Financial crises like we had in 2008 before the Great Recession, and earlier in the 1930's before the Great Depression, are the triggers for big, long lasting economic downturns that require painfully long times from which to recover. They differ from ordinary economic recessions (i.e., two quarters of negative economic growth), which generally don't last more than a couple of years and are usually followed by good levels of growth. Financial crises are caused by liquidity shortages in the financial system. When major banks and other financial institutions cannot obtain ready access to loans, especially short term loans, the financial system can teeter, and in worst case scenarios, collapse.
Recent news articles report that European banks are under stress because of the decline in oil prices (http://www.cnbc.com/2016/02/08/european-banks-face-major-cash-crunch.html), and because of low interest rates and legal costs, as well as oil prices (http://money.cnn.com/2016/02/05/investing/bank-stocks-worse-than-oil/index.html?iid=EL). Things got so shaky today that Deutsche Bank, Germany's largest, felt compelled to put out a statement reassuring shareholders about its financial condition. http://www.reuters.com/article/us-deutsche-bank-stocks-idUSKCN0VI1WI. If Europe's major banks begin to encounter liquidity shortfalls, we could have a problem. If not addressed properly, it could be a big problem.
Europe's big banks are in general not as well capitalized as America's big banks, so it's not surprising that the Europeans might encounter turbulence sooner. But if Europe's big banks teeter, America's big banks will, because of the interconnections between all major banks worldwide, at least feel pretty nauseated. Of course, in such a scenario, the European Central Bank and U.S. Federal Reserve will mount up and ride to the rescue. But not even the Brobdingnagian bailouts of 2008 prevented the Great Recession.
If the financial system stays sound, the slowdown in China and the other BRICS may cause a recession, but probably not a catastrophe. But if the financial system dives into the septic tank, as it did in 2008, then we can expect a stinky mess. So watch the banks.
Showing posts with label oil price. Show all posts
Showing posts with label oil price. Show all posts
Tuesday, February 9, 2016
Thursday, February 4, 2016
How to Manipulate the Stock Market
The recent unusually close correlation between the price of oil and the prices of stocks offers an opportunity to manipulate the stock market. A trader could purchase a large holding of stock index futures that would increase in value if the stock market rises, and then purchase oil futures contracts in rapid sequence in order to push up the price of oil. The price jump in oil would, presumably, pump up stocks. The stock index futures would rise in value and the trader could sell them for a quick profit. An individual person couldn't do this, except one who is exceptionally wealthy. But large hedge funds and other financial entities might have enough funding to pull this off. It could be done in the U.S. markets, and some foreign markets (since the oil-stocks correlation isn't limited just to the U.S. markets).
Doing something like this could be seriously illegal. Kids, don't try this at home, not unless you want to be a long term guest of the U.S. government at a facility not of your choosing. But, as hardly needs to be said, not all participants in the financial markets observe the highest degree of fidelity to legal requirements. Mega bucks could be made this way, and for some, money talks even if getting it involves stepping off the curb. Hopefully, financial regulators worldwide are tuned into this possibility. The recent exceptional volatility in the oil markets, and consequential sympathetic gyrations in stock prices, could raise the specter of shenanigans. Some financial markets players are big thinkers, and will do very aggressive things to make big money. Regulators need to think as big in order to keep up with them.
Doing something like this could be seriously illegal. Kids, don't try this at home, not unless you want to be a long term guest of the U.S. government at a facility not of your choosing. But, as hardly needs to be said, not all participants in the financial markets observe the highest degree of fidelity to legal requirements. Mega bucks could be made this way, and for some, money talks even if getting it involves stepping off the curb. Hopefully, financial regulators worldwide are tuned into this possibility. The recent exceptional volatility in the oil markets, and consequential sympathetic gyrations in stock prices, could raise the specter of shenanigans. Some financial markets players are big thinkers, and will do very aggressive things to make big money. Regulators need to think as big in order to keep up with them.
Wednesday, December 16, 2015
Fed Raises Rates, Civilization Ends
Today, the Federal Reserve raised short term interest rates a quarter point. Stock up on food, water, blankets, toilet paper and ammo. Barricade your doors and windows. Civilization is ending. Massive hordes wielding pitchforks will rage through the streets. Entropy will increase. Chaos will reign.
Okay.
Actually,
in all likelihood, not much will happen in the near future. A quarter point really isn't a lot. If the typically usurious credit card interest rate were increased a quarter point, you'd barely notice it, unless you're so deep in debt that bankruptcy is a more realistic option than minimum monthly payments. If a quarter point increase on your mortgage rate knocks you out as a buyer of your dream home, you were probably about to pay too much for that house. Money market funds and bank money market accounts have been paying almost nothing in interest. If they now start paying a quarter point, you won't see a stampede from stocks to money markets. The only thing that will happen is that savers will start thinking they can add one four-dollar cup of coffee per year to their budgets.
Will the rate increase exacerbate the fallout in the junk bond market? Maybe by a bit. Mathematically speaking, higher interest rates imply lower bond prices. But, again, a quarter point won't greatly change bond prices. The junk bond losses are, to a large degree, a result of the oversupply in the energy markets (oil and natural gas). That's not the result of Fed policy. It's because the energy markets were overstimulated by rapid growth in some parts of the world (especially China) which has now abated.
The key question is how fast the Fed will raise rates over the one, two and three years. Rapid increases will, indeed, significantly change the relative values of assets. But Fed Chair Janet Yellen is signaling that the Fed will be kinder and gentler with rate increases than it has been in the past.
Could the Fed be making a mistake? As one former vice presidential candidate would have put it, you betcha. The Fed has made many mistakes in the past and some of them were egregious. Stay alert for trouble--the junk bond market, the manufacturing slowdown, China's slowdown, falling commodities prices and who knows what else could signal the next economic dislocation. But the market was expecting a quarter point increase today, and if the Fed hadn't raised rates, it would have probably created more market turmoil than raising rates causes.
Okay.
Actually,
in all likelihood, not much will happen in the near future. A quarter point really isn't a lot. If the typically usurious credit card interest rate were increased a quarter point, you'd barely notice it, unless you're so deep in debt that bankruptcy is a more realistic option than minimum monthly payments. If a quarter point increase on your mortgage rate knocks you out as a buyer of your dream home, you were probably about to pay too much for that house. Money market funds and bank money market accounts have been paying almost nothing in interest. If they now start paying a quarter point, you won't see a stampede from stocks to money markets. The only thing that will happen is that savers will start thinking they can add one four-dollar cup of coffee per year to their budgets.
Will the rate increase exacerbate the fallout in the junk bond market? Maybe by a bit. Mathematically speaking, higher interest rates imply lower bond prices. But, again, a quarter point won't greatly change bond prices. The junk bond losses are, to a large degree, a result of the oversupply in the energy markets (oil and natural gas). That's not the result of Fed policy. It's because the energy markets were overstimulated by rapid growth in some parts of the world (especially China) which has now abated.
The key question is how fast the Fed will raise rates over the one, two and three years. Rapid increases will, indeed, significantly change the relative values of assets. But Fed Chair Janet Yellen is signaling that the Fed will be kinder and gentler with rate increases than it has been in the past.
Could the Fed be making a mistake? As one former vice presidential candidate would have put it, you betcha. The Fed has made many mistakes in the past and some of them were egregious. Stay alert for trouble--the junk bond market, the manufacturing slowdown, China's slowdown, falling commodities prices and who knows what else could signal the next economic dislocation. But the market was expecting a quarter point increase today, and if the Fed hadn't raised rates, it would have probably created more market turmoil than raising rates causes.
Tuesday, December 16, 2014
OIl's Great Fall: This Time, The Bailouts Will Be Harder
In a desperate move, Russia's central bank recently raised a key interest rate by 6.5% to 17%, propping up the ruble at least momentarily. This was after the ruble had already lost about 50% of its value in the past few months. Even if the ruble stabilizes, Russia verges on economic collapse.
Venezuela was already hitting the skids when the price of oil began its big swoon. Now, it will possibly default on its sovereign debt. Other oil producing nations are hurting, too. Some could survive by drawing down their financial reserves. Others may not have adequate reserves on which to draw.
The impact of the oil price drops on major financial institutions and financial markets players is much more opaque. When a key commodity like oil, and the currencies issued by its producers, belly flop as we have seen in the past few months, big losses are inevitable. Some of these losses could be greatly magnified by the leveraging effect of derivatives. A crucial question for regulators is where these losses are landing. Surely there are losses on Wall Street and in the City of London. But proportionately much greater losses may have been sustained by Russian and other European banks. Dec. 31, 2014 will mark the close of financial reporting periods for many banks and other institutions. At that point, they will be required to disclose their financial conditions. It wouldn't be surprising if the losses are big. Talk of bailouts might follow.
It's one thing for the taxpayers of a nation to bail out the banks of their own nation. They may be frustrated and outraged, and demand the punishment of bank executives and others. But they have a strong interest in preserving their own financial system. It's another thing when a foreign country wants a bailout, just after it sent its Special Forces surreptitiously into a neighboring country to seize territory by force, lied to the world about what it was doing, and then made aggressive moves against many other nations--especially those that border it and have historically been dominated by it. The West has imposed sanctions on Russian banks. It can't now bail them out. It's attempting to force Russia out of Ukraine, using financial leverage as a key weapon. It can't provide Russia with a financial bailout.
Venezuela has for years been seriously hostile toward the U.S., while getting cozy with Cuba. Its current predicament is the result of spending way more than it was taking in. A bailout for Venezuela has no chance of receiving Congressional approval, nor would American generosity do anything to ameliorate the key problem, profligacy by the Venezuelan government in order to win over voters. The IMF would impose financial discipline on the Venezuelan government as a condition of any international bailout, something the current Venezuelan government surely wouldn't accept.
Free market advocates have railed for years about the bailouts made in the aftermath of the 2008 financial crisis, proclaiming that handouts to the wealthy and powerful would only foster moral hazard and encourage undue risk taking at the expense of taxpayers. They may have their way in the wake of oil's great fall. Some of the key players likely to need a bailout won't be getting them. Chips will fall where they may, and we'll see how the markets operate in the absence of government intervention. The results will be good for some, bad for others, and undoubtedly painful for many.
A destabilized Venezuela will probably experience internal political change. But a destabilizing Russia is much less predictable. As long as Putin is in power, who knows what will happen? And what is the potential for Putin to leave power? Not much and it's not likely to happen in a gracious way. Demagogues at risk of losing power sometimes turn to foreign adventurism to stay in control. The farther oil prices drop, the harder these questions will become, and the more disturbing the potential answers.
Venezuela was already hitting the skids when the price of oil began its big swoon. Now, it will possibly default on its sovereign debt. Other oil producing nations are hurting, too. Some could survive by drawing down their financial reserves. Others may not have adequate reserves on which to draw.
The impact of the oil price drops on major financial institutions and financial markets players is much more opaque. When a key commodity like oil, and the currencies issued by its producers, belly flop as we have seen in the past few months, big losses are inevitable. Some of these losses could be greatly magnified by the leveraging effect of derivatives. A crucial question for regulators is where these losses are landing. Surely there are losses on Wall Street and in the City of London. But proportionately much greater losses may have been sustained by Russian and other European banks. Dec. 31, 2014 will mark the close of financial reporting periods for many banks and other institutions. At that point, they will be required to disclose their financial conditions. It wouldn't be surprising if the losses are big. Talk of bailouts might follow.
It's one thing for the taxpayers of a nation to bail out the banks of their own nation. They may be frustrated and outraged, and demand the punishment of bank executives and others. But they have a strong interest in preserving their own financial system. It's another thing when a foreign country wants a bailout, just after it sent its Special Forces surreptitiously into a neighboring country to seize territory by force, lied to the world about what it was doing, and then made aggressive moves against many other nations--especially those that border it and have historically been dominated by it. The West has imposed sanctions on Russian banks. It can't now bail them out. It's attempting to force Russia out of Ukraine, using financial leverage as a key weapon. It can't provide Russia with a financial bailout.
Venezuela has for years been seriously hostile toward the U.S., while getting cozy with Cuba. Its current predicament is the result of spending way more than it was taking in. A bailout for Venezuela has no chance of receiving Congressional approval, nor would American generosity do anything to ameliorate the key problem, profligacy by the Venezuelan government in order to win over voters. The IMF would impose financial discipline on the Venezuelan government as a condition of any international bailout, something the current Venezuelan government surely wouldn't accept.
Free market advocates have railed for years about the bailouts made in the aftermath of the 2008 financial crisis, proclaiming that handouts to the wealthy and powerful would only foster moral hazard and encourage undue risk taking at the expense of taxpayers. They may have their way in the wake of oil's great fall. Some of the key players likely to need a bailout won't be getting them. Chips will fall where they may, and we'll see how the markets operate in the absence of government intervention. The results will be good for some, bad for others, and undoubtedly painful for many.
A destabilized Venezuela will probably experience internal political change. But a destabilizing Russia is much less predictable. As long as Putin is in power, who knows what will happen? And what is the potential for Putin to leave power? Not much and it's not likely to happen in a gracious way. Demagogues at risk of losing power sometimes turn to foreign adventurism to stay in control. The farther oil prices drop, the harder these questions will become, and the more disturbing the potential answers.
Wednesday, December 10, 2014
Oil Prices: The Next Test For Central Bankers
Most of the benefits of falling oil prices are obvious. Consumers, whose median incomes have been falling too, are fist bumping over lower gas prices. Businesses are seeing some energy costs fall, burnishing the bottom line. Members of Congress, who aren't doing jack about stimulating the economy anyway, can breath a sigh of relief over the economic stimulus from the gas pump.
Falling prices, however, have downsides. Today, the stock market tumbled because energy stocks are under stress. The more vulnerable oil producing nations might default on their sovereign debt (think Venezuela, and maybe others). Many oil frackers are heavily leveraged, and they could start defaulting as their cash flow sputters. Some financial market players are surely taking losses on falling currencies of many oil producing nations (the ruble being Exhibit A). More opaquely, but perhaps of great concern, big banks, hedge funds and other financial market players might well be taking losses on derivatives contracts bets linked to the price of oil or the currencies of oil producing nations. With oil price losses approaching the 50% level in the past few months, it looks like we have a bursting bubble on our hands--and the potential for another financial crisis.
Recall that it wasn't falling real estate prices alone that triggered the 2007-08 financial crisis. It stemmed from a poisonous synergy of massive quantities of poorly underwritten mortgage loans, falling real estate prices, defaulting mortgage borrowers (many of whom didn't have the ability to repay the loans, measured by any reasonable standard), a compounding of the losses because falling prices precluded the availability of refinancing, the massive impact of these losses on the financial system through diverse and obscure derivatives contracts not well understood by market players and regulators, and, ultimately, a surprising concentration of losses onto a single entity (AIG-Financial) to which numerous key players in the financial system had unmanageable exposures. Only an unprecedented bailout by the federal government prevented the collapse of the world financial system.
A sharp fall in oil prices doesn't necessarily mean the financial system is at risk. There was a proportionately larger oil price fall in the middle of the 1980s which didn't result in a financial collapse (although this occurred before the evolution of complex derivatives markets that allow risk to metastasize with blinding speed). Another big drop in oil prices in 2008-09 also didn't tip the big banks into bankruptcy (although they were already in major bailout mode by this time because of the mortgage crisis, so this instance may not prove much).
But the proliferation of risks created by today's highly imaginative financial engineering can mean that any major drop in the price of a key asset like oil could surprise us in unpleasant ways. One lesson from the 2008 financial crisis is that regulators didn't know where the hot tamale would land, until it hit the fan. Regulators worldwide should be sending their examination SWAT teams into the major money center banks and other key financial institutions to scope out the direct, secondary and tertiary impacts of falling oil prices. And that should be now--as in right now--not weeks or months from today when it may be too late to take protective action.
Falling prices, however, have downsides. Today, the stock market tumbled because energy stocks are under stress. The more vulnerable oil producing nations might default on their sovereign debt (think Venezuela, and maybe others). Many oil frackers are heavily leveraged, and they could start defaulting as their cash flow sputters. Some financial market players are surely taking losses on falling currencies of many oil producing nations (the ruble being Exhibit A). More opaquely, but perhaps of great concern, big banks, hedge funds and other financial market players might well be taking losses on derivatives contracts bets linked to the price of oil or the currencies of oil producing nations. With oil price losses approaching the 50% level in the past few months, it looks like we have a bursting bubble on our hands--and the potential for another financial crisis.
Recall that it wasn't falling real estate prices alone that triggered the 2007-08 financial crisis. It stemmed from a poisonous synergy of massive quantities of poorly underwritten mortgage loans, falling real estate prices, defaulting mortgage borrowers (many of whom didn't have the ability to repay the loans, measured by any reasonable standard), a compounding of the losses because falling prices precluded the availability of refinancing, the massive impact of these losses on the financial system through diverse and obscure derivatives contracts not well understood by market players and regulators, and, ultimately, a surprising concentration of losses onto a single entity (AIG-Financial) to which numerous key players in the financial system had unmanageable exposures. Only an unprecedented bailout by the federal government prevented the collapse of the world financial system.
A sharp fall in oil prices doesn't necessarily mean the financial system is at risk. There was a proportionately larger oil price fall in the middle of the 1980s which didn't result in a financial collapse (although this occurred before the evolution of complex derivatives markets that allow risk to metastasize with blinding speed). Another big drop in oil prices in 2008-09 also didn't tip the big banks into bankruptcy (although they were already in major bailout mode by this time because of the mortgage crisis, so this instance may not prove much).
But the proliferation of risks created by today's highly imaginative financial engineering can mean that any major drop in the price of a key asset like oil could surprise us in unpleasant ways. One lesson from the 2008 financial crisis is that regulators didn't know where the hot tamale would land, until it hit the fan. Regulators worldwide should be sending their examination SWAT teams into the major money center banks and other key financial institutions to scope out the direct, secondary and tertiary impacts of falling oil prices. And that should be now--as in right now--not weeks or months from today when it may be too late to take protective action.
Friday, September 23, 2011
Why Gold Isn't A Safe Haven
In the past couple of days, gold has dropped close to 10%, and is now trading around $1650 per ounce. That's 15% down from its recent peak price of around $1920. Why the belly flop? The answer is that, contrary to pronouncements of bug-eyed gold fanatics who drool from the sides of their mouths, gold is not a safe haven from fiat currencies or the financial system. Instead, it is joined at the hip with the financial system.
Among the most active traders in gold are hedge funds and other financial firms. These market players mainline leverage. And when they can't find a vein, they smoke the stuff. Consider the nature of leverage. It's a loan denominated in fiat currencies like the dollar and the euro. Leverage must be repaid in fiat currencies. Banks extending margin loans don't want to speculate in gold themselves, so they require repayment in dollars, euros or some other fiat currency.
Leverage financed the great gold rush of 2008-2011. This time, prospectors didn't search for yellow metal in stream beds or under the ground. They sought riches in the trading platforms of exchanges. The ones that got into the market two or three years ago hit the motherlode. But as gold bubbled up, smart players began to wonder when the party would run out of punch. The financial crisis of 2008 taught us that bubbles will burst at some point. Stocks and real estate both bubbled up and burst, and gold isn't different. Part of today's selling is to lock in profits while the getting is good. Locking in profits involves converting gold holdings to a fiat currency. That's the only way to take your gold profits and use them to repay margin loans, and buy cars, food, housing, and so on. So when money managers think the gold bubble, as valued by fiat currencies, has peaked, they will sell gold in order to obtain fiat currencies.
Other hedge fund managers may be selling gold because their investors, seeing the world go hinky in recent months, are making redemption requests to cash out. Investors may be worried about stocks, oil, or other assets besides gold that the hedge funds invested in and are now falling in value. But gold is easier to sell than some assets because it has a highly liquid market. So investor redemption requests, in effect, hit the gold market. Investors want payments in fiat currencies, not distributions of gold. That means the gold has to be sold to convert it into fiat currencies.
The players who dove into gold also traded on a leveraged basis in stocks, other commodities and maybe derivatives that no one can easily learn about because the derivatives market, three years after the financial debacle of 2008, remains opaque. Part of the selling of gold is due to speculators having to raise cash to meet margin calls resulting from falling prices for stocks, commodities other than gold (such as oil, which has lost some of its sheen) and, perhaps, derivatives contracts. In this way, leverage used to invest broadly on a diversified basis can have an interlinked downward impact when some markets go wobbly.
The recent woes of the euro add to the problem. A fall by the euro has pushed up the comparative value of the dollar. Since gold tends to trade inversely to the dollar, a good day for the dollar means a bad day for gold. That's another reason for gold investors to bail before they sustain more losses. The inverse correlation between the dollar and gold reveals a vulnerability of gold to a fiat currency.
With the financial markets and world getting hinkier by the trading minute, the selling has accelerated in the past two days. The ship seems to be sinking, and you know who is scrambling to get off first. Leverage dramatically pushed up the price of gold, and now deleveraging and other financial factors are driving it down.
Today's gold market is a creature of the financial system, and is subject to the same pressures and constraints as other assets. Gold isn't a safe haven. What is? That's the question people have been asking since they sharpened long sticks for protection and sought shelter in caves. When you have the answer, please clue in the rest of us.
Among the most active traders in gold are hedge funds and other financial firms. These market players mainline leverage. And when they can't find a vein, they smoke the stuff. Consider the nature of leverage. It's a loan denominated in fiat currencies like the dollar and the euro. Leverage must be repaid in fiat currencies. Banks extending margin loans don't want to speculate in gold themselves, so they require repayment in dollars, euros or some other fiat currency.
Leverage financed the great gold rush of 2008-2011. This time, prospectors didn't search for yellow metal in stream beds or under the ground. They sought riches in the trading platforms of exchanges. The ones that got into the market two or three years ago hit the motherlode. But as gold bubbled up, smart players began to wonder when the party would run out of punch. The financial crisis of 2008 taught us that bubbles will burst at some point. Stocks and real estate both bubbled up and burst, and gold isn't different. Part of today's selling is to lock in profits while the getting is good. Locking in profits involves converting gold holdings to a fiat currency. That's the only way to take your gold profits and use them to repay margin loans, and buy cars, food, housing, and so on. So when money managers think the gold bubble, as valued by fiat currencies, has peaked, they will sell gold in order to obtain fiat currencies.
Other hedge fund managers may be selling gold because their investors, seeing the world go hinky in recent months, are making redemption requests to cash out. Investors may be worried about stocks, oil, or other assets besides gold that the hedge funds invested in and are now falling in value. But gold is easier to sell than some assets because it has a highly liquid market. So investor redemption requests, in effect, hit the gold market. Investors want payments in fiat currencies, not distributions of gold. That means the gold has to be sold to convert it into fiat currencies.
The players who dove into gold also traded on a leveraged basis in stocks, other commodities and maybe derivatives that no one can easily learn about because the derivatives market, three years after the financial debacle of 2008, remains opaque. Part of the selling of gold is due to speculators having to raise cash to meet margin calls resulting from falling prices for stocks, commodities other than gold (such as oil, which has lost some of its sheen) and, perhaps, derivatives contracts. In this way, leverage used to invest broadly on a diversified basis can have an interlinked downward impact when some markets go wobbly.
The recent woes of the euro add to the problem. A fall by the euro has pushed up the comparative value of the dollar. Since gold tends to trade inversely to the dollar, a good day for the dollar means a bad day for gold. That's another reason for gold investors to bail before they sustain more losses. The inverse correlation between the dollar and gold reveals a vulnerability of gold to a fiat currency.
With the financial markets and world getting hinkier by the trading minute, the selling has accelerated in the past two days. The ship seems to be sinking, and you know who is scrambling to get off first. Leverage dramatically pushed up the price of gold, and now deleveraging and other financial factors are driving it down.
Today's gold market is a creature of the financial system, and is subject to the same pressures and constraints as other assets. Gold isn't a safe haven. What is? That's the question people have been asking since they sharpened long sticks for protection and sought shelter in caves. When you have the answer, please clue in the rest of us.
Tuesday, March 8, 2011
Will the Arab Revolution Topple the Dollar?
As unrest in the Arab world has grown over the past few weeks, the dollar has fallen in value. That would seem anomalous, since the dollar has served for decades as a safe haven in times of crisis. But investors apparently have noticed that the U.S. is unbalanced: too much in the way of imports, not enough in the way of exports, and a growing federal deficit that is likely to punish holders of U.S. Treasury securities if it isn't brought under control.
Exacerbating things is the rising price of oil. Since oil is traded in dollars, the lower the value of the dollar, the cheaper oil becomes to holders of other currencies. One player to watch in particular is China, a large consumer of oil with a growing appetite. The Chinese have already been gradually diversifying their foreign currency investments away from the dollar. Rising oil prices may, more than all the political pressure that can be exerted by the U.S. and other Western governments, convince the Chinese government to truly de-link the yuan from the dollar. As the yuan rises, oil becomes cheaper for the Chinese. If China can turn its economy toward domestic consumption--a goal the Chinese government acknowledges--look for the yuan to rise markedly against the dollar.
Some in the U.S. government would contend all this is good. A cheaper dollar enhances America's exporting competitiveness. But the price of a cheaper dollar is likely to be higher inflation--in gasoline prices and also the price of our numerous imports. The Fed's ultra-easy money policies would have to end and interest rates would rise. That would throw a wrench into the economy in many ways, from slowing the still feeble real estate market to discouraging business expansion to wrecking Wall Street profitability (which rests on a zero cost of funds) to knocking down stock prices.
The Arab revolution is almost entirely out of the control of Western governments, especially the mess in Libya. And even if things in the Arab world settle down in a few months, growing demand from Asia will continue to support and maybe push up oil prices. It's in the interest of the rest of the world to weaken the dollar in order to make oil cheaper. Even serial exporters like China and Japan have to weigh the increased cost of oil against their export revenues in deciding whether or not to keep their currencies weak against the dollar. Also, it seems to be a goal of the Federal Reserve's relentless easy credit policy to weaken the dollar. As the dollar drops, OPEC and other sellers of oil may begin to demand payment in other currencies. The dollar would drop further in such a scenario. Even though America would get an exporting boost from a falling dollar, rising interest rates here would slow the economy at the same time. How this mix of countervailing forces would play out is anyone's guess.
In the financial markets, something unexpected usually causes market breaks, crashes and other singularities. After all, expected events are quickly incorporated into asset prices. The dollar market is too big for an abrupt crash. But the Arab revolution has unexpectedly highlighted the dollar's weaknesses. That won't be good for the greenback.
Exacerbating things is the rising price of oil. Since oil is traded in dollars, the lower the value of the dollar, the cheaper oil becomes to holders of other currencies. One player to watch in particular is China, a large consumer of oil with a growing appetite. The Chinese have already been gradually diversifying their foreign currency investments away from the dollar. Rising oil prices may, more than all the political pressure that can be exerted by the U.S. and other Western governments, convince the Chinese government to truly de-link the yuan from the dollar. As the yuan rises, oil becomes cheaper for the Chinese. If China can turn its economy toward domestic consumption--a goal the Chinese government acknowledges--look for the yuan to rise markedly against the dollar.
Some in the U.S. government would contend all this is good. A cheaper dollar enhances America's exporting competitiveness. But the price of a cheaper dollar is likely to be higher inflation--in gasoline prices and also the price of our numerous imports. The Fed's ultra-easy money policies would have to end and interest rates would rise. That would throw a wrench into the economy in many ways, from slowing the still feeble real estate market to discouraging business expansion to wrecking Wall Street profitability (which rests on a zero cost of funds) to knocking down stock prices.
The Arab revolution is almost entirely out of the control of Western governments, especially the mess in Libya. And even if things in the Arab world settle down in a few months, growing demand from Asia will continue to support and maybe push up oil prices. It's in the interest of the rest of the world to weaken the dollar in order to make oil cheaper. Even serial exporters like China and Japan have to weigh the increased cost of oil against their export revenues in deciding whether or not to keep their currencies weak against the dollar. Also, it seems to be a goal of the Federal Reserve's relentless easy credit policy to weaken the dollar. As the dollar drops, OPEC and other sellers of oil may begin to demand payment in other currencies. The dollar would drop further in such a scenario. Even though America would get an exporting boost from a falling dollar, rising interest rates here would slow the economy at the same time. How this mix of countervailing forces would play out is anyone's guess.
In the financial markets, something unexpected usually causes market breaks, crashes and other singularities. After all, expected events are quickly incorporated into asset prices. The dollar market is too big for an abrupt crash. But the Arab revolution has unexpectedly highlighted the dollar's weaknesses. That won't be good for the greenback.
Wednesday, February 23, 2011
The Easy Stock Market
The Dow Jones Industrial Average has dropped almost 300 points in the last two days, and oil prices have popped up to $100 a barrel. Gas will reach $3.40 to $3.50 a gallon in a week or two. This, all because unrest in the Arab world has upended the government of Libya, a major oil producer. Libya's erstwhile leader, Muammar Khaddafi, is holed up with several thousand loyal troops. Much of Libya is now in rebel hands, and some military units have abandoned Khaddafi. His survival looks increasingly unlikely. But if his forces are well-provisioned, the fighting could continue for who knows how long.
Libya has no governmental structure (no constitution, no formal process for succession of leadership). If Khaddafi falls, a hundred claimants to leadership could step forward. That would take a while to sort out.
Oil production in Libya is grinding to a halt, and may stay halted for a long time. Other OPEC nations might be able to increase their production enough to fill the gap. But much of the new production would be sulfur-heavy, expensive to refine crude, not the light, sweet, low-polluting crude that Libya produces. And that assumes OPEC would be willing to increase production instead of cash in on the higher prices.
Gas prices have already drifted up 15% in the past six months. At some point, rising oil and gasoline prices, declining real estate values, continued high unemployment, stagnating (or in the case of many public employees, falling) incomes, and cutbacks in state and federal government spending will combine to chill the economic recovery. Whether we fall into recession again, or just idle in neutral, things won't be good.
It's no surprise the Dow fell so abruptly. Today's stock market is bipolar, either delirious with joy or down in the dumps. The market's recent meteoric rise created the conditions for an abrupt pullback. Whether it's easy come or easy go, we have an easy stock market.
Policy wonks on both the left and right will renew calls for energy independence. The programs they recommend will differ. None will be simple or cheap. However achieved, independence will be expensive.
The economic distress caused by volatile oil prices, the 5,000 plus American dead and hundreds of billions of American dollars spent fighting the Iraq and Afghanistan wars, and the need for expensive continued U.S. presence in an increasingly unstable region haunted by seemingly unstoppable nuclear proliferation make the cost of inaction extremely high. That doesn't mean there will be action. America's divided government is struggling to accomplish anything. Thus far in 2011, it's mostly followed past policies of expanding the federal deficit by cutting taxes and increasing spending. A gargantuan problem such as energy independence may be impossible for the pushmi-pullyu in Washington to handle. Save your nickels. Cash money will command a premium as uncertainty grows.
Libya has no governmental structure (no constitution, no formal process for succession of leadership). If Khaddafi falls, a hundred claimants to leadership could step forward. That would take a while to sort out.
Oil production in Libya is grinding to a halt, and may stay halted for a long time. Other OPEC nations might be able to increase their production enough to fill the gap. But much of the new production would be sulfur-heavy, expensive to refine crude, not the light, sweet, low-polluting crude that Libya produces. And that assumes OPEC would be willing to increase production instead of cash in on the higher prices.
Gas prices have already drifted up 15% in the past six months. At some point, rising oil and gasoline prices, declining real estate values, continued high unemployment, stagnating (or in the case of many public employees, falling) incomes, and cutbacks in state and federal government spending will combine to chill the economic recovery. Whether we fall into recession again, or just idle in neutral, things won't be good.
It's no surprise the Dow fell so abruptly. Today's stock market is bipolar, either delirious with joy or down in the dumps. The market's recent meteoric rise created the conditions for an abrupt pullback. Whether it's easy come or easy go, we have an easy stock market.
Policy wonks on both the left and right will renew calls for energy independence. The programs they recommend will differ. None will be simple or cheap. However achieved, independence will be expensive.
The economic distress caused by volatile oil prices, the 5,000 plus American dead and hundreds of billions of American dollars spent fighting the Iraq and Afghanistan wars, and the need for expensive continued U.S. presence in an increasingly unstable region haunted by seemingly unstoppable nuclear proliferation make the cost of inaction extremely high. That doesn't mean there will be action. America's divided government is struggling to accomplish anything. Thus far in 2011, it's mostly followed past policies of expanding the federal deficit by cutting taxes and increasing spending. A gargantuan problem such as energy independence may be impossible for the pushmi-pullyu in Washington to handle. Save your nickels. Cash money will command a premium as uncertainty grows.
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