Westpac’s James Shugg
Today on the podcast, commodity prices, food prices, global unrest, domestic shots from David Rosenberg and James K. Galbraith, and back to the emerging BRIC’s.
There is a distinction we have been trying to draw over the past few months here at Demadn Side. The commodity bubble now unfolding is a prominent element of our 2011 forecast. We wholeheartedly agree that it is the Fed’s actions that is causing this rise in prices. But we do not agree with the simplistic argument that it is more money chasing the same amount of goods that is creating food inflation, nor that booming demand from emerging markets is bidding up commodity prices. Our argument is quite different. The Fed’s cheap money is available to financial players both to create booms in emerging markets with the carry trade and to invest in the commodities themselves. Commodities are no longer products, they are an asset class. Diversifying into commodities is a strategy, just as it was in the great commodities bubble of 2008.
The proof of this is the fact that all commodity prices are going up together. When you have everything from alfalfa to zinc rising, it is a financial market event. Likewise we see that even as serious weakness begins to show in the BRIC’s – more about this later – the commodity prices continue upward.
The distinction is not a splitting of hairs. It is the difference between actually dropping money from helicopters and giving money to supposedly passive intermediaries. The Fed’s intention is to spur investment by making financing cheaper. But it is spurring speculation, instead, as investors shy from illiquid long-term real investment and pile into liquid, short-term and financial product investment. Hence bonds, stocks, and tradable commodity instruments are preferred to plant, equipment, or R&D. We see it instead as the Fed feeding chips to bankers and speculators who fuel bubbles with financial instruments now favoring emerging markets and commodity output.
So how much do food prices have to do with the outbreak of protest in the Middle East? We suggest it is a great deal, as it fuels a fundamental desperation in these nations. At a minimum, we know unrest is happening at the same time as food price spikes.
On the other hand, it is also happening at the same time is the realization that Barack Obama is not going to be the transformational figure many had hoped, and that policy is basically more of the same, only expressed with more finesse. And the population of the Arab world is young, educated, and without real prospects. In Egypt, and elsewhere, the economic policies of privatization so beloved by the IMF, and which failed so completely in Russia, were instituted in the middle of the decade. The result was the predictable disaster. Well-connected insiders took over state-run businesses for their own account. That is called corruption.
So the regimes of this area are ripe for revolution. As John Kenneth Galbraith said, and we repeat, “All successful revolutions are a kicking in of a rotten door.”
Still, we contend that the food price increases, and the energy price increases, are a product of monetary policy by the central bank of the United States. For three and a half years, the Fed has had its foot to the floorboard. There has been no forward movement for us, but the exhaust is choking our neighbors.
The real private economy, where money grows by investing in a system that is more efficient or provides a product that returns real value, there is no action. In the public economy, where even more gains can be made by investing in bridges, schools, public safety and health, even less is happening – choked off by reactionaries who take advantage of the fact that the returns cannot be captured for public viewing. But in the private financial economy, the Wall Street economy of financial speculation, no real value is produced. And as much as the Fed wants housing or real investment to be spurred by its easy money, it is not happening. Instead liquid financial instruments and short-term speculation have benefitted.
With respect to commodities, just as in 2008, commodities are deemed to be inflation-proof and sound, since after all, people have to survive. But that spending is a subtraction from other sectors. Your speculation may net you a dime, but unless you use that dime to purchase something else, there is a downward movement in real output. And you don’t spend that dime on something else. Your object is the money, the claims on future goods, or another liquid financial asset, not anything to do with real economy activity.
This is casino capitalism. A zero sum game. Many of the losers don’t even know they are playing. It is Wall Street economics.
The dominance of finance is unquestioned by the central bank and the current administration, who facilitate it with chips it uses in its games. But the causal chain is short. Asset and commodity bubbles raise prices for necessities. Desperation turns to the obvious near-at-hand repressive regimes.
Whenever we get glum about being the only doomsayer in the room, we open David Rosenberg’s daily newsletter and take heart. His is a market-driven analysis. Since we see financial markets as basically gaming operations, we are less frustrated than Rosenberg, who wants them to be more coherent and connected to the economy.
First out of the box was his remark on Gallup’s tracking of the U.S. unemployment rate, which puts it at 10.0 percent as of mid-February. This is up from 9.8% at the end of January. The underemployment rate spiked back to a 10-month high of 19.6% from 18.9%. “Nice recovery,” says Rosenberg.
Gallup’s numbers are not seasonally adjusted, but tend to anticipate the Bureau of Labor Statistics by about two weeks.
Rosenberg notes that the four-week moving average at 418k represents a jobs market backdrop that can only be described as pathetic for an economy halfway into year two of a
Then , in a segment he called the PHILLY FLYER, Rosenberg took a potshot at the economics media.
The Philly Fed index surged to 35.9 in February from 19.3 in January ― not to mention a massive swing from the -5.6 print last August when the economy seemed to be staring into the abyss. Most of the components were up, including the employment index but that has proven to be a poor indicator for nonfarm payrolls. But the problem was with the six-month outlook component, which really rolled over, sliding from 55.4 in December, to 49.8 in January, to 46.8 in February. Interestingly, hiring intentions sank to a three-month low of 24.4 from 31; and capex intentions plunged to 16.2 from 29 to stand at the lowest level in five months ― and this metric has a decent 75% historical correlation with capital spending from the GDP accounts. See if you find that anywhere in today’s morning papers.
Home prices hit post-bust lows in most big cities according to Case-Shiller. “Muddle through” housing policy did not work, is not working and will not work. Nevertheless, what has worked is the elimination of principle write-down as a means to recreate a healthy housing market. The model was set in the Great Depression with the Home Owners Loan Corporation. In the current crisis, the way was barred by the massive securitization that not only found the capital for the bubble but blocked by complexity this basic exit of renegotiation between borrower and lender. Rather than unpack the process for a front door fix, the Fed opted to buy up the bogus securities to keep their prices up. Well, securitization has dried up, so that didn’t work. The Fed has a trillion and a quarter dollars of them on its balance sheet and the previous owners have cash. That worked for some. Debt IS being reduced by foreclosure and bankruptcy. Policy makers have moved on to muddle through somewhere else. The key to this notation is that muddle through really means sink deeper.
Does anybody doubt that it was a huge credit bubble and enormous excesses in private residential real estate that are the proximate causes of the Great Financial Crisis? Why then is it sovereign debt and fiscal tightening by governments that is the solution?
There is a reason. Well, two. One, the leverage of insolvent financial players is migrating to governments where it can be criticized by the private side, and two, the real solution which involves letting the private financial players take their hit is not popular with them.
As succinct a summary as can be found was offered this week by James K. Galbraith
And finally today,
Stocks in developed countries are rising the most since 1998 while emerging markets slump, a sign the U.S. is returning to its role as the engine of world growth aided by a recovery in Europe.
The MSCI World Index of equities in 24 countries rose 6.1 percent for 2011 through yesterday, the best annual start in 13 years, and the MSCI Emerging Markets Index of shares in nations such as Brazil, Russia, India and China lost 2.7 percent.
While emerging-market equities beat developed countries every year except 2008 in the past decade, they’re falling now as Brazil, Russia, India and China battle inflation.
Econ Intersect phrases it this way.
“The question then becomes one of de-coupling again but under a different guise … than that usually depicted. If the most dynamic economies of the world – where final demand is increasing more rapidly than in North America, Japan and most of Europe – are being forced to tighten monetary policy to preserve purchasing power of their currencies, and to avoid the political and social fallout of higher food costs, then for how much longer is it safe for the USA, UK and Eurozone to maintain the confidence trick that ZIRP is not a hazardous policy which will eventually lead to troubling and ubiquitous global inflation?”Happy Gaming
“There are several ETF’s that enable investors to have exposure to some key emerging markets and these include EWZ, which tracks the MSCI Brazil index; INP, which tracks the MSCI India Index; IDX, which tracks the MSCI Indonesian market; ILF, a fund which tracks the Top 40 Latin American equities, and which provides exposure to Brazil as well as Mexico. These are all relatively large and liquid exchange traded funds and there are also inverse funds for taking a short position with respect to BRIC and emerging markets in general.”
But again, it is Demand Side’s contention that the transmission of price hikes to commodities is not a consumer demand thing, but a “lever up in the U.S. and carry your trade to emerging markets” thing. To some extent emerging economies may have higher demand than they used to, but developed economies have lower demand. The question facing the BRIC’s is whether their capital controls will withstand the inevitable meltdown in their currencies.