Monday, November 17, 2008

Greenspan's monster eats Goldman's BRICs

The business cycle, as we have so vociferously been reminded, is not dead.

Not only is it alive, but it's now bigger and stronger than ever!

For over a decade, it had become conventional wisdom to assume that rapid growth among the developing economies of, inter alia, Brazil, Russia, China and India (or BRICs, as Goldman Sachs coined them) had become a permanent feature of the global landscape and would be strong enough to compensate for any slowdown that might occur in advanced economies.

Not only would a slowdown in, say, Germany or the US be mitigated by growth overseas in India or Brazil but that such a period would bring with it a redistribution of wealth from rich to poor (i.e. if one group of economies is growing while others are shrinking then a rebalancing of wealth would follow).

And up until the middle of this year everything was going according to plan.

Then oil stopped rising and everything went into reverse, especially among the BRICs.

Two questions now arise (to which you will struggle to find anyone capable of providing a clear and convincing answer):

1) Why did oil prices rise to $150/barrel?
2) Why did oil prices then more than halve in four months?

A third question, to which it's always fun to see people attempt to provide an answer which they can believe:

3) Where will oil prices go from here?

While it would be tempting to try and predict where oil prices will go or explain why they have risen and fallen in such dramatic fashion, it's more important to realise what just happened in the context of oil's gyrations, since much of this backdrop helps to explain why movements in oil and other financial assets follow the paths they do. This will also explain the meaning that's hiding behind the title of this post.


In 2001, Goldman Sachs economist Jim O'Neill predicted that the BRICs would be among the world's most dominant economies by 2050.

This ambitious prognostication helped create one of the largest proverbial bandwagons in history.

The number of people searching for the term "BRIC" on Google has grown every year. With a growing intellectual curiosity came a growing financial interest. The smart money started going South and East.

Then the stupid money followed.

At the same time as money was flowing into emerging markets, the US was facing the prospect of deflation (falling prices everywhere), something it hadn't seen since the Great Depression.

As now Fed Chairman Ben Bernanke, said at the time, interest rates could and should fall more rapidly than in normal times to avoid such a thing from happening.

And that's exaclty what they did. Until mid-2004, US interest rates remained at 1%.

What then Fed Chairman Alan Greenspan didn't realise what that investors would use the money they could borrow so cheaply to invest in emerging markets, which Jim O' Neil had predicted would offer sustained economic growth for at least the next generation.

Greenspan was creating a monster, and it's color would be green.


With the volatility we are now seeing in financial markets it has become a fruitless endevour to bet on the next move, up or down.

However, it's important to not lose sight of the fact that we are seeing something no different to the bursting of any bubble gone before.

What caused the bubble in oil and emerging markets was a combination of a low cost of borrowing and gullible investors.

While all bubbles teach a different lesson, they all result in the same thing: the search for a new bubble. But you can't burst the same bubble twice. And oil prices and emerging markets have both now clearly burst.

Only time will tell what Bernanke's monster will destroy...

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