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The current economic
situation brings to mind 1999 when worries about the state of the US economy
were piling up faster than rationalisations about the country's alleged
growth rate. There was less talk of a "new era" economy and more
about a "correction". What was it that brought about a more subdued
assessment in so many quarters? Commodity prices are the answer.
The problem with commodity
prices is not their price falls but the squeezing of their price margins, the
difference between costs and prices. This is an important signal to look for
yet, like the Titanic's SOS,
no one seemed to have been listening. It's the same old problem of not seeing
the trees because of the wood. And in this instance, price margins were the
trees.
We witnessed mood swings from
overvalued stock to falling commodity prices and back again. First, so we
were told, the former could burst and send the economy into recession; on the
other hand, a continuing fall in commodity prices would tip the world into a
global recession. Well, which one was it? Neither, is the answer. Falling
commodity prices can no more cause a recession than falling share prices can.
And yet the two are closely linked just as some clusters of mergers are. In
economics, everything is connected to everything else and prices are the
means by which this is accomplished.
Distort prices and you discoordinate the whole economic process. This,
unfortunately, is precisely what the Fed did, and still is doing. What is
equally unfortunate is that the vast majority of economic and financial
commentators are totally oblivious to this fact. Loose monetary policy
fuelled Clinton's
stock market boom and fuelled corporate mergers while having a malign
influence on commodity price margins. Commodities are inputs. As I explained
in previous articles, artificially lowering the rate of interest causes
over-expansion in higher stages of production.
Commodities are part and
parcel of those stages, meaning that lower interest rates also raise the
demand for commodities, even though their secular price trend is downward. Once
the higher stages find themselves in a profits squeeze as rising costs and
falling demand puts them in a financial vice, this will feed back into a
reduced demand for these products which in turn reduces their price margins. This
is why commodity price margins rather than commodity price trends should be
followed more closely*.
But where do mergers enter
the field? Two periods in American economic history throw considerable light,
at least in my opinion, on "corporate mega-mergers". Readers will
recall that I have referred several times to the 1920s economic "new
era". But the boom of 1896 to 1903 was also very much a "new
era" phenomenon. Now 1924 to1929 was characterised by considerable
take-over activity, just as the 1899-1902 period was.
These "new eras"
were marked by 'cheap credit' and feverish stock market activity. With ample
credit available and stocks rapidly rising it
becomes easier to issue abundant securities, which made it easier to buy out
other companies and consolidate holdings. Once again, it is what fuels the
action that counts rather than the action itself. Each era of considerable
merger activity was fuelled by credit expansion.
Like the rest of the world,
America
is going through not a business cycle but a cycle of ignorance. The belief
that the so-called business cycle is a natural and unfortunate feature of
market economies is so ingrained that it is rarely questioned. For nearly
2000 years Aristotle's assertion that heavier objects fall faster than
lighter objects held sway over the European mind. Then one day Galileo
completely demolished Aristotle by simultaneously dropping from the top of
the Tower of Pizza objects of different weights.
Regrettably it is not as
easy to refute the fundamental belief that the trade cycle is a sad
by-product of capitalism, especially since the birth of Keynesianism. But
until we do our economies will continue to undergo periodic booms and
depressions. Even though the Austrian
School of economics has
provided an analytical refutation of Keynesianism it has yet to receive the
recognition it deserves. This means that we shall continue to suffer the
consequences of the public's economic ignorance.
*This does not mean that
commodity prices always rise during a boom. After WW I commodity prices were
depressed despite the post-war booms The reason is that the war had created
an excess supply that that took years to balance out. On the other hand,
current booms in China,
the US, India have
driven up commodity prices.
One must also consider a
situation in which improved technology could keep commodity prices stable
even as demand increased significantly. In the absence of a rise in demand
commodity prices would have risen. We can therefore say that the difference
between the boom price and the price that would have otherwise prevailed
amounts to an increased prices for commodities.
Gerard
Jackson
Brookesnews.com
Gerard
Jackson is Brookesnews Economics
Editor
Information
contained herein is obtained from sources believed to be reliable, but its accuracy
cannot be guaranteed. It is not intended to constitute individual investment
advice and is not designed to meet your personal financial situation. The
opinions expressed herein are those of the author
and are subject to change without notice. The information herein may become
outdated and there is no obligation to update any such information. The author, 24hGold, entities in which they have an
interest, family and associates may from time to time have positions in the
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