Connecting monetary inflation with speculation

May 10th, 2008

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One of the common explanations we find in the news media for high oil prices is that they are the speculators’ fault. In our previous article, Price fluctuations and hoarding, we have a better word to describe such speculative activity- hoarding. Speculators (or rather hoarders) are blamed for bidding up the price of oil, resulting in a global price inflation scourge. Many economists call such price inflation as ‘cost-push’ inflation.

But in reality, there is a deeper underlying cause for such price inflation. As we quoted Marc Faber in Marc Faber: Bernanke Policy Will ?Destroy? U.S. Dollar,

As the US began their aggressively loose monetary policy from September 17 2007 by cutting interest rates from 5.25% to 3% [, Marc Faber said,]

What is the result? I tell you what the result is! The stock market in September 17 by the S&P is down 10%, the US dollar is down 10%, gold and oil are up 40%. Well done Mr. Bernanke!

How does monetary inflation (see Cause of inflation: Shanghai bubble case study) lead to speculation? At the root of speculation lie human decisions for improving one’s lot in life. The ultimate aim of the economy is to satisfy infinite wants with finite resources. With all these mal-investments accrued over the years, it has come to the point that too many resources are wasted in ends that are either (1) cannot be completed or (2) unwanted. As we said before in Why does the central bank (RBA) need to punish the Australian economy with rising interest rates?,

Therefore, in order to put the economy back into a sustainable growth path, consumptions and investments have to slow down in order to allow for the economy to catch a breather for the rebuilding of its capital structure. The rebuilding of capital structure is necessary for the economy to replenish its resources for the future so that growth can continue down the track. Unfortunately, this rebuilding itself requires resources now. Therefore, current wasteful consumptions have to be curtailed and mal-investments have to be dismantled to make way for the rebuilding.

Thus, by further inflating the supply of money and credit in the financial system at such a time, there comes a situation whereby there are excess liquidity without adequate avenues for appropriate investments.

To understand this idea, put yourself in a position of a person with excess wealth in US dollars to invest in. Where can you invest your wealth to give yourself a real return in an economy that is in recession with serious price inflation? With asset price deflation and a credit crunch, there are not many financial assets to park your wealth in. At least in Australia, with rising interest rates, cash is an option. But in the US, with short-term interest rates lower than the price inflation rate, cash is not an option. Even long-term Treasury bonds are not good enough. In the end, the most attractive option would be to hoard commodities that have good supply/demand fundamentals. But if too many people are in the same boat as you, such hoarding will only result in further rise in prices.

So, is there any wonder why there are speculations (or rather, hoarding) in commodities?

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