Message: Credit Bubble Bulletin, by Doug Noland
This is a must read.
Deno
A New Inflationary Epoch
Crude oil closed today above $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 ten-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% y-t-d price surge at the same time as international reserve positions have expanded at about a 30% annualized rate - to a stunning $6.769 TN. Over the past 4 ½ years, official international 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 $303bn; and Brazil enjoyed a four-fold increase to $189bn. After beginning 2004 at $73bn, Russian reserves have almost reached the half Trillion mark ($493bn). And in just the past year, OPEC reserves have inflated 42% to $490bn. 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 Fed’s Credit System Bailout, anticipating Heightened Global Monetary Disorder has been a key CBB 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 today at an all-time high, sporting a y-t-d 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’s and Administration’s desperate measures to sustain the U.S. 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 U.S. 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 upon them, not to mention the IMF and other western policy strongmen.
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 nineties’ “Asian contagion.” The head of the Asian Development Bank this 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% this week and have more than doubled over the past year. Throughout Asia, nervous policymakers are wasting little time in reacting to surging prices, hording 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 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, 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 Alan Greenspan warning us of the risks of trade frictions and “protectionism.” These are, after all, the predictable consequences of a bursting U.S. 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 U.S. 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 now 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 (i.e. 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. 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 was met by a massive increase in technology production capacity. The incredible growth in semiconductor and technology output was known as a “productivity miracle.” It was, however, industry idiosyncratic. The buyers of these relatively inexpensive new products benefited, while fortunes were made (and many then lost) in the Internet and technology stock Bubble.
The next Fed-instigated round of Credit and Asset Bubble Dynamics then invaded mortgage and housing markets. Wall Street simply created Trillions of new higher-yielding securities, while the homebuilding industry constructed millions of new homes. Most American relished the wealth effects from inflating home and stock prices. The economy enjoyed a Credit-induced boom. Corporate cash-flows boomed, while government receipts swelled. Similar to the technology Bubble, few felt or thought they were suffering from the ill-effects of inflation.
I am this evening referring to A New Inflationary Epoch because today's unfolding inflationary dynamics are Different in Kind. For one, prevailing inflationary pressures are global in nature. Wall Street finance is not the source fueling the boom, and it’s running outside the Fed’s control. American asset inflation and resulting wealth effects are minimal, while price effects for food, energy, and commodities are extreme. In contrast to previous inflationary booms, while some selected groups benefit, the vast majority of people today recognize they are being hurt by rising prices. This pain comes concurrently with atypical housing price declines. Today’s price effects pummel already weakened consumer sentiment, as opposed to previous effects that tended (through asset inflation) to bolster confidence. Furthermore, current inflationary forces are destabilizing and even destructive to many businesses, while playing havoc with the fiscal standing of federal, state and municipal governments.
Revolving around booming Wall Street finance, previous inflationary booms naturally fueled surges in securities issuance and speculation. These Bubble Effects worked as powerful magnets in attracting foreign financial institutions, foreign-sourced speculators, and cheap foreign-sourced borrowings (i.e. yen borrowings financing higher-yielding U.S. securities) that all worked in concert to “recycle” our Current Account Deficits (“Bubble dollars”) directly back to our securities markets.
In contrast, inflationary forces these days largely bypass U.S. securities to play global energy, commodities, and hard assets. Foreign financial institutions are fleeing the U.S. risk intermediation business, while “Bubble dollars” are chiefly recycled back into Treasury and agency securities (where they now have minimal effect on U.S. home and asset prices). Meanwhile, the massive Global Pool of Speculative Finance is today focused on energy, commodities and the “emerging” economies.
Unlike tech stocks/junk bonds, and U.S. mortgages/houses, it is today extremely difficult to meaningfully increase the supply of energy, agricultural commodities, and many natural resources. Moreover, the longer this boom is sustained the greater the demand for energy and commodities from the likes of China, India, greater Asia and the Middle East. And the higher prices rise, the greater the tendency for hoarding and problematic supply disruptions – only aggravating supply/demand imbalances and emboldening aggressive speculation. Wall Street can’t fix this demand imbalance.
Importantly, surging prices for vital necessities such as energy and food by their nature elicit expanded Credit creation - albeit our consumers using Credit cards at the gas pump; our Congress deficit financing economic stimulus packages; our state and federal deficits expanding to pay for generally rising costs; corporate America borrowing to finance surging energy and other expenses; aggressive borrowing by U.S. and global energy/commodities-related industries expanding operations; by the alternative energy Bubble; by speculation-related leveraging; by governments around the globe that will expand deficit spending programs implemented in an effort to placate outraged citizenry; and by OPEC, Brazil, Russia, Australia, Norway and other economies directly prospering from the boom. Or, stated differently, through various mechanisms, processes, dynamics, and rationalizations there will be overriding tendencies to “monetize” today’s inflationary effects. And unlike previous inflation manifestations that tended to remain largely contained within asset markets, today’s virulent energy and commodities inflation will spawn broad-based secondary price effects. As recent trends corroborate, inflation begets only greater inflation.
The reality that powerful inflationary psychology has taken hold - and that the world’s leading central banks show no inclination to confront this worsening problem - motivates tonight’s title, “A New Inflationary Epoch.”
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