Not content with saving the world from financial Armageddon (although judging by the stock market’s recent performance, it looks as though that hope might have been a bit premature), Gordon Brown is now single-handedly lowering petrol prices.
Basking in the adoration of the Europeans, he said that petrol prices had better come down to follow oil prices, or he’d want to know why. “We have had reports done on this before to look at what is happening in the market place. We will continue to examine these things.”
There’s no need to worry, Mr Brown. The good news is that petrol prices are already falling and we’re sure they’ll keep doing so.
The bad news is that this is because we’re facing a massive recession. And thanks to our Prime Minister’s utter lack of prudence, we’re too broke to do anything about it…
Petrol prices are falling because we’re facing a massive recession
Markets are waking up to the fact that the recession won’t be shallow or non-existent, as many pundits were predicting at the start of the year. Instead, it’s going to be deep and last a long time.
The oil market has been the most obvious casualty. From a high of around $147 a barrel in July, the price has dived by more than 50%. That puts the falls seen in most stock markets in the shade. Yet oil could easily fall further, despite talks of Opec production cuts. Bear in mind that the levels we’re seeing now are roughly the same as those seen in the aftermath of Hurricane Katrina. At that point, three years ago, the idea of oil rising above $70 a barrel was staggering.
The good news is that this will mean lower prices at the pump. The only reason the full plunge hasn’t fed through to the pumps yet is because it’s happened so fast. Supermarkets aren’t daft – they know that cheap petrol is a great weapon in the war to attract customers, so they’ll cut as soon and by as much as they can. Mr Brown is just being clever enough to stick his oar in now so he can attempt to take some credit for what will be a simple function of economics.
The bad news is that the falling oil price is being driven by the two major problems facing the world – massive deleveraging, and a global recession. One’s a “financial” economy problem, the other the “real” economy, but they’re linked – inseparable, in fact. On the one hand, oil prices rose for the sound underlying reason that emerging nations were using more and more, while supply was having difficulty keeping up.
They shot up so rapidly, because speculators, often using borrowed money, pumped it into the market, betting on prices rising. The exact mechanism of speculation is a matter of debate, but it seems pretty clear that oil prices have not been driven simply by supply and demand.
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Lenders around the world are calling in loans
Now that the credit bubble has popped, lenders around the world are calling in loans and looking for more collateral from borrowers. This isn’t just happening in the property market, it’s everywhere. And regardless of how much money governments pump into banks, this will continue to be the case.
If, as a buy-to-let investor say, you are told you have to raise an extra £5,000 to prop up your loan-to-value ratio for example, then you face a choice. If you haven’t got the ready funds, you have to sell some assets to raise them. Do you sell a property? No, it takes too long. Instead, you go to the next most liquid asset you have – a portfolio of FTSE 100 shares perhaps, or gold – and you offload it. Of course, that then drives prices down further.
Deleveraging has serious effects in the ‘real’ economy
Meanwhile, in the ‘real’ economy, deleveraging has ‘real’ effects. Businesses rely on borrowed money and faith in short-term lending to conduct all sorts of transactions. If banks suddenly don’t want to lend, or make their borrowing conditions far harsher, companies need to find more money, or simply go bust. And if consumers can’t borrow, then they can’t continue to fund their spending, or house purchases.
The knock-on impact of all this is finally becoming apparent in the rising unemployment figures. As we’ve pointed out before, unemployment is a lagging indicator. People stop spending, then company profits fall, and then the job cuts begin. This isn’t a difficult concept to grasp. Even so, when the housing crash began a year or so ago, plenty of economists were saying that it wouldn’t be as bad as the 1990s, because unemployment was historically low.
We’re still a long way from the end of the market turmoil
And of course, as more companies go bust, they stop paying their debts, which has a knock-on effect to those relying on those income streams. Rising corporate bond defaults are one reason why the market has started to worry that insurers could end up being the next victim of the credit crunch.
So as problems in the real economy continue to worsen, we’ll see more deleveraging and bankruptcies in the financial economy, which will feed back once again into the real world. Looking at it that way, we are still a long way from the end of the market turmoil.
Our recommended article for today
How a lack of credit sent markets tumbling
If you play the same trades as highly-leveraged investors, you’re in for a fall. But get your hands on assets that don’t suffer such ‘demand destruction’ and you’ll have some protection.