Food For Thought: Instability and Political Interference

There are instances where markets need the comforting hand of politically justified guidance.  However, such instances are few and far between.  The ongoing efforts of the world’s leading Central Banks as they strive to maintain calm and confidence in short term money markets is perhaps one of those rare instances.

However, market interference is becoming a more regular feature of today’s newsflow.  The EU is reportedly considering pronouncing the European energy industry ‘strategic’.  The French government has finally engineered the merger of Suez and GdF.  Political interference/influence is the modus operandi of the Russian energy industry.  And today we are reminded that it is not only energy that government’s consider to be strategic.  It is also food.

Russia is considering imposing a ban on its wheat exports.  The apparent reasoning is not so much strategic as economic:  the ban is designed to restrict inflationary pressures in Russia’s own food prices.  Russian inflation rose to 8.7% in July from 8.5% in June and was partially driven by higher food prices.

Global cereal markets are under substantial and protracted pressure.  The emerging Chinese and Indian middle classes are fuelling demand for cereals as their aspirations evolve away from traditional rice-based diets.  Poor harvests in Europe, North America and Australia have dented the supply-side of the equation.  The costs of the world’s most basic need is increasing and nobody seems confident those costs will subside any time soon.

Rather than allowing the operation of markets to deal with the supply/demand imbalance, the Russian government is simply shifting its own inflationary pressures abroad and creating artificially low prices for its own consumers.  Short-term political expediency fails to resolve long-term structural issues.

Traders will not want to short wheat and cereal markets will continue to soar as they discount the possibility of delivery defaults and watch the Australian weather with heightening tension.

Not only are the costs of life’s basics increasing, as energy and food prices fuel inflation, but markets are having to discount political interference as a key variable in evaluating value.  The consequences for markets could well be catastrophic.  The fact of the matter is there is an emerging dislocation between operation of free-markets and the reality of political interference.  This dislocation is certain to have one long lasting effect:  instability.

Rock. Hard Place.

Perhaps the central tenet of free markets is the Darwinian threat to poor performance:  if a management team doesn’t perform, fails to create value for shareholders, the business will be vulnerable to takeover.  Poor managements can, ultimately, create value for shareholders as, more often than not, strategic value is greater than any company’s fair trading value.

It’s one of the wonderful paradoxes of the free market.  It’s a paradox that drives innovation and progress throughout the western, democratic free markets.  It’s why we are most comfortable when markets are free to operate without the heavy hand of government intrusion or regulatory restriction.

Yet, as governments and regulators become attuned to the profound changes afoot in the energy industries we are possibly faced with the prospect of the EU’s energy industries being labelled ‘strategic’.  In effect these industries could well be too important, too critical, to be left to the mercy of free markets.

It’s not that markets don’t work, per se.  The EU’s thinking stems from the fact that these free markets are coming under the increasing influence of parties who themselves do not respect free market rules.

Energy is the global economy’s sine qua non.  Any economy that possesses cheap and abundant energy and cheap money is positioned for growth. Either of those two factors fail and we’re talking a possible recession.  Both fail and we’re screaming pain.

The EU is pondering a quandary that markets haven’t ever really had to consider.  In the past the markets have been too powerful for vested interests to disturb with any meaningful success.  Such is the power of money.  Such has been the value of cheap strategic resources.

The fact of the matter is that expensive energy is a difficult and challenging enough obstacle for the global economy.  Any increased regulation of markets would make that obstacle all the more complex and protracted.  The inevitable consequence is confusion and uncertainty.  Add those ingredients to a recipe of a liquidity crisis and volatile oil prices and the global economy will have to do something fairly spectacular to continue to sustain its value.

The FT’s front page this morning confirms one thing:  reading market performance is becoming an increasingly political affair.  Read the politics right and you’ll be more than halfway to reading the markets.