Slowdown in China Bruises Economy in Latin America

Eduardo Porter

DEC. 16, 2014 .

An open-pit mine in the Andes mountain range near Santiago, Chile. A boom in Latin America’s raw materials is ending. Credit Ivan Alvarado/Reuters       

Not only does China buy nearly 40 percent of Chile’s copper, but its once-insatiable demand helped push copper prices from $1 to $4 a pound.
Meanwhile, Beijing plowed billions into Peruvian mines and fisheries and spent billions more buying soybeans from Argentina and Brazil. And it propped up the Venezuelan government to the tune of $50 billion in loans, to be paid in shipments of oil.
China’s voracious hunger for Latin America’s raw materials fueled the region’s most prosperous decade since the 1970s. It filled government coffers and helped halve the region’s poverty rate.
That era is over. For policy makers gathered here last week for the International Monetary Fund’s conference on challenges to Latin America’s prosperity, there seemed to be no more clear and present danger than China’s slowdown.
“The commodity boom allowed governments and companies to avoid hard choices,” Andrés Velasco, Chile’s finance minister from 2006 to 2010, told me. “For goodness’ sake even Argentina grew by 5 to 6 percent per year for almost a decade.” 

Copper is back under $3. As commodity prices continue to swoon, driven in large part by China’s weaker demand, the going will get much tougher.
That’s especially true of the major oil exporters, clobbered by a collapse in oil prices driven by faltering global demand and increased supplies from the United States and elsewhere.
Venezuela, notably, is in free fall. The I.M.F. expects the Venezuelan economy to contract both this year and next. And it has been forced to limit its promised oil shipments to China, in effect defaulting on its Chinese debt.
But the commodity decline isn’t sparing many. “Growth in Latin America should move back to pre-commodity boom rates,” said Alejandro Werner, who leads the Western hemisphere division at the I.M.F. Indeed, the fund expects the region to grow barely 1.3 percent in 2014, a third of its pace just three years ago.
The bust underlines how Latin American economies have failed to overcome the existential weakness that has plagued them throughout history: a dependence on raw materials that has shackled the region’s development to an incessant sequence of booms and busts.
From Brazil and Argentina in the southern tip of the region to Mexico in the north, officials across Latin America fretted for years that China undermined their decades-long efforts to build the manufacturing industries that, they hoped, would provide a ticket into the developed world.
Not only did China’s cheap labor outcompete Latin American industry and draw the lion’s share of global manufacturing investment, but its appetite for Latin America’s minerals, oil and agricultural products also raised the value of currencies around the region, making their manufactured goods even less competitive.
Manufacturing’s share in Latin America’s economic output has declined steadily for more than a decade, ever since China inserted itself aggressively into the global economy by entering the World Trade Organization.
At the same time, the share of raw materials in Latin America’s exports, which had fallen to a low of 27 percent in the late 1990s, from about 52 percent in the early 1980s, surged back to more than 50 percent on the eve of the global financial crisis.
China’s footprint on Latin America is contributing to what the Harvard development expert Dani Rodrik would call its “premature de-industrialization,” shutting off the standard path of economic development followed by pretty much everybody since the industrial revolution.
Mr. Velasco, 54, recalled when a 23-year-old student in Antofagasta asked him what the Chilean government would do with the nation’s copper riches. By the time the student was his age, Mr. Velasco responded, Chile would have no more copper.
“The question,” he said, “isn’t what should we do with copper but what will we do without it.”

China’s diplomats emphasize that it is a developing country, not an advanced, “imperialist” power like the United States or the European colonial powers who ruled for centuries and served as the first foreign exploiters of Latin America’s mineral wealth. To many in Latin America, the difference hardly seems relevant.
Take San Juan de Marcona, a remote village on the edge of the Pacific Ocean in the Nazca region of Peru. Built in the 1950s to house workers at the vast open-top American-owned iron mine, the town no longer houses managers from the United States. In the 1970s, General Juan Velasco Alvarado, then Peru’s military dictator, pushed them out.
Today, Marcona’s managers come from Shougang, of China, which bought it from the Peruvian government in the 1990s.
“A growing China was very important to bring Peru along in the last 10 years,” said Cynthia Sanborn, who leads the Research Center at the Universidad del Pacífico in Lima.
North of Marcona, Chinalco built a town to relocate 5,000 inhabitants of Morococha, where it will blast open a copper mine. This year, China’s MMG, Guoxin International Investment and Citic Metal bought the Las Bambas copper mine from the Anglo-Swiss conglomerate Glencore.
Chinese companies are interested not only in raw materials but also in vast public works to transport the raw materials, including rail links across Brazil and a proposed $50 billion, 171-mile canal across Nicaragua.
In 2010, Chinese lending to Latin America roughly equaled that of the World Bank, the Inter-American Development Bank and the United States Ex-Im Bank combined. (It has since slowed.) Carmen Reinhardt of Harvard forecasts that China could become Latin America’s main source of financing.
Perhaps Latin America should just count its blessings. “The concerns of dependency are there, but if China weren’t there, Peru would be seeking other markets for its minerals,” he told me.
Mr. Werner of the I.M.F. argues that the case for deindustrialization is overblown. “From a medium-term perspective, China is a plus, plus, plus for Latin America,” he said.
In agriculture, for instance, exports to China are leading to lots of innovation and efficiency improvements. Demand for Brazil and Argentina’s soy — a principal source of animal feed — is unlikely to wane as the Chinese become richer and eat more meat.
“Don’t bet against nature,” Mr. Werner urged policy makers in the region. “Play to your comparative advantage.”
In some of the region, however, China has inspired a nostalgic reinterpretation of its economic history and a re-examination of the policy choices of its past.
Remember Dependency Theory?
The doctrine, which spread across Latin America from the 1950s through the 1970s, proposed that the region, or any developing country, could never advance simply by selling natural resources to the rich North, using the money to import the North’s industrial goods. Import substitution, behind a wall of trade barriers, was the path to prosperity.
The theory fell into disrepute during Latin America’s “lost decade” of the 1980s — blamed by a new crop of market-oriented, United States-trained leaders in the 1990s for turning the region into an uncompetitive backwater.
Courtesy of China, it’s back, fine-tuned to adapt to a more integrated global economy.
“We’re not calling for more protectionism, but to substitute imports within competitive open economies,” said Alicia Bárcena, who leads the United Nations’ Economic Commission for Latin America and the Caribbean. “We must think of creating regional production chains to serve regional markets.”
She suggests that China should still be invited to participate in Latin America’s development, but on different terms: “You want our commodities? O.K. But also invest in solar panels here,” she proposed.
Yet for all the hopes in Latin America that a new kind of deal can be had, the symbiotic relationship between the largest importer of commodities and one of the biggest commodity-exporting regions of the world is unlikely to change in any substantial way.
“Without this complementarity, the Chinese don’t have much to go on,” said Matt Ferchen, who runs the China and the Developing World program at the Carnegie-Tsinghua Center for Global Policy in Beijing. “It’s working out quite well for China.”
And the symbiosis could survive for a long time. As Huang Haizhou, the managing director of China’s International Capital Corporation, told the nervous Latin Americans at the I.M.F.’s conference here, despite any slowdown in growth, China’s long-term demand for commodities remained voracious.
China’s income per person is still only about one-third that of Chile. Every year for the next 30 years, it plans to move 1.3 percent of its population from the countryside to cities. That will require a lot of construction.
“China’s demand for commodities is more important for Latin American growth than exports to the United States,” Mr. Huang said, “and it will be more important for many years to come.”
This may come as a relief to the worried finance ministers here, struggling to recrunch their budgets to fit lower growth and scarcer tax revenue. But it also poses a challenge to the region’s leaders: maybe the traditional development strategy based on manufacturing needs to be recast in Latin America for a new era.

On the Brink of War and Economic Collapse

Paul Craig Roberts

December 12, 2014

On occasion a reader will ask if I can give readers some good news. The answer is: not unless I lie to you like “your” government and the mainstream media do. If you want faked “good news,” you need to retreat into The Matrix. In exchange for less stress and worry, you will be led unknowingly into financial ruin and nuclear armageddon.

If you want to be forewarned, and possibly prepared, for what “your” government is bringing you, and have some small chance of redirecting the course of events, read and support this site. 

It is your site. I already know these things. I write for you.

The neoconservatives, a small group of warmongers strongly allied with the military/industrial complex and Israel, gave us Granada and the Contras affair in Nicaragua. President Reagan fired them, and they were prosecuted, but subsequently pardoned by Reagan’s successor, George H.W. Bush.

Ensconced in think tanks and protected by Israeli and military/security complex money, the neoconservatives reemerged in the Clinton administration and engineered the breakup of Yugoslavia, the war against Serbia, and the expansion of NATO to Russia’s borders.

Neoconservatives dominated the George W. Bush regime. They controlled the Pentagon, the National Security Council, the Office of the Vice President, and much else. Neoconservatives gave us 9/11 and its coverup, the invasions of Afghanistan and Iraq, the beginning of the destabilizations of Pakistan and Yemen, the U.S. Africa Command, the invasion of South Ossetia by Georgia, the demise of the anti-ABM Treaty, unconstitutional and illegal spying on American citizens without warrants, loss of constitutional protections, torture, and the unaccountability of the executive branch to law, Congress, and the judiciary. In short, the neoconservatives laid the foundation for dictatorship and for WW III.

The Obama regime held no one accountable for the crimes of the Bush regime, thus creating the precedent that the executive branch is above the law. Instead, the Obama regime prosecuted whistleblowers who told the truth about government crimes.

Neoconservatives remain very influential in the Obama regime. As examples, Obama appointed neoconservative Susan Rice as his National Security Advisor. Obama appointed neoconservative Samantha Power as U.S. Ambassador to the United Nations. Obama appointed neoconservative Victoria Nuland as Assistant Secretary of State. Nuland’s office, working with the CIA and Washington-financed NGOs, organized the U.S. coup in Ukraine.

Neoconservatism is the only extant political ideology. The ideology is “America uber alles.”

Neoconservatives believe that History has chosen the United States to exercise hegemony over the world, thereby making the U.S. “exceptional” and “indispensable.” Obama himself has declared as much. This ideology gives neoconservatives tremendous confidence and drive, just as Karl Marx’s conclusion that history had chosen the workers to be the ruling class gave early communists confidence and drive.

This confidence and drive makes the neoconservatives reckless.

To advance their agenda neoconservatives propagandize the populations of the U.S. and Washington’s vassal states. The presstitutes deliver the neoconservatives’ lies to the unsuspecting public: Russia has invaded and annexed Ukrainian provinces; Putin intends to reconstitute the Soviet Empire; Russia is a gangster state without democracy; Russia is a threat to the Baltics, Poland, and all of Europe, necessitating a U.S./NATO military buildup on Russia’s borders; China, a Russian ally, must be militarily contained with new U.S. naval and air bases surrounding China and controlling Chinese sea lanes.

The neoconservatives and President Obama have made it completely clear that the U.S. will not accept Russia and China as sovereign countries with economic and foreign policies independent of the interests of Washington. Russia and China are acceptable only as vassal states, like the UK, Europe, Japan, Canada, and Australia.

Clearly, the neoconservative formula is a formula for the final war.

All of humanity is endangered by a handful of evil men and women ensconced in positions of power in Washington.

Anti-Russia propaganda has gone into high gear. Putin is the “new Hitler.”

Daniel Zubov reports on a joint conference held by three U.S. think tanks.

 The conference blamed Russia for the failures of Washington’s foreign policy. Read this article: to see how neoconservatives operate in order to control the explanations. Even Henry Kissinger is under attack for stating the obvious truth that Russia has a legitimate interest in Ukraine, a land long part of Russia and located in Russia’s legitimate sphere of influence.

Since the Clinton regime, Washington has been acting against Russian interests. In his forthcoming book, The Globalization of War: America’s Long War against Humanity, Professor Michel Chossudovsky presents a realistic appraisal of how close Washington has brought the world to its demise in nuclear war. 

This passage is from the Preface:

“The ‘globalization of war’ is a hegemonic project. Major military and covert intelligence operations are being undertaken simultaneously in the Middle East, Eastern Europe, sub-Saharan Africa, Central Asia and the Far East. The US military agenda combines both major theater operations as well as covert actions geared towards destabilizing sovereign states.

“Under a global military agenda, the actions undertaken by the Western military alliance (US-NATO-Israel) in Afghanistan, Pakistan, Palestine, Ukraine, Syria and Iraq are coordinated at the highest levels of the military hierarchy. We are not dealing with piecemeal military and intelligence operations. The July-August 2014 attack on Gaza by Israeli forces was undertaken in close consultation with the United States and NATO. In turn, the actions in Ukraine and their timing coincided with the onslaught of the attack on Gaza.

“In turn, military undertakings are closely coordinated with a process of economic warfare which consists not only in imposing sanctions on sovereign countries but also in deliberate acts of destabilization of financial and currency markets, with a view to undermining the enemies’ national economies.

“The United States and its allies have launched a military adventure which threatens the future of humanity. As we go to press, US and NATO forces have been deployed in Eastern Europe. US military intervention under a humanitarian mandate is proceeding in sub-Saharan
Africa. The US and its allies are threatening China under President Obama’s ‘Pivot to Asia’.

“In turn, military maneuvers are being conducted at Russia’s doorstep which could lead to escalation.

“The US airstrikes initiated in September 2014 directed against Iraq and Syria under the pretext of going after the Islamic State are part of a scenario of military escalation extending from North Africa and the Eastern Mediterranean to Central and South Asia.

 The Western military alliance is in an advanced state of readiness.

“And so is Russia.”

As I have often remarked, Americans are an insouciant people. They are simply unaware. 

Suppose they were aware, suppose that the entire population understood the peril, could anything be done, or have the insouciant Americans fallen under the control of the police state that Washington has created?

I don’t think there is much hope from the American people. The American people cannot tell genuine from fake leadership, and the ruling private elites will not permit real leaders to emerge. Moreover, there is no organized movement in opposition to the neoconservatives.

The hope comes from outside the political system. The hope is that the House of Cards and rigged markets erected by policymakers for the benefit of the One Percent collapses. David Stockman regards this outcome as a highly likely one. The collapse that Stockman sees as being on its way is the same collapse about which I have warned. Moreover, the number of Black Swans which can originate collapse are even more numerous than the ones Stockman correctly identifies. Some financial organizations are worried about a lack of liquidity in the fixed income (bonds) and derivatives markets. Barbara Novack, co-chair of Black Rock, is lobbying hard for a derivatives bailout mechanism.

David Stockman’s article is important. Read it until you understand it, and you will know more than most everyone.
Many will ask: If the wealth of the One Percent is vulnerable to economic collapse, will war be initiated to protect this wealth and to blame the Russians or Chinese for the hardships that engulf the American population? My answer is that the kind of collapse that I expect, and that David Stockman and no doubt others expect, presents government with such social, political, and economic insecurity that organizing for a major war becomes impossible.

Whereas the political impotence of the American people and the vassalage of the Western World impose no constraints on Washington, economic collapse brings revolutions and the demise of the existing order.

As hard as collapse would make it for people to survive, the chances for survival are higher than in the event of nuclear war.

Getting Technical

Despite Fed-induced Rally Key Stocks Send Red Flag

Bellwether stocks such as Google and Freeport-McMoRan have weak charts, which doesn’t bode well for market.

By Michael Kahn

Dec. 17, 2014 5:22 p.m. ET

Every market era has several stocks that seem to lead the indexes both higher and lower. In any given decade, investors can realistically keep tabs on the market’s health by following just a handful of bellwether stocks.
Today’s bellwether stocks are different from those of the ’80s or ’90s, but they still offer insights into the mood of the market. Right now, bellwethers are throwing off warnings despite Wednesday’s rally following the Federal Reserve’s promise of patience before raising interest rates.
In the 1960s, the phrase “As goes General Motors so goes the nation” was an economic mainstay. For technical analysts, General Electric was often a favorite leading indicator on the charts. If GE started to weaken, a market correction often followed.
Over the years, the bellwethers have changed. Google is an obvious choice today as it is the premier technology company, which many liken to a high-tech venture capital fund. On the charts, Google has had a rough two months, falling from a mid-October high of $568, in round numbers) to a low just under $500 (it traded at $505 Wednesday). Indeed, it has been underperforming the market most of the year (see Chart 1).

Chart 1


The real problem emerges on long-term charts. A triangle or coiling pattern in progress since late last year broke to the downside, and the stock set a 52-week low. Clearly, energy stocks are not the only ones plumbing the depths of their ranges, and this has worrisome implications for the market.
Wednesday morning, FedEx reported fiscal second-quarter profit that missed analyst estimates, and its stock broke down (see Chart 2). While it did benefit from falling fuel prices, other factors caused the miss.

Chart 2


I consider this to be a bellwether stock because as a shipping stock it gives us a direct read on commerce and economic activity. On the charts, FedEx had led the market higher for the past two years, so with Wednesday’s sharp drop we have a leader that is no longer leading. We can argue that the long-term rising trend remains intact – and it’s possible to make a case for FedEx stock based on fundamentals – but by leaving a gap on the charts as it opened, it sent a powerful bearish signal to chart watchers.
Although it seems outdated, I still consider Freeport-McMoRan to be a bellwether. This copper and gold miner, as expected, got hurt as gold prices tumbled this year. However, it is its copper component that I find to be more important. Copper is considered to be a tell for the economy, so much so that it is dubbed “Doctor Copper,” the metal with a Ph.D. in economics. It is used everywhere from wires to pipes so if demand for copper slumps, it is a good bet that the economy is having its troubles.
Freeport-McMoRan’s stock has been cut in half since the summertime. It has also moved below chart support in effect since 2010, and that is a very big – and bearish – technical signal (see Chart 3).

Chart 3


To be sure, the stock is extremely oversold by many measures, leaving the door open for a rebound rally. The technical damage, however, is extensive and likely to require plenty of time to heal.
The list of bellwethers is, of course, subjective. Apple is clearly an important company due to its sheer size and reach, but it has not been a great predictor of overall stock market action. Caterpillar is an important stock in terms of indicating construction and mining health, but has been moving more or less sideways in a wide range for several years. Facebook is the top social media stock, but it is a juvenile in terms of market history, and therefore not a proven market indicator.
Banking giant JPMorgan Chase, a true survivor of the 2008 financial crisis, is arguably a bellwether candidate as well. But given that the market rallied for several years before the bank finally broke out, it is hardly a true bellwether. We can say the same thing about retail giant Wal-Mart Stores.
Whether the market follows through on its post-Fed rally remains to be seen. The point is that several stocks that seem to be very important to the economy and to the market are not doing well. They may hold the key to the market’s performance next year as the effects of quantitative easing, the energy debacle, and the social media initial-public-offering frenzy fade from the headlines.

Russian crisis turns systemic as rouble crashes 13pc

Russia's central bank is letting the rouble plunge as the path of least resistance, but this is becoming dangerous as fear spreads

By Ambrose Evans-Pritchard, and Peter Spence

8:16PM GMT 15 Dec 2014

A reflection of a yearly chart of U.S. dollars and Russian roubles are seen on rouble notes in this photo illustration taken in Warsaw
The rouble smashed through resistance to an all-time low of 65.5 to the dollar Photo: Reuters
Russia is in the grip of full-blown currency crisis after a panic scramble for dollars sent the rouble crashing 13pc, with contagion spreading to Brazil, Indonesia and across the emerging market nexus.

The rouble smashed through resistance to an all-time low of 65.5 to the dollar in a crescendo of selling on Monday, as oil prices continued to slide and markets braced for a likely default in Ukraine.

The Russian currency has lost half its value since President Vladimir Putin first sent forces into Ukraine, setting off a chain of events that the Kremlin can no longer control.
“This is being driven by pure fear. We have crossed a line and the crisis is now self-feeding,” said Chris Weafer, from Macro Advisory in Moscow. “The central bank must intervene immediately with a great deal of money to overwhelm the sense of panic.”
The central bank said capital flight will reach $130bn this year. In a drastic change in outlook, it warned that the economy may contract by 4.7pc in 2015 if oil settles near $60 a barrel. Morgan Stanley said the economy will shrink at a rate of 6pc if crude drops to $50.
The sell-off is spreading far beyond Russia and risks turning into a broader market emerging rout, made worse by fears of a dollar surge as the US Federal Reserve prepares for the first rate rise in seven years. The MSCI index of emerging market stocks has dropped to a 10-month low, led by a 2.4pc slide in the Brazilian Bovespa. Dubai’s DFM index crashed over the weekend and is now down 26pc in nine days.

Russia’s central bank raised interest rates last week by 100 basis points to 10.5pc but this merely signalled a lack of determination to stop the slide. It burned through $80bn of foreign reserves earlier this year defending the rouble but is now holding on jealously to the $416bn that remains.
It is relying instead on pin-prick interventions, but this strategy of managed weakness has clearly failed. The rouble collapse will feed into double-digit inflation in short order. “This is extreme central banking, and the question is, what are they trying to achieve?” said Tim Ash, from Standard Bank.

“Moves like this create systemic risks: the risk of panic among the general population, and surely risks major deposit flight. It makes you think whether they forgot to read the manual which came with the bazooka. But this is a really high-risk strategy from the central bank."

The Institute of International Finance says Russia's reserves are not as large as they appear, given the levels of external debt and a chronic capital deficit of 2pc to 3pc of GDP a year. It says the danger line is around $330bn, suggesting that the central bank cannot safely bleed its funds for long to stem the outflow.
Mr Putin has so far defended the central bank against accusations from populists in the Duma that it has betrayed Russia by letting the rouble crash, and is run by “liberal feminists” in thrall to the International Monetary Fund.

He has promised "harsh" measures against traders betting against the rouble, warning that “we know who these speculators are” and how to deal with them. Yet the Kremlin appears out of its depth and is struggling to keep up with events.
The crumbling rouble has effectively doubled the real burden of nearly $700bn in external debt, mostly owed by banks and companies, and mostly in dollars. They cannot roll over the loans because the global capital markets are shut for Russian companies.
These firms must repay $125bn by the end of next year. Several have already requested help from the state to meet their dollar obligations. Mr Weafer said others have built up a stash of dollars in reserves and should be able to weather the crisis.
Credit default swaps (CDS) measuring bond risk in Russia soared 67 points to 556 on Monday, pricing in a 28pc chance of a sovereign default within five years. Ukraine's CDS spiked 389 points to 2414. The country seems headed for near certain debt restructuring, with serious implications for Russian and Austrian banks.
“The rouble is behaving as if we were back to the default crisis in 1998 but the situation is nothing like that,” said Mr Weafer.
“The Russian balance sheet is one of the strongest in the emerging markets. There is no danger of default whatsoever. The weaker rouble is actually protecting the budget and is preventing the collapse of the economy.”
Neil Shearing, from Capital Economics, said there is growing pressure for more drastic action. "Hardliners inside the Kremlin are most likely to be making the case for capital controls. But we suspect that stringent forms of capital controls are likely to remain a measure of very last resort," he said.
These sorts of controls are porous and would have limited impact. "They would eliminate any remaining credibility that Russia has," he said.

The Republicans in the US Congress are pushing for further sanctions against Russia but these are becoming increasingly redundant at this stage as oil prices bring the economy to its knees.
President Barack Obama said it would foolish to break ranks with Europe by going too far.
“The notion that we can simply ratchet up sanctions further and further, and then, ultimately, Putin changes his mind I think is a miscalculation," Mr Obama said.
"What will ultimately lead to Russia making a strategic decision is if they recognize that Europe is standing with us and will be in it for the long haul and we are patient. And if they see that there aren’t any cracks in the coalition, then over time, you could see them saying that the costs to their economy outweigh whatever strategic benefits that they get.
"Putin does not have good cards, and he has not played them as well as the Western press seems to give him credit for. Putin will succeed if he creates a rift in the Trans-Atlantic relationship, if we see Europe divided from the United States. That would be a strategic victory for him and I intend on preventing that." 

Why Are Commodity Prices Falling?

Jeffrey Frankel

DEC 15, 2014    

Newsart for Why Are Commodity Prices Falling?

CAMBRIDGE – Oil prices have plummeted 40% since June – good news for oil-importing countries, but bad news for Russia, Venezuela, Nigeria, and other oil exporters. Some attribute the price drop to the US shale-energy boom. Others cite OPEC’s failure to agree on supply restrictions.
But that is not the whole story. The price of iron ore is down, too. So are gold, silver, and platinum prices. And the same is true of sugar, cotton, and soybean prices. In fact, most dollar commodity prices have fallen since the first half of the year. Though a host of sector-specific factors affect the price of each commodity, the fact that the downswing is so broad – as is often the case with big price swings – suggests that macroeconomic factors are at work.
So, what macroeconomic factors could be driving down commodity prices? Perhaps it is deflation. But, though inflation is very low, and even negative in a few countries, something more must be going on, because commodity prices are falling relative to the overall price level. In other words, real commodity prices are falling.
The most common explanation is the global economic slowdown, which has diminished demand for energy, minerals, and agricultural products. Indeed, growth has slowed and GDP forecasts have been revised downward since mid-year in most countries.
But the United States is a major exception. The American expansion seems increasingly well established, with estimated annual growth exceeding 4% over the last two quarters. And yet it is particularly in the US that commodity prices have been falling. The Economist’s euro-denominated Commodity Price Index, for example, has actually risen over the last year; it is only the Index in terms of dollars – which is what gets all of the attention – that is down.
That brings us to monetary policy, the importance of which as a determinant of commodity prices is often forgotten. Monetary tightening is widely anticipated in the US, with the Federal Reserve having ended quantitative easing in October and likely to raise short-term interest rates sometime in the coming year.
This recalls a familiar historical pattern. Falling real (inflation-adjusted) interest rates in the 1970s, 2002-2004, and 2007 -2008 were accompanied by rising real commodity prices; sharp increases in US real interest rates in the 1980s sent dollar commodity prices tumbling.
There is something intuitive about the idea that when the Fed “prints money,” the money flows into commodities, among other places, and so bids their prices up – and thus that prices fall when interest rates rise. But, what, exactly, is the causal mechanism?
In fact, there are four channels through which the real interest rate affects real commodity prices (aside from whatever effect it has via the level of economic activity). First, high interest rates reduce the price of storable commodities by increasing the incentive for extraction today rather than tomorrow, thereby boosting the pace at which oil is pumped, gold is mined, or forests are logged.
Second, high rates also decrease firms’ desire to carry inventories (think of oil held in tanks).
Third, portfolio managers respond to a rise in interest rates by shifting out of commodity contracts (which are now an “asset class”) and into treasury bills. Finally, high interest rates strengthen the domestic currency, thereby reducing the price of internationally traded commodities in domestic terms (even if the price has not fallen in foreign-currency terms).
US interest rates did not really rise in 2014, so most of these mechanisms are not yet directly at work. But speculators are thinking ahead and shifting out of commodities today in anticipation of future higher interest rates in 2015; the result has been to bring next year’s price increase forward to today.
The fourth of the channels, the exchange rate, has already been functioning. The prospect of US monetary tightening coincides with moves by the European Central Bank and the Bank of Japan toward enhanced monetary stimulus. The result has been an appreciation of the dollar against the euro and the yen. The euro is down 8% against the dollar since the first half of the year and the yen is down 14%. That explains how so many commodity prices can be down in terms of dollars and up in terms of other currencies.


December 15, 2014 7:09 pm

Bankers, like alcoholics, must first admit they have a problem

The temptation to circumvent the rules might prove irresistible, writes Philip Augar
They really can’t help it, can they? Like alcoholics in a liquor store, the investment banks cannot resist an illicit swig whenever they think nobody is looking. That is the conclusion from the fines imposed on 10 US investment banks last week for breaking the rules designed to manage conflicts of interest in initial public offerings.
The shock is that the event in question occurred in 2010, a mere seven years after rules were passed to clean up the IPO market in the wake of the dotcom crash. Back then Eliot Spitzer, then New York State attorney-general, had led an investigation that showed how investment banks’ analysts had been puffing new issues. It was a scandal that blew Wall Street’s claim to be a trusted adviser out of the water. Ten investment banks paid $1.4bn to settle the matter and signed up to new rules restricting analysts’ involvement in IPOs.

This seemed to have cleaned up the mess. After the settlement, lawyers attended banks’ pitch meetings to police good behaviour; and investment bankers were no longer allowed to influence research. Analysts working on house stocks complained that they could not go to the lavatory except in the presence of a compliance officer; and senior management assured anyone who asked that the IPO market had been reformed.

And that was what we believed until last week,when the US Financial Industry Regulatory Authority (Finra) fined 10 firms a total of $43.5m for allowing their equity research analysts to solicit investment banking business, and for offering favourable research coverage in connection with the 2010 planned IPO of Toys R Us, the American chain store. The fines are not big in the context of the $100bn-plus paid so far to cover the post-2008 banking crisis scandals but this is still a very damaging episode for the industry.
It is the seven years that jars: just seven years from the industry making what was at the time a record payment to restore its badly tarnished reputation to, it would appear, blatantly dodging the new rules.

Furthermore, this was not a single rogue bank going off the rails. The 10 firms fined by Finra included many signatories to the 2003 settlement and nine of the top 10 banks for US equity offerings in 2010. It was only a single deal but the involvement of so many big-league firms suggests that the industry was already back to its old tricks well before the time frame suggested by the regulators’ rule of thumb that reckons on good behaviour prevailing for a working generation after a scandal.

Post-crisis regulation is at a crucial point right now. The banks are complaining that the tide of regulation is choking capital markets in a bureaucratic tangle and impairing their ability to provide capital for the real economy. Their lobbyists focus their considerable resources on lawmakers and regulators, and it must be tempting for the authorities to give some ground.
But the short period it took for the investment banks to game the post-Spitzer settlement provides a little look at how the land will lie in, say, 2020, by which time new bankers will be in charge and the temptation to game the latest rules might once more prove irresistible. This would bring the post-2008 regulations into the line of fire. Far from lightening up, the regulators would be well advised to remain focused on the investment banks and their business model.

In mitigation, the investment banks might argue that 2010 is not 2014 and that finally after the Libor and currency benchmark scandals the message has hit home. But we heard all that in the liquor store, too. So like a repentant alcoholic, banks should just come clean and admit: “I am an investment banker and I can never be cured. Please save me from myself.”

The writer, a former banker, has written books about finance. A non-executive director at TSB, he writes in a personal capacity

How Long Does A 'Typical' Oil Downcycle Last?

  • Oil price patterns observed during some of the previous “mega-corrections” imply that this time a decline to a $45-$55 per barrel range cannot be ruled out.
  • It is difficult to expect a rapid recovery. At least three previous mega-corrections took almost two years to run their full course.
  • The current correction’s structural logic does not imply that there is a fundamental change to the industry’s capacity or cost base, which are the key drivers of the long-term price.
With the price of crude being in an essentially uninterrupted free fall for the fifth month in a row, it would seem useful to have an answer to the following:
  • Where is the bottom?
  • How long would it take for oil price to recover?
  • Will oil return back to ~$100 per barrel level or has the paradigm changed?
In search of an answer (and for the lack of an appropriate crystal ball), historical analogies may not be a bad place to start.

Given the magnitude of the current decline - ~45% from last summer's peak levels - it would be logical to narrow down the comparison to the most significant "mega-corrections" that the industry experienced in the past several decades.

It is difficult to summarize the relevant precedents better than was done last week by BP p.l.c (NYSE:BP). The following slide maps the current oil price trajectory versus the corrections of the 1985-1986, 1997-1998 and 2008-2009 periods. Specific macro factors that caused each of those three precedent mega-corrections were of course different. However, the net effect of deep price declines experienced each time was creation of an economic signal that forced producers to reduce supply so that demand was matched. In this regard, the current oil price correction may be no different in its substance and may exhibit some similarities in terms of its structure and duration.

(click to enlarge)
(Source: BP p.l.c, December 2014)

BP highlights the fact that it has historically taken up to 2 years for prices to complete a deep decline and then undergo a recovery. In two instances out of the three shown on the left-hand side of the graph above, OPEC was forced to respond to the declines with a series of production cuts (while OPEC cut production during the 1985-1986 correction, oil price was already on a recovery path by that time).

Another important observation provided on the slide relates to the strong cyclical correlation between oil prices and the industry's costs. The graph suggests that cost changes tend to react to oil price movements with a lag of 1-2 years. BP commented that over the past 12 to 18 months, industry cost inflation had caught up with $100+ oil prices and was already showing signs of slowing, even before the recent sharp fall in oil prices. With oil prices where they are today, BP expects that this natural self-correction mechanism will lead to supply chain deflation. I should note here that BP's view of the industry's cost structure likely includes international and offshore segments where margins often have stronger contractual support and the cycle may be slower to turn around than in unconventional resource plays.

If one were to assume that the current correction will repeat the path of its historical analogues, the following observations may be derived:
  • While declines appear to be more precipitous than recoveries, the 1997-1998 correction provides an example of a rapid price recovery. The graph also shows that it may take over a year for an oil price recovery to run its course. Given that oil prices began to move lower in July of this year, a 20-month downcycle would mean that oil price may not recover until approximately Q1 2016.
  • The average peak-to-trough decline for the three corrections was slightly over 60%. For the current correction, a 60% peak-to-trough decline would imply a "bottom" price of approximately $45 per barrel. If one were to use the shallowest of the three corrections, the 1997-1998 one, as a benchmark, the bottom price level would be approximately 50% of the previous peak price. In the context of the current decline this would equate to ~$50-$55 per barrel. The duration of the price "bottom" is approximately 3 to 5 months.
  • In two cases out of the three, one year after the low price had been reached, the price of oil was still ~30% below the previous peak price. In one case out of the three, the recovery was all the way up to the price level at the beginning of the correction. Applying the average measure to the current situation, this would imply a recovery to approximately $80-$85 per barrel level towards the end of 2015.
  • From an operating margin perspective, using historical precedents, 2015 promises to be a very challenging year for the Oil & Gas industry. Operating costs will provide only moderate relief, whereas revenues will trough. The following year, 2016, should see the opposite trend: operators would benefit from a strong recovery in revenues, whereas costs may still be on a decline trajectory.

Of note, according to an October 13, 2014 Reuters article, Saudi officials had communicated in meetings with investors and analysts that the kingdom would "accept oil prices below $90 per barrel, and perhaps down to $80, for as long as a year or two, according to people who have been briefed on the recent conversations." One could interpret such message as an admission by Saudi Arabia that a significant downcycle was unavoidable at that point and the kingdom was expecting it to last 1-2 years, which would be similar to the shape of the previous major downcycles. The price expectation, however, appears somewhat optimistic when compared to previous mega-corrections.

Another recent comment by a senior OPEC official is interesting in this regard. Today's Bloomberg article quoted the United Arab Emirates' energy minister Suhail Al-Mazrouei as saying that OPEC will stand by its decision not to cut output even if oil prices fell as low as $40 a barrel and will wait at least three months before considering an emergency meeting.

What is driving this correction that seems to have caught many investors and industry participants by surprise? BP did not provide any new insights, suggesting that market fundamentals are driving this trend include:
  • Increase in global supply, mainly due to the return of shut-in production "in a number of locations" - such as Libya - and continued production growth in the United States;
  • Relatively high petroleum storage levels;
  • Weaker demand globally (it was not quite clear from the comment whether it meant "weaker growth rate of demand globally").
BP also commented that OPEC's recent decision not to cut production "has left the market more vulnerable to these natural forces of supply and demand."

Notwithstanding near-term uncertainties, BP sees this environment as potentially healthy for the industry overall as it can drive greater efficiency across the value chain and is one of the mechanisms that underpin long-range returns in the Oil & Gas sector. Despite this optimism, it is clear that this price correction caught the industry by surprise and it will take operators some time to make adjustments to their business plans.

BP's example provides an illustration. The company commented that it sanctions its Upstream projects assuming $80 per barrel, at which level the company expects a project to generate "competitive returns." The company also tests each project at $60 per barrel to understand the resilience of its portfolio at a range of prices. With oil currently trading below $60 per barrel, many of BP's projects will likely fall below the return threshold.

In March of this year, BP planned to spend ~$24-26 billion per annum between 2015 and 2018, of which $20-22 billion related to the Upstream. In October, BP told analysts that it would pare back or re-phase capital spending wherever possible, targeting to achieve a capex reduction of $1-$2 billion in 2015 across the group. In light of the recent position taken by OPEC and with oil prices where they are today, BP will clearly need to take a much more radical approach to its budget reductions.

However, given the scale of the company's operations and the fact that many of its mega-projects are well underway, a significant change to the previous operating plan is no easy task. The company intends to provide a revised guidance for 2015 in February. Significant changes could also be costly and disruptive to the business. As an example, BP expects to incur about $1 billion of non-operating restructuring charges over the next five quarters, including the current quarter, in connection from a business streamlining program that the company initiated some 18 months ago in response to resizing the group.

In Conclusion…

In the absence of a quick and decisive production cut by key OPEC members, the industry lacks a mechanism that would allow to adjust supply volumes to the level of demand. If such reduction is required, the price may need to travel down all the way to the level where operators begin to take volumes off the market and stay at those levels for several months to give the industry sufficient time to agree and implement necessary operational steps. The industry's sheer size and significant storage capacity define the relatively slow cyclical turnaround times.

In this regard, the deep decline in the price of oil that we are currently witnessing should by no means be interpreted as a fundamental change in the industry's productive capacity or cost structure (the two key components that could lead to a "paradigm shift" as it relates to the long-term price of oil).

Asia Stocks

Emerging Markets See Equity Markets, Currencies Decline

Jitters Rise Over Falling Oil Prices, Fed Policy Outlook

By Nicole Hong And Anjani Trivedi

Updated Dec. 15, 2014 3:34 p.m. ET 

Markets across the developing world fell on Monday, on heightened jitters over falling oil prices and U.S. monetary tightening.

Currencies were especially hard hit, with the Russian ruble and Turkish lira plunging to record lows against the dollar. The Brazilian real, South African rand and Indonesian rupiah also sank to fresh multiyear lows.

Analysts say there was no specific catalyst for the selloff, but a number of factors converged to put downward pressure on emerging markets. Global oil prices continued to tumble, exacerbating problems for oil-exporting countries like Russia and Colombia. The Federal Reserve is also scheduled to issue a statement on Wednesday, which could signal that the central bank is closer to raising interest rates. That would deliver a blow to emerging markets that have benefited from years of easy money from the Fed.

As investors scrambled to dump their risky assets, the selloff in emerging markets spread beyond oil exporters into countries like India and Indonesia, which had been relatively resilient in recent weeks.

“There’s just a lot going on in emerging markets, and investors are having some difficulty absorbing that information and figuring out what will happen next,” said Lucas Turton, chief investment officer of Windham Capital Management LLC in Boston, which manages $1.8 billion and cut back on its exposure to emerging-market stocks two months ago.

In afternoon trading in New York, the dollar was up 3.1% against the lira, with the Turkish currency trading at 2.3706 to the greenback. The real was off more than 1% at 2.6884 to the dollar, while the ruble plunged by more than 10% to trade recently at 65.615 to the dollar.

Investors may be pre-emptively selling emerging-market assets ahead of the Fed statement on Wednesday. The statement is likely to “reinforce the divergence between the policy stance of the Fed and other major central banks,” said Mitul Kotecha, head of foreign exchange strategy at Barclays in Singapore.

The Fed is expected to raise interest rates next year as the economy improves, while central banks in Europe and Japan are pursuing strategies to stimulate growth and inflation. This divergence has caused the dollar to soar against currencies around the world in recent months.

“If the Fed indicates that interest rates are going to be raised earlier rather than later…that’s likely to have a further negative impact on emerging markets,” said Clem Miller, a portfolio manager at Wilmington Trust in Baltimore, which oversees $80 billion and has bearish bets on emerging-market stocks and bonds. Mr. Miller said he hasn’t had such a small exposure to emerging markets since the early 2000s.

Thai stocks were one of the biggest victims of the broader selloff on Monday, collapsing over 9% at one point before recovering. The plunge prompted the country’s finance minister, Sommai Phasee, to urge investors to remain calm. “The fall is in line with overseas market movement,” Mr. Sommai told reporters. “Trust me, if it can go down, it can go up.”

Many investors are bracing for turmoil in emerging markets as the dollar strengthens, making it more expensive for these countries to pay back international debt, and as U.S. growth beats much of the rest of the world. For instance, Indonesian companies have issued $11.4 billion of foreign-currency debt so far this year, according to Dealogic, putting them at risk for what analysts call a “currency mismatch.” This means these companies could struggle to pay off their dollar debts as their local currency, the rupiah, weakens in value against the greenback.

Stephen Jen, founding partner of hedge fund SLJ Macro Partners, said emerging-market currencies could “melt down” as investors accelerate their selling.

“Nothing the [emerging market] economies can do will stop these potential outflows, as long as the U.S. economy recovers,” Mr. Jen said.

Read This, Spike That

Drilling Down on Oil’s Surprisingly Big Drop

Several articles explore the reasons and ramifications behind the decline. And what asset is even worse off?

By John Kimelman   

December 15, 2014

 As 2014 enters the home stretch, the big collapse in the price of oil since June remains the biggest running story impacting the economy and the market this year.
So I thought I’d highlight a few articles written in recent days that approach this story from various angles.
A piece in the New Yorker, by respected business writer James Surowiecki, argues that the world has entered a new era of bigger volatility when it comes to oil and other commodities.
“The real story of the past few months isn’t that oil prices have fallen; it’s that they’ve fallen so far so fast, and that they may still have a long way to go before hitting bottom,” writes Surowiecki. “That suggests that the stability of the past few years has yielded to a new era of volatility, in which small changes in supply and demand will lead to big price swings.”
Surowiecki goes on to explain some of the underlying economic principles that lead to high volatility in oil and other hard assets.
“Commodities are more volatile than other assets -- the price of copper fluctuates a lot more than that of a television set -- and oil has historically been more volatile than most other commodities; a 2007 study found that in the U.S. it was more volatile than ninety-five per cent of other products,” Surowiecki adds. “The biggest reason for this volatility is that short-term supply and demand for oil are what economists call ‘price-inelastic,’ which means that they don’t respond much when the price of oil changes. People don’t immediately start driving less when gasoline prices spike -- they just pay more for gasoline. On the supply side, drilling projects take a long time to start up or to shut down, so higher prices don’t immediately translate into more supply, or lower prices into less.”
Surowiecki explains that as a result, the way prices typically return to normal -- through increasing supply or diminishing demand -- doesn’t really happen in the oil market.
“So a two- or three-per-cent change in supply, which is about how much the shale boom and the Libyan rebound added to global daily production, can spark a huge move in price,” he concludes.
Most Investors are probably less concerned about understanding the whys of collapsing oil prices than the way it which that roughly 45% decline is impacting certain segments of the marketplace.
On that score, a piece by the Wall Street Journal’s Greg Zuckerman discusses how cheap oil in impacting other investable areas of the marketplace.
The piece discusses the obvious and not-so-obvious winners and losers tied to the big oil-price swoon .
I’d rather focus on the less obvious. For example, Zuckerman points out that certain commercial banks exposed to energy producers are clear losers, including Oklahoma lender BOK Financial Corp., which has extended 19% of its loans, by value, to energy-related companies; Cullen/Frost Bankers  and Zions Bancorp ).
In addition, the junk-bond market is being hit hard in part because 14% of those bonds are energy-related,” Zuckerman writes.
For those of you who wonder what kind of impact the oil-price drop has had on the stock market, check on Joshua Brown’s blog devoted to this topic.
Brown, a popular financial blogger, does a nice job showing how wrong-headed and contradictory journalists can be when they attempt to explain the stock market’s gains or declines on a particular day based on moves in the oil price
As he puts it in his headline: “they’re all making it up.”
Finally, as bad as oil has performed this year as an investment, it hasn’t been the worst performing asset.
As Quartz’s Matt Phillips puts it, that dubious honor goes to bitcoin, the electronic currency that was all the rage in 2013 but has fallen by roughly 52% this year.
“Clearly bitcoin bulls have found themselves on the bleeding edge. But the question is why?,” writes Phillips. “One of the clearest answers seems to be that some of the shadier usages of the currency -- say for evading taxes and buying drugs -- have been tougher to execute as governments increasingly try to clamp down on the “dark web” sites where bitcoin quickly became the cryptocurrency of choice. Collapses of large, unregulated bitcoin exchanges -- such as Mt. Gox -- have done little to instill confidence in the currency either.”
Anyone who thought that bitcoin was the perfect novelty Christmas or Chanukah gift last year for a spouse or other family member should be feeling bad right about now.

The Russian Ruble Is Hereby Halted Until Further Notice

Earlier, we reported that various currency brokers such as FXCM and FxPro, would - as a result of the soaring liquidity in the USDRUB pair - suspend trading in the Russian Ruble (while other merely hiked margins to ridiculous levels). It appears things have escalated again, and as FXCM just reported, instead of just politely advising clients not to open new USDRUB position tomorrow, it has advised anyone long, or short, the USDRUB that their positions will be forcibly shut in moments.

So for those curious why there appears to be a collapse in Ruble volatility in the past few hours which in turn has sent both stocks and crude soaring, the answer is simple: nobody is trading it!
And this is what happened following the post: as soon as all those short the RUB (long USDRUB) realized they have to take profits, the USDRUB tumbled some 500 pips (!) in the process sending stocks surging.

h/t @Paul_Courtney