Monday, August 23, 2004

Rising oil prices give central bankers a lift

While many of us look on in despair at the rising price of oil, Alan Greenspan and his friends are enjoying every minute.


Because rising oil prices are doing the job most central banks need to do but resent doing: raise interest rates and damp rising demand.

The dilemma for most central banks is how to achieve price stability while not jeopardizing economic growth. This is not an easy task and more often than not entails sacrificing one for the other, making central banks very unpopular when the situation gets nasty.

In the past year central banks around the world have been on tightening mode. Global economic growth was getting to the point where it might generate more inflation than necessary. Things needed to be kept under control. So central banks, armed with their interest rates, starting raising.

Higher interest rates always make central banks unpopular. After all, most people need to borrow money to buy a home, a car or whatever. Savers always look to alternative means of outperforming the saving rates a bank offers, so they aren't going to complain too much either way so long as the stock market is given a chance to provide them with a decent return.

The issue for central banks is how to keep everyone happy. How to make everyone better off.

The rising price of oil is a convenient scapegoat for everyone and this includes the central banks.


It's important to remember that rising oil prices are not the same as rising inflation.

Accelerating inflation usually happens when the economy is growing out of control, not when oil prices rise (the 1970's was an exception to this rule).

Global inflation picked up in the past year, making central banks nervous.

Rising oil prices have come just at the right time. Why?

Higher oil prices will help cool demand and keep the economy from generating too much inflation.

It's easy to forget that a large part of the reason why oil prices have risen this far is because of increased demand from China, not to mention the summer driving season in the U.S.

Higher fuel costs will act to correct the pickup in demand, without causing central banks to break a sweat.


We don't live in the 1970's anymore.

We are't experiencing the type of oil price shock that will tip the global economy into recession.

What we are seeing, however, is a convenient way for central banks to get out of doing their least favorite job: raising interest rates.

Saturday, August 14, 2004

Investing 301

Investors are getting smarter.

They're still pretty stupid, but they're getting smarter nonetheless.

There used to be a time when investors would lose money when stock prices fell. That doesn't always happen now.

Some investors still complain about the low value of the stock market.

That's because their methods of investing haven't changed in decades. They need to catch up or forever lack the wealth they need to survive into old age.

Some people never get the chance to learn about how to invest and that's a shame. It's a shame because they will live their lives without job security and a sufficiently large pension.


Investing isn't just about the stock market.

Investing is about stocks, bonds and currencies (in ascending order of importance). When you invest in the stock market you need to be aware of what's happening in the other two since all three interact with each other on a daily basis.

Investing is about the future and being able to correctly predict where all of these prices are going to go.

The majority of investors hope prices will move in one direction, and that's up.

Unfortuntaely for them, prices also go down.

The way around this is to trade derivatives.

The derivatives market started in the 1970's, became big in the 1980's, got even bigger in the 1990's and keeps getting bigger. So what's it all about?

Essentially, trading in derivatives allows you to benefit when prices rise or fall.

Not everyone expects prices to move in the same direction.

If you expect the price of apples to fall you would want to agree to sell apples to someone at a certain point in the future at today's price. If that person expects the price of apples to remain the same as today or to go higher then they will happily enter this agreement with you.

Of course you don't need to trade with someone else directly. You can sit at home at trade on the web.


Investors today understand the importance of reading the financial press to understand when is the right time to buy and sell stocks.

If they broadened their knowledge of how the financial markets work they can avoid getting burned when stock prices (inevitably) fall.

One way to be wise of events on the horizon is to monitor leading indicators! But that lesson is for another day...