Central Bankers Making Global Economy Worse

Recessions%20Sept12.pngBy John Richardson

A NEW research note from our colleagues at International eChem discusses how central bankers have pledged to do “whatever it takes” to achieve a sustainable economic recovery. Click here for a full copy – Research-Note-24Sept12.pdf.

Their well-meaning efforts have failed, and are instead likely to do the exact reverse of what is intended as a result of the soaring cost of crude.

As the chart above illustrates, oil prices are now at levels that have historically always led to recession.

Quantitative easing, and other central bank efforts to rescue the global economy, have led to more expensive crude – and could lead to other asset bubbles in Asia.

The reason, in the case of oil, is that printing money has led to rising investor concerns over currency risk for both the US$ and the euro, and about inflation risks.

Investors see crude oil markets as a potential ‘store of value’. Some now even believe oil markets should be seen as part of a broader commodities-based asset class, rivalling equities and fixed interest.

Oil markets have proved unable to absorb these one-sided flows of money. Those value investors who attempted to realign the market with the fundamentals of supply and demand were swept away.

And the effect on petrochemicals is that as crude has increased over the last few months, we are have been dragged into another “buying forward” cycle, which works as follows:

*Manufacturers cannot adjust their prices on a daily basis to reflect higher oil prices. They are locked into fixed price contracts with their end-user customers, often for 6 months or more.

*When oil prices start to rise, they cannot simply sit back and allow future margins to disappear. Instead, they are forced into the market to stockpile raw materials before prices rise.

*This process continues until it becomes apparent that prices have plateaued. Then companies seek to destock again, but find this difficult as their immediate customers are also destocking.

*At the same time end-consumers have all been reducing their purchases, due to the loss of discretionary income. This then creates a double whammy for profit margins.

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