Friday, February 06, 2015

US Economy Burdened by Perpetual, Massive Trade Deficits

The U.S. trade deficit soared 17.1% in December, reaching a two-year high. The trade gap spiked to $46.6 billion from a revised $39.8 billion in November, the Commerce Department said Thursday.

It was the biggest percentage increase since July 2009, and the largest month-over-month increase, in dollar terms, ever recorded.

U.S. exports slipped 0.8% to $194.9 billion, while imports increased 2.2% to $241.4 billion. The stronger dollar made imports more affordable, while making exports more expensive. The dollar has strengthened steadily since July, recording its second fastest acceleration in 20 years.

For all of 2014, the goods and services deficit was $505 billion, up $28.7 billion (6 percent) from $476.4 billion 2013, the Commerce Department reported. Exports were $2.35 trillion, up $65.2 billion or 2.9 percent. But imports were $2.85 trillion, up $93.9 billion or 3.4 percent.

So, imports were higher than exports in terms of total dollars, in terms of an increase in dollars, and as a percentage increase.

Annual trade deficits of half-a-trillion dollars are now the norm.

Year after year, the trade deficit sucks hundreds of billions of dollars, and millions of jobs, out of the U.S. as we continually buy products from overseas that could instead be made here at home.

The trade deficit in 2013 was $476.4 billion, which was the lowest since 2009. Think about that for a moment; the trade deficit in 2013 was nearly half a trillion dollars, yet it was the smallest in four years. It was down from $534.7 billion in 2012, according to the Commerce Department. The deficit shrank in 2013 due to lower petroleum imports.

The unfortunate reality is that the trade gap is a decades-old problem.

The United States has been running persistent trade deficits since 1974 due to high imports of oil and consumer products. The trade gap increases the debt held either by Americans or by the federal government.

Since a strong U.S. dollar makes American exports more expensive, the trade deficit will almost certainly increase again this year. As long as the trade deficit persists, the U.S. will continue borrowing from abroad to pay the difference between imports and exports.

Every $1 billion of a larger deficit subtracts about 0.1 of a percentage point from the annualized GDP growth rate. That's bad news for an economy that is currently struggling to eek out a mere 2 percent annual growth rate.

Traditionally, countries that have a trade surplus with the U.S. have used their surplus dollars to buy government or corporate bonds, to make investments in U.S. real estate, or to invest in the U.S. stock markets.

But what if a country, such as China, decides to use its surplus dollars to instead purchase gold? Unless that gold is purchased from the U.S., those dollars are never repatriated. In essence, they never come home.

China has a ravenous, and apparently growing, appetite for gold. While the world's second-largest economy has not formally disclosed any changes to its gold holdings since 2009, when it claimed to possess 1,054.1 tonnes of gold, it is now estimated by gold analysts to have around 2,000-3,000 tonnes of gold reserves.

As sovereign bond yields plummet, the tendency for gold will be to move higher. Though gold has a zero interest rate, that is still higher than the negative rates currently being offered in some countries.

When China diverts its dollar holdings for the purchase of gold, those dollars no longer have any beneficial investment affect in the U.S.

The danger of a trade deficit was spelled out quite clearly in Discourse of the Common Wealth of this Realm of England, in 1549: "We must always take heed that we buy no more from strangers than we sell them, for so should we impoverish ourselves and enrich them."

This is not a new concept. No nation can indefinitely buy more than it sells.

A wider trade deficit creates a drag on economic growth because more of the nation's consumption is coming from overseas rather than from domestic production.

The U.S. has led the world in imports for decades. Meanwhile, exports represent just 13.5% of our economy, according to the World Bank. It's a bad combination.

The massive U.S. trade deficit is emblematic of the fact that we are the world's biggest debtor nation.

For decades, we have imported more than we have exported, consumed more than we have produced, and spent more than we have saved. The result is that we must continually borrow to fund our nation — to fund our debt-driven ways.

It's all led to an unsustainable debt problem that will likely have a very bad ending.

Monday, January 19, 2015

Negative Interest Rates an Alarming Development

If you think you've got it bad because your bank pays you just 0.10 percent (or even 0.01 percent) for keeping your money in a savings account, consider the plight of European bank customers.

Many European banks (such as those in Sweden, Switzerland, Denmark, etc.) pay negative interest. Depositors are actually charged to keep their money in an account. In essence, depositors are lending money to borrowers for free. Consequently, the banks are making money coming and going; both borrowing and lending.

The idea is to dissuade people from saving and instead encourage spending, with the hope that this will stimulate the economy.

While high interest rates discourage borrowing and encourage saving, low rates have the inverse effect.

However, the central banks in some countries are also attempting to make their currencies less valuable. A lower valued currency makes exports cheaper, and increasing exports can also stimulate an economy.

The European Central Bank (ECB), for example, cut a key interest rate below zero in June — the rate it pays to banks on reserves held at the ECB. The idea is to compel banks to lend money, rather than lose principle by having it sit idly at the central bank.

The ECB will vote this week on whether to engage in a money-printing / bond-buying scheme known as "quantitative easing." However, due to Germany's history with hyperinflation after WWI, it has been hesitant to approve such a strategy, which is intended to stimulate the eurozone economy and combat deflation. Despite this, the plan is expected to pass.

A "quantitative easing" program of this type would drive down the value of the euro, pushing higher the value of other currencies, such as the dollar.

These are strange times indeed, and policy makers are willing to employ the most extreme measures to stimulate their economies, fight deflation, and boost exports.

However, negative interest rates can have unintended consequences, such as compelling depositors to remove their money from banks and seek higher yielding assets or investments.

Money market funds, for example, can plunge as investors exit. Yet, money markets are key sources of short term financing for banks and corporations. If money markets crash, the entire financial system would be thrown into turmoil.

Most critically, when a central bank offers negative interest rates, other banks are disinclined to keep deposits parked there. Rather than encouraging lending (the desired outcome), this can instead cause increased speculation and risk taking through "yield chasing."

While the Federal Reserve and US banks are not (yet) offering negative rates, they could be compelled to follow Europe's lead to fight deflation, or to help boost US exports and lower the massive trade deficit.

A financial crisis can quickly become an economic crisis, and both can lead to contagion. The 2008 financial crisis, which initiated in the US, quickly went global. The international response became a game of follow the leader.

With that in mind, the precedent for negative rates has been set, and it's not unimaginable that US banks might eventually offer negative interest rates as well. But that would just cause Americans to hoard cash in safes, vaults, and bank deposit boxes, rather than deposit it.

Though all export countries want a devalued currency to make their exports more desirable, such a strategy is a race to the bottom. Not everyone can have the cheapest currency and the cheapest exports.

A devalued currency also makes the repayment of fixed debts less painful, which is why governments generally favor devaluation.

But this is not a zero sum game. Every central bank is pursuing the same strategies, and hoping for the same outcomes. That is not possible.

If every country has a cheap currency, then none of them do. And investors will always chase higher yields — even the highest yields — despite the risks involved.

Perhaps the most sobering takeaway is this: If central banks aren't intentionally reducing the value of your money through inflation, they are willing to depreciate the value of your savings with negative interest rates.

Heads, they win. Tails, you lose.

Friday, January 09, 2015

Americans Are Living On The Edge

Stagnant incomes have resulted in little or no emergency savings for most Americans.

Approximately 62% of Americans have no emergency savings for things such as a $1,000 emergency room visit or a $500 car repair, according to a new survey of 1,000 adults by personal finance website

In the event of an emergency, they say they would have to cover the cost by reducing spending elsewhere (26%), borrowing from family and/or friends (16%) or using credit cards (12%).

Financial planners typically recommend that people have a minimum of three to six month’s worth of living expenses in emergency savings. Clearly, $500 or $1,000 is far less than that, so this survey indicates that a significant majority of Americans are living on the edge, from paycheck to paycheck.

Last summer, in the same size survey, found that 26 percent of all Americans have no emergency savings whatsoever.

Personal savings are low by historical standards, and they are trending downwards.

Personal savings in the US decreased to 4.40 percent in November from 4.60 percent in October of 2014, as reported by the US Bureau of Economic Analysis. Personal savings averaged 6.81 percent from 1959 until 2014, reaching an all time high of 14.60 percent in May 1975 and a record low of 0.80 percent in April 2005.

The downward trend in savings is little surprise. If people don't have money to save, then they won't — or can't.

Americans are 40% poorer today than they were in 2007. The net worth of American families — that is, the difference between the values of their assets, including homes and investments, and liabilities — fell to $81,400 in 2013, down slightly from $82,300 in 2010, but a long way off the $135,700 in 2007, according to a report released last month by the nonprofit think tank Pew Research Center in Washington, DC.

The problem isn't isolated to the fact that most Americans suffered from the housing crash. The issue is also related to stagnant wages, which has been a big problem for decades.

After looking at five decades’ worth of government wage data, the Pew Research Center found that for most U.S. workers, real wages — that is, after inflation is taken into account — have been flat or even falling for decades.

Pew noted the following:

"After adjusting for inflation, today’s average hourly wage has just about the same purchasing power as it did in 1979, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then. In fact, in real terms the average wage peaked more than 40 years ago: The $4.03-an-hour rate recorded in January 1973 has the same purchasing power as $22.41 would today."

The problem of stagnant wages has continued over the past year, with a mere 1.7% increase in average hourly earnings from December 2013 to December 2014. However, average hourly earnings fell 0.2% in December, the first drop since July 2013.

In November 2014, the average weekly wage was $853 versus $833 for November 2013, according to the Bureau of Labor Statistics.

This is not an environment that allows Americans to save for personal or family emergencies, much less plan for retirement.

So, the findings by should surprise no one.

Thursday, December 18, 2014

Deflation is Taking Hold in Some Economies. Is the US Next?

In response to the 2008 financial crisis and resulting Great Recession, the Federal Reserve (followed by central banks around the world) slashed interest rates to near zero and engaged in a policy of unprecedented money printing, know as "quantitative easing."

This combination spurred concerns that inflation would accelerate, perhaps rampantly.

But that hasn't occurred — at least not yet.

The pace of inflation over the past 12 months fell to 1.3% in November and is down sharply from 2.1% just five months ago.

The Federal Reserve has a publicly stated goal of 2% annual inflation. As recently as 2011, the US inflation rate averaged 3.2%. But the rate dropped to 2.1% in 2012 and then 1.5% in 2013. The steady decline is clear.

The financial world has been cautiously watching and waiting for any indication that the Federal Reserve will raise interest rates next year.

However, bond guru Bill Gross says the Fed may refrain from hiking rates in 2015 due to a lack of inflation.

"Why would the Federal Reserve raise interest rates in order to slow economic growth if inflation in fact was moving lower?"

It's an excellent question; one that many of us are asking. Oil is tumbling and cheaper energy means lower inflation.

In fact, the bigger concern at the moment is deflation, which is rearing its ugly head around the world.

Delation is the continual decline in prices and assets. It is often associated with a reduction in the money supply, or credit.

While the money supply has certainly expanded in an unprecedented manner (the Fed’s balance sheet has expanded from about $850 billion to more than $4.4 trillion since the 2008 financial crisis), economic demand and consumer spending remain weak.

Though Americans have paid down much of their household debts (including car loans, credit cards, student loans and home mortgages) from 130% of disposable personal income in 2007 to 103% today, it means that households still have more debt than disposable income. That is holding back spending.

Ultra low interest rates were supposed to be a temporary inducement to get households borrowing again and reverse the housing bust. But six years later, though rates remain at historic lows, mortgage lending remains weak.

The US homeownership rate fell to 64.4 percent in the third quarter, the lowest level since early 1995. First-time buyers have been kept out of the market by strict lending standards and low wages.

Weak and steadily falling inflation, plus weak demand, is raising fears of deflation.

Investopedia explains deflation this way:

"Declining prices, if they persist, generally create a vicious spiral of negatives such as falling profits, closing factories, shrinking employment and incomes, and increasing defaults on loans by companies and individuals."

Japan, most famously, has been battling deflation for two decades. The Bank of Japan had a zero interest rate policy in affect for many years, which didn't cure the problem. Then the BOJ initiated its own massive money-printing scheme last year, which has also failed.

Falling prices have hurt consumption in Japan, as consumers wait for prices to keep dropping before spending. If consumers refrain from spending long enough, it hurts corporate profits. That limits hiring and can even lead to layoffs. This vicious circle has led Japan back into recession.

There are concerns that the euro zone could be plagued by deflation in 2015. As it stands, Sweden and Spain are already grappling with its menace.

Now, some economists and analysts are concerned about the possibility of deflation arising in the US. It may not be that far-fetched, as the specter of deflation is growing globally.

Commodities — such as oil, gold and copper — have experienced serious declines this year.

The US economy has remained one of the lone bright spots on the global stage in 2014, but in a highly interconnected global economy, that could change quickly in 2015.

A lack of economic demand is a pernicious problem, which leads to a lack of consumption, fewer jobs, and a lower GDP.

Since consumer spending accounts for more than two-thirds of US economic activity (GDP), it's no surprise that this has been the weakest recovery since the Great Depression.

In fact, this is the first economic “recovery” in which median family income continues to drop. That is holding back consumer spending, which, in turn, is holding back economic growth.

Though the Great Recession is officially over, Americans are still 40% poorer today than they were in 2007, the year before the global financial crisis.

The net worth of American families — the difference between the values of their assets, including homes and investments, and liabilities — fell to $81,400 in 2013, a long way off from the $135,700 in 2007, according to a new report released this month by the nonprofit think-tank Pew Research Center in Washington, DC.

Over just the past year, incomes have barely budged. In November 2014, the average weekly wage was $853 versus $833 for November 2013, according to the Bureau of Labor Statistics.

Falling oil prices should allow Americans to spend more of their incomes on other things, which should buoy the economy. But if broader deflation sets in, lower oil prices won't matter.

While much of the decline in oil prices has been attributed to higher supplies, demand has also fallen around the world. The International Energy Agency has cut its estimates for demand for crude five times in the past six months, The Wall Street Journal reports.

Oil is the lubricant of the global economy and a lower demand indicates a slowing economy. Demand has fallen even in the US, where motorists are driving more fuel efficient vehicles and using less gas.

However, those trends could change in the face of tumbling oil and gas prices. Americans could revert to buying bigger, less efficient vehicles.

The diminishing demand for oil, and the robust drop in prices that has ensued, is sparking deflation concerns around the world.

The bond market has taken notice, as reported by Bloomberg:

"The difference in yields between Treasury two-year notes and comparable maturity inflation-indexed securities turned negative yesterday for the first time since the aftermath of the global financial crisis in 2009. The measure, known as the break-even rate, is generally seen as reflecting investors’ expectations for inflation over the life of the securities."

In other words, investors have abandoned all fears of inflation in the short term.

To be clear, the US is not in deflation at present, and it may not face it in 2015. But there are plenty of reasons to be concerned. Inflation, already below the Fed's target, is steadily declining.

The consumer price index fell by a seasonally adjusted 0.3% in November to mark the largest drop since December 2008, during the depths of the Great Recession.

The decline was driven by the sharp slide in gasoline prices. Energy costs fell for the fifth straight month, said the Labor Department, led by a 6.6% decline in the price of gasoline.

Here's the thing that really jumps out at me: If the Federal Reserve can add $4.4 trillion to the money supply in just six years — while dropping interest rates to near zero — without sparking rampant price inflation, some very powerful deflationary forces are surely working against it.

In other words, the US economy remains quite fragile as we head into 2015.

Monday, December 08, 2014

National Debt Surpasses $18 Trillion

A pretty major event took place recently, yet most people barely noticed.

The national debt eclipsed $18 trillion. That is a number so large that it is almost incomprehensible. For the record, a trillion has 12 zeros. A trillion is one thousand billion. So, 18 trillion is 18,000 times a billion.

Chew on that for a moment.

The U.S. economy totaled $16.77 trillion last year, according to the International Monetary Fund (IMF). If our economy grew by 2.8% in 2014, as the IMF projects, it will reach $17.24 trillion this year.

Obviously, that number is smaller than our national debt. But, quite critically, it also means that economic growth for the year was smaller than the budget deficit for the fiscal year.

According to the Congressional Budget Office (CBO), the federal budget deficit was $506 billion for fiscal 2014, which ended on September 30.

While that’s about a third the size of the deficit in 2009, during the depths of the Great Recession, it also means the deficit for a single year still surpassed half a trillion dollars.

The only good news in this story (and there are those who are surely spinning it as good news), is that the size of our annual deficits has shrunk in recent years. But the deficit is still massive by any reasonable measure.

The deficit has fallen from more than 10% of GDP in fiscal 2009 to only 2.9% of GDP in fiscal 2014. That puts the U.S. below the 3% limit at which the European Union requires member countries to take corrective action. The CBO expects us to remain near that level for the next five years.

While this is all very good news, it does not diminish the fact that the U.S. government is still spending more money than it collects in taxes, and therefore continues to add to the underlying national debt.

To be clear, the deficit represents excess spending above tax collections in any given fiscal year, while the debt is the sum total of decades of this excess.

The federal debt held by the public should reach 74% of GDP this year — the highest percentage since 1950. That was five years after WWII, so there was a good reason for all that debt back then.

The debt held by the public must be collected with taxes to pay off our creditors (i.e., Treasury bond holders). The rest of the public debt is money the government owes to its citizens for things such as Social Security and Medicare, plus military and civil service pensions, etc.

Since the government has already collected and spent these monies, it now needs to obtain additional funds to repay these debts. The government will either collect more taxes or make cuts to other budget items to repay the debts owed to the American people.

Social Security and Medicare are technically considered liabilities, not debts. Though the government has spent all the money in the Social Security Trust Fund on other budget items — and owes that money back to the people from which it was collected — it is still not considered "debt."

Including the national debt, the government's (meaning the taxpayer's) unfunded liabilities totaled $71 trillion at the end of fiscal 2013 (Sept. 30, 2013). It has since gone higher, though no official figure is currently available.

Ultimately, this debt belongs to us — the public — as well. We owe all of it, on behalf of our government. There is no differentiating our government's debts and liabilities. The taxpayers will fund it all in the end.

In order to stop adding to the debt, the government must first end it deficits — not merely lessen them.

In 2011, Congress and President Obama negotiated $1 trillion in cuts to discretionary domestic and defense spending over nearly a decade. Yet, this “sequestration” process still left us with annual deficits.

The government is currently being spared much higher debt payments because interest rates are historically low. But when rates are this low, they have only one way to go — up.

The 10-year Treasury currently yields 2.31%. Debt-service costs will be crippling when yields revert back to long term norms. For example, over the 20-year period from 1994 to 2013, the yield on the 10-year Treasury averaged 4.60%.

That's twice the current rate.

Since we're continually adding to the debt, it will make that eventual reversion all the more painful.

The U.S. public debt crossed the $1 trillion mark for the first time October 22, 1981. It took 205 years to get there. We've now added another trillion in roughly one year. And that's being heralded by some as progress.

This is very troubling, and the consequences will be quite harsh at some point in the future. It doesn't matter whether it's sooner or later. Some extraordinarily large debts are coming due, and they will impact all of us. They will impact our very way of life.

Money spent servicing our debts is money not spent on health, education, or our crumbling infrastructure.

In other words, the national debt is already robbing from our nation, and it will only get worse — much worse.

But here's the rub: Our entire monetary system is based on debt. In the absence of continually growing debts, the system will collapse. Yet, under the burden of all this debt, the system will eventually collapse anyway.

That makes for one hell of a predicament.

The only solution is to change the very essence of our debt-based, fiat monetary system.

Sunday, November 16, 2014

Falling Oil Prices Reflect a Slowing Global Economy, Yet Benefit US Consumers

Even if you don't watch the news and haven't heard about falling oil prices, chances are you've seen the results as the gas pump.

After months of tumbling prices, the cost of a barrel of US oil has fallen to roughly $75.

US crude prices have dropped 30% from their June peak of $108, putting oil in bear market territory. In fact, oil prices have fallen to a three-year low.

Brent oil, the international benchmark, has also fallen below $80, reaching a four-year low.

This tumble is good for consumers. Every one-cent drop in the price of gasoline amounts to a $1 billion boost to US household incomes, according to the automobile group AAA.

According to AAA, the national average price of gas has dropped for 46 days in a row (a cumulative decline of 42 cents), which is the longest consecutive decline since 2008. Last week, the national average for regular unleaded gasoline was $2.93 per gallon, which was the lowest price since Dec. 4, 2010.

So, what's behind this plunge in oil prices? Well, it's a combination of things.

First, the global economy is slowing, and oil is the lifeblood of economic growth. If there's less growth, there's less demand for oil. The European, Chinese and Japanese economies are all slumping, and they represent much of the global demand for oil.

Secondly, oil is priced in dollars, and the dollar is strengthening against other currencies. This is increasing the purchasing power of the dollar, meaning we can buy more oil with each dollar. In other words, as the dollar strengthens, oil becomes relatively cheaper.

This is great for the US, but not for other nations, which must first convert their currencies to dollars before buying oil. It now requires more of each of those currencies to obtain the dollars needed to buy oil.

Lastly, even as demand has fallen, the supply of oil has continued to grow. US oil production, for example, is at its highest level since 1970. Meanwhile, domestic demand is down because Americans are driving less and using more fuel-efficient cars.

This combination of slumping demand, a stronger dollar, and ample supplies have led to a big drop in oil prices.

Fracking for shale oil in the US has altered global oil markets — at least for the time being. The process has allowed the US to overtake Saudi Arabia as the world's biggest oil producer. The US hasn't seen this level of production in more than four decades.

However, the US is still the world’s largest oil consumer, and imported an average of 7.5 million barrels of crude per day in April, according to the Energy Information Agency. This undermines any reasonable notion of the US becoming an oil exporter.

Yet, even as the price of oil is tumbling, the cost of finding it is not. Fracking, in particular, is a very expensive process.

Shale oil is expensive to extract by historical standards, and is only viable at high-enough prices. Shale oil costs $50 to $100 a barrel to produce, compared with $10 to $25 a barrel for conventional supplies from the Middle East and North Africa.

At the current price of $75 per barrel, many producers will not be able to survive. The cost to extract shale, as well as Canadian tar sands, may be exceeding the returns from those extractions (more on tar sands in a moment).

Many shale oil producers do not have free cash flows, and are in fact in the negative. In other words, their capital expenditures result in negative operating earnings. In essence, their cost of operations exceeds their earnings, thwarting profitability.

These companies have taken advantage of low interest rates and assumed enormous sums of debt to finance their huge operating expenses. This huge drop in oil prices will leave them quite vulnerable, and many will likely collapse and go out of business. Many of them will find it difficult, or impossible, to return to the debt markets in this environment, as the capital markets decide not to throw good money after bad.

In the 1930s, it cost about $400,000 in today's dollars to drill an oil well in Texas, from which crude gushed plentifully. Such a well produced thousands of barrels a day for decades.

However, it now costs $6 million to $12 million to drill a well in the Bakken shale oil field in North Dakota. This requires complex fracking techniques and produces roughly 100 barrels (sometimes more, sometimes less) per day for just a couple of years. Then the well runs dry. This is why so many wells need to be continually drilled.

It's not just shale oil that's being affected by tumbling oil prices. The extraction and production costs of Canadian tar sands, or oil sands, are perhaps becoming too expensive to sustain at today's prices.

The Canadian Energy Research Institute estimates that oil-sands projects need a price of $85 a barrel to be profitable in the current cheapest method, and new standalone mines will require $105 a barrel to make a reasonable return.

Those prices don't seem likely for quite some time.

A recent report from OPEC cut the group’s forecast for global demand and prices over the next five years, which helped to drive down prices even further.

Goldman Sachs’ analysts have slashed their target price for US crude oil for the better part of 2015 from $90 to $75.

Sensing an opportunity to crush its competition, OPEC has stood pat and not altered supplies. The cartel seems satisfied with current low oil prices (at least for now) since they will likely kill the competition coming from North American shale oil and tar sands producers.

Acting unilaterally, Saudi Arabia cut oil prices for the US this month, while increasing prices to other large buyers, such as China. The move helped to push US oil prices to three year lows.

The Saudis seem to be aggressively moving against US frackers in an attempt to drive them out of business. With oil prices under $80, extracting shale oil may no longer be viable for many producers.

Typically, when demand for any product slumps, producers cut supply to stabilize prices. That isn't happening in the oil markets, despite projections that the demand for crude will remain weak for the next few years.

In its annual world outlook released this month, OPEC predicted less demand for its oil through 2017.

The cartel expects demand for its crude oil to fall from the current 30 million barrels a day to 28.2 million barrels a day by the end of 2017, as output from producers outside the cartel (such as the US, Canada, Latin American countries, and Russia) continues to rise.

Demand for OPEC crude will pick up again in 2018, but a year later it will still be lower than demand was in 2013, OPEC said.

OPEC crude presently meets around a third of global oil consumption needs. Perhaps that share will shrink if production increases in other nations, but, given the projections for global demand, that is no certainty.

If Saudi Arabia and OPEC are successful in crushing North American shale and tar sands producers, they will secure more market share and could then tighten supplies, thereby raising prices.

Higher prices are also needed for traditional US crude oil producers to maintain their investments in exploration, and for their highly expensive offshore drilling projects.

While lower oil prices are a boon to consumers, acting as a sort of tax cut, they also reflect a weakened global economy, which is not positive.

Given the growing world population and expanding global middle class, demand for oil will continue to rise, albeit more slowly than in the past. Oil prices will remain volatile, but even at $75 per barrel, they are still quite high by historical standards.

Oil was $9.95 a barrel in April 1986, and the annual average stayed below $30 a barrel until 2000. Rising global demand has since driven up prices considerably. Despite the recent price drop, oil is still 250% higher today than it was at the start of the millennium.

So, while $75 oil may seem like a bargain, a little historical perspective indicates otherwise. Nonetheless, American drivers are surely quite thankful for the current price drop every time they pull into a gas station.

Moreover, lower oil prices should ultimately reduce the cost of every transported product in America, and that's a whole lot of stuff.

Saturday, October 18, 2014

Where's the Inflation? (It's in the Asset Markets)

“The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements, or a disease that comes like the plague. Inflation is a policy.” - Ludwig von Mises, “Economic Policy”

The Federal Reserve has a publicly-stated goal of achieving a 2 percent inflation rate. However, the US is running an annual inflation rate of just 1.7 percent through the 12 months ended in August 2014.

Many economists and analysts expected soaring inflation when the Fed initiated its quantitative easing (QE) program. Creating all that excess money in the absence of an equal expansion of goods and services in the economy was supposed to trigger price inflation.

But continued weakness in the US economy has thwarted any prospects of the runaway inflation that was expected in coincidence with the nearly $4 trillion dollars created out of thin air by the Federal Reserve (the Fed’s balance sheet has expanded from about $850 billion to more than $4.4 trillion since the 2008 financial crisis).

To be sure, there has been inflation -- it just hasn’t been in the consumer price index (CPI). Instead it's been manifested in assets. All that money had to go somewhere, and it has flowed into -- and distorted -- the markets.

Look at the stunning rise of the stock markets, not to mention the housing market, since the lows of 2009. Each of the Fed’s three QE programs have caused the stock market to surge as more liquidity was pumped into the financial system.

Before the recent turmoil, the stock market had tripled in value since the bull run started in early-2009. That is not reflective of the weak US economy, diminished household incomes, or reduced consumer spending.

During the throes of the financial crisis and subsequent Great Recession, the stock markets reached stomach-churning lows.

In March of 2009, the Dow fell to a 12-year low of 6,547; the S&P slumped to a 13-year low 676; and the NASDAQ dropped to a seven-year low of 1,268.

Yet, even after this week's market upheaval, the Dow now stands at 16,380; the S&P at 1,887; and the NASDAQ at 4,258.

This surging bubble in U.S. stock markets was created by the Federal Reserve through its record low interest rates.

So, in reality there's been plenty of inflation — it's all been in asset prices and, in many markets, housing. Home prices have once again reached 2005 levels.

Ultra-low interest rates have discouraged saving and instead encouraged massive speculation in volatile asset markets.

As history has shown repeatedly, this never ends well.

Looking for the highest possible returns, investors have forgotten the recent crashes of 2000 & 2008. Shunning savings accounts, CDs, money market accounts and Treasuries, investors have instead piled into stocks and high-yeild bonds, which are historically volatile.

Since the start of 2009, funds invested in junk bonds have returned an average of 14 percent each year. That's been very alluring.

For comparison, the yield on the benchmark 10-year Treasury note recently fell below 2 percent for the first time in more than a year. Moreover, the yield on the 10-year Treasury note hasn't consistently traded above 4 percent since shortly before the financial crisis of 2008.

U.S. Treasuries are viewed as the safest of all investments. In other words, investors are spurning safety in favor of high-risk yields. The alarm bells are ringing!

Less than ten years after the dot-com bubble burst, there was a housing bubble that inevitably burst. Money that drained out of stock markets during the dot-com panic instead flowed into housing markets and the now infamous mortgage-backed securities.

One form of massive speculation was simply traded for another.

Yet, we now find ourselves in the midst of concurrent equity and bond bubbles throughout the world's financial markets.

Most incredibly, we are now faced with our third asset bubble in less than 15 years. Will investors never learn? This is like the film Groundhog Day. Yes, history repeats, but three times in 15 years? This is the height of recklessness and delusion.

Former Fed Chaairman Alan Greenspan famously referred to it as "irrational exuberance."

Somehow, it's returned, and it seems to be a sign of the times.

So, the next time you hear someone (particularly some talking head news pundit) say there's little or no inflation, ask yourself how they can so blindly miss the absolutely massive level of inflation in the asset markets.