This is a chart of the CRB commodities index which shows that all price gain by the index, for the past two years, has been wiped out.
Isn't this a little weird? I mean, it wasn't that long ago that the world was on the brink of a fiscal disaster, and is perhaps still trying to find its feet. Shouldn't commodities be booming? And considering that both crude oil and the CRB index are dollar denominated, where and how did the USD find such strength?
It all started with carry trade unwinding. Carry trade is the name given to the practice of borrowing a currency (yen) with low interest rate, converting it to a higher interest paying currency (USD) and depositing it in banks with high credit ratings. So basically you make money, using your line of credit, by taking advantage of the difference in interest rates.
These funds then make their way into the interbank lending market in euro or risky dollar assets. But the plunging securities and equities markets have triggered a reversal. Credit limits have been tightened to compensate for the losses in other markets. Which has brought about the unwinding of the carry trade. This, in turn, means less liquidity all around and therefore lots of players running after the dwindling supply of the USD, pushing it higher.
Trillions have been lost across the world's crashing stock markets. Which has meant a reduction in the money supply available to the world at large, either in terms of credit, or cash valuation of share certificates held. Even the massive cash injections by the world's central banks are not sufficient to offset this loss to the world's financial system. And so, the liquidity crunch continues.
Shrinking credit markets leading to shrinking liquidity results in a reduction of financing available to the real economy. This leads to an onset of recession, first in the US and then followed by a chain reaction leading to recessions all across the world.
The US is the world’s largest consumer. And the first country to suffer the full negative effects of a US recession is likely to be China, being its largest trading partner. The Chinese economy is heavily dependent on exports to the US and a recession in China will mean a slump in its huge demand for natural resources and commodities. Now, this Chinese demand has been one of the major forces behind the previous boom in those markets. The current decline in commodity prices is perhaps a reflection of the realization of this fact.
As the saying goes, when the US catches a cold, the world gets the flu. The reason is that the entire global financial system is set up in such a way that the US effectively controls global money supply and all other countries are, like it or not, hostages to the US currency.
But that may change in the future. This could perhaps be the the first step on the path to a new world order.