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Does MMT hint will we see $2.00 gasoline by July 15th?

May 17, 2011

It could happen

Oil is falling. Oil is falling rapidly. The drop is nothing short of astounding.  The conventional wisdom is:

“The Fed’s view, and our view in the UBS mining team is that QE2 operates through portfolio choices. When the Fed buys treasuries, it lowers yields relative to other risk assets – forcing portfolios to shift up the risk curve. That shift incorporates strong capital flows overseas – which can be seen in the dramatic rise in foreign exchange reserves in recent months.”

The MMT view is different.  It says:

“QE II is an asset swap.  Investors that wanted to swap their treasuries for higher yield assets could have done so at any time through the repo market or tiny margin haircuts at any bank.   The yield curve tends to float to indifference levels for future inflation – so if there is $3T or $13T of Treasuries out there, the yield curve will gravitate to levels that discount future inflation.  In general, QE won’t push the market to speculate more due to the mix of assets investors hold.”

These views do not seem that different to lay people, but to investors, they are hugely different.  If you believe the conventional view, QE of moderate size is the equivalent of  pouring gasoline on a fire.  People cannot do anything without cash, and forcing people out of T-bills and 2 year notes into cash makes them spend it on riskier assets.  Riskier assets should embark on huge rallies as QE takes effect.

So we get a commodity bubble, oil prices go through the roof.  Silver and Gold rationally respond by tacking on 50% or so in a year.  As QE takes hold, people will respond by shifting to slightly riskier assets.

Perhaps this conventional view is true.  However, I do know that professional traders and firms prefer to post t-Bills as collateral at the Chicago Mercantile exchange over cash.  T-Bills still pay the bearer money. And the CME treats T-Bills just like cash. So posting a t-Bill or treasury at the CME turns your required margin account into an interest bearing account.

Banks also accept T-Bills as collateral on very similar haircut schedules.

In other words, large speculators – or the firms that hold accounts for small speculators – prefer to post T-Bills instead of cash as collateral.

If you had:

  • held T-Bills or Treasuries,
  • got “pushed out” of U.S. debt due to QE,
  • and thought to yourself, “Now I want to speculate in Commodities”,

the first thing you would do is turn around and buy T-Bills with your cash or short term U.S. debt with your cash.  You’d do this so you could speculate in commodities but still get paid interest.

You can see why I’d think this chain of events doesn’t make much sense.  Why bother speculating?  It probably wasn’t QE that made you speculate in the first place.

The MMT view is that due to effects like this, it doesn’t matter if people hold cash or T-bills.  T-Bills are so close to cash.  T-Bills are “better than cash” for speculation, because they get treated like cash for margining, and still earn interest.

What does this have to do with Oil?  The speculation in oil does not have anything to do with Quantitative easing.  It’s just speculation.  It isn’t supported but a massive U.S. Government program.  It’s just speculation that oil will go up.

The data from the Chicago Mercantile Exchange tells us there is a ton of speculation. If you are going to speculate in oil, the Nymex division of the CME is the place you’d do it.  The conventional view is that QE II is driving this speculation.  But the odds are strong QE II has nothing to do with record speculation.

The fundamentals of oil are not strong.  Maybe the CEO of Exxon is trying to deflect criticism when he says that oil should be at $60-$70 based on fundamentals.  But everywhere you look, there is lots of oil, and moderate demand.

Last time oil was at $60 a barrel, gasoline was at $2.00 a gallon.  If oil prices fall as people realize QE II didn’t force speculation in oil, we could easily see gasoline prices fall dramatically – and in a short period of time.

MMT doesn’t guarantee lower oil prices.  All it says that the current crop of speculation in Commodities wasn’t forced by QE.  The speculation in the markets could be due to people wrongly thinking QE would push others to embrace riskier assets.  But not one person got pushed out of Treasuries and then decided to speculate in commodities.

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  1. Peter D
    May 17, 2011 at 11:09 pm

    TC, isn’t there a fallacy of composition lurking somewhere in this argument? True, Tsys can serve a collateral etc, but the non-govt sector as a whole now swapped Tsys for reserves and deposits. So, unless there is absolutely no preference to swap those reserves and deposits into something else, you’d expect them to find their way into other asset types.
    I am sure you’re right about CME and oil. But what about, say, a pension fund that now has extra cash? It still needs to seek return, so, lets say it buys the next best thing – say, a muni or a high quality corp bond. Then those that sold those would have to park their extra cash somewhere, so, they might go and speculate in gold or oil or stock market.

    • TC
      May 17, 2011 at 11:36 pm

      I am with you part of the way. Forcing people out of their positions could make them more apt to speculate. But most big institutions have risk committees and investment plans. They just won’t be able to pull the trigger on the Commodities that easily.

      They could do it through a CTA, or a long only commodities fund, or through a CPO, or a Hedge Fund, or just by themselves. But making a shift from Treasuries to Commodities isn’t as easy as you and I could do it.

      And basically, any fund that would get the cash would then need to shift back into T-bills. The rubber needs to hit the road at some point. It seems to me that people who wanted to speculate in Commodities are using QE II as an excuse more than a real mandate to move to commodities.

      Still, I could totally be wrong about this. It’s happened before. 😉

  2. carnahan
    May 18, 2011 at 10:42 am

    “If you had:

    held T-Bills or Treasuries,
    got “pushed out” of U.S. debt due to QE,
    and thought to yourself, “Now I want to speculate in Commodities”,

    the first thing you would do is turn around and buy T-Bills with your cash or short term U.S. debt with your cash.”

    I’m not clear to me how holders get “pushed” or “forced” out of T-bills and why they would then turn around and buy T-bills with the cash especially since there is probably some friction on both transactions. Nobody is holding a gun to a T-bill holder and forcing them to sell.

    • TC
      May 18, 2011 at 10:58 am

      I find the conventional thinking confusing as well. When I go through the actual steps to get moved out of T-Bill and then into commodities it seems totally foolish or even contradictory.

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