Monday, October 03, 2005

Signs of the Economic Apocalypse 10-3-05

From Signs of the Times 10-3-05:

Friday was the last day of the third quarter of 2005, so let's review the numbers for the quarter and for the year.

The U.S. dollar closed at 0.8319 euros, up 0.2% from 0.8306 for the week, down 1.0% from 0.8400 for the quarter and up 12.6% from 0.7390 for the year. Oil closed at $66.24 a barrel, up 3.2% from $64.19 last week and up 12.7% from $58.75 at the end of Q2 and up 52.5% from $43.45 for the year. Oil in euros was 55.11 euros a barrel, up 3.4% compared to 53.31 a week ago and up 11.7% from 49.34 at the end of the second quarter and and up 71.7% from 32.09 at the beginning of the year. Gold closed at 472.20 dollars an ounce on Friday, up 1.0% from $467.40 a week earlier and up 10.0% from $429.30 for the quarter and up 8.0% from $437.10 for the year. In euros, gold closed at 392.66 euros an ounce, up 1.1% from 388.21 last week and up 8.9% from 360.51 for the quarter and up 21.8% from 322.32 for the year. The gold/oil ratio closed at 7.13 barrels of oil per ounce of gold, down 8.3% from 7.28 last week and down 2.4% from 7.31 for the quarter and down down 41.1% from 10.06 for the year. In the U.S. stock market, the Dow closed at 10,568.70, up 1.4% from 10,419.59 last week and up 2.6% from 10,303.44 at the end of the second quarter and down 3.5% for the year so far from 10,783 on December 31, 2004. The NASDAQ closed at 2151.69 on Friday, up 1.6% from 2,116.84 on the previous Friday and up 4.6% from 2057.37 at the end of Q2 and down 1.1% from 2175 at the beginning of the year. The yield on the ten-year U.S. Treasury note closed at 4.33 percent, up from 4.25 the week before, up from 4.04 at the end of the second quarter and 4.22 on Dec. 31, 2004.

Here are some charts showing trends for 2005:

The big story for the year so far is the rise in the price of oil and gold. Oil rose 53% in dollar terms and a whopping 72% in euros. The euro lost ground against the dollar so far this year, falling 12.6%, something I did not predict at the beginning of the year. This in spite of the fact that the United States is in the process of losing two wars, wars which were financed by borrowing money from foreign central banks. Some of this loss in value for the euro may end up being attributed to the rise in the price of oil, which must be purchased in dollars, but some may be due to the fact that European voters have wisely rejected neoliberal prescriptions for their societies, causing consternation among the elite. If the euro lost, however, that did not mean that the dollar gained, since the dollar lost 8% of its value compared to gold. The euro lost 22% of its value compared to gold.

The United States was able to keep its economy from crashing during the third quarter of 2005, in spite of the ongoing disasters in Iraq and Afghanistan and the embarrassing fiasco in New Orleans. At the end of the previous quarter I wrote the following:

Stephen Roach of Morgan Stanley is now saying that the bubble-like asset inflation economy of the United States could go on for a while longer, making the ultimate reckoning even worse:

I suspect the US interest rate climate is likely to remain surprisingly benign and, therefore, supportive of yet another wave of debt-intensive asset inflation. As a result, the housing and bond bubbles could well continue to expand, allowing asset-dependent American consumers to keep on spending. US economic growth, in that climate, may well remain surprisingly firm -- even in the face of $60 oil. All this would be a textbook example of another period of "bad growth" -- the last thing an unbalanced US and global economy needs. Likely by-products of another spate of bad growth include more debt, further reductions in income-based saving, and an ever-widening current account deficit. Eventually, the balance-of-payments constraint will take over -- triggering a renewed weakening of the dollar and a sharp back-up in real interest rates. But the emphasis, in this case, is on the word "eventually."

It looks like Roach was right. But it also looks like the "eventually" is here, with interest rates rising and the dollar weakening (against gold).

Why is gold rising so sharply now? No paper currency looks good at the moment. Take the Yen, for example:

Japan's National Debt Hits US$ 7.1 Trillion

Japan's government debt, already the highest in the industrialized world, rose 1.7 per cent to a record high of 795.8 trillion yen ($7.1 trillion US) at the end of June, according to a report released by the Finance Ministry.

The latest figure marked an increase of 14.3 trillion yen from the end of March, the ministry said Thursday. The amount is equivalent to about 6.24 million yen ($55,900) for every Japanese.

Japan has relied on government bond issues to make up for falling tax revenues, turning into one of the world's most indebted countries.

Japan's public debt burden is almost 160 per cent of its GDP and already the highest in the industrialized world.

As Kevin at Cryptogon put it:

How does this show stay up on a day to day basis? HOW!? Japan is keeping the U.S. afloat by buying up U.S. debt. But who's buying Japanese debt to the tune of 7.1 trillion?

Don't get caught without a chair when the music stops playing.

And the euro is in bad shape as well. Marshall Auerback has this to say concerning the German election and the recent increases in the price of gold:

Political fragmentation induced by economic malaise and high unemployment has finally tipped the euro zone's largest economy into a full-blown political crisis. Although gold has long been viewed as the correlative of a weaker dollar, we have always felt that its long term viability as a genuine safe haven alternative rested on a broadening loss of confidence in paper currencies in general. To the extent that Germany's current political stalemate creates further long term doubts about the future viability of the euro zone, it helps to underpin the gold price in euro terms.

Let us be clear: there is no imminent prospect of the European Monetary Union imploding. But the euro zone economies have continued to grow very slowly, probably not much more than 1% a year. Unemployment in Germany is 10% and is almost as high in the rest of much of Europe. France, Germany and Italy are all running significantly higher deficits than the original Stability pact authorized and they have a mockery of the agreement's legitimacy as a consequence. And the increased doubts about the euro's long term viability are creating a highly propitious psychological backdrop for bullion.

...For all of the talk of Chancellor Schröder's unexpected success in converting an anticipated landslide defeat into a Parliamentary cliffhanger, the reality is that both major parties performed abysmally, as smaller parties ate into their traditional constituencies. In fact, this election marked the first time since 1949 that the SPD and CDU failed to garner more than 70 per cent of the votes collectively. The result appears to reflect the disillusionment of the German electorate with the tired and overused idea of "reform," correctly understanding that there is not much if anything in it for them the way it was presented by either of the two major parties. As such the outcome represented a repudiation of Germany's political class. It amounted to a declaration by the voters that the solutions on offer for Germany's problems and the ideas on offer for Germany's future were unacceptable.

At some point the German electorate could well put two and two together and realize that it is this very political class which junked the D-mark, and legislated away arguably the most successful experiment in post-war monetary management without even the hint of a referendum. This is a problem for Germany's leadership and for the other member states, because the single currency project has over-promised and under-delivered. Indeed, the manner in which Germany's post-war monetary institutions and currency were casually discarded is symptomatic of the profoundly undemocratic nature of the European Union itself. Its concept of democracy amounts to the will of the collective trampling down individual national interests - a collective without even a language in common, which also explains why the French and Dutch voters in the roundly rejected referenda on the European Constitution held earlier this year. Denied similar opportunities to express their views on the constitution and the single currency before it, Germany's voters have taken the only route open to them and rejected their leadership.

What does this mean for the euro and gold? Criticism of the single currency project has long been a taboo topic in Germany, although this is no longer the case in other euro zone countries. The issue of euro withdrawal has been broached in Italy, of all countries. Ironic, because Rome has effectively had a free ride in the euro zone's integrated bond markets for years, obtaining Germanic levels of interest rates (as a consequence of Germany's historic record of fiscal prudence), despite maintaining historically retaining profligate levels of public sector expenditure and debt to GDP ratios well in excess of most of the other founding member states in the monetary union.

But were Italy to withdraw ultimately from the euro zone, this would expose other countries to Italian competition, especially as this would almost certainly be accompanied by a significant devaluation of the newly restored Lira. Other countries with a dominant manufacturing base, such as Germany, would almost certainly come under pressure and the whole system could, in these circumstances come under threat. Where would investors turn at that juncture? The resultant financial chaos could be considerable, given the lack of a "plan B" in the event that monetary union came under threat.

To a limited degree, the markets already intuit this. It is noteworthy that the start of gold's most recent rise has been coincident with the French and Dutch referendum results on the EU constitution last spring. Germany's political crisis has provided yet another blow to confidence in the euro zone and whilst the euro may be under no imminent threat of dissolution, its manifold structural weaknesses are becoming increasingly evident to the markets. Gold's rise is a politically incorrect reminder that the euro zone rests on the tenuous foundations of bureaucratic legerdemain, with no economic, cultural or political anchorage to sustain it longer term.

The fundamental problems of the dollar have been well-documented, with snowballing deficits reaching the point where even Alan Greenspan says, of a Republican government, that the deficits are "out of control." After last week, with the indictment of U.S. House Majority leader Tom DeLay for political money laundering, the ongoing investigations into DeLay's close associate, Jack Abramoff for a whole range of gangster-like activity, including murder of a former business partner, the SEC investigation into Senate Majority Leader Bill Frist for massive inside trading, and the mysterious drop in the stock price of Diebold, you have the real possibility of a complete falling away of any confidence by the U.S. population in the government, now seen more in terms of an organized crime takeover.

Since the rest of the world has already lost confidence in U.S. political leadership, the only reason the dollar has any value is pure fear.

With the present moment being so precarious, the near term future looks frightening. Contrary to the initial reports, Hurricane Rita has seriously damaged the U.S oil refining and shipping infrastructure, an infrastructure already insufficient to meet demand. Here is what one industry insider (anonymous) was quoted as saying on Urban Survival:

OK, it's bad. There are dozens of rigs and platforms damaged, missing or sunk. Katrina put the whammy on production platforms, and Rita slammed the drilling rigs...Some of the rigs are upside down, others are twisted and destroyed, still others are just plain gone...either sunk or drifting.

As I have been telling anyone willing to listen, there really is no such thing as Peak Oil, as far as I can tell. The real problem is a complete lack of infrastructure for moving and refining oil and gas, as well as a serious shortage of drilling rigs, tankers and refineries. The situation was close to dire before the storms. It is critical now.

Over the past couple of decades, there has been little investment in tankers, new drilling rigs and refineries. As a consequence, we may be running out of gasoline while drowning in oil. This is the cause of the disconnect recently between pump price and barrel cost. All the storage areas are full of oil, the problem is there is no scalable means to refine it and/or ship it. Even starting this minute, the supply can not be increased by even one percent for the next three to five years.

Should the next storm hit shipping, I can almost guarantee the pump lines we recently saw in Houston will be nationwide. I am fairly sure that we will see them by Christmas, as it is. A cold winter will virtually ensure radical price hikes in natural gas, electricity and heating oil.

While this may sound alarmist, I assure you that I am taking the best information from offshore interests, as well as what I know about the industry into account. The outcome will most likely not be pleasant, and the time frame for the unpleasantness to start is about one month, maybe slightly more. When you hear Bush taking steps to limit gasoline usage in the White House and encouraging people to conserve, you can bet that he knows what's coming.

...These are just prudent suggestions. I see no reason to panic about the situation. It will progress quickly, but those who are looking for the signs will know when things start to go down hill. Until you have spent days looking for a gas station, or gone grocery shopping when nothing was on the shelves, or gone five days without electricity during a heat wave, you can not appreciate the situation.

...To summarize, the GOM (Gulf of Mexico) oil and gas industry has been hit pretty hard. ALL oil and 80% of natural gas production is shut in. Four refineries are seriously damaged, needing about a month or more to repair. Dozens of rigs and platforms are sunk, missing or damaged. There is currently about a month's supply of refined petroleum products in storage, and they are decreasing rapidly. Your readers would do well to consider prudent preparations for a severe disruption in energy by year's end.


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