Disarm: The Lesson of the Georgia Fiasco
George Bush, with the clock ticking down the last months of his presidency, nearly started yet another war that might have escalated in the manner of World War I: a diplomatic failure backed by arms that resulted in a superpower clash.
It is a wonder that the world has survived his "war on terror," which turned out to be a war on American liberty and anyone in the world who got on his nerves. His confrontation with Russia in defense of a belligerent little client state of the United States could have sealed his fate and ours too.
We need to examine Bush's actions and see how the United States nearly stumbled into a calamity. For in the last weeks, we have gained a picture of the future with this continued push for a secure American world empire with its endless webs of payments, relationships, jockeying for power and treasure, and a diplomatic corps honeycombed with belligerents and lobbyists for foreign governments. The peace, such as it is, can be shattered through small screw-ups that will end in massive death.
Make no mistake about it: the flare-up was caused entirely by US diplomatic failures. You wouldn't know this, however, if all you did was watch television news. Fox and CNN have portrayed Georgian president Mikheil Saakashvili as a benevolent leader of a "young democracy" struggling in the shadow of the mighty bear Russia.
In fact, Saakashvili was elected on a "National Movement" ticket with a centralizing, revanchist platform of retaking the autonomous provinces in the Caucasus, and he has ruled this country the size of South Carolina with an iron fist under a state of emergency for years. He had every intention of ruling these non-Georgian peoples who do not want to be ruled by him, as even the CIA admits. As for his domestic program, it has consisted mostly of cracking down on tax evasion and beefing up state coffers.
After smashing the province Ajaria in 2004 following his rigged election, and then crushing Kodori Gorge in Abhkazia (which even has a separate language) in 2006, he moved on to South Ossetia (which also has its own language) this year, where Ossetians and Russians live and Russian peacekeepers patrol.
A young democracy? Ossetians never voted for Saakashvili. But he insisted on ruling them anyway, moving militarily and bombing the capital in the middle of peace talks on the opening day of the Olympics.
Tin-pot, fascist minidictators like this are a dollar a dozen, and such territorial disputes will always be with us. The critical question is, what gave Saakashvili the confidence that he could pull this off? He believed that the United States would back him as a quid pro quo for his having sent troops to Iraq. The United States responded to his cooperation in Iraq — sending Georgian citizens to kill and be killed — by sending him military training support and guns and bombs, and wining and dining him in Washington.
In all the confusion of the last days, there is no question, then, that Georgia was the aggressor in South Ossetia. Russia responded within its sphere of influence both against Georgia but mostly against an incredible show of arrogance by the Bush administration. According to the New York Times, which interviewed many officials who refused to be named, the Bush administration began backpedalling very quickly, claiming that they never gave permission to Georgia to crush any separatist movement.
But by that time, the politics began. In a very scary editorial and series of speeches, John McCain all but threatened nuclear war against Russia, failing to mention that his own foreign policy adviser was a paid lobbyist for Georgia. Had McCain had his way, the United States very well might have a hot war going on right now on the Russian border, fighting for the privilege of a dictator to crush the rights of South Ossetians to their own self-determination.
No doubt that had the conflict continued — and it still might — we would have been told that we were fighting for the rights of the poor Georgian people against Russian imperialism. The American media, even before looking at the facts, had already decided who wore the halo and who wore the horns in this struggle, giving loving interviews to liars of all stripes, so long as they took the US line.
None of which is to say that Russia wears the halo and Georgia the horns. In war, blood ends up on the hands of everyone involved, and there is no shortage of evidence to prove the case against any and all governments involved.
What we need to fix on here are the first principles. It's an upside-down world, not all that different from the one that existed at the start of World War I, another conflict that was said to be about fighting against aggression and for democracy and self-determination. As Francis Neilson said in his 1915 classic How Diplomats Make War, "No country thinks of putting these principles into practice, but somehow they seem to be worth fighting for."
If we are to follow Neilson further, we will see that in his lessons of the start of that war, he takes aim at a central pillar of diplomacy then and now, namely the claim that the proliferation of arms guarantees the peace. He quotes Richard Cobden: "the greatest evil connected with these rival armaments is that they destroy the strongest motives for peace."
So it has been in these diplomatic games played by our rulers. They believe they are controlling the world, when suddenly they are controlled by events. Then they rope the rest of us into it, following the usual plan of war: forcing the rest of us to adopt the government's view of who is wearing the halos and horns, regardless of the facts:
During a war it is no easy task to prevent your sympathy clouding your reason. The whole social system seems to be organized against any individual attempt to concentrate the attention dominantly upon the causes of the war. Governments, churches, theatres, the press, and local authorities, direct their efforts, in the main, warwards; the whole thought of society and commerce seems to be occupied with war; and all desire to question the reasons given by statesmen for participating in the war must be suppressed. It has been ruled already by certain 'leaders of thought' that it is unwise, unpatriotic, and un-English, to suspect the motives of Governments, or waver for a moment in swearing wholehearted allegiance to the authorities: you must think only of the war. If you dare ask for the truth, you are helping the enemy; if you suggest an early peace, you are hindering the militarists who desire no peace until their enemy is utterly crushed. Insidious, bewildering, and plausible, are the reasons given by statesmen and journalists for inflicting a humiliating defeat; without it, they tell us we must not hope for disarmament. No patriot is supposed to ask if disarmament is at all probable. No one must ask if a single statesman really believes such a blessing will follow if the enemy be annihilated.
In just a few short days recently, we started this whole process beginning to play itself out, in an ominous sign for the future. But it is a future that can change. As Neilson wrote, "Citizens who desire peace can indulge in no greater folly than that which is summed up in the phrase, 'the best way to preserve peace is to prepare for war.' … Governments have made the war; only the peoples can make an unarmed peace."
Bernanke's Speech on Economy at Jackson Hole Conference (Text)
Aug. 22 (Bloomberg) -- The following is a reformatted version of Federal Reserve Chairman Ben S. Bernanke's speech today at the Kansas City Fed's annual conference in Jackson Hole, Wyoming:
Reducing Systemic Risk
In choosing the topic for this year's symposium -- maintaining stability in a changing financial system -- the Federal Reserve Bank of Kansas City staff is, once again, right on target. Although we have seen improved functioning in some markets, the financial storm that reached gale force some weeks before our last meeting here in Jackson Hole has not yet subsided, and its effects on the broader economy are becoming apparent in the form of softening economic activity and rising unemployment. Add to this mix a jump in inflation, in part the product of a global commodity boom, and the result has been one of the most challenging economic and policy environments in memory.
The Federal Reserve's response to this crisis has consisted of three key elements. First, we eased monetary policy substantially, particularly after indications of economic weakness proliferated around the turn of the year. In easing rapidly and proactively, we sought to offset, at least in part, the tightening of credit conditions associated with the crisis and thus to mitigate the effects on the broader economy. By cushioning the first-round economic impact of the financial stress, we hoped also to minimize the risks of a so-called adverse feedback loop in which economic weakness exacerbates financial stress, which, in turn, further damages economic prospects.
In view of the weakening outlook and the downside risks to growth, the Federal Open Market Committee (FOMC) has maintained a relatively low target for the federal funds rate despite an increase in inflationary pressures. This strategy has been conditioned on our expectation that the prices of oil and other commodities would ultimately stabilize, in part as the result of slowing global growth, and that this outcome, together with well-anchored inflation expectations and increased slack in resource utilization, would foster a return to price stability in the medium run. In this regard, the recent decline in commodity prices, as well as the increased stability of the dollar, has been encouraging. If not reversed, these developments, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next year. Nevertheless, the inflation outlook remains highly uncertain, not least because of the difficulty of predicting the future course of commodity prices, and we will continue to monitor inflation and inflation expectations closely. The FOMC is committed to achieving medium- term price stability and will act as necessary to attain that objective.
The second element of our response has been to offer liquidity support to the financial markets through a variety of collateralized lending programs. I have discussed these lending facilities and their rationale in some detail on other occasions.1 Briefly, these programs are intended to mitigate what have been, at times, very severe strains in short-term funding markets and, by providing an additional source of financing, to allow banks and other financial institutions to deleverage in a more orderly manner. We have recently extended our special programs for primary dealers beyond the end of the year, based on our assessment that financial conditions remain unusual and exigent. We will continue to review all of our liquidity facilities to determine if they are having their intended effects or require modification.
The third element of our strategy encompasses a range of activities and initiatives undertaken in our role as financial regulator and supervisor, some of which I will describe in more detail later in my remarks. Briefly, these activities include cooperating with other regulators to monitor the health of individual financial institutions; working with the private sector to reduce risks in some key markets; developing new regulations, including new rules to govern mortgage and credit card lending; taking an active part in domestic and international efforts to draw out the lessons of the recent experience; and applying those lessons in our supervisory practices.
Closely related to this third group of activities is a critical question that we as a country now face: how to strengthen our financial system, including our system of financial regulation and supervision, to reduce the frequency and severity of bouts of financial instability in the future. In this regard, some particularly thorny issues are raised by the existence of financial institutions that may be perceived as ``too big to fail'' and the moral hazard issues that may arise when governments intervene in a financial crisis. As you know, in March the Federal Reserve acted to prevent the default of the investment bank Bear Stearns. For reasons that I will discuss shortly, those actions were necessary and justified under the circumstances that prevailed at that time. However, those events also have consequences that must be addressed. In particular, if no countervailing actions are taken, what would be perceived as an implicit expansion of the safety net could exacerbate the problem of ``too big to fail,'' possibly resulting in excessive risk-taking and yet greater systemic risk in the future. Mitigating that problem is one of the design challenges that we face as we consider the future evolution of our system.
As both the nation's central bank and a financial regulator, the Federal Reserve must be well prepared to make constructive contributions to the coming national debate on the future of the financial system and financial regulation. Accordingly, we have set up a number of internal working groups, consisting of governors, Reserve Bank presidents, and staff, to study these and related issues. That work is ongoing, and I do not want to prejudge the outcomes. However, in the remainder of my remarks today I will raise, in a preliminary way, what I see as some promising approaches for reducing systemic risk. I will begin by discussing steps that are already under way to strengthen the financial infrastructure in a manner that should increase the resilience of our financial system. I will then turn to a discussion of regulatory and supervisory practice, with particular attention to whether a more comprehensive, systemwide perspective in financial supervision is warranted. For the most part, I will leave for another occasion the issues of broader structural and statutory change, such as those raised by the Treasury's blueprint for regulatory reform.2
Strengthening the Financial Infrastructure
An effective means of increasing the resilience of the financial system is to strengthen its infrastructure. For my purposes today, I want to construe ``financial infrastructure'' very broadly, to include not only the ``hardware'' components of that infrastructure--the physical systems on which market participants rely for the quick and accurate execution, clearing, and settlement of transactions--but also the associated ``software,'' including the statutory, regulatory, and contractual frameworks and the business practices that govern the actions and obligations of market participants on both sides of each transaction. Of course, a robust financial infrastructure has many benefits even in normal times, including lower transactions costs and greater market liquidity. In periods of extreme stress, however, the quality of the financial infrastructure may prove critical. For example, it greatly affects the ability of market participants to quickly determine their own positions and exposures, including exposures to key counterparties, and to adjust their positions as necessary. When positions and exposures cannot be determined rapidly--as was the case, for example, when program trades overwhelmed the system during the 1987 stock market crash--potential outcomes include highly risk-averse behavior by market participants, sharp declines in market liquidity, and high volatility in asset prices. The financial infrastructure also has important effects on how market participants respond to perceived changes in counterparty risk. For example, during a period of heightened stress, participants may be willing to provide liquidity to a market if a strong central counterparty is present but not otherwise.
Considerations of this type were very much in our minds during the Bear Stearns episode in March. The collapse of Bear Stearns was triggered by a run of its creditors and customers, analogous to the run of depositors on a commercial bank. This run was surprising, however, in that Bear Stearns's borrowings were largely secured--that is, its lenders held collateral to ensure repayment even if the company itself failed. However, the illiquidity of markets in mid-March was so severe that creditors lost confidence that they could recoup their loans by selling the collateral. Many short-term lenders declined to renew their loans, driving Bear to the brink of default.
Although not an extraordinarily large company by many metrics, Bear Stearns was deeply involved in a number of critical markets, including (as I have noted) markets for short-term secured funding as well as those for over-the-counter (OTC) derivatives. One of our concerns was that the infrastructures of those markets and the risk- and liquidity-management practices of market participants would not be adequate to deal in an orderly way with the collapse of a major counterparty. With financial conditions already quite fragile, the sudden, unanticipated failure of Bear Stearns would have led to a sharp unwinding of positions in those markets that could have severely shaken the confidence of market participants. The company's failure could also have cast doubt on the financial conditions of some of Bear Stearns's many counterparties or of companies with similar businesses and funding practices, impairing the ability of those firms to meet their funding needs or to carry out normal transactions. As more firms lost access to funding, the vicious circle of forced selling, increased volatility, and higher haircuts and margin calls that was already well advanced at the time would likely have intensified. The broader economy could hardly have remained immune from such severe financial disruptions. Largely because of these concerns, the Federal Reserve took actions that facilitated the purchase of Bear Stearns and the assumption of Bear's financial obligations by JPMorgan Chase & Co.
This experience has led me to believe that one of the best ways to protect the financial system against future systemic shocks, including the possible failure of a major counterparty, is by strengthening the financial infrastructure, including both the ``hardware'' and the ``software'' components. The Federal Reserve, in collaboration with the private sector and other regulators, is intensively engaged in such efforts. For example, since September 2005, the Federal Reserve Bank of New York has been leading a joint public-private initiative to improve arrangements for clearing and settling trades in credit default swaps and other OTC derivatives. These efforts include gaining commitments from private-sector participants to automate and standardize the clearing and settlement process, encouraging improved netting and cash settlement arrangements, and supporting the development of a central counterparty for credit default swaps. More generally, although customized derivatives contracts between sophisticated counterparties will continue to be appropriate in many situations, on the margin it appears that a migration of derivatives trading toward more-standardized instruments and the increased use of well-managed central counterparties, either linked to or independent of exchanges, could have a systemic benefit.
The Federal Reserve and other authorities also are focusing on enhancing the resilience of the markets for triparty repurchase agreements (repos). In the triparty repo market, primary dealers and other large banks and broker-dealers obtain very large amounts of secured financing from money funds and other short- term, risk-averse investors. We are encouraging firms to improve their management of liquidity risk and to reduce over time their reliance on triparty repos for overnight financing of less- liquid forms of collateral. In the longer term, we need to ensure that there are robust contingency plans for managing, in an orderly manner, the default of a major participant. We should also explore possible means of reducing this market's dependence on large amounts of intraday credit from the banks that facilitate the settlement of triparty repos. The attainment of these objectives might be facilitated by the introduction of a central counterparty but may also be achievable under the current framework for clearing and settlement.
Of course, like other central banks, the Federal Reserve continues to monitor systemically important payment and settlement systems and to compare their performance with international standards for reliability, efficiency, and safety. Unlike most other central banks, however, the Federal Reserve does not have general statutory authority to oversee these systems. Instead, we rely on a patchwork of authorities, largely derived from our role as a banking supervisor, as well as on moral suasion, to help ensure that the various payment and settlement systems have the necessary procedures and controls in place to manage the risks they face. As part of any larger reform, the Congress should consider granting the Federal Reserve explicit oversight authority for systemically important payment and settlement systems.
Yet another key component of the software of the financial infrastructure is the set of rules and procedures used to resolve claims on a market participant that has defaulted on its obligations. In the overwhelming majority of cases, the bankruptcy laws and contractual agreements serve this function well. However, in the rare circumstances in which the impending or actual failure of an institution imposes substantial systemic risks, the standard procedures for resolving institutions may be inadequate. In the Bear Stearns case, the government's response was severely complicated by the lack of a clear statutory framework for dealing with such a situation. As I have suggested on other occasions, the Congress may wish to consider whether such a framework should be set up for a defined set of nonbank institutions.3 A possible approach would be to give an agency-- the Treasury seems an appropriate choice--the responsibility and the resources, under carefully specified conditions and in consultation with the appropriate supervisors, to intervene in cases in which an impending default by a major nonbank financial institution is judged to carry significant systemic risks. The implementation of such a resolution scheme does raise a number of complex issues, however, and further study will be needed to develop specific, workable proposals.
A stronger infrastructure would help to reduce systemic risk. Importantly, as my FOMC colleague Gary Stern has pointed out, it would also mitigate moral hazard and the problem of ``too big to fail'' by reducing the range of circumstances in which systemic stability concerns might be expected by markets to prompt government intervention.4 A statutory resolution regime for nonbanks, besides reducing uncertainty, would also limit moral hazard by allowing the government to resolve failing firms in a way that is orderly but also wipes out equity holders and haircuts some creditors, analogous to what happens when a commercial bank fails.
A Systemwide Approach to Supervisory Oversight
The regulation and supervisory oversight of financial institutions is another critical tool for limiting systemic risk. In general, effective government oversight of individual institutions increases financial resilience and reduces moral hazard by attempting to ensure that all financial firms with access to some sort of federal safety net--including those that creditors may believe are too big to fail--maintain adequate buffers of capital and liquidity and develop comprehensive approaches to risk and liquidity management. Importantly, a well-designed supervisory regime complements rather than supplants market discipline. Indeed, regulation can serve to strengthen market discipline, for example, by mandating a transparent disclosure regime for financial firms.
Going forward, a critical question for regulators and supervisors is what their appropriate ``field of vision'' should be. Under our current system of safety-and-soundness regulation, supervisors often focus on the financial conditions of individual institutions in isolation. An alternative approach, which has been called systemwide or macroprudential oversight, would broaden the mandate of regulators and supervisors to encompass consideration of potential systemic risks and weaknesses as well.
At least informally, financial regulation and supervision in the United States already include some macroprudential elements. As one illustration, many of the supervisory guidances issued by federal bank regulators have been motivated, at least in part, by concerns that a particular industry trend posed risks to the stability of the banking system as a whole, not just to individual institutions. For example, following lengthy comment periods, in 2006, the federal banking supervisors issued formal guidance on underwriting and managing the risks of nontraditional mortgages, such as interest-only and negative amortization mortgages, as well as guidance warning banks against excessive concentrations in commercial real estate lending. These guidances likely would not have been issued if the federal regulators had viewed the issues they addressed as being isolated to a few banks. The regulators were concerned not only about individual banks but also about the systemic risks associated with excessive industry-wide concentrations (of commercial real estate or nontraditional mortgages) or an industry-wide pattern of certain practices (for example, in underwriting exotic mortgages). Note that, in warning against excessive concentrations or common exposures across the banking system, regulators need not make a judgment about whether a particular asset class is mispriced--although rapid changes in asset prices or risk premiums may increase the level of concern. Rather, their task is to determine the risks imposed on the system as a whole if common exposures significantly increase the correlation of returns across institutions.
The development of supervisory guidances is a process which often involves soliciting comments from the industry and the public and, where applicable, developing a consensus among the banking regulators. In that respect, the process is not always as nimble as we might like. For that reason, less-formal processes may sometimes be more effective and timely. As a case in point, the Federal Reserve--in close cooperation with other domestic and foreign regulators--regularly conducts so-called horizontal reviews of large financial institutions, focused on specific issues and practices. Recent reviews have considered topics such as leveraged loans, enterprise-wide risk management, and liquidity practices. The lessons learned from these reviews are shared with both the institutions participating in these reviews as well as other institutions for which the information might be beneficial. Like supervisory guidance, these reviews help increase the safety and soundness of individual institutions but they may also identify common weaknesses and risks that may have implications for broader systemic stability. In my view, making the systemic risk rationale for guidances and reviews more explicit is certainly feasible and would be a useful step toward a more systemic orientation for financial regulation and supervision.
A systemwide focus for financial regulation would also increase attention to how the incentives and constraints created by regulations affect behavior, especially risk-taking, through the credit cycle. During a period of economic weakness, for example, a prudential supervisor concerned only with the safety and soundness of a particular institution will tend to push for very conservative lending policies. In contrast, the macroprudential supervisor would recognize that, for the system as a whole, excessively conservative lending policies could prove counterproductive if they contribute to a weaker economic and credit environment. Similarly, risk concentrations that might be acceptable at a single institution in a period of economic expansion could be dangerous if they existed at a large number of institutions simultaneously. I do not have the time today to do justice to the question of the procyclicality of, say, capital regulations and accounting rules. This topic has received a great deal of attention elsewhere and has also engaged the attention of regulators; in particular, the framers of the Basel II capital accord have made significant efforts to measure regulatory capital needs ``through the cycle'' to mitigate procyclicality. However, as we consider ways to strengthen the system for the future in light of what we have learned over the past year, we should critically examine capital regulations, provisioning policies, and other rules applied to financial institutions to determine whether, collectively, they increase the procyclicality of credit extension beyond the point that is best for the system as a whole.
A yet more ambitious approach to macroprudential regulation would involve an attempt by regulators to develop a more fully integrated overview of the entire financial system. In principle, such an approach would appear well justified, as our financial system has become less bank-centered and because activities or risk-taking not permitted to regulated institutions have a way of migrating to other financial firms or markets. Some caution is in order, however, as this more comprehensive approach would be technically demanding and possibly very costly both for the regulators and the firms they supervise. It would likely require at least periodic surveillance and information-gathering from a wide range of nonbank institutions. Increased coordination would be required among the private- and public-sector supervisors of exchanges and other financial markets to keep up to date with evolving practices and products and to try to identify those which may pose risks outside the purview of each individual regulator. International regulatory coordination, already quite extensive, would need to be expanded further.
One might imagine also conducting formal stress tests, not at the firm level as occurs now, but for a range of firms and markets simultaneously. Doing so might reveal important interactions that are missed by stress tests at the level of the individual firm. For example, such an exercise might suggest that a sharp change in asset prices would not only affect the value of a particular firm's holdings but also impair liquidity in key markets, with adverse consequences for the ability of the firm to adjust its risk positions or obtain funding. Systemwide stress tests might also highlight common exposures and ``crowded trades'' that would not be visible in tests confined to one firm. Again, however, we should not underestimate the technical and information requirements of conducting such exercises effectively. Financial markets move swiftly, firms' holdings and exposures change every day, and financial transactions do not respect national boundaries. Thus, the information requirements for conducting truly comprehensive macroprudential surveillance could be daunting indeed.
Macroprudential supervision also presents communication issues. For example, the expectations of the public and of financial market participants would have to be managed carefully, as such an approach would never eliminate financial crises entirely. Indeed, an expectation by financial market participants that financial crises will never occur would create its own form of moral hazard and encourage behavior that would make financial crises more, rather than less, likely.
With all these caveats, I believe that an increased focus on systemwide risks by regulators and supervisors is inevitable and desirable. However, as we proceed in that direction, we would be wise to maintain a realistic appreciation of the difficulties of comprehensive oversight in a financial system as large, diverse, and globalized as ours.
Conclusion
Although we at the Federal Reserve remain focused on addressing the current risks to economic and financial stability, we have also begun thinking about the lessons for the future. I have discussed today two strategies for reducing systemic risk: strengthening the financial infrastructure, broadly construed, and increasing the systemwide focus of financial regulation and supervision. Work on the financial infrastructure is already well under way, and I expect further progress as the public and private sectors cooperate to address common concerns. The adoption of a regulatory and supervisory approach with a heavier macroprudential focus has a strong rationale, but we should be careful about over-promising, as we are still rather far from having the capacity to implement such an approach in a thoroughgoing way. The Federal Reserve will continue to work with the Congress, other regulators, and the private sector to explore this and other strategies to increase financial stability.
When we last met here in Jackson Hole, the nature of the financial crisis and its implications for the economy were just coming into view. A year later, many challenges remain. I look forward to the insights into this experience that will be provided by the papers at this conference.''
Aug. 22 (Bloomberg) -- Crude oil may tumble to $80 a barrel within 12 months as supplies of alternative energy increase, while grain prices may climb on emerging-market demand, said Renee Haugerud, whose hedge fund gained 18 percent this year.
The surge in oil has been ``overdone'' by investors seeking holdings in raw materials through the Standard & Poor's GSCI Index, a commodity gauge weighted toward energy, she said. Industrial metals also rose too high, she said.
``They were the sexy commodities,'' Haugerud, founder of the $2.5 billion commodities hedge-fund firm Galtere Ltd., said in an Aug. 19 interview in her New York office. ``Everyone wanted to get long an asset class via the GSCI, and let's face it, the GSCI is crude.''
Grains including corn and wheat may double as wealthier populations in nations such as Brazil and Russia eat more meat, boosting demand for livestock feed, Haugerud said. New energy sources such as solar power and ethanol will stall a recovery in oil prices, she said.
Haugerud's flagship fund has surged almost fivefold since starting in 1999. The long-term performance and this year's return were outlined in a letter sent to an investor. She declined to comment on her fund's returns.
Oil has slumped 22 percent from a record $147.27 on July 11. Futures for October delivery tumbled $6.59 to $114.59 today on the New York Mercantile Exchange. The 5.9 percent drop was the most since December 2004.
Energy prices account for 74 percent of the S&P GSCI Index, with crude oil making up 38 percent of the gauge.
`Hard Assets'
Price swings, or volatility, in commodities will continue as investors increase demand for ``hard assets'' as a store of value amid slumping financial markets and negative real-interest rates, Haugerud said.
``Commodities as an asset class are like an emerging market that comes in and out of favor,'' she said. ``It's exciting.''
Haugerud began her career in 1981 trading commodities at Cargill Inc., the largest U.S. agriculture company, and later worked at NatWest Markets, a unit of U.K.-based National Westminster Bank.
Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices and participate substantially in profits from money invested.
They have dropped an average of 3.5 percent this year, according to Chicago-based Hedge Fund Research Inc.'s Global Hedge Fund Index.
The U.S. economy, wallowing in the worst housing crisis since the Great Depression, may have entered a recession, she said. Growth in other countries will probably slow, she said.
`Epicenter of Disaster'
``We might be in a recession here and go into slower global growth in the rest of the world,'' Haugerud said. ``The U.S. financial system is the epicenter of disaster. It's heinous.''
North American banks, including Citigroup Inc. and Merrill Lynch & Co., lead overseas rivals with $252.9 billion in writedowns related to the subprime mortgage market, more than half the global total. The International Monetary Fund has forecast that global losses will total $1 trillion.
Gold may rise to $1,000 an ounce on investor demand for a haven should equity prices tumble, Haugerud said. The precious metal fell $5.50 to $833.50 today in New York and has dropped 19 percent from a record $1,033.90 on March 17.
The commodity surge that started in 2001 and sent prices of copper, corn, soybeans, wheat and gasoline to all-time highs this year may be only a third or halfway through, Haugerud said.
`Not Enough'
``There's too much money in the world, and there are not enough commodities,'' she said.
The Reuters/Jefferies CRB Index of 19 raw materials has dropped 17 percent from the record on July 3 after posting the best first half in 35 years.
Copper may fall ``to the mid $2-a-pound range in the short term in a worst-case scenario,'' should the U.S. housing slump plunge the world's largest economy still deeper into recession, Haugerud said. The metal may be on an ``uptrend'' over the next decade, she said.
Copper futures for December delivery dropped 7.9 cents, or 2.2 percent, to $3.4595 on the Comex division of the Nymex. The price last touched $2.50 in February 2007.
U.S. natural gas is ``a buying opportunity'' at a range of $6 to $8 per million British thermal units, she said. Futures fell to $7.843 today, tumbling 43 percent from $13.694 on July 2. That had marked the highest since December 2005.
Aug. 23 (Bloomberg) -- International observers are arriving in Georgia after Russia announced it had completed a troop pullout under terms of the cease-fire that ended its war with Georgia over the breakaway region of South Ossetia.
Finnish Foreign Minister Alexander Stubb, chairman of the Vienna-based Organization for Security and Cooperation in Europe, said in Tbilisi today the OSCE will deploy 20 armed observers and seven armored personnel carriers into the conflict zone ``this weekend.'' Some monitors have already arrived and another 80 will be deployed in coming weeks, the OSCE said.
``This is significant because an OSCE deployment can only be made with Russian agreement,'' said Jan Techau, a security analyst at the German Council on Foreign Relations in Berlin. Russia is a member of the 56-nation OSCE. ``The OSCE serves as a sort of intelligence-gathering body and will make the situation on the ground far more transparent.''
Defense Minister Anatoly Serdyukov said yesterday Russia had withdrawn its troops -- numbering 10,000 at the peak of the five-day war, according to state-run Russian news service RIA Novosti -- into South Ossetia before their planned pullout to Russia. Vladimir Boldyrev, head of Russian land forces, said on Aug. 21 it would take 10 days to bring those forces home.
The pullback failed to satisfy President George W. Bush, who has called for the full withdrawal of all troops that entered Georgia. Russian troops moved into South Ossetia after Georgia's military advanced into the region, where Russia had 588 peacekeepers before the conflict.
Not `in Compliance'
``We are not seeing that they are in compliance right now,'' White House spokesman Gordon Johndroe said at a briefing in Crawford, Texas, where Bush is spending time at his ranch. ``They have not completely withdrawn from areas considered undisputed territories and they need to do it.''
``The Russians need to withdraw all troops and assets that entered after Aug. 6,'' the day before hostilities broke out in South Ossetia, Johndroe said. ``That's not only what we expect, it's what the French expect, that's what the European Union expects; frankly, it's about what the whole world expects.''
Georgian Foreign Minister Eka Tkeshelashvili said only Russian peacekeepers can remain on Georgian territory under the cease-fire. ``But this is a temporary measure under the agreement,'' she told reporters in Tbilisi. Georgia considers South Ossetia to be part of its territory.
Russia has deployed 272 peacekeepers at eight posts along the edge of a buffer zone that extends as deep as 7 kilometers (4.3 miles) from South Ossetia's border into the rest of Georgia, said Anatoly Nogovitsyn, deputy chief of Russia's General Staff. Another 180 men will be deployed in a second line of posts on the border.
Buffer Zone
``Russia's decision to keep troops in a buffer zone outside of South Ossetia is arrogance aimed at the Georgians,'' said Techau. ``The Western states don't want any violation of Georgian sovereignty.''
Russia rejects such assertions. ``The buffer zones are legitimate and were created within the framework of existing agreements,'' Nogovitsyn said.
The Russians have repeatedly said they are observing the cease-fire brokered by President Nicolas Sarkozy of France, the current holder of the European Union's rotating presidency. The agreement calls for the withdrawal of Georgian and Russian troops, renunciation of the use of force, an end to all military operations and a commitment to making humanitarian aid freely available in the conflict zone.
The first major foreign military operation by Russia since the collapse of the Soviet Union in 1991 widened a rift with the West, which has courted Georgia and Ukraine, both former Soviet republics, to counter the influence of Moscow's leaders in the region.
NATO Membership
Both countries have been promised eventual membership in NATO, which has frozen contacts with Russia to protest its Georgia incursion. Georgia is considered an important strategic ally to the West in part because of its key role in a U.S.- backed ``southern energy corridor'' that connects the Caspian Sea region with world markets, bypassing Russia.
South Ossetia and another region, Abkhazia, broke away from Georgia in wars in the early 1990s. Russian peacekeepers have served in South Ossetia under a 1992 agreement with Georgia. Russia also has 2,142 peacekeepers in Abkhazia under a Commonwealth of Independent States mandate, Nogovitsyn said. Georgian President Mikheil Saakashvili said on Aug. 12 that Georgia is quitting the CIS, a loose grouping of former Soviet republics excluding the Baltic states.
`Nobody Is Safe'
Saakashvili said yesterday that more than Georgia's chances of joining the North Atlantic Treaty Organization is at stake in the conflict.
``It's about the future of NATO,'' he said on the British Broadcasting Corp.'s ``Today'' radio show. ``Basically if NATO fails to come up with a united response, nobody is safe, even if they are in NATO.''
Speaking late yesterday at the country's Security Council, Saakashvili said the Russians must also leave South Ossetia and Abkhazia.
The next geopolitical battle over Georgia will be the future status of those two regions.
Bush has insisted that the regions remain a part of Georgia. Russian President Dmitry Medvedev said on Aug. 14 that Russia will support the regions' decisions on their legal status, though he stopped short of formally recognizing them.
Both houses of Russia's parliament will discuss whether to recognize the two regions in special sessions on Aug. 25. Vadim Gustov, chairman of the Commonwealth of Independent States committee in Russia's Federation Council, said the upper house will back their independence bids, RIA reported. The lower house, the State Duma, may also vote in favor of statehood. Gustov said that under the Russian constitution, the final decision lies with Medvedev, RIA reported.
Abkhazia and South Ossetia have cited Kosovo's Feb. 17 declaration of independence from Serbia as a precedent for their aspirations. Russia, an ally of Serbia, opposed Kosovo independence as illegal, while the U.S. and many European countries supported it.
Aug. 22 (Bloomberg) -- Crude oil fell more than $6 a barrel, dropping the most in percentage terms since December 2004, as the U.S. dollar strengthened and BP Plc restored shipments on a Caspian Sea pipeline through Turkey.
Energy futures fell as the rising dollar eased demand for commodities as an inflation hedge. The Baku-Tbilisi-Ceyhan pipeline, which moves oil from Azerbaijan through Georgia to Turkey's Mediterranean coast, resumed normal flows today after a fire shut it earlier this month, a Turkish official said.
``The dollar sent oil prices higher yesterday and lower today,'' said Rick Mueller, director of oil markets at Energy Security Analysis Inc. in Wakefield, Massachusetts. ``The reopening of the BTC pipeline through Turkey is being greeted with relief because there will be additional barrels of really good-quality crude available.''
Crude oil for October delivery fell $6.59, or 5.4 percent, to settle at $114.59 a barrel at 2:49 p.m. on the New York Mercantile Exchange, the biggest drop on a percentage basis since Dec. 27, 2004. In dollar terms, it was the biggest decline since Jan. 17, 1991, when U.S.-led forces expelled Iraq from Kuwait.
Futures erased yesterday's $6.20 gain. The October contract rose 0.6 percent for the week.
The dollar climbed 0.9 percent to $1.4772 per euro in New York from $1.4899 yesterday, when it fell 1 percent, the biggest decline since June. Dollar-based commodities such as oil and gold are often viewed by investors as a store of value when the currency weakens.
``It's hard to tell whether the dollar is shifting oil or the opposite,'' Mueller said. ``It's obvious that there is a relationship and that they intensify the moves of each other.''
Caspian Supplies
BP, Europe's second-largest oil company, StatoilHydro ASA and partners cut output at Caspian oil fields following the closure of the 1,768-kilometer (1,100-mile) link on Aug. 5. The pipeline is used to carry oil from Azerbaijan through Georgia to Turkey, where it's loaded onto tankers for U.S. and European markets. BP said loadings are scheduled to begin next week.
``The pipeline's flow has returned to normal levels,'' Akif Sam, a spokesman for the Turkish Energy Ministry, said in a telephone interview.
A Ceyhan loading schedule yesterday showed 24 cargoes totaling 18.2 million barrels, or an average of 868,155 barrels a day, will be exported from Aug. 25 to Sept. 14.
``The volume of oil will be ramped up over the weekend, and if everything is set, loadings will begin on Monday,'' said Murat Lecompte, a spokesman for BP in Istanbul. He said some of the oil would be used to replenish supply depots.
Russian Invasion
The shutdown of the BTC pipeline was followed three days later by Russia's invasion of Georgia, which further disrupted Caspian fuel shipments.
Oil prices have also fallen on reduced demand in the U.S., the country responsible for almost a quarter of global oil use. The credit crisis has led to a higher U.S. jobless rate and slower economic growth this year.
``The economy continues to be on the bearish side of the ledger while geopolitical concerns are on the bullish side,'' said Christopher Edmonds, the managing principal of FIG Partners Energy Research & Capital Group in Atlanta. ``In between, there is the dollar, which can send prices either way. I think Russia and the dollar will determine what prices do next week.''
Sixteen of 29 analysts surveyed by Bloomberg News, or 55 percent, said prices will increase through Aug. 29. Seven of the respondents, or 24 percent, said oil will be little changed and six said there would be a drop in prices. Last week 63 percent expected prices to increase.
Brent Oil
Brent crude oil for October settlement declined $6.24, or 5.2 percent, to settle at $113.92 a barrel on London's ICE Futures Europe exchange.
Crude oil may tumble to $80 a barrel within 12 months on increasing supplies of alternative energy, while grain prices may climb on emerging-market demand, said Renee Haugerud, whose hedge fund gained 18 percent this year.
The surge in oil has been ``overdone'' by investors seeking holdings in raw materials through the Standard & Poor's GSCI Index, a commodity gauge weighted toward energy, she said. Industrial metals also rose too high, she said.
The Organization of Petroleum Exporting Countries will probably increase oil supply in August by 400,000 barrels a day, or 1.2 percent, as Iran releases crude oil held in storage, according to preliminary estimates from PetroLogistics Ltd. OPEC will next meet to review production targets on Sept. 9 in Vienna.
Gasoline for September delivery fell 17.66 cents, or 5.8 percent, to settle at $2.8686 a gallon in New York.
Pump prices haven't increased since July 19, according to AAA, the nation's largest motorist organization. Regular gasoline, averaged nationwide, fell 1 cent to $3.692 a gallon, AAA said today on its Web site. Prices reached a record $4.114 a gallon on July 17.
Aug. 22 (Bloomberg) -- U.S. stocks advanced, led by banks and retailers, on oil's biggest plunge in four years and speculation a purchase of Lehman Brothers Holdings Inc. would end the worst slump by financial shares since at least 1962.
Lehman, which tumbled almost 80 percent this year, rallied 13 percent after Korea Development Bank said it's considering an investment in the brokerage. Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. gained more than 3.8 percent, helped by Federal Reserve Chairman Ben S. Bernanke's forecast that inflation will ease. United Airlines parent UAL Corp. rose 12 percent as crude lost 5.4 percent, the most since 2004.
The Standard & Poor's 500 Index added 14.48 points, or 1.1 percent, to 1,292.20, reducing its first weekly drop since July to 0.5 percent. The Dow Jones Industrial Average advanced 197.85, or 1.7 percent, to 11,628.06. Only 888 million shares changed hands on the New York Stock Exchange, the fewest for a full trading session since Dec. 26. Volume this week was 35 percent less than the year-to-date average.
``The U.S. financial system is not going down the tubes,'' James Gaul, a money manager at Boston Advisors LLC in Boston, which oversees about $2 billion, told Bloomberg Radio. The Lehman development ``assuages investor fears.''
The 54 percent plunge in the S&P 500 Financials Index from its February 2007 record through July 15 of this year was the steepest retreat in at least 46 years, according to data compiled by Birinyi Associates Inc., the Westport, Connecticut-based research and money management firm founded by Laszlo Birinyi.
Bear Stearns Collapse
Financial companies in the S&P 500 dropped 31 percent this year before today after the market for subprime home loans collapsed. Bear Stearns Cos., once the largest underwriter of mortgage bonds after Lehman, was rescued by JPMorgan Chase & Co. in a March takeover brokered by the Federal Reserve.
Lehman added 69 cents to $14.41 after surging as much as 16 percent. Korea Development Bank is considering investments including Lehman, a KDB spokesman said without elaborating. Chief Executive Officer Min Euoo Sung and Lehman spokesman Mark Lane declined to comment.
``Lehman Brothers was the next firm likely to fail,'' said Jeffrey Kleintop, who helps oversee $273 billion as chief market strategist at LPL Financial in Boston. ``The market looks at this as a positive in that there have been expectations Lehman would survive in some form. The question was where was the money going to come from.''
Citigroup added 67 cents to $18.14, Bank of America rose $1.17 to $30.21 and JPMorgan increased $1.41 to $37.67. The S&P 500 Financials Index jumped 3.1 percent, the most since Aug. 8.
Bernanke on Inflation
Banks extended their gain after Bernanke said inflation should ease later this year and in 2009 thanks to a recovery in the dollar and declines in commodity prices. The Fed is ``committed to achieving medium-term price stability,'' Bernanke said in a speech in Jackson Hole, Wyoming.
Freddie Mac dropped the most in the S&P 500, while Fannie Mae swung between gains and losses. Their $36 billion in preferred stock was downgraded to the lowest investment-grade rating by Moody's Investors Service, which said the increased likelihood of ``direct support'' from the U.S. Treasury may devalue the securities. Billionaire investor Warren Buffett told CNBC that the firms ``don't have any net worth.''
Fannie Mae added 15 cents to $5. Freddie Mac lost 35 cents, or 11 percent, to $2.81. Both are trading near the lowest prices in two decades.
Stocks fell this week on growing concern shareholder value will be wiped out at the two largest mortgage-finance companies if they are bailed out by the government and commodities surged before today. The S&P 500 has dropped 17 percent from an October record as credit losses at banks topped $500 billion globally and record oil curbed growth.
Airlines, GM Rise
UAL added $1.39 to $12.72 today, US Airways Group Inc. increased $1.06 to $7.86 and Continental Airlines Inc. climbed $1.52 to $15.86. General Motors Corp., the largest U.S. automaker, gained 52 cents to $10.44.
Oil fell as the U.S. dollar strengthened and BP Plc restored shipments on a Caspian Sea pipeline through Turkey. Crude tumbled $6.59 a barrel to $114.59 in New York.
Gap Inc. climbed to the highest price since April, rising 87 cents to $19.88. The largest U.S. clothing retailer said second- quarter profit rose 51 percent, beating estimates, after it discounted fewer jeans and T-shirts.
JPMorgan Chase & Co. strategists said investors should buy more financial stocks and U.S. companies that rely on discretionary spending by consumers and sell energy and raw- material producers.
Dollar Boosts Profit
``Weakness in the dollar over the past year should support U.S. earnings in 2008,'' JPMorgan strategists led by Adrian Mowat wrote in a note to clients today.
The S&P 500 Consumer Discretionary Index rose 2.2 percent, the most among 10 S&P 500 industries after financials. Department-store operator Dillard's Inc. had the biggest gain, rising 77 cents, or 7 percent, to $11.85.
Crude's retreat drove S&P 500 energy stocks to a 1.6 percent decline. Oil producers Exxon Mobil Corp. and Chevron Corp. were the only decliners in the 30-company Dow average. Exxon slipped 5 cents to $80.30, and Chevron lost 42 cents to $88.10.
Cabot Oil & Gas Corp. had the second-steepest drop in the S&P 500, losing $2.77, or 6.1 percent, to $42.66. The natural-gas producer was cut to ``neutral'' from ``buy'' at Merrill Lynch & Co. by analysts who reduced their 2008 earnings estimate on a lower price forecast for the fuel.
Raw-materials producers were the only other industry among 10 to slump, losing 0.4 percent. Copper declined 2.2 percent in New York, the most since Aug. 8. Gold and silver also fell.
Freeport-McMoRan Copper & Gold Inc., the world's largest publicly traded copper producer, declined $3.06 to $90.60. Newmont Mining Corp., the largest U.S. gold producer, lost 60 cents to $44.29.
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