By John Richardson
ALBERT Einstein is widely credited with saying this: “The definition of insanity is doing the same thing over and over again, but expecting different results”. Who cares if it is either paraphrased or he didn’t even say it at all? This is a fantastic quote.
For me, what makes this quote so fantastic is that it sums-up the behaviour of central bankers the world over since the Global Financial Crisis (and in the case of the US, right back to the dot com bubble of 1995-2000).
Essentially, what the central bankers have done is print more and more money, thus keeping the costs of borrowing very low.
In the US, as I said, this started with the run-up to the bursting of the dot come bubble. This was followed by the low costs of financing that led to the sub-prime crisis. Sub—prime had a much greater global effect than the dot com bubble because as we all know, it almost caused the collapse of the global financial system.
Since 2008, central bankers – not just in the US now but now also in Europe and Japan – have doubled, or should I say tripled-down, on their insanity: They have created the mother of all investments bubbles, this time in commodities.
So what is the mechanism behind all of this? The best explanation I’ve been able to find was in a post by fellow blogger Paul Hodges in December of last year where, having interviewed a major asset manager, he wrote the following:
His argument was simple, namely that the Fed and Bank of Japan and others are forcing him to invest in stocks as the money earns nothing sitting in the bank. He is being effectively held hostage by the central banks.
In the case of oil, the asset manager accepted that prices in H1 2014 did not reflect the real supply and demand fundamentals. But he added he had no choice but to park his money there as he chased yield in a very low interest rate world, wrote Paul.
This fantastically cheap money has also incentivised oil and gas, iron ore and petrochemicals producers to bring on-stream or plan vast increases in capacity that are again not justified by the real laws of supply and demand.
The case for adding new capacity seemed overwhelming because a.) As I have just said, there was lots of cheap financing around b.) Everyone kept telling you that we were in a“new paradigm”, where China that would boom forever, c.) You had in the case of US shale oil, gas and petrochemicals very, very cheap raw materials and d.) You needed a good investment story to sell to your shareholders to keep your share price up.
But now this is all going wrong and the damage from the unwinding of the commodities bubble is having far greater implications than even sub-prime. Countries from Brazil to Indonesia to Australia are waking up to find that because of events in China, the markets for the commodities they produce are simply not there in the volumes that they expected.
It also needs to be stressed that China’s economic stimulus has played a big role in this bubble. People took China’s credit-fuelled growth rates of 2009-2013, extrapolated these in the future and missed the fact that this growth was always unsustainable.
Here is a further important point: All the excitement and hype surrounding the commodities bubble has diverted attention from the biggest issue confronting the West, which is the ageing of its populations.
So where do we go from here? One of two directions, I think:
- We go through a long and painful adjustment period, where oil prices will fall to $30 a barrel or below over the long term as the Fed etc. wind back stimulus. Commodities prices in general will be depressed as we work through all this vast oversupply and debt, which will be made a lot harder by the world being caught in a deep deflationary down-spiral. Meanwhile, chemicals companies will need to start the search for new, more sustainable sources of growth built around satisfying basic needs, such as ageing populations in the West and providing safe drinking water and sanitation in the developing world. And in all regions, another big opportunity will be reducing our carbon footprint.
- The Fed rolls the dice once more by launching its fourth quantitative easing programme – “QE4”. And the Fed’s actions are backed up by the European Central Bank and the Bank of Japan, which also print lots more money.
Let’s assume that No2 happens. When might it happen? Perhaps the Fed will kick off this process as soon as 17-18 September, during its next Federal Open Market Committee (FOMC) meeting. Or maybe it will wait for the FOMC meeting after that, which takes place on 27-28 October.
And what would No2 mean? It would mean this:
- Oil might well surge back to $100 a barrel, or thereabouts, by Christmas – along with a recovery in petrochemicals prices and other commodities, such as iron ore.
- The Cassandras will be told, “You were wrong” as global stock markets also rebound very strongly.
- Investment analysts will start talking about another new “growth paradigm” – maybe “the rise of the middle classes” in India, Latin America, Southeast Asia, even Africa – or how about Mars? Many people will believe them, even though the data will always say something else.
- If this new bubble lasts long enough, more easy financing will find its way into further additions to oil, gas, petrochemicals and iron ore capacity that is surplus to real needs.
- People in the financial sector will take home fantastic bonuses,
- Policy makers and chemicals companies will forget about what will really get the global economy back on the right track: Tackling basic needs, some of which I mentioned above.
The end result? Even more deflation and bad debts, making the eventual and inevitable adjustment for the global economy even more painful. And maybe this time around, if QE4 does happen, the global financial system will collapse.
We have had enough, surely? No more insanity, please.