2011 flashback: The 2015 Banking Crisis Begins in Commodities

[Chomsky]

Simplistic enough, but prescient nonetheless?

--

The 2015 banking crisis begins in commodities

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Tracy Alloway used to be deputy editor of FT Alphaville. Here she learned the details of derivatives, the absurdities of accounting and the various structures of ... erm ... structured finance. She now covers big US banks for the FT paper, including Goldman Sachs and Morgan Stanley. She pops up on FT Alphaville every once in a while.
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| Jan 31 2011 11:13 | Share

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John picked up the phone. It was the bank’s legal counsel, Peter Thompson, calling. He had dramatic news. Garland Brothers, one of the world’s oldest banks, would declare bankruptcy tomorrow. As he lay there in his spacious air-conditioned bedroom, unable to return to sleep, John tried to reconstruct the events of the last four years…

So starts a 28-age report by consulting firm Oliver Wyman, ominously titled: “The Financial Crisis of 2015: An Avoidable History.” It’s grabbing some headlines this week, thanks to a Davos-related set-piece by Bloomberg, and is worth a read.
In a nutshell, Wyman argues that banks will be squeezed by regulation imposed post the 2008 financial crisis. Unwilling to accept reduced returns, they’ll go after higher-yielding assets like commodities and emerging markets until … KABOOM!
Or in detail(ed phases):

During phase 1 we distinguish between two sources of demand affecting commodities prices: demand for use in the production of other goods (“real” demand) and demand for the purpose of price speculation (“speculative” demand). There are three major groups of players in our scenario. Firstly, there are economies, such as Latin America, Africa, Russia, Canada and Australia, which are the largest commodities producers. Secondly, there is China, which is now the world’s largest commodity importer. Thirdly, there are the developed world economies, such as the US, which are pumping liquidity into the financial system through their loose monetary policies.

As with any bubble, our scenario contains a compelling narrative that allows investors to convince themselves that “this time is different”. In this case it is a story of strong economic growth coming from China creating a sustainable increase in demand for commodities.

However, it is already apparent that increasing commodities prices are also creating inflationary pressure in China, which is exacerbated by China holding its currency artificially low by effectively pegging it to the US dollar. This makes commodities look like an attractive hedge against inflation for Chinese investors. The loose monetary policy in developed markets is similarly making commodities look attractive for Western investors. This “commodities rush” is demonstrated in the right-hand chart below, which shows the asset allocations of European and Asian investors. A recent investor survey by Barclays also found that 76% of investors predicted an even bigger inflow into commodities in 2011.

Based on the currently inflated commodity prices, commodity producers in countries such as Brazil and Russia have clear business cases for investing in projects to dig more commodities out of the ground. As competition to launch such projects increases, the costs of completing them also starts to rise, with the owners of mining equipment and laborers capitalizing on the increased demand by charging higher rates. Because a portion of the demand for the projects is not coming from the real economy, an excess supply of mining capacity and commodities will be created.

As with previous asset bubbles, we expect much of the debt financing for these projects to come from banks. And much of this bank financing is likely to be supplied by Western banks that are eager to preserve their diminishing return-on-equity and need to find lending opportunities that are sufficiently lucrative to cover their own increasing cost of funds. The balance sheets of life insurers will play a supporting role here, as insurers look for long-term investments that can match their liabilities and seek to earn additional illiquidity premia.

So as soon as investors start to doubt what constitutes ‘real’ demand for commodities and what’s pure speculation, they’ll head for the exits en masse, which will lead to a collapse in commodity prices, abandoned development projects and bank losses.

And then we’ll have banks that need to be bailed-out by sovereigns, and sovereigns that need to be bailed out by … well, you get the picture.
The good news is, if Wyman’s predictions prove true, we’ve got four years of an inflationary commodities super-cycle to look forward to. What fun!

http://ftalphaville.ft.com/2011/01/31/474211/the-2015-banking-crisis-begins-in-commodities/

[Chomsky]

Re: 2011 flashback: The 2015 Banking Crisis Begins in Commodities

Here's the Bloomberg piece on this from the same time.

[EJ]

Re: 2011 flashback: The 2015 Banking Crisis Begins in Commodities

Here's the Bloomberg piece on this from the same time.

Well I've met all these guys. Let me translate:

"Regulators, by focusing their restraints on banks, may drive risk-taking into unregulated funds that also pose danger to the system."

Translation: "None of these hedge funds has offered me a job."

“I came into this dinner somewhat pessimistic and worried about the assignment we are here to discuss,” Simon Johnson, a professor at the Massachusetts Institute of Technology’s Sloan School of Management and a Bloomberg News columnist, said halfway through the evening. “I am now terrified. There is an incipient sovereign crisis here mixed in with the bank crisis.”

Translation: "I have been struggling for relevancy during the past five years since the recovery began and have to keep doubling down on the doom prognostications to stay in the lead in my doomer role."

Under our system where there's a will there's a way and today there's plenty of both.

[Chomsky]

Re: 2011 flashback: The 2015 Banking Crisis Begins in Commodities

Well I've met all these guys. Let me translate:

"Regulators, by focusing their restraints on banks, may drive risk-taking into unregulated funds that also pose danger to the system."

Translation: "None of these hedge funds has offered me a job."

“I came into this dinner somewhat pessimistic and worried about the assignment we are here to discuss,” Simon Johnson, a professor at the Massachusetts Institute of Technology’s Sloan School of Management and a Bloomberg News columnist, said halfway through the evening. “I am now terrified. There is an incipient sovereign crisis here mixed in with the bank crisis.”

Translation: "I have been struggling for relevancy during the past five years since the recovery began and have to keep doubling down on the doom prognostications to stay in the lead in my doomer role."

Under our system where there's a will there's a way and today there's plenty of both.

Thanks for letting me draw you out. I appreciate the comments.

[GRG55]

Re: 2011 flashback: The 2015 Banking Crisis Begins in Commodities

Simplistic enough, but prescient nonetheless?

--

The 2015 banking crisis begins in commodities


| Jan 31 2011 11:13 | Share

...As with any bubble, our scenario contains a compelling narrative that allows investors to convince themselves that “this time is different”. In this case it is a story of strong economic growth coming from China creating a sustainable increase in demand for commodities.

However, it is already apparent that increasing commodities prices are also creating inflationary pressure in China, which is exacerbated by China holding its currency artificially low by effectively pegging it to the US dollar. This makes commodities look like an attractive hedge against inflation for Chinese investors. The loose monetary policy in developed markets is similarly making commodities look attractive for Western investors. This “commodities rush” is demonstrated in the right-hand chart below, which shows the asset allocations of European and Asian investors. A recent investor survey by Barclays also found that 76% of investors predicted an even bigger inflow into commodities in 2011.

Based on the currently inflated commodity prices, commodity producers in countries such as Brazil and Russia have clear business cases for investing in projects to dig more commodities out of the ground. As competition to launch such projects increases, the costs of completing them also starts to rise, with the owners of mining equipment and laborers capitalizing on the increased demand by charging higher rates. Because a portion of the demand for the projects is not coming from the real economy, an excess supply of mining capacity and commodities will be created.

As with previous asset bubbles, we expect much of the debt financing for these projects to come from banks. And much of this bank financing is likely to be supplied by Western banks that are eager to preserve their diminishing return-on-equity and need to find lending opportunities that are sufficiently lucrative to cover their own increasing cost of funds. The balance sheets of life insurers will play a supporting role here, as insurers look for long-term investments that can match their liabilities and seek to earn additional illiquidity premia.

So as soon as investors start to doubt what constitutes ‘real’ demand for commodities and what’s pure speculation, they’ll head for the exits en masse, which will lead to a collapse in commodity prices, abandoned development projects and bank losses.

And then we’ll have banks that need to be bailed-out by sovereigns, and sovereigns that need to be bailed out by … well, you get the picture.
The good news is, if Wyman’s predictions prove true, we’ve got four years of an inflationary commodities super-cycle to look forward to. What fun!http://ftalphaville.ft.com/2011/01/31/474211/the-2015-banking-crisis-begins-in-commodities/

"four years of an inflationary commodities super-cycle"? Prescient?? I don't think so.

Have a look when commodities started to roll over compared to the date of the article. That's some super-cycle :