More Market Distortions Ahead

The full and fair pricing of goods and services will continue to be hampered by monetary crack cocaine...

WELL FANCY THAT! One of the few Grand Wizards of the global Oz in which we live last week chose not to openly deny reality. And wouldn't you know, it was none other than 'Blackhawk' Ben Bernanke, writes Sean Corrigan for the Cobden Centre.

The occasion was the post-FOMC press conference. Bernanke openly confessed to not having a clue about why the US economy seemed to be stuttering, once more,

Not only that, he then ruefully responded to a Japanese interlocutor that, yes, it had been easy enough for him to make an academic name for himself by pontificating on what the BOJ should and should not have done to escape the clutches of the country's (supposed) economic stagnation, all those years ago, but that his experience as a policy-maker had since taught him to be far more forgiving of his predecessors in office.

As for the first, we are not so much surprised at his cluelessness, per se, but at his admission thereto. 

As for the second burst of illumination, we would dearly like to know whether this was the first glimpse of a newborn humility, fostered by the demoralizing effects of a partial realization of the limits of his powers, or simple fatigue at the political brickbats he must suffer being hurled at him during their exercise.

Being of a cynical bent, we rather suspect the latter.

In contrast, the little bald men behind the curtain at the Bank of England could only retreat, this week, into a form of casuistry to gladden the heart of a mediaeval theology student.

Here, we were treated to a particularly pathetic from of special-pleading which we characterized as 'Foreigners ate my inflation target'.

The argument here was that the Bank was not to blame for missing its inflation target (yet again), or for missing it by a widening margin, or for not being able confidently to predict when the disparity between hope and expectation might at last be eradicated, but rather it was all the fault of 'imported inflation' and government tax hikes.

That the only way to 'import' inflation is either to authorize use of a second country's surplus money inside the realm, or to freely exchange any such influx for newly-created money of one's own, seems not to have registered with the great and good of the MPC. 

Nor can one lean too heavily on a state impost to explain rising prices since, if the ad valorem tax were used to fund a level of welfare payments whose disbursement was previously reliant on the printing press, this must serve to reduce overall monetary demand and so lead to a lower volume of sales, lower prices, or some combination of both.

Naturally, high prices have nothing to do with the fact that the Bank (along with one or two key members of its international peer group) have slashed rates and monetized the state's enormous deficit (directly during the first year of the crisis and indirectly via the commercial banks in the past twelve months). 

Nor was it a consequence of the rather sharp decline in Sterling (second only to the one suffered by the Icelandic Krona) brought about as a deliberate act of policy which, incidentally, Thou Holier than Me, helped inflict a 15% 'haircut' on the foreign holders of long-dated Gilts.

Nay, nay, and thrice nay! Nothing the Bank did was responsible for this offshore:onshore split, or for the rather more loudly barking dog that what the country has undergone is not just a shift in RELATIVE pricing (arguably to the good, to the extent that it needs to address its chronic external deficits), but a major one in ABSOLUTE pricing, to boot.

The real concern here – as elsewhere that such specious reasoning is being advanced – is that the false distinction with which the Bank is trying to exculpate itself implies that any reduction in the 'domestically-generated' price component will give it free rein to repeat the dosage, all the while grumbling about what mischief the untrustworthy blaggards east of Calais are about.

The second contender for this week's award for a mix of extremely wishful thinking and blatant propagandizing has to be China's Premier Wen Jiabao, currently en route for a much-trumpeted visit to Europe.

On the eve of his departure for London, Wen (or, more accurately, his speechwriters) issued an editorial, duly published in the FT, which contained a whole litany of Swiftian enormities as, for example, when he preened that:

China has moved swiftly to fight the financial crisis, adjusting macroeconomic policy to expand domestic demand, and introducing a stimulus package to maintain growth, advance reform and improve people's lives. By taking these steps, we have overcome extreme difficulties and laid a solid foundation for China's development.

Our emphasis shows that this might have been better promulgated in the pages of The Onion, rather than in the august columns of the FT, but unconscious irony is not exactly in short supply these days, so perhaps the satire was not broad enough for the former's editors.

After delivering a long list of triumphant materialist achievements (though, alas, for those nostalgic for a whiff of the rhetorical style of Communist mass-murders of yore, no mention of any records in pig-iron production), Wen then went on to claim that, despite the gargantuan stimulus delivered, the state finances had actually been improved – well, yes, but only if you exclude all the overstretched lower tiers of government, or the subsidy-bloated, price-capped SOEs, or the true capital position of the 'policy-lending' banks).

Apparently, thanks to the enlightened guardianship of the central planners, growth in money and credit supply has "returned to normal", allowing him to declare victory in the war on inflation as the "overall price level — we presume he means rate of change in that level — "is within a controllable range and is expected to drop steadily."

So no worries that his own apparatchiks are currently warning of further gains in the pace of price rises in the coming months, or that these are only as modest-looking as they have been, thanks to a toxic combination of capital-destroying price caps, governmental menace, volume and quantity downgrading in the product mix, and outright exclusion from the reference basket of all manner of inconveniently uncontrollable, privately-supplied goods and services.

No mention either of the fact that the cronyism which runs deep through this most oligarchic of states has seen the full brunt of what credit restriction there has been fall upon the unprotected shoulders of the SMEs — forcing many of them to cover working capital needs, via kerb lenders, at usurious rates of up to 15% a month (a mere 435% APR). These funds often sourced through the collusive cheating of regulatory restrictions by those able to import copper, zinc, and possibly even soybeans, on term credit abroad (presumably the SOEs with the aid of their pet banks).

If you are basing your world view on China being able to establish some new, Third Way utopia of benign central planning in order to show us degenerate Westerners the way to the Land of Milk and Honey, you are in for a disappointment. The same sort of disappointment as was suffered by those earlier intellectual 'second-hand dealers in ideas' who thought the Soviets were about to do likewise, eighty years ago.

There is even a potential paradox here, for those who are interpreting Wen's PR fluff as a substantive guide to a switch in policy objectives from one of capping price rises to one of again boosting what passes for growth in the land of cadres, clipboards, and top-down targets. 

This is that while the knee-jerk trade will be to bid up the price of commodities on any relaxation of credit in China, if this were to obviate the need to use raw materials on anything like the rumored scale as collateral for the import of foreign credit to the grey market, an awful lot of metal—and perhaps—agricultural products will instead be looking for a buyer.

China may be the big spider at the center of the web, but do not lose sight of the fact that she is a screwdriver factory for many of the products of her more advanced neighbors, into the bargain, with her trade surplus with the US almost exactly offset by her combined deficits with Taiwan, South Korea, and Japan, for example. Nor should we overlook the nation's pivotal role in the seemingly currency-inelastic success of high value-added exporters from the likes of Switzerland and Germany.

Recent data shows those satellites may just be beginning to wobble, with the German business expectations falling for four successive months, according to the Ifo Business Survey ; with Korean business investment flagging badly; with Taiwanese commercial sales growing at their slowest pace since the Crash; and with estimated world industrial production not only crawling along at the bottom of the range experienced during the pre-Crash cycle, but decelerating at an alarming rate as it does so — making commodities look rather expensive (and, hence, overly QE-II dependent) in the process.

It may be a task beyond the ken of all but the wildest-eyed visionary to encompass, but imagine — just for a moment — that we operated in a milieu characterized by the sort of rational markets which the portfolio peddlers and DSGE pseudo-mathematical planners assure us — in the face of all the evidence to the contrary — does actually prevail.

Now, suspend your disbelief for one further moment and suppose that some Emmett Brown-type bursts out of his tumbledown laboratory, crying 'Great Scot!' at the top of his lungs and waving around a gleaming glass phial which — when he has finally succeeded in calming himself — he explains contains a miracle compound which will henceforth provide humanity with a near costless, readily-scalable, pollution-free source of energy.

Having set this somewhat unlikely stage, let us now consider what should be the reaction of all rational actors in the world's financial markets.

Obviously, the prices of oil, natural gas, coal and their derivatives should plunge, taking with them all the securities issued by those companies whose revenues depend upon them, as well as the currencies of those countries whose external surpluses are largely predicated upon their sale.

But, ipso facto, we should also expect the prices of all other commodities and all other equities to rise since these should immediately benefit from a vast redirection of expenditures toward them from the now liberated portion of everyone but the oil and gas men's budgets. 

Granted, such a titanic reallocation would not proceed without a range of secondary and higher-order effects as those whose incomes are dependent upon the now-redundant energy businesses also dry up, but let us keep matters simple here.

Thus, where the householder used to spend $100 a week on gasoline and home heating, he can now buy an extra iPad and so push up the shares of Apple, Foxconn, the rare earth miners, and so forth.

Where the businessman was starved of the necessary capital to expand his existing line or to introduce another, the cash flow spared from his energy needs (as well as those entrained in all the other goods and services he buys in) can be used to buy plant and equipment, potentially pushing up the price of steel and copper, not to mention paper, paint, and plaster.

To the extent that, before Dr. Brown's most singular intervention, a high and rising price of energy was being blamed for throttling the life out of all manner of other consumptive activities — both exhaustive and productive — the revelation of the fruits of his genius should give rise to a burst of well-founded optimism about the prospects for everyone for whom energy was a cost and not a source of profit.

So, on a decidedly more mundane scale, what was the market's reaction to the news last week that the International Energy Agency had decided to release 60 million barrels of oil from their emergency stockpiles, ostensibly to smooth out the disruptions caused by the loss of Libya's light, sweet crude?

To sell WTI and Brent, RBOB, Heat and Gasoil, obviously. Just as obviously to narrow the anomalously wide spread between them (since European refineries were the obvious beneficiaries of the decision). 

Again, obviously, to collapse the steep backwardation as the immediate physical scarcity was alleviated. With a touch more subtlety, to erode US crack spreads as more refiners can compete on a lower cost base for their production and sale. To push ethanol, natural gas, and coal lower, in their turn.

But what it also did, for several long hours after the announcement, was to drive the price of ALL other commodities southwards, in company with 468 out of 486 European and 465 out of 500 major US equities!

A more clear-cut demonstration could not be had of the sorry truth that, in place of a transparent and reputable forum wherein far-sighted participants combine to allocate scarce capital among the most promising suitors for its use, what we really have is a grimy favela, teeming with indexed and basketed, algo-conducting, ticker pimps — each one a member of a relentless swarm of highly leveraged, nickel-before-a-steamroller, financial scavengers, high on the freebase of near-zero central bank margin provision.

Fundamentals? Rationality? Scientific asset allocation? Come on — what do you take us for?!

In truth, the IEA's decision was a little strangely timed, given that oil prices were already in retreat and with intimations from the Saudis that they would make good the Libyan lack (albeit that it is not within their capability to provide the right blend of the stuff to suit the needs of the Colonel's former customers). But perhaps this was just as much a publicity stunt aimed at deflecting some of the growing criticism of NATO's role in that country's internal affairs as it was a shot across the bows of an OPEC otherwise in disarray.

Whatever the Realpolitik behind the move, it has helped further discomfort the oil bulls and the contagion effect has spread the unease to other sectors among which Wen's intervention has offered only a partial respite from the downdraught.

Everywhere we look, trend lines and moving average indicators have been threatened or violated outright and a number of individual commodities, as well as several sub- and comprehensive indices itself, are either a whisker, or an on-close confirmation, away from breaking prominent head-and-shoulders formations and throwing wide the trap–doors creaking ominously below.

Whatever the short term gyrations to be endured, nothing so far has changed our long held view that the second half of 2011 will be a tough one to negotiate as the Austrian imperatives of empowering entrepreneurs and allowing for the full and fair pricing of all goods and services offered for sale continue to be neglected in favor of the currency doctors' quack nostrums and the collectivists' fatal conceits.

In the absence of the fundamental political and social shift needed to provide an environment conducive to the sustainable achievement of material progress across the whole range of activities, we are therefore left with a sickly reliance on artificial excitements — whether these occur in the boardroom or on the trading floor.

Unless and until another source of extra monetary crack can be exploited — and, so far, none of the critical quartet of the Fed, the ECB, the BOJ, or the PBoC seem either willing or able to provide one — the easiest direction remains downwards.

While that remains the case, all the vainglory of soon-to-be retired politicians and all the insincere cheerleading of stock touts and asset harvesters will only make limited and transitory headway against the unflagging pull of gravity that grim probability entails.

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