The economics of fools and thieves

I know I harp on this a lot, but there is just no getting around the fact that allowing Predators to run a technologically fragile economy is a prescription for disaster.

And while high commodity prices are usually a good thing for Producers like farmers and mine operators, they are bad for manufacturers and a host of others who have absolutely nothing to gain from the run-up in prices of things like food and energy.  So with few exceptions, commodity price speculation only benefits the speculators.

The Biggest Bubble of All Time – Commodities Market Speculation 

By L. Randall Wray, a Professor of Economics at the University of Missouri-Kansas City and Senior Scholar at the Levy Economics Institute of Bard College.

Back in fall of 2008 I wrote a piece examining what was then the biggest bubble in human history: http://www.levyinstitute.org/pubs/ppb_96.pdf.

Say what? You thought that was tulip bulb mania? Or, maybe the NASDAQ hi-tech hysteria?

No, folks, those were child’s play. From 2004 to 2008 we experienced the biggest commodities bubble the world had ever seen. If you looked to the top 25 traded commodities, you found prices had doubled over the period. For the top 8, the price inflation was much more spectacular.  

As I wrote:

“According to an analysis by market strategist Frank Veneroso, over the course of the 20th century, there were only 13 instances in which the price of a single commodity rose by 500 percent or more. For example, the price of sugar rose 641 percent in 1920, and in the same year, the price of cotton rose 538 percent. In 1947, there was a commodities boom across three commodities: pork bellies (1,053 percent), soybean oil (797 percent), and soybeans (558 percent). During theHunt brothers episode, in 1980, silver prices were driven up by 3,813 percent. Now, if we look at the current commodities boom, there are already eight commodities whose price rise had reached 500 percent or more by the end of June: heating oil (1,313 percent), nickel (1,273 percent), crude oil (1,205 percent), lead (870 percent), copper (606 percent), zinc (616 percent), tin (510 percent), and wheat (500 percent). Many other agricultural, energy, and metals commodities have also had large price hikes, albeit below that threshold (for the 25 commodities typically included in the indexes, the average price rise since 2003 has been 203 percent). There is no evidence of any other commodities price boom to match the current one in terms of scope.”

Now here’s the amazing thing about that bubble. The staff of Senator Joe Lieberman and Representative Bart Stupak wanted to know whether the bubble was just due to “supply and demand”. Relying on the expertise of Frank Veneroso and Mike Masters (two experts on the commodities market), I was able to conclude beyond any doubt that it was a speculative bubble driven by a “buy and hold” strategy adopted by managers of pension funds. Hearings were held in Congress, with guys like Mike Masters testifying as well as representatives from the airlines and other industries.

The pension funds panicked, realizing that their members would hold them responsible for exploding prices of gasoline at the pump. Pension funds withdrew one-third of their funds and oil prices fell from about $150 per barrel to $50. If you want to read the detailed analysis, go to my paper cited above—it has to do with commodities indexes, strategies pushed by your favorite blood sucking vampire squid (Goldman Sachs), and futures contracts. It gets wonky. To make a long story short, the bubble ended in fall of 2008.

But then the crisis wiped out real estate markets and the economy. Managed money needed another bubble. They whipped up irrational fears of hyperinflation that supposedly would be caused by Helicopter Ben’s QE1, QE2, and the newly announced QE3. Better run to good “inflation hedges” like gold and other commodities. That did the trick. The commodities speculative bubble resumed.

And boy, oh boy, what a boom. An April report by expert Jeremy Grantham looks at the last decade’s bubble in commodities; Frank Veneroso expands upon that in a more recent report. Here’s the elevator speech summary. Take the top 33 commodities that are globally traded—everything from gold and oil to to rubber, flaxseed, jute, plywood, and something called diammonium phosphate. Over the past 110 years, an index price of these 33 commodities has declined at an annual rate of 1.2% per year. (Sure there are variations across the commodities—this is the average. And so much for inflation hedges.

Commodities prices fell—they did not keep up with inflation. If you liked negative returns, commodities were a good bet.) Although demand for these 33 commodities has increased a lot over the century, new production techniques plus successful exploration has resulted in a declining price trend.

Further—and this is a bit surprising—deviations from the trend follow a normal distribution (you learned about this in high school; it is a bell curve with nice properties; chief among these is the finding that about 68% of outcomes fall within one standard deviation; about 95% fall within two standard deviations (once a generation); and you’ve got just about a snowball’s chance in hell of finding outcomes that are three or four standard deviations from the mean). more 

This is especially rich.  The biggest, baddest banks of Europe have been involved in investments that are mostly useless and often insane.  So now when their loans are going bad, they scramble around looking for someone to cover for them.  But governments are broke and their citizens want never to bail out another bank again.  So now they turn to their central banks where they hope someone can conjure up the voodoo that will cause their accounts to reset.

I say FINE.  I only want everyone else to to have access to the same magic reset button when they discover their mortgages are too large or that their useless college educations are certainly not worth being $125,000 in debt.

EU Set to Speed Up Recapitalization of 16 Banks
Published: Thursday, 22 Sep 2011 
By: By Brooke Masters, Peggy Hollinger and Alex Barker, Financial Times

European officials look set to speed up plans to recapitalize the 16 banks that came close to failing last summer’s pan-EU stress tests as part of a coordinated effort to reassure the markets about the strength of the 27-nation bloc’s banking sector.

A senior French official said the 16 banks regarded to be close to the threshold would now have to seek new funds immediately.
Although there has been widespread speculation that French banks are seeking more capital, none is on the list. Other European officials said discussions were still under way. 

The move would affect mostly mid-tier banks. Seven are Spanish, two are from Germany, Greece and Portugal, and one each from Italy, Cyprus and Slovenia. The list includes Germany’s HSH Nordbank and Banco Popolare of Italy. 

When the European Banking Authority, the new pan-EU supervisor, tested 91 banks against a stressed economic scenario — including rating downgrades of sovereign debt — nine banks failed and were told to raise more capital by the end of December.

The 16 institutions that are now the focus of attention ended up with core tier-one capital ratios — the key measure of financial strength — of 5 percent to 6 percent. The pass mark was 5 percent. The EBA had given those banks until April 2012 to implement plans to shore up their capital buffers. 

While the banks are expected to turn to private markets first, officials said that state aid may be required. 

The French government appears to favor using the new 440 billion euro (US$591.7 billion) rescue fund, known as the European financial stability fund, but other member states are likely to argue for national action. more

Finally, another look at the craziness of the 2005-2008 economic meltdown through the eyes of Al-Jarzeera.  It's pretty well done.

Meltdown
The men who crashed the world
The first of a four-part investigation into a world of greed and recklessness that led to financial collapse. 

Meltdown Last Modified: 21 Sep 2011 09:26

In the first episode of Meltdown, we hear about four men who brought down the global economy: a billionaire mortgage-seller who fooled millions; a high-rolling banker with a fatal weakness; a ferocious Wall Street predator; and the power behind the throne. 

The crash of September 2008 brought the largest bankruptcies in world history, pushing more than 30 million people into unemployment and bringing many countries to the edge of insolvency. Wall Street turned back the clock to 1929. 

But how did it all go so wrong?

Lack of government regulation; easy lending in the US housing market meant anyone could qualify for a home loan with no government regulations in place. 

Also, London was competing with New York as the banking capital of the world. Gordon Brown, the British finance minister at the time, introduced 'light touch regulation' - giving bankers a free hand in the marketplace.

All this, and with key players making the wrong financial decisions, saw the world's biggest financial collapse.  more