Saturday, 29 January 2011

How Lehman brought down the pro-western governments in North Africa

The world is always throwing up surprises. Did the leaders of Tunisia and Egypt think that their regimes could be threatened by the collapse of a highly leveraged bank like Lehman? Yet, that seems to be what is happening.

The casuality is straightforward. When Lehman crashed, central banks cut interest rates to prevent Wall Street banks and hedge funds from going under. As soon as the immediate risk of a financial meltdown subsided, these low rates unleashed a speculative bubble in commodities.

The consequences can be seen in the chart above that illustrates the FAO's world food price index. Since December 2008, world food prices have increased by 55 percent. Some items have increased much faster; sugar is up 148 percent, cooking oil is up 116 percent.

These increases can not be explained by falling supply or increasing demand. The price changes are too large and over a very short time period. No, it is the derivatives market. Speculators borrow cheaply and seeking higher yields, speculate on commodities futures. This speculative trade pushes commodity prices up, creating a massive surge in inflation.

The social and political implications of this speculation in developing countries is devastating. Regimes in places like Tunisia, Egypt and Yemen were always highly unstable. With double digit food inflation, they are crumbling. Moreover, this crisis is unlikely to stop in North Africa. Dare I mention the P word? - P---stan and their red hot nuclear arsenal.

There is now a conflict emerging between the strategic interests of Western governments and those of Wall Street and the City of London. The balance sheets of Western banks remain fragile. They need low interest rates to maintain cheap sources of financing. Global stability, on the other hand, requires higher interest rates to defuse the speculative bubbles in commodities.

Currently, this conflict is at its sharpest in Egypt. Should Mubarak fall, thirty years of carefully crafted US diplomacy in the Middle East will be destroyed. Anyone who thinks that Egypt will effortlessly transform into a thriving western democracy while food prices are crippling the urban poor is living out of fantasy.

Two years on from the Lehman collapse, what has the bailout achieved? Economies in western economies have crashed; their governments have become loaded up with debt, and inflation has ripped apart the tenuous living standards of the poor in the developing world. Yet, Goldman, JP Morgan and Merrill continue as if nothing has changed.

The world is too fragile to absorb another speculative bubble. However, that is what this extended period of low interest rates has unleashed. It has destabilised North Africa and other regions could follow. Who could have seen that when Lehman filed for bankruptcy?


Sobers said...

Hmm. Or is it that Central Banks around the western world are printing money, and anyone with a brain would prefer to own a physical asset that can't be replicated by a printing press?

Agricultural commodities have been undervalued for years (I should know I'm a farmer!). The price of wheat for example was around £100/tonne 20 years ago, much the same as it was just before the rapid price rise in the middle of 2010. Nations have gotten used to the idea of food being cheap, and getting cheaper, for too long.

If inflation has averaged 3% over the last 20 years, £100 would be £180 now. Which is pretty much the rise in the wheat price. So in real terms it has not risen at all.

Alice Cook said...


Many physical assets were already inflated prior to the crash. Therefore, lower interest rates haven't prompted another bubble. However, commodities have offered speculative opportunities for Wall Street. It seems crazy, but we are in the midst of another bubble.

The problem is that they went up 50 percent in around a year. Nothwithstanding your calculation about the real price of wheat, it is hard to believe that fundamentals are driving the market.


bill said...

The rising cost of food is complicated.

- Farming costs have gone up (Fuel/fertilizers)
- Food has been taken off the market for ethanol production (and other biofuels)
- Banks printing money like crazy
- Commodities bubble(s)
- Bad weather
- Very big fire in Russia
- Wheat rust

Interestingly the two food items quoted (sugar & oil) have seen huge demand increases due to ethanol/bio diesel production.

As an example the US produced 1700 million gallons(us) of ethanol in 1999. In 2010 that increased 7 fold to 13000 million gallons.

Elby the Beserk said...

"Yet, Goldman, JP Morgan and Merrill continue as if nothing has changed."

Well, it hasn't for them has it?

Sobers said...

All I know is that if I had hundreds of millions to invest for my Hedge Fund, the last place I'd want it at the moment was in paper assets. I'd want something that can't be destroyed by a Central Banker pressing the 'Print' button.

The rush to physical commodities is IMO directly the consequence of financial meltdown elsewhere, and the ensuing money printing.

Anonymous said...

Three bubble in a about 12 years; a), b) housing and now c) commodities (esp. Gold).

All three were created by unreasonably low interest rates.

The first two ended in a deep recession and a massive destruction of paper wealth.

Where will this one end?

I think we know.....