-- Published: Wednesday, 21 January 2015 | Print | Disqus
By Harris Kupperman
Modern central bankers are from the school of thought where there is always an eloquent academic model to approach each crisis with. Naturally, volatility is their enemy—in a highly leveraged world, volatility usually leads to dislocation and crisis. Central bankers obviously know that the halving of oil’s price in a few short months adds unnecessary volatility to their carefully orchestrated worlds. What they want to do is corner the price of oil within a narrow range, suppress volatility and allow complex derivatives to be built up around it so that they can use financial means to manipulate it.
Unfortunately, oil doesn’t behave like an interest rate derivative. When there is too much supply, the only way to solve the problem is to destroy supply. When there is too much demand, it is impossible to create supply—or not within the timelines demanded by central bankers. Have the central bankers finally met the first crisis that they cannot solve?
Ever since the great crash of 2008, central banks have learned that the solution to any instability is to print money and lower interest rates. This approach has been used repeatedly, because every crisis has stemmed from either a solvency issue caused by a lack of equity capital or a near-term liquidity constraint at some financial institution. As the oil crisis asserts itself, the central banks may have finally found a crisis that will not respond to their magic elixir of QE. In fact, lending more money to insolvent share producers will only serve to increase oil supply. To the central banker with a hammer, every problem looks like a nail. This will be one well-oiled nail.
Over the past six years, investors have been treated to a false sense of security regarding the financial markets—one where they’ve learned to trust that the central banks are there to bail them out. The violence of the move in EUR/CHF shows what happens when everyone expects a central banker to support things, but the support isn’t there. I think this oil crisis will be the first one to really test the Central Bankers globally. Too much money was lent to too many oil companies and oil producing nations—most of which cannot service this debt, much less pay it off at $45 oil. For once, the central banks have no way to save the situation--it may actually be out of their hands. When investors realize that the central bankers aren't there...
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