On Understanding Present Financial Markets

2. George Soros and concept of “reflexivity”—how the “distorted views” of participants, and price itself, change the actual “fundamentals” See The New Paradigm for Financial Markets (2008) Niall Ferguson and the three reasons why financial markets have not and never can be a “smooth ride” (There have been more than 100 “panics” since 1870) : “So much of the future—or rather futures, since there is never a singular future—lies in the realm of uncertainty, as opposed to calculable risk”; “Human behavior, with all financial institutions at the mercy of our innate inclinations to veer from euphoria to despondency, our recurrent inability to protect ourselves from rare events, and our perennial inability to learn from history”; The character of finance itself is evolutionary About one in ten US companies disappears every year Of the world’s largest 100 companies in 1912, only 19 remain there today Market selection is the main Darwinian factor, but there is also “intelligent design,” that is, government policy, at work See The Ascent of Money; A Financial History of the World (June, 2008), and go to Niall Ferguson.com for latest essays On Understanding Present Financial Markets

3. In Ferguson view, world financial crisis continues to deepen Credit crunch/recession will last through 2009, maybe longer Commodity prices (incl. oil and corn) are clearly subject to outside markets overshooting fundamentals last Spring undershooting now (?) Will commodity prices find equilibrium near Cost of Production? Situation and Outlook

4. After over/undershooting, will each commodity find a new equilibrium at its “Cost of Production”?

5. Despite the radical uncertainty in “Big Picture,” clients must keep a sharp idea on likely details of state net exports/net imports and coastal movements.

6. From Ferguson’s “Geopolitical Consequences of the Credit Crunch,” Sep-30-08 But what can the US Fed & Treasury do about a GLOBAL ASSET BUBBLE? And what about the role of crude oil?

8. In Ferguson view, world financial crisis continues to deepen Credit crunch/recession will last through 2009, maybe longer Commodity prices (incl. oil and corn) are clearly subject to outside markets overshooting fundamentals last Spring undershooting now (?) Will commodity prices find equilibrium near Cost of Production? Crude oil COP put at $80/bbl by IEA, Nov-08 Crude oil price affects all commodities, incl. corn (via fertilizer, fuel) Corn price also affected by RFS mandate Waivers possible if ethanol premium to gasoline “too high”? How will GHG provisions be calculated in EPA regulations? Situation and Outlook

9. Let’s assume that crude oil price will remain weak for a couple of years, and then begin to increase toward the IEA’s $80 per bbl. Let’s assume, however, that ethanol price remains at a premium to gasoline—as dry mill capacity has stopped increasing. Let’s assume that the RFS mandate is effective, with no waivers granted to refiners—and that the ethanol cost above gasoline is passed on to the American consumer, and that E-10 gives way legally to flex fuels. And let’s assume that the Obama EPA finds a way to issue LCA/LUC regulations which does not kill either Advanced Biofuels or additional new corn dry mills—and that sugar ethanol imports are counted against the Advanced mandate, not against corn. What would US Corn Supply-Demand and Price look like, given other sensible assumptions on acreage, yield, corn exports, DDG exports and feeding, etc.? Here’s the “What If” Game We’ll Play

15. EPA’s Official RFS Percentage Inclusion Rate for Biofuels in Calendar 2009 —Issued Nov-14-08. The numerator is 10.5 billion gallons of Conventional Ethanol (from “corn starch”) plus 0.6 billion gallons of Advanced Ethanol, of which 0.5 is Biodiesel. The denominator is 138.47 billion gallons of motor fuel consumption, estimated by DOE STEO-Oct-08, adjusted for Alaska; plus 11.03 billion galloons of biofuel consumption in 2009, estimated by DOE STEO-Oct-08 plus 13.5 percent of motor fuel consumption from “small refiners,” not included as “obligated parties” under the RFS.

27. Cheap energy is key to economic growth (and “spreading the wealth” and “fixing the environment”) Cheap money is needed, too, but this is created ex nihilo by people Obama, like FDR, will experiment with economic stimulus plans But if money and demand return, will crude oil remain cheap? Supply diminishing 9% per year, without $350 bil investment per year & Persian Gulf now independently wealthy, does not need to add capacity Alternative energy sees $80 per bbl crude oil replacement cost Competition between row crops, cellulosics, & forestry raising land values Energy policies are hop-skotch RFS-1 mixed corn, biodiesel, and sugar RFS-2 coming under Obama, first regulations on LCA/LUC High tech seeds could mean more row crops for fuel, outside of policy Supreme Court Apr-07 decision in “Massachusetts vs. EPA” CO-2 is “pollutant” under CAA, EPA must decide “endangerment” Could credit crunch/economic recession last forever? Summary

28. Cheap energy is key to economic growth (and “spreading the wealth” and “fixing the environment”) Cheap money is needed, too, but this is created ex nihilo by people Obama, like FDR, will experiment with economic stimulus plans But if money and demand return, will crude oil remain cheap? Supply diminishing 9% per year, without $350 bil investment per year & Persian Gulf now independently wealthy, does not need to add capacity Alternative energy sees $80 per bbl crude oil replacement cost Competition between row crops, cellulosics, & forestry raising land values Energy policies are hop-skotch RFS-1 mixed corn, biodiesel, and sugar RFS-2 coming under Obama, first regulations on LCA/LUC High tech seeds could mean more row crops for fuel, outside of policy Supreme Court Apr-07 decision in “Massachusetts vs. EPA” CO-2 is “pollutant” under CAA, EPA must decide “endangerment” Could credit crunch/economic recession last forever? Summary