Crude Arguments
Painful for Some, but Hardly a Crisis

Our Mutual Friend
The Coming Storm
OPEC: Let’s See Them Stick to this One
The G7 and the Duck-billed Platypus

Markets should worry about the surging oil price

NERVES, it is clear, are becoming increasingly frayed in financial markets. In general, the riskier and more generously valued the market, the edgier investors are. They are increasingly fearful about political stability around the world, following the bombings in Madrid, yet more tension in the Middle East and a disputed election in Taiwan. Perhaps even more concerning are worries about the sustainability of global growth. Goldman Sachs now thinks that the world economy will grow by 3.8% this year, not the 4.6% it had originally forecast. The main reason for this sharp reduction is the sustained rise in the price of a commodity long dismissed by most economists as having little impact on mature economies: oil.

That the rise in the oil price might be more than a temporary blip is best illustrated by the price of oil for future delivery. When the spot price of crude (that is, oil for immediate delivery) spiked in the past, notably on the eve of both Gulf wars, the forward price rose only slightly, mainly because the market expected the interruption to be short-lived. This time, not only is the oil price rising, but the forward price is going up sharply, too. On March 18th, the recent high, when West Texas crude rose to $37.93 a barrel, the price for delivery a year hence rose to $32.51, its highest ever.

Last week, the spot price of crude rose to its highest level (in nominal terms) since 1990. The proximate cause was an announcement in February by OPEC, the producers’ cartel, that it would cut production by 1m barrels a day from the beginning of next month. But other factors are at work, too. There have been supply problems both within and without OPEC. Some of these problems are likely to be temporary, but then analysts have been saying this for months.

OPEC’s desire to force the oil price up is almost certainly linked to the falling dollar. All crude is priced in dollars, and exports are thus worth a lot less because the dollar has plunged. Many think that this is one reason why OPEC is happy to see the oil price remain higher than its self-imposed band of $22-28. Possibly, too, Arab-dominated OPEC is rather less enthused by America’s war in the Middle East than George Bush.

If oil supplies have been tight, demand has been expanding briskly, and in China—where else?—it has been growing at a breathtaking pace. China’s rapidly growing economy will account for 40% of the 1.65m-barrels-a-day increase in demand expected this year by the International Energy Agency, according to David Fyfe, one of its analysts. Last year, China overtook Japan as the second-largest consumer of oil after America.

Many argue that the latest jump in oil prices is far more modest than it was in the two oil shocks of the 1970s. In real terms—that is, adjusted for inflation—the price is still a lot lower than it was then. Rich countries are, moreover, far less dependent on oil than they were, because they have become more efficient at making things, and anyway make fewer of them. And the rise in the oil price, as measured in anything other than the beleaguered dollar, has been comparatively trifling. All true, but Buttonwood can’t help feeling nonetheless that many pundits have cried sheep once too often.

In Asia—whose economies are far more dependent on oil for growth than America's—there are, for a start, the risks of higher inflation, or lower growth, or both. Goldman Sachs thinks that Asian growth will bear the brunt of the oil-price rise. Since the region accounted for half of world growth last year (measured on the basis of purchasing-power parity), this is disturbing. To those who have been wondering what ill effects might come from Asian countries’ attempts to hold down their currencies against the dollar, the rise in the dollar price of oil—and, indeed, of just about every other commodity—provides an answer.

China is already on the verge of overheating. But inflationary pressures are mounting elsewhere in the region. If companies do not or cannot pass on the rise in their input costs to consumers, they will either have to cut costs by sacking people (not a policy that finds much favour in China) or accept lower profits.

The effect of the rising oil price on America could be even more disturbing. America may be more efficient than it was, but it is far from immune to higher prices. For consumers, the recent sharp rise in petrol prices—which hit an all-time high this week—is, in effect, an increased tax burden. And it comes just as the effects of Mr Bush’s (official) tax cuts start to wear off.

But there is an indirect effect on consumption, too. Costs are rising for companies as the price of oil and other commodities goes up. In the past, this would have been inflationary: companies simply passed these higher costs on to consumers. But as Stephen King, the chief economist at HSBC, points out, that link seems to have gone, perhaps because of excess capacity at home, or because China’s increasing presence in world trade pushes the prices of manufactured goods and labour down. As a result, wholesale prices have been rising much faster than the price at which companies are able to sell their wares.

To stop profits from falling, American companies must keep a tight lid on labour costs. As Mr King puts it, shareholders have been benefiting at the expense of those who work for them (though not CEOs, of course). A prolonged rise in the price of oil and other commodities would make this problem still more acute: America’s jobless recovery is likely to stay jobless. This would eventually kill the recovery, since consumers in fear of their jobs are unlikely to carry on splurging.

Goldman Sachs now thinks the American economy will grow by only 2.75% (on an annual basis) in the second half of this year and the first half of next—a forecast it has revised down by three-quarters of a percentage point. It might, Buttonwood thinks, even turn out lower than that. Slower economic growth in turn bodes ill for stockmarkets and corporate-bond markets. And if markets tumble, consumer confidence will surely follow. The rise in the oil price, in other words, may leave nerves not so much frayed as in tatters.

Light crude is hovering around a 13-year high. But are companies protesting too much about high oil prices?

“FOR the last 30 years, the price of oil has been the single most important determinant of the economy and the stockmarket.” So claim the authors of “Oil Factor”, one of a spate of gloomy new books about energy. They claim that the oil price will soar above $100 a barrel “by the end of the decade, and possibly sooner”. Such a spike, they say, would drag the global economy into a severe recession.

You do not need to believe such scenarios (which rest on the dubious assumption of imminent oil scarcity) to be worried about the impact of oil prices today. After all, the OPEC cartel, which controls roughly half the world’s crude exports, has kept prices above $30 a barrel for much of the past three years. In America, petrol prices at the retail pump are approaching all-time highs. Headlines on both sides of the Atlantic have proclaimed an energy crisis.

On the face of it, oil consumers have much to worry about. On Wednesday March 17th, American light crude ended trading in New York at $38.18 a barrel, the highest closing price since October 1990, in the run-up to the first Gulf war. So far this year, consumers have paid an average price of $35 per barrel (based on American light crude), compared with $31 in 2003. Prices have been driven higher in the past week by concerns about terrorism in the wake of the Madrid bombings. Add to that worries about stocks in America: on Wednesday, the government released data showing that gasoline stocks fell last week by 800,000 barrels, to a level 5% below their five-year average, raising fears of a supply crunch (though crude stocks have risen slightly from their near-30-year lows in the winter).

At least for some gas-guzzling industries, the fear of exorbitant prices seems justified. Airlines, for example, have been hit hard by the surge in the price of jet fuel. American, Delta and several others announced a temporary fuel surcharge of $10 per ticket to compensate, only to reverse it when rivals did not follow suit. The chemicals business is also vulnerable, as it uses hydrocarbons both as a feedstock and as a source of energy. Du Pont, the world’s biggest chemicals firm, recently estimated that a $1 rise in the price of both oil and natural gas adds about $135m a year to its pre-tax costs.

But look beyond the most energy-intensive sectors, and the notion that high oil prices are quashing demand and wrecking firms is overdone. One reason is that OECD economies are less energy-intensive than three decades ago when the first oil shocks occurred, thanks to the shift out of manufacturing into services and information technology. And, in real terms, even the current “high” oil price of over $38 a barrel is still below half its historic peak.

The story is further complicated by the recent plunge of the dollar, the only currency in which oil is traded. The relative strength of the euro and sterling has greatly reduced the pain of dollar-price increases for firms in Europe (see chart).

But what of other big oil-guzzling economies? “Americans might whine about it, but they aren’t in pain because the oil price is $35,” argues Roger Diwan of PFC Energy, a consultancy. As evidence, he points to the robust growth in demand for oil in America in recent months—one of the main reasons why prices are now so high.

The same is true of China, which has a currency peg to the dollar and is thus fully exposed to the rising oil price, and has also, like many other developing countries, become much more reliant on oil in recent years as its economy has moved from agriculture to heavy manufacturing. Higher prices have not dented Chinese demand. In fact, China has just passed Japan to become the world’s second-largest oil consumer.

Certainly, some firms in energy-intensive industries are in for a rough ride as OPEC tries to keep prices high through America’s summer “driving season”. Indeed, the cartel shows no sign of reversing its recent decision to cut its official production limit (of 24.5m barrels per day) by 4% from April 1st. But claims that today’s oil prices amount to anything approaching a crisis for business at large are unfounded.

George Bush and Donald Rumsfeld have pledged to change the way America's armed forces are distributed around the globe. What do they have in mind?

WHEN the second world war and the Korean war had ended, America found itself in possession of what turned out to be some pretty useful territory. The bases used in the Japanese, European and Korean campaigns proved vital in the prosecution of the cold war. During it, the disposition of America's forces petrified, and large concentrations are still in Germany, South Korea and Japan. Now, as George Bush announced at the end of last year, that pattern is being re-thought, in advance of what Donald Rumsfeld, his defence secretary, grandiosely describes as the biggest restructuring of America's global forces since 1945. The outcome will intimate not only America's perception of the threats it faces in the new century, but also its attitude towards friends and alliances.

Three main factors are driving the review. The first is the emergence of new and unpredictable dangers—one of them manifest in Madrid last week. The Pentagon still worries about China and North Korea; about an India-Pakistan conflagration; and about the security of the Gulf. But alongside these concerns are the unknown unknowns of international terrorism, and an arc of post-cold-war instability that stretches from the Balkans to the Caucasus and around the Asian shore.

In the kinds of operations that these new threats may entail, American troops are less likely to have to “fight in place” on the plains of Germany than to get to remote regions quickly. And such wars and skirmishes may turn out to be as controversial as the ousting of Saddam Hussein. This means that America will need to rely on new allies in hitherto neglected regions, and avoid depending on bases in countries that might prove squeamish about pre-emption or prevention. Douglas Feith, a Pentagon official who is helping to conduct the review, says that there is no point having forces in places from which they can't be moved to the fight. The pre-Iraq international rancour is bound to inform such calculations, however much it is now said to be ancient history.

As these new threats have emerged, others have changed or receded—most obviously, Mr Hussein himself. His demise has already led to the withdrawal of most American forces from Saudi Arabia (an “occupation” famously anathema to Osama bin Laden), and the shifting of an air HQ from there to Qatar.

Then there is Kim Jong Il. The hollowing of North Korea's armed forces, and the growing competence and confidence of South Korea's, mean that the South could defend itself much better than in the past against a conventional attack from the north. Plans have already been announced for the South to take over more responsibility from the Americans up near the demilitarised zone. Some in America, who worry that paternalism risks emasculating their country's allies (as well as needlessly consuming American resources), have long advocated such a handover. So some American assets will be moved down the peninsula, where they may be more use for other contingencies, as well as for a counter-attack in the event of an invasion. The main base outside Seoul—a source of friction with the locals, as are the cluster of marine bases on the claustrophobic Japanese island of Okinawa—will move too.

The second important factor is technology. Jobs such as surveillance and reconnaissance can increasingly be done from America itself (and from space). The lighter ground forces that America's army is hoping to field soon should be more easily deployable than today's tanks. The air force can do ever more damage with ever fewer planes. Enemy technology is also a consideration: adversaries may in future be more able and willing to attack American bases in volatile places with missiles and WMD, making those bases more vulnerable and more expensive to maintain.

Given this technological progress, one Pentagon mantra is that its involvement in a region should no longer be measured by the number of boots, tanks and aeroplanes that it has on the ground, but on its “capabilities”—ie, the force that it can bring to bear. That is just as well, since those boots are in short supply and high demand, another of the considerations that will help to shape the global review.

America's active-duty force shrunk by around a third during the 1990s—it now numbers around 1.4m altogether—even as the eruption of small, hot wars made it busier. Now the labour-intensive task of pacifying Iraq is straining America's army almost to breaking point. Before September 11th there was talk of further manpower cuts; many in Congress now want a statutory increase in the army's size. They argue that, as things stand, army recruitment and retention will suffer, especially after units who have already fought in Iraq are sent back.

Mr Rumsfeld is resisting these calls: his budget is coming under pressure; people are expensive and getting more so; and he would prefer to avoid a statutory force increase that would compromise the funds available for the modernisation (or “transformation”) to which he is devoted. (Mr Rumsfeld's unconvincing answer to the Iraq problem is a temporary troop increase, under emergency powers, plus internal army restructuring.) But his global review will need to take account of these strains, as well as those induced by the ongoing deployments in Korea, the Balkans and Afghanistan.

In theory, the first two factors—new threats and technology—suggest a revised global “posture” in which, while retaining some large “hubs”, America also develops smaller, dispersed bases in previously unconsidered regions, as it did in central Asia at the time of the Afghan war. Some of these could be lightly manned or even manless when not in use, and rapidly reinforced by air and sea in times of crisis. Andrew Krepinevich, of the Centre for Strategic and Budgetary Assessments, compares the frontier posts of the Roman empire, which could be (relatively) speedily reinforced by road (see Mr Krepinevich's maps below). Paul Wolfowitz, the deputy defence secretary, also talked recently about the importance, in the disparate “war on terror”, of working with indigenous forces—as America did in Afghanistan, and as Britain regularly did when its own empire sprawled across the globe.

To be specific, Mr Rumsfeld has said there will be changes to the American presence in Japan—home to around 40,000 servicemen—and in South Korea and Germany (though the status of Ramstein air base there seems assured). Although he has also said that he doesn't plan many new bases, there are likely to be new facilities in the countries of his “new Europe”, which are closer to the Balkans and to central Asia than is “old Europe”.

Elsewhere, more Americans may wind up in Africa, and some of the Okinawa marines could conceivably be sent to northern Australia, where they will consolidate one of America's most durable alliances. New naval arrangements in Asia are also being considered. Bosnia will eventually be left to the Europeans. In time, the Pentagon may develop the futuristic concept of offshore bases, loosely based on oil platforms, which might help to circumvent diplomatic and “access” problems, though only up to a point. Meanwhile, more stocks may be pre-positioned in strategic places, and more servicemen—happily for them—will be based back in America.

What might the diplomatic consequences of such a re-jig be? Russia seems prepared to swallow an American presence in Bulgaria and Romania, which are keen on the jobs and extra security that hosting the Americans would bring (though the Russians would like to draw the line at the Baltics). Moving many of the 70,000-odd personnel and around 80,000 dependants based in Germany either east, or west across the Atlantic, will cost Germany jobs and, in the long term, might weaken an old alliance. Military co-operation acts as a ballast when diplomatic relations fray; less of it increases the chances of drift. Yet some newer allies might be less than thrilled with the idea of hosting empty or near-empty bases. As John Hamre, a former deputy secretary of defence, puts it, such countries might ask: “If it isn't a permanent commitment of troops, is it a permanent commitment to our security?”

None of these decisions will be finalised until after an equally sensitive round of base closures in America itself is completed. But if the third important factor—the strain on the force—hasn't receded, the restructuring may turn out to be humbler than Mr Rumsfeld would like. Troops in Germany live in western comfort and with their families. Michael O'Hanlon of the Brookings Institution points out that shifting people to less salubrious bases in eastern Europe or elsewhere would increase the burden on an overstretched force, since those troops would have to be rotated back to America after their tours, with other units taking their place.

Mr Feith says this is a good time to review America's place(s) in the world, because the rationale for doing it is widely understood. But, because of Iraq, this may be the worst, as well as the best of times, to redesign the American empire.

Deficits do matter, says the Federal Reserve chairman. But not enough to start raising taxes

THE tax cuts George Bush enacted in 2001, 2002 and 2003, though large, were not permanent. Most contain “sunset clauses”, and are scheduled to expire over the next five years. But will the sun ever set on Mr Bush’s tax cuts? Some in Washington think the cuts should be extended because, after all, deficits don’t matter. Alan Greenspan is not one of them. In his testimony to the budget committee of the House of Representatives on Wednesday February 25th, he noted the “growing concern” about the federal budget. Nonetheless, he also voiced his support for making Mr Bush’s tax cuts permanent. The monetary maestro has waded into matters fiscal. And neither side of the House knows whose side he is on.

Owlish in appearance, Mr Greenspan is, by temperament, a deficit hawk. But he is a very long-sighted hawk. Right now, he points out, the budget deficit—$375 billion last fiscal year and expected to grow to more than $500 billion this year—is providing valuable support to the American economy as balance sheets are repaired and excess capacity worked off. Even in the medium term, he said in reply to a congressman’s question, deficits of $400 billion-500 billion would represent a manageable share of a larger national income. He thinks the market has already priced in deficits of this size for the next ten years. Mr Greenspan’s real worries are long-term. He believes the American government has over-committed itself to an ageing population. As the ratio of workers to retirees falls from 3.25 to 1, as it is now, to just 2.25 to 1 by 2025, the burden of pensions will rise remorselessly; the cost of health care incalculably.

To raise taxes sufficiently to meet these commitments would stifle growth and erode the tax base, Mr Greenspan fears. Because raising taxes is dangerous, the Fed chairman believes that Congress should lower them, by extending Mr Bush’s tax cuts into the future. This non sequitur has been gratefully received by the Republican side of the House. But Mr Greenspan combines this recommendation with another: that Congress reinstitute the “pay-go” rules of the 1990s, which require that tax cuts be matched by spending cuts. This recommendation goes down less well with Republicans.

If the budget-setting congressmen who heard Mr Greenspan’s testimony on Wednesday were to take his words to heart, how would they go about their business for the rest of the decade? Extending the tax cuts, as Mr Greenspan recommends, would cost the Treasury $1.7 trillion over the next decade, according to the Brookings Institution. If nothing were done on the other side of the ledger (ie, if real spending per head were held steady) the budget deficit for the year 2014 would stand at $687 billion, the think-tank calculates. But under Mr Greenspan’s pay-go logic, these tax cuts would have to be matched by cuts in spending. Where would the cleaver fall?

The Brookings Institution identifies some choice cuts of corporate pork, politely referred to as commercial subsidies, the removal of which could save the federal government $137.5 billion. For example, air traffic control could be privatised, agricultural prices left unsupported, and fossil-fuel research left to the oil companies. Brookings reckons the federal government could save another $123 billion by leaving education, housing, training, local law enforcement and environmental protection to states and localities. Abolishing manned spaceflight, slowing the growth of the National Institutes of Health and putting the screws on discretionary spending could save a further $56.5 billion. In all, the Brookings budget wonks find $326 billion-worth of savings for the year 2014: no small chunk of change, but not even close to what is needed to balance the budget.

Which is a pity, because the budget outlook only worsens from then on (see chart). As the baby boomers retire, the Office of Management and Budget reckons spending for Social Security will rise from 4.2% of GDP in 2010 to 6.2% by 2040. Spending on Medicare and Medicaid—health-care benefits for the old and poor respectively—is harder to forecast because the costs of new treatments are unpredictable. Nonetheless, on quite conservative assumptions, Medicare and Medicaid expenditures combined will rise from 4.6% of GDP in 2010 to 10.1% in 2040. These projections, said Mr Greenspan, are both vivid and sobering.

Mr Greenspan believes legislators will eventually have no choice but to tamper with health benefits and Social Security. He suggests that retirement benefits might be restrained by stealth, by linking them to a less generous measure of inflation. The “chained” consumer price index he favours adapts to changing patterns of spending. According to this index, the cost of living has risen by just 1.8% in the past three years, rather than the 2.2% rise recorded in the official consumer price index.

Congress may not follow Mr Greenspan’s advice. But perhaps it should heed his example. The best and perhaps the only way to relieve the impending pensions burden is to postpone the retirement age. Mr Greenspan, for one, is 78 next week and still going strong.

The trouble with paper money

IS THE problem with the dollar only that it is falling? It has certainly been doing that. This month, it fell to $1.29 against the euro. This is its lowest-ever rate against the euro, and represents a decline of 19% since the beginning of 2003. In trade-weighted terms, the dollar has fallen less over the same period (15%), but mainly because Asian central banks have been intervening heavily to stem their currencies' rise against it. Of late, it has been wobbling around unconvincingly: America needs a weaker dollar to correct its current-account deficit. But given the dollar's role as a currency of last resort, some wonder if its decline heralds not just an economic adjustment by the United States, but a crisis of sorts in the value of paper money itself.

Money in its present form is a relatively new invention. For most of human history money meant either gold or silver, either directly, or indirectly by means of the “gold standard” which meant, at least in theory, that all paper money was backed by gold. Enthusiasm for the gold standard evaporated in the 1930s, when it made dreadful conditions worse. But it was adopted in a watered-down version after the second world war, when only the dollar was backed by gold. This arrangement made some sense, since America held three-quarters of the world's gold stock. But it came to an end in 1971, when inflationary pressures in America caused the country's manufacturers to become uncompetitive and forced the country off the gold standard. Since then the world has relied on “fiat money”, so-called because it is created by government fiat and is backed only by the promises of central bankers to protect the value of their currencies. It is the value of those promises that some are now questioning.

Certainly, those promises have only been worth much in recent years. In the early years of fiat money, inflation took off, especially in America, in part because of the two oil shocks of the 1970s. This debased the value of the dollar, and the price of gold climbed from $35 an ounce to $850.

It was only in 1979, in his famous “Saturday night special”, that Paul Volcker, then chairman of the Federal Reserve, raised interest rates sharply to clamp down on inflation. The gold price subsequently fell sharply and in its place came a bull market in government bonds that has, with a few sharp interruptions, continued to this day. Although central banks around the world still hold about 30,000 tonnes of gold in their reserves, many have been offloading their stocks over the years. They can earn only a nugatory rate of interest on these stocks (by lending them out) compared with what they can earn on government bonds. For most people, gold has been relegated to the status, in the words of Keynes, of a “barbrous relic”; its price has risen only feebly when investors have fretted about inflation.

Those who doubt the continued worth of paper money as a store of value point to two things. The first is that the price of gold has been rising even though official inflation is low. From $253 an ounce in the late 1990s, gold now fetches just over $400 an ounce, and it rose as high as $430 an ounce earlier this year. It is not just the price of gold that has been rising: so, too, have the prices of precious and base metals. There may, of course, be many other reasons for these rises. China's rapidly expanding economy is gobbling up metals and other commodities for its factories. Moreover, the rise in the price of commodities also reflects the weakness in the dollar: these rises look much less impressive when quoted in euros or yen. But the rise in the price of gold in particular has raised questions.

The biggest of these—and the second main reason for concern—is the amount of debt that rich-country governments have been running up. America's official budget deficit has surged in the three years since George Bush became president, to around $520 billion and climbing. But this is just the shortfall this year. The government's total future liabilities are much larger. In fact, according to a forthcoming book by Laurence Kotlikoff, an economist, the present value of the American government's future obligations, taking into account promised pensions and health-care benefits, is a staggering $45 trillion. European governments are only slightly better at managing their budgets—witness the breaching of the single currency's growth and stability pact. Japan's attempts to coax its economy back to life have left it with a gross national debt of some 160% of GDP, the highest of any big country. No country has tried harder to debase its currency.

In theory, such debts would not be tolerated for long by investors, since the easy way out for central banks is to “monetise” them with inflation. Bond prices would fall (and thus yields rise) as investors worried that they would be paid back in a debased currency. But capital markets currently seem oblivious to spiralling debts. At some 4%, yields on ten-year American Treasury bonds are close to their lowest in two generations, although this is partly explained by huge purchases by Asian central banks. Yields elsewhere are also very low, nowhere more so than in Japan, where ten-year government-bond yields are now 1.3%.

The problem may be that bond investors, far from being far-sighted, are in fact myopic, and are perhaps being fooled by the temporary disinflationary effects of excess capacity and debts built up over the bubble years in both Japan and America. Perhaps, too, investors have been lulled into a false sense of security by the performance of central banks in recent years, and the independence that has been granted to many of them by governments. But this very aura of inviolability may be storing up problems, since it means that governments can borrow still more at cheap rates. And if governments then find themselves crushed by debt, you can rest assured that this independence will be taken away. And then, once again, the paper in your pocket will only be as good as a politician's promise.

Why is so much money pouring into mutual funds?

AN UNUSUAL slip by a great writer, but there is little doubt that the Dickens novel of the title was tautologous: either “a mutual friend” or “our friend” would have been fine. Of course, were Dickens writing now, he might well use the word “mutual” as a sort of shorthand noun. And in that case, the title would be entirely reasonable: for mutual funds—or at least flows into them—have been decidedly friendly to American stockmarkets these past few months. According to Strategic Insight, a research firm, a net $60 billion flowed into equity and hybrid funds in January alone, on top of the $233 billion that investors popped into such funds last year. Strategic Insight estimates that this month the amount of money managed by mutual funds of all descriptions will top $8 trillion. “Without a doubt, mutual funds continue to be the preferred vehicle through which America invests,” says Avi Nachmany in the firm’s press release.

Not Dickens, perhaps, but difficult to deny. Whether investors are sensible to put so much into mutual funds, and equity funds in particular, is, however, a different question. The industry, after all, is not untouched by scandal. Some 20 firms—including ten of the 25 largest—are being investigated by the Securities and Exchange Commission for activities that, in effect, skimmed returns off investors in those funds. Still, a phone call to Mr Nachmany found him in bouyant mood with ready answers to Buttonwood’s queries. The renewed flows, which started to pick up with the stockmarket last April, “reflect tremendous confidence in America’s capital markets”. And the scandals? “Participants in the news are not participating in the upturn,” he says; the money simply “goes from one bucket to another”. Thus have the likes of the Capital Group, Fidelity and Vanguard, which have been untainted by scandal, pulled in billions of dollars of new money. Regulatory scrutiny, says Mr Nachmany, not unreasonably, suggests that whatever is wrong will be fixed. “Faith in the mutual-fund industry remains extraordinary.”

That, at least, is a sentiment with which Buttonwood can concur. The proverbial wall of money, as well as being a sign of confidence in the stockmarket, is used by many as an argument for why it will climb higher. This argument seems flawed. If demand for a product is insanely high, then supply will eventually rise to meet it. Certainly, demand has not slackened in February by all accounts. And, points out Charles Biderman, founder of Trim Tabs, another research firm (which, incidentally, has rather lower, though still very high, estimates for inflows in January), the supply of equity is not so much rising as soaring. Offerings of new shares have recently averaged $1.7 billion a day. In the first six weeks of this year, some $42 billion of new stock was issued—twice the level in the same period last year.

Mr Biderman has a refreshingly harsh view of one reason why this might be so, involving the economics of investment banking: “If you’re paid 4% to 7% to sell new shares and one-tenth of 1% for trading them, what do you think you would want to sell?” The supply of shares from firms’ managers anxious to cash in their chips has also risen, to $600m-800m a day. And stock buy-backs from firms wanting something to do with their spare cash have tailed off sharply. “The new bubble is going to end up like the old bubble,” says Mr Biderman.

Whether the present, apparently insatiable, appetite for equities should be classified as a bubble is a moot point. What is certainly true, as this column has noted before, is that Americans need to invest in apparently turbo-charged assets because they save so little: more than 12% of income in 1981, the personal savings ratio has now fallen to 1.3%. The great American public has instead relied in recent years on heady financial and property markets to save on its behalf. People are now pulling money out of federally insured, low-yielding bank deposits, which had seemed so safe when shares were falling.

In less doubt is that investors’ appetite for risk is very high by historical standards at a time when valuations are already stretched, to put it mildly. Previous columns have touched on corporate debt, both investment grade and junk; on emerging-market bonds; and on the price of shares. None of these markets could be described as cheap. Flows follow returns, and investors generally pull their money out of markets that are and have been falling and put them into those that are going up. This means that they sell assets when they are cheap and buy them when they are more expensive. The huge flow into mutual funds specialising in junk bonds started last year only after that market had enjoyed much of the year’s 28% rise. When the market was at its cheapest, in October 2002, investors were pulling their money out.

The same has been true for equity funds. Shares were at their cheapest that same October, and again in March of last year. In the six months from October 2002, equity funds pulled in a paltry $1.3 billion. By contrast, inflows into equity mutual funds last month were even higher than the previous record of $56 billion, set in February 2000. Those with longer memories than a goldfish might recollect that the stockmarket, or the most exuberantly irrational part of it that hadn’t fallen already, peaked a month after that first record was set, and fell with a series of sickening thuds for another two-and-a-half years. The worst of times, as it were, swiftly followed the best of times.