ECB Missing the point with crude

Discussion in 'Economics' started by scriabinop23, Jun 6, 2008.

  1. Just wrote this today ... I had a lot to think about when seeing the Euro, crude, and dollar assets move today in response to Trichet's comments. Here's the article. Summing it up, I dismiss rate policy as an inefficient way to deal with the oil problem.

    June 5

    Upon reading headlines from today's ECB meeting with comments from Jean-Claude Trichet as "We considered that ... that after having carefully examined the situation, we could decide to move our rates (by) a small amount in our next meeting," I can't help but see this as absolute confirmation that the ECB is not backing up the Fed, and additionally has their eyes off the ball.

    Statements and attitudes such as this put an upward bias on long rates as Euro bonds attract money flows instead of treasuries. This is obviously the last thing the Fed wants if it is to have any meaningful impact providing a stable floor for home prices via interest rate policy. Despite cooperation displayed for TAF with European banks, it tells me there is a tug-of-war of sorts between ECB and Fed policymakers.

    The surprising dollar and inflation hawkishness out of Ben Bernanke himself these past several days suggests that ECB hawks may have tipped him off in advance, implying that perhaps Trichet and company are sounding hawkish as a means to politically please their own direct constituents. After all, the worldwide inflation push driven by high oil prices is noticeable to plenty besides merely central bankers.

    These comments seem justified in an effort to fight inflation. But today's immediate reaction was likely the exact opposite versus original intention: Crude (the source of all this cost-push inflation) made a record $5.00+ move up in its somewhat predictable way with Euro correlation. In the end this may be moot, as an oil bubble caused by speculative hoarding versus actual supply shortfall will not be sustainable, and will eventually result in a price collapse (due to logistical limitations in price maintenance of such a bubble).

    The mismatching amplitude of these moves suggests the Euro zone did not benefit from these comments. With the EuroUSD pair only strengthening by 1.3% today (1.54 to 1.56), crude moved in high beta with a 4.9% move (122 to 128). That means crude was up at least 3%+ in some Euro terms today. The jury is still out whether these moves in crude are justified by genuine supply concerns versus speculative fervor, but the coincidental correlation of the Euro and crude does little to convince the casual observer that the crude oil markets are not beholden to speculative price manipulation tactics.

    Continued Euro strength and ascending long note/bond rates that result from mismatched interest rate policy (with the ECB raising while the Fed is on hold) does immeasurable damage to the EU's export sector in addition to prolonging the US housing downturn. Judging by Crude's high beta correlation to Euro strength and US Dollar weakness, the strong Euro has done nothing to thwart crude's ascent. What makes ECB managers think this correlation would suddenly change? My suggestion: The ECB should realize this and consider the danger of publicly diverging interest rate policy with the US, at least in the near term deferring hawkish tone in exchange for accelerating the pace of discovery of the status of the character of the price ascent in crude.

    Since the days of Volcker, it's clear that high interest rate policy is a blunt instrument of aggregate demand destruction, having unintended consequences itself, mainly wreaking havoc on the world's job markets. Reducing money supply via massive rate hikes is merely a method of bluntly downsizing economies to force any and all supply problems into no longer being a supply problem. This policy style functions effectively the same as the destructive forces from war, disease, or famine. If you have less units of consumption (aggregrate demand), any supply shortage can easily become a supply surplus.

    I am of the camp that supply shortages should and can be worked out on their own, even if threatening to spur trends that appear inflationary in the near term. Crude oil price needs to get high enough to force product replacement and productivity increases that result. Imagine the alternative of destructive interest rate policy whereby users of crude are forced to discover a cheaper and more efficient method of energy production and consumption (conservation?), encouraging a switch away from crude. Wouldn't that be a deflationary pressure, all without central bank intervention? A free market can do this on its own, and is the very impetus for human advancement. I can think of much better fiscal and government policy methods to solve this oil problem without resulting in more blunt economic destruction if these oil prices are indeed entirely supply driven. Developed countries can afford massive government subsidies to force product demand replacement (ie nuclear and solar infrastructure buildout with electric and hybrid cars becoming the new fuel consumers). Additionally, they can use political will to strong-arm developing trade partners (China) into removing subsidies that encourage otherwise unsustainable and economically unprofitable end user waste and demand.

    Instead, we live in a world where bankers and policy makers are flying solo instead of working together. The results of this disconnect will be disastrous if continued.