COMMODITIES INVESTING
On the other hand, we have often been haughtily dismissed by
Freebasing Risk
institutional investors who could very well scoff that, say, nickel
Apart from “the problem is fully contained” school and the
might be overstretched in the near-term, or that oil contangoes
usual crowd of “buy the dips (and preferably from me,
made passive indexing a mug’s game. Yet they were still perfectly
please)” chancers, the air is filled with the misleadingly
content to buy yet another gallimaufry of dubious, rag-tag credits
upbeat strains of the gospel choir belting out that old-time
from their over-eager investment bank account managers, each
religious standard: “The Economic Fundamentals are Sound”,
secure in the belief that the value of these baskets afforded them a
even as all manner of high-falutin’ investment schemes are
wide margin of safety. However, as the events of the past few weeks
detonating around us.
have begun to reveal, this last presumption has proved just as fatal
True enough, the world is not going to go into a tailspin as all of its many, less-than-illustrious predecessors in the perpetra-
because of the travails of fifty-odd thousand poor fools whose
tion of mathematical hubris.
painful desire to make a fast buck flipping condos met a none-
And yet, even now there is a current of denial still insidiously
too-choosy lender with similarly short-sighted motives.
embedded in the minds of people who do not wish to acknowledge
The plain fact is that the laxity of lending and the euphoric that their own deeds have given rise to what they insist on miscon-
rush of freebasing risk never limited itself to such a low-rent struing as just one more ‘six sigma event’.
corner of the world, for far more sophisticated financial
operators were also far too eager to don their beads and A House Divided
boaters and to join in the Chuck Prince Charleston, for as long One month into the current turmoil, despite the barely-contained
as the band was playing. panic haunting the world’s trading floors, the professional Sirens
So, the whole colourful motley of hedge fund gunslingers,
have reappeared to tell you to dive back in, now that things are
private equity barons, bond insurers, CDO traders, and fixed-
‘cheap’. This is just a little local difficulty – a “financial squeeze” as
income investors – the whole, out-of-control business of
Credit Suisse recently put it – which the forthright and far-sighted
steepling M&As, of vast share buybacks (and hence of main-
central banks will soon overcome (to the gratification of today’s
market equity market performance, as well as emerging intrepid buyer).
market re-rating) – the whole self-aggrandising swagger of Be assured, things will get a great deal ‘cheaper’ before we extri-
the Bulge Bracket bonus bonanza – all of it (every last red cate ourselves from the current morass. Once again, let us reiterate:
cent of it) has been, in turn, the cause and effect of the build- the business cycle IS the credit cycle because, as Mises/Hayek taught
up of the storm system which now threatens to sweep this us, a producer-led boom which has been launched on a wave of easy
Big Easy of false prosperity away, leaving little but the credit starts out on the shakiest of foundations.
matchwood of shattered dreams and disabused
For the benefit of those unfamiliar with this highly consequential
expectations in its wake.
diagnosis, a brief rehearsal shows us that overeasy credit – and the
artificially suppressed real, risk-adjusted interest rates it engenders –
asset classes – both ‘conventional’ and unfailingly encourages too much investment in too many false proj-
‘alternative’ – and that this was unlike- ects. Financiers become reckless, investors switch what savings they
ly to pass until the we had removed the still make into more speculative, longer-lived vehicles and entrepre-
cause of all this mischief, namely, the neurs are mislead en masse to see real opportunity where there is
credit bubble. This had continuously only the shimmering mirage given off by hot money. The resulting
been inflating prices everywhere you surge of new project financings, of increased bank lending and bond
looked, though ironically everywhere issuance, and the enthusiastic provision of venture capital soon gives
the central banks were choosing not to rise to a marked resurgence of general business activity and to
look at the same time. falling levels of unemployment.
The real bubble, we maintained, was in
credit. All others – whether in lead
Be assured, things will get a great deal ‘cheaper’
futures, LBO targets, Patek Philippe before we extricate ourselves
watches, or Modernist daubings – were
from the current morass
ancillary to what the woefully uncom-
prehending ex-Fed Chairman once Until costs make up their initial lag and begin to rise in proportion
called a ‘conundrum’. It was, in reality, to selling prices, the injection of new credit and the stimulation of
an all too understandable phenomenon. new investment will also have the effect of boosting accounting
In saying this, we would be assailed on profits at both the micro and aggregate levels, appearing to justify
the one side by starry-eyed resource pro- the mass hysteria that this latest of ‘New Eras’ will by now have
moters (many of whom had increasingly unleashed.
only come across a ‘mine’ in the refer- Sadly, the whole of this gleaming superstructure will all be built on
ence section of the Harvard library) who sand. For, as Léon Walras once put it here in Lausanne: “The expan-
would insist on telling us that our cau- sion of …credit does not create [physical] capital, but a new demand
tion was misplaced. We “didn’t get it” for capital and the capital itself remains to be created.”
because we did not understand China’s It is in the pervasive semantic confusion over the meaning of the
influence on the supply and demand word ‘capital’ where most of the problems arise. The crucial flaw in
dynamics of the metals concerned (sic). the development of the boom lies in the fact that entrepreneurs and
36 SEPTEMBER 2007 COMMODITIES NOW
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