What have the banks done to the markets making them unable to bear cheap oil?

Members of the European Parliament make a visit to the stock exchange in Shanghai, China. ( ©European Union EP/PE ).

Last Tuesday, a new steep fall of the price of crude oil by almost 5%, triggered another selloff in all the major capital markets of the world. The New York and the European stock exchanges lost anything between 2% and 3% of their capitalization. One may observe that this development is one of many of the kind we have witnessed just after the first day of 2016. However, this latest development demonstrated a very clear connection between the price of oil and the general indexes of all key stock exchanges. Undoubtedly, it was a really new and exemplarily solid correlation.

It’s a bit awkward though that the world stock markets – and together with them the prospects of the global economy – are so straightforwardly following the fall of the prices of oil. And this despite the fact that most of the big developed and developing countries are great oil consumers. A first year student of economics would logically expect them to increase growth gear on so much cheaper oil.

Biased economic analysts?

On the contrary, many mainstream economic analysts support a just coined theory, that cheap oil is not a very good base for faster growth for the real economy of our energy thirsty world. They argue that the global economy doesn’t necessarily profit from cheaper oil. There may be some truth in this claim, because oil producers are now having a hard time and consequently are extensively cutting down their purchases from the rest of the world. In this line of thinking, the prospects for the world economy are worse at times of very cheap oil, and that’s why stock markets keep falling.

Nevertheless, this is the first time in the history of economic theories that Russia, Saudi Arabia, the United Arab Emirates, Venezuela and Kuwait are thought to be setting the tempo for the global economy. They may be very important players in the international oil arena, but they have never set the path for the developing economies and of course not for the developed ones.

How much growth is enough?

In any case, the world economy is not doing that bad. According to IMF’s World Economic Outlook of last January, global growth is expected to increase this year and reach 3.4% after a modest 3.1% in 2015. For 2017 is predicted to reach 3.7%, not at all a bad prospect. The same source refers to the “exit from extraordinarily accommodative monetary conditions in the United States” as one of the major “Risks to the global outlook… relate to ongoing adjustments in the global economy”.

In plain English, this means that the difficult part for the world economy is the adjustment of the giant banks, in the new environment of gradual exit from the super generous ‘money for nothing’ policy, the American central bank, the Fed has followed since 2008 and up to December 2015. Mind you, that there is an ongoing quasi blackmail of the ‘markets’ aka banks towards the Fed, to water down its plan to exit from the ‘money for nothing’ policy.

They do need more than $4.5 trillion

Of course, the Fed’s $4.5 free trillions have been handed out only to the largest world banks and now it seems difficult for them to learn living without it or with less and a bit more expensive of it. It seems, though, that this is not the only problem for banks and their relationship with the oil markets needs more attention.

A suspicious observer has to look for more hidden corners in the currently very delicate and complex situation in the global financial scenery. And this hidden corner is the newly emerging tight correlation of the price of crude oil with the major stock market indexes. The conclusion then comes freely; stock markets led by banks seem very exposed to oil prices. In short, the banks have now one more challenge to face. Apart from being completely dependent on the Fed’s super accommodative monetary policy which has to change now, they also have to cope with their now emerging new exposure to the oil market. Let’s see what has happened.

What if some oil bubbles bust?

Apparently the banks have used the Fed liquidity and to a smaller extent the money from other monetary authorities to place massive bets in the derivative markets related to oil and other commodities. In short, the banks have used the free trillions from the monetary authorities to profit from those underlying real markets but at the same time having created unbelievably dangerous bubbles.

As a result, the vertical fall of the price of oil has caused substantial losses for the banks and consequently has hurt the stock markets. In reality, the global real economy has no problem whatsoever with the falling oil prices as it has always been the case, at the newfound exception though of the ‘too big to fail’ banks.

The banks will get more money

As a matter of fact, the vast size of the banks and the immense volume of the out of control grey derivative markets now threaten once more the real economy with another financial Armageddon. However, the monetary authorities armed with the experience of the 2008-2010 crisis are aware of this new menace. That’s why the other major central banks in Europe, China, Japan and elsewhere appear ready to fill the gap that the Fed plans to leave in the ‘money for nothin’ game.

The ECB is ready next month to expand its extraordinary monetary easing measures beyond the limit recently set at €1.8tn to 2tn. Even more so, because the Eurozone lenders seem to be more exposed to risks than their American counterparts. Deutsche Bank is a disappointing example of that. That’s why Germany will very probably not block Mario Draghi’s new quantitative easing initiative.

Alas, it’s pretty clear that the world real economy is once more threatened by the ‘too big to fail’ financial conglomerates.