A classic Wall Street joke illustrating an important concept

Forgive me if you've heard this one before.

One sday in the markets, trader A decided to open bidding on a can of Olives. He offered it at $1. It was snapped up by B at $2, who sold it to C at $3. D jumped in at $4 and E finally prevailed at $5.

Proud owner E opened the can and found the Olives had gone bad. He went back to A and complained, " You sold rotten Olives! I want my money back."

Grinning, A said, "Son, those weren't eating Olives. Those were trading Olives."

Anything can be made into a store of value if everyone agrees. Western societies have had a fondness for gold and precious metals, but any material will do. The Mayans used feathers.

Oil and commodities are increasingly being used as a store of value as inflation concerns make the wisdom of relying on financial instruments seem dubious. But per the little story above, once participants quit seeing commodities as an inflation hedge, they will revert to their fundamental price level. And the indications increasingly are that those values are well below the price the market currently assigns them.

The cure for high prices is high prices :)

The cure for high -prices is high -prices and once the customers , enjoying these subsidies ,are increasingly exposed to world -price levels, their demand will fall.

From "Enjoy the Energy Subsidies While You Can," by Stephen Jen and Luca Bindelli:

A quarter of the world’s gasoline consumption is subsidised, and, in terms of population, half of the world uses energy subsidies. This policy has created an important distortion, whereby rising oil prices have been effectively prevented from destroying oil demand. Subsidies have artificially raised inflation in the developed world (through artificially high oil prices) and suppressed inflation in the developing world (inflation would have been even higher in the absence of subsidies). As fiscal pressures mount, some countries will be forced to incrementally remove these subsidies. The net result will be an unwind of these distortions. For currencies, I believe that the net effect will be negative for emerging countries, as this process will be stagflationary for them.

Economists tend to be less well-versed in supply conditions in the energy sector. But the current oil price increases are curious. They are not quite supply driven, and the fact that global demand is decelerating appears to be inconsistent with accelerating oil prices. While the logic behind the increasing structural energy demand from emerging makes a lot of sense, it is still difficult to justify how oil prices could more than double in 15 months, or rise by six-fold in seven years, unless one subscribes to the ‘Peak Oil Thesis’, i.e., we are at the steep part of the supply curve.

Right now, half of the world’s population enjoys gasoline subsidies, and a quarter of the world’s gasoline consumption is subsidised. While three-quarters of the world’s gasoline consumption is taxed, the level of ‘net taxes’ has actually declined as oil prices have increased, for various reasons. To show this look at the end- 2006, when crude oil was trading at around US$60 a barrel. Back then, only 10.4% of the world’s gasoline consumption was subsidised (compared to 22.2% right now). Essentially, what this means is that the extent to which the world has been subsidising its consumption of gasoline has actually increased, with the rise in crude oil prices.

Is China's growth sustainable !!

Demographics is often an under -appreciated determinant of the fates of countries. Certainly the baby boomer generation in the U.S., the rapidly aging population of Japan andthe outright declines of Russia's population all have a tremendous long-term impact on their respective countries.

China will need to deal with the long-term consequences of its one-child rule, both the lack of youngsters, and the lack of young females (how do you manage a bunch of single, young males with no prospects of marrying and raising a family? That is, outside of starting a war to reduce their ranks?)

With regards to return on capital investments, it has been frequently pointed out that India, with about half the GDP of China, manages to get about 75% of China's growth rate with about 1/10th the foreign capital investment. Soon people might start to wonder which country is a better investment.

And of course, perhaps the biggest question mark is the stability of China's political system, which is facing stresses and pressure to change despite achieving stunning growth for its people for the past few decades. What happens to the communists when they get their first recession? Perhaps they should ask Suharto in Indonesia what economic crises tend to do to authoritarian governments.

So I agree that China, despite achieving impressive goals in the past few decades, has difficult challenges ahead. And I wouldn't be surprised if it stumbles over one or the other of them.

Commodities bubble

There is , what i believe, a bubble -mentality with respect to oil and other commodities -i.e. long term trends of increasing demand and diminishing supply are used to justify any increase in prices as sustainable, no matter how high. I realize that near-vertical supply and demand curves as well as other non bubble dynamics can explain sharp price increases, but the pervasiveness of this 'do not question it' mentality seems to make a bubble likely in any market where the mechanics of exchange and inventory make it feasible.

Has anyone seen attempts at predicting consequences if commodities are in a huge bubble? i.e., if peaking speculative interest and a demand shock cause oil prices to drop in half over a period of months, the impacts on agriculture commodity prices, US trade deficit, currencies, etc seem likely to be quite dramatic.

Moral Hazard

Risk transfer is the gist of modern economies. Citizens pay taxes to ever expanding governments in return for a variety of "safety nets" and state-sponsored insurance schemes. Taxes can, therefore, be safely described as insurance premiums paid by the citizenry. Firms extract from consumers a markup above their costs to compensate them for their business risks.

Profits can be easily cast as the premiums a firm charges for the risks it assumes on behalf of its customers - i.e., risk transfer charges. Depositors charge banks and lenders charge borrowers interest, partly to compensate for the hazards of lending - such as the default risk. Shareholders expect above "normal" - that is, risk-free - returns on their investments in stocks. These are supposed to offset trading liquidity, issuer insolvency, and market volatility risks.

The reallocation and transfer of risk are booming industries. Governments, capital markets, banks, and insurance companies have all entered the fray with ever-evolving financial instruments. Pundits praise the virtues of the commodification and trading of risk. It allows entrepreneurs to assume more of it, banks to get rid of it, and traders to hedge against it. Modern risk exchanges liberated Western economies from the tyranny of the uncertain - they enthuse.

But this is precisely the peril of these new developments. They mass manufacture moral hazard. They remove the only immutable incentive to succeed - market discipline and business failure. They undermine the very fundaments of capitalism: prices as signals, transmission channels, risk and reward, opportunity cost. Risk reallocation, risk transfer, and risk trading create an artificial universe in which synthetic contracts replace real ones and third party and moral hazards replace business risks.

Moral hazard is the risk that the behaviour of an economic player will change as a result of the alleviation of real or perceived potential costs. It has often been claimed that IMF bailouts, in the wake of financial crises - in Mexico, Brazil, Asia, and Turkey, to mention but a few - created moral hazard.

Governments are willing to act imprudently, safe in the knowledge that the IMF is a lender of last resort, which is often steered by geopolitical considerations, rather than merely economic ones. Creditors are more willing to lend and at lower rates, reassured by the IMF's default-staving safety net. Conversely, the IMF's refusal to assist Russia in 1998 and Argentina in 2002 - should reduce moral hazard.