April 2, 2012
Have you noticed how expensive petrol is these days? It now costs over â‚¬100 to fill up an average family car. In Ussher’s Quay the other day, there was a tailback of cars because a petrol station decided to offer a cut-price deal on petrol.
Why is the price of fuel going up?
Lots of media coverage is focusing on the Straits of Hormuz and the sabre-rattling between Iran, America and Israel at a time when Syria burns in the background. We are told that old-fashioned supply problems can explain the price of oil. Then, last Thursday, the main oilman in Saudi Arabia told us to chill out there was loads of the stuff left and there wouldn’t be any supply problems. Of course, this is all playing out against a background where the proponents of ‘peak oil’ argue that the stuff is running out anyway.
But might there be another reason that petrol prices are so high? Is there anything else driving up the price of petrol at the pumps that could be closer to home?
The answer is yes. At the moment, the central banks of the world are responding to this mega-debt crisis and huge de-leveraging everywhere with lower and lower interest rates. Earlier this month, a report from the US Federal Reserve (www.federalreserve.gov) on the flow of funds in the US made for quite shocking reading if you are someone who worries about what central banks all around the world are doing.
The report reveals that the Fed bought 61 per cent of the net new debt the US government issued last year. Before the financial crisis, the Federal Reserve used to buy small amounts, but not the lion’s share of the US government’s debt. This is quantitative easing like we have never seen before.
One way of putting all this into context is to examine how much this is in terms of US total income. This is particularly important right now in order to ascertain whether the US recovery is real or temporary.
Net treasury debt amounts to 8.6 per cent of GDP. If 61 per cent of that figure is caused by printing money, it means that about 5.3 per cent of US economic output is now being driven by the Federal Reserve’s printing presses. This is reminiscent of Argentina in its 1980s heyday, and is extremely worrying.
The report also reveals that the US is more dependent on short-term funding than Ireland, Greece, Spain and Portugal. The average maturity of the US government’s debt was 62.8 months. That means the US has to rollover a whopping 71 per cent of its debt pile – $5.9 trillion worth – over the next five years.
Now, all this means that the US will have to keep interest rates very low, because the state simply can’t afford to raise them. This has huge ramifications for the central bank because only if it ignores inflation – which will come – can it carry on financing the government at these levels.
But it is not just the US at this carry-on. Interest rates everywhere are as near to zero as possible. The Bank of Japan, the Bank of England and the ECB are all at the same game. In China, they might be in the Year of the Dragon, but elsewhere we are in the Year of the Central Bank, during which the only action is what policy-makers are doing.
They are injecting as much liquidity as necessary to bail out the banks. Now, let’s get a handle on how much money we are talking about. Over the last three and a half years, Britain, Europe, Japan and the US have boosted their central bank balance sheets to $8.76 trillion and pumped that much new money into the banking system. This is more money than it cost to fight World War II, the first Gulf War, put a man on the moon and the entire African aid budget for the past 30 years – all put together.
The central banks have opened the discount window and taken in all sorts of collateral and in return given out this cash. Today, the balance sheet of the ECB is 30 per cent of GDP. The figure for the Federal Reserve is 17 per cent and the Bank of England 18 per cent.
This is an increase without historical precedent or parallel. Under these circumstances, we may say that the economy is “recovering”, as we have been hearing in the US, but it lacks real meaning because we are so awash with central bank cash and credit.
Now here’s the rub. One of the reasons the price of oil is going up is that the markets, buoyed up by all this money sloshing around, are buying oil. After all, why would you hold an asset that is being printed every day, like cash, when you can buy an asset which is running out, like oil? This is basic supply and demand.
Ultimately, all this free money will find its way into other assets and push up prices. This will be the return of inflation. The spike in oil is a leading indicator.
But here’s the problem. In normal times, the central banks would just take all the money out, via higher interest rates. But in the US, if the Fed stops buying US treasuries, who will take up the slack? This means that the Fed and the central government will be on a collision course because raising interest rates will cause the government’s budget to go haywire. Independent estimates suggest that an increase of 1 per cent in the average interest rate would add an extra $88 billion to the Treasury’s debt service payments in 2012 alone (www.zerohedge.com).
The financial markets know about this conflict at the heart of the US establishment. Therefore, this all reminds me of the Irish property market when, the more money that was pumped in, the more the “trapped bulls” who owned property used the new liquidity to justify the mad valuations and prices.
Yet, the more the bubble was blown up by new money, the more the crash became inevitable. When the US bond market blows, the European crisis will seem like a skirmish.
Hold on to your seats.
The New Punk Economics -Lesson 3 – is now out. See it on YouTube.