The following editorial was published in Price Perceptions issue #1377 on January 3, 2009

Recession of a Different Kind - Part I

Many in the commodity business are expecting a significant price recovery during 2009. Reasons for expecting a bull market resurgence are varied. They include . . .

  • For the first time in history, the Fed has promoted a zero interest rate policy. In addition, they are expanding their balance sheet by printing money to buy or loan against distressed assets. This magnitude of “quantitative easing” has never been tried before by an industrialized nation. Some economists believe the Fed’s actions will lead to a dollar collapse and rampant inflation next year.

  • The recent price collapse and tightening credit availability are expected to reduce crop acreage next spring. They are also expected to lead to mine closures, reduced oil and gas drilling, and lower meat production. Some in the trade are already referring to this prospect as “supply destruction.”

  • Higher living standards in China, India, Brazil and Russia will increase demand for food. After all, people may buy fewer cars and houses, but they must still eat. Demand for food will remain strong and clash with reduced production to provide major bull markets during the coming year.

Many of us have learned over the past fifty years that easy money policies cause inflation. With the Fed pumping out money at an unprecedented rate, it is becoming conventional wisdom that inflation and higher commodity prices lay ahead.

However, this is a recession of a different kind. All recessions since the end of World War II were the result of the Fed tightening monetary policy to discourage inflation. Once inflation was reduced, the Fed eased back on monetary policy. This time, the Fed is pumping money into the economy to encourage inflation. Most economists readily acknowledge the current recession is unlike any experienced in modern history. Therefore, a forgone conclusion that Fed expansionism will lead to commodity inflation may be a false premise.

Reasons for not expecting a resurgence of inflation are . . .

  • Some economists believe we are in a liquidity crisis and Fed monetary expansion will solve the problem. However, we are not in a liquidity crisis... we are in a solvency crisis. If a homeowner owes more than the house is worth, an additional mortgage is out of the question. If auto manufacturers have more debt than the company is worth, there are no assets to pledge for additional loans. If an individual cannot meet monthly payments on a credit card, it is unlikely the bank will increase his credit limit. In other words, credit expansion is no longer a function of liquidity... It’s a function of solvency. Therefore, the Fed’s liquidity expansion program may be ineffectual in solving the current economic crisis.

  • Because we now live in a global economy, central bankers and politicians must coordinate efforts to combat the recession. One industrialized nation cannot have a zero interest rate policy while others maintain significantly higher rates. This leads to currency instability and defeats efforts to expand production and trade. Nations must also avoid competitive devaluations to gain export advantage. This offsets efforts of one central bank to spur growth when imports are priced artificially low due to currency manipulation. Also, protectionism can become a significant risk to global recovery. Trade barriers are always countered by offsetting barriers. This results in reduced trade and economic stagnation for all.
It is important for commodity traders to realize this is a recession of a different kind. Although government and central bank efforts have been monumental, unemployment continues rising and bankruptcies are expanding rapidly. Financial stress is growing globally and efforts to date have failed to stabilize the situation. Government programs should be expected to come and go for months to come as world leaders grapple to find solutions. There will be periods of hope and promise of recovery, only to be followed by disappointment. Although this turmoil will provide many excellent profit opportunities, traders must be flexible and avoid adopting themes such as inflation will eventually push all prices higher.

Bill Gary
CIS, Inc.


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