Wednesday, April 27, 2011

Surge of Unsettling News Foreshadows Crisis Ahead

If you've been paying attention lately, you've surely noticed the steady flow of rather stunning developments portending great disruptions and dislocations for the US and global economies.

It's difficult to know where to begin.

Robert Zoellick, the president of the World Bank, has warned that the world is "one shock away from a full-blown crisis".

It doesn't require a whole lot of imagination to figure what any one of those shocks might be: high unemployment, rising global food prices, rising global oil prices, an unstable global banking system and/or unsustainable sovereign debts.

While much of the focus has been on the European sovereign debt crisis, the US has its own developing debt crisis which is finally getting the world's attention.

The IMF says the US budget deficit in 2011 is expected to hit 10.75 percent of national output, the highest among the developed nations.

Consequently, last week Standard and Poor's cut its ratings outlook on the US to negative from stable. It was a stunning development since it is the first time S&P has ever lowered its outlook for the US from "stable".

The rating agency effectively gave Washington a two-year deadline to enact meaningful change or face the consequences; an actual downgrade from its long term, top-notch AAA rating. As of now, the US remains one of 19 sovereign governments rated AAA by S&P, out of 127 rated countries.

A downgrade would push up interest rates on Treasurys, raising the cost of borrowing for a government that already can't afford its bills. It would also push up rates for businesses and consumers, creating a further drag on an already sluggish economy.

The US debt is just shy of the $14.294 trillion federally mandated cap. Congress is essentially damned whether it does, or does not, elect to raise that debt ceiling. The US has the ugly choice of sliding further into perilous, intractable debt, or defaulting and living through the ensuing chaos.

The writing has been on the wall for quite some time and the consequences of are already occurring.

Bill Gross, a founder of Pacific Investment Management Co., manager of the world's biggest bond fund, dumped US government-related holdings in February and began shorting them in March.

“There is really no way out of this [debt] trap and this conundrum at this point,” says Gross.

That seems to be the growing consensus.

Last week, the People's Bank of China announced that the country's excessive stockpile of US dollar reserves has to be urgently diversified. China's foreign exchange reserves included more than 3 trillion in US dollars at the end of March.

Subsequently, the Xinhua news agency reported the following:

Xia Bin, a member of the monetary policy committee of the central bank, said on Tuesday that 1 trillion U.S. dollars would be sufficient. He added that China should invest its foreign exchange reserves more strategically, using them to acquire resources and technology needed for the real economy.

This indicates that China plans to "diversify" (read: liquidate) itself of $1 trillion in US holdings. Of course, this will occur over time. But it is bad news for the US nonetheless.

It is the exact opposite of what the US is seeking. It needs buyers, not sellers.

Then, at a time when the US didn't need any more bad news, the IMF just dropped a major bombshell: It forecast that China’s economy will surpass that of America in real terms in 2016 — just five years from now.

This is a positively stunning development. For most of the past century, China was an impoverished Third World nation. Then last year it vaulted past Japan to become the world's second biggest economy. In the process, it also became the world's biggest car market.

And now it is poised to surpass the US. When such an event unfolds, the US will lose its vaunted status as the world's reserve currency, and all of the privileges that come with that.

The key requisite for any economy to grow is energy — specifically oil — which is becoming increasingly difficult to recover. As a finite resource, the supply of oil is limited. However, the demand for oil is relentless and perhaps infinite.

However, the International Energy Agency (IEA) recently warned that, "The age of cheap energy is over."

Here's the kicker:

IEA analysts said the world needs another 50 million barrels of oil from new fields by 2035 in order to meet expected demand. Crude oil production from existing fields, meanwhile, is expected to decline from the 68-million-barrel-per-day mark in 2009 to just 16 million bpd by 2035.

Let's break this down:

Global oil production is expected to decline by nearly 77%. Yet — within just 24 years — the world must somehow find about 74% more oil than it is currently consuming, even though 77% of current supplies are expected to be exhausted.

Got that? Does that make any sense to you at all? Me neither. That's because it simply makes no sense whatsoever.

If you're feeling unnerved by this litany of sobering, downright scary news, you should be. It's ugly. It's freaky. And it's real.

What you do with all of this is up to you. But, by all means, you should do something well-planned because the unsustainable clearly cannot, and will not, continue.

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