Thursday, 8 May 2008

Information Asymmetry & Inflation: Have the inmates taken over the asylum, again!?! [Part 1]

Posted by: Ash Khanna

Part 1:

During the ‘credit-boom’ years, low inflation was attributed to the “China factor”.

Now, in the “credit-crisis” era, high energy, food and metal prices (the prime contributors of the current high inflation, globally) are because of China & India!

This flip has happened in less than 10 months! Are others also questioning the convenience of such statements as ‘explanations’? Is this a ‘sales-pitch’ of the commodities trading desks of banks?

Why am I so cynical? - because of statements like this:
“Some of the factors that are more likely to influence oil supply and demand, such as figures of oil demand from China, are not available.”
(Anthony Reuben, BBC Business 20th February 2008)

Further, do ‘we’ have (know of) reliable demand figures for the other commodities like wheat, rice (i.e. food), steel, copper (i.e. metals), etc. from China?

Now I’m no finance wiz who can mathematically prove that one plus one is not equal to two. But common sense asks: If we don’t know the demand figures how does ‘the market’ determine price? Answer: “It speculates!” Most financial experts agree that “speculative pressure” in the commodities market, especially for oil, food and metals, is high.

I don’t claim that there is not a significant increase in demand from India and China. Actually, from a development lens it is a very good thing! In fact China has been growing at over 10% for over a decade and India at about 8% for half a decade. These growth figures are sustainable for at least the next decade, has been common knowledge for a few years now. So what happened in the last 4 months that oil prices rose by 25%? Some of the brain-washed will claim that it is the effect of the decline in the dollar. Then, now, that the dollar is showing signs of stabilizing (if not recovering) - how come Arjun Murti, an ‘energy strategist’ at Goldman Sachs, is ‘warning’ of the likelihood of a ‘super-spike’, past $200 in the next 6 months?

Informed by the cliché : "Markets are inefficient!"
There are some inter-related questions we should really be asking:

Why have the prices of ‘essential’ commodities shot up so sharply? (I emphasize the word ‘essential’.)
Who is buying and what instruments are being used to trade in these commodities at such inflated prices?
Who can afford such prices?
What is the source of the liquidity glut in the commodity market?

It is my (and I believe a lot many others) opinion that the prime cause of current global inflation is this so called “speculative pressure”. The unintended consequence of the central banks pumping in hundreds of billions into the financial markets to bail out banks exposed to the now toxic “sub-prime mortgages”. (– which had the real potential to explode into a full-fledged “credit market meltdown”. Thankfully it is only a “crisis”!)
[I stopped counting around half a trillion dollars! – Does some one know the exact bail-out figures, details?]

Part 2:


Karolis said...

Very insightful...I always thought that there has to be link with bail outs and commodities rocketing prices...

Ian Angell and Ash Khanna said...

I agree with Ash. When the cash rich decide not to invest in (other) banks, the place of choice for their money is commodities. In this case it is the demands of speculators that push up the prices to ridiculous levels, not the shortage of goods needed by genuine buyers. But the rollercoaster always goes too far, just as George Soros describes in his Alchemy of Finance. Ultimately the speculators have to realise the value in these goods, but with buyers unwilling or unable to pay the silly prices, the boom is inevitably followed by bust.