Friday, January 14, 2011


Beans in the teens

The Federal Reserve has followed an easy money policy for most of the last 20 years. What that means is they have allowed banks to borrow from them especially in times of crisis and they have lent at below market rates, again chiefly when the economy was weak or during a financial crisis. Markets got use to the removal of moral hazard aka the Greenspan put.

Cheap money will flow into areas of speculation which is why we have had a running series of bubbles during this time. The stock market, housing, and, now, commodity markets are the areas that have seen hot money. These money flows have distorted prices and lead to economic dislocations the biggest being the huge amount of foreclosures due to overbuilding of homes.

In 2008, crude oil approached $150/barrel and $5/gallon by the summer. This was another bubble and it could not be sustained because commodity prices eventual run into the consumers ability to pay. Unlike previous bubbles the commodity bubble hurt many more people than it helped and it made a bad recession much worse. We are seeing the return of the commodity bubbles in 2011 and I think it will have the same effect. Look at charts of soybeans, oil, gold, the stock market, and many other markets and you will see people piling onto trends caused not by economic growth but by cheap credit offered by central banks all over the world in the mistaken notion that the only way to fight deflation is with inflation.

Unfortunately this is likely to end badly.* Watch long term interest rates. I think they will keep going up as long as the commodity bubble is alive. I still think deflation is going to win in the long run. We have to ring out the excess speculation** out of economy before it can begin growing again in a non-stimulated, business driven way.

Update: It's beginning to feel like the '70s.

*Also unfortunately I have no idea when this will end. Could be next week, could be in a year.
**Prices need to reflect incomes and returns on investment, not the momentum of speculators piling into the latest hot market.

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