprising to investors was that the frozen paper came with the highest rating from DBRS. Indeed, it wasn't until several days after the freeze-up that the company put the stalled ABCP under review.

Ten months later, the market is still tied up in a complex restructuring with holders unable to trade their notes.

Issuers, ratings agencies too close for comfort
The cozy client relationships in the credit-ratings business that helped lead to the meltdown in the mortgage market has an old scapegoat: the photocopier.

Worried their client lists were shrinking as non-paying investors started photocopying their bond-ratings reports, the three major U. S. credit-rating agencies started getting the debt issuers themselves to pay to have their debt securities rated.

The adoption of that business model decades ago helped give rise to the widespread practice of "ratings shopping," in which new issuers would hire the credit-rating agency willing to hand out the highest rating on their debt securities.

That financial dependence on the very entities they rate has been blamed for the doling out of the safest investment-grade ratings on what has turned out be risky securities tied to mortgages, including bundles of billions of dollars worth of now nearly worthless subprime loans.

Since the mortgage market blew up last summer after a slew of borrowers started defaulting, policy-makers have been grappling with how to address the conflict issue.

Despite early talk of a broad regulatory crackdown in the US$5-billion-a-year bond-rating industry, credit-rating agencies have gotten off fairly lightly so far, some industry observers say.

New York state Attorney General Andrew Cuomo last week reached a settlement with the three largest ratings agencies by market share, Moody's Corp., McGraw-Hill Cos.' Standard & Poor's unit, and Fimalac SA's Fitch Ratings. Under that pact, the Big Three agencies agreed to overhaul the way they collect fees, a move aimed at making it tougher for investment banks and other debt issuers to play the agencies off one another to get a higher rating.

This week, the U. S. Securities and Exchange Commission proposed new rules designed to curb conflicts of interest by, for example, prohibiting ratings analysts from accepting gifts in excess of US$25 from issuers they're rating.

The agency also is considering proposals to enhance disclosure about how ratings are determined and to attach a special symbol on the ratings of more complex securities, such as the "structured" products at the centre of the mortgage mess.

"I think these proposals are just dancing around the edges," says Jerome Fons, former managing director with Moody's who is now an investment consultant.

"There is no magic bullet that is going to eliminate the conflicts of interest. You can't eliminate it. You can only manage it," he added.

Not all publicity is good for DBRS
DBRS, which morphed into a formidable rating agency from its humble roots in 1976, has taken on the global heavyweights S&P, Moody's Investors Service and Fitch Ratings by offering boutique-style services....

....To underscore its big-league arrival, DBRS has abbreviated its name and crowned its downtown Toronto head office with the logo. The corporate journey has been a long one for the 66-year-old, Winnipeg-born Walter, who, along with son David, established DBRS into one of the most respectable rating agencies around.

But that credibility is now on the line. Swept up in the turmoil, DBRS has spent the past year meeting with stakeholders to patch up relations while staring down critics.

Lehman's Weekend Meetings Raise Questions
Wall Street executives say Lehman's current problems have taken a tremendous toll on CEO Fuld, known as the "gorilla" on Wall Street because of his tough management style that has saved Lehman from crisis in the past.

Fuld has resisted selling Lehman to bigger players in the past, and in doing, has built one of the most successful securities firm, which before the recent crisis was a darling of Wall Street.

However, many Wall Street executive believe the current fiscal crisis hitting Lehman is different that past troubles because of the size of the bad loans on the firm's balance sheet, and because Wall Street firms will likely face eroding profit margins for at least the next year.

Like most firms on Wall Street, Lehman has been cutting back on how much risk it will taking in trading and other businesses, in an attempt to prevent the firm from imploding as Bear Stearns did three months ago. While taking less risk may soothe investors concerns that the firm may lose even more money, it also means that Lehman will produce lower profits in the future.

The lower profit margins combined with the possibility of further writedowns of losses could force Fuld to sell the firm. At the very least, people close to Lehman expect Fuld to make some announcement about Lehman's future on Monday when it releases earnings.

Unusual weekend meetings at Lehman
I remain skeptical of all those glowing comments from bottom fishers, and I still question the viability of the company itself. This is not a call for bankruptcy. Rather it is a call that Lehman will not stay together in one coherent piece.

Last week was a Wild Ride In Lehman, Financials. Next week just may be more of the same. One thing I do know for certain is that the world's largest experiment in creative financing has failed miserably. The fallout has just started. Bottom fishing at this point is likely to be punished severely.

The BCE showdown
It's been one of the hardest-fought pieces of litigation ever to hit Canada's court system. Tens of thousands of pages of affidavits, thousands of exhibits, 6,000 pages of summaries, 28 days of trial and 3½ days of appeal court time. Now, the $52-billion leveraged buyout of BCE Inc. by the Ontario Teachers' Pension Plan and its partners hinges on two hours of oral argument.

Welcome to the ligation between BCE and its bondholders. On Tuesday, almost one year to the day that BCE announced its "plan of arrangement" to take the company private, the Supreme Court of Canada will hear arguments on the biggest corporate-commercial case ever to reach the top court. It's an appeal of a 5-0 Quebec Court of Appeal ruling, which found that the BCE plan did not properly consider the impact on bondholders.

Three sets of investors holding bonds in Bell Canada -- a BCE subsidiary that accounts for a significant portion of its parent company's revenue -- objected to the deal because under the plan to take the company private Bell Canada would guarantee the $34-billion needed to finance the deal. Yet, according to the bondholders, Bell itself would receive nothing in return, a point hotly disputed by BCE.

Common shareholders will earn a 40% return on their shares from the date the auction began while preferred shareholders will also receive a premium. However, the value of the bonds will drop between 18% to 23%, and strip bonds could lose 50% of their value because of the added debt and downgrade in ratings on their bonds.

Senator says loan favoritism is possible
Senator Kent Conrad, Democrat of North Dakota, said Saturday that he would donate $10,500 to charity and refinance a property loan after suggestions that he and other prominent Washington figures received preferential treatment from Countrywide Financial Corporation.

Though Mr. Conrad, chairman of the Budget Committee, said he was not aware of any favoritism shown by the lender that has come under scrutiny in the mortgage crisis, he said a review of e-mail traffic suggested that the loan fee for a beach house may have been reduced because of his status, while a second loan called for an exception by the company.

“Although I did not ask for or know that I was receiving a discount, and even though I was offered a competitive loan from another lender, I do not want to have received preferential treatment,” said Mr. Conrad, who said he was giving $10,500 to Habitat for Humanity. The amount was equivalent to estimates of what Mr. Conrad saved through a reduction of one point on a $1.07 million mortgage.

The dealings of Countrywide with Washington officials have come to light in the past week after James A. Johnson, a former head of Fannie Mae, was forced to give up an influential advisory role with the presidential campaign of Senator Barack Obama following suggestions that Mr. Johnson got special treatment from Countrywide. Mr. Johnson was leading the search for a vice-presidential candidate.

Mr. Conrad and Mr. Johnson, as well as other notable Washington figures including Senator Christopher J. Dodd, Democrat of Connecticut, were apparently beneficiaries of the mortgage lender’s V.I.P. program, known informally as the “Friend of Angelo” program for Angelo Mozilo, the chief executive officer.

Statewide teacher layoffs: It's 20,000
The number of teachers in California who have been issued notices of potential layoffs has hit 20,000, the state's education chief said Friday.

School districts are required by law to notify teachers and other certificated staff members that they could be laid off by March 15. The recent layoffs — including dozens in Placer County districts — have been spurred by $4.8 billion in cuts to education contained in Gov. Arnold Schwarzenegger's January proposed state budget.

In a statement, State Superintendent of Public Instruction Jack O'Connell blamed the layoff notices on a "priorities problem" and decried the governor's proposed budget for putting student performance "in grave jeopardy."

20,000 Teacher Layoffs In California
Laid off teachers are not going to be buying cars, eating out, or doing much shopping in general. They certainly will not be buying any houses. Some will even decide to walk away. And we are not just talking about teachers here. There will be cutbacks across the board in California's budget. And it won't be just California either.

Suicide calls jump amid economic woes, hot line says
A local hot line has seen a dramatic spike in suicide calls from people in Palm Beach County who are facing foreclosure and can't pay their bills, according to numbers released today.

Since the start of the year, 256 people in the county told operators at the 211 hot line that they were thinking about suicide. Of those, 44 told operators that their main reason was that they had lost a job, were facing foreclosure, couldn't afford to pay their bills or were homeless.

During the same period in 2007, from Jan. 1 to June 10, the hot line received 137 suicide calls from people in Palm Beach County. Only 15 of those gave economic reasons.

The callers' problems seem markedly different than in the past, said Susan Buza, executive director of 211 Palm Beach/Treasure Coast. Many callers, she said, have tried to find work for months.

Life aint easy at the RBA these days
"Back in 1989 and 1990, it was also the case that the world economy was slowing, but because Australia's export links were so closely tied to the miracle economy – Japan it was then – and the rest of Asia was strong and growing, the slump in business and consumer sentiment was put down as self interested groups complaining about a short period of economic hardship or a partial reversal of the excesses of the 1980s. What's more, the labour market was tight, there were fears of wages accelerating and the fall in house prices was merely a welcome correction to what had been a frenzied house price bubble in 1987, 1988 and 1989."

Sounds familiar?

Says Koukoulas today: "What's worrying now is that the household debt to household income ratio is now around 165% (it was under 50% in 1990) and 12% of household disposable income is used to service that debt (it was 9% in 1990). With mortgage rates up 150bps or more in the last year, the consumer sector is under the pump as it uses money for debt servicing and not consumption."

Turns out Koukoulas could have hardly picked a better timing to publish his flashback: on the very same day the Australian Bureau of Statistics revealed employment in May fell for the first time in 19 months. Economists had predicted a rise, so you can imagine the head scratching that is currently going on through the country.

According to the ABS, employment fell by 19,700 in May with full-time jobs down 10,400 and part-time employment down 9,300. The unemployment rate was stable at 4.3%. The participation rate fell from 65.5% to 65.2%.

Economists, in their initial responses to the surprising fall, maintain there's no need for panic of any sorts, but one would have to be a real hardliner on interest rates and inflation to not acknowledge the odds have shifted further in favour of the Reserve Bank of Australia leaving interest rates on hold for the time being. Certainly, ANZ's prediction of two more hikes before year end seems less plausible as weaker economic indicators see the light of day, though some economists, including CBA's Monica Eley, maintain there remains a greater than 50% chance the RBA will lift official interest rates again in 2008, taking the cash rate to a likely cyclical peak of 7.50%.

China's hands tied over US government bond investments
An influential politician expressed regret on Friday that China has more than a quarter of its huge stockpile of foreign exchange reserves invested in US government bonds.

China held $US492 billion worth of US government bonds at the end of March, when its reserves totalled $US1.68 trillion, according to Cheng Siwei, a former vice-chairman of the National People's Congress, the largely ceremonial parliament.

"We have no other choice but to buy (US) bonds because we have no better options," Cheng told a conference on mergers and acquisitions.

As well as owning US Treasuries, China has substantial holdings of other US fixed-income assets including agency bonds and mortgage-backed securities, bankers and analysts say. Cheng did not give details of these.

But he said China would be better off if it knew how to manage its foreign exchange reserves more smartly, for instance by investing more in corporate M&A.

"If we have people who know how to invest the money better, there will be no need to buy US bonds," Cheng, who is now chairman of the China National Democratic Construction Association, told reporters.

China's Shangdong hikes power fees as shortage looms
"Shandong was worried about power shortages in the summer peak consumption season," said Lin Boqiang, director of the China Centre for Energy Economics Research at Xiamen University. "So it took a smart move."

State-set power tariffs have been frozen since June 2006, as Beijing worries that a hike may fuel inflation that jumped early this year to its highest in more than a decade. That capped earnings from power producers as the cost of coal mounted.

But analysts say Shandong's intent was less to aid struggling generators than to avert rolling summer brownouts. Coal inventories have become dangerously lows as power producers put off stocking up on the increasingly expensive hydrocarbon.


Anonymous said...

"Living habits don't change that quickly and, as a result, neither does demand. The only thing that changes that quickly is expectations -- which keep on driving up prices."

What an idiotic statement. Demand doesn't change that quickly, supply does. Prices are set my demand AND supply of the commodtiy. They are not set by people buying paper. And small changes in supply can result in large changes in price, when a critical commodity is in short supply.

In oil at least, the outstanding contracts have been shifting towards shorts steadily as oil has risen. This has tended to push the price of the paper contracts down, only to shoot back up when the paper is marked to the actual price at the spot market.

The worlds largest oil producer is in decline. The US's largest 2 suppliers' exports are down 32% annualized in the past 8 months. And OPEC production is down. Meanwhile, the EROI of oil ingeneral is going down, which means that less energy is being delivered to the market per barrel pumped. And during this time, global demand has conintued to grow at a near-record pace. You really have to be digging to blame the risin in oil prices on anything but supply & demand

Ilargi said...

no shargash

You don't have to be digging, just paying attention is enough. Denying the impact of money flowing towards oil, and from other investments, is not very constructive.

And you should not words like that for our statements. It is not appreciated, and it makes you look even more foolish than your limited grasp of the situation already does.

Stoneleigh said...


When I say speculation is driving oil prices into a blow-off top, or that rapidly changing expectations are a key price driver, I am not denying the reality of peak oil. Supply and demand are tight, but as I said yesterday, that is a recipe for substantial price volatility, with prices potentially veering wildly from over-valued to under-valued. Supply and demand establish the fundamental trading framework, but internal market dynamics drive prices in the short term.

To understand what is happening with oil, understanding peak oil is not sufficient. It is necessary to understand both peak oil and market dynamics.

Here is the intro I wrote yesterday, commenting on an article that compared oil prices to dotcom stocks:

While I agree that speculation and the fear factor (common for commodity tops) have driven oil prices to a level from which they are likely to fall substantially (although not necessarily immediately). However, comparing oil prices to the dotcom mania and expecting the same resolution is far too simplistic. Dotcom stocks were not a strategic resource in finite supply - one that appears to be poised at or near a global production capability peak.

Tight supply and demand is not necessarily a recipe for ever-rising prices - it is more likely a recipe for high and increasing price volatility. Tightness creates conditions whereby the effects of even small events can be felt disproportionately, and those effects can also be magnified by those able to take advantage of the situation. Speculators like volatility. They don't care which way prices are moving - they make can money on movements in either direction, and their actions reflexively feedback into market expectations and the actions of other through momentum-chasing.

Both the short-term effect of speculation kicking into reverse (shorting) and the longer-term effect of demand destruction due to a collapse of purchasing power should cause oil prices to fall substantially, but there are significant factors that should also drive oil in the opposite direction. Even a perception of shortage can be enough to lead to a shift towards hoarding behaviour - in this case on a national level - which points to further aggressive actions in aid of securing national supply before others can tie up scarce resources. As the evidence of impending actual shortage is increasing, such actions are even more likely. Even a temporary reversal of tight conditions due to demand destruction is unlikely to alter this dynamic once set in motion.

Oil is power in this world. Without it, no nation's military would have a chance against those who did have an adequate supply, and they know it. To think therefore that oil prices could simply decline into oblivion like dotcom market froth is naive in the extreme. In contrast, both price retreats and advances should be expected in a world of titanic forces pulling in opposite directions, but over time the importance of oil will grow and access to it by anyone other than the wealthy and powerful will decline dramatically. Prices are therefore set to increase over the long-term, probably to levels we can scarcely conceive of today, but trying to bet on this trend in a volatile market is a dangerous game. Timing will be everything, and it will be far easier to lose a fortune than to make one.

bicycle mechanic said...

Speculator is a bad term. Appears to me everything in the stock and commodity market is "speculation". Speculation is not illegal, is it, unless it is done by teaming up and communication between parties etc. in ways determined illegal to manipulate. Hard to prove, but doesn't mean it does not happen.

Is there evidence of this. Probably not. Is the type of oil that many wish to buy in demand? Yes, and appears to be "tight" in supply. This appears to be the case.

The market is worldwide, not only the US. Complicated issue, and the price on the board is what rules the game if you wish to play.

Wish to "win"?

Do not support that which causes the "pain". If you do, be prepared to pay the price and perhaps more.

Not to start anything, but "living habits" don't change quickly. Most people will not, unless motivated to do so, logic and facts, well humans are funny that way, ... what they don't do it appears to me is plan ahead, they don't plan if they are wrong, and why that is... thats another blog.

cj said...


How soon do you think that we will see dramatic effects to show themselves relative to deflation? There has been some evidence, but to date it seems rather small. As long as the Wall Street gangsters have the support of the US Fed and Treasury they can for a while hide their losses, but at some point there must come a day of reckoning. It seems to me that the enormous collapse or vanishing of credit has to show itself soon. I am sure that there are more shell games that they can play

Edward Lowe said...

Hi All

Great blog...I read often and with interest.

Re: the market speculation thread and oil prices. I have been struggling with this one myself. Mainly because of the feedback system between investment markets and commodity producers.

To be brief, higher market prices will encourage more producers to get into the market with their product, particularly if there is a perception of plenty of potential resource in reserve. Why ... bring as much to market as possible before the price collapses, particularly the marginal product that will be too expensive to produce at lower prices.

So ... commodity market speculation should lead to a glut of the commodity, and then a dramatic price collapse as the market becomes over supplied.

My reading of the situation is that this is precisely what happened in the dot com bubble (lots and lots of dot com businesses came to market) and housing (lots and lots of new housing came to market).

So, will the same be true for oil in particular? Again, my understanding is that this will happen only if the amount "in reserve" is actually available in sufficient amounts to over supply the existing markets [yes...I have some understanding of what that means in terms of spare production capacity of existing and soon to be online infrastructure)....

So, will we reach a moment of oversupply leading to extremely volatile prices? Waiting to see the real world corollary to the speculative market dynamic that is supposedly at work right now.

Bigelow said...

CJ has the big question: “How soon do you think that we will see dramatic effects to show themselves relative to deflation?”

I haven’t a clue. Things can lurch along for longer than they possibly should …then presto! What say you two?

Anonymous said...

“The following letter was written to the editor of the British newspaper, The Independent, about their article, Fade to Black: Is This The End of Oil? Mike is asking blog readers to write to the paper in support of his letter. --Michael C. Ruppert”

Stoneleigh said...

CJ and Bigelow,

I think we're uncomfortably close to a tipping point to say the least, but it's difficult to be specific as to when we might reach it. So far we''re ratcheting down in stomach-churning lurches interspersed with periods where everyone goes back to sleep again for a couple of months.

As to timing clues from the market, the DJIA has been approaching a trendline that has acted as support and contained the downside since 1974. It is common to see a bounce from such a trendline, as we have in fact seen, but I doubt if it will last long (I would guess measured in days at most).

If that trendline is then broken, the selling pressure would likely intensify considerably, and the next support is very, very much lower (thousands of points). That's not to say the Niagara Falls moment is necessarily imminent, but it draws ever closer.

I don't expect an initial crash to carry us all the way to a bottom though - I expect a series of crashes (interspersed with sometimes-dramatic countertrend rallies of varying lengths and degrees of retracement) to carry us much lower over the next several years. When I say much lower, I fully expect the DJIA to end up well below 1000, with the bulk of that decline in the relatively early stages.

Anonymous said...

“The US & Canada have finally set their sights on tighter control of non-dollar based transactions over the internet. They want to avoid proliferation of such commerce, first because it represents an alternative universe outside the dollars, but secondly because it avoids sales tax revenue income for the respective governments. They therefore smear such commerce as having its origin in organized crime and terrorism, which sets the stage for later control deemed acceptable by the public. My expectation has been firm, that the second round of terrorism charades in the wake of carefully orchestrated NineEleven events would involve the internet so that the Powers could control the internet much more closely. They failed to direct in the summer of 2005 new regulations whereby all internet registration would be funneled through select large corporations at fees ranging from $2500 to $10k to $25k per website in annual domain service fees. Somewhere in the future, internet content will be controlled, certain types will be closely regulated, and a select few will be banned. Starting later in 2007, Canadian dealers of precious metals and stones, both tangible and digital, must register with the government. The die has been cast.”
HAT TRICK LETTER Issue #51, Jim Willie CB

Stoneleigh said...


I agree that such commerce is likely to be far more closely monitored and controlled we develop an ever greater resemblance to a police state. Those lucky enough to have been born here over the last few decades have enjoyed more freedom and comfort than almost any humans who ever lived, but unfortunately it's not destined to last.

In hard times, when the potential for unrest is high as sky-high expectations are dashed, social control will be more and more prevalent. Being able to take advantage of your knowledge to prepare in advance will become more and more difficult, hence leaving things to the last minute is really not an option if you want to have a hope of succeeding.

It is already far more difficult than it used to be to extract significant amounts of your own money in cash. Large cash transactions will get you red-flagged as a potential criminal, as governments are less inclined to accept any legitimate reasons for wanting to use cash. They want you to use traceable forms of exchange that can be data-mined.

If you want cash because you (wisely IMO) don't trust the banking system, you need to get hold of it a little at a time over a long time. Since we are getting closer to the point where bank runs could eliminate access to your savings altogether, you probably don't have that long.

Be careful.