The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Thursday, May 12, 2011

Did the US Government Short Oil Prices?

For a month or two now, I have been thinking, Why doesn't the US Government just short the hell out of oil price futures and crush the self-reinforcing speculative bubble? After all, the price of oil was the single biggest threat to a sustainable US recovery, and its MENA-induced ascent was already being felt in surprisingly weak data.

This was a recovery that the world's largest economy desperately needed in order to have any hope of chipping away at its 9% unemployment rate. A recovery that was a sine qua non to the US Government's ability to service its seemingly never-ending debts. Indeed, a recovery that was arguably required to confidently secure the Western liberal model's dominance in an increasingly multi-polar world overshadowed by an ambitious, patently non-democratic state--nay kleptocracy--otherwise known as the Middle Kingdom.

It is widely accepted by economists that crude prices much higher than $120 a barrel pose a clear and present danger to not just the US's prospects of revitalising its stagnant engine, but also those of Europe and many developing countries. In fact, in 2011 the risk of deflation had been quickly supplanted by the risk of stagflation as the meme of the day.

So while I was listening to President Obama, members of Congress, President Sarkozy, and countless other heads of state rail against the hoardes of faceless speculators that were wantonly chasing highly destructive gains, driving an inequitable transfer of wealth from global consumers of oil, including, crucially, US families, to a few, mostly non-democratic producers of oil, like those upstanding international citizens, Saudi Arabia, Russia, Iran, Venezuela, Nigeria, Algeria and Kazakhstan, I thought to myself, Surely there is a very simple and conveniently deniable solution. And it only involves killing one person, somebody you were maniacally seeking to eviscerate anyway.

If the US Government is willing to spend hundreds of billions on military sorties into Iraq to, at least in part, safeguard vital oil reserves; if it is willing to spend over a trillion dollars buying its own bonds to drive down yields; and if central banks are prepared to intervene in freely floating foreign exchange markets to prevent currencies overshooting, why not brutalise some excessively well-compensated speculators by taking the other side of this bubbly trade? Especially when you can have some confidence that the price dynamics are not entirely justified by fundamentals. While painfully reminding investors that this is not a one-way bet, you might actually make some money for taxpayers in the process. This is particularly true if you just so happen to know, in advance of anyone else, about the likelihood of major geopolitical event that has direct ramifications for the pricing of the asset in question.

Since the US still retains the global reserve currency, there is no real limit to how much it can spend on this endeavour. It is all then about timing. You need a catalyst. And this is precisely where the plot thickens.

The US was first made aware of Osama Bin Laden's Pakistani hide in August 2010. The kill (or pretend to capture and kill) mission was many weeks in the planning. The terrorist himself was finally put to rest leagues under the sea on the 2nd of May. Coincidentally, this is precisely when the first phase of the extraordinary, circa 20% 'flash crash' in commodities began. The losses grew by the 4th and 5th of May when the collapse found a base. By this time, WTI oil prices had plummeted from over $113 per barrel to just $97. Newly emergent commodities hedge funds, like Clive Capital, were reported to have individually lost up to $400m on a single day.

The final act in this little saga was perhaps the Government's coup de grace. Having knocked the speculators to the ground, why not change the rules of the game? I was compelled to write this note when I heard that the world's largest derivatives platform, the Chicago Mercantile Exchange (CME), had suddenly decided to increase the cash margins speculators have to hold against listed oil futures by a whopping 25%.

Crazed investors high on the fumes of recent price rises are awfully hard to dissuade. The first commodities crash was being written off by some as only a temporary retracement. Yet the CME's ruthless intervention ensured that this rebound has, for the time being, been but a short-lived, dead cat bounce.

I hope I am right. It would be a small, and entirely reasonable triumph for the man on the street, who has increasingly borne the burden of the financial oilgarchy's follies. First, their mutual funds halved in value. Then they were retrenched, or their businesses rationed credit. And finally, the Government decided to socialise the worst Wall St debts, which your average Joe has to now work to service via higher taxes and substandard amenities.

This ain't schadenfreude! Call it Karma, baby.