Thursday, February 3, 2011

Commodity Bubble Next to Burst?

Davos Déjà Vu View

Some voiced the suspicion that not enough has been done to improve the system after the global financial system melted down and was re-formed. Another system crash may occur sooner than we think.

Such bearish views, however, were not heartily embraced this year at Davos.

In an imagined meltdown envisioned in  "The Financial Crisis of 2015: An Avoidable History" white paper set to occur mid-decade, "The new wave of regulations had proved ineffective at stopping another bubble from forming." 

"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."

"Our scenario builds on these historical observations and has a commodity price bubble at its center. The fallout from such an emerging markets crisis could be even more severe than in previous crises, with the biggest losers coming from the developed world. Western monetary policy is looser than ever, so the bubble could be unprecedented in size. And the high levels of indebtedness in developed economies means that they are in no position to absorb a rapid monetary tightening without experiencing a massive rise in insolvencies, including perhaps the insolvency of several developed world sovereigns."

"Our worst-case scenario assumes that default rates move back up to their historical peak based on the 200 years of data....This would represent the culmination of trends that amount to a complete global rebalancing of economic power: most likely from the US and European economies to the emerging markets. From this perspective, the sub-prime crisis was merely the start of a period of economic instability engendered by this realignment."

Right back where we started from.

The sound of bearish talk, however, was drowned out in the noisy recovery euphoria of the Davos world stage. The bears were told to crawl back into their caves and go back to sleep.