2009-06-20

谢国忠 Andy Xie: Fear the Dark Side of China's Lending Surge

Here's a long and important section of Andy Xie's latest:
The current surge in commodity prices, for example, is being fueled by China's demand for speculative inventory. Damage to the domestic economy is already significant. If lending doesn't cool soon, this speculative force will transfer even more Chinese cash overseas and trigger long-term stagflation.

Commodity prices have skyrocketed since March. The Reuters-Jefferies CRB Index has risen by about one-third. Several important commodities such as oil and copper have doubled in value from this year's lows. As I have argued before, demand from financial buyers is driving commodity prices. The weak global economy can't support high commodity prices. Instead, low interest rates and inflation fears are driving money into commodity buying.

Exchange-traded funds (ETFs) alone account for half of the activity on the oil futures market. ETFs allow retail investors to act like hedge funds. This product has serious implications for monetary policymaking. One consequence is that inflation fears could lead to inflation through massive deployment of money into inflation-hedging assets such as commodities.

Financial demand alone can't support commodity prices. Financial investors can't take physical delivery and must sell maturing futures contracts. This force can lead to a steep price curve over time.

Early this year, the six-month futures price for oil was US$ 20 higher than the spot price. Investors faced huge losses unless spot prices rose. A wide gap between spot and futures prices increased inventory demand as arbitrageurs sought to profit from the difference between warehousing costs and the gap between spot and futures prices. That demand flattened the price curve and limited losses for financial investors. Without inventory demand, financial speculation doesn't work.

For some commodities, warehousing costs are low, limiting net losses for financial buyers. Some commodities can be used just like stocks, bonds and other financial products. Precious metals, for example, are like that. Copper, although 5,000 times less valuable than gold, still has low warehousing costs relative to its value. Some commodities such as lumber and iron ore are bulky, costly to warehouse, and should be less susceptible to financial speculation. Chinese players, however, are changing that formula by leveraging China's size. They've made everything open to speculation.
The worldwide rally of commodities and equities is a speculation led bubble based on future growth expectations that have no basis in reality. Economic data continue to point to a very weak U.S. economy, check out a recent post by Mish on truck and rail traffic. The Baltic Index is up because the Chinese demand requires shipment of commodities, but rail traffic in the U.S. doesn't show resource demand.

Andy Xie's comments on ETFs and the implications for monetary policy are important. Never before have commodity markets been so accessible to retail investors, yet the commodity markets themselves remain relatively small compared to stock and bond markets. There's a lot of room for growth, should investors decide they want out of equities and into commodities. This also means investors can exit the U.S. dollar and financial assets at a moment's notice.

In the early 1980s, Ed Yardeni dubbed the inflation hawks in the bond market "bond vigilantes". Today, there are still bond vigilantes, but now retail investors can join the game via derivative ETFs such as ProShares Ultra Short 20+ Year Treasury (TBT), or various commodity ETFs such as SPDR Gold Shares (GLD), PowerShares DB Agriculture (DBA) or PowerShares DB Oil (DBO).

Financial markets don't do what everyone is expecting though—"the market" is the master of misdirection. If investors anticipate high inflation, they will pour into commodity funds and drive up interest rates. The government may try to restrict commodity speculation, and that could be a part of upcoming financial reforms. Otherwise, the Federal Reserve and other central banks will be forced to raise interest rates and drain liquidity from the system, and that will touch off another round of deflation.

The speculators are in the driver's seat because they suspect (many would say they "know") that the government finds another deflationary event unacceptable. They are playing chicken with the central bank because they believe central banks will swerve their inflationary Fiat in the face of the deflationary Mack truck. The behavior of speculators guarantees very high inflation if the central banks do not curtail credit. In order to have the "healthy" inflation the central banks want, they must restrict access to commodity markets and/or chase the speculators out. A well-timed liquidity drain or surprise rate hike would put the central bankers in the driver's seat of the Mack truck and leave the speculators packed in the Fiat.

I do not believe the central banks can create the inflation they desire while the world is watching. There is a natural law underpinning the world that cannot be defied for long. In the absence of central bank inflation, speculators are setting up the next round of deflation as high resource costs drain the pockets of consumers and business alike. The central banks cannot print money unless people are willing to hold it, i.e .unless there is a healthy demand. Recently, demand for cash was so strong that the velocity of money plummeted. In a high velocity environment, with very low demand for money, central bank printing is suicidal. The central bankers need to keep demand high, and they will do by keeping the spectre of deflation alive. Without it, they can only fail.

No comments:

Post a Comment