Wednesday, July 2, 2008

Here we go again?

Let's see...stocks, CDOs, oil?
Once upon a time...a long long time ago...Investors piled into tech stocks in the belief that it was a new economy with a new all-star sector. That conviction prompted relentless buying of 'New Economy' stocks and propelled a bevy of overpriced start-ups.

It proved to be more of a house of cards than one of chips and the tech bubble did burst.

The best of the best of the best of the best - Now we wear black
Next, it was a dark and stormy night...our best and brightest decided that they could turn uncertainty into risk by using some complex statistical process, credit enhancement, some bat wings, an eye of newt and such. But packaging straw and spinning it into gold has failed in the past. As it turns out, the only spinning was the yarn that told this story. Packaged CDO's were as big a bust as any ancient alchemist's promise. Our best and brightest failed us again. They called it gold, and priced it accordingly, but it rightly belonged in our septic tanks.

So what is that they are at again?

Oil prices... justifying ever higher oil prices.

Just trust more time
Tech stocks spun estimates of market value and future sales that were wild. They became the basis for buying. CDOS promised to transform risk with sophisticated models mangers could not understand so they assumed the models had to be right - wrong again! The bill for those CDOs came COD, and hey I think that is the deliveryman at the door right now. With oil experiencing gains based on forecasts about things we cannot possibly know- they truly are at it again.

T-bone has his stake
Oil prices are crazy. They are extremely high. They continue to move up in spurts bolstered repeatedly by the same news -- again and again. The increase in REAL oil prices has surpassed the hike from 1973-1979. The main cheerleader for higher oil prices are not oil companies or producers but speculators and hedge funds. Yet we continue hear that speculative money is not behind this move. Right.

...and I do not know what I do not know
But we do not know about oil supply and demand that exists today, let alone what it will become five years from now. Because of steep-sloping short run supply and demand schedules the market clearing price can be quite volatile in the short run. Still, history tells us that the more that oil prices rise the more that we will get conservation and a supply response over the following period. Yet forecasts continue to find tighter and more squeezed oil market conditions in the future, as supply responses are ignored conservation is factored out and new demand from China and India are factored in.

Science in action or science inaction?
The relentless rise in oil prices because of China's and India's demand growing is not really scientific. It may not even happen. If high oil prices sent the global economy into recession China's and India's plans to develop could slow. China is creating pollution hand over fist... Is the world going to simply allow that to continue as the polar ice melts? China has pegged its exchange rate to take advantage of US China trade. Will that continue to drive China's growth as US consumers become bogged down in debt? There are an armload of issues that could slow China rapidly.

What goes straight up, must come down - As you look ahead and 'make up forecasts' about an unknown future, realize that the world can change in many ways. So cranking up oil prices for reasons that seem to have some validity today could prove another fatal error. One of the lessons in markets is that when prices go straight up, that price rarely sticks. I don't see why oil should be an exception to that. The faster and farther that a price rises, the less we know about how the economy- demand and supply as well as competition - will react to it. Remember that in economics it is the price mechanism that makes things work. A high price is supposed to be remedial.

The invisible hand at work or just a finger?
On balance oil is another of those famous bubbles. The higher the price goes the less likely that it will be sustained either because it will crash the economy and bring world demand down or because it makes substitutes viable- oil shales, tar sands, and other fuels. Let me go on record to say that these high oil prices are dumb. Its way too much way too fast.

1 comment:


Like the title of the post sounds like ronald reagan.