Commodities Spike: Vote of No Confidence in Central Bankers?

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Steve Waldman, in a colorful post, “A run on central banks?” contends that the rapid rise of commodities prices isn’t the result of mundane factors like negative real interest rates, but a more fundamental cause: loss of faith in the monetary authorities:

Just as the fear of a bank’s insolvency can precipitate a run that drives a bank to ruin, loss of confidence in a central bank can provoke a great inflation. The Federal Reserve, much I might criticize it, has not gone on a printing spree…. The Fed’s actions are best described as antideflationary, not inflationary.

But confidence is a funny thing. Central bankers are supposed to be dour and dependable. The current crop is not… Japan’s central bankers hand out Yen like free acid. China’s guy will give you a microwave oven and a DVD player if you draw him a picture (and sign Henry Paulson’s name to it). Our man Ben is an Amadeus-cum-Macguyver, he’s brilliant, unpredictable, he’ll improvise a Delaware company from paper clips and vacuum up your derivative book with a toenail clipper. Even the ECB’s Trichet, who at first comes off like a sourpuss, turns out to be alright, when you’ve got some Spanish mortgages to pawn….

So, we lose faith. When we lost faith in Northern Rock, Bear Stearns, Citigroup, or Lehman, the central bankers stepped into the fray, and stood behind them. So, we ask, who stands behind the central bankers? We take a peek, and all we see is our own money. Which we quickly start exchanging for something else.

Although commodity prices have been increasing for years, you’ll notice that the very sharp run-up began last summer, at roughly the same time as the credit crisis. Commodities soared when interest rates were still high, but predicted to fall. Commodities are soaring today, even though US interest rates are now predicted to rise. Commodities have soared in euro terms, despite the ECB’s refusal to drop interest rates.

This commodities run-up (at least as of 2008) has had the quality of not adding up. The fundamentals are not a sufficient explanation for the velocity of the move. The hype, the desperation, the conviction seem out of proportion to the underlying facts (save in some agricultural commodities). A Journal story today gives indications in the oil market of actions consistent with a price overshoot: inventory accumulation (China and airlines), traders unwinding misplaced bets, leading to further upwards price pressure. Similarly, the predictably contrary Ambrose Evans-Pritchard provides evidence that relief on the supply side is coming sooner than expected. Waldman is right that there is something more at work here.

But is lack of faith in central bankers, as much as it makes for great phrase-making, the best way to frame this? What we are seeing is a large-scale repudiation of financial assets. US stocks have been less badly hit; indeed, the real train wrecks have been in OTC markets.

In a weird way, belief in an inflationary scenario (which is the assumption underlying a commodities run-up, that is, if you accept the speculative hypothesis) reveals a limited degree of trust in central bankers. Investors believe Bernanke will ward off deflation; they see the overhang of debt to GDP and assume inflation is the only way out. Either Bernanke will inflate to diminish the real value of the liabilities, or many of these will effectively be moved over to the Federal government’s balance sheet, and the resulting fiscal deficits will be inflationary.

But consider: narrow money supply growth has been negative, despite the Fed’s aggressive cuts. M3 growth has been very high, due to movement of funds into deposits (that is consistent with general risk aversion and perhaps also deflationary fears). The Fed’s monetary options are severely constrained at this juncture. Even if you use a magic wand and wave away inflation worries, the Fed can cut at most another 1%. It isn’t willing to go into zero nominal interest rate territory. There have been some weak Treasury auctions on the longer end of the yield curve. Even if the Fed were to cut interest rates down the road, any rise in long rates would neutralize its effect via their effects on mortgage markets. Thus the Fed may not be able to provide enough easing to ward off deflation. A re-run of Japan’s experience (with complications due to our lack of savings) is not out of the question.

So many investors are looking into a chasm. It’s not the mind-focusing abyss of mid-March, of possible major meltdown of the financial system (although that danger is still lurking in the background with the credit default swaps market). It’s that they are unmoored. What they know how to do, what they trust, no longer seems to work. Run to commodities? If you think we are going to have stagflation, that’s a simple move in this unsettled environment that makes sense. Run to cash until the smoke clears? That sounds like a good precaution. Buy stocks on dips? Sure, Greenspan provided deep conditioning for that reflex (and hey, even in bad markets, there are always good stocks, right?)

But most investors are in denial about unpleasant truths:

1. Financial assets are far riskier than the press, the textbooks, and conventional methodologies indicate. The models that the pros use are based on assumptions that are fundamentally flawed. The dangers of the erroneous belief that financial assets are safe is now being revealed.

2. The people who control the markets (the intermediaries) have their own, and not the publics’, best interest at heart. Due to the proliferation of OTC markets and the value of assets involved, they cannot be dispensed with. And the regulators lack the skill and will to ride herd on them. As Keynes remarked,

When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.

We see ample evidence of that problem, yet seem to lack a way out.

So in a way, these gnawing issues do come around to Waldman’s point. In times of crisis, people look to leaders for guidance. But in our prevailing doctrine of free markets, there are no leaders, just agents interacting in ways purported to produce virtuous outcomes. And the parties who ought to step into the breach fail to understand the need for that role right now. That is why an old fashioned (and very tall) banker like Volcker is so reassuring. He handled a crisis; he’s not afraid to take the reins or say things are bad and changes are needed.

We are at the end of a paradigm: large scale OTC markets, lightly regulated players and instruments, dollar as reserve currency, US as the most important global economic actors. Waldman is good here:

People are losing faith in financial assets for good reason. Rather than organizing productive economies, the machinery of finance has recently functioned as an anesthetic, masking the pain while resources were mismanaged and stolen. We need a solid financial system, but confidence cannot be imposed or legislated. It will have to be earned. There has to be a plan.

But Yeats is better:

Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.

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  1. RN

    What an incredibly dour and negative post.

    And also “tall”.

    I agree with every word.

  2. Richard Kline

    At night human cries
    cross the open sea
    with the winds.

    It’s not safe yet
    to sail the open sea at night . . .

    The fields haven’t been plowed for six years
    tank treads still track the earth.
    will bury the tank tracks this winter.

    Ah, light of my life,
    the antennas are lying again
    so the merchants of sweat can close their books
    with a hundred-percent profit.

    But those back from feasting at Azrael’s table
    have come back with sealed fates . . .

    —Nazim Hikmet—

    To have a plan, we need, y’know, some planners. And not the present lot of mooks and third-stringers: too many of them are men of no good will, wired to past advantage.

    And re: commodities, follow the money—except we can’t. If we knew who was putting on this forward collar of high-leverage futures and jacking prices, we might infer why and what of it. But we don’t know since we let them operate in the shadows. I’ll bet _my_ bottom dollar that the public interest has no place in their heart or purse.

  3. Anonymous

    Most money managers I know have a great deal of faith in Bernanke. Personally, I think he’s doing a good job keeping the system afloat while it works through this mess, and he’s been very conscientious about inflation–he’s actually shrinking money supply, possibly to mop up the excesses of places like China.

    Also, I don’t see a commodity bubble–there was a brief period when commodities were moving together, and there may have been a move to goods component in that buying, but it has clearly come apart. Oil has been moving in a completely different direction from wheat for months now. Metals, both precious and industrial, have pretty much stalled out. Soybeans corrected and stalled out.

    Since we haven’t seen commodities moving in sync for months now, I don’t see how you can even talk about a “commodity run-up” in 2008. What we have is an oil run-up in 2008, and even that is not a very accurate characterization of what’s going on.

    Oil was stuck in a trading range all the way to February 19th. Some new supply had hit the inventory reports in January and early February, heating demand was high but gasoline demand was low, and so the price was basically stable. The price then moved up on a jump in buying from China, and settled into another, higher trading range that lasted into mid-April as Russian exports dropped 3.3% yoy. Supply from OPEC started taking some hits in March and April, and these hit the inventory reports in late April, when the price rose again. The price then started to correct on April 23, and would likely have stabilized for months, except that we ran into a series of supply crises: first, the strikes in the UK and Nigeria, which took roughly 400,000 barrels per day out of May supply while bunching this supply loss into a period of roughly two weeks, and second, the China earthquake, which is causing China to burn diesel for electric power, and right at a time when their inventories are particularly low, not high. (Check Google for numerous stories about China’s gas stations running out of supply prior to the earthquake.)

    China’s pent-up demand and earthquake alone are worth at least $20 of the price if the average price in June is roughly $135–and I’m being conservative at $20. (Again, we may see a dip before they begin buying in earnest.)

    We’re entering a period of high seasonal demand (diesel for peak electricity demand in the Middle East, and high driving demand in China, Russia and the U.S.). That’s worth roughly $4.00 to $4.50 of the price, if the average price is $135 in June.

    We’re going to be filling the SPR at a faster rate in June, before the July cut-off. That’s worth about a buck of an average $135 price in June. Plus there’s a decline rate to overcome with new production–the decline rate is worth another $3.50 or so of the price.

    Against all of that, we have 600k barrels per day of supply coming on in June. The rest of Evans-Pritchard’s chart is far from reality. He has Russia growing when it’s falling (and its exports are falling at 3x the production decline rate). He has the U.S. growing when the new production he’s talking about won’t come online until at least December. Most of the new Kazakhstan production has been postponed, and he’s understating North Sea decline rates. And he leaves most of the Middle East off the charts, when their exports are declining sharply (even where production is in a plateau).

    That is why the price is where it is. It’s very rational.

    I wouldn’t be surprised to see prices fall late this summer, as China goes into one of its psycho buying strikes and seasonal demand around the world drop off. But it won’t drop by the full amount of the build, because we have a production decline rate that keeps marching on. When seasonal demand kicks back in with the approach of winter, we’ll probably see prices rise again to a new high.

    Also, didn’t somebody around here point out just the other day that demand for TIPS point to low inflationary expectations?

    M3 got extremely high, but has been starting to fall. And at least some of the loss of interest in financial markets has got to be due to demographics. The baby boomers are getting older and are probably going to remain more conservative with their investments.

    I’m not trying to say we don’t have problems–we’re in debt up to our eyeballs, housing prices are still falling, unemployment is rising, and energy costs are going up.

    I understand where people are coming from. You and the readers of this blog are probably people who have worked hard their whole careers, been prudent about their money, and socked away a good chunk of it. It’s extremely annoying, even scary, to see its value getting corroded by price inflation.

    But if people want to deal effectively with this problem, they had better understand it correctly.

    Moe Gamble

  4. shargash

    Russian (#1 producer) oil production in April was down 3.6% from March. OPEC deliveries for the 4 weeks ending May 4th declined 4.3%. Supply & demand have been very tight all year, and supply just seized up. If you believe in basic market principles (e.g. that supply & demand set prices), then it should come as no surprise that oil spiked up. But people are still looking everywhere (anywhere) else for an explanation.

    As for the short-covering rally in oil on Wednesday, prices fell back within 24 hours. That’s exactly the kind of effect speculators have on prices.

  5. S

    Anon those PMs must be in the fixe dincome universe – read thank s I have a job. As for PM there is a huge dichotomy between hedge fund amangers and long only managers. The long only crowd is cheerful – S/P estimates are still double digits for 2H? The Hedge fund crowd is far more skeptical. As has been said repeadetly the finance based economy is so detached from reality that it will take a lot to reign it in. I am not optimistic at all. All you have to do is spend a fair amount of time around the finance based crowd to realize that they still think they add value – only this month it is in the commodities space. As a colleague wonce said: Wall Street is a series of bad short term decisions (in perpetuity).

    The whole Bernanke is so smart things is tired. Everyone in the finance game is pretty smart. Bernanke may be doing the best he can with the cards he was delt (or helped arrange better yet) but ascribing super hero status to him and his NY Fed sidekick is pathetic. Thes guys are doing nothing but protecting incumbant interests at the cost of the crowd. The onkly sound investment thesis for equity is that the fed can ram rates down so low that people go fishing for equity returns. Given the huige moves in commodity and energy, look for technology to be the next speculative driver in equity. The game of musical chairs goes on. When this charade ends it will be amusing. bernanke is hardly a genius, he is just lucky to be playing to a friendly crowd. MNost Americans have no idea whatr the fed does or better yet who bernanke is. So all the cheering is from the enlighted crowd. Therein lies the greatest irony of all. End of empire.

  6. David Pearson

    I don’t find much support for your comment that Bernanke is unwilling to take rates to zero. His academic writings point to the oppposite: he criticized other Central Banks for NOT taking rates to zero to fight deflation. He doesn’t come out and say (or rather write) “better inflation than deflation”, but he invites readers to make that conclusion. Clearly, according to Bernanke, the 1930’s Fed and 1990’s both worried too much about the currency and inflation — exactly the same worries that are being pressed upon the Fed today.

    Despite all the rate cuts, the monetary base has not budged, and this must worry Bernanke. If the contraction steepens, he may well conclude that the system needs to be force-fed funds via quantitative easing. Under this regime, the Fed wouldn’t set rates to zero, it would let rates fluctuate freely as it purchased a pre-determined amount of Treasuries from the banking system.

  7. Yves Smith


    I do recall a Fed watcher or two saying the central bank is concerned about winding up in zero interest rate land (and if you follow Japan, that is not a good situation to fall into). But that may be the FOMC as a whole, not Bernanke.

    The criticisms of the Fed in the 1930s and Japan in the 1990s is that they did not cut deep enough early enough. The Fed I believe increased rates to defend the dollar (remember, we were on the gold standard; England devalued I think in 1931, we didn’t until 1934). In Japan, the powers that be raised rates to kill the asset bubbles, and then did not reduce them (in the conventional analysis) fast enough. Personally, I think the de facto lack of equity in the banking system in Japan was at least as big an issue as the monetary management.

    I plan to check and see who said what re the Fed and ZIRP….

  8. bobo7874


    In thinking about the fed going to zirp, you have to take into account that money market funds start losing money at rates below 1% because they only invest in extremely short-term securities. The money market funds have the political power to push their representatives in Congress to jawbone the fed not to go below 1%. Right now, the mutual fund industry is pushing to severely reduce the tax benefits of exchange traded notes, so their representatives in Congress introduced bills to do just that, even though SIFMA has been lobbying against it.

  9. David Pearson


    Here’s a bit from BB’s 2003 Japan speech:


    Here’s a bit from BB’s 2003 Japan deflation speech (link below):

    “My thesis here is that cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own. Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt–so that the tax cut is in effect financed by money creation. Moreover, assume that the Bank of Japan has made a commitment, by announcing a price-level target, to reflate the economy, so that much or all of the increase in the money stock is viewed as permanent.”


    “Of course, one can never get something for nothing; from a public finance perspective, increased monetization of government debt simply amounts to replacing other forms of taxes with an inflation tax. But, in the context of deflation-ridden Japan, generating a little bit of positive inflation (and the associated increase in nominal spending) would help achieve the goals of promoting economic recovery and putting idle resources back to work, which in turn would boost tax revenue and improve the government’s fiscal position.”

  10. David Pearson

    And an excerpt from “Essays On The Great Depression”:

    …consistent with the views of Hamilton (1987), contraction or slow growth of the nominal money stocks was an important cause of deflation in the earlier phase of the Depression…

    “Contraction or slow growth” exactly characterizes the monetary base today.

    Of course, all of BB’s writing on deflation-fighting carry a caveat: provided that inflation is low and declining. Right now, obviously, it is neither, and we probably have their earlier experiment with deflation fighting (2002/2003) to thank for that. What does the BB academic playbook prescribe at the juncture of inflation and deflation? Its quite possible that he’s adaptable enough to have thrown the playbook out the window, but given its his life work…

  11. Yves Smith


    Thanks so much for the links. Will give the speech a look.

    The thing that I find disconcerting in reading the extracts is the faith, which I find naive, that low interest rates will stimulate spending, as opposed, say to asset inflation, or simply be unproductive (the famed “pushing on a string” syndrome).

    In really bad times, consumers tend to increase their cash holdings. That is a almost a reflex. I now hear cab drivers tell me how they are saving (or buying gold coins).

    Consider Paul Krugman’s explanation in the New York Review of Books of why the Depression came about. Krugman disagrees with the common view that the Fed failed to provide enough liquidity:

    If the money supply consisted solely of currency, it would be under the direct control of the government—or, more precisely, the Federal Reserve, a monetary agency that, like its counterpart “central banks” in many other countries, is institutionally somewhat separate from the government proper. The fact that the money supply also includes bank deposits makes reality more complicated. The central bank has direct control only over the “monetary base”—the sum of currency in circulation, the currency banks hold in their vaults, and the deposits banks hold at the Federal Reserve—but not the deposits people have made in banks. Under normal circumstances, however, the Federal Reserve’s direct control over the monetary base is enough to give it effective control of the overall money supply as well…..

    In interpreting the origins of the Depression, the distinction between the monetary base (currency plus bank reserves), which the Fed controls directly, and the money supply (currency plus bank deposits) is crucial. The monetary base went up during the early years of the Great Depression, rising from an average of $6.05 billion in 1929 to an average of $7.02 billion in 1933. But the money supply fell sharply, from $26.6 billion to $19.9 billion. This divergence mainly reflected the fallout from the wave of bank failures in 1930–1931: as the public lost faith in banks, people began holding their wealth in cash rather than bank deposits, and those banks that survived began keeping large quantities of cash on hand rather than lending it out, to avert the danger of a bank run. The result was much less lending, and hence much less spending, than there would have been if the public had continued to deposit cash into banks, and banks had continued to lend deposits out to businesses. And since a collapse of spending was the proximate cause of the Depression, the sudden desire of both individuals and banks to hold more cash undoubtedly made the slump worse.

  12. Anonymous

    The lines “The best lack all conviction, while the worst / Are full of passionate intensity” are a paraphrase of one of the most famous passages from Percy Bysshe Shelley’s Prometheus Unbound, a book which Yeats, by his own admission, regarded from his childhood with religious awe:

    In each human heart terror survives
    The ravin it has gorged: the loftiest fear
    All that they would disdain to think were true:
    Hypocrisy and custom make their minds
    The fanes of many a worship, now outworn.
    They dare not devise good for man’s estate,
    And yet they know not that they do not dare.

  13. Anonymous

    Off topic but topical is an article in
    Perspectives on Psychological Science

    Volume 3, Number 3 · May 2008

    Morality: An Evolutionary Account
    Dennis L. Krebs

    Seen from an evolutionary prospective of this type, we may be able to get a more real idea of “economic man”.
    And of course as we have been learning recently from interbank lending, there needs to be some more emphasis i developing a trusting relationship within our economic system

  14. david pearson


    I agree — velocity is hard to predict much less control. What is interesting about this juncture is that velocity sits on a knife’s edge: on one side a deflationary spike in the savings rate; on the other an inflationary hoarding of goods. To complicate matters, the knife’s edge exists globally and velocity may go one way in China and another in the U.S..

  15. Richard Kline

    Yo Moe,

    I do not place any faith in ad hoc explanations for behaviors with large underlying trend functions. That’s not to say I completely disagree with you, but the argument as you frame it is anything but convincing, to me. You speak of how agricultural commodities and minerals “can’t be in a bubble” because they plateaued earlier this year. That time point you chose has its back turned to the huge run-up these commodities had had to that point, rather like saying in later 05 that house prices couldn’t be in a bubble because price rises were flattening. I do wonder whether many of those holding those high-bid commodity futures are having stomach cramps over whether demand will be there to meet them come delivery time; that might be an alternate understanding of the plateau. The supply of greater fools may have proved unequal to demand in these markets.

    “Pent up demand in China” for oil worth $20 a barrel? Really? Like, all the experts in the world got demand growth there soo wrong that they missed $20 worth, and then suddenly caught on during a few weeks in April? And these ad hoc issues in China right now with diesel and whatnot: the supply to meet them is already in the supply chain at a lower number, so why are we seeing a huge price spike on oil which will be delivered about the time you are positing a Chinese buyer’s strike later this year? Where were these ad hoc arguments six months ago when oil was knocking around the $90s? Either the price rise from there to ~$135 and more follows a real trend function or it doesn’t, but ad hoc undulations don’t move the number by 50% without something like Nigeria tilting on end and sliding into the Atlantic Ocean.

    Ad hoc explanations, even if everyone is valid, and I’m doubtbul regarding some you advance, do not explain trends; at most they respond to trends. Now, I am not convinced that oil is in a bubble per se since global supply and demand are simultaneously undergoing major shifts over the last half dozen years, making good estimates about where a non-arbitrary ‘real price range’ might lie. The issues you and the later poster make regarding actual real if modest production declines this Spring, Nigeria aside, do speak to endogenous drivers in the market price. At the stame time, this tight coupling of supply-demand would also serve to firm a floor under an upward bounce: all the producers know how to play this game very, very well, and a seet little clinch just when the summer buying season has to come to market is more like an exogenous disturbance to me—and we always, always get these ad hoc ‘explanations’ in these circumstances. If short covering can knock $8 off the per barrel price in a day I’d say there is plenty of speculative money in the game.

    Then there is the issue that the spot price has no downward pressure on futures to speak of because futures look to be in a hard collar with very little excess supply able to reset to spot marginal pricing. Would you care to comment on that?

  16. Richard Kline

    Regarding Bernanke’s position on zero rates: BB has an intellectual history on this issue, but I think that it’s time we stopped refering back to it. Bernanke faces a financial crisis that is significantly _more complex_ than anyone has ever faced before. I believe by his actions that he understands this now, even if he did not before November; he is a bright man, and financial crisis is his area of specialty: he can do the comparisons in his head, down to numbers and timelines. He is in a box on the currency. He already has negative real rates. The primary dealers in the US banking system only exist because he gave them public money to keep them from washing away—but they aren’t _making_ any money to speak of, and their losses just don’t stop. The Fed is talking about no more cuts; I don’t think that’s a head fake as clear moves are absolutely necessary with everything so wobbly. If the Fed goes down to effective zero, a major consequence is that they will lose almost all remaining ability to influence subsequent outcomes, and a complete loss of influence is likely what the Fed fears (and rightly) more than any one thing.

    Ben Bernanke is making it up as he goes along—and that’s a good thing. An adherance to orthodoxy or cant are the last things needed. The problem is that he has no solution for the way the pieces are cobbled on the chess board, and not enough pieces to begin with. The Fed has gone too low for the current problem set as a whole, and would actually be in a better place 100 basis points higher. To turn around on a dime would wreak havoc, particularly in equities, so that’s out until late in the year at the earliest. In my view, this will be the first best point to be raised when the history of _this_ crisis is analyzed and published: the Fed has overshot too fast low and is now clinging to the tightrope in a strong wind rather than standing upon it.

    Ben, here’s some advice from the third tier cheap seats: yah gotta let something go if you’re going to crawl ahead outta this thing, you can’t hold everything up. So what’s it gonna be: house prices, equities, the currency, or the banking system? If you don’t make a choice and bloody soon, your arms are gonna get tired, and you’ll go down into the abyss with all of them. Come on, friend . . . we’re waiting.

    I think we can forget about what he’s written and watch what he does, because he’s having to bushwhack off the map and seems to realize that.

    Regarding Von Mises, credit expansions _follow_ cyclical trends, not lead them. That, for example, is the thesis of G. Soros, but I think one can make a far better historical argument for it, too. I see this very much with the kind of cycle models I’ve worked with myself, but that’s a contention I can’t support without a bunch of discussion that doesn’t belong here, really. The historical examples in the linked post for ‘crack up’ booms are all massively influenced by war-induced price and commodity dislocatins; they aren’t good historical comparables for our situation. Personally, I’m deeply skeptical that the major driver in commodity prices is a ‘flight to substance’ following a panic flight of capital from ASB securities. For one thing, the real problem with those securities is that capital _can’t get out of them_ though it would desperately love to flee anywhere other. The big ‘flight to safety’ appears to be into money market instruments. Sure, some speculation shifting out of trainwreck securitized atomic glass has gone over to commodities. I’m more of the view that speculative flows into commodities are following a prepared strategy then a reactive one, but I’m only guessing there.

  17. Anonymous

    Bill Gross’s latest [June] comments deals with the understated rate of inflation in the U.S. Whether or not the money supply growth is inflationary, a desire to protect oneself from hidden inflation can also propel investors to own commodities.

  18. Anonymous

    “the public lost faith in banks, people began holding their wealth in cash rather than bank deposits”

    True. And the government lost faith in the people be creating legislation that forced Banks to make sure an IRS agent was on hand every time a person wanted to open up their safety deposit boxes.

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