Wednesday, 12 November 2008

Waking up to the crisis

The price of oil

Oil prices continue to fall amid persistent fears of a sustained global recession. Until last August the price of oil and the price of oil futures (claims on future oil production that can be originated, bought and sold) consistently fluctuated in a counter-cyclical fashion in relation to the values of major stock indices. The fact that oil tended to go up in price when stocks went down while oil tended to down if stocks went up indicated a shuffling of funds between the two markets. The causality was case by case but there was certainly a strong negative correlation between the two classes of investment. Since late September, equity and oil have been continued to exhibit strong correlation. This correlation, however, is now positive. Both stocks and oil have been plummeting in step with one another.
How should this change in the relationship between oil and equity be interpreted? This is one point where virtually all schools of economic thought can probably agree. The downward movement is a reflection of the economic crisis deepening and becoming universal. In order for investors to move money from sinking stocks into the oil market they would have to believe that global demand for petrol was buoyant. This would imply that the global slowdown was such that the worlds appetite for fossil fuels would continue through what would have to be a relatively mild period of global gloom. Investors are coming to understand the gravity of the situation. This is far from news. The shift in the relationship between equity and petrol began in August--before the collapse of Lehman Bros. What is note worthy is that the price of oil seems to have no floor. It has continued to sink in step with equity far below where many thought it possibly could.


Global trade is expected to contract, in global terms, for the first time in 26 years. This news is coming at a time in the history of the global economy when trade constitutes a more important role in growth than at any other time. Throughout the global expansion of the last decade and a half, increases in trade have out paced global growth by a large and consistent margin. The world bank has announced that it will be releasing $100 bn in funds to deal with the slowdown in trade and some of the devastating effects it is expected to have on poor and middle income countries.

Fiscal policy

One of the only issues that the nations participating in the G20 meeting in Washington this weekend can agree on is the need for major fiscal stimuli. This comes after the realization that even the most aggressive monetary policy (rate cuts to stimulate lending and increase the money supply) would have little effect on the willingness of financial institutions to begin lending again. Money markets (the markets in which firms raise money for short and medium term debt usually related to raw materials and pay-role; the overhead costs that bring firms through one production cycle to the next) are still hemorrhaging funds as investors pull back from market exposure.
A major fiscal response by China has just been announced ($586 bn) while preliminary responses by the worlds richest countries have been made public (USA $170 bn, Japan $168 bn, Germany $15.7 bn). The spending packages announced will most likely be spent on everything from consumer stimulus (tax rebates to increase demand), transport investment, and possibly investment in utilities such as water and electricity. The nature of the distribution of the fiscal package will depend largely on the ideological leanings of the government implementing it. In the free-market spirit of minimized state intervention the US is more likely to concentrate on stimulating consumption. Other nations, such as China, can be expected to concentrate on long term investment like infrastructure--this creates jobs in the short term while creating long term capacity increases. European and North American nations will do the same albeit in a smaller scale.
Can this sort of massive public expenditure benefit normal people? If so how? And, if the answer is yes, how can we ensure that aside from bettering our lot economically it also deepens democracy? Can there be democratic accountability of public revenue of the sort that could empower normal people? These are questions to think about.

Other economic news...

Bush has rejected continued calls for a rescue for Detroit's big 3 auto makers. Economists predict that allowing the companies to collapse would cause more than 2.5 million job losses. The effect of that would be devastating for the American economy and would certainly pull the rest of the world down with it.

Between now and the end of 2011, approximately $2,100 bn of European corporate debt will be due to be payed back, $800 bn of which will be due next year. These massive paybacks come at a time when it will be harder to refinance (take out new loans to pay back old ones) debt than at any other time since the great depression. With the world economy in free fall, the default of more major companies would surely only accelerate the decline.

The IMF, in its World Economic Outlook Update, predicted that the advanced economies, taken as a whole, would experience a contraction of output for the first time in the post-war period.

If you cannot feel the effects of the economic crisis yet, expect to soon.

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