The Real (and Troubling) Reason Behind Lower Oil Prices
Rana Foroohar @RanaForoohar March 10, 2015
It isn't supply and demand, as most people believe
I am obsessed with how the top tier of finance has undermined, rather than fueled, the real economy. In part, that’s because of I’m writing a book about the topic, but also because so many market stories I come across seem to support this notion. The other day, I had lunch with Ruchir Sharma, head of emerging markets for Morgan Stanley Investment Management and chief of macroeconomics for the bank, who posited a fascinating idea: the major fall in oil prices since this summer may be about a shift in trading, rather than a change in the fundamental supply and demand equation. Oil, he says, is now a financial asset as much as a commodity.
The conventional wisdom about the fall in oil prices has been that it’s a result of both slower demand in China, which is in the midst of a slowdown and debt crisis, but also the increase in US shale production and the unwillingness of the Saudis to stop pumping so much oil. The Saudis often cut production in periods of slowing demand, but this time around they have not. This is in part because they are quite happy to put pressure on the Iranians, their sectarian rivals who need a much higher oil price to meet their budgets, as well as the Russians, who likewise are on the wrong side of the sectarian conflict in the Middle East via their support for the Syrian regime.
Sharma rightly points out, though, that supply and demand haven’t changed enough to create a 50% plunge in prices. Meanwhile, the price decline began not on the news of slower Chinese growth or Saudi announcements about supply, but last summer when the Fed announced that it planned to stop its quantitative easing program. Sharma and many others believe this program fueled a run up in asset buying in both emerging markets and commodities markets. “Easy money had kept oil prices artificially high for much longer than fundamentals warranted, as Chinese demand and oil supply had started to turn back in 2011, and oil prices have now merely returned to their long-term average,” says Sharma. “The end of the Fed’s quantitative easing has finally pricked the oil bubble.”
If this is the case, the fact that hot money could have such an effect on such a crucial everyday resource is worrisome. And the fact that the Fed’s QE, which was designed to buoy the real economy, has instead had the unintended and perverse effect of inflating asset prices is particularly disturbing. I think that regulatory attention on the financialization of the commodities markets will undoubtedly grow; for more on how it all works, check out this New York Times story on Goldman’s control of the aluminum markets. Amazing stuff.
http://time.com/3737506/low-oil-prices-reason/
Why Finance Is Still a Problem
Rana Foroohar @RanaForoohar March 9, 2015
Warren Buffett warned investors that bankers were still up to their old tricks in his recent investor letter. Vanguard founder Jack Bogle is writing about how high fee mutual funds are ripping off investors and endangering retirement security. And Fed Chair Janet Yellen is touting new, tougher capital rules for “Too Big to Fail” banks. Despite the recovery and strong jobs numbers last week, the re-regulation of the financial sector isn’t yet finished. But a deeper worry, and one that’s taking center stage amongst academics, is the fact that finance has yet to be re-moored to the real economy. That may be dampening the recovery for many.
A growing slew of research, including several just-published papers, has found that over a multi-decade period, the rise of finance is associated with lower capital investment in the real economy, greater inequality, and the demise of more productive industries. Brandeis International Business School professor Stephen G. Cecchetti and Enisse Kharroubi, a senior economist at the BIS, recently published a paper entitled “Why Does Financial Sector Growth Crowd Out Real Economic Growth?”
The answer: because finance looks for quick growth rather than long-term rewards. And because finance wants to invest in industries like real estate and construction where there are tangible assets to be collateralized, rather than intangible assets like the ideas and intellectual property that typically power more productive sectors like, say, technology, pharmaceuticals, or advanced manufacturing. What’s more, the disproportionate pay of bankers (they still make about three times what their similarly well-educated colleagues in other sectors do, even post crisis) continues to lure talent away from areas that create more and better jobs for the population as a whole. “When I was at MIT many years ago,” says Cecchetti, “everyone wanted to work in cold fusion or recombinant DNA. By the 1990s, nobody wanted to do that.” Solution? “I think we should take some proportion of the smartest people in the room and make sure they don’t go into finance,” says Cecchetti, only half joking.
Part of the problem with the rise of finance is that it encourages the culture of shareholder value over all else. That means CEOs focus more on buoying stock prices rather than making the best long-term decisions. The effects can be seen in the fact that since the 1980s, share buybacks and dividend payments have increased in direct proportion to a decrease in productive capital investment, according to a recent Roosevelt Institute paper entitled “Disgorge the Cash: The Disconnect Between Corporate Borrowing and Investment.”
What’s more, says JW Mason, a Roosevelt fellow who authored the paper, the low interest rates that have prevailed particularly since the 2008 crisis have sped up the trend as firms actually borrow money at lower rates to do more buybacks, rather than invest in the real economy. (The later is, by the way, what the Fed’s easy money policy was intended to encourage.) In fact, business investment dropped 20 % since 2008, as almost all borrowing went back to investors in the form of such payments. “It may be that we need to move to a more active control of investments to make sure that useful projects get funded,” says Mason, who says a kind of “World Bank for the US” might be one answer.
All this dovetails with the country’s inequality problem, which is an issue that will be big in the 2016 election cycle. As Wallace Turbeville, a Demos fellow who has done yet another influential paper on financialization points out, both the Republican and Democratic positions on inequality are lacking. Conservatives believe in bootstrapping, and liberals in redistribution of wealth. But if the very structure of our capitalism is designed to reward mainly elites (something Thomas Piketty’s best seller Capital in the 21st Century pointed out so well last year), then no amount of redistribution or hard work can fix the problem.
We need to fix the structure of capitalism itself and, in particular, figure out a way to make it work better for the masses. Turbeville has some of his own ideas about how to do this, including incentivizing long-term share ownership over high-speed trading, and limiting the use of derivatives. I hope that the economic debate in the primary season will be filled with many more.
http://time.com/3736713/american-finance-problem/
So that is all interesting in the BAU scheme, but what about the "transition" scenario? How do you convince people to look at the long term profit rather than the short term proft?
