If only the oil bubble would burst. That will be the natural hope of many who watched crude soar to nearly $150 (Rs6,435) a barrel. Maybe the sharp declines of Wednesday—and, to a lesser extent, Thursday—are the start of a plunge. But financial markets shouldn’t get too excited. An oil bust wouldn’t be unalloyed joy. Bursting bubbles almost always cause collateral damage: just look at carnage left by the housing bubble.
Sure, if the oil bubble bursts, it will take some of the heat off inflation. That would allow central banks such as the US Federal Reserve and the European Central Bank to focus on recession. Fighting a war on two fronts has made them dizzy. Hike rates to fend off inflation and the slowdown could turn into a slump; pump yet more liquidity into the markets and inflation could skyrocket. With only one (and a half) enemy to fight, the central bankers would stand a better chance of success.
Of course, there’s a long way to go before oil reaches “fair value”. The near $11 decline in the past two days may be dramatic. But at $134 a barrel, crude is still way above the long-run marginal cost of production which is probably around $50. That said, bubbles tend to burst more rapidly than they inflate. Rapid-fire margin calls can force people off the bandwagon faster than they climb aboard.
Any spiralling declines could be messy. It’s not clear who might be splattered this time round. But it wouldn’t be surprising if the already crippled financial sector was in the firing line. Banks engage in commodities trading, help finance others who play in the market and even invest directly in oil and other commodities. Unfortunately, they disclose virtually nothing about their activities. By comparison, what they have revealed about subprime mortgages is a model of transparency. Hopefully, their regulators, at least, have a clearer view and have asked their charges to take evasive action.