Wednesday, September 02, 2015
Is this it? Is this the big one?
Or is it the biggest buying opportunity since..., well, the last one?
In the time between my trip to Cancun and what was to be my blog post about the speakers, all Hell has broken loose throughout the world's economy. China has finally capitulated to reality, and devalued it's currency twice in quick and unannounced fashion. The price of oil has cratered, and while that's normally seen as a good thing, it's declared an emergency by talking heads in America and beyond. Stocks have been beaten to a pulp, leading me to exchange texts with Scott at midnight, checking Dow futures, and speculating on both the results of the next day's trading (my guess for tomorrow, 9/2/15? Up 115 at the end of the day, with intraday highs of 300 or more...) and the overall direction of the market and the economy.
Ed. Note: Wrong! Up 293 for the day.
So is this the collapse I've been blogging about endlessly since 2005? While trying to avoid being dramatic, it's possible. Much of the carnage being wrought is the result of profit taking. In other words, people and nations want to get paid, and not in the fictional sense. Russia needs desperately needs currency to offset the pain of sanctions due to it's meddling in Ukraine, so it will produce as much oil as possible. This is also true for Saudi Arabia (with the added bonus of crushing the shale oil and tar sands businesses in North America), and Iran, which has more opportunity to dump oil than at any point it recent history. The other side of the equation is that demand for oil has plummeted. So why would the Saudis, et al, flood the world with oil? The oil producing nations made lots of promises to their citizenry, and whether they're getting $40 a barrel or $140, bills have to be paid, or not paid as the case may be. If you're curious, research the toilet paper shortage in Venezuela for a darkly humorous example of this, or its food shortage for a simply dark one. It's worth noting that small villages in Greece that had farms fared best in the recent crisis.
On the whole, low oil prices are a good thing for almost all consumers. Businesses and governments have different needs, and therefore different opinions. So what makes the drop in oil so bad for them? For one, it breeds instability in areas of the world that weren't stable to begin with. The other is that oil consumption is a forward-looking economic indicator. If Americans aren't driving as much because they can't afford to do so, it means that the next round of quarterly reports will show a slowdown in sales, which means China can't expect as many electronic widgets to be exported, which means... you get the point. The odd part of this is that America doesn't seem to be the problem, from a global perspective. Our economy, Potemkin though it might be, is in relatively good shape. I was listening to Bloomberg radio while the stock market was diving off a cliff, and the DJ stated that America is an inward looking economy, which is a polite way of saying we don't export all that much. Our insulation has some value, however. If China looses 5% of it's exports, that's catastrophic. America would collectively shrug.
Continuing the discussion from an American perspective, there is another dark aspect to low oil prices. As mentioned above, $40 a barrel cuts off all the newer sources of oil in North America: shale oil and tar sands. These were only profitable at around $70 a barrel, according to Bloomberg, but production is a major money loser at $40. The financialization of the shale and tar sands oil companies is the real issue here. Some pundits would have you believe that the American shale oil industry has never generated any real profits, just junk bond debt. I didn't believe this for all companies, but the article gives credence to the idea. Shale oil wells have large upfront costs, and the short life of the wells means that reinvestment is needed throughout. The Saudis, hurt by falling oil prices in it's own right, are playing the long game in my opinion. Saudi Arabia is flush with cash, so they can afford to sell oil at a loss - for now. The term loss is a little misleading anyway. Producing the oil is dirt cheap. Stick a pipe in the Arabian desert, and it will produce oil. The Saudi government's promises to it's people (mostly to keep them happy and quiet and not blowing up things to pieces, or Heaven forbid, demanding elections or something equally silly), its outrageous salaries for do-nothing jobs for innumerable prices, and the building of mosques throughout the world, require $91 dollars a barrel. Companies only require $20 a barrel. When the alternative oil sources are all but dead and buried, OPEC can cut production and it will take years for the production capacity outside the cartel to be restored.
There's a whole argument to be made about the deflationary aspect to cheaper oil, but I consider them spurious. When people save money on gas, the GDP improves, by 1% for every $10 drop in the price of oil per barrel. If the government loses tax revenue in one way, it gains it in other transactions, so I don't buy it. If your nation is heavily dependent on oil, and if it is profitable only at a certain price, that's a problem. Canada is a little nervous, for example.
So cheap oil is a net benefit for most, though not all, but it has serious implications for the price of oil over the long term. Investors are going to get hosed, though crisis investors stand to make a mint buying depressed assets. Much like the natural gas in Binghamton, the oil isn't going anywhere, and will be extracted when it's profitable to do so. Of course, that may be $140 a barrel.
The junk bonds mentioned above are a handy segue to the next issue facing the world economy: China. Honest economic data out of China is all but impossible to find. Just like a friend telling a fish story or a man bragging about how many women he's slept with, you have to take what ever stat is given and reduce it. The extent to which you trim the given estimate is entirely subjective, so you can't really know how big that trout really was, or how many partners your buddy truly had. You can only guess it's lower than reported. Thankfully, there are numbers that Beijing can't fudge: the extent to which it buys natural resources from other countries. The two most telling are Australia and Chile. Oz supplies coal, and Chile provides copper. Both are vital to the Chinese economy. Any reduction in exports of these commodities is a fair barometer of how the Chinese economy is doing. Before looking at the raw data, one must remember that China is dependent on nearly 10% year over year growth. Much like the Saudis, China wants its people happy, working, and docile. Using Chile, copper is down about 22% for 2015, and China is the world largest importer of copper, with most coming from Chile. Does this mean that the Chinese output has shrunk by 11%? No, but it does mean that the boom times have come to an end. Something had to be dome to increase exports, and that something was weaken the Yuan relative to the dollar.
Much hay has been has been about the replacement of the greenback as the World's Reserve Currency (please say that in an ominous announcer voice for proper dramatic effect...), including myself, your humble financial aid blogger. This was before the Chinese decided to weaken the Yuan, sending the planet scrambling. The dollar's strength is relative to other currencies, of course, and has been going up simply by standing still. Japan is a basket case, so the Yen is trash; The EU is performing a laggard, disjointed QE, and China's exports have been falling, so the Yuan was overvalued. The Yuan and dollar traded in a tight range, so by doing nothing, the dollar is stronger because other currencies are falling behind. Simon black remarked that the dollar was worthless, but for once I disagree with him. China dumping T-bills is proof that the dollar has value, if only psychological, to the rest of the world - for now. People bought them, after all. It's the cleanest shirt in the hamper, and will be for a bit longer. There's much discussion about the Fed raising rates this month, with most believing (more like praying) the Fed won't raise rates in September, but will have to in December. I believe rates will be increased, both this month and December. Jim Kramer may have an aneurism live on CNBC if that happens; stay tuned. Stock market pundits, thoroughly panicked by Wall Street's drubbing, want the Fed to swear it won't raise rates this year, with some screaming for QE4, but the story has no legs, again for now. It does seem that Monetary Easing has run it's course, and the harm it caused has been noted by those in charge. The truly funny part is that the increase would be 0.25%! Our entire economy is teetering on the possibility of a rise by one quarter of one percent? Yes and no.
The effect is purely psychological. If the market believes that the ear of easy money is truly over, where will economic stimulus come from? Nowhere, and Wall Street knows it. This leads me to our final topic, referenced in the second paragraph: profit taking.
Jim Rickards, in his talk in Cancun, talked about people leaving a room. If you're in a room with 100 people, and 10 get up and leave, you'll probably shrug it off and stay in your seat. If 20 leave, you might wonder if something is wrong. If 50 leave, you might get panicked yourself and get up and follow them to the exits. They must know something you don't, right? If 90 leave, you're probably already out the door, and the remaining 10 will either feel incredibly smart or incredibly stupid. This dovetails with the notion that humans hate risk on the whole. The average person would rather not lose money versus make money, relatively speaking. When people perceive risk, they tend to fly to safety. In the above scenario, safety is the lobby. Eventually, bills have to be paid, and all those paper gains in the various markets need to be converted to real gains. Quoth the great Will Rodgers: "I'm not so concerned about the return on my money as the return OF my money." (Emphasis mine, though it's kind of implied.) If the world economy is slowing, and there are fewer buyers for goods and commodities, emerging markets will have to sell their central bank reserves to prevent capital outflows, much the way China just did, then it doesn't matter what the Fed does; American interest rates will go up automatically. Debt servicing will go up, and even a small increase could wreck the American economy.
The real answer to the overarching question is not what the economy does; it's what the government does in response. Capital controls are the true boogeyman lurking under the bed, and once people feel they can't get at their money, panic will ensue. This almost happened in 2008, when President Bush had to take the unprecedented step of insuring money market accounts like saving deposits. If he hadn't, the entire economy would have frozen. Our entire world nearly fell apart, and most people didn't know it. The subsequent recession gave people a painful reminder that the economy doesn't always deliver kittens and rainbows, and I believe the citizenry is more aware today of the potential risks. The irony is that these risks are much greater today then 7 years ago, with trillions worth of indecipherable derivatives and shadow banking systems bubbling just below the surface. If the average American was somewhat chastened by the Great Recession, Wall Street was emboldened.
So what to do? I can't answer that question just yet. Just typing this post has given me a migraine, and I'm sure reading it hasn't been a cakewalk either. Let's face it, this post is crappy and disorganized. Sorry everybody, I guess I'm rusty. Anyway, there are a few simple steps the average person can take in preparation, and all have value regardless of the economy. I'll preface this list that money (really credit, which is the lubricant of the economy) is cheap right now; in a crisis, all forms of money, especially hard cash, will be scarce. 1) Get yourself healthy. Get your asses off the couch and put down the Cheez-Doodles. Thanks to my lovely lady, my capacity for physical exertion has dramatically increased. (Thanks beautiful!) If something is wrong, get it treated now, especially your teeth. 2) Hold physical cash. Keep 2 months of bills on hand in an envelope stashed somewhere in your home; that way, if we go the way of Greece and the money ATM's deliver is limited, you have a cushion. Take out what you can every day, and use the money stashed at home to fill in the gaps. That will allow you to survive, hopefully to when the dust settles and the world regains its footing. Additionally, pay your most important bills ahead if you can: rent, insurance, etc. 3) Keep some food and supplies in reserve. Pasta and canned tuna may be stereotypical and boring, but it's better than starving. Remember the lessons of Venezuela, and buy plenty of toilet paper. You'll use it. 4) Learn a useful skill or two to help yourself and your neighbors. Keeping things and society in working order will be of utmost importance if the worst happens. Knowing how to garden or fixing things around the home will go a long way. 5) Learn to do with less. A gradual reduction in your consumption is much easier to deal with than going cold turkey. You may find yourself happier, and find you didn't need most of that crap anyway. Frugality is its own reward? Eh, try it out and see. 6) Assuming the worst does not occur, keep an eye open for investment opportunites. The best time to invest is when there's blood in the streets. We may all be a little bloodied soon.
In the time between my trip to Cancun and what was to be my blog post about the speakers, all Hell has broken loose throughout the world's economy. China has finally capitulated to reality, and devalued it's currency twice in quick and unannounced fashion. The price of oil has cratered, and while that's normally seen as a good thing, it's declared an emergency by talking heads in America and beyond. Stocks have been beaten to a pulp, leading me to exchange texts with Scott at midnight, checking Dow futures, and speculating on both the results of the next day's trading (my guess for tomorrow, 9/2/15? Up 115 at the end of the day, with intraday highs of 300 or more...) and the overall direction of the market and the economy.
Ed. Note: Wrong! Up 293 for the day.
So is this the collapse I've been blogging about endlessly since 2005? While trying to avoid being dramatic, it's possible. Much of the carnage being wrought is the result of profit taking. In other words, people and nations want to get paid, and not in the fictional sense. Russia needs desperately needs currency to offset the pain of sanctions due to it's meddling in Ukraine, so it will produce as much oil as possible. This is also true for Saudi Arabia (with the added bonus of crushing the shale oil and tar sands businesses in North America), and Iran, which has more opportunity to dump oil than at any point it recent history. The other side of the equation is that demand for oil has plummeted. So why would the Saudis, et al, flood the world with oil? The oil producing nations made lots of promises to their citizenry, and whether they're getting $40 a barrel or $140, bills have to be paid, or not paid as the case may be. If you're curious, research the toilet paper shortage in Venezuela for a darkly humorous example of this, or its food shortage for a simply dark one. It's worth noting that small villages in Greece that had farms fared best in the recent crisis.
On the whole, low oil prices are a good thing for almost all consumers. Businesses and governments have different needs, and therefore different opinions. So what makes the drop in oil so bad for them? For one, it breeds instability in areas of the world that weren't stable to begin with. The other is that oil consumption is a forward-looking economic indicator. If Americans aren't driving as much because they can't afford to do so, it means that the next round of quarterly reports will show a slowdown in sales, which means China can't expect as many electronic widgets to be exported, which means... you get the point. The odd part of this is that America doesn't seem to be the problem, from a global perspective. Our economy, Potemkin though it might be, is in relatively good shape. I was listening to Bloomberg radio while the stock market was diving off a cliff, and the DJ stated that America is an inward looking economy, which is a polite way of saying we don't export all that much. Our insulation has some value, however. If China looses 5% of it's exports, that's catastrophic. America would collectively shrug.
Continuing the discussion from an American perspective, there is another dark aspect to low oil prices. As mentioned above, $40 a barrel cuts off all the newer sources of oil in North America: shale oil and tar sands. These were only profitable at around $70 a barrel, according to Bloomberg, but production is a major money loser at $40. The financialization of the shale and tar sands oil companies is the real issue here. Some pundits would have you believe that the American shale oil industry has never generated any real profits, just junk bond debt. I didn't believe this for all companies, but the article gives credence to the idea. Shale oil wells have large upfront costs, and the short life of the wells means that reinvestment is needed throughout. The Saudis, hurt by falling oil prices in it's own right, are playing the long game in my opinion. Saudi Arabia is flush with cash, so they can afford to sell oil at a loss - for now. The term loss is a little misleading anyway. Producing the oil is dirt cheap. Stick a pipe in the Arabian desert, and it will produce oil. The Saudi government's promises to it's people (mostly to keep them happy and quiet and not blowing up things to pieces, or Heaven forbid, demanding elections or something equally silly), its outrageous salaries for do-nothing jobs for innumerable prices, and the building of mosques throughout the world, require $91 dollars a barrel. Companies only require $20 a barrel. When the alternative oil sources are all but dead and buried, OPEC can cut production and it will take years for the production capacity outside the cartel to be restored.
There's a whole argument to be made about the deflationary aspect to cheaper oil, but I consider them spurious. When people save money on gas, the GDP improves, by 1% for every $10 drop in the price of oil per barrel. If the government loses tax revenue in one way, it gains it in other transactions, so I don't buy it. If your nation is heavily dependent on oil, and if it is profitable only at a certain price, that's a problem. Canada is a little nervous, for example.
So cheap oil is a net benefit for most, though not all, but it has serious implications for the price of oil over the long term. Investors are going to get hosed, though crisis investors stand to make a mint buying depressed assets. Much like the natural gas in Binghamton, the oil isn't going anywhere, and will be extracted when it's profitable to do so. Of course, that may be $140 a barrel.
The junk bonds mentioned above are a handy segue to the next issue facing the world economy: China. Honest economic data out of China is all but impossible to find. Just like a friend telling a fish story or a man bragging about how many women he's slept with, you have to take what ever stat is given and reduce it. The extent to which you trim the given estimate is entirely subjective, so you can't really know how big that trout really was, or how many partners your buddy truly had. You can only guess it's lower than reported. Thankfully, there are numbers that Beijing can't fudge: the extent to which it buys natural resources from other countries. The two most telling are Australia and Chile. Oz supplies coal, and Chile provides copper. Both are vital to the Chinese economy. Any reduction in exports of these commodities is a fair barometer of how the Chinese economy is doing. Before looking at the raw data, one must remember that China is dependent on nearly 10% year over year growth. Much like the Saudis, China wants its people happy, working, and docile. Using Chile, copper is down about 22% for 2015, and China is the world largest importer of copper, with most coming from Chile. Does this mean that the Chinese output has shrunk by 11%? No, but it does mean that the boom times have come to an end. Something had to be dome to increase exports, and that something was weaken the Yuan relative to the dollar.
Much hay has been has been about the replacement of the greenback as the World's Reserve Currency (please say that in an ominous announcer voice for proper dramatic effect...), including myself, your humble financial aid blogger. This was before the Chinese decided to weaken the Yuan, sending the planet scrambling. The dollar's strength is relative to other currencies, of course, and has been going up simply by standing still. Japan is a basket case, so the Yen is trash; The EU is performing a laggard, disjointed QE, and China's exports have been falling, so the Yuan was overvalued. The Yuan and dollar traded in a tight range, so by doing nothing, the dollar is stronger because other currencies are falling behind. Simon black remarked that the dollar was worthless, but for once I disagree with him. China dumping T-bills is proof that the dollar has value, if only psychological, to the rest of the world - for now. People bought them, after all. It's the cleanest shirt in the hamper, and will be for a bit longer. There's much discussion about the Fed raising rates this month, with most believing (more like praying) the Fed won't raise rates in September, but will have to in December. I believe rates will be increased, both this month and December. Jim Kramer may have an aneurism live on CNBC if that happens; stay tuned. Stock market pundits, thoroughly panicked by Wall Street's drubbing, want the Fed to swear it won't raise rates this year, with some screaming for QE4, but the story has no legs, again for now. It does seem that Monetary Easing has run it's course, and the harm it caused has been noted by those in charge. The truly funny part is that the increase would be 0.25%! Our entire economy is teetering on the possibility of a rise by one quarter of one percent? Yes and no.
The effect is purely psychological. If the market believes that the ear of easy money is truly over, where will economic stimulus come from? Nowhere, and Wall Street knows it. This leads me to our final topic, referenced in the second paragraph: profit taking.
Jim Rickards, in his talk in Cancun, talked about people leaving a room. If you're in a room with 100 people, and 10 get up and leave, you'll probably shrug it off and stay in your seat. If 20 leave, you might wonder if something is wrong. If 50 leave, you might get panicked yourself and get up and follow them to the exits. They must know something you don't, right? If 90 leave, you're probably already out the door, and the remaining 10 will either feel incredibly smart or incredibly stupid. This dovetails with the notion that humans hate risk on the whole. The average person would rather not lose money versus make money, relatively speaking. When people perceive risk, they tend to fly to safety. In the above scenario, safety is the lobby. Eventually, bills have to be paid, and all those paper gains in the various markets need to be converted to real gains. Quoth the great Will Rodgers: "I'm not so concerned about the return on my money as the return OF my money." (Emphasis mine, though it's kind of implied.) If the world economy is slowing, and there are fewer buyers for goods and commodities, emerging markets will have to sell their central bank reserves to prevent capital outflows, much the way China just did, then it doesn't matter what the Fed does; American interest rates will go up automatically. Debt servicing will go up, and even a small increase could wreck the American economy.
The real answer to the overarching question is not what the economy does; it's what the government does in response. Capital controls are the true boogeyman lurking under the bed, and once people feel they can't get at their money, panic will ensue. This almost happened in 2008, when President Bush had to take the unprecedented step of insuring money market accounts like saving deposits. If he hadn't, the entire economy would have frozen. Our entire world nearly fell apart, and most people didn't know it. The subsequent recession gave people a painful reminder that the economy doesn't always deliver kittens and rainbows, and I believe the citizenry is more aware today of the potential risks. The irony is that these risks are much greater today then 7 years ago, with trillions worth of indecipherable derivatives and shadow banking systems bubbling just below the surface. If the average American was somewhat chastened by the Great Recession, Wall Street was emboldened.
So what to do? I can't answer that question just yet. Just typing this post has given me a migraine, and I'm sure reading it hasn't been a cakewalk either. Let's face it, this post is crappy and disorganized. Sorry everybody, I guess I'm rusty. Anyway, there are a few simple steps the average person can take in preparation, and all have value regardless of the economy. I'll preface this list that money (really credit, which is the lubricant of the economy) is cheap right now; in a crisis, all forms of money, especially hard cash, will be scarce. 1) Get yourself healthy. Get your asses off the couch and put down the Cheez-Doodles. Thanks to my lovely lady, my capacity for physical exertion has dramatically increased. (Thanks beautiful!) If something is wrong, get it treated now, especially your teeth. 2) Hold physical cash. Keep 2 months of bills on hand in an envelope stashed somewhere in your home; that way, if we go the way of Greece and the money ATM's deliver is limited, you have a cushion. Take out what you can every day, and use the money stashed at home to fill in the gaps. That will allow you to survive, hopefully to when the dust settles and the world regains its footing. Additionally, pay your most important bills ahead if you can: rent, insurance, etc. 3) Keep some food and supplies in reserve. Pasta and canned tuna may be stereotypical and boring, but it's better than starving. Remember the lessons of Venezuela, and buy plenty of toilet paper. You'll use it. 4) Learn a useful skill or two to help yourself and your neighbors. Keeping things and society in working order will be of utmost importance if the worst happens. Knowing how to garden or fixing things around the home will go a long way. 5) Learn to do with less. A gradual reduction in your consumption is much easier to deal with than going cold turkey. You may find yourself happier, and find you didn't need most of that crap anyway. Frugality is its own reward? Eh, try it out and see. 6) Assuming the worst does not occur, keep an eye open for investment opportunites. The best time to invest is when there's blood in the streets. We may all be a little bloodied soon.
