Softer Commodity Prices Signal Weaker Growth
August 4th, 2008 - Commodity and energy prices have continued to soften and this has resulted in some optimism on equity markets. But don’t cheer too loudly because softer prices are also signalling weakening global economic growth. Meanwhile, cries from politicians to beat up commodity “speculators” have become less shrill.
Ostensibly the home of free markets, policymakers in the United States have been busier than their counterparts elsewhere in interventionism. They are doing their best to keep Fannnie and Freddie from collapsing - - two companies that took on excessive risk, made bad decisions and should go bust.
But, as the saying goes, they are too big to fail. And, inevitably, the taxpayer will have to shoulder the expense of shoring them up. With all the rescue attempts that the government and the Fed are engaged in, the final bill for saving Wall Street from the consequences of its earlier excesses is likely to be substantial. Socialism for the rich is decidedly costly.
Ultimately, the funding will have to come from somewhere, either higher taxes, or more borrowing or by printing money. For politicians, the latter two courses are the most appealing, which means that we will have to be on the lookout for upside risks to inflation and longer-term interest rates. Yes, you’re right Bernanke is not a politician. But he is as weak-kneed as they come and will bend to any political pressure.
Officials have also been moving aggressively to discourage the shorting of financial stocks. Of course, this smacks of market manipulation. Shorting is a legitimate investment practice that ensures efficiency in the pricing of securities - - they teach this in basic finance courses. True, that at this point in time, financial-services companies badly need to have higher stock prices. But this should be left to the market to decide.
Bank stocks have been rallying, partly because of a short squeeze (i.e. a rise in prices goosed up by those with short positions who try to cover their shorts), and partly because there is renewed investor interest in picking up beaten-down stocks in the financial-services sector.
As for the sector’s health, there is almost certainly more bad news to come. With the economy weakening, loan-loss provisions will have to be added to the write-down of deteriorating assets. Risk-averse investors are likely to stay away from bank stocks. But waiting until all the bad news is out will be too late to capture most of the upside gains.
Chinese authorities are also trying to goose up their stock market, which has swooned substantially from its highs. This isn’t a new approach, because they have frequently engaged in manipulation in the past. Besides, unlike the Americans, they have never spouted capitalist high principles.
With regard to the renminbi, they want to go easy on further currency appreciation. Exporters are squealing that it’s tough to make any money as the global economy slows down, and they don’t need a more pricey currency on top of that. Who said that communist apparatchiks are insensitive to people’s needs?
They are also being less than forceful in tightening monetary policy, even as inflation is rising. The overall objective is to keep domestic demand humming while export growth flags, and there is evidence that they are having some success in achieving their goals. Still, the high inflation numbers are a source of concern.
With the softening of commodity prices, previously highflying energy and basic-materials stocks have been grounded. These two sectors are now underperforming the indices and show few signs that a turnaround is in sight. Naturally, stock markets in Canada and Australia have also swooned.