Friday, August 3, 2012

When will central banks act?

When will the central banks act? That seems to be the question on every investor's mind. However, I would propose that the right questions to be asking are 'If central banks were to act; what would be the result? Would it be worth it? and how long would it last?'. Over the last year you may have noticed the constant announcements of emergency easing and lending having a far from drastic effect on the global economy. The effect of the acts hasn't been drastic because the acts themselves have been constant - but should central banks not act there would be a drastic drop in economic activity. In other words, emergency easing and the hope of emergency easing is the new normal and is becoming the sole factor in market moves.

So why now are the Fed and ECB "staying on the sidelines"? Analysts and experts have become so focused on what central banks are going to do next to "promote growth" that many seem to be forgetting that there are underlying fundamentals more powerful than central banks. Nothing in this blog post is new, everything I'm going to talk about now are concepts I've visited before in many other posts but as long as I continue seeing the populations of the world crying out for more central bank easing I am going to continue writing about why that won't work and is temporary at best.

Where's the growth?

You'll notice that when any amount of time passes without major central bank intervention, a significant collapse in certain sectors of the economy occurs.
NAPM Export Orders have plunged over 3 sigma in the last 3 months and have only dropped more (in history) immediately after the Lehman debacle.
If you're looking for the drastic results central bank easing should have then look no further than the drastic results that happen when it doesn't occur. The global economy has for the last few years been entirely fuelled by "growth" in central bank easing, easing which must be offset by lower and lower interest rates and heavier and heavier manipulation of commodity prices. This central bank fuelled growth has become the new standard for growth and so the "drastic" changes will not be visible just as an economic bubble isn't visible when you are within it. We are within a "central bank bubble" currently.

If you look back earlier in the year there was a significant amount of hope and faith that we were in some sort of new long term bull run. Oil was being projected by analysts as remaining above $100 / barrel, but it didn't happen. Instead, oil and all economic momentum has steadily been collapsing since. The yields (borrowing costs) of European nations continue to climb making their bailouts and easing even more unsustainable and impossible to pay down.

The connection between the price of oil and viability of GDP growth is essential to understanding the seemingly chaotic global economy. Even as market orders collapse and the unemployment rate rises in the U.S. commodities still have upward pressure. Growth really has no room to grow as oil is only $10 away from the $100 barrier which cash-strapped families today cannot afford. The price of oil follows growth projections, not actual growth, meaning that should the "experts" come to "consensus" about Q4 growth for instance - oil will rise in response prior to the growth it is supposed to represent and subsequently becomes unaffordable before the wealth needed to afford it can be generated. This is the source of oil's volatility and will be ongoing indefinitely as the window between the cost of production and the affordability of energy that industrial societies exist in continues to shrink.

Adding to this problem is the increasing focus on central bank announcements. Investors and speculators now instead of waiting for real data to confirm claims of growth before making their bets, simply make the bets now based on what they speculate the central bank is going to say next. Rarely do they even wait for the actual annoucement anymore, usually assuming that since thigns are getting worse the central banks will make it better. This means that before the added liquidity to fuel the anticipated central bank annouced growth is even confirmed to exist, commodity prices are already being pushed up - either negating the increase in liquidity (if it actually ends up happening) or even worse, creating demand for liquidity that doesn't even exist at all.

The window between the cost of production and consumer affordability is so small, that in no time a few annoucements can push the price of commodities up so fast that there isn't enough time for the actual wealth that's needed to purchase them to actually be built up. The result? We are borrowing further and further from wealth in the future to service today and all under the assumption that that future wealth will in fact exist.

I'd say the world as a whole has reached "peak easing", and even with central bank intervention - the accumulated debt and interest is so grand that stagnation is about the best we can hope for. Without the easing and bailouts a sharp cliff drop back towards levels of real growth is inevitable, and those levels without the inflated service and financial sectors pale in comparison to current obligations.

Why is oil manipulated?

I see a lot of theories going around on why oil is manipulated. The most common of which is the simplest: oil companies want huge profits. However, this is not the reason oil is being manipulated as if it were you would not see the drastic responses to growth projections in oil price. Oil companies simply wouldn't care about the demand side of oil and focus on supply knowing that it will be purchased sooner or later.

The reason oil is being manipulated is stability, and oil production stability is threatened by the pursuit of extreme energy and the availability of cheap energy.

OPEC is the leading producer of the world's cheapest oil. Or at least, what should be the cheapest based purely on the cost of production and supply and demand. They are well connected with pipelines, have coasts, and are a part of a large land mass with many customers, however OPEC over the last few years has been pursueing higher prices. The reason? Their populations have - since the oil negotiations with the U.S. - been promised an ever-increasing standard of living as a result of their oil work and sales. However, now that OPEC has reached peak oil they are finding the profit margins shrinking as they look more towards offshore and as maintenance costs rise and terrorist threats expand. OPEC requires the high prices to keep their own population happy, it has nothing to do with profits and everything to do with keeping the pending Arab Spring revolutions at bay.

OPEC and Alberta both have a vested interest in oil being manipulated, but for completely opposite reasons. While the OPEC populations believe they are not receiving enough, Albertans (and Canadians) actually believe they are getting more then they really are. In Alberta, our desire for high oil prices comes purely from the fact that our oilsands operations can't afford to operate at low oil prices. Actually, it's worse than that as the price itself doesn't matter. A higher price simply raises the bar on what the next higher price will have to be. Alberta relies on an economic model (which prior to 2008 proved true) in which the price of oil is always climbing. Our economic model depends on producing the oil at lower prices, and selling them at higher prices.

To understand why this is, one must understand that currency (money) simply represents energy in a transaction. The price is relative, but the value is absolute. The Alberta oilsands have a 3:1 energy return ratio as opposed to convential oil which can exceed 200:1. This means that for conventional oil, spending $1 could yield a $200 return where as in the oilsands spending $1 might yield a $3 return. On top of this, the risk associated with exploration is increasing as the number of places to look diminishes. The cost of even accessing these places can be staggering and should nothing be found all of the resouces, time and money used has been in waste.

So why is oil manipulated? In short, to keep enough stability in the oil market to continue producing oil. Instability in the oil market could quite literally compound and spread where it becomes inequitable for anyone to drill anywhere, some predictability is needed of future events to being down the risks associated and since we can't predict those events, we're just making them up instead and using portions of the banking sector to make it reality. When asking questions about the way oil profits work, ask in the context of 'if it takes you 1 barrel of oil to find and then extract 1 barrel of oil, would you bother?'.

The profit motive fallacy

This over-simplification of the profit motive exists within banking too as I quite often see statements such as banks are manipulating rates to keep the profits rolling in, and while this is correct you must understand the context in which this statement is correct.

For those of us making a standard wage, the pursuit of something more then just more money is hard to understand. For your average consumer, money is itself the end goal of working. To have a nice stash, and retire. etc. However, for those with a lot of money it becomes a tool used to accomplish goals. You must understand the bankers running the show are kings of their banking castles and as kings of the banking castles are the source of currency. The idea that banks are manipulating Libor rates or other interest rates for the purpose of "making money" ignores the fact that they are themselves the source of this money they would be making.

Banks, like oil companies, are interested in real assets and their currency is only a tool being used to acquire them. Assets can be houses, or cars, or even your own time you spend working. Energy exerted working is no different then the energy that moves a car and human labour is itself an asset.
Our economy is debt based, meaning that at any given time more debt obligations exist then there is available currency to pay it. The debt and associated interest also exists (generally) prior to the wealth generation needed to service it. The more debt, the more currency in circulation, the more wealth is needed. Historically, this circle of debt service is offset by savers - savers make "deposits" (loans to the bank) and the savers "make money" by not spending their cash but by having the bank pay them interest on their savings this interest based wealth accumulation is supposed to balance out the capitalization of banks that use a fractional reserve banking system (which all modern ones do).

Understanding this should help explain why the global debt crisis has been acting like a downward spiral getting ever worse even as those in charge of it promise it'll get ever better. Banks are keeping interest rates low so that they can continue lending to each other and keep it affordable to service needed liquidity, but this short term solution has a long term compounding effect in which savers are now no longer keeping up with the rate of inflation which in our current no-growth scenario is actually currency devaluation. Savers are slowly losing wealth, instead of gaining it and this causes a response in the population which is eventually seen as a "loss of confidence" and if that continues can lead to bank runs. It can lead to bank runs because without the incentive to deposit and the cumulative building of wealth for savers, banks need to "recapitalize" - meaning, they are not bringing in enough new money to back existing debt obligations (deposits) and should those deposits be requested and they exceed the bank's existing capital, look out!

So when and will central banks act?

This really depends on the action. You can still expect bailouts as the bankers attempt to starve off a chain of sovereign defaults (this is like ensuring the minimum monthly payment on a credit card is met), but when it comes to "stimulus" such as quantitative easing or "operation twist", I don't expect any until the runway to pick up momentum is long enough. Right now, there is practically no runway, which is why the moment the economy seems to be picking up steam it putters out. I suspect any growth oriented stimulus that would come would accompany a low oil price, below $80 most likely - however, since oil producing nations currently need prices upwards of $80 this doesn't seem likely for any prolonged amount of time. Interest rates are at a prolonged historic low and they can't really go any lower, so the banks have no where to go to offset the added obligations stimulus would bring. The bet on growth has to pretty well be a sure thing at this point for the banks to take it.

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Richard Fantin is a self-taught software developer who has mostly throughout his career focused on financial applications and high frequency trading. He currently works for CenturyLink

Nazayh Zanidean is a Project Coordinator for a mid-sized construction contractor in Calgary, Alberta. He enjoys writing as a hobby on topics that include foreign policy, international human rights, security and systemic media bias.

1 comment:

  1. The economy of the country depends on domestic and foreign policy. The rise in the price of oil affects the domestic economy. In order to normalize this, the government uses different tools. Starts to operate by the Central Bank in order to obtain money from the population by reducing loan rates and increasing interest on the deposit. People are starting to take bank credit, to use easy money payday loans online, etc. But due to inflation people get into debt and more and more.. Therefore, in order to avoid such situations it's better to study the economic forecasts of experts..