Energy and Money
Yesterday, it was good to see the Wall Street Journal push down their warmongering, if only briefly, and put the money beat on top. After all, the Fed raising rates and promising to keep pushing up the rest of the year is big news. Except for a couple short, abortive efforts, it’s been 17 years since the Fed went on a truly determined rate hike campaign, and we all remember what then resulted.
However, yesterday's real money story was in Europe. The FT writes, “Energy traders call for ‘emergency’ central bank intervention.” It's an important story for all sorts of reasons, most importantly in revealing how the money system has changed over the last several decades. The FT writes,
“Europe’s largest energy traders have called on governments and central banks to provide 'emergency' assistance to avert a cash crunch as sharp price moves triggered by the Ukraine crisis strain commodity markets.
“In a letter seen by the Financial Times, the European Federation of Energy Traders — a trade body that counts BP, Shell and commodity traders Vitol and Trafigura as members — said the industry needed “time-limited emergency liquidity support to ensure that wholesale gas and power markets continued to function”
The EFET letter states,
“Since the end of February 2022, an already challenging situation has worsened and more [European] energy participants are in [a] position where their ability to source additional liquidity is severely reduced or, in some cases, exhausted.”
Now remember, only a month ago, Shell boasted an increase in profits to $19.5 billion last year, BP, $12.9 billion. What happened to that money, you might ask. But this is not the main question. The FT goes on,
“But prices for oil and gas, where Russia plays a central role, have also rocketed since the war began. Futures linked to TTF, Europe’s wholesale gas price, surged almost 200 per cent over four days earlier this month. In some cases, variation, or mark-to-market margin, in the gas market have increased 10 times from one day to another.”
Which gets to a more important problem, the value of exchanges, especially today, when exchanges are more influential across markets than ever. Yet, markets do not necessarily need exchanges. Indeed, Peter Styles, executive vice-chair of the EFET board states, “It is possible to hedge risk without exchanges.” Which gets to the heart of the matter, “ECB vice-president Luis de Guindos said last week that derivatives, including commodity derivatives, were a 'very specific market that we are looking at very carefully'”.
There's that word, “derivatives.” Last time it made it into the popular lexicon was the bank crash of 2008. Derivatives were failing, massively. Which gets to the most amusing part of the article, of course a statement made by an American,
“Speaking at a conference on Wednesday, Rostin Behnam, chair of the Commodity Futures Trading Commission, the top US derivatives regulator, said appropriate margins must 'unfailingly' be maintained. “We must hold fast to our regulatory structures and resist the urge to make ad hoc decisions to avoid the natural outcomes of market forces,” he said.”
First, there’s no such thing as “natural” market forces. All markets are human derived. Second, getting to a larger and more important question, how do we actually define markets, that is, not just as some sort of magical panacea? That's well beyond the scope of this piece, but something to at least give thought.
Let’s get to the nut. Despite Mr Benham's concern, central banks have increasingly become determinative players in the “natural outcomes of market forces,”
“Central banks provide emergency liquidity during times of market stress to stem cash flow problems at solvent institutions. Generally, lenders pledge collateral in exchange for emergency loans. It is unclear exactly how any assistance for commodity market participants would work.”
This is essential in understanding how the money system has changed. The modern money system of the 20th century was based on bank-debt money. Banks created money by lending. The loan getting paid back meant it was good money. Not paid back, it's written off the books, bad money destroyed. The money system was not just banks themselves, but the networked banking system. All the money the Fed created, entered the economy through the banking system, including the sale of US Treasuries.
In the last several decades, we've had all sorts of financial innovation. The economist John Kenneth Galbraith gave the best advise on financial innovation, when hearing any such thing, the best thing to do is run. Nonetheless, money innovating we've been, including the most worthless, derivatives. Today, there's lots and lots of money that's been created outside the banking system, not talking about bitcoin, but dollars. What's its value? This is the question of the day.
We do know in 2008, as value on all sorts of things became questionable, the Fed pumped trillions, not just into the banks, but other institutions too. One can call it, precedent. Since, the continuation of financial innovation has been made possible by a regulatory system owned by money and a Federal Reserve making the dollar cheap and plentiful.
In 2008, I was having a phone conservation with historian Lawrence Goodwyn, one of a few who actually knew something about the history of money. As exchanges rocked, he asked, “Is this a liquidity crisis or an insolvency one?” In retrospect, it was an insolvency problem, pushed forward by massive injections of liquidity. The question since has been how long can that continue, and I'll say straight out, a lot longer than I ever thought possible.
The Fed's warning, maybe – place your bets.