Monday 22 May 2006

Pic of the day: Sunset in the west.

Red week on stock exchanges

It's been some pretty harsh days for stocks all over the world. Oslo Stock Exchange in Norway was particularly hard hit, being associated largely with oil. It had also risen more than comparable exchanges elsewhere in the world, so it is natural that investors were nervous and tried to withdraw their profit.

Why now? One possible reason is the recent rise in metal prices and other raw materials. Oil prices have been high for a while, but some central banks (including ours here in Norway) use a price index that excludes energy. The official reason is that energy prices naturally fluctuate much. But this should warrant using an averaged index rather than none at all. Perhaps a 6 month average, for instance: If energy prices remain high for 6 months, it is a safe bet that it will influence purchasing decisions both in private households and businesses. The immediate effect will be that people have less money to buy other things. This will put a downward pressure on the rest of the prices, causing the official inflation figures to go DOWN when actual costs are going UP.

Metals, however, are definitely not excluded from price indexes. There is also a general fear that higher costs of raw materials will bleed over into consumer prices. This will surely cause central banks to increase interest rates too. Higher wage claims from workers will further squeeze the profit of companies. Meanwhile the higher interests will make it more expensive to buy houses, and harder to sell old ones. The change could attack the economy on a broad front, hurting almost everyone. (Except those who have lots of money in the bank and don't spend much of it anyway. They are likely to benefit. Apart from typical capitalists, this also includes many elderly people who hold on to their savings till they die.)

We seem to be entering an economic phase which discourages investment and consumption, and encourages passive saving.

***

Another noteworthy change is that the dollar is sliding again, after a very long and frankly unnatural ridge of strength against other currencies. The reason for the strength of the US$ probably was steadily rising interest rates combined with what was perceived as a strong economy. How anyone in their right mind could file reckless borrowing under "strong economy" is beyond me. But evidently the key is to see things in a short enough perspective, and then get out at the last moment. It is a bit like kids who play on the ice in spring, egging each other to see who can go the furthest out on the thinning ice. And then when there is this cracking sound, everyone runs at once.

It bears mention, though, that the "problem" is still not a sudden lack of supplies, but an ever growing demand, particularly from the countries crawling from third world over to first. Lately this makes up quite a large part of the world's population. China, India, Brazil are all huge countries with rapid growth compared to what they used to have. Other formerly third world countries such as Thailand and Malaysia are also pretty active. This is important. It means that if prices of raw materials rise high enough, the growth will slow down naturally. The demand will slacken, and the prices will fall again. The global economy is too large a thing to react immediately, there is a span from months to years before the change is complete. Therefore there will be great losses and some great gains, depending on your timing. But unless there is mass panic, it is not the end of the world as we know it.

It may however be the beginning of the end of the USA as we know it, "the world's only superpower" whose representative to the United Nations is known for joking that the Security Council only should have one permanent member.

In the USA, it is not a sustainable growth that drives the demand, but consumption without equivalent production. This is not easy to treat differently because most action happens on the "micro" level. For the shopkeeper, it literally makes no difference whether the customer has earned or borrowed the money. The customer pays, walks out the door, and only the money remains. But for the customer, in the long run, it makes all the difference. Loans must be paid back, and with interest. It is not much different for a nation. At some point, the bills fall due. And when the money runs out, merchants become a lot less friendly really fast.

Unfortunately, much of the world depends on the USA as a customer of last resort. And so much of the seemingly reasonable growth in China, India and other newly industrialized countries is actually investment in production for the USA. A sliding dollar makes it much less lucrative to export to the USA... the money you get for your wares is less and less worth for each passing month.

What we can hope is that the large new middle class in former poor countries will be able to trade with each other and satisfy their own needs. There is certainly enough to do in these countries. People who lived in small huts want to live in houses. People who shared a bicycle want a car each. Whether this level of consumption really is a good idea is another matter, but this is how people think. It is therefore likely that after USA imports less, other people will be willing to buy the goods instead. Just not at the same high price.

I am not really worried about this economic setback. What worries me is that it comes so late. Too late, I fear. If your dog misbehaves today, punishing it tomorrow will teach it nothing. Humans do have somewhat longer attention span; but when the children pay for the sins of the fathers, it is a bit late.