The grand euro experiment is grinding toward its ultimate conclusion, this can be seen in the petroleum markets. The chart by Bloomberg:
|UBS Bloomberg CMCI||1,414.65||-23.91|
Commodities Futures Indexes
BRENT CRUDE FUTR (USD/bbl.)
|GAS OIL FUT (ICE) (USD/MT)||846.250||-20.500||-2.37%||16:29|
|HEATING OIL FUTR (USd/gal.)||263.990||-6.330||-2.34%||16:29|
|NATURAL GAS FUTR (USD/MMBtu)||2.323||-0.099||-4.09%||16:28|
|GASOLINE RBOB FUT (USd/gal.)||266.200||-6.070||-2.23%||16:28|
WTI CRUDE FUTURE (USD/bbl.)
Here we see what happens when a belief system dies. The grinding part is caused by the high price of petroleum. It has cost so little for so long the entire machinery world has been built up around it. A low price has been assumed forever. Now fuel is unaffordable by a large and increasing part of the world economy: the part that has been charged with servicing the world’s debt.
The outcome of the high price has been demand destruction with resulting sharp fall in the price: down then up then down again. The public naively believes the decline in price is an unadulterated ‘good thing’ but prices fall today because something important has died … such as a country.
Either the nominal fuel price is too high and other prices cannot be raised, or the low price represents diminishing purchasing power across the entire economy. In either event, the price of petroleum relative to other goods and services is unaffordably high and the consequence is being felt. People blame bankers but the real problem is the assumed/desired perpetual low fuel prices.
The low prices represented an excess of supply on the market, the outcome of the low price was a self-entrenching belief that the excess of supply and the accompanying low prices would last forever. Too low for too long has been a trope of economic pop culture. The big idea is that bankers held interest rates too low: that what bankers do is of vital importance. Umm … not really, JW Mason at Mike Konczal’s Rortybomb consolidates some of the various interest rate arguments here:
Far Too Low for Far Too Long
So, what caused the economic and financial crisis of 2007-whenever? It’s an open question. Presumably we’ll continue to argue about it until the next crisis (or until the Moon Men invade.) But right now let’s talk about one possible story, or really family of stories: that the root cause of the crisis is that interest rates were too low for too long.
You can even find this type of argument among Keynes scholars, like the brilliant Axel Leijonhufvud:
Operating an interest targeting regime keying on the consumer price index (CPI), the Fed was lured into keeping interest rates far too low for far too long. The result was inflation of asset prices combined with a general deterioration of credit quality. This, of course, does not make a Keynesian story. Rather, it is a variation on the Austrian overinvestment (or malinvestment) theme.
In the current crisis, he adds, “The General Theory is not particularly helpful.” (Heresy!) Well, it is certainly true that Keynes wasn’t writing about a situation where the market interest rate was in some sense too low. Indeed he believed that an excessively high rate of interest explained not only crises in rich countries but what would we would today call the underdevelopment of poor ones (Keynes): “The history of India at all times has provided an example of a country impoverished by a preference for liquidity amounting to so strong a passion that even an enormous and chronic influx of the precious metals has been insufficient to bring down the rate of interest to a level which was compatible with the growth of real wealth.”
One is loath to argue with Leijonhufvud, a far smarter and deeper thinker about the economy than most of us (me certainly included!) can ever hope to be. And yet I can’t shake a nagging feeling that the “far too low for far too long” story doesn’t quite add up.
It doesn’t add up because Mason leaves out petroleum. Fuel prices have increased 10x since 1998 and 3x since 2004. The increase in price has not produced 10x or even 3x as much fuel. Instead, the price rationing dynamic has kicked in leaving players on the sidelines. The players’ choice is to drive cars or pay the interest on trillions in debt … accumulated to drive cars. Drivers can buy fuel with credit or pay the interest, they cannot afford to do both at the same time.
Paying interest leaves nothing for driving and the car industry fails along with everything that accompanies it (as is underway in the EU right this second).
The price declines because users cannot afford fuel, not because technology has brought a new supply of the cheap stuff to the markets. Rationing by price is a blunt instrument, what remains after comic book fantasies about unlimited petroleum energy are substituted for common sense. Comic book never says that any new oil is going to cost a lot of money. It never says the only source of the new money is Wall Street and City of London finance.
$98 per barrel Brent is lower than the price cited by analysts as the break-even amount for many producers of crude. Selling at a loss can only be supported by producers for very short periods and only by their accepting (bad) credit.
After rationing by price/access to credit is physical rationing by way of shortages. These takes place after the price is insufficient to bring expensive replacement crudes to the market. The reduced price is always too high for shortage-crippled customers to afford: as fast as the price declines the ability to meet the price declines faster. Here is fuel-driven deflation, much like the debt variety, where the real worth of the fuel balloons relative to the income- or credit-worthiness of the purchaser.
The ordinary solution of flooding the markets with oil is unavailable when cheap oil cannot be found or the cost of the flooding is ruinous to the producer. The economy freezes and prices fall because inputs are unaffordable.
Looking behind the curtain, it is possible to see the outline of this dynamic underway within the euro-area. Countries have borrowed staggering sums to afford fuel along with the means to burn it. Neither the means nor the fuel provide any return so additional debt is taken on to retire the first round of loans and purchase more fuel and more means. More debt is taken on to the point where the entire capacity of the borrower is utilized to service and retire debts.
Lenders question whether debts can be repaid, they make repayment demands which cannot be met. The revealed worthlessness of one group of loans calls illuminates the worthlessness of the rest. The edifice of loans is useful only in the sense that the cost to restructure is now greater than what the edifice itself is worth.
Europe cannot borrow any more, no one will lend. If Europe cannot borrow she is bankrupt, if she lends she is also bankrupt as she lends against worthless collateral. There are no other choices besides lending and not lending.
The stock markets reflect uncertainty, is this the ‘Big One’?
Figure 1: World stocks from a March 2009 baseline by Doug Short (click on chart for big).
Markets swoon and authorities swoop in with newly-recycled credit and promises of recovery to come. The markets rise on the euphoria until the next round of borrowing difficulties and the swoon begins again. Monetary policy has proven to be the least effect means of promoting recovery as tens- of trillions of dollars, euros, yen and yuan have been recycled to produce the effects seen in the chart.
The political establishments have no credibility at all: please refer to the last post. Politics matter, good politics would be a tonic compared to the current nonsense in high places. Nobody knows what to do, nothing worthwhile is on the negotiating table. Political nerves amplify market tension as finance is stretched to the breaking point.
There is no credible enterprise which is able to make a good loan. Here is the widening gap between reality and what market participants want to hear.
The time for a fiscal union or European federation has passed. The point of such a union would be to create a credible Pan-European entity that could make a good loan: a source of new capital, in other words.
– Won’t work now because all loans are demonstrably bad loans.
– Loan quality AND quantity is a problem not the euro itself.
– Resource/energy waste is the REAL problem as what is done with the resources cannot pay for the resources themselves. This is the ‘why’ of the euro in the first place: to waste today and (not) pay sometime in the future.
– The euro was to allow individual European countries to afford fuel imports without having to buy dollars or sterling in the forex markets first.
– The euro gave the EZ mercantile countries a captive market, denominated in euros.
– The euro made all EZ loans uniform, it gave all euro-denominated sovereign loans the appearance of being risk-free: too low for too long!
– At the same time there was the implied interest rate differential that could only emerge after it was exploited by insiders. Far from being a real currency union, the EZ is a collection of different states all using different currencies all pegged together called ‘the euro’. All the nations — including Germany — are thence dependent upon external financing.
The euro is a form of sub-prime instrument, where the promised benefits cannot exist. However, this fact cannot be determined until the euro-customer is committed to it and discovers its defects the hard way.
There is no credibility within the EZ because there are no good loans, there never have been any good loans. Lending for consumption requires external repayment agents (bankers from Mars). Europe can lend to itself only when everyone understands that Europe has resources-in-kind to repay the loans. Now what? False promises of ‘prosperity’ can only be met with more false promises from incompetents who don’t understand the nature of their own claims.
Any non-European entity attempting to ‘bail out’ any euro-zone or EU country faces the same credibility issue: that includes the Fed and the IMF. When it makes a loan in order to retire bad loans, it is making a bod loan itself.
The fault lies with the original loans which never should have been made in the first place.
The entire world has been had, the car dealers and developers made some ‘money’ … whatever that is. There is nothing useful to show for the enterprise except some useless junk. A fine mess we’ve made for ourselves …