In the Beginning, There Was the Bubble
London, England
Tuesday, November 18, 2008
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*** So much to correct, so little time...companies that make ‘stuff’ are facing a world of hurt...
*** First the bubble pops...the demand collapses – and takes stocks down with it. But never fear, it’s all part of Nature’s plan...
*** Seeing the world through Dr. Richebächer’s eyes – or at least, his chair...the only cure for bubbles...I.O.U.S.A. on the short list for the Academy Awards...and more!
So many things to correct...so little time.
Citigroup said it was letting 50,000 people go. How much will those people spend this Christmas?
USA Today says, “Americans are digging to save money.” They’re digging into their budgets...exhuming every expense they can. And they’re digging into their attics too – selling “stuff” they no longer need.
Most people say they are cutting back on restaurants, travel, and luxuries, the paper reports. Instead, they’re staying at home and renting movies for entertainment.
Here in London, we went out to a restaurant last night and found it almost empty. “Where are the customers?” we asked the waiter, thinking we were too early. “Oh...it’s this financial mess...nobody wants to come out to a restaurant any more.”
eBay says the average family has about $3,200 worth of stuff it doesn’t need. People are getting it out...cleaning it up...and shipping it off. In return, they get what they need – cash.
Readers with a weakness for economics will see in both of these examples a dismal herald. They announce a collapse of consumer demand. Not only are people spending less...but even when they do shop, they’re buying more second hand stuff...stuff that comes from closets and attics – not from China.
So what? Well...if they’re not buying new stuff there’s no need to make new stuff...or sell new stuff...
“Fewer spots on the sales floor,” this Christmas season, announced one headline. Fewer spots on the assembly line too. And fewer paying spots anywhere.
And if nobody wants to buy new stuff, the companies that make and sell new stuff are going to be in a world of hurt. Which is why the stock market is collapsing. The Dow fell another 223 points yesterday.
Oil fell yesterday too – down below $55. If you’re not making stuff, you don’t need so much energy to make it and ship it... And if you’re not buying stuff, you don’t need so much gasoline to get to the mall.
Oh! Bama! Where is thy bounce! We’re getting tired of waiting.
But hold on...settle down...relax. Breathe deeply. Take it easy.
After demand collapses, supply collapses. Yes, dear reader, it’s all part of Nature’s plan. In the beginning, there is The Bubble. Then, the bubble pops. Then, people look around and take fright. They realize they’ve got to stop spending. So, demand collapses. Then, stocks collapse too. And asset prices fall too – especially for speculative assets. As orders and asset prices tumble...merchants and manufacturers cut back too. Jobs are lost. And then, with less income...demand collapses some more.
But then, eventually, the bubble is completely flattened. Weak companies have gone out of business. Good companies are holding on, but producing less. Many retail shops have closed. Many malls have gone out of business. Supplies of goods and services have fallen as far as they’re going to fall. Then, with supplies tight, prices begin to rise again.
The whole process takes time. There are millions of mistakes in need of correction. Each one has to be marked down, written off, worked out, and forgotten. We still have to see the show trials. And the perp walks. And the kvetching...the complaining...the whining...the wimpering. The bailouts and the payoffs... The bottles of whiskey and the loaded revolvers. It’s all still ahead!
Dow 5,000...
10% - 15% unemployment...
Another 20% off house prices...
There’s a lot of ruin left to go...
*** Sunday afternoon, we sat down in the large leather chair in front of the fire. Its arms were shiny and worn...much lighter in color than the rest of the brown chair.
Immediately, we felt wiser. Then, a blindingly bright flash of insight seem to come out of nowhere. Suddenly, we saw into the dark heart of the beast itself – and peered into its soul. And then, we watched in horror. In our mind’s eye we saw images of recession...depression...despair...desperation...and finally upheaval...in which the whole system...the world’s dollar-based money system...came crashing down.
Yes, dear reader. We are a proud heir to Dr. Kurt Richebächer. Not of his weighty intellectual career in economics. We are heir to his chair. After he died, his estate sold us his chair. We keep the Dr. Kurt Richebächer chair in our library. Sitting in it this weekend, we thought we saw the whole financial crisis more clearly.
“The only cure for a bubble is to prevent it from developing.” said Kurt Richebächer.
In other words, you can’t cure a bubble by cutting interest rates, easing bank lending requirements, running bigger government deficits, sending out ‘rebate’ checks, buying up Wall Street’s stupid mistakes, or bailing out sinking businesses. You can’t cure a bubble by reflating it. You can’t cure a bubble at all. You have to let it pop...and then go about your business. Get it over with quickly; that’s the best you can do.
Think that will happen? Where have you been, dear reader? Out of Blackberry range?
No, the feds are at work – with their patches, their rescues, their bamboozles and their swindles.
In our brief moment of clarity, induced by the Richebächer chair, we saw what was coming – the biggest financial bailout of history. It will be like WWII, without Betty Grable...like the New Deal without the wheelchair – and like nothing we’ve ever seen.
Saving America from free-market capitalism will become the Great National Project of the Obama years. Deficits will top $1 trillion...maybe $2 trillion. Brain dead businesses will be kept alive. Whole industries that should be allowed to go broke will be protected. Towns, states, and colleges that should go bust will be propped up. There will also be a huge building boom – in infrastructure. Bridges, trains, highways...
... it may be time to buy cement companies!
The bailouts are just money down the drain. As for the bridges, who knows whether they are worth the money? But this massive program will achieve its real purpose – distracting and diverting Americans from their loss of wealth.
*** If Olympic medals were given for consumer spending, Americans would have won the gold, silver and bronze every year for the last 20. But now, Americans may become champion savers. Savings could rise to maybe 10% of GDP.
What will happen to all this money? It will be lent to the government. (About which...we will have more to say tomorrow.)
So do you see, dear reader, how the new financial system will work? Instead of squandering their money – as Americans have done for the last 20 years – now, the government will squander it for them.
*** Here comes the Era of Conspicuous Thrift. Yes, you heard it here first.
“No more fancy pants,” is a headline at the New York Times . The gist of the accompanying article is that even expensive restaurants are now trying to look cheap. People who still have money to spend don’t want to spend it...and when they do spend it, they don’t want to look like they are spending it. So restaurants are putting on de po’ bo’...that is, they’re acting poor. Gone are the sumptuous drapes...gone are the plush carpets and marble tables...gone are the fancy pant waiters.
“Luxury is a dirty word,” said one of the designers.
Don’t get us wrong. People always look for ways to feel superior to their fellows. In the bubble years, they did so by spending wildly...trying to outdo each other with the extravagance of their purchases and the sans soucis of their budgeting. Young Wall Street pros...or rap musicians...would go out to a fancy restaurant and order a big bottle of Cristal – just to show off.
But styles change. Now, people are showing off by NOT spending money. Sound unbelievable? Well, maybe. But our guess is that people are going to find more subtle...and less expensive...ways to wink at each other. Heavy spending is going the way of heavy drinking. It will be seen as vulgar.
*** And today, we add to our short list of the world’s greatest inventions. So far, we have only three inventions that have been unequivocally great boons to mankind – crispy duck (as it is prepared here in London’s China Town)...the beret...and the semi-colon. All three are such marvelous innovations that they seem to be almost divinely inspired.
Today, we add one more – the bicycle. Despite the skinned knees and broken necks, the bicycle has done more for mankind than any other transportation device. In fact, we feel we must apologize to the bicycle for not adding it to our list sooner. Millions and millions of people depend on the bicycle to get around. Millions more may soon take it up...
Until tomorrow,
Bill Bonner
The Daily Reckoning
P.S. Speaking of short lists...we just got the news that I.O.U.S.A. made it onto the short list for the 2009 Academy Awards. That means, among all 94 documentaries that qualify for an Oscar nod in 2008, the Academy has whittled down the 15 they’re willing to consider for the final nominations on January 22nd. Five films will be chosen on that date. Keep your fingers crossed...
The Daily Reckoning PRESENTS: The price of crude oil has been falling lower and lower in recent weeks...and while that may be good when you are filling up your gas tank, the bigger picture is much more serious for the U.S. economy. Byron King explores...
UNSUSTAINABLE ENERGY TRENDS
by Byron King
I’ve been getting a lot of calls and e-mails from people asking about the falling prices for oil in recent weeks. The immediate explanation is that world economic activity is decelerating. Demand is falling. OPEC announced cuts in output. But the markets still believe that economic decline will trump the ability of OPEC to prop up the price of oil. Enjoy it while it lasts.
Just over the horizon, things are about to become dicey. This week, the International Energy Agency (IEA) will release a new report on the future of world energy. In its World Energy Outlook, the IEA will state categorically that “Current global trends in energy supply and consumption are patently unsustainable.”
There’s not much wiggle room in that statement. According to the IEA, despite the recent fall in oil prices, the medium- and long-term outlooks for energy supply are grim. Conventional oil output is destined to decline. Demand will still grow, however, especially in the developing world. And the twain shall only meet by prices rising to clear the market. “It is,” as our Arab friends like to say, “written.”
The IEA performed a comprehensive study of 800 of the world’s largest oil fields. And it concluded that depletion in conventional oil fields is occurring at a rate in excess of 9% per year. (That’s an average. We see depletion rates in excess of 15% in Mexico’s Cantarell field, for example.) This means that absent large amounts of new drilling, new investment in enhanced recovery and new discoveries, the current worldwide oil output will decline by over 9% per year. And if it keeps going along this trend (there’s no reason why it won’t), the base of world oil output could conceivably dry up within seven-10 years.
Don’t get me wrong. The world won’t run out of oil in seven-10 years. That’s not how it works. It’s just that volumes of conventional oil are declining. The takeaway point is that the energy markets will tighten up, like a hangman’s noose around the collective neck of the oil-consuming world. We might not quite realize it, but when it comes to oil, we are all walking that long green mile.
The investment angle for OI is that the companies that own oil reserves in the ground, and the oil service companies that extract oil and natural gas, should profit in the future. Yes, the portfolio is down. It has been a hard hit to everyone (me too) who bought into the market up until midsummer. We’ve all lived through a midsummer’s nightmare on this one.
So how long will we have to wait for this “future” to show up? Well, how long will the current worldwide recession last? I don’t know. But I do know that many energy companies in the OI portfolio are at long-term lows in share price. If you can afford to be patient with your funds, these firms should eventually stage a comeback as oil prices rise again. As I said above, “It is written.”
Says who, you ask? Written by whom? Well, how about the IEA? According to the IEA, even with massive levels of investment in the oil patch, the best estimate is that the global oil industry can reduce the rate of depletion to perhaps the 6% range. So the world energy industry will have to run faster just to keep from falling too far behind the demand curves.
Again, you need to keep in mind that current energy prices are just too low to support the level of energy investment that the world needs going forward. (Meanwhile, the U.S. government is spending trillions of dollars forward just to bail out the banks and bankers, not one of whom runs pump jacks.)
The IEA estimates that the oil industry will have to invest over $350 billion per year to counter the steep rates of decline in output. And even that will not be sufficient to maintain levels of output for traditional forms of crude oil. Thus, much of the future investment will have to go toward extracting other kinds of hydrocarbon substances.
What do I mean by “other kinds” of hydrocarbon substances? Fortunately, there are many different kinds of hydrocarbon molecules out there. The total worldwide carbon base actually adds up to a very big number, and that is NOT including the carbon that is part of the current living biology of the planet. For now I’m just discussing the fossilized carbon like oil, natural gas, bitumen in tar sands, oil shale and coal.
The big problem for the nonoil forms of carbon is affordability. That is, are people willing to pay? It takes a lot of steel and technology to transform some kinds of carbon into something we want to use. We see that, for example, in the Canadian tar sands projects. Lots of steel, concrete, labor, machinery, water and energy input – all to extract this thick, gunky crud that has to be upgraded to something that looks like diesel fuel. And the whole thing emits lots of carbon dioxide (CO2) in the process, as well.
The other big problem is whether or not there is the political will to “do carbon.” Will the governments of the world allow – let alone promote – industry to invest in the industrial base that will be required to transform the varying kinds of carbon into something that the world can use? Because the other side of this coin is ever-increasing CO2 emissions, global warming and climate change. The more carbon that gets burned, the more CO2 that goes up the flue and into the atmosphere. In essence, within about two centuries, mankind is undoing the geological work of tens of millions of years.
This is not a “global warming” article. But most nations of the developed world have governments that are more and buying into the global warming thesis more. The political gun sights are on carbon. But if we collectively decarbonize the economy, the energy supply will dry up and we’ll wish for the “good old days” when we had to worry only about Wall Street crashing. And besides, try telling the developing world not to develop. People have fought wars over lesser issues.
Do you want some numbers on hydrocarbon resources? Here are estimates of the total hydrocarbon resources in the world and the relative costs to convert them. This is my summary, based on several different government and academic compilations:
These are big numbers, right? And they can supply a lot of energy over a long time, but only if the world collectively decides to utilize the resources. If not? Well, you had better own some gold too.
The stark assessment from the IEA described above comes just as much of the world’s banking and finance system lies in ruins. Many forms of lending have dried up, and much of the former system of world commerce is just not functioning.
So the politicians, bankers and investors of the world – including us – have their work cut out.
Until we meet again...
Byron W. King
for The Daily Reckoning
P.S. I’ll keep you updated on these issues, and on other news about the OI portfolio, in future articles. In the meantime, check out my latest report...
Editor’s Note: Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. Byron is also co-editor of Outstanding Investments , and editor of Energy & Scarcity Investor .
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