Parivartan Information

The evidence is mounting that every Tom, Dick and Harry is investing in commodities, not to mention a few hedge funds and other financial market speculators.

Everyone’s jumping on the back of the fundamentals and riding the wave. Oil’s around $130 a barrel; but analysts reckon the supply/demand situation suggests the price should be around $60. Talk is that’s where OPEC would like to see it. When everybody’s in the market buying, there’s usually a bubble.

The total volumes accounted for in corn future contracts now constitute around 2.5 times what is potentially deliverable: clear evidence of over hyped financial speculation.

The problem with over hyped markets is that, just like the dotcom and housing bubbles, when things go bad, they go very bad, and threaten the whole system.

We’ve got to the stage where we need a  very close examination of financial speculation, and perhaps some global regulation, not to stop it, but to make sure speculation, rather than fundamentals, is not driving the global capital system. We’ve got to keep the benefits of freedom of movement of capital and of the market smoothing effect of moderate levels of speculation while curbing the excesses of the cowboys. We’ve got to stop the tail wagging the dog, without cutting off the tail.

Australia is the latest country to join those nations setting up a sovereign wealth fund. It did so in last week’s government budget, adding an infrastructure fund to the Future Fund ( set up to pay for previously unfunded public sector pensions).

It means the Land Down Under will have about A$100 billion salted away. This is a tidy sum, and probably places it in the top ten in the world, behind Abu Dhabi’s US$875 billion, Norway’s US$380 billion and Singapore’s US$330 billion, and a few others. These funds invest in a variety of assets, many of which are outside the home country. Indeed some Middle East and Asian funds have bailed out troubled US banks since the sub prime crisis surfaced last year. There’s talk that China wants to get into the Australian resources sector in a big way by taking out substantial stakes in BHP Billiton and Rio Tinto, and perhaps other mining groups.

The issue troubling observers is who makes the investment decisions and on what basis. The fact is we just don’t know for most funds.

Even in Australia, which has a more open political and economic climate than other sovereign fund homes, questions are starting to be raised about how the infrastructure fund will be invested and then spent. The government has made soothing noises about rigorous cost-benefit analysis but, as every economist knows, assumptions can be tweaked to deliver results in line with politics.

Also the notion that current taxpayers should be paying for future infrastructure is also causing some eyebrows to be raised. Wouldn’t it be better and fairer for taxes raised now to be invested in infrastructure today. This would increase economic capacity and ensure there are more taxes tomorrow to pay for tomorrow’s infrastructure.

But, argue the government’s advisors, if we spend on infrastructure today we’ll overheat the economy. Maybe. But these days there’s little correlation between the size of the government budget surplus and interest rates.

On balance, the rise and sheer weight of Sovereign funds, and the uncertainty about what signals they will respond to, is a worrying development in the international economy, where what we need is transparency.

When I was studying economics full time, eons ago, I learned there were different types of inflation, different types of unemployment, different ways to get growth. These days we seem to have adopted a one-size-fits-all approach to managing the economy.

Take inflation. There are two very big nasties pushing up prices across the globe right now. Very high energy costs and high food costs. But what are central banks doing? Some of them - like in Australia - are pushing up interest rates to curb demand.

Well, it is not local demand for energy that is responsible for high pump prices. It is concerns over Peak Oil and the high and growing demand in China. Higher Australian interest rates are going to have no impact on the price of oil.

Cost-push inflation, price rises that are imported into an economy independent of domestic demand, can only be ameliorated by finding substitute goods or services. Say pedal power instead of vehicle power. But you can’t pedal goods to market, you have to send them by trucks running on diesel. Those costs are passed on through the economy.

I can’t see how higher interests improve this picture. If anything they could make things worse by forcing manufacturers to increase prices on the fewer goods they are selling to make a profit. Or, maybe higher interest rates topple the balance sheet and the firm goes out of business.

Banks around the western world are clearing out their books, taking hits on their balance sheets, raising new capital and working out where the next (lucrative) banking wave will be.

There is no concensus yet emerging in the industry about where that next wave is. That means we’ll likely see some tussles on boards of directors, between boards and CEOs, and some casualties among senior staff as opposing views lay out new strategies. Many banks will need a new group of senior management to bring fresh ideas to the table.
A quick review of the business pages tells the story. Bank A will grow into China - Asia is where the future lies! Bank B believes there will be rich pickings in the detritus of the subprime market in the US, in the same way that hedge funds cleaned up after the LTCM crisis in ‘98 .

The banking cultures in US, France, Switzerland and Germany are still strikingly different, despite almost three decades of globalised capital markets, so each will respond in their own way. The UK banking sector is now dominated by US and German banks, so London’s solution may be the hybrid that points the way for others.

For London, (and the UK) there is a great deal riding on this search for new growth streams. Its economy has become extremely dependent on and exposed to global banking, that any moves that smack of ‘renationalising’ global capital (where local markets dominate) will be a severe jolt.

Investors need to watch the noises banks make about future growth and make their own judgments about how sensible they seem. Warren Buffet makes his money through a no-nonsense strategy of investing where he sees real value based on common sense. Don’t let the snake oil salesmen con you.