Global Agenda: Nothing to fear but fear itself

The Israeli offensive against Hizbullah has overshadowed everything else.

It was, of course, Franklin D. Roosevelt who coined the phrase "Nothing to fear but fear itself," in the context of the Great Depression of the 1930', but his idea has since been applied across a very wide range of subjects. It is especially apt in the context of the global showdown with Islamist terrorism - in more ways than meet the eye. Undoubtedly, the outstanding event of the past 10 days from a global perspective has been the Israeli offensive against Hizbullah. This has overshadowed everything else - from the meeting of the G-8 leaders whose agenda was effectively hijacked, to the victims of another Asian tsunami whose fate was ruthlessly shoved to the margins of media interest. In the financial markets, however, this week has been quite different from last week. The final three days of last week saw a massive wave of selling across global equity markets while oil and gold prices jumped - in short, all the things that are supposed to happen when there is a geopolitical crisis took place. This week saw precisely the opposite occur. The most important element within this general trend, surely, has been the decline in the price of oil: "Wednesday marks the third day in a row that oil prices have fallen after hitting a record trading high of $78.40 Friday, bringing its loss over that period to more than 8%" is how CNN reported oil market activity on Wednesday. Despite the latest price action, the consensus opinion is now extremely bullish on oil and prices are expected to climb much higher, especially if there are further stimuli, such as hurricanes, wars and the like. However, short of a direct US attack on Iran, the market has had as much stimulus as it could hope for - and has been found wanting. It, therefore, seems, to me at least, that the suspicions aired here recently - that the boom in the price of oil was basically over - have been strongly supported by the events of the past two weeks. Last week, when panic gripped the markets, oil managed to climb five dollars or so a barrel. Since this move marked "new all-time highs," it grabbed big headlines even in the general press. But the truth is that this was a wimpy performance. Had the biggest military operation mounted by Israel in decades taken place last year, oil would have jumped not five, but 10 or 15 dollars - because that's what it did on lesser "opportunities" in 2004-05. This week, as noted, prices fell. Meanwhile, the mainstream media remain convinced that the price is set to jump to $100 or $120 a barrel. Why should this happen? Because, say the pundits, the market is no longer being driven by normal supply and demand factors. Instead, a massive risk premium has developed because of geopolitical risk. Take, for example, the following extract from a column by Robert Samuelson in "Newsweek" this week: "Oil markets are operating on fear. The gap between demand and productive capacity is tiny, perhaps 1 million or 2 million barrels a day. Because oil demand is what economists call "inelastic" (meaning that consumers see fuel as essential and curb their buying only slightly as prices rise), even modest threats to supply can create big price increases." That's absolutely right. That's exactly what happened from June 2003 until quite recently. However, it is apparent from the recent price action that this is no longer the case. When the risk premium was becoming the key factor driving prices, most analysts refused to recognize it. Now, everyone and their dog knows that oil is going to $100 because "the markets are operating on fear." But suppose they aren't. Suppose the G-8 decides to let Israel clobber Hizbullah, as a way of setting back Iranian ambitions in the entire region. Suppose the Saudis silently scream support for Israel from the sidelines in an effort to thwart the Shi'ite theocracy that threatens the Wahhabi theocracy in Saudi Arabia. Suppose the Israelis do everyone's dirty work and make the Iranians look stupid. Then the fear factor in the oil market - which is a critical part of the whole Iranian bluff - actually goes down. When the fear factor declines, the price declines and Iranian oil revenues decline and the whole Persian rug unravels. What happens next? Well, on the way up, the experts kept telling us that prices could only rise a few more dollars, at most, because of basic supply and demand factors. Now the consensus is that prices might fall but no further than the mid-$60s because of underlying supply constraints and surging demand. I'm afraid not.