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Happy New Year!

I wish all of you the best for 2008!

Posting will resume on Wednesday, January 2.

Happy New Year!

Christopher E. Hill
Editor
editor@boom2bust.com

Goodbye, Middle America

As 2007 comes to a close, President George W. Bush wished the United States a Happy New Year today from his ranch in Crawford, Texas, and reassured Americans that the U.S. economy remained vibrant as we enter the new year. According to the UPI, the President’s message said that the economy had strong underpinnings and that his administration would continue to encourage economic growth “so Americans have more money to invest in their businesses, spend on their families and put aside for the future.”

The President’s greeting reminds me of a saying they use in Texas that goes like this:

“All hat and no cattle”

These past few years I’ve dedicated a significant amount of time studying the U.S. economy and where it’s headed. Regular readers of Boom2Bust.com know where I think this is going. As the storm creeps in, I keep hearing the same things from the same people. “We’re in a goldilocks economy,” according to Wall Street, the government, real estate agents, and just about anyone else who makes a living off of a “vibrant” economy. Just remember that where you stand often depends on where you sit.

As President Bush tells us that the U.S. economy has strong underpinnings, all around me I see the signs to the contrary. A quick glance down the street and it looks as if the lawns are sprouting “for sale” and “for rent” signs instead of plants. No one dares talk about real estate at social gatherings these days, whereas a few years ago I told my girlfriend that if one more person brings up the housing market and how much their home’s value has gone up (because of their investing genius, of course), I’d go ballistic. Then there’s talk of growing financial problems with the City of Chicago, Cook County, and the State of Illinois, as revenues aren’t keeping up with expenditures. I could go on for quite a while. But, don’t just take my word. Consider two articles I came across today in The Times (UK) and the Chicago Tribune. According to the London-based paper:

While the forecasts of some of Wall Street’s top number-crunchers suggest that America may avoid a nasty recession, it is unlikely to feel that way for many families across the United States. Americans, who for the past two years have spent more than they took home for the first time since 1933, are arguably at their most financially vulnerable for generations. The risk that Americans may be forced to tighten their belts, dampening consumer demand, is a real one, now that they are confronted with a decreasing value of their homes, rising fuel prices and uncomfortably high food costs.

According to today’s Chicago Tribune, U.S. food prices have risen this year at more than twice the rate of 2006, and at a pace not seen since 1990. The outlook doesn’t look any better, as many economists believe this year’s estimated price increase of about 5% may be part of a trend that threatens to ratchet up food costs for years. The Chicago-based paper points to the rise of ethanol and strong economic growth in developing nations as the catalysts for higher prices. The Tribune concludes:

If this year’s rise in food prices is indeed part of a long-term trend, lower- and middle-income consumers in particular will feel a pinch in years to come. And U.S. economists might have to rethink the way they view food inflation, which is predicated on the view that food price swings are inherently cyclical and therefore less worrisome than long-term changes.

Benjamin Senauer, co-director of the University of Minnesota’s Food Industry Center, told the paper that, “The days of cheap food may be over.”

Going back to The Times piece, the situation faced by a Nebraska ice cream parlor owner illustrates how the odds are stacked against Middle America:

The milk price has doubled this year, to keep pace with the soaring cost of maintaining a dairy herd. Corn prices used to feed dairy cattle have doubled because of the rising demand for corn to ferment to make ethanol, the biofuel. Amy Green, the proprietor of the Ivanna Cone Ice-cream Emporium in Lincoln, Nebraska, has raised her ice cream prices by 37 per cent in the past 18 months. “Everything has gone up. All the raw materials that I need to run my business have risen – the butterfat, the milk, the sugar and the fuel. I had to pass on the rising costs,” she said.

The Times noted that according to research compiled over the past three years by Harvard University, Middle America is experiencing the most severe financial hardship for more than five decades. Edward Wolff, Professor of Economics at New York University, told the paper that the squeeze on the middle class would get tighter as banks tighten lending criteria in the wake of this summer’s credit crisis. He said, “These families are just not going to be able to take out additional debt. Credit-card companies and auto-loan groups are just going to start saying no.” Contrary to the belief that Americans can’t control their spending habits, the economics professor said “they’re not expanding consumption, they are just trying to tread water.” He pointed out that median household income has nose-dived by 7% between 2000 and 2004, while increasing only 6% between 1983 and 2004.

In retrospect, while President Bush wished us all a “Happy New Year,” perhaps “Goodbye, Middle America” may have been more appropriate, considering the circumstances.

Yale’s Shiller Warns Of Prolonged Housing Slump

According to the New Year’s Eve edition of The Times (UK), Robert Shiller, Professor of Economics at Yale University, is predicting that U.S. home prices may decline for years. The co-founder of the S&P Case/Shiller house-price index said:

American real estate values have already lost around $1 trillion. That could easily increase threefold over the next few years. This is a much bigger issue than sub-prime. We are talking trillions of dollars’ worth of losses…

Over the next five years, the futures contracts are pointing to losses of around 35 per cent in some areas, such as Florida, California and Las Vegas. There is a good chance that this housing recession will go on for years.

Professor Shiller explained how the U.S. housing bubble came to be:

This is a classic bubble scenario. A few years ago house prices got very
high, pushed up because of investor expectations. Americans have fuelled the myth that prices would never fall, that values could only go up. People believed the story.

The Times pointed out that until two years ago, each of the fifty states participated in the housing boom, where properties in some states, such as Arizona, California, Florida, and Nevada, doubled in price, “fuelled by cheap credit and lax lending practices to borrowers who ordinarily would not have been able to secure a mortgage.”

“Now there is a very real chance of a big recession,” according to Dr. Shiller.

The Science Behind Market Bubbles

Back on May 23, 2007, the Wall Street Journal talked about Nobel laureate economist Vernon Smith, a George Mason University professor who shared the 2002 Nobel economics prize for his work on how individuals behave in simulated markets. A number of his experiments looked at how investors create market bubbles, how the bubbles pop, and how participants behave afterwards. Dr. Smith found that once investors inflate a bubble and endure a crash, they are unlikely to repeat the mistake until memories fade.

According to the Journal:

In a lab setting, almost any group of subjects, including businessmen studying an executive M.B.A program and professional stock traders, will create a bubble if given adequate cash, Prof. Smith found. In one experiment, where participants could win small amounts of cash by trading successfully, a participant called him over to complain the market was running amok. “He said, ‘What is this buying panic’ ” Professor Smith recalls. Even so, the investor returned to the fray. “He waited a while. Then he started buying.”

Prof. Smith’s experiments show that participants typically inflate a large bubble, cause a crash and then inflate a much smaller bubble, followed by a much smaller decline. After that, they trade cautiously. That helps explain the once-a-generation element of these extra-long bull markets. “Once people get experienced, it is very hard to reignite a bubble with those same people. You’ve got to bring in novices and mix them in,” Prof. Smith says.

So where does that leave us? Did the downturn in the U.S. stock market earlier this decade qualify as the “crash” of a larger market bubble? If so, we may be heading toward yet another decline where investors tread lightly when it comes to equities. Or, are stock investors living on borrowed time before a “once-in-a-generation” market crash ravages Wall Street?

Bubble, bubble, toil, and trouble

Jim Rogers Packs His Bags

And if you pull a double one
I’ll pack my bags and I’ll be gone
If you pull a three and four
I’m flying off to Singapore
Where women dance and tigers roar
I’m lying on a distant shore
I’m living life as fast as I can
A nod, a wink, another drink I am the domino man.
-The Beautiful South, “Domino Man”

Jim Rogers is getting out. Of the United States, that is. Fortune Magazine managed to interview the 65-year-old legendary investor and author while he was making final preparations for his move from Manhattan to Singapore. The following excerpts are from CNN Money on Christmas Eve:

You mention the possibility that we might go into a depression. What is your assessment of the U.S. economy right now?
In my view, the U.S. economy is in recession. I know the government says we’re not. But as I look around, we know that automobiles are in worse than recession. The same thing is true for homebuilders. Much of the financial sector is in worse than recession. So many parts of America are in worse than recession, and yet the government says we’re not in a recession. I don’t know what’s so strong that it’s offsetting these major weaknesses in the American economy. I just assume that the government is lying.

A few months ago you said if Fed Chairman Ben Bernanke cut interest rates in response to the credit crunch, it would be “pure madness” and “a disaster.” He did. What do you think now?
We have terrible inflation in America, not according to the government but according to people who buy things. We have the dollar under terrible duress. What I said was, if they cut interest rates it’s going to be a signal to the rest of the world that we don’t care about the dollar, that we want the dollar to go down. That is what has happened. The rest of the world has read the signal very clearly. Inflation, of course, is going up. Commodities prices go higher in this kind of scenario. I think it’s a terrible mistake. It may be good for Wall Street. It may bail a few people out. But it’s not good for America. I will tell you that I was terrified recently when I saw Bernanke testifying before Congress, and he said that if an American buys only American products in American currency he is not affected by the decline in the U.S. dollar. I couldn’t believe the man said that! I was looking at him to see - Is he lying? Is he just using government propaganda? Or does the man just not know? He’s supposed to be an economist, and he doesn’t know how the economy works! Let’s say you only buy American tires. Well, if the price of foreign tires goes up because the dollar goes down, the price of American tires is going to go up too. American companies are going to raise the prices if the competition goes higher. And if the dollar goes down, the price of the rubber in the tires is going to go higher. The price of oil, wheat, copper, everything is going to go higher if the dollar goes down. So it’s another signal to get out of the dollar.

You’ve been betting against U.S. commercial and investment banks for some time. Are you still shorting their stocks? Are you making other moves?
I am still short Citigroup. I’m still short Fannie Mae. I’m still short homebuilders. And I just increased my short positions on the investment banks last week, because that’s where the excesses have been in the U.S. economy. There have not been excesses in sugar farming in the past 30 years. There have not been excesses in silver mining. The excesses have been on Wall Street. That’s why I’m shorting Wall Street. You see 29-year-old kids making $10 million or $20 million a year and thinking, “This is the way the world is. This is normal.” Well, I don’t think it’s normal.

Why move to Singapore and not Shanghai or Beijing?
Well, we would like to move to China, but the air is so terrible, the pollution is so bad, that we can’t bring ourselves to do it. Everything works in Singapore. It’s an astonishing place. It’s got the best education system in the world. It’s got the best health care in the world. And it’s Chinese-speaking. Our 4-year-old daughter, Happy, goes to a school where they only speak Chinese. One of our motivations was that she continue to speak Chinese. It may not be as exciting as Shanghai or New York, but it’s exciting enough for me.

Downtown Singapore

Investment Bank Predicts Ron Paul Victory As Economy Weakens

Every year, the Strategy Team at Danish investment bank Saxo Bank puts together a list of ten long-shot predictions for the new year. It’s interesting to note that more than a few of these predictions have come true over the years. For example, at the end of 2006, Saxo analysts said they were bullish on oil “given the raft of alarming geopolitical scenarios with alarming implications for global supply.” Crude oil prices in 2007 almost reached $100 per barrel. Another prediction by bank staff was that the Federal Reserve would bring the federal funds rate down to 4% by the end of 2007. It now stands at 4.25%.

Here are some of the investment bank’s more notable predictions for 2008 (from Emirates Business 24/7):

World oil prices to hit $175 even if growth slows
Much of the conventional wisdom on oil has been proven wrong over the past few years, as previously unimaginable new highs in the price of oil have only been a reflection of the strength of global growth, rather than an obstruction in its path. With the weak US dollar and shrinking profit margins for refiners, the end consumer in many places worldwide hasn’t noticed a difference between oil prices at $99 compared to oil prices at $75. Even if global growth slows in 2008, it will continue to move ahead in the emerging markets of the world where marginal energy demand is growing the most. As “peak oil” becomes an accepted principle and supply and demand do a nervous dance, the price risk in energy remains firmly to the upside.

UK economy likely to go into a nosedive
The British economy may go into a nosedive in 2008, weighed down by some of the same factors that have toppled the US. The UK housing bubble is possibly worse than the US bubble and has only begun to unwind. The Bank of England has dragged its feet as the credit crisis has unfolded, which could worsen the situation compared to the Fed, where “Helicopter” Ben Bernanke has replaced “Easy” Alan Greenspan. The UK consumer is even more overextended in terms of all forms of debt than his US counterpart.

S&P 500 falls 25% from its 2007 high to 1,182
Why 1,182? That would be an exact 25 per cent drop from the 1,576 high the S&P 500 index reached in mid-October this year. History shows that a stock market drops 15 to 30 per cent when housing markets fail. “Easy Al” and “the slice and dice any manner of junk and pass on the risk to your clients” investment banking paradigm triggered the biggest housing bubble in US history. The unwind from the height has already been severe, but it has further to go. So we are daring to forecast that the fall in the major US index will lie at the extreme end of the scale.

Grain prices to double again as demand rises
This year saw the most spectacular gains in the grains complex in recent memory as wheat prices doubled and soybean prices rose to levels not seen since the wild grain markets of the 1970s. Human population growth has slowed on a percentage basis, but per capita consumption of grain is accelerating as emerging markets switch to higher protein diets, which have a multiplier effect on the grain market. Every kg of beef requires seven kgs of feed, for example. Chinese meat consumption has also doubled per capita since 1990 and milk consumption has tripled since 2000.

Many of the big US home builders to go bankrupt
As 2007 draws to a close, many of the stocks for the largest home construction outfits in the US are rallying after George W Bush rolled out his desperate attempt to stem the sub-prime tidal wave by fiddling with rate reset mechanisms and implementing other measures, which seem like pumping medicine into a dead horse. These steps are too little and too late, as the last phases of the US housing boom were one of the worst examples of overextension by any industry – driven by excess liquidity. At least three of the largest US home builders could go bankrupt in 2008.

Chinese equities likely to see correction next year
The Chinese stock market bubble in 2007 saw one of the most remarkable accumulations of paper wealth in financial market history. The rise in Chinese equities is certainly due in part to solid fundamental underpinnings, including a liberalisation of markets and remarkable economic growth. But there are a number of factors we believe may have resulted in an unhealthy overextension in equity prices that could mean an ugly correction in 2008 – possibly around the psychologically important 2008 Summer Olympics in Beijing.

Ron Paul elected President of the United States
The most outrageous! One would imagine a party with the least popular president to inhabit the White House – ever – wouldn’t stand a snowball’s chance in Texas of getting a new candidate elected to the presidency. But Ron Paul is no George W Bush, even if he is a Republican like Bush and is from Texas like Bush. His libertarian, anti-war platform is about three standard deviations away from the platform of any other republican candidate — or even Hillary Clinton, for that matter. Paul’s share in the Republican candidate polls has rocketed from one to six per cent in the space of a few months and there is the best part of a year to go until the election. As should be clear from this year’s outlook, we are quite negative on the US economy in 2008. A general slowdown and stock market turmoil must increase the odds of a Ron Paul nomination as he has been the only candidate to speak about the budget, account deficits and the dollar crisis.

Wall Street’s Happy Holidays

“He’s making a list, checking it twice. Gonna find out who’s naughty and nice…”

I’m not referring to the jolly old fat man with the red suit and beard here. Instead, I’m talking about your boss and those in management, as they determine who will be receiving a year-end bonus. A long time ago (in a galaxy far, far away) bonuses were given out in recognition of an employee’s contribution to the organization. It used to be the greater the contribution, the larger the bonus (theoretically). Nowadays, as more managers are afraid to withhold bonuses from employees who may not deserve them in the first place, equal bonuses (usually as a percentage of salary) are given out across the board, thereby removing an essential financial incentive in the workplace. Bravo. Even worse, in some cases the “bonuses” that are distributed aren’t bonuses at all. Instead, they are really just cost of living adjustments. In stark contrast to the situations these poor souls are facing, it’s party time on Wall Street. Ironically, in a year when investment bank stocks plunged 45% in value, Wall Street bonus checks rose an average of 14% from last year, according to the Associated Press last Friday. Dean Baker, Co-Director of The Center for Economic and Policy Research (CEPR), noted in TruthOut on Christmas Eve that Morgan Stanley’s stock is down almost 20%, Lehman Brothers stock is down a bit more than 20%, and Citigroup’s stock price is down almost 50% from the beginning of the year. Baker said:

With a year like this, you might have expected that most of the Wall Street gang would be waking up on Christmas morning to find lumps of coal in their stockings. But, that’s not the way that the modern economy works… In a year in which tens of millions of families are struggling to pay their heating bills and hang onto to their homes, it seems that Santa still has a soft spot for the folks who cut deals on Wall Street.

Still, unless you’re a stockholder, it’s really none of your concern. However, Main Street might have a problem with the other reason why Wall Street is especially festive this holiday season. Baker explains:

Of course, it’s not just the shareholders who are generous with the Wall Street crew. All of us, as taxpayers, have done our part to ensure that these folks have a happy holiday season. In particular, we deserve thanks because we gave hedge and equity fund managers a special tax break that allows them to pay a much lower tax rate than workers like firefighters and schoolteachers. The fund managers’ tax break allows some of the richest people in the country to pay a tax rate of just 15 percent on their earnings, as compared to the 35 percent tax rate that they would face if they had to pay taxes like ordinary workers.

Congress did consider eliminating the fund managers’ tax break this year, but a determined lobbying effort saved the day. The fund managers told Congress that if they had to pay the same taxes as everyone else, their hundred million dollar salaries would not give them enough incentive to work. Undoubtedly some sizable campaign contributions made this argument more compelling to members of Congress.

One of the leaders of this lobbying effort was Peter Peterson, an investment banker with the Blackstone Group, a private equity firm that earned Peterson and other partners billions when it went public this year. Mr. Peterson is primarily known for having spent much of the last fifteen years arguing for cuts in Social Security and Medicare for people like schoolteachers and firefighters. When arguing for these cuts Mr. Peterson routinely asserts that he does not need his Social Security. With the tens of millions in tax breaks he gets from the government, this is surely true.

I sure hope Mr. Peterson has fire sprinklers in his home, because I have a feeling his local fire department may get “lost” should a fire ever break out…

Everyone smile and say “Medicare”

Merrill Lynch, PIMCO: No Avoiding Recession

President Bush said today at a White House news conference that the nation’s economic “fundamentals are strong,” and that his administration will “consider all options” to prevent a recession from happening in the United States. The White House may be late to the party, according to two articles I came across today.

The Toronto-based Globe and Mail said that a Merrill Lynch recession probability indicator is pointing to a “painful and pronounced downturn next year” for the U.S. economy. According to the Globe, Merrill Lynch uses the U.S. National Bureau of Economic Research’s definition of recession, which is a significant decline in economic activity lasting more than a few months and evident across economic measures including GDP, employment, and retail sales. Their recession probability indicator looks at a combination of the yield curve and corporate spreads, and is now signaling that there is a 100% probability that a U.S. recession will take place within the next 12 months. David Rosenberg, Merrill’s North American economist, warns, “Clients should be taking recession risks very seriously.” The odds have grown since October, when the indicator was at 75%. Only this past summer did the tool show no threat of recession.

While Merrill Lynch’s recession probability indicator may warn of an inevitable recession on the horizon, Bill Gross of Pacific Investment Management Company, LLC (PIMCO), one of the world’s largest fixed-income managers, says the U.S. economy has already gone into recession, according to the Financial Times (UK). In an interview with the Times, Gross said, “If I had to be bold I’d say we began a recession in December.” The U.S. recession would last “four to five months,” he thought, but warned it could be prolonged if the White House and Congress neglected to “take some rather unperceived and unforecasted measures in terms of fiscal stimulation.” Gross explained:

What needs to be done is something fairly radical compared to Republican orthodoxy, which means spend money and absorb the deficit as opposed to pretending that you’re fiscally conservative.

According to the Times:

He said: He was highly critical of the complicated financial instruments that have exacerbated the credit squeeze, saying the trend of over-leverage was a “dying concept” that will “lead to an implosion at the edges . . . of this new financial marketplace.” He also had stern words for hedge funds, describing them as a “con”. A hedge fund, he said, was “an unregulated bank. A bank isn’t a con but a bank is a regulated entity. A hedge fund is not . . . it’s been a con on the government in terms of their unwillingness to regulate the industry.”

Say fella, what hedge fund do you work for?

Gross called for the Federal Reserve to bring interest rates down to 3%, and was critical of U.S. attempts to stabilize credit markets, describing the “Super SIV” and plans to freeze mortgage teaser rates as a “temporary fix.”

It’s interesting to note that PIMCO switched out of mortgage-backed securities last year, and for the first half of 2007 fell behind its competitors. Since that time it has outperformed the market as subprime-related losses mount.

Doubts Linger About The Dollar

On Wednesday, Kathy Lien, Chief Strategist of DailyFX wrote:

As 2007 draws to a close, the US dollar is making a nice comeback. Since December 1st, when “The Panic about the Dollar” was the headline on the front page of the Economist, the mighty buck has increased 600 pips against the British pound, 400 pips against the Euro and 300 pips against the Japanese Yen. What has changed? Has the curse of the magazine cover marked the bottom in the US dollar yet again?

Perhaps nothing has changed. In fact, a senior economic adviser at UBS Investment Bank in London told Bloomberg that the credibility of the U.S. dollar as the world’s benchmark currency will be tested as it loses value against other major currencies. In an interview with Bloomberg on Wednesday, George Magnus said, “We’re clearly at a point where credibility is being stretched, and we don’t really know what comes afterward.” The UBS analyst added that while it’s unlikely that entities in the emerging economies in Asia and the Middle East are at the point of ditching the dollar and pricing assets in other currencies in 2008, the U.S currency is being “severely tested.” Magnus pointed out that sovereign wealth funds are just one example of institutions that are avoiding falling greenbacks in favor of assets that will preserve their wealth.

The economic adviser concluded:

This is not something which we’ll get closure on in three weeks… It takes a long time for reserve currencies to be born and to disappear, but we can see a stretching of credibility.

Last week, the U.S. dollar was down 8.5% against the European currency for 2007.

Bad Moon Rising

On Monday, the Bush administration released its Financial Report of the United States Government for the 2007 budget year. And guess what? The U.S. government is promising $45 trillion more than it can deliver on Social Security, Medicare, and other benefit programs, according to the Associated Press yesterday.

I see the bad moon arising.
I see trouble on the way.
I see earthquakes and lightnin.
I see bad times today.

The Bush administration said Monday that the $45 trillion represents the gap between the promises the U.S. government has made in benefits, and the projected revenue stream for these programs over the next 75 years. The shortfall increased by nearly $1 trillion in just one year when using the 2006 report as a benchmark. In addition, the gap between entitlements and revenue is up 67.8% in just the past four years. Martin Crutsinger, an AP Economics Writer, said that in 2003 the shortfall was projected to be only $26.9 trillion over the same 75-year time period.

I hear hurricanes ablowing.
I know the end is coming soon.
I fear rivers over flowing.
I hear the voice of rage and ruin.

Even worse, when the gap in funding social insurance programs (Social Security, Medicare, Railroad Retirement, and Black Lung Program) is added to other government commitments, the total shortfall as of September 30 increases to $53 trillion, up more than $2 trillion in just a year, according to the report. Comptroller General David M. Walker, who serves as the head of the Government Accountability Office (GAO), said Monday that, “Our government has made a whole lot of promises in the long-term that it cannot possibly keep.”

Hope you got your things together.
Hope you are quite prepared to die.
Looks like were in for nasty weather.
One eye is taken for an eye.

As usual, Congress said something should be done as 78 million Baby Boomers reach retirement age…

On a side note, the report said that the federal budget deficit would have been 69% higher than the $162.8 billion reported two months ago if the government were held to the same accounting standards as private companies. Using the accrual method of accounting, the deficit would have totaled $275.5 billion for the fiscal year ending September 30.

Head Of Group That Identifies Recessions Says 50% Probability

Last Friday, the head of the nation’s leading nonprofit economic research organization told Bloomberg in an interview that the chance of a recession in the United States stood at about 50%. Martin Feldstein, a Harvard University economist and president/CEO of the NBER (the group responsible for dating U.S. economic cycles), said there may “easily” be a U.S. economic recession in 2008 if consumer spending declines along with home values. When asked about the chance for an economic contraction, Feldstein replied, “I would put it at about 50 percent…” He said the risk “clearly has been increasing.”

The Ivy League economist also warned that, “There’s a danger of the U.S. falling into stagflation,” with gross domestic product shrinking and inflation increasing by around 3.5%. Feldstein added, “We are looking at a slightly higher inflation rate than we want.” However, he noted, “We are not back to the very high inflation rates we had in the late 1970s.” On whether or not the United States is heading towards stagflation, it “depends on how you want to define it.” Investopedia defines stagflation as, “A condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, or inflation.” On the Sunday ABC program “This Week,” fellow economist and former Fed chair Alan Greenspan told host George Stephanopoulos that, “We are beginning to get not stagflation, but the early symptoms of it.”

New Report Suggests No Relief From High Oil Prices

According to global news agency Agence France-Presse, leading energy consultants are forecasting oil prices will remain high in 2008 due to tight supplies and despite fears of a weakening U.S. economy. Consultants at the London-based Centre for Global Energy Studies also used their December report to attack the Organization of the Petroleum Exporting Countries (OPEC), saying that the oil cartel deliberately restricted oil production in 2007 to prevent prices from declining.

The CGES said earlier today that:

Although oil production at last appears to be rising, oil prices are expected to remain high over the winter and into 2008, despite fears about the true state of the US economy.

Regarding OPEC, the energy analysts pointed out:

This year OPEC deliberately kept the world short of oil in order to avoid a repeat of last year’s autumn price fall, a policy that has been extremely effective from the organisation’s point of view…

As a result of OPEC’s supply restraint, global oil inventories are expected to fall by 425,000 bpd (barrels per day) this year and it is difficult to see how this, combined with strongly rising prices, can be described as a market that is well supplied, as OPEC has repeatedly claimed.

In a post from December 12 I noted that Goldman Sachs, the most active investment bank in the energy markets, is also forecasting higher crude oil prices in 2008, buoyed by restricted production levels. Goldman analysts are predicting an average of $95 a barrel next year.

OPEC, which produces about 40% of the world’s crude, has insisted it was not responsible for the price of crude soaring to almost 100 dollars a barrel in 2007. Rather, the cartel said that speculators were to blame for the spike in prices.

Vanguard Founder Says Recession Odds At 75 Percent

Earlier today, CNN Money posted the answers to questions Fortune readers asked of John Bogle, the 78-year-old founder of mutual fund giant Vanguard. With $1.3 trillion in assets, Vanguard is now the second-largest mutual fund company. Bogle talked about the odds of a U.S. recession, the U.S. housing market, the subprime crisis, and challenges to the U.S. economy, among other issues.

What are the odds of a recession right now?

I would put the odds of a recession at 75 percent. This economy is very much consumer-based, and I believe that 70 percent of the GDP is consumer spending. That’s a very high number. Two things are happening there: Consumers have fewer resources because from 2001 to 2005 they took $5 trillion out of real estate. That will not recur. This is a big drop. We also see weakness in auto sales and retail spending - we even see it at companies like Starbucks. There is another, equally important factor in consumer spending, and that is confidence. Consumers are not going to spend if they are worried about the future.

Will the real estate market improve anytime soon?

It doesn’t look so good. I really don’t see it improving soon. At some point homes will have to be built. But right now there is not much incentive to build new places when there are so many old places on the market. When those lines cross I don’t know. It’s complicated by the fact that many people have gotten into ARMs [adjustable-rate mortgages] who didn’t know what they were doing. I don’t know what is going to happen to those people when lenders foreclose. When banks were community banks, they were more careful. But when banks sell loans in a bundle, they are clearly not going to be concerned about mortgage quality. So we have to have a better system in the future to make sure we have a much better element of credit quality in mortgages.

How does the U.S. subprime mess compare with other crises you have seen in your career?

I’d say the most similar example was the S&L crisis of the late ‘80s and early ‘90s. The issues were somewhat the same: Institutions borrowed short and lent long.

The immediate concern for most investors is the subprime market, but over the long term what do you see as the biggest challenges facing the U.S. economy?

Externally, we are faced with $1.5 trillion already poured into Iraq and Afghanistan. So you have enormous expenditures in a corner of the world that is important to us, but it is very unwise to think we can bring democracy to a place that doesn’t share our values. There are also the challenges from low cost production in China and India. At home, we have a tremendous future financial problem with the federal deficit. We’ll have to take action on Social Security someday. Government spending has gotten to the point where we will have to either cut spending or raise taxes. Another problem is this deadlocked Congress. And I see the quality and caliber of our presidential nominees, and I am not impressed.

It raises the question of whether this country is even able to run itself anymore.

Morgan Stanley Asia’s Chairman Issues U.S. Recession Warning

Morgan Stanley Asia’s chairman, Stephen Roach, spoke to Sky News earlier today while visiting Australia and warned that while the U.S. economy is entering a recession, the Federal Reserve, along with the rest of the world, doesn’t appear to grasp its significance. While the Fed cut interest rates the last time they met, Roach feels their work is far from done. He said:

They will move again, most assuredly. The US is going into a recession, they’ve a lot more work to do. They could cut their policy short term interest rate by one to 1.5 percentage points over the next nine to 12 months.

During the interview, Roach spoke about the indifference of the global economy to the prospect of an economic recession in the United States. He warned:

There is a view that the world has somehow decoupled from the American growth engine. I think that view will turn out to be dead wrong and this is a global event with consequences for Asia and Australia.

The head of Morgan Stanley Asia also told Sky News that he didn’t believe growing demand from India and China will be able to “save the global economy.” He explained:

The US is a US$9.5 trillion consumer. China is a US$1 trillion consumer. India’s a US$650 billion consumer. Mathematically, it is almost impossible for the young dynamic consumers of China and India to fill the void that would be left by what is likely to be a significant shortfall of US consumer demand.

Back in a November 2 post, I discussed Roach’s views on “decoupling,” which he shared in a speech given in Mumbai, India:

I think the thing that worries me the most, and this is where I would really underscore the point for you in India, is that equity markets in this region, including your own, are discounting this optimistic, rosy scenario called decoupling. There is the strong belief that because the US has slowed so far, and Asia hasn’t, that any further slowdown will leave Asia unscathed. Think about it for a second. The slowing that’s occurred in the US right now has been in homebuilding activity. It’s America’s least global sector. You stop building a house in America, there’s almost no impact on Asian exports to the US. The slowing that will be coming over the next year will be in the consumer demand sector, which is America’s most global sector. So, we are going to see the US slowdown go from a domestically driven to a globally driven slowdown. I am sorry, as bullish as I am about Asia, Asia will not be an oasis of prosperity in a softer global demand climate. To the extent that emerging market equities are buyers of the global decoupling thesis, including in your own market right here, I think there could be a significant correction in emerging market equities that certainly could hit the Indian stock market quite hard.

Roach is well-known on Wall Street as a perennial “bear” on the U.S. economy. In November 2004 (while still Morgan Stanley’s chief economist), he attended a meeting with a select group of fund managers and shocked the audience with his observation that the U.S. had no better than a 10% chance of avoiding an economic “Armageddon.”