derryl

The Global Oil Scam: 50 Times Bigger than Madoff

Mark Anthony:

It is true, as you say, that speculation in commodities futures is a zero sum game. When speculators buy commodities they increase demand and thereby increase the price of the commodity. But when it comes time for those same speculators to sell their commodities they increase supply which puts downward pressure on the price of the commodity. The excess demand of speculation on the upside is exactly equal to the excess supply of speculation on the downside so there should be no net effect on the price of the commodity. Some speculators 'win' by selling to other speculators who lose. It is precisely a poker game where speculators' money is the pot and some win and some lose.

But this is not what is happening anymore. Now we have very deep pocketed speculators who keep their money in the futures market. They are no longer buying and selling deliveries of oil. They have 'securitized' the futures market. Now they buy and sell "contracts", not oil deliveries. So they push up the price of real future delivery contracts by raising demand, but they never push the price back down by unwinding those positions and increasing supply. They just roll over their contracts again and again, with GS and friends collecting fees on each transaction. So the fee collectors like GS reap gains while investors in the GS index fund lose their money to pay Goldman's gains. Speculators who buy commodities futures as a hedge against currency devaluation may actually come out ahead, if the US$ loses 5% and their loss on the futures market is only 2%, for e.g.

Meanwhile the speculative money that is holding demand price at artificially high levels means real oil suppliers sell to real oil buyers at the inflated price. Oil suppliers get the gain. And that inflation is 100% passed on to us, the ultimate consumers of gas and diesel and jet fuel. Actually a bit less than 100% is paid by end consumers, as refiners have been suffering lower profit margins so they eat a share of the cost too.

Oil was pushed down to $30 when GS and the other big speculators faced the cash crunch of 2008-09 and had to liquidate their commodities positions to cash up and cover losses (i.e. "add capital") in their other activities. That is what happens when speculators actually sell, the price collapses to (or below) its natural supply-demand level. But TARP, etc "recapitalized" the newly converted "bank holding company" GS and friends so they're back in business inflating the futures markets and sucking money out of the pockets of consumers and the smaller scale suckers who try to profit from commodities speculation in a field that is owned and operated by GS & Co.

Extraordinary Popular Delusions and the Madness of Crowds

Tack wrote,
"This scenario has been repeated time and again throughout history. The price of everything, as measured in fiat currencies, only progresses higher over time. The idea that prices will decline systemically and stay there has no factual historical basis whatsoever."

The deflation we are talking about is not the idea that prices will decline and stay there forever. It is the historical precedent of the 1930s balance sheet depression where asset prices (stocks and real estate) collapsed and took decades to recover to their 1929 nominal prices. CPI does not change in direct relation to money supply (productivity gains can produce more goods to absorb increased money without prices rising, for e.g.). Asset prices do. So it's asset prices that inflate and deflate, not CPI prices.

Loan defaults and personal and bank bankruptcy all destroy money supply. Money supply and GDP move together, both up and down. So when money supply is contracting/deflating GDP contracts/deflates with it. Unless there is some renewed exuberance among borrowers to take on new debt to re-expand the money supply and the economy, the contraction can continue for a very long time. That's where we're at right now, overindebted, losing jobs, defaulting and going bankrupt, and unwilling or unable to take on more debt.

A balance sheet recession happens when too many people took on more debt than they can repay, especially if their income takes a hit, and the asset prices that were supported by that debt-money collapse. Those collapsed-value assets are the collateral the banks were holding against the loans and when the assets are marked to a 20% down market value the banks don't have enough capital to extinguish the losses so they are insolvent. By law they are then taken into receivership and restructured or dissolved, but now bailouts that are presumed to be funded by future taxes keep 'too-big-to-fail' insolvent banks alive.

The Fed has created something over $1 trillion of new money to buy toxic assets from failing banks, but this new money ends up on the asset side of bank balance sheets where they must hold it against their liabilities on the other side of the sheet. The banks were failing because the value of their asset side was shrinking. The Fed replaced shrinking assets (mortgages and other loans the banks had made) with "cash".

But banks have to HOLD their assets, or trade or sell them for better assets, so they can meet their liabilities as demanded. So the banks have to hold the Fed's cash, or trade it for a better asset. As an asset cash is sterile for the banks, it pays no interest. What asset is as liquid as cash AND pays interest? Treasury debt for one. And "excess reserves" deposited at the Fed which now pays interest. Any way you slice it this new Fed cash is locked into banks' balance sheets and cannot 'escape' into the economy and contribute to inflation.

Meanwhile bank capital is being destroyed liquidating loan losses. People are paying down their debts which extinguishes both the debts and the deposit money that those bank loans created. Money supply is deflating and GDP is deflating with it.

The Fed can reflate equities markets by making free money available to GS and JPM to game the markets, but this rally is a mile deep and an inch wide. The government can generate some GDP and real estate blips upward with cash for clunkers and $8000 first time homebuyer grants, but on the one hand these are just pulling forward future demand which will leave holes in the future, and on the other hand these are being financed with your future tax payments which will produce holes in your spending later.

This is not "the economy" growing. This is just a transfer of debt from private borrowers (who have quit and gone home) to public borrowers who want to keep playing.

After a really good run since 1947 we have finally reached terminal debt. The economy has reached its debt ceiling and cannot or will not borrow any more. Rapid population growth and productivity growth in the postwar period easily absorbed all the new debt-money that was being created as America's middle class took on mortgages and raised families. That trend is over and there is no new impetus of sufficient scale for renewed economic growth on the horizon.

So from here into the foreseeable future debt growth will trend downward and GDP will sink with it, unless the Fed comes up with some innovative QE program that can reduce total debt without simultaneously collapsing asset prices and the banking system. The secular trend is deflationary. CPI prices will inflate only if the dollar declines and oil and other imports become more expensive (stagflation). But asset prices are in a secular decline and only a renewed period of inflationary real economy growth can reverse this trend.

What's Oil's Future?

Good analysis. Even though this recession might somewhat reduce short term oil demand growth it would take minimum 10-20 to rebuild the world's energy infrastructure to some post-oil scenario. A lot of alt energies will help reduce oil needs once the technical problems have been worked out and they are up and running. But to rebuild your physical infrastructure takes a lot of energy and for now that means oil.

Many producing oilfields (e.g. Alaska's) are mature and output has been declining for years. And you have made the case why national oil companies will starve their business before reducing their social spending. Without large scale new investment oil supplies will decline and we will indeed find ourselves in another supply crunch and god only knows where prices will go next time.

Today I put in an order for some Suncor Energy Inc (a major tarsands producer who can make profit from $40 oil) at under $24, about 1/3 of its peak price. You say the bottom for oil stocks will come "soon" but today's G20 meeting confirmed that governments are commited to whatever it takes to ease and end the recession, so I wouldn't wait too long to start jumping in.