Sunday, July 16, 2006
It's The Crude, Dude!
Public confidence, the main governing variable of real estate and financial markets in North America, stems out from and finds its roots right in the center of Jerusalem.
QUESTION: what do North-American real property owners have to do with the Middle East conflict? ANSWER: everything and anything they can possibly imagine.
Fluctuations in the world economy are largely driven by confidence. A changing level of public confidence is the ultimate driver behind much of the variation in individual and national incomes, in employment rates, in corporate earnings, in interest rates and in many other measures of the world economy. All the more so when nations, and indeed entire continents, are as economically intertwined as nowadays. In these times of globalization, the political-economic policies of the European Union, for good or bad, are exported to North America. Unrest in China or a terrorist attack in Mumbai are reflected in the public confidence of financial and investment markets. A more and more despotic and dictatorial Putin has the effect of altering the commodities markets by undermining investors' confidence worldwide.
But there is nothing, nothing at all short of another September 11 disaster that works so much as an impediment to financial and real estate markets in North America than a conflict in the Middle East. And this week's attack of Lebanon on Israel is yet another proof of it. Just take a look at the dive of the Dow Jones of these past few days. Just take a look at the spike of the price of crude. To be sure, it is not so much the Lebanese or Hizbollah per se that kill investors' confidence in North America. Afterall the Lebanese or Hizbollah are, taken all and by themselves, nothing more than a bunch of ignorant, fanatical boors. But it is what's behind them that worries Capitalism.
It's the crude, dude!
There is a very specialized field of Economics, known as ‘Behavioral Finance', which applies scientific research on human and social cognitive and emotional biases to better understand economic decisions and how they affect market prices, returns and the allocation of resources. Behavioral Finance is the heart of Capitalism, the pump that moves money worldwide. To better realize how important is Behavioral Finance, one must understand that one of the tenets of Capitalism is that democracy has significant indirect effects which contribute to growth. Democracy is associated with higher capital accumulation, lower inflation, less political instability, and greater economic freedom. Anytime democracy is threatened either by war, terrorism or unwarranted attacks to free and sovereign countries, even in places as far away as the Middle East, Capitalism grinds to a halt. Capitalism abhors the uncertainty created by political instability.
This particular concept is very clear to the ‘Masters of Capitalism' - all the American Administrations since the end of WWII. And of all places on the planet, no one is as important to Capitalism as the oil fields of Islam. This is the reason for American direct political involvement in the Middle East since mid-1947, following the departure of Britain from Palestine and the creation of the State of Israel. This is also one of the key reasons behind Washington's intervention in Iraq - to take control of that country's massive oil resources. Controlling the region in order to ensure US access to its ample oil resources has been one of the key features of American foreign policy for decades, dictated in large part by Arab flimsiness and unreliability. And in light of this policy, a strong, powerful and nuclear Israel has been and is the best sentry America can have in the region. Thus the USD 4 billion plus that America shells out to Israel annually in loans, grants, financial aids and military armaments, as well as the political support at the United Nations (another unreliable organization in large part financed by America).
Oil is essential to the economies of the industrialized world, at least for now. Yet it is a finite resource, and there is less of it in the Earth's crust than the general public probably wants to realize. We have at least enough to last for another few decades - although that is not a huge amount of time, considering how central oil is to our lives. Furthermore, while we are not about to run out of oil, we may soon run out of cheap oil. That is, oil which can be pumped out of the ground without great difficulty, and that therefore can be brought to markets at the sort of prices we have become accustomed to in recent years. In the coming decades, we can expect an intensified international competition, even military rivalry, over the increasingly valuable remaining reserves of cheap oil, most of which are located in the volatile Middle East.
In light of this geopolitical and economic context, naturally one might expect a relation between oil and house prices, since high oil prices tend to damage the economy and hence people's ability to pay for their homes. They also raise the cost of heating a home. There ought to be at least some relation, since an oil price boom can create a recession, and recessions tend to be bad for housing markets.
An examination of oil price behavior in recent decades indicates, in general lines, that oil prices rose abruptly between 1973 and 1974, during the first oil crisis thanks to the supply squeeze by OPEC, the oil-producers' cartel. Oil increased again between 1979 and 1980, during the second oil crisis, due to the Iranian revolution and the Iran-Iraq War. Overall, oil has remained an expensive commodity since 1974. Starting in 1998, with a brief interruption in 2002, oil prices have increased four-fold. Many have attributed this to demand from fast-growing developing markets like China and India. Moreover, there are fears that, as this growth continues, China and India will make even more extraordinary demands on natural resources like oil. These fears have pushed prices even higher.
Unlike stock prices, which change randomly, house prices are governed by ‘momentum' and sentiment. Therefore, given the recent rises in real estate values and assets appreciation, one might expect further increases later on, even though at present many real estate markets have fizzled out. However, the oil price boom could threaten the world economy, thus bringing with it the end of the housing boom. The ascent of oil price, due especially to the voracious energy appetite of India and China and coupled by the instability in the Middle East, is generating a resurgence of public fears about the oil markets. The sudden public recognition that there could be binding resource constraints as emerging countries develop, may very well encourage potential oil suppliers to hold off on development so that they can sell at higher prices later on. This fact in itself has the potentiality of creating higher prices today, sparking a prolonged speculative oil bubble that can spell real trouble for the stock and housing markets.
Indeed, the risk of such an oil bubble can be the biggest threat to the world economy - if not now, in the coming years. There is even a danger that, instead of looking at ways of reducing consumption or for alternative sources, we will become transfixed by the risks of high oil prices to an increasingly competitive world economy.
It is clear now, therefore, how relevant is the stability in the Middle East to real estate markets in North America. As I said before ... It's the crude, dude.
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