After the stock market's worst half-year since the early 1990s, nobody - not
even I - can deny any longer that financial assets around the world are in a
severe bear market. But with so many of the world's most important markets
last week retesting their post-credit crunch extremes - the FTSE at 5,500,
the S&P 500 at 1,280, oil at $140 and the euro at $1.60 - it seems worth
asking the defiant Churchillian question: Is this the end of the beginning
or the beginning of the end? Is the bear market only just starting and about
to break down to much lower levels? Or is it possible that last week was a
test of the lows hit by equities and the dollar in the credit crisis and the
high hit by oil two weeks ago?
You might say that this hardly matters. The financial markets are a casino and
therefore of interest only to gamblers, clairvoyants and cheats.
Politicians, businessmen, homeowners and consumers should focus instead on
the economic fundamentals and an article such as this should try to explain
whether these are really better or worse than suggested by the media
headlines and the stock market talking heads. The trouble with trying to
focus on fundamentals, however, is that these fundamentals are themselves
enormously affected by financial behaviour. In a world in which politicians
and investors believe that the market price of oil tells us more about
supply and demand than any amount of statistical analysis, the doubling of
oil prices in the past 12 months appears to have rendered irrelevant all the
fundamental analysis which has been pointing to lower oil prices for the
past 12 months - even though demand for oil is falling and supply is
gradually rising, in precisely the way that economists would predict when
the price of a commodity goes up.
The sensible economist's response to the paradox of rising prices at a time of
falling demand and increasing supply would be to try to understand the
reasons for this market failure - in this case, most probably herd-like
behaviour of momentum-driven investors, of the type we saw in the credit
bubble, the housing bubble, the internet bubble, the Japanese bubble and so
on.
We live, however, in a world of naive market fundamentalism, where politicians
and media commentators assume that the market is always right, despite the
copious evidence that markets are often very wrong indeed. In these
conditions, financial market movements can sometimes become self-fulfilling
prophecies - if bank shares keep falling they can cause financial crises and
recessions, simply because the world starts to believe that investors must
“know something” about banking solvency that is not apparent to the naked
eye. Similarly, if oil and commodity prices keep rising, they can create a
permanent inflationary psychology, if consumers and producers conclude that
the market must “know something” about the world running out of energy and
food.
To try to understand the gyrations of financial markets - or at least to
respond to them in a calm and rational manner - is therefore an essential
part of the policy-orientated economist's job. What, then, can we sensibly
say about the awful developments in all the financial markets this month?
There seem to be three main anxieties linked to the present bear markets: the
fear of recession, the risk of inflation and the spiralling price of oil.
The possibility of a serious US recession, which has dominated most media and
market comment since the credit crunch began in America last summer, is in
my view the least plausible of these threats. Statistics suggest that the US
economic slowdown is already at or near its low-point and the risks of a
serious recession are rapidly diminishing. GDP, consumption, industrial
activity and employment have all been consistent with a fairly typical
mid-cycle slowdown and none have fallen sufficiently to signal even a mild
recession. In short, the cautiously optimistic assessment of last week's
Federal Reserve communiqué seems to be justified by the statistical facts:
“although downside risks to growth remain, they appear to have diminished
somewhat” since the last FOMC. Of course it is possible that the US economy
will deteriorate in the months ahead, but this seems unlikely, given the
huge tax cuts and interest rate reductions to which American consumers are
likely to start responding in the second half of this year.
Britain and Europe, on the other hand, are only just entering the bust phase
of the credit and housing cycle that started in America almost two years
ago. The scale of these credit busts is likely to be at least as severe in
the UK and Europe as it was in America, for the simple reason that the
credit and housing booms were even bigger on this side of the Atlantic.
Moreover, exchange-rate policies imply that US industry and employment will
recover mainly at Europe's expense. All this means that, in the year ahead,
a serious recession is a much bigger threat for Britain and Europe than in
America.
Having said this, however, there still seems a decent chance that Europe and
Britain may avoid recessions for the same reason as the US - consumers and
non-financial businesses are turning out to be much less vulnerable to
credit tightening and falling property prices than widely assumed.
But if a global recession is likely to be avoided, why are investors in such a
funk? The answer is that most now see inflation as a much greater threat
than recession. This makes sense, but only up to a point. The bad news is
that inflation is much harder to cure than weak growth or unemployment
because the remedies required - higher interest rates and cuts in government
spending - are painful to implement.
The good news is that inflationary pressures in the US, Britain and the
eurozone are still fairly weak - and will get steadily weaker in the year
ahead, as house prices keep falling, consumption growth slows and
unemployment drifts up.
I suspect that what really worries investors in the US and Europe is not
really the likelihood of high inflation, but the risk that central banks
will over-react to inflation fears. If central banks are paralysed by fears
of igniting inflationary expectations they may stop supporting financial
institutions through the credit crunch. This idea seems to be behind the
panic selling of financial stocks. In addition, there is a growing worry
that developing countries, including China, will be overwhelmed by
inflation, like Italy and Britain in the 1970s, instead of learning to tame
it as did Germany and Japan. A long period of disappointing performance from
the developing countries would be a big shock to the world economy, since
global growth depends increasingly on emerging markets. US consumption
growth, while it is not collapsing, is bound to be much weaker in the next
decade than it was in the last.
On this interpretation, the real worry for financial markets is neither
recession nor inflation, but rather the policy paralysis caused by $140 oil.
The oil shock has created a pincer movement of inflationary and deflationary
pressures that is not only threatening the world economy but also disabling
the policy tools of Western governments and central banks. This is why I
have always said that another oil shock is a far greater threat to the world
economy than any conceivable credit crisis.
The future of the world economy now depends entirely on whether America and
Europe can stop the feeding-frenzy among investors that suddenly pushed oil
above $100 four months ago, even as demand began to collapse. What is ailing
the world economy is now quite simple: it is $140 oil. If investors come
back to their senses, the oil price will fall back below $100 after the
summer and the second half of this year will prove less traumatic than the
first. But in the unlikely event that oil is still trading above $140 by the
year-end, all bets are off on world economic prosperity.
It is about corporations grabbing the public assets of the USA & other countries. The U.S. must remember their past and Nationalize half of all oil wells and refrinery's immediately.
this will give competition to the oil monopoly.The corporate free market wars for public assets will continue. sad
Emma, Ashtabula, USA
Oil is now part of a bigger game, speculators are driving up the price not surprising given the share and property markets
but Russia and the middle eastern states have there own agenda, the price will not go down, so even Mr Soros can get it wrong, oil is now political, get over it.
captbob, Megido, UK
Mr Kaletsky should check his figures. Oil supply worldwide has been essentially flat since mid-2005, despite rising market prices. The exports and production data are well publicized. The Supermajor CEOs are publicly revealing that annual production has reached a plateau.
Paul A. Wozniak, Green Bay, USA
How strange to say that demand for oil is falling. The price elasticity of demand for oil is extraordinarily low as it is such an essential input to modern western lifestyles. Lifestyles that naturally appeal to the residents of developing nations - who are only demanding more oil.
A Clarke, London,
When the west talks about the world ... they forget about every one else!
harry, manchester, uk
The writer of this article should carry out an environmental impact analysis based on his economic forcasts. If the world economy contiinues to grow along with populations, there will be the worlds biggest economic disaster and a total ecological breakdown. We need a massive economic decline!
Jim Wills, Brisbane, Australia
We all should be deeply concerned over the oil price. Its knock on effect will trigger a domino effect of wars and major social unrest throughout the world if it crosses the $150 dollar barrier.
Even if it drops to $120 it will still have the same effect if it stays there any length of time.
J Nowland, Leeds, United Kingdom
The world is quite wrongly addicted to news of what happens in the US, but even so, when the American housing market truly bottoms out, sentiment will improve and the economy will rebound. Other economies will follow, and then China and India will lead the prolonged global recovery.
nick gardner, Sydney , Australia
The perfect storm : Petrol, credit, rising inflation, high debt, no savings (The proportion of income being saved has fallen to the lowest level since 1959), others competing for resources, low productivity, must have it now mentality. All striking at once, sorry but we are in for a bad time indeed
Jason Pearson, Toronto, Canada
Last week Nigeria, today Iran. Really its just one story after another here. The fact is we keep using more oil & others are now using it too. They are NOT making anymore. However, the USD is a factor as is speculation look at the sudden run up seems familiar doesn't it?
Jason Pearson, Toronto, Canada
I thought it was a bubble!
Adam, London,
David, Your comments are just recycled media talk. Yes, there is fundamental reason for rising prices in oil, but not the hysteria and ignorance that is occuring now and is indicative of any bubble. The only people who talk of oil running out are those who would see rises increase bottom line!
Kv, London,
Oil is expensive because it is priced in dollars, as the dollar re-values upwards so will Sterling, and oil will reduce in price once again, the housing market is a different matter, anyone liquid at present will benefit from high interest rates, and anyone purchasing an annuity , congratulations!
John Wood, Poinciana, USA
all bets are already off Anatole as it is quite possible we are facing a prolonged deflationary downturn as a result of the unprecedented credit bubble.
JImmy Mac, London, UK
The "huge tax cuts" that "the Americans will respond to later this year" AREN'T "HUGE" and they are already being spent, on NECESSITIES (gas, milk, ulitilies and borrowed-money bills). Compare Mr Z.'s past US prognistications/analyses to the recent historical record--he's miles off every time.
Simon W, Jersey City, USA
I'm afraid that markets are rarely "wrong". Today's market is not telling us something is wrong with banks that is "not apparent to the naked eye". It is telling us something is wrong with banks that is apparent to anyone who takes a glance. Their assets include too many mispriced instruments
jon livesey, Sunnyvale, CA/USA
Quelle surprise. Deluge next.
Bryn Garn, Greenwich, UK
Is there not a way of breaking the price tranfer mechanism between the futures and the physical dated Oil markets ?
With World demand falling and supply increasing surely that is the only way to reflect the real price,and with Gas being priced off of oil this is extenuating the situation.
Tony, Cheltenham,
As usual you ignore the basic fundamentals about the US economy. By any measure, the US has a level of debt and financial obligations that can respectively never be repaid or met. The economic figures issued by the US authorities are distorted and are useless. You choose to overlook these facts.
Scott, Bangkok, Thailand
I think we tend to identify the problems to a single
cause.In reality we are in the uncharted waters of the oil price, global credit, trade imbalances, significant currency distortions
and national fiscal policy spilling over into world inflation.The
result is for markets to use marginal pricing.
roger, bridport,
How about simply not pricing oil soley in USD? America gave us bank losses & a credit cruch, Trying to live off cheap borrowed $$, & Bush's war sucking the life out of its economy & transfering its wealth to China. . Why should 5.7 billion of us pay the price for the actions of 300M Americans?
Jason Pearson, Toronto, Canada
My friend Ali al Battutah says this article is hopelessly West oriented. The rest of the world will be fine and stinking rich, he says, especially his country, Russia and his uncle's country. Unless the West finds an alternative to oil which is very dubious, Allah be praised.
john problem, winchester, uk
Anatole, there is only one solution and that is for the G8 including China, to intervene aggressively in the currency markets. Knocking the Euro down will take pressure off the holders of dollars to diversify, reduce imported inflation on states pegged to the US unit & lower Oil & commodities
Peter, Chelmsford, england
"Not in the long term anyway. It will rise and rise in price, maybe drop back to $100 or so before picking up head of steam again to head higher....so what happens to world economic prosperity then??" You mean western World prosperity? The oil generatin nations will be prosperous.
T.Andre, London,
What is the difference between oil running out and the 'herd" believing it does? For a realist, if oil is actually running short, it will do so irrespective of our believing it does and perhaps even faster if we consume as if it doesn't! We have a real dependency on really limited supplies of oil.
Titos Christodoulou, London, UK
The presumption here is that speculators are driving up the price of oil - which is not necessarily the case. Look at page 4 of the fact sheet published by the US market regulator the CFTC and the correlation breaks down in Sept last year ($70). www.cftc.gov
Guy Weatherall, Lutterworth, UK
It seems to me that economists call futures markets a "price discovery mechanism" when they like the discovered price but "speculation" when they don't. I'll believe the oil price is _all_ speculation when someone can show me where the fixers are storing all that light crude. In City basements?
Edmund, Bristol, UK
Of course it will be if not higher, the banks are desperate to make up the credit losses so they & hedges are piling in for yet another quick kill. America financial status is making it worse as oil producers are getting less because they get paid USD. OPEC is right to fear a crash with these guys
Jason Pearson, Toronto, Canada
Anatole has finally 'smelled the coffee'. Market failure driven by waves of cheap US dollars, funded by weak japanese restructuring in the last decade (AKA the carry trades), has meant that the speculative oil that is meant to grease the machine, has itself become the machine.
Graeme, Hua Hin, Thailand
I blame largely the panic rate cuts post 9/11, much applauded by Mr Kaletsky. They set off a massive property price and consumer boom which sucked in imports from the Far East - these economies are booming thanks to the money that has poured in, thus massively increasing the demand for oil..
cww, ipswich, UK,
The West feels guilty about having had such a good economic run. It now feels that the Evil Eye has caught up with it, and the West deserves to suffer. The gloom will continue until Westerners feel they have paid the price of prosperity. Then it will be full steam ahead again, in 18 months' time.
Paul Francis, Brisbane, Australia
Investment capital (running from inflation-inducing negative real interest rates) has been seeking safe harbour in oil, and pace-setting the oil price in the process. Soon the real world economy will respond with flagging demand to tell the capital markets the affordable and sustainable price. Paring back of Chinese & Indian subsidies that unintentionally supported higher prices is a key part of this process.
John Scott, Gateshead, UK
Succesful speculation can only operate against a background of shortage.
Any war time black marketeer would tell you this.
The world faces increasing competition for resources which is what the problem is essentially about.
Speculators are a symptom not a cause.
stuart , Fleet, Hants
The market will fix all. Yeah right. Go tell it to the marines!!!!!!
Frank, Sydney, Australia
David Martin is spot. The biggest fields are in decline the world over and high oil prices are promoting rapid increases in oil demand in oil producing nations. Exports to net importtng countries are down and will continue to fall. The real bubble is in the USD money supply. USD is overvalued.
Nigel, London, UK
Don't worry, like Norway, the UK has been investing the profits from North Sea Oil for just such a rainy day. This vast fund will ensure that the extravagant social spending can continue for years to come....
Hang on -- where's all that money gone? + How can Norway be rich and not be in the EU?
James Dowling, London, UK
We've had almost three and a half decades since the oil shocks of the early 70's to tackle our dependence on the stuff. Meanwhile, aside from the Greens, no one much dares talk about population. The old adage that no one bothers to mend the roof when the sun is shining seems apposite.
Jonathan, London,
We are at the end of year one of what I predicted to be a five year long bad spell.I don't look for the high prices to go away anytime soon.I have adjusted my spending to buy only gas and food.All other discretionary spending is on hold for the foreseeable future.
ron, toronto,
Any mention of growth by these 'experts' remind me of the pyramid schemes where you soon need many times the worlds population to keep the rewards coming.
There is something seriously wrong with their mind set which is going to destroy the planet.
ged, manchester,
High oil price is the problem so cut tax on oil & petrol. Govt cannot abdicate responsibility for petrol prices. It should have petrol price staiblisation policy (varying tax) to control inflation. The BoE does not have the tools.
Govt would then need to cut expenditure or raise taxes elsewhere.
Alistair Nicholls, Manchester, England
Speculators (banks/hedge funds) are driving the oil prices and the opinion is firm that $150 is on the horizon.. if u owned options at $135 u will bedoing all u can to ensure $150.. it cant be regulated but the bubble will burst eventually until then the words economies are in the hands of the marke
zugerman, zurich, switzerland
Katesky is 100% correct.
Oill price is going up.
Oil is running out.
Ignore this point - pay later.
Dr Addy , Hempstead, Kent
Cheap oil is fine--unless you have nothing to eat! Don't forget there are an extra one and a half million extra mouths to be fed EVERY WEEK!
David Vinter, Louth, Lincs., UK.
What nonsense. Why blame investors? How can investors force up the price of oil? It's like saying that if I invest in Marks & Spencer I can force up the price of underwear. Only a shortage of underwear can force up the price of underwear. It's got nothing to do with my decision to invest in M&S.
Jaxx, UK,
Change what you can effect. Switch to EFTA from EU. Save billions, and raise tax thresholds. With EFTA, you only get 300 new regulations a year, with EU, 1,000+.
Google: efta, and click on seminars
Hugo van Randwyck, London, UK
The world is going through a slow-motion oil embargo by OPEC
They could retaliate by placing high tariffs on all goods sold to OPEC member countries
After all, OPEC needs food and technology as much as the west needs oil !
NMB, California, USA
Saying 'future of the world economy' he cries about the future of monopolistic, money wasting big companies.
High oil price is logical and it is only redistribution of oil money.
So, tomorrow world will have more billions in oil countries and less in EU and USA.
savo, london, uk
It is not a question of suffering either recession or inflation. Haven't you heard the term stagflation? Surely that is the most likely consequence of current pressures.
Alex, Salisbury, UK
Don't worry, everything will become cheap again and we can carry on consuming and polluting to our hearts content when we discover that oil- and mineral-rich planet on the other side of the sun.
Mike, Harlow,
Stating the obvious and getting paid for it. Nice work if you can get it.
Fred, London, UK
A good analysis, but what is completely ignored is the collapse of the dollar, one of the main reasons for the oil price speculation: and that collapse can only worsen as America continues it's Iraq and Afghanistan 'policy' and lurches towards an insane confrontation with Iran.
Jon Kent, Hertford, Herts
I agree with David Martn below, oil prices are not due to a speculative bubble. Not in the long term anyway. It will rise and rise in price, maybe drop back to $100 or so before picking up head of steam again to head higher....so what happens to world economic prosperity then??
rikrok, London, UK
Mr Kaletsky - spot on article. Absolutely right and the sooner the speculative oil bubble bursts, the better off the world economy will be. This is when politicians in power can show what they're made of and stand up to the hedge fund managers if they have our best interests at heart.
Mac, Uk, UK
For last several years I've nagging you middle-age, middle class guys still resident in UK to cash out; real estate, securities, sterling, and fly the coop. Bet you wish you'd listened.
Andrew Milner, Karuizawa, Japan
Oil is expensive as the cheap fields are rapidly being exhausted.
Demand in China and India, and importantly in oil exporters like Russia and Saudi is rising.
With less oil available for export and demand inelastic what is surprising about a price rise?
The 'speculative bubble' is in shares, not oil
David Martin, Bristol,