Signs of the Economic Apocalypse, 8-21-06

From Signs of the Times, 8-22-06:

Gold closed at 612.00 dollars an ounce on Friday, down 5.0% from $642.40 at the close of the previous week. The dollar closed at 0.7797 euros Friday, down 0.7% from 0.7855 for the week. The euro closed at 1.2825 euros, up from 1.2732 at the close of the previous Friday. Gold in euros would be 477.19 euros an ounce, down 5.7% from 504.56 for the week. Oil closed at 71.14 dollars a barrel Friday, down 4.4% from $74.30 at the close of the Friday before. Oil in euros would be 55.47 euros a barrel, down 5.2% from 58.36 for the week. The gold/oil ratio closed at 8.60 Friday, down 0.5% from 8.64 at the close of the previous Friday. In the U.S. stock market, the Dow closed at 11,381.47 last week, up 2.6% from 11,088.03 for the week. The NASDAQ closed at 2163.95 Friday, up 5.2% from 2,057.71 at the close of the previous Friday. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 4.85%, down 12 basis points from 4.97 for the week.

With gold and oil down and U.S. stocks up, the mainstream media last week credited a mood of optmism. About all they could point to was the cease fire between Israel and Lebanon, which lowered oil prices and the lower than expected inflation numbers in the U.S.

Dow closes up 47 on investor optimism

By Joe Bel Bruno, AP Business Writer

Fri Aug 18, 4:53 PM ET

Investors eked out Wall Street's fifth-straight day of gains Friday, bucking concerns about lagging consumer sentiment and disappointing second-quarter results from Dell Inc.

Trading got off to a shaky start after the University of Michigan released its preliminary consumer sentiment index, which fell to 78.7 in August, down from 84.7 a month earlier. Wall Street had been looking for the index to slide to 83.8, and the greater-than-expected drop was viewed as a signal the economy may weaken too much.

The poor sentiment index threatened to stall the market's rally this week, which came on evidence of lower inflation risk and a gently slowing economy. Yet the market's recovery from its session lows — aided by a $36 billion stock buyback announced by Microsoft Corp. — shows investors remain optimistic that the Federal Reserve will keep the economy strong enough to withstand recession while keeping inflation contained.

"If this rally continues on bad economic news, that's saying that investors have already made a decision we're going to have a soft landing in this economy," said Alexander Paris, economist and market analyst for Chicago-based Barrington Research.

Technology stocks nevertheless saw pressure after Dell reported second-quarter profit fell 51 percent, with sales growth slowing to the lowest rate in three years. The world's largest computer maker — already reeling from a massive laptop battery recall earlier in the week — also disclosed the Securities and Exchange Commission has been investigating its accounting for the past year.

The Dow Jones industrial average rose 46.51, or 0.41 percent, to 11,381.47.
Broader stock indicators also made modest gains. The Standard & Poor's 500 index added 4.82, or 0.37 percent, to 1,302.30, and the Nasdaq composite index gained 6.34, or 0.29 percent, to 2,163.95.

For the week, the Dow jumped 2.65 percent, the S&P 500 gained 2.81 percent and the Nasdaq surged 5.16 percent.

Bonds pushed toward gains for a fourth straight session, with the yield on the benchmark 10-year Treasury note falling to 4.84 percent from 4.86 percent late Thursday. The dollar was mixed against other major currencies, while gold prices fell.

Oil prices moved higher in trading after tumbling a day earlier on cooling of Middle East tensions. A barrel of light, sweet crude for September delivery settled at $71.14, up $1.08 from Thursday's close, in electronic trading on the New York Mercantile Exchange. On Thursday, oil fell as low as $69.60 a barrel — a level not seen since June 21.

The optimistic story had to ignore the plainly temporary lull in the aggressive actions of the United States and Isreal as well as both countries’ recent abysmal failures in their wars. The media also had to downplay a bad housing market and low consumer confidence numbers in the United States.

Home sales decline in 28 states, D.C.

By Martin Crutsinger, AP Economics Writer

The slowdown in the once-sizzling housing market is spreading, with 28 states and the District of Columbia reporting spring sales declines, led by big drops in former boom areas of Arizona, Florida and California.

Nationally, sales were down 7 percent in the April-June quarter this year compared with the same period in 2005, the National Association of Realtors said Tuesday in its latest state-by-state look at housing conditions around the country.

The Realtors survey showed that the biggest declines occurred in states that had been enjoying red-hot sales during the five-year housing boom.

The five biggest declines this spring compared to the April-June period of 2005 were Arizona, down 26.9 percent; Florida, down 26.7 percent; California, down 25.3 percent; Virginia, down 23.9 percent, and Nevada, down 23.5 percent.
The Realtors report depicted a tale of two housing markets, with former boom areas experiencing declines and other areas of moderate sales gains during the boom years experiencing strong growth.

In all, 20 states had sales gains in the spring, led by Alaska, which enjoyed a 48.6 percent jump in sales; followed by Arkansas, up 17.9 percent; Texas, up 11.3 percent; North Carolina, up 11 percent, and Vermont, up 9.1 percent compared to the spring of 2005.

Now the optimists can say that 20 states had housing sales gains, and that the 28 states that had declines were those which saw the greatest gains in the bubble. The problem, as always, is that the process of decline will not be linear. Here is the Billmon blogger:

Home is Where the Sink Hole Is

…Here in paradise, the housing boom is over:

Southern California home sales fell to their lowest level in nine years last month as price appreciation continued to decelerate, data released Tuesday showed . . . .

The figures could rev up the debate over whether the Southland's housing market will be able to navigate a "soft landing" that produces only moderate price declines, or face a brutal correction.

…[T]alk of a "soft landing" is one of the normal steps in a bubble addict's recovery program.

It goes something like this:

1.) We're not in a bubble. Prices are just recovering from years of underappreciation.

2.) It's a bubble, but it's a sustainable bubble because the fundamentals of the market have changed in the past decade. People need to recognize this. (Note: this stage is usually recognizable by an explosion in popularity of increasingly desperate and bizarre financing options.)

3.) Yes, growth is slowing, but we think we'll navigate a soft landing. It's absurd to think that housing in [fill in area where you live] will actually lose value.

4.) This is a disaster! Somebody better step in and do something! People are losing their life savings!

5.) Buyers have learned a permanent lesson this time. Homeowners need to accept the reality that the bubble of the past five years was a one-time fluke and we'll never see it happen again.

Rise and (eventually) repeat.

These are actually the residential real estate versions of the more generic speculative cycle described by economist (and wise old man of the academic hills) Charles Kindleberger in his classic text Manias, Panics and Crashes.

Working from a schematic first developed by the late financial economist Hyman Minsky, Kindleberger described the idealized bubble thusly:

· Displacement: Some sort of exogenous shock -- such as the huge drop in interest rates in the early '00s -- gets the speculative juices flowing.

· Credit expansion: Lenders hustle to get in on the action, feeding more liquidity into the market, creating a self-sustaining loop of price increases, which leads to:
· Euphoria: (Minsky, following Adam Smith, called it "overtrading.") Since expectations are adaptive, not rational, a prolonged period of rising prices creates a growing consensus that the boom will never end. Clever writers and hack economists like Jim Glassman and Kevin Hassett, hustle to develop new wave theories showing why this must be true.

· Distress: As price gains slow or plateau (there are only so many fools in the world with money to wager) it begins to dawn on the crowd -- always slowly, never at once -- that the boom will NOT last forever.

· Revulsion: (Minsky also used the term "discredit") The conviction sets in that the one thing you do not want to own, under any circumstances, is the asset in question -- the same one the Glassmans and Hassets of the world were recently predicting would grow to the sky.

It appears that Southern California (which originally was the product of an 1880s real estate bubble deliberately engineered by the Southern Pacific railroad) has arrived at the stage of "distress" and is quickly moving on to "revulsion."

In the stock market, the revulsion stage typically ends in massive panic-driven price declines, as everybody and their broker tries to crowd through the same small door. However, because real estate markets are less liquid and have higher transaction costs, and since houses are a consumption item as well as an asset, what traditionally happens when the bubble bursts is that sales just dry up. Nobody wants to buy at quoted prices (usually based on previous, overinflated appraisals) but sellers aren't willing -- and often aren't able -- to sell for less. So the market can't clear, as Southern California markets aren't clearing now.

This tends to make housing busts the economic equivalent of Chinese water torture: they generally begin slowly but last a long time, as home "owners" gradually capitulate to reality and lenders (or in the S&L industry's case, the federal government) slowly write off all that bad debt and dispose of all those foreclosed homes.

That's one reason why the collapse in real estate values that accompanied the Great Depression didn't bottom out until the late 1940s. It's also why it took almost ten years for the last home price boom/bust cycle in California to come around again. According to the Office of Federal Housing Enterprise Oversight, the reg agency that tracks these things, home prices in the greater Los Angeles metro area didn't return to their 1990 peak until the spring of 2000.

But what makes things different -- and potentially more exciting -- this time around are the gaudy new financing gimmicks Kevin mentions: no money down loans, interest-only mortgages, ARMs that reset to truly usurious rates, etc. If and when these loans blow up, and they will, it could leave many home "owners" with no alternative but to sell and sell quickly -- or simply mail the keys back to the bank.

Combine that with the fact that this housing bubble, far more than past bubbles, appears to have been driven by the speculative investment demand of people who have no intention of living in the houses they've bought, and the finale could be much more spectacular, and play out a lot faster, at least in some markets.

How fast and how spectacular depends in part on Chairman Ben and the boys and girls at the Fed. Although short-term interest rates have now jumped 425 basis points since the trough in the summer of 2004 (a whopper of a move by past standards, particularly in real, after-inflation terms) long-term mortgage rates have increased much more modestly, thanks in large part to our good friends at the People's Bank of China. This is the main reason anyone can still talk about a "soft landing" for Southern California home prices.

However, now that the downward wave of the cycle is well-entrenched, the Fed is going to have to move relatively fast to keep the "soft landing" scenario from smashing into the runway. But experience teaches that the Fed rarely shifts from tightening to easing fast enough to head these kind of things off -- the fall of 1990 and the summer and fall of 2000 being two case studies in point.

My guess is that the Southern California market (along with the New York metro market and the South Florida market and a few other places where the bubble got well out of hand) are going to "auger in," as the test pilots used to call it. They've soared too high, and the Fed isn't going to be able to move quickly enough to catch them because national growth and inflation conditions aren't going to let it.
But whether the bust is national, as opposed to just regional, may depend as much or more on our Chinese benefactors as on the Fed.

The chain of causation is somewhat perverse: The Fed's recent decision to at least pause in its tightening campaign has put downward pressure on the dollar, which is forcing the People's Bank to buy dollars to protect the "crawling peg" with the renminbi, said dollars then being reinvested in the Treasury market, which drives long-term yields down, which pulls mortage yields down, too.

As long as that particular windfall lasts, the prospects for a soft landing to the national real estate bubble look reasonably good -- that is, as long as the regional real estate busts, plus the overextended state of the American consumer and the mysterious reluctance of U.S. firms to funnel their bloated profits into capital spending, don't tip the national economy over into a recession.

You'd need a Cray supercomputer hooked up to a crystal ball to figure out the odds on that latter scenario, and I have neither. What I do have is a conventional 30-year mortgage at 6.12%, and a house with lots of equity located in one of the country's more stable real estate markets. So I'm personally not sweating the housing bubble too much. Yet.

Last week we wrote about the longer-term issues of imperial competition for resources and cheap labor. We should not think that these competitions between different power centers are exclusively economic. In Political Ponerology, Andrzej Lobaczewski wrote in 1984:

Upbeat economists point out that humanity has gained a powerful slave in the form of electric energy and that war, conquest, and subjugation of other countries is becoming increasingly unprofitable in the long run. Unfortunately… nations can be pushed into economically irrational desires and actions by other motives whose character is meta-economic (Politcal Ponerology, p. 93)

In fact, reducing all motivations to economic ones is precisely the kind of oversimplification that plays right into the hands of the pathocrats. Lobaczewski argues that, to the extent that a society’s working model of human nature is inadequate, that society’s institutions are more vulnerable to ponerization, or takeover by psychopaths. What Lobaczewski writes about western European legal psychology in the Middle Ages can be applied to the homo oeconomicus of classical economics, the rational calculator of economic advantage:

A “Western civilization” thus arose hampered by a serious deficiency in an area which both can and does play a creative role, and which is supposed to protect societies from various kinds of evil. This civilization developed formulations in the area of law, whether national, civil, for finally canon, which were conceived for invented and simplified beings. These formulations gave short shrift to the total contents of the species Homo sapiens. For many centuries any understanding of certain psychological anomalies found among some individuals was out of the question, even though these anomalies repeatedly caused disasters.

This civilization was insufficiently resistant to evil, which originates beyond the easily accessible areas of human consciousness and takes advantage of the enormous gap between formal or legal thought and psychological reality. (Politcal Ponerology, p. 48)

Such models have just enough truth in them to seem plausible while concealing dangerous simplifications. The neoclassical economic model of human psychology, a model with deepest roots in the Anglo-American world, cannot adequately reflect the complexity of motivations in most humans. Its psychology is plainly inadequate to all but psychopaths. It should be no surprise, then, that our culture is wide open to ponerizing forces. Furthermore, late capitalism’s preferred institution, the modern business corporation, provides an ideal vehicle for ponerization. The recent boom in the study of psychopathy has led many to see the corporation as a psychopath, that is, someone without a conscience. Given legal personhood under the Constitution by the U.S. Supreme Court, the psychopath that pretends to have empathy when it has absolutely none. It’s rules are the same as an individual psychopath’s.

Neoliberals have pushed the privatization of just about everything. Even roads are now beginning to be privatized in the United States. However, we clearly cannot depend on corporations to fund infrastructure investment—usually only government can do that—but in the United States, with a neoliberal economic policy and a neoconservative foreign policy, the government is only good for destroying other countries’ infrastructure and for funnelling money to cronies in the military-industrial complex.

Alice Friedemann compares multinational corporations to “out of control robots.” The economic rationality of these psychopathic actors are placing the world in increasing danger. Friedemann, a proponent of peak oil, marshals some startling facts about the lesser-known aspects of our energy dependence. Supply chains, made more efficient with just-in-time supply, and the offshoring of jobs to low-wage, low regulation countries, have increased the vulnerability of developed economies to transportation interruptions due to natural disasters or high energy costs:

The fragility of global trade and infrastructure
By Alice Friedemann

Science fiction movies used to scare us with out-of-control robots bent on world destruction. If there’s a runaway robot now, it’s global corporations doing what’s best for the shareholder rather than the citizens and nations of the world. Pensions have been looted, health care benefits taken away, taxes avoided, and regulations ignored.

Risks are being taken that could bring down the global financial system.

One of the risks to global trade is due large computer and electronic companies using the same outsourcers for similar components from the same region -- even the same place – such as an industrial park in Hsinchu, Taiwan. The risk is a single source of failure.

Microprocessors are essential to the modern world.

Billions of chips are created every year for a myriad of applications: in autos, airplanes, ATMs, air conditioners, calculators, cameras, cell phones, clocks, DVDs, machine tools, medical equipment, microwave ovens, office and industrial equipment, routers, security systems, thermostats, TVs, VCRs, washing machines – nearly all electrical devices.

So when an earthquake struck Taiwan in 1999, world markets were shaken. Willem Roelandts of Xilinx immediately knew this had the possibility of hurting the world economy. “There is not an electronic product in the world that does not contain a Taiwanese component”, he said.

Even though the factories were fine, electrical and transportation systems weren’t, so production and delivery of components stopped, which caused assembly lines in the United States to halt as well. Wall Street traders sold off electronic firms, especially Dell, HP, and Apple.

You wouldn’t think the United States would build microchip factories offshore in industries that were essential to its national and economic security. But low wages are irresistible to corporations. Also, many foreign countries are closer to sources of natural gas, which is declining at an alarming rate in North America.

According to Jack Gerard, president and CEO of the American Chemistry Council, “Natural gas is a raw material for compounds used in thousands of consumer products — from agriculture, telecommunications and automobiles to pharmaceuticals…and food packaging. More than 96 percent of all manufactured goods are directly touched by chemistry. The industries that rely on chemistry together represent more than a quarter of the nation's entire workforce." Unaffordable natural gas is driving away investment, crippling our manufacturing base, and reducing job opportunities. It is transferring to foreign countries the advanced research and technology desperately needed in order to compete on the world stage. In effect, our nation's energy policy has become its de facto manufacturing and national-security policies as well.26

Industries also like to locate factories where environmental regulations are less stringent.

The chemicals used to create computer parts have resulted in 29 superfund sites in Silicon Valley, the most concentrated number of superfund spots in America. At the Advanced Micro Devices superfund site in Sunnyvale, California, chemicals are in the groundwater and soil that can cause death, cancer, brain and central nervous system damage, leukemia, anemia, convulsions, nausea, unconsciousness. The zinc and copper at this site are toxic to plants, ruining what were once some of the best orchards in the world.

The need to go where costs are lowest is driven by the enormous amount of money it takes to build a mega-size wafer fabrication plants -- nearly ten billion dollars.27

Part of this amount is due to very high insurance costs. In 1997, an Hsinchu Taiwan fabrication plant had a fire that caused $421 million dollars in smoke and water damage.

Business interruptions can cost a fabrication plant 20-30 million dollars in lost revenue. For instance, a plant that had a four-hour long electricity outage had to spend the next four days recalibrating their equipment, resulting in a $5 million dollar loss. Insurance companies have responded with huge deductibles and capped the loss amounts.28

As unexpected energy shortages and outages grow more common in the future, this will wreak havoc on microprocessor production.

Outsourced products are delivered just-in-time to the factory assembly. According to Barry C. Lynn, “Our corporations have built a global production system that is so complex, geared so tightly, and leveraged so finely, that a breakdown anywhere increasingly means a breakdown everywhere, much in the way that a small perturbation in the electricity grid in Ohio tripped the great North American blackout of August 2003”.29

Less major blows to assembly lines have come from strikes, SARS, fires, explosions, and manufacturing mistakes, such as the ones that resulted in Chiron’s failure to deliver half of the American flu vaccine. Fortunately, the impacts so far have been temporary and regional. But it’s not hard to imagine events that could result in worldwide disruptions leading to a global depression.

United States Infrastructure

While the EROI of oil was high, we built a vast infrastructure to deliver clean water, treat sewage, built roads, bridges, dams, and so on. Any non-fossil fuel type of energy will have a great deal of work just maintaining the existing infrastructure.

…Consider just the drinking water infrastructure, the main reason our life spans have increased so much.23 In this century, all of the 600,000 miles of pipes delivering clean water to homes will need to be replaced. Every component of the water system is aging. The energy required to replace or maintain thousands of treatment plants, pumping stations, reservoirs and dams over the next century is staggering.24

...And consider the energy required to deliver the water. According to Allan Hoffman, “Energy is required to lift water from depth in aquifers, pump water through canals and pipes, control water flow and treat waste water, and desalinate brackish or sea water. Globally, commercial energy consumed for delivering water is more than 26 Quads, 7% of total world consumption”.25

Energy shortages for instance. Already many businesses in the chemical, agricultural, steel, glass, and other industries have failed or are in pain from high natural gas prices in America.30 31 32 When enough key suppliers of infrastructure components fail, this will stop the downstream assembly line. Suppliers might also go out of business because of economic failure in the manufacturing country, civil or regional wars, and extreme weather.

Despite the risk, single-sourcing occurs because cutting costs is how you stay in business, so the cheapest supplier wins the race to the bottom. Corporations have gone cuckoo with outsourcing; letting suppliers located in potentially shaky political and economic countries hatch their nest eggs.

When the fledglings hatch they often fly on Fed Ex, which is so reliable it seems as if the supplier were on the other side of town instead of across the world. But the airline industry is reeling from higher energy prices, so it’s possible that the intricate, just-in-time, high-speed aircraft delivery of electronic gear will shift to ships, a much slower, less predictable way to deliver cargo “just-in-time”.

Most products traded globally travel by sea. Over 50,000 large ships carry 80 percent of the worlds’ cargo. Shipping faces critical challenges in the future.

Oil and LNG tankers are increasingly failing from corrosion. Over 2400 tankers split up or nearly did so from 1995 to 2001 according to the International Association of Independent Tanker Owners.33

…Continued global trade at current levels cannot be sustained as energy declines. At some point global trade will lessen due to a combination of declining fossil fuels, piracy, terrorism, energy shocks, pandemics, natural disasters, political turmoil, global depression, and a shortage of large, non-oil based vessels.

Global trade will not disappear, since moving freight over water is very efficient, but there will be several discontinuities as declining energy forces us to roll backwards though history.

Most cargo is shipped on enormous container vessels that can be over 1100 feet long with ten thousand containers stacked many stories high.

The first discontinuity will come when we have to retrofit ships to run on coal, and set up coal stations and tenders all over the world.

The second discontinuity will occur when coal gets scarce and container ships are moved by wind power (if this is even possible), with liquid fossil fuel only used when entering and leaving ports. A further step down will happen when it’s too energy-intensive to keep harbors dredged deep enough accommodate large container ships. It’s already very tricky getting these large ships into port, a local pilot is brought in and complex computer systems are used to delicately park these gargantuan ships along the wharf.43 These huge ships would have to remain offshore and unloaded to smaller ships, if that is possible, since they weren’t designed for this.

The third discontinuity will come when containerization can no longer be supported due to lack of fuel and/or electricity for cranes, trucks, and trains. Containerization revolutionized the amount of cargo and the swiftness with which it could be loaded and delivered from origin to destination by orders of magnitude over earlier forms of transportation.

The final discontinuity will come when ships need to be built from wood, because the remaining mineral ore is too low quality and energy-intensive to process, and when we can no longer recycle the rusted and dispersed iron and steel.

Whether “Peak Oil” reflects actual short-sighted over-exploitation of a limited resource or a deliberate strategy of elites without conscience creating shortages to establish control and increase the suffering of others, our society is frighteningly vulnerable to its effects.