An excellent article by Andy Xie of Morgan Stanley
*High commodity prices are causing demand destruction. A significant downturn in Chinese demand for hard commodities suggests that demand is reacting to unsustainably high prices. As the property cycle turns down globally, demand for hard commodities should weaken further.
*Commodity prices reflect liquidity rather than demand: Commodity prices react sharply to the policy outlook for major central banks, indicating that liquidity rather than demand drives commodity prices. Hence, demand weakness is insufficient to bring down prices in the short term.
*Oil prices should lag demand even more. Oil exporters have become enormously rich from high oil prices in the past three years and are in a strong position to cut production to sustain high prices. It may take a global recession to bring down oil prices.
*Property downturn may exacerbate inflation. The global property boom has increased the share of corporate earnings in GDP, which has allowed businesses to hold price increases despite rising costs. As the property cycle turns down, businesses may have to raise prices more.
*High commodity prices force central banks to tighten. Global inflation is reaching ten-year
highs and is likely to move higher in the coming months. Commodity prices are a major factor. As weak demand is insufficient to bring down commodity prices, central banks have to tighten aggressively to contain inflation even as the global economy cools. Financial speculation makes it difficult for central banks to achieve a soft landing for the global economy.
Global inflation is close to a ten-year high and is likely to rise further into 2007. The culprit is the unsustainably high level of liquidity. As deflation shocks have ended, the current level of money supply is not consistent with price stability.
Commodity inflation is a major channel for excess liquidity to turn into inflation. Even though high prices are destroying demand, prices remain very high despite the recent decline and tend to surge whenever the expectation for rate hikes by central banks diminishes. This suggests that central banks have to tighten more than what the real economy requires in order to contain inflation.
Central bank signaling has been driving financial markets lately. Their ambivalence towards inflation only incites more financial speculation. In the end, the reality of high and rising inflation will catch up with central banks, and I believe that the more dovish they are now, the more they will have to raise their interest rates later.
The commodity bubble is a knife hanging over the heads of dovish central bankers, [The reaction to the Fed’s statement last week is a good example that commodity prices are far more sensitive to liquidity indicators than real demand. As the Fed sounded more dovish than the market expected, commodity prices rebounded sharply from the recent decline] because it encourages more speculation, which in turn causes more inflation, and I believe that the reality will catch up with the central banks that sound dovish today. The commodity bubble is one manifestation of the inflationary pressure from the very high monetary stock in the global economy. The inflationary effect of the abundant money supply was suppressed by global deflation shocks. Instead, the liquidity caused asset inflation. As deflation shocks end, asset inflation is causing consumer price inflation.
Central banks have tightened substantially already, and this is now causing the global property cycle to turn down. Central banks are worried about the effect of this downturn on demand and do not want to tighten more to risk a recession. The current level of tightening is not sufficient to stop commodity speculation. This essentially puts central bankers in a box — if they focus on achieving a soft landing, they run the risk of letting inflation get out of control.
Source: Morgan Stanley
:) Falkor
*High commodity prices are causing demand destruction. A significant downturn in Chinese demand for hard commodities suggests that demand is reacting to unsustainably high prices. As the property cycle turns down globally, demand for hard commodities should weaken further.
*Commodity prices reflect liquidity rather than demand: Commodity prices react sharply to the policy outlook for major central banks, indicating that liquidity rather than demand drives commodity prices. Hence, demand weakness is insufficient to bring down prices in the short term.
*Oil prices should lag demand even more. Oil exporters have become enormously rich from high oil prices in the past three years and are in a strong position to cut production to sustain high prices. It may take a global recession to bring down oil prices.
*Property downturn may exacerbate inflation. The global property boom has increased the share of corporate earnings in GDP, which has allowed businesses to hold price increases despite rising costs. As the property cycle turns down, businesses may have to raise prices more.
*High commodity prices force central banks to tighten. Global inflation is reaching ten-year
highs and is likely to move higher in the coming months. Commodity prices are a major factor. As weak demand is insufficient to bring down commodity prices, central banks have to tighten aggressively to contain inflation even as the global economy cools. Financial speculation makes it difficult for central banks to achieve a soft landing for the global economy.
Global inflation is close to a ten-year high and is likely to rise further into 2007. The culprit is the unsustainably high level of liquidity. As deflation shocks have ended, the current level of money supply is not consistent with price stability.
Commodity inflation is a major channel for excess liquidity to turn into inflation. Even though high prices are destroying demand, prices remain very high despite the recent decline and tend to surge whenever the expectation for rate hikes by central banks diminishes. This suggests that central banks have to tighten more than what the real economy requires in order to contain inflation.
Central bank signaling has been driving financial markets lately. Their ambivalence towards inflation only incites more financial speculation. In the end, the reality of high and rising inflation will catch up with central banks, and I believe that the more dovish they are now, the more they will have to raise their interest rates later.
The commodity bubble is a knife hanging over the heads of dovish central bankers, [The reaction to the Fed’s statement last week is a good example that commodity prices are far more sensitive to liquidity indicators than real demand. As the Fed sounded more dovish than the market expected, commodity prices rebounded sharply from the recent decline] because it encourages more speculation, which in turn causes more inflation, and I believe that the reality will catch up with the central banks that sound dovish today. The commodity bubble is one manifestation of the inflationary pressure from the very high monetary stock in the global economy. The inflationary effect of the abundant money supply was suppressed by global deflation shocks. Instead, the liquidity caused asset inflation. As deflation shocks end, asset inflation is causing consumer price inflation.
Central banks have tightened substantially already, and this is now causing the global property cycle to turn down. Central banks are worried about the effect of this downturn on demand and do not want to tighten more to risk a recession. The current level of tightening is not sufficient to stop commodity speculation. This essentially puts central bankers in a box — if they focus on achieving a soft landing, they run the risk of letting inflation get out of control.
Source: Morgan Stanley
:) Falkor
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