Buttonwood

Gas, grains and growth

Making sense of the fall in commodity prices

Jun 23rd 2012
                  


IS IT good news or bad news? Commodity prices have been falling sharply in recent weeks—the S&P GSCI index dropped by 13% in May alone, the biggest monthly decline in two years. That amounts to a tax cut for Western consumers but it may also be a worrying sign that global growth is decelerating.
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A striking feature of the world economy in recent years is that commodity prices have held up so well. Even the recent decline still leaves them well above their levels of January 2007 (see chart). Normally, you would expect a weak period for developed economies to result in a bear market for raw materials. But rich economies are turning into price-takers, not price-setters, for commodities.
China buys 40% of world copper supplies, for example. Harry Colvin of Longview Economics calculates that the four BRICs countries (Brazil, Russia, India and China) will consume 3.7m more barrels of oil a day in 2012 than they did in 2008; demand in America and the larger European economies has dropped by 1.5m b/d over the same period.



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The persistent strength of commodity prices helps to explain why headline inflation rates have been stubbornly high in many countries, despite their struggling economies. With wages weak, the result has been a squeeze in real incomes.



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But the recent softening of commodity prices is now showing up in the inflation numbers. In Britain, where inflation has consistently been above the Bank of England’s target, prices fell in the month of May. The annual figure has dropped to 2.8%, having been more than 5% last year. As the summer driving season in America gets under way, the average price of a gallon of petrol at the pump has fallen to $3.47 from almost $3.88 in early April.



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It is possible to put a benign interpretation on the fairly uniform falls in raw-materials prices. Commodities have become an investment class: declines in their prices may simply reflect the whims of speculators. Kevin Norrish of Barclays says that short positions in copper (ie, those betting on a price fall) are their highest in two years, a sign that hedge funds may be expecting a global downturn.




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As Michael Lewis, a strategist at Deutsche Bank, points out, the correlation between energy and equity prices has risen sharply since 2007. Indeed, May’s joint sell-off in commodities and equities echoes similarly timed declines in 2010 and 2011.



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The more gloomy possibility is that the hedge funds are right and that commodities are acting as a leading indicator of a global recession. They are far from reliable in this regard, however: prices were still very strong in the summer of 2008, for instance, as the economy was about to tank.


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Economic forecasts have been edging down. In May the OECD predicted global growth of 3.4% this year, down from 3.6% in 2011. The sluggishness of European economies is no surprise to anyone; America also seems to have lost impetus after an encouraging start to the year. For commodity bulls, the really big worry is China, which cancelled a slew of raw-materials orders in the spring.



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Those cancellations could be explained by shrewd bargaining tactics rather than slumping demand. With prices now falling, Chinese oil imports reached a record high in May and copper imports were up by 12% on the month. Some commentators feel that the Chinese investment boom must eventually run out of steam, whether for lack of good projects to finance or because the country will shift to a more consumption-led model. But it seems unlikely that the switch will be sudden, and those import numbers suggest it has not happened yet.



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Commodity booms generally come to an end when high prices bring forth a torrent of new supply. The main sign of this now is the development of the shale-gas market in America, which has caused a collapse in natural-gas prices in that country. The Saudis have recently been pumping more oil in a bid to weaken prices; OPEC is producing 1.6m b/d above its formal target. But there is still weakness in non-OPEC supply: oil prices could yet rebound in the second half of the year, reckons Mr Norrish.



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If that prediction is unwelcome, take heart from the 9.3% fall in agricultural prices in May. Mild weather is leading to the expectation of bumper harvests in the northern hemisphere, while it seems as if less of the American corn crop will be used to produce ethanol. Not only do high food prices weigh heavily on the incomes of the poor, they lead to more political unrest around the world. At a time when markets seem to deliver nothing but bad news, that is a rare source of cheer.


Up and Down Wall Street

THURSDAY, JUNE 21, 2012

Twist, but No Shout

By RANDALL W. FORSYTH

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The Fed takes the safe policy tack even as economic outlook worsens. Saving their bullets.

 

Ben Bernanke has a lot to learn from the corporate world. In a well-worn routine preceding every corporate earnings season, chief financial officers lower "guidance" about the quarter's results, so the numbers can "beat expectations" when they're reported and produce a lift to the stock price. So the companies are rewarded for doing no more -- or even less -- than what was expected initially.




.The Federal Reserve chairman wound up having to do just the opposite. The central bank was "too optimistic," in its expectations for the economy, he admitted in his press conference Wednesday following the conclusion of the Federal Open Market Committee's two-day policy-setting meeting. That was apparent in a reduction of the panel's expectations for gross domestic product growth and an increase in its projection for the unemployment rate.



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As a result, Bernanke added, the FOMC had to "add accommodation" in its monetary policy. Specifically, the Fed will extend its current Operation Twist through the end of year, swapping some $267 billion of shorter-term Treasury securities for longer-dated paper. Numbers aside, the real take-away is that the Fed missed its numbers, in stock-market parlance, and this was the least it could get away doing to compensate.



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The Federal Reserve chairman and his associates, notably Vice Chair Janet Yellen, have given the markets plenty of reason in various speeches to believe the central bank is prepared to act to bolster the tepid U.S. recovery. So, given the recent spate of economic data -- rated M for Meh -- market participants had been set up for some action, more Operation Twist at a minimum.



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That the FOMC opted for the minimal response was reflected in the questions from reporters at Bernanke's press conference. One line of questioning was, given the downgrade of the Fed's economic projections why didn't it take more aggressive action? Conversely, given the already record-low level of Treasury yields and the lack of economic response, what could be gained from further contortions of the yield curve through Operation Twist?



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Legitimate questions, to be sure. The FOMC's "central tendency" for GDP was revised down to 1.9%-2.4% for 2012 from 2.4%-2.9% less than two months ago after the previous meeting concluded on April 25. (Let's call it two-ish percent from the mid-twos. Economists use decimals points to show they have a sense of humor.) Next year's growth was lowered to 2.2%-2.8% from 2.7%-3.1%--just in line with the panel's estimate of the economy's long-run growth 2.3%-2.5%.




.But coming out of the worst recession since the 1930s, the economy ought to be ripping along to make up for earlier shortfalls -- especially with the record application of monetary and fiscal stimuli that injected trillions into the U.S. economy.



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So, with the Fed facing criticism for both having done not enough by its critics on the Left and for doing too much according to its critics on the right, the central bank took steps that were "modest" and "incremental" representing "the path of least resistance," according to Vincent Reinhart, chief U.S. economist at Morgan Stanley and a former high-level Fed insider. He suggests the Fed "has lost confidence it has a tool to make a difference" for the economy.



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Bernanke disputed that notion, contending the Fed wasn't out of tools once short-term interest rates -- central banks' traditional policy lever -- hit zero. That happened back in late 2008 in the wake of the financial crisis. And the FOMC at the beginning of the year announced its intent to maintain its target for the overnight federal funds rate at "exceptionally low" levels through the end of 2014.




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Mostly unnoticed, that consensus became tighter at this week's meeting. The FOMC's assessment of future monetary policy had 11 of the 19 total participants keeping the funds rate well under 1% by the end of 2014. (That takes in the seven members of the Federal Reserve Board plus the 12 Fed district bank presidents, five of which vote on a rotating basis except for the New York Fed president who has a permanent vote.)






But in April, only seven FOMC participants thought the fed-funds target would be under 1% by the end of 2014 while 10 thought it would be higher. (There were two vacancies on the Fed's Board then, which since have been filled.) That suggested the long-term intent was more of a committee compromise engineered by the chairman than a solid consensus.



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The weaker economic outlook and greater agreement that short-term rates will remain ultra-low still raises the question of why Bernanke & Co. didn't take stronger action. Unlike corporate America, which tries to lower expectations in order to beat them, the Fed is necessarily reactive.



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In his presser, Bernanke noted there are costs and risks to more aggressive actions, such as quantitative easing -- the outright purchase of securities to expand the central bank's balance sheet. Not the least of which is the political ire from Republicans, including presumptive presidential nominee Mitt Romney, who has vowed to fire the Fed chairman if elected. No matter that George W. Bush named Bernanke to the Fed Board, as chairman of his Council of Economic Advisors and then Fed Chairman.




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That's best left to Georgetown parlor talk. Notwithstanding Bernanke's insistence the central bank still has plenty of firepower at its disposal, it would seem he would want to hold back some ammunition in the event of an outright downturn in the economy or a renewed global crisis, as happened in 2008-09. Then he could pull the trigger of quantitative easing to counter attacks on the financial system.




.Ultimately, monetary policy is the least of the U.S. economy's problems while it hurtles to the fiscal cliff at year's end. When the prospect of a sharp contraction in 2013 imposed by sharp tax hikes and draconian spending cuts hits the stock market and sends the averages into bear-market territory, the Fed will likely act. But not before.


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Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved



Markets Insight

 
June 21, 2012 4:04 pm

Race to save euro will follow ‘Grexit’


Following the re-run of the Greek parliamentary elections, we have a New Democracy-led coalition government. This removes the risk of an earlyGrexit” as it is likely the minimum demands for relaxation of fiscal austerity by the new government will not exceed the maximum fiscal austerity concessions Germany and other core euro area member states are willing to make.



Some relaxation on the timing of austerity, some limited early disbursement of funds to pay for essential public goods and services, and some token pro-growth gestures courtesy of the European Investment Bank and EU structural and cohesion funds will most likely keep Greece in the euro for the time being.


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However, we consider it highly unlikely that Greece will comply sufficiently with evenlitefiscal austerity conditionality, let alone with structural reform conditionality, including privatisation targets, which are unlikely to be relaxed. Political opposition to both austerity and reform is now stronger in Greece than ever before. So is resistance to bailouts in the core. The troika – the European Commission, European Central Bank and the International Monetary Fund – may forgive a Greek failure in the September progress assessment, but is unlikely to tolerate another failure to comply on all fronts by the December assessment.



Grexit may well be triggered by a troika review declaring Greece wilfully non-compliant with the conditionality of its programme, stopping the disbursements to the Greek sovereign. Greece defaults and the eurosystem and the Greek ELA (emergency liquidity assistance provided by the Greek central bank) stop funding the Greek banks. At that point Greece exits the euro area, following the imposition of capital controls, foreign exchange controls, restrictions on deposit withdrawals and a temporary suspension of the Schengen agreement.



It is highly unlikely the core eurozone would be willing to take on significant exposures to Spain and Italy unless it can be established unambiguously that a wilfully and persistently non-compliant programme beneficiary will be denied further funding. Therefore Grexit would become even more probable should Spain and Italy require a broader troika programme and external help, respectively, which appears likely. The greatest fear of the core nations is not the collapse of the euro area but the creation of an open-ended, uncapped transfer union without a surrender of national sovereignty to the supranational European level.




Grexit is likely to create extreme deprivation in Greece, and lead to social and political instability. We are likely to see evidence of this even before it takes place. The damage can be limited by ensuring that Greece stays an EU member even after it exits the euro. This is the most likely outcome.




The direct impact of a Greek exit on the rest of the eurozone, the EU and the rest of the world through trade and financial links is minor. The only risk is through exit fear contagion. This will lead to a sudden funding stop for all sectors in any economy perceived as being at material risk of exit after Greece. The European Central Bank, supported by the troika, has the resources and may have the will to keep at-risk sovereigns and banking sectors funded until the markets are convinced no country that is adequately compliant with programme conditionality and which does not want to leave the euro will be allowed to be forced out by a sudden stop on market funding.



There is now a material risk, if procrastination and policy paralysis prevail, that the endgame for the euro could be an onion-like unpeeling and unravelling. Survival to fight another crisis will require at least the following: an enhanced sovereign liquidity facility, banking union and sovereign debt and bank debt restructuring, with only limited sovereign debt mutualisation.



The endgame for the euro area, if the political will to keep it alive is strong enough, is likely to be a 16-member area, with banking union and the minimal fiscal Europe necessary to operate a monetary union when there is no full fiscal union.


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Minimal fiscal Europe will consist of a larger European Stability Mechanism, the permanent liquidity fund, and a sovereign debt restructuring mechanism (SDRM). The ESM will be given eligible counterparty status for repurchase agreements with the eurosystem, subject to joint and several guarantees by the euro area member states. There will be some ex-post mutualisation of sovereign debt. Sovereign debt restructuring through the SDRM will recur.



Banking union aims to sever the poisonous umbilical cord between sovereigns and the banks in their jurisdictions. A road map to banking union will likely be announced at the EU summit on June 28-29. It had better be a credible path. In any case, implementation is the hard part, and time is of the essence.


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Willem Buiter is chief economist at Citigroup


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Copyright The Financial Times Limited 2012.


Labor’s Paradise Lost

Robert Skidelsky

21 June 2012
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LONDONAs people in the developed world wonder how their countries will return to full employment after the Great Recession, it might benefit us to take a look at a visionary essay that John Maynard Keynes wrote in 1930, called “Economic Possibilities for our Grandchildren.”


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Keynes’s General Theory of Employment, Interest, and Money, published in 1936, equipped governments with the intellectual tools to counter the unemployment caused by slumps. In this earlier essay, however, Keynes distinguished between unemployment caused by temporary economic breakdowns and what he calledtechnological unemployment” – that is, “unemployment due to the discovery of means of economizing the use of labor outrunning the pace at which we can find new uses for labor.”


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Keynes reckoned that we would hear much more about this kind of unemployment in the future. But its emergence, he thought, was a cause for hope, rather than despair. For it showed that the developed world, at least, was on track to solving the “economic problem” – the problem of scarcity that kept mankind tethered to a burdensome life of toil.


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Machines were rapidly replacing human labor, holding out the prospect of vastly increased production at a fraction of the existing human effort. In fact, Keynes thought that by about now (the early twenty-first century) most people would have to work only 15 hours a week to produce all that they needed for subsistence and comfort.


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Developed countries are now about as rich as Keynes thought they would be, but most of us work much longer than 15 hours a week, though we do take longer holidays, and work has become less physically demanding, so we also live longer. But, in broad terms, the prophecy of vastly increased leisure for all has not been fulfilled. Automation has been proceeding apace, but most of us who work still put in an average of 40 hours a week. In fact, working hours have not fallen since the early 1980’s.


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At the same time, “technological unemployment” has been on the rise. Since the 1980’s, we have never regained the full employment levels of the 1950’s and 1960’s. If most people still work a 40-hour week, a substantial and growing minority have had unwanted leisure thrust upon them in the form of unemployment, under-employment, and forced withdrawal from the labor market. And, as we recover from the current recession, most experts expect this group to grow even larger.


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What this means is that we have largely failed to convert growing technological unemployment into increased voluntary leisure. The main reason for this is that the lion’s share of the productivity gains achieved over the last 30 years has been seized by the well-off.

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Particularly in the United States and Britain since the 1980’s, we have witnessed a return to the capitalismred in tooth and clawdepicted by Karl Marx. The rich and very rich have gotten very much richer, while everyone else’s incomes have stagnated. So most people are not, in fact, four or five times better off than they were in 1930. It is not surprising that they are working longer than Keynes thought they would.


.But there is something else. Modern capitalism inflames through every sense and pore the hunger for consumption. Satisfying it has become the great palliative of modern society, our counterfeit reward for working irrational hours. Advertisers proclaim a single message: your soul is to be discovered in your shopping.


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Aristotle knew of insatiability only as a personal vice; he had no inkling of the collective, politically orchestrated insatiability that we call economic growth. The civilization of “always more” would have struck him as moral and political madness.


.And, beyond a certain point, it is also economic madness. This is not just or mainly because we will soon enough run up against the natural limits to growth. It is because we cannot go on for much longer economizing on labor faster than we can find new uses for it. That road leads to a division of society into a minority of producers, professionals, supervisors, and financial speculators on one side, and a majority of drones and unemployables on the other.


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Apart from its moral implications, such a society would face a classic dilemma: how to reconcile the relentless pressure to consume with stagnant earnings. So far, the answer has been to borrow, leading to today’s massive debt overhangs in advanced economies. Obviously, this is unsustainable, and thus is no answer at all, for it implies periodic collapse of the wealth-producing machine.

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The truth is that we cannot go on successfully automating our production without rethinking our attitudes toward consumption, work, leisure, and the distribution of income. Without such efforts of social imagination, recovery from the current crisis will simply be a prelude to more shattering calamities in the future.


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Robert Skidelsky, Professor Emeritus of Political Economy at Warwick University and a fellow of the British Academy in both history and economics, is a working member of the British House of Lords. The author of a seminal three-volume biography of John Maynard Keynes, he began his political career in the Labour party, before helping to found the short-lived Social Democratic Party and eventually becoming the Conservative Party’s spokesman for Treasury affairs in the House of Lords. He was forced out of the Conservative Party for his opposition to NATO’s intervention in Kosovo in 1999.
 
 
 

Copyright Project Syndicate - www.project-syndicate.org


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HEARD ON THE STREET

Updated June 21, 2012, 11:19 a.m. ET

The Fed's Soft Launch of QE3

By JUSTIN LAHART




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It is unlikely that the Federal Reserve's efforts to boost the economy will end with "Operation Twist."


The Fed's rate-setting committee decided Wednesday to extend its so-called Twist operations. These involve it selling short-term Treasurys and using the funds to buy long-dated ones. The goal is to bring down long-term interest rates.

Associated Press
Job seekers line up to talk to recruiters in Anaheim, Calif.


The extension of Twist assuaged markets, which had expected action along those lines. But the Fed also lowered the bar for further efforts, noting in its statement that it was ready to do more to promote "a stronger economic recovery and sustained improvement in labor market conditions." And, in projections released shortly afterward, the Fed said the central tendency of board members' year-end unemployment estimates ranged from 8% to 8.2%, versus the 7.8% to 8% they expected in April. The unemployment rate last month was 8.2%.


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.So, to sum it up, the Fed wants a better job market. And the Fed doesn't think that the job market is going to show much, if any, improvement through the end of the year.



.Absent a turn for the better between now and the Fed's two-day meeting July 31 and Aug. 1, more action could be in the offing. That would likely involve a third round of quantitative easing, or QE3, involving outright purchases of Treasurys and, especially, mortgage-backed securities.
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FEDHERD
Associated Press
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The hawks on the Fed will complain, and with rates at rock-bottom levels already, the efficacy of further action is indeed open to debate. But they are now more outnumbered than ever. Both new Fed board membersDemocratic economist Jeremy Stein and Republican businessman Jerome Powellappear to be in Chairman Ben Bernanke's more dovish camp. Notably, the Fed's projections showed that an additional two board members don't expect the Fed to tighten policy until 2015. And an about-face would be tricky at this point, since investors now expect the Fed will do more. QE3 is out of the bottle.

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Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved