The economists warned that the situation is dangerous enough when there were 10 times more commodity derivatives than commodities. Currently we have the market when the total value of sold contracts is approximately 100 to 1000 times greater (by different estimates of different professional participants – what’s the real figure I wonder?) than the total value of commodities produced. And while only 5 to 10% of the contracts give a buyer the right to request actual delivery, it is still at least 5 times more than the volume of actual goods.

So the speed of possible inflation and negative consequences is limit only by governments’ intervention to control prices and distribution directly. But as current crises shows governments are always too slow to react and worry much more how their actions look than about consequences.

When investors realize their commodity derivatives are worth significantly less than multi-layered structured sub-prime mortgages (which means “nearly nothing”) the current crisis will seem just small waves on the surface compared to the storm that will follow.

But all the companies exposed to these risks, investment banks and governments prefer to stay blind to this problem.

I think it’d be useful to plot the PCE/DPI ratios with your M1 mult’r. They appear to be mirror images.

http://www.bea.gov/national/nipaweb/Nipa-Frb.asp

I suspect Team Obama is sensitive to this issue.

As to management of the other aspects of the real economy – it seems the Obama administration should get better marks than its management of the fake economy (e.g. finance).

They are right to target the medical system; we have a system in which (whether you like it or not) the emergency room has become a public health system. In which we overdiagnose and overtreat, with little concrete proof of effectiveness. In which other countries pay far less than the US for the same drugs (which were developed in the US). In which GPs are underpaid and overstretched. In which the costs of pursuing payment, managing the system to prevent non-payment, and negotiating payment levels have created real burdens on everyone – even though we have proven incapable of denying treatment in many cases for those that cannot pay. And, finally, in which the private insurance system is incapable of making rational decisions between million-dollar end of life care and providing less expensive prenatal care – simply because hospitals are compelled to chase profits.

The argument for letting the profit motive drive the entire health care system was that it would give us a better (and more disciplined) system, yet there is no evidence to that end, and mounting evidence that the opposite is true. While we do see some excellent private sector innovations (health clinics in drugstores and Walmart), the health care system is _inherently_ plagued by incredible market distortions:

- Asymetric information
- non-rational behavior
- individuals who are non-functional (dying, senile) making complex “decisions”
- bargaining inequities/oligopolies (insurance companies pay much less for identical services than individuals)
- both adverse selection and moral hazard in insurance contracting
- previous non-market attempts to ‘fix’ the system that were patched over 70 years, now creating huge competitive disadvantages for US firms

Team Obama has also targeted energy, environment, infrastructure, and education as primary areas for additional investment. And they are right across the board. To place your faith _entirely_ in the profit motive and sanctity of contracts to mobilize the US economy to fix drastic problems within a decade is entirely unrealistic.

The baseless and unchallenged faith in the profit motive to _always_ work has allowed grossly anti-productive behavior to continue unchallenged.

Consider one example of how the profit motive increases economic “growth”:

Company X is a mining company. In order to keep costs down, the Federal govt. relaxes effluent and emissions controls (turns out the agency in charge has some bribery and sex scandals, but heh, who doesn’t these days?). Company X generated $100 million in revenues and $20 million in profits over 10 years, until the mine is played out. The wages and profits are then recycled into the economy, and it looks like we have a lot of growth.

Unfortunately, after the mine distributes its winnings, it closes down and declares bankruptcy – leaving large unpaid environmental debts. As with the financial sector, it’s virtually impossible to recover profits that were already distributed over 10 years prior to declaring bankruptcy, even if you can win the lawsuit (a costly and time consuming process). And even then, the total profits generated would not come close to covering the cost of cleanup…

Destroyed waterways, arsenic and slag-tainted soil and underground water supplies, and a littany of health problems among employees (and even non-employees in the vicinity).

The “economy” then “grows” because the govt. has to pay for health/end-of-life care for disabled workers. It also has to pay for cleanup. And for this, it levies taxes.

In this sense, official GDP number grew twice – once from the damage-causing activity, and again from repairing the vast amount of damage. But are people better off?

One of my great feats regarding the financial crisis is that Team Obama’s incompetence at handling it would cause collateral damage to its other initiatives, which are much more sensible.

I will try to answer. Oil prices had been rising steadily since 2003. If you did a curve fit, as I did in the 1st half of 2008, oil would have come in at about $110-$115/barrel according to supply/demand fundamentals. You should know that world oil production declined year-over-year in 2006 and 2007 (EIA data). You say a “slowing global economy” but oil demand in the emerging economies (outside the OECD) was still quite robust. Importantly, the oil price was driven by demand for middle distillates (diesel, jet fuel, etc), not gasoline. Emerging economies are still quite dependent on diesel fuel in ways that advanced economies are not.

So if the price should have been in the range stated above, then we must account for another $30-$35/barrel (at the high point). The added premium was caused primarily by 1) the slack dollar and 2) speculation in the futures market.

What could happen this time? If global demand is way down — it is — then there is at least 3 million daily barrels of spare capacity out there (all in OPEC). If printing money boosts inflation, we will see modest price rises based on the usual rule (oil is traded in dollars) but nothing like the surge in price we saw in late 2007/first part of 2008. For example, the imports/exports drop in China will not be undone anytime soon.

I wouldn’t worry too much about a big increase in oil prices in the next few years. If you do see one, you will know that something isn’t kosher about the price.

best,

Dave

How is stagflation possible? Very simply, if you grossly mismanage the real economy while increasing the money supply, you get Jimmy Carter style stagflation. It is possible to hit the accelerator and the brake simultaneously. If you do, the engine revs and the car goes nowhere.

The Obama administration has initiated a permanent, massive expansion in the burden of government on the economy which will be paid for by huge tax increases on the most productive and energetic people. The rational response on the part of people in a position to save is to increase their savings further. And higher taxes will lead them to do this by reducing consumption rather than postponing retirement or having both spouses work.

Bush-Obama bailout policies will make it impossible to fund the draw-down of the Social Security system. Prudent and insightful people will cut consumption.

There is the impact of inflation on vested pensions and other dollar-denominated assets. Another reason to save.

We will see large numbers of highly-skilled immigrants return to their homelands as opportunity evaporates in the US and the Asian economies recover. This also will depress the real economy.

Finally, there is the Peronist-style demagoguery of the news media and the Congress. Threaten the sanctity of contracts and you turn America into another banana republic.