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Merrill Lynch Economist Warns Of Multiple U.S. Recessions

According to the Financial Post (Canada) from July 9, David Rosenberg, the chief North American economist at Merrill Lynch, is warning of the possibility of not one U.S. economic recession, but a series of them. The Post’s Jacqueline Thorpe wrote:

Rosenberg has consistently held one of the more pessimistic views on Wall Street, arguing the housing slump and credit crunch will exact a heavy toll on U.S. consumer spending. He believes the data will eventually show the recession started in January.

But he adds it’s not the peak-to-trough decline in real GDP that’s important but the duration. Trouble is, the duration could be Japanese-like (about a decade).

Just like Japan, he says a series of rolling recessions is possible for the next three to five years, making it extremely difficult to time the market. Japanese equities got trashed through the process. At the 1998 post-bubble lows, Japanese bank, construction, real estate and transport stocks were all down 80%, retail stocks were down 50%. The only place to hide was bonds, notes the bond bull.

Rosenberg told the Canadian publication:

We are nervous that we have ended up following in Japan’s footsteps due to the inept fiscal response to the problem. A temporary tax rebate from Uncle Sam to buy iPods tackles a real estate deflation and credit crunch as effectively as the LDP’s (Liberal Democratic Party) “solution” in the early 1990s to build bridges and pave river beds that nobody needed.

The Vapours, “Turning Japanese” (1980)
YouTube Video Link

Source:

“Rosenberg on strike, fed up trying to pinpoint U.S. recession”
Jacqueline Thorpe
Financial Post (Canada), July 9, 2008

Congress Approves National Colosseum

Not really. But Capitol Hill politicians might as well allocate funds to build one, complete with chariot races and gladiators to keep us happy, considering the way they’re pandering to the masses these days. When Congress only has a 20% approval rating (Gallup), what else would you expect? Something like what happened today. Hoping to sooth the economic pain (and gain the electoral support) of Joe Six-Pack and Suzy Soccer Mom, both the U.S. Senate and House of Representatives, in a direct challenge to President Bush, voted to temporarily halt the shipment of thousands of barrels of oil a day into the government’s emergency reserve. The Strategic Petroleum Reserve, a system of underground salt domes on the Gulf Coast, was created by the U.S. government in the seventies as a precaution against major interruptions of oil supplies. With 701 million barrels in storage, it is currently 97% full, yet the equivalent of only two months of oil imports.

The Senate voted 97 to 1 in favor of suspending the shipments, which average about 70,000 barrels a day, until the end of the 2008. Only Senator Wayne Allard of Colorado voted against the measure. Presidential hopefuls Barack Obama and Hillary Rodham Clinton also voted to halt the shipments as well. John McCain was not present for the vote. Mirroring the same bipartisan support as in the Senate, the House voted 385 to 25 in favor of halting the program.

For some time now, Congress has wanted to tinker with the SPR, jawboning on and on about how curbing deliveries to and/or drawing from the emergency reserve (by the way, what part of “emergency” don’t you get?) can ease tight oil supplies, curb market speculation, and possibly lower crude oil prices. Case in point. MSNBC’s John Schoen wrote back on May 19, 2004 (that’s right, 4 years ago):

With oil prices stuck above $40 a barrel, attention has turned to the U.S. Strategic Petroleum Reserve, a vast stockpile of oil stored underground that the U.S. continues to add to. While Democrats call for releasing some of those reserves to help ease oil prices, President Bush Wednesday repeated his long-standing position that the stockpile should only be used in the event of a critical cutoff of fuel needed to maintain the country’s national defense…

“Since the price of oil is so closely tied to inventory levels, filling the SPR under these market conditions both depletes private sector inventories and pushes up prices for America’s consumers,” said Sen. Carl Levin, D-Mich., in a floor speech in April defending an amendment to defer SPR purchases.

More recently, New York Democratic Sen. Charles Schumer has introduced an amendment to draw 1 million barrels a day from the reserve for the next 30 days.

“Joey, do you like movies about gladiators?”

And Congress’ assertions that curbing shipments to and/or drawing from the SPR could help with our supply problems, dampen speculation, and lower oil prices? Wrong, wrong, and wrong, according to the experts (or, at least, people who know what they’re talking about). Regarding the supply problem, the 70,000 barrels that are being sent to the reserve on a daily basis represents only 0.3% of the 20 million barrels consumed by Americans each and every day. 0.3%? Can anyone tell me how this could possibly help alleviate tight supplies? Regarding the perception that high oil prices are caused by speculators, legendary energy investor T. Boone Pickens told attendees at the Oklahoma State University’s Energy Conference on April 23:

Only 5 percent of oil is in the commodity pool. If you did run it up, it would be briefly. Speculators cannot move it that much.

He would know. Finally, a number of politicians believe (or want us to believe) that halting shipments and even drawing from the SPR will somehow lower oil prices. CNN Money’s Steve Hargreaves wrote today:

A statement from Speaker of the House Nancy Pelosi, D-Calif., said it could bring down gas prices by as much as 24 cents a gallon.

Or so she claims. The CNN Money staff writer also wrote:

The U.S. Energy Information Administration predicts oil prices would fall by only about $2 a barrel - or shave 4 to 5 cents a gallon off the price of gas - if the president suspended deliveries to the SPR.

“It’s a very small amount” of oil going into the reserve, said EIA oil market analyst Doug MacIntyre. “And it’s very transparent to the market.”

Should I believe House Speaker Pelosi or the EIA? Tough call, right?

Here’s something to think about. A possible explanation for the high price of crude oil is that global demand is running at 87 million barrels per day, while the global oil supply is at 85 million barrels per day. Furthermore, while older oil fields are starting to go dry, no suitable replacements are being found. Finally, even though the U.S. economy is slowing, for every 1 barrel of reduced American demand there are 14 barrels of increased demand from developing countries like China, India, and Brazil.

Oh, but this just in…

“Middle East Oil Cut Off By Coordinated Attacks Throughout Region” and “Gulf Oil Infrastructure Destroyed By Category 5 Hurricane”

Well done. Thanks for saving me that nickel.

Sources:

“Senate votes to halt oil reserve shipments”
H. Josef Hebert
Associated Press, May 13, 2008

“House votes to stop adding to oil stockpile”
Tom Doggett
Reuters (UK), May 13, 2008

“Debate flares over strategic oil stockpiles”
John W. Schoen
MSNBC, May 19, 2004

“Oil stockpile a drop in the bucket”
Steve Hargreaves
CNN Money, May 13, 2008

“Pickens: Oil to go to $150 a barrel”
Jerry Shottenkirk
Journal Record, April 24, 2008

Boycott Chinese Goods? Get Real

Earlier today I came across the following comments on a blog post about “saving” the U.S. dollar:

Boycott chineese goods, all of our good paying jobs are being shipped over sea’s mostly to china and how do the expect us to buy anything when we have no good paying jobs beside we have nothing to sell back which weakens our currency.

Stop buying products made from China! American jobs and money is being shipped to that country everytime you purchase those cheap and substandard products.

Hey, I’m all for “Buy American” and do it whenever I can. But, the reality is that it’s darn near impossible. Don’t believe me? Back on August 19, 2007, I happened to read an article in the Chicago Tribune about a Louisiana family who tried to go without Chinese-made goods for an entire year. Sara Bongiorni of Baton Rouge came up with the idea on Christmas Day 2004 when she noticed that 25 of the 39 Christmas gifts were made in China. It was then she decided to boycott Chinese goods for the entire 2005 calendar year. She eventually went on to write a book about the experience.

The mother of three had this to say of her family’s boycott of products made in China:

It was really all-consuming… You realize the inconvenience factor was tremendous. We totally take advantage of these things from China.

When local stores didn’t have a non-Chinese product that she needed, she was forced to turn to catalogs and the Internet, which ironically didn’t make things easier, as she often had to make phone calls to see if “imported” stood for “made in China.” Customer service agents would place her on hold for an eternity as they researched the origin of products she inquired about. Even a task as simple as shopping for sneakers turned into a nightmare. Mary Ellen Podmolik, special to the Tribune, wrote:

… when Bongiorni found that her 4-year-old son had outgrown his sneakers, her hunt for a replacement pair took her to a children’s shoe chain, two department stores and a discount shoe warehouse, all to no avail.

Two weeks later and fearing that her son’s toes were starting to curl in his too-small shoes, she found a pair of Italian-made sneakers online for $68. Before ordering them- in a size one larger than he needed- she found herself running outside to get a neighbor’s opinion on whether $68 was too much to spend for children’s shoes.

Often, the family of five had to improvise to avoid buying Chinese goods. Podmolik wrote:

When they needed a mousetrap, for instance, they tried fashioning one from an empty milk jug and broken pieces of cookies and chocolate. The mouse won.

At the time the article was written, Sara Bongiorni said:

I absolutely could not do it permanently. You’d have to be able to give up a telephone and a cell phone, computers.

She noted that her family’s experiment was somewhat easier because she had small children. It would have been different, she surmised, had her kids been teenagers with their need for electronic gadgets.

So, the next time someone blurts, “Boycott Chinese goods,” you may want to tell them, “Get real.”

Source:

“A family tries 12 months without ‘Made in China’”
Mary Ellen Podmolik
Chicago Tribune, August 19, 2007

Dave Barry On Economic ‘Stimulus’ Payments

Well, it looks like the first of the economic ‘stimulus’ payments are arriving in the mailbox (and being spent at the gas pump). The other day I noticed that Dave Barry had added his two cents on the tax rebate checks. For those of you who aren’t familiar with Dave Barry, he is a humor columnist whose work appeared in more than 500 newspapers in the United States and abroad for 25 years. In 1988, he even won the Pulitzer Prize for Commentary.

Barry wrote in the Miami Herald on April 13:

…this year, filing taxpayers will receive an Economic Stimulus Payment. This is a very exciting new program that I will explain using the Q and A format:

Q. What is an Economic Stimulus Payment?
A. It is money that the federal government will send to taxpayers.

Q. Where will the government get this money?
A. From taxpayers.

Q. So the government is giving me back my own money?
A. Only a smidgen.

Q. What is the purpose of this payment?
A. The plan is that you will use the money to purchase a high-definition TV set, thus stimulating the economy.

Q. But isn’t that stimulating the economy of China?
A. Shut up.

Source: Hong Kong Tourism Board

Source:

“Dave Barry: How your taxes turn into manure”
Dave Barry
Miami Herald, April 13, 2008

Who’s To Blame For The High Price Of Oil?

I read the following the other day in a grocery store publication on Chicago’s northwest side. Regarding the high cost of oil and gasoline, the bureau chief of the paper wrote:

Whew! What is the answer? I think we should contact our elected officials, both state and national, and let them know we, the taxpayers, need some relief. Yes, I know about Bush’s economic stimulus package that is on the way- but I don’t want to put it all in my gas tank.

There’s no use arguing with most Americans over who’s to blame for high oil and gasoline prices. In their minds, “Big Oil” is the culprit, with a dash of President Bush, his oil buddies, and every level of government sprinkled in for good measure. But before you forward on that e-mail about a “gas station holiday” to five of your friends, consider this: Could it be possible that the high price of crude oil is mainly due to the basic principle of supply-and-demand? Just a thought. Bloomberg’s Mark Shenk wrote today:

China, India, Russia and the Middle East for the first time will consume more crude oil than the U.S., burning 20.67 million barrels a day this year, an increase of 4.4 percent, according to the International Energy Agency in Paris.

And here in the good old US of A?

U.S. demand will contract 2 percent to 20.38 million barrels daily, the IEA says.

Shenk noted that economic growth in China and India of more than 8%, coupled with increasing car ownership among the countries’ combined populations of 2.45 billion people, will more than compensate for declining demand in the United States. According to the IEA, global oil use will increase 2% this year largely because of emerging market growth.

Regarding the topic of car ownership, China’s passenger car sales jumped 22% to 6.3 million units sold last year. Reuters’ Joe Mcdonald reported on the Chinese auto sector today, and wrote:

Auto sales in China are booming, with analysts and automakers forecasting growth at 15-20 percent this year. But demand for the biggest vehicles is even stronger, with sales of luxury cars and SUVs expected to surge by 40-45 percent…

“Chinese buyers typically like bigger cars and they have the resources to go for them,” said Tim Dunne, J.D. Power’s director of Asia-Pacific market intelligence.

Source: China Daily

Mike Wittner, head of oil research at Societe Generale SA in London, told Bloomberg:

Does the U.S. matter anymore? Has the U.S. mattered for the last few years? It is debatable. As far as the oil market is concerned, demand growth is going to be continued to be driven by China and the Middle East.

Still feel like contacting your elected officials?

Sources:

“Emerging Market Oil Use Exceeds U.S. as Prices Rise (Update2)”
Mark Shenk
Bloomberg, April 21, 2008

“Gas guzzlers a hit in China, where car sales are booming”
Joe Mcdonald
Reuters, April 21, 2008

Banks May Write Down Additional $300 Billion

Yesterday, global strategy consulting firm Oliver Wyman said in a new study that an additional $300 billion in write-downs related to the U.S. subprime mortgage meltdown may be announced by banks before the crisis is over. Back on January 18 I noted that write-downs had already surpassed $100 billion. In a press release picked up by Yahoo! Finance yesterday, John Colas, Managing Director and head of the North American Corporate Strategy Practice at Oliver Wyman, said:

The credit crisis is unlikely to resolve itself before the end of this year. We also see strong likelihood of price corrections in emerging markets and this combination will extend the value loss and turbulence witnessed in 2007.

The management consultancy said in its “State of the Financial Services Industry” report:

We expect a stormy 2008. While governments, central banks and regulators scramble to address the aftermath of the sub-prime fallout, several other crises are mounting.

These other disruptions include:
• A significant slowdown in European real estate markets, especially in Spain and the UK
• The continued weakening of the U.S. dollar
• A collapse in commodity prices
• A fall in Chinese and Indian stocks

The financial services industry should expect “turbulent conditions for 2008 and beyond.” Oliver Wyman predicted that American banks are especially at risk. From its 2008 report:

North American financial services firms will have a tough year. Market uncertainty, combined with further write-downs and expected home-price and loan-volume declines, implies more squeezes on earnings. Banks most likely will have to increase loan-loss reserves.

In North America last year, the financial sector lost 13% in market value, second only to Japan. In contrast to the United States, the value of financial companies in Canada grew 12%.

For the first time since 2002, the global market value of the industry fell, according to the annual report. Controlling for exchange rates, the industry lost 7% of its market value last year. While $300 to $400 billion was gained in red-hot emerging markets last year, financial institutions lost more than $1 trillion in mature economies.

Stock Markets Fall Around The Globe

Returning to work on Monday is hardly ever fun. Losing a ton of money makes it even worse. While American financial markets were closed in remembrance of Martin Luther King, Jr., stock markets around the world were being hammered.

Indexes in Japan, China, Hong Kong, India, South Korea, and Singapore fell at least 3%. Indian stocks were punished severely, dropping nearly 11% at one point in the trading session before finishing off more than 7%. The Australian and New Zealand stock markets have now experienced losing sessions for 11 and 13 days, respectively.

Photo from DailyHaHa.com

The carnage in equities spread to Europe. The pan-European Dow Jones Stoxx 600 index ended down 5.4% at 309.67. At one point earlier in the trading session, the index earlier reached a low of 308.69, which was the largest one-day percentage drop since the September 11 terrorist attacks. The index has lost around 23% from its mid-2007 high of 400.99. The French CAC-40 index ended the day down 6.8% to 4,744.45. The German DAX 30 index was down 7.2% to 790.19. The U.K. FTSE 100 index declined 5.5% to 5,578.20.

Making its way to the Americas, the global sell-off spread to Canada and Latin America. The S&P/Toronto Stock Exchange composite index sank 4.7% to end the day at 12,132.14. Brazil’s Bovespa fell 6.6% to 53.694, and Mexico’s Bolsa index declined 4.8% to 25,444.

According to MarketWatch today, losses from financials were largely to blame after U.S. bond insurers came under attack by a ratings agency, and the proposed economic stimulus plan from President Bush failed to convince investors that it would be enough to prevent a recession in the United States. The stock sell-off occurred after the worst weekly performance on Wall Street for five years.

All eyes are now turned to Wall Street, which resumes trading Tuesday. As of this afternoon, the Dow Jones Industrial Average futures contract was down 520 points to 11,586, the Nasdaq futures were down 76.25 to 1,773.25, and the Standard & Poor’s 500 futures had fallen 60.3 to 1,265. According to MarketWatch:

If futures contracts traded on a day when U.S. stocks weren’t even due to open are anything near accurate, then markets will be in for a major decline on Tuesday, with concerns about bond insurers and the health of financial institutions dragging markets lower.

Father of Reaganomics: Nothing Can Be Done To Save Economy

This morning I came across an interesting article by Paul Craig Roberts in the Coastal Post. Who is Dr. Roberts? He is an economist who served as an Assistant Secretary of the Treasury in the Reagan Administration, and is known as the “Father of Reaganomics.” Outside of the public sector, he was a former editor and columnist for the Wall Street Journal and Business Week.

What initially caught my eye was the title of the article- “The Impending Destruction Of The U.S. Economy.” No use beating around the bush. But he did manage to beat up the Bush administration and other policymakers in Washington for their mishandling of the U.S. economy. Dr. Roberts wrote:

Hubris and arrogance are too ensconced in Washington for policymakers to be aware of the economic policy trap in which they have placed the U.S. economy. If the subprime mortgage meltdown is half as bad as predicted, low U.S. interest rates will be required in order to contain the crisis. But if the dollar’s plight is half as bad as predicted, high U.S. interest rates will be required if foreigners are to continue to hold dollars and to finance U.S. budget and trade deficits.

Which will Washington sacrifice, the domestic financial system and overextended homeowners or its ability to finance deficits?

The answer seems obvious. Everything will be sacrificed in order to protect Washington’s ability to borrow abroad. Without this, Washington cannot conduct its wars of aggression, and Americans cannot continue to consume $800 billion dollars more each year than the economy produces.

Nice job, Washington!

However, this line of credit is threatened. According to Roberts:

No country wants to hold a depreciating asset, and no country wants to acquire more depreciating assets. In order to reassure itself, Wall Street claims that foreign countries are locked into accumulating dollars in order to protect the value of their existing dollar holdings. But this is utter nonsense. The U.S. dollar has lost 60 percent of its value during the current administration. Obviously, countries are not locked into accumulating dollars…

Japan and China - indeed, the entire world - realize that they cannot continue forever to give Americans real goods and services in exchange for depreciating paper dollars. China is endeavoring to turn its development inward and to rely on its potentially huge domestic market. Japan is pinning hopes on participating in Asia’s economic development.

The dollar’s decline has resulted from foreigners accumulating new dollars at a lower rate. They still accumulate dollars, but fewer…

Foreigners have continued to accumulate dollars in the expectation that sooner or later Washington would address its trade and budget deficits. However, now these deficits seem to have passed the point of no return.

Faced with the realization that the twin deficits will not be addressed, will foreigners finally stop accumulating dollars and/or significantly reduce dollar holdings, causing a dollar crash?

Dr. Roberts explained why the twin deficits could no longer be fixed:

The sharp decline in the dollar has not closed the trade deficit by increasing exports and decreasing imports. Offshoring prevents the possibility of exports reducing the trade deficit, and Americans are now dependent on imports (including offshored production) for which there are no longer any domestically produced alternatives. The U.S. trade deficit will close when foreigners cease to finance it.

The budget deficit cannot be closed by taxation without driving up unemployment and poverty…

In the 21st century, the U.S. economy has been driven by consumers going deeper in debt. Consumption fueled by increases in indebtedness received its greatest boost from Fed chairman Alan Greenspan’s low interest rate policy. Greenspan covered up the adverse effects of offshoring on the U.S. economy by engineering a housing boom. The boom created employment in construction and financial firms and pushed up home prices, thus creating equity for consumers to spend to keep consumer demand growing.

This source of U.S. economic growth is exhausted and imploding. The full consequences of the housing bust remain to be realized. American consumers lack discretionary income and can pay higher taxes only by reducing their consumption. The service industries, which have provided the only source of new jobs in the 21st century, are already experiencing falling demand. A tax increase would cause widespread distress.

The old-school Republican had this to say about our precarious position:

Superpower America is a ship of fools in denial of their plight. While offshoring kills American economic prospects, “free-market economists” sing its praises. While war imposes enormous costs on a bankrupt country, neoconservatives call for more war and Republicans and Democrats appropriate war funds, abroad….

We have arrived at the point where it is no longer bold to say that nothing now can be done. Unless the rest of the world decides to underwrite our economic rescue, the chips will fall where they may.

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.

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.”

Yale’s Shiller Warns Of Major Global Correction

Somehow, I missed this story. Didn’t see it in the mainstream financial media, as it was probably deemed too gloom-and-doom to print. On November 18, ArabianBusiness.com talked about this year’s Dubai International Financial Centre (DIFC) Week. At the gathering, Robert Shiller, the Stanley B. Resor Professor of Economics at Yale University and author of the New York Times bestseller Irrational Exuberance, warned that a sharp downward correction is due in the global markets as real estate, stocks and energy soar to record highs. You may recall that in his bestselling book, Shiller waned that the U.S. stock market of the late nineties had become a bubble that would eventually pop. These past few years, he told anyone who would listen that the U.S. housing boom that came on the heels of the bust on Wall Street also shared the characteristics of a bubble.

According to the website, Dr. Shiller told attendees that while emerging markets like China, India, and Brazil continue to grow, speculative “bubbles” are appearing in the global markets, which could pop and cause a major global recession. He explained:

Perhaps we have gotten a little too confident in the global economic growth. The problem is high oil, stock and real estate prices. I believe that a substantial part is speculative bubble thinking. We have gotten too confident of the prices in these markets.

The global credit crunch has curtailed the lending and borrowing frenzy that fueled price run-ups in energy, stocks, and real estate. As a result, the markets could face significant corrections ahead. Professor Shiller said, “The unwinding of these markets is the most serious risk facing these markets today.”

Sunday Edition: November 25, 2007

Subprime Mortgage Crisis Growing
According to the Wall Street Journal yesterday, calculations by the Bank of America Corp. show that interest rates are set to rise on $362 billion worth of adjustable-rate subprime mortgages in 2008. Banc of America Securities, a unit of Bank of America, estimates that $85 billion in subprime mortgages will reset this quarter, another $85 billion will reset in the first quarter of 2008, and $101 billion of mortgages will reset in the second quarter of 2008. The estimates include loans packaged into securities and held in bank portfolios. In addition to the $362 billion of subprime ARMs that are scheduled to reset during 2008, Banc of America Securities said $152 billion in other loans with adjustable rates are scheduled to reset next year, including “jumbo” mortgages of more than $417,000 and Alt-A loans, a category between prime and subprime.

According to the Journal:

Many of the subprime mortgages that have driven up the default rate went bad in their first year or so, well before their interest rate had a chance to go higher… Now the real crest of the reset wave is coming, and that promises more pain for borrowers, lenders and Wall Street. Already, many subprime lenders, who focused on people with poor credit, have gone bust. Big banks and investors who made subprime loans or bought securities backed by them are reporting billions of dollars in losses… The reset peak will likely add to political pressure to help borrowers who can’t afford to pay the higher interest rates.

The Mortgage Bankers Association estimates that 1.35 million homes will enter the foreclosure process this year with another 1.44 million homes in 2008, up from 705,000 in 2005.

U.S. Recession May Harm Emerging Markets
London-based HSBC Asset Management told Reuters yesterday that an economic recession in the United States will affect emerging markets, even though some believe that decoupling from U.S. growth has taken place. Christian Deseglise, head of HSBC AM’s $85 billion global emerging markets business, told Reuters that the possibility of a U.S. recession was looking real now compared to earlier this year. Deseglise said:

Talk of recession in the US economy has increased lately so the story of decoupling from the US economy is being looked at more carefully … this may be causing the latest bout of nervousness. In February-March, there were fears but no evidence of slowdown. Now we are not dealing just with fears, but with something that is really out there. There are real issues with many sectors that may have a slowdown impact on the rest of the world.

Deseglise talked about the fallout from a U.S. recession:

If the US were to go down to one percent growth, emerging markets have the inner strength to grow within themselves. But if the US were to enter into a prolonged and severe recession that will have a detrimental effect. Emerging markets don’t need a fast growing US economy but they still need a growing US economy… I don’t think a recession is priced into the market.

HSBC Asset Management wouldn’t be the first to dispel the notion of decoupling from the United States. On November 2, I talked about how Stephen Roach, Chairman of Morgan Stanley Asia, told an audience in Mumbai, India, that he didn’t buy into the theory of decoupling:

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.

Supporters of decoupling disagree. Reuters said:

Some observers say solid fiscal and monetary policy, healthy balance of payments, and China’s rise as a counterweight to the United States has helped emerging nations decouple from US growth and act as a safe haven from developed market turmoil.

In addition, they argue that the United States takes in just 16% of emerging market exports now, compared with 25% in 2001. In 2006, exports to other emerging nations overtook the volume of goods and services sent to developed nations.

Parting Shot
On the Euro Pacific Captial website, president and investment advisor Peter Schiff talked about how the actions of Wall Street and the U.S. government are forcing Gulf and Asian nations to reconsider their efforts in propping up the U.S. economy. In “Heads We Win, Tails You Lose” from November 23, Schiff said:

Perhaps the icing on this “let them eat cake” mentality was provided by Wall Street itself. In a year with record losses, Wall Street firms announced that they would also be paying record bonuses to their employees. The rationale for this PR fiasco was that since the losses were not the fault of the employees (really?), they should not be made to suffer. So rather than sharing the pain being endured by their firms’ shareholders (clearly even less culpable then themselves), Wall Street’s fat cats will rub salt in their owners’ wounds by compounding their losses with the additional expense of lavish bonuses. Following the outlandish pay packages already given to ousted CEO’s who clearly were responsible for the losses, Wall Street’s “heads we win, tails you lose” attitude will not go over well abroad.

Enjoy it while it lasts… which won’t be for much longer.

Have a wonderful week,

Christopher E. Hill
Editor
editor@boom2bust.com