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Neo-liberalism and the rise of stagflation

By Marko Beljac - posted Tuesday, 22 July 2008


The large unregulated market that was created by credit default swaps meant that no central authority existed to ensure that the risk burden that was passed along could be adequately guaranteed. Of course, they could not. Following the bail out of Fannie Mae and Freddie Mac even The New York Times observed that the crisis "will also represent, in stunning red ink, the cost to society of financiers who are short sighted and greedy, and regulators who don't regulate".

The issue here really lies with regulation, not the financiers. It is perfectly rational for them to be short sighted and greedy, and they will continue to be so. Contrary to market theory, the role of the public is to socialise risk and cost, hence the bailouts. In return, business should expect regulation.

The high price for oil is undoubtedly playing a very important role in the rise of inflation. This can be gauged by the rise in producer price inflation. Producer prices measure the price of goods as they leave the factory gates, thereby making them a good metric for assessing the role of raw material costs, such as oil, on inflation.

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Over the past year most industrial economies have reported producer price inflation greater than 4 per cent: if this persists this should lock in inflationary expectations. In early July the price of oil passed through $145 a barrel, a 187 per cent increase since the August 2007 price level. There is a clear correlation between producer prices and the price of oil.

Many suppose that the price of oil has risen sharply because the demand for oil has outstripped supply on the back of demand from the emerging economies, especially China and India, and the fall in the US Dollar. Others point to the role of speculation in the oil futures market.

Prior to the recent high level energy summit OPEC was pumping 32.2 million barrels a day of oil. In June the International Energy Agency estimated that the globe in 2008 needs 31.6 barrels a day of OPEC oil. This suggests that the global oil market is indeed tight but it does not indicate a sudden and big imbalance in supply and demand fundamentals as is commonly asserted.

We can largely dismiss the decline in the dollar as a factor. It can be shown that over time there is no correlation between the real value of the dollar and oil prices, in fact if anything the relationship is reversed.

However, there is good reason to suppose that the price of oil has been correlated with speculation. Huw McKay and Justin Smirk, two senior economists at Westpac, wrote in the Australian Financial Review that "speculative activity can be tracked via trading contracts on futures exchanges. When the accumulated position is net-long, speculators have been buying oil. When they are net-short, sellers have been selling oil". They go on to write, "the peak in non-commercial long positions happened in the week ended August 7 last year".

This would suggest that speculation has little to do with the rise in the price of oil since August 2007. However, according to market analyst Ted Butler, "so while I agree that speculation caused oil prices to jump sharply, at least we should correctly identify which speculators did the buying. It was the shorts, not the longs. In fact, the data shows that the longs were selling." In other words, the McKay and Smirk analysis, though factually accurate, rests on a faulty assumption.

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According to the German news weekly, Der Spiegel (which helped to break the story), "in the past five years investment in index funds tied to commodities has grown from $13 billion to $260 billion. More than 630 energy hedge funds are placing bets, up from just 180 in 2004." Moreover, "futures contract traders on the Intercontinental-Exchange made bets on oil with a total paper value of $8 trillion in 2007, up from $1.7 trillion in 2005, according to US Securities & Exchange Commission filings. Over the same period the volume of futures contracts traded on the New York Mercantile Exchange more than doubled." There is a correlation between this frenzied rate of speculative activity and the shift in the price of oil.

The very same 2000 Commodities Futures Modernization Act that enabled the rise of a large un-regulated market in credit default swaps also, at the behest of Enron, allowed for the large-scale trade in unregulated energy futures. Further de-regulation enabling trade in oil futures on the Intercontinental-Exchange of West-Texas Intermediate since 2006 has also contributed to this boost in speculative activity.

It is possible thereby to discern that an ideological commitment to de-regulation, made possible by an unquestioned adherence to neo-liberal doctrines among policy makers, has played an important contributory role to the onset of mild stagflation by partly leading to a liquidity crisis and spikes in producer prices.

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About the Author

Mark Beljac teaches at Swinburne University of Technology, is a board member of the New International Bookshop, and is involved with the Industrial Workers of the World, National Tertiary Education Union, National Union of Workers (community) and Friends of the Earth.

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