how to rescue a failing banking system. The crisis was turning into a global panic of the sort that had not been seen for many decades. The impact on what had been healthy economies, including the BRICs, was, as Federal Reserve Chairman Ben Bernanke said, like “a cold wind from nowhere.”
CRUDE OIL PRICES
Source: IHS CERA
U.S. GASOLINE PRICES
Source: IHS CERA
In the midst of what would become known as the Great Recession, demand for oil continued to decline while supplies continued to build up. Yet even in the week that Lehman collapsed, a prediction of “$500 per barrel oil” managed to make its way prominently onto the cover of a leading business magazine. At that moment, however, oil was heading down, and precipitously so. Before the year was out, as the tanks at Cushing, Oklahoma, ran out of storage space and crude backed up in the system, the price of WTI fell to as low as $32 a barrel.
Even though prices subsequently recovered, the spell had been shattered.
For some, prudence paid off, when prices came tumbling down. Indeed, there is no better example of the value to an oil producer of hedging its production forward than the sovereign nation of Mexico. Its government is very vulnerable to the price of oil, as about 35 percent of its total revenues are generated by Pemex, the state company. A sudden fall in the price of oil can create budgetary and social turmoil. For years, Mexico had been hedging part of its oil output. In 2008 Mexico went all out and hedged its entire oil exports and locked in a price. It was not cheap; the cost of this insurance was $1. 5 billion. But when the price plummeted, Mexico made an $8 billion profit on its hedge, thus preserving $8 billion for its budget that, without the hedge, would have otherwise disappeared. It could only have done that huge trade over the counter. If it had tried to do it on the futures market itself, the scale would have set off a scramble by other market participants before Mexico could even begin to get all of its hedges in place.
That transaction was, on Mexico’s part, an act of prudence but also audacity. On the basis of the transaction’s success, Mexico’s finance minister received a unique honor—he was dubbed the “world’s most successful, but worst paid, oil manager.”28
How much of what happened in the oil market can be ascribed to the fundamentals, to what was happening in the physical market, and how much to financialization and what was happening in the financial markets? In truth, there is no sharp dividing line. Price is shaped by what happens both in the physical and financial markets.29
A couple of years later, Robert Shiller, who had become prominent for calling the Internet stock bubble and then the real estate bubble, was having breakfast in the restaurant of the Study, a new hotel on Chapel Street in New Haven, before walking over to lecture in his famous Yale class on financial markets. By then, with recovery well along in the global economy, the price of oil had more than doubled from its lows back to a range of $70 to $80 a barrel. Handed a piece of paper, Shiller looked carefully at what it showed—a plot depicting the movement of oil prices since 2000 culminating in the sharp ascent to its peak in mid-2008, and then its precipitous fall. It was superimposed on a plot of stock prices that culminated in the market boom that went bust in 2000. The fit was very tight. The two curves looked very similar. But the steep, bell shape of the curve instantaneously reminded Shiller of something else as well.
“That looks very much like what happened with real estate prices,” he said. A bubble.30
The rise in oil prices had not begun as a bubble. For the price had been driven by powerful fundamentals of supply and demand; by the demand shock arising from unexpectedly strong global growth and major changes in the world economy, led by China and India; and by geopolitics and the aggregate disruption. But it was a bubble before it was over.
9
CHINA’S RISE
It was one of those sharp, cold nights in Beijing when the smell of burning, crisp and a little sweet, wafted through the dark. This was the very end of the 1990s when the swelling hordes of cars were beginning to fill the new eight-lane highways and push the bicycles to the side. The burning still mainly came not