Speculators 'R' Us: The G-8 and Energy Prices
The G-8 summit was obviously disappointing, even for those with low expectations. Usually, the substance is lacking but the public relations are well managed. This year even the messaging was messed up—they said some new things on climate change but not what we were told they could say, the food aid/development package was lamer than advertized, etc. So the whole thing looks like an expensive flop.
But actually it was much worse.
I've written elsewhere this week about the G-8's broad decline in legitimacy and appeal relative to the G-20 [note that this link refers to the third piece in this mashup], and the specific pressing issue of cross-border resolution authority for failed banks, which is a matter of pressing urgency, yet not something taken up in or around this summit.
Think now about the macro/financial angle. Writing in the Wall Street Journal on Wednesday, Gordon Brown and Nicolas Sarkozy argued that speculation in financial markets lies behind the fluctuations in oil prices. The G-8 went along with this message.
On any given Friday, I'm perfectly willing to believe that there are either specific manipulations or broader structural issues with regard to trading in oil futures. I welcome the CFTC's moves to (finally) regulate markets more effectively.
But, more generally, the G-8, and its members this week, are disingenuous when they speak about energy prices in three ways.
2) They claim to see no link between their failure to converge on climate change/environmental policies and what happens to energy prices. The extent to which industrialized countries effectively control carbon emissions will have a big impact on the longer-run demand for oil. Flip-flopping on this issue discourages investment in the energy sector (regular and alternative), and thus directly and indirectly contributes to oil price volatility.
3) The very cheap money policies of leading central banks, including the Fed, the Bank of England, and arguably also the European Central Bank, lower the funding costs for big players who want to take large positions in commodities markets. Essentially, we are providing the credit that makes big speculative positions possible. Add to this mix a "too big to fail" attitude and a "yes we can, recapitalize through trading profits" deal with policymakers, and you see why major financial firms are likely to place huge commodity bets in the months ahead.
The G8, separately and jointly, destabilizes energy prices and refuses to even talk about this reality, taking the view that being more candid would just upset consumer, business, and investor confidence. They gamble, on energy and more broadly, that the road to recovery runs parallel with pretending there are no problems.
The true speculators here are your elected representatives.
Also posted on Simon Johnson's blog, Baseline Scenario. Previous postings:
Old Whine in New Bottles: Commercial Real Estate Lobbies for Bailout (July 9)
The commercial real estate industry would like a bailout—see my preview/links to testimony before the JEC today. This is not a surprise; even some of the most libertarian people I meet think the government should help them personally when times are bad. Is there a case for treating commercial real estate as special?
The sector is definitely taking a beating, but who is not? This lobby's most sophisticated advocates are arguing that various Fed facilities can be extended to support commercial real estate financing, so there is no cost to the government's budget or your future taxes.
This is illusory.
We cannot have the Fed indefinitely take over the provision of credit to most of the economy. Asset prices need to fall and, if necessary, debts have to be restructured. This is easier, generally, for commercial real estate developers and operators than it is for residential mortgages.
The global crisis is surely not finished, but we are out of the panic phase. There is little compelling reason to provide "emergency" financial support to anyone at this point.
The price of retail space is falling because consumers are spending less and retailers are contracting or going out of business. This is painful and will turn around only when consumers figure out the new (higher) level of savings they want. We are already cushioning this blow with a big increase in public spending and a difficult future for public debt issues.
Going further for commercial real estate specifically is not appealing. If we do it for them, why not for everyone?
Of course, if commercial real estate worsens considerably, we will see further damage among banks. But didn't the government stress tests assure us that the banks have enough capital to handle even the worst case scenarios?
The G-7/G-8: Why Bother? (July 9)
The G-7 was originally conceived as a form of steering committee for the world economy (antecedents). Existing formal governance mechanisms around the International Monetary Fund (IMF) and the UN seemed too cumbersome (and too inclusive) during the 1970s, with the breakdown of fixed exchange rates, assorted oil shocks, and the broader shift of economic initiative toward Western Europe and Japan.
And the G-7 had some significant moments, particularly with regard to moving exchange rates in the 1980s. More broadly, behind the scenes, it served as a communication mechanism between the world's largest economies ("coordination" is a dirty word in G-7 policymaking circles). And it was probably a good thing in the 1990s that Russia wanted to join the G-7—hence the G-8 once a year, although many of the most important technical meetings are just the G-7.
But today, honestly, what's the point?
The L'Aquila summit seems likely to achieve nothing; i.e., nothing that could not have been agreed upon in a conference call among deputy ministers. Just because there's a communiqué does not mean it has any real content. Does this kind of expensive pageant make politicians today look important or frivolous?
More broadly, three longer-run shifts mean the G-7/G-8 is increasingly anachronistic.
First, emerging markets have obviously risen in both respectable clout and ability to make trouble. China's exchange rate policy is a leading example, but think also about Mexico, Brazil, or India. Having a global economic discussion (e.g., on climate change or aid to Africa) without these players fully at the table does not really make sense, particularly as the G-20 now operates effectively at the heads of government level. And inviting these countries to a dinner or other event on the fringes of the main meeting just adds insult to injury.
Second, the Europeans are now organized into a loose political union and all of the major economies, except the United Kingdom, are in a currency union. What is the point of sitting down with Italy, Germany, France, and the United Kingdom separately? It is much more effective when they, and other Europeans, work out common positions and bring those to the table collectively. The European Union belongs to the G-20 but not the G-7.
Third, the idea that the United States and its allies "lead" by any kind of economic policy example is plainly in disarray. The recent crisis focuses our attention, but we've seen two or three decades with irresponsible credit and throwing fiscal caution to the winds across these countries. These countries traditionally position themselves as "G-7 models" worth emulating; this message needs to be toned down.
President Obama obviously has a talent for diplomacy (e.g., at the April G-20 summit). He should use the Pittsburgh G-20 summit in September to transition away from the dated emphasis on the importance of a G-7/G-8 heads of government meeting (e.g., reduce the excessive display of nothingness, lower the hype, have it feed into the G-20 more explicitly). Canada, chair of the G-7 next year and usually very sensible on these kinds of issues, can help.
The G-7 is still a useful forum for senior staff meetings on some technical issues, but it would be much more appropriate and effective for the high profile pinnacle organization to be the G-20, not the G-7.