Left Flank

Inflation is back, and the Chinese economy has to cool down.

In short, substantial RMB appreciation would reduce the bilateral
US-China trade deficit and China’s overall trade surplus significantly,
but it would do little to reduce the overall US trade deficit. In the
absence of a generalized appreciation of all Asian currencies and
unchanged American policies, possibly only a deep recession could
reduce the overall US current-account deficit. A stronger RMB can help
only the overheated Chinese economy. And it has the virtue of doing so
without hurting China’s future production capacity.

How much is a «substantial appreciation»?

To curb future inflation, China therefore needs to stem the flood of capital.

One solution would be a large one-off appreciation of the yuan so
that investors no longer see it as a one-way bet. This, in turn, would
give the PBOC room to raise interest rates. The snag is that the yuan
would probably have to be wrenched perhaps 20% higher to alter
investors’ expectations, and this is unacceptable to Chinese leaders,
especially when global demand has slowed and some exporters are already
being squeezed.

This implies that monetary policy will remain too loose. The longer
that the torrent of hot money continues and interest rates remain too
low, the bigger the risk that underlying inflation will creep up.

Mark Trumball explains why Beijing, and not the US Federal Reserve, has to take the lead.

Slate's Yves Smith asks, «What is the «right» price for a barrel of oil?»

During congressional testimony, five oil-industry CEOs each gave estimates of where oil «ought» to be, with results ranging from $35 to $65 a barrel to $90. Even the implacable Saudis are reportedly about to increase production by half a million barrels a day, a sign that they are concerned that the current price is too high. Yet BP's chief recently said current price levels are warranted, and the oil bulls at Goldman forecast a «super spike» to $150 to $200 a barrel.

Yet, two energy consultants think that approach is wrong.

So, gentlemen, if I ask you first, Peter Beutel, to give me a quick tour of petroleum economics, why is the price of oil now so high?

PETER BEUTEL, President, Cameron Hanover: Well, there are lots and lots of factors. I would have to say that, since August or September, probably the biggest single factor was the fact that the Fed tipped its hand and let everybody know that it was going to cut interest rates. That put selling pressure on the U.S. dollar.

And since commodities are denominated in dollars, that has made all commodities cheaper for Asians and Europeans. And it's meant that Americans have had to bid the price higher.

But there are a lot of factors here. Certainly, there is more demand than supply, although demand is now falling. China has been subsidizing energy prices, and that's created artificially high demand.

We have had lots of problems in Nigeria, ongoing now for about a year. We've had lower refinery runs, a curious little thing. Gasoline prices are not as strong against crude oil as they were, say, a year or two ago. And that's meant that independent refineries or people without oil in the ground have not been able to run as much.

So it's a combination of factors, but if you ask me, who is the biggest culprit in the last 12 months? Curiously enough, it's been the Federal Reserve.

RAY SUAREZ: Stephen Schork, first, do you agree with that analysis? And how would you explain a doubling over the last year?

STEPHEN SCHORK, Energy Analyst: Absolutely. I am on board with Peter with the Federal Reserve's decision in August.

We have to remember that, in January of 2007, crude oil was below $50. Now, we moved from $49.90 back in January to on the cusp of $80 by the end of July 2007.

Now, if you look at the net length held by large traders, quote, unquote, your «speculators,» your large hedge funds, they were holding record length at the end of July.

Well, what happened last August? You had the credit meltdown. And, therefore, you had all these hedge funds that also had large positions in the commodity markets who also had large positions with exposure to the credit meltdown.

Therefore, when those markets began to get hit and the margins started racking up, these hedge funds had to sell. We know they sold because, at the end of July, like I've just said, they were holding record length, the net obligation to own 127 million barrels of oil at some point in the future.

Four weeks later, at the end of August, these funds were holding only 21 million barrel obligations. They sold the equivalent of 100 million barrels inside of four weeks. Therefore, that drove the price down of oil from about $80 to back below $70.

Now, in September, as Peter just said, the Fed tipped its hand. They were going to cut interest rates. That meant a cheaper dollar. So these hedge funds that liquidated all that selling back in August started piling back into the market back in September. And prices have doubled since then.

CFR's Tom Johnson dissents and quotes calls for caution about scapegoating «speculators».

Powered by ScribeFire.