Irrationally Rational

It is interesting to talk to colleagues and find them scratching their heads on why commodities fell so sharply last week and why the rumour on Greece exiting the Eurozone was floated. I used to do that too and perhaps, still do on some maters. On these two, I have come to the conclusion that searching for rational clues is irrational. Commodity collapse was engineered just to slow down the pace of appreciation. It is a substitute for meaningful action to end the commodities boom and that is to raise interest rates. The Fed won’t do that. Check out my piece in MINT. 

Nor does it want to end the commodites boom since its favourite Wall Street would lose an important source of profit. At the same time, the pressure to do something was rising. Emerging economies were hurting and gasoline price was at 4 dollars per gallon.

So, throw some sand gravel under the juggernaut. That is what the Commodities Futures Trading Commission did with its huge increment to the margin requirement on silver trading. That set off alarm bells in other commodities classes too. Bingo, we had some breather. Different story that it is unlikely to last more than a couple of weeks, at most.

The same irrational framework should be used to understand the rumours of Greek exit from the Eurozone. It was not going to happen. It would be messy, ugly and would set off a chain reaction had to control and hard to fathom. But, it helped to weaken the Euro. That is what the Eurozone needed. The Euro is overvalued against the US dollar by about 20% to 30%, according to various calculations.

The European Central Bank cannot set out to weaken it . America would not like it nor America would help the dollar by raising interest rates. Germany has an inflation problem and hence it prefers to see a strong Euro and higher interest rates. That medicine does not work for the other Eurozone countries. So, the next best thing is to engineer artificial depreciation of the Euro, even if shortlived.

These are not the ways to run the world eocnomy,  I know.  But, this is the path policymakers are locked into by their own past actions, their personal ideologies, their ties to special interests, etc.

One more way of doing away with the search for rational clues is to start connecting dots.  Here is an example. Read this news story in Reuters (ht: Felix Salmon) on how Goldman Sachs is working feverishly and furiously to dilute the Volcker Rule; then read this brief interview that the journalist who wrote this news-story had with Mr. Paul Volcker, then read this blog post by Felix Salmon on the Federal Reserve and how seriously (?) it takes banking regulation.  Finally, read Bernanke’s ‘response’ to Felix Salmon’s poser here.

I suspect that we would have to rely on seemingly irrational explanations more in the next two years as the existing order begins to unravel. Once it completely unravels, we can then go back to looking for sane explanations for what we see around us.

This post originally appeared at The Gold Standard and is reproduced here with permission.