KH: I see that OPEC are going to cut oil output by 1.5 billion dollars a day from November 1st.
AA: Well, now we know that the world economy is going through a deep deflation, it would be crazy to do otherwise. I hope you noticed that we didn’t propose any cuts when the oil price started falling a month ago. That’s because we knew the commodities boom was an investor-driven bubble, successor to the dot com boom and Greenspan’s housing bubble. Oil, gold, wheat — it was all hot money. I laughed when I read those newspaper reports about how increased demand in China and India had pushed these things to a new level of scarcity. Oil going to $200, global starvation, gold replacing the dollar, that sort of thing. The hedge funds took a ride on the bull market for commodities and look what has happened to them. But now is different. The money has gone up in smoke and the markets are starved of cash, not to mention credit. So how much oil are people going to be able to buy? The price will go through the floor unless we cut back production. It could go through the floor, as it is.
KH: The Norwegians say they are not going to cut back. I wonder why? It’s not as if they need the money. Or maybe it’s because all the money from the oil surplus that they put into their ‘national pension fund’ has just been blown on Wall Street. The S & P 500 lost 23% in the last month. Perhaps they want to get the stuff out of the ground while there’s still a market for oil.
AA: OPEC is trying to get Russia on board, but they could probably use as much hard currency as they can get, what with the implosion of their banks and stock market. They have the second or third highest currency reserves in the world, but Putin can’t be feeling comfortable enough to play hardball, right now. Funny, isn’t it, that just a short time ago, everyone was talking about the Axis of Diesel — Russia, Iran and Venezuela, the oil powers who stood against the US and were bound to be strengthened by the inexorable rise in the price of fuel. Chavez got it right when the price was in the $50s range and rising. He offered long-term contracts at $70 a barrel. I wonder if he got any takers? I bet he would grab that price now.
KH: Apart from Russia, I read that the most vulnerable economies in the world today are many of the countries formed after the break-up of the Soviet Empire, places like Kazakhstan and Bulgaria. They are in the same boat as Iceland, small countries who bought the idea that they could play the emerging market game, even when they had no internal economic backing for it. Apparently the worst hit is Hungary. They suspended trading there for four days last week.
AA: The problem is that they took out lots of hard currency loans. Not just the government and firms, but ordinary households for mortgages and the like. Japanese yen and Swiss francs were the currencies of choice, I believe. Now they have no way of finding that money. The story of what happened to the former communist bloc is one of the great tragedies of our time. Of course, we were all delighted that they got out from under the Stalinist jackboot. But look what happened when they did. They ran into neoliberalism in its full pomp: all they had to do was privatise everything and encourage the free flow of international capital. The gangsters bought up whatever was going and now, just when some of them had got up off their knees and were thinking they had an economic future, puff!
KH: I still don’t get why the Europeans haven’t woken up to the depth of the crisis on their own doorstep. A bunch of these countries are now in the EU. Ambrose Evans-Pritchard wrote an incendiary article today about the prospects for a European currency meltdown. It looks as if the second epicentre of the crisis will be Europe because their banks are much more exposed to emerging markets than the Americans and the Japanese. Austria is the most exposed and could trigger the European bank collapse, just as it did in 1931 with the failure of Credit-Anstalt. But I don’t get any sense of urgency about what the economic crisis will mean for Western Europe. It’s like they have grown so used to thinking of neoliberalism as an Anglo-Saxon disease, they don’t think it can happen to them. What happens to Germany, for example, now that, instead of being the natural centre for a strongly integrated European economy, it is neighbour to an economic disaster? They already took the biggest hit from the collapse of the Iceland banking system.
AA: Isn’t Ambrose the son of the godfather of your discipline in Britain?
KH: Yes, small world, isn’t it? He has a lot of beefs against Europe, so he’s prone to see the downside there. But I think he is right with this one. That’s why I’m as fast out of euros as I can.
AA: Talking about disaster, do you remember when, three years ago, the FT described the British economy as nothing more than a glorified hedge fund? Well, the hedge fund has well and truly tanked now. Sterling has already lost 27%, more than at any time since 1967, including Black Wednesday in 1992. One thing to be said for neoliberalism is that it is very easy to get your money in and out of currencies these days. My daughter asked me in January what my prediction was for the new year. She was impressed that I stopped her from buying a house in LA before the subprime crisis broke in early 2007. So I said, “Sell sterling!”. That put me in her good books even more. My main home is in London, so I need to keep some pounds for local use. But I am glad I got out of sterling and euros into dollars and yen.
KH: I see The People’s Daily has come out with an attack on the dollar to coincide with a meeting of European and Asian governments. The Chinese say the US has exploited the dollar’s hegemony to loot the world and the rest should agree to boycott its use, trading in euros, pounds, yen and yuan instead. They didn’t say how you can do that with yuan when it isn’t convertible on the capital account. But you can see how they would be mightily peeved at so much of their US investments getting blown away.
AA: I don’t think the Europeans and the Japanese are going to boycott the dollar when so many of their investors have fled into US T-bonds out of the stock market. There was a time recently when the yields on treasury paper were negative, there were so many buyers trying to get in. In any case the Japanese are sitting pretty with over half of the outstanding value of US Treasury bonds. If in a great deflation cash is king, the Japanese will be able to buy everything up in the fire sale that starts soon. They began to do that when Mitsubishi put $9.5 billion into Morgan Stanley. That’s one of the reasons why I think the yen could be a major reserve currency. The Chinese have a lot of US bonds too of course, less than the Japanese. But what they are worried about is losing the market for their cheap manufactures and they hope to set up an anti-US cartel. I doubt if it will come off, especially when Obama turns up in January as the world’s new great hope!
KH: I’m supposed to getting my lump sum for retirement soon, but it’s in sterling and I’ve already lost a big chunk of it. Mervyn King, the Governor of the Bank of England, got a lot of stick for saying the UK was going into recession (only a few days before the figures were published!) and the markets took sterling down as a result.
AA: Well, think about what happened in the Great Depression. Countries went in for competitive devaluations in order to grab a share of a shrinking world market; and that was what pushed the global economy over the cliff. If we look at this crisis in the long run, the first big devaluation was the long decline of the dollar under Bush/Cheney. It is now recovering rapidly, actually the fastest move in exchange rates since the Bretton Woods system went down in 1971. Then sterling followed over a rather shorter period and it looks as if the euro could be next. As long as everyone else doesn’t devalue, this has got to encourage a shift back from financial services to export production in each of these currency areas. It’s already happened in the US. So maybe King was encouraging a devaluation for that reason. Remember not long ago — it seems an age now — when the dollar/euro exchange rate was $1.70 and people were talking about $2 soon? At that sort of level, Europe’s aerospace, nuclear and other heavy export industries would have been priced out of the world market. I couldn’t see Sarkozy putting up with that. So there is an upside to devaluation. The people who lose are the bankers who just trade money for money and get stuck with a currency nobody wants.
KH: Maybe I will write an article, Deflation: what is there to like (if you are not already rich)? Talking of which, what’s been happening to gold? I thought that everyone was supposed to rush into gold in a deflation, but gold stocks and futures have lost 16% in the last month.
AA: It’s what I was saying about the commodities bubble being the last dying gasp of the credit boom. People are still buying physical gold in Asia. You can’t find bullion anywhere. But a lot of the gold price came from the same investors who pushed up oil. Gold went from $250 in April 2001 to over $1000 in March 2008. Some of that was Asians getting a bit richer and saving the stuff; some of it was the gold bugs looking for an escape from paper money; but a lot of it was just speculation. Imagine what losing a sixth of its value in a month will do for the imagine of gold as the ultimate safe haven!