As the price of oil plunges, one reads that the domestic industry expanded in a leveraged way and by issuing junk bonds with low coupons. Since the FED explicitly tried to cause risk premia to shrink, it appears it may have been successful. Lower risk premia mean risk investments were made unnaturally attractive by the FED’s buying of mortgage bonds and government bonds, by the QE3 program. Risky investments were backstopped by the FED psychologically too.
The oil industry appears to have over-invested in domestic oil production (including fracking), and this looks classifiable as a case of malinvestment, as predicted by the Austrian analysis of central bank securities buying. The FED, following an aggregate way of thinking about total demand, pays no attention to such industry and sector bubbles. They completely missed the last one in the housing sector. They are not always easy to diagnose before the bubble bursts, as seems to have occurred in oil. There is some speculation that the U.S. has pressured Saudi Arabia to break the oil price in order to punish Russia. That’s another possibility. There is speculation also that the Saudis want to undermine the domestic U.S. production. While there may be truth in one or more of these hypotheses, it’s still a fact that the domestic industry found readily available financing at low rates in the junk bond market. And similarly, there are European sovereign bonds that traded up to very low yields despite the precarious finances of the governments.
1:53 pm on December 14, 2014
