No wonder the British Airways share price fell to a new four-year low yesterday. Less than two months ago, the finance director Keith Williams warned that his operating profits would be completely wiped out by an oil price of just under $120 a barrel, and that, if sustained, such a price would lead to fundamental change across the airline industry as a whole.
Back then, it seemed quite unlikely prices would reach such an elevated level, yet here we are, less than two months later, with the price of oil at a point which apparently spells financial Armageddon even for relatively healthy airlines such as BA. I hope you have already paid for this summer's airline tickets, for, the way things are going, the age of cheap air travel may already be a thing of the past, along with cheap mortgages and low-cost flatscreen TVs from China.
Either by stealth or overtly, airlines will be pushing through some steep increases in ticket prices over the next six months. As demand falls, there will also be widespread cuts in capacity.
Alarm among policymakers is already evident. Contrary to expectations, this month's decision by the Bank of England's Monetary Policy Committee to reduce interest rates was not unanimous.
Minutes published yesterday reveal that two of the MPC's nine members voted for no change. In this minority view, the downside risks to the economy posed by the credit crunch are more than matched by the upside risk to the inflation target.
Retailers have so far struggled to pass on to consumers the rising wholesale price of goods and food, but, even in circumstances where demand is falling, they won't forever be prepared to sit there and take the hit to margins. Corporate profits, which until very recently were at record levels, obviously provide some sort of an anti-inflationary cushion, yet companies are bound eventually to move to protect earnings.
The curiosity of the present spike in energy costs is that, with the world economy slowing fast, you would expect that by now prices would be falling. Yet along with other commodity prices from metals to foodstuffs, they are refusing to behave in the normal way.
Some of the reasons for this phenomenon are temporary, but others are of a worryingly permanent nature. In part, the rise in the price of oil is just a function of dollar weakness. Oil and many other commodities are priced in dollars, so when the dollar becomes weak relative to other currencies, the price naturally rises as a hedge.
The mass of speculative activity surrounding the oil price cannot be helping matters, while there may also be something in the argument that the credit crisis is squeezing the price higher because of the difficulty of financing stocks in the supply chain. Speculators look at the parlous state of inventory and draw the obvious conclusion: shortage of supply will inevitably drive the price higher still.
Yet the deeper reasons for high energy prices are unfortunately more structural and long term. Rapid economic development in Asia has caused a step change in demand which is unlikely to be reversed by a slowing world economy. On the other side of the ledger, there has been very little increase in supply to satisfy this enhanced demand, nor is this likely to be on the scale necessary to bring prices back to historic norms.
Venezuela, Iraq and increasingly Russia are all but closed off to foreign development capital, while, even if the Saudis felt minded to lend a hand by significantly upping their production, the easy low-cost pickings are already tapped. Saudi Arabia may already be close to peak production, and even this is proving increasingly costly to sustain.
All this suggests powerfully that while the price of oil may eventually fall a bit in response to a slowing world economy, the new benchmark is much more likely to be $100 a barrel than the $50 or lower that has ruled historically.
Coming on top of the credit crisis, high commodity prices serve as a double whammy to economic activity. By reducing disposable incomes, they constrain the amounts available for spending on other things at a time when it is becoming ever more difficult and expensive to borrow for the purpose of filling the gap.
After recent initiatives, policymakers are optimistic that they might be able to see the economy through the worst consequences of the financial crisis, but can they also cope with sky-high energy and commodity prices? A hard landing may still be the wrong way to bet, but the odds are shortening fast.
Taming the boom and bust of bankers
I'm not going to defend Sir Fred Goodwin, chief executive of Royal Bank of Scotland. Let the chips fall as they will. But nor are the wolves baying for blood at his door a very edifying spectacle. Back in the autumn when Sir Fred was hubristically doing the wrong thing in paying top dollar for ABN Amro, there was no one calling on him to resign or for his board to exercise restraint.
Now that he's doing the right thing by seeking to recapitalise his bank, he's painted as a reckless daredevil who must pay for his sins by being hung from the nearest lamp-post. Sir Fred's high-risk approach was once applauded. Now that he has moved decisively to adapt to changed circumstance, it's reason for the lynch mob.
As the Governor of the Bank of England, Mervyn King, has frequently pointed out, banks are innately dangerous beasts. If not the actual cause of the boom and bust of the economic cycle, they are certainly an integral part of it, feeding the boom through the reckless provision of credit in the upswing and then greatly exaggerating the bust by taking it all back again.
For that reason there is plainly something to be said for the idea, now much touted among policymakers, of counter-cyclical capital controls, whereby banks would be forced to increase their capital through the boom, providing a brake on the provision of credit, but allowed to ease in the downturn, so that they can lend more on less capital when times get bad.
What we have seen is the very reverse, with banks allowed to reduce their capital and liquidity cushions even as they were hugely expanding their lending, and now that the balloon has gone up, being forced by regulators to improve their capital strength and liquidity into the downturn.
Fixing the roof while the sun is still shining makes obvious sense, yet markets and banks by their nature seem quite incapable of it. To the contrary, as the good times roll, they become ever more oblivious to risk until eventually they are blown out of the water by it and are forced into a painful workout.
Mr King wants this week's £50bn banking support package to be seen not as a bail-out, but as a low-risk way of preventing the banking crisis from causing collateral damage among the innocent. The Bank of England, he has said, is not in the business of providing bail-outs, but it should very much be about protecting the public from the consequences of banking greed and stupidity.
In the months ahead, politicians, regulators and central banks will seek to bolster these noble ambitions by hemming the banks in with all manner of new rules and regulations designed to forestall the sort of mayhem we have just seen, and to allow a more calibrated, transparent, understanding of the risks that banks are taking on. From complex derivatives, to hedge fund managers and off-balance-sheet lending, the unregulated will become regulated.
It scarcely needs saying that overt product regulation of the type some are now demanding is largely pointless and potentially quite damaging. Bankers have just received the shock of their lives. They have also cost their shareholders hundreds of billions in value destruction. They won't be returning to these structures for a generation or more.
Instead, yet more ingenious ways of feeding the next credit boom or asset bubble will be found, and regulators will again be behind the curve when they are. Yet there is nothing wrong with broad-brush, principles-based, regulation that seeks to remove the incentives in banks to boom and bust.Reuse content