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Saturday, December 13, 2008

Recession, USD, Crude and Conspiracy Theories !!

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Well here my attempt at simplifying things first for my own understanding and then for the understanding of readers :).

When did it began - pretty difficult to say the history of global trade and economics can extend back to centuries, but perhaps if we confine our discussion from great depression of 1930s followed by World War -II and adaptation of Bretton Wood system sometime in 1944. The history of The Great Depression can be easily located here -> 3 school of thoughts explain it differently -
1) Macroeconomics effect of Money supply & Gold
2) Structural Theories
3) Marxist point of view

1) Post World War 1 era every country in order to protect its exports printed money. Currencies were not inter convertible and were pegged against Gold. High liquidity caused high level of inflation, a stock market crash, a black Tuesday and a recession which turned into Great depression.
2) Keynesian theories attribute depression to lack of government spending which resulted in lower employment, lower income of middle class and great lack of confidence in the system triggered by stock market crash.
3) Marxists call this as accumulation of wealth in pockets (mainly industries), aberrations in wealth distribution which couldnt be sustained and hence recession which later turned into depression.

To some extent or the other all the theories are interrelated. Things subsided to varying extent in various parts of the world. Thrust on agriculture, infrastructure created employment and wealth for masses, but all of it was short lived. 1940s saw increased military spending worldwide which eventually culminated in the World War II and change in World order which lasted in 1944-45.

Bretton Wood conference in 1944 laid the founding stone of International Monetary Fund (IMF), USD become the new world order, USA was given the responsibility to hold the price of gold and marked the beginning of cold war between USA & former USSR which lasted till 1989.

However US couldnt hold the responsibility too long. Rise of Japan, growth of international currency markets, weak USD ($) AND once again led by increased military spending on Vietnam War made USA to shrug off the responsibility eventually in early 1970s.

Lets now fast forward to late 1990s and early 2000s, this time led by emergence of China followed by emergence of BRIC nation once again became threat to US manufacturing superpower. Hi-end manufacturing from automobiles to missiles, arms ammunitions to oil rigs slowly started taking place from South Korea, China, Isarel, India to Brazil. US exports started declining once again simply due to decreased demand of Made in USA goods and services due to availibility of same or better quality goods and services at much lesser the price. However this time around USA used the period from 1970s to 1980s smartly by convincing Saudi Arabia and other Gulf countries to sell OIL in USD. Long Iran - Iraq war, fall of USSR further strengthened the US position globally. Gold got replaced or perhaps paralleled by OIL. However the structural change is that ALL the countries in WORLD needs to buy US Dollars ($) to pay for the OIL. With no more Bretton Woods in place printing USD is all USA has to do to buy all that OIL.

This deamnd of USD helped it to remain strong for considerable time. Oil futures literally allowed big US banks, hedge funds to buy oil futures at NYMX worth 1000 $ by having merely 50-60$ in bank account. On the one hand it increased liquidity on the other hand it increase speculation. The inherent problem of decline in manufacturing output, decline in working population, high % of retiring population, unemployment couldnt be suppressed for too long. A low interest rate regime led to increase liquidity and silently created an enemy in the backyard - DEBT. Unfortunately lot of bad things happened parallely - speculators made money as Oil price rose from 40 to 140 USD within 1 year. These speculators lended this money to masses at abysmall interest rates which blowed up the real estate prices. High oil prices fired inflation, which decreased internal consumption and exports were already under pressure and hence triggered the unemployment which in turn triggered loan defaults which in turn triggered bankrupt banks and big financial institutions. Interesting to note is that with the collapse of Lehman & Goldman of the world OIL prices declined even more sharply which further strengthens our assumption that rise in Crude price from 40 to 140 USD was not due to demand supply gap but perhaps due to huge built up in speculative positions which were eventually squared due to bankruptcies casued by famous sub prime crisis.

I think the last paragraph is witnessed by all of us and Rest as they say is History !!!

1 comment:

  1. Good point about oil speculation. Speculation is similar to short selling in stocks. Since there are rules for short selling , in my opinion, there should be oversight on speculation of all commodities.


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