| Today's Daily Reckoning: |
| Depression II: The Horror --------------------- *** Oh the horror, the horror...one person’s cost-cutting is another’s income... *** Geithner’s new program is bold in scale, vague in detail...are we going to see a run on all forms of U.S. paper sometime in the near future? *** Stay in investments you’ll want to hang on to over the next ten years (and that, of course, includes gold)...the greatest central banker of all time is going, going, Gono!...and more! DEPRESSION II ...The Horror...coming soon to theatres near you! “It’s gone deep. It’s gotten worse,” said the president. We’ve seen so many shock and horror movies over the years. We recognize the dialog. But this is no Hollywood thriller. This is real life. It is like a Netscape News story: “WASHINGTON (AP) – On a single day filled with staggering sums, the Obama administration, Federal Reserve and Senate attacked the deepening economic crisis Tuesday with actions that could throw as much as $3 trillion more in government and private funds into the fight against frozen credit markets and rising joblessness. “...Wall Street investors sent stocks plunging, objecting that new rescue details from the government were too sparse. The Dow Jones industrials dropped 382 points. “...shortly after Senate passage of an $838 billion emergency economic stimulus bill cleared the way for talks with the House... Separately, Treasury Secretary Timothy Geithner outlined plans for spending much of the $350 billion in financial bailout money recently cleared by Congress, and the Federal Reserve announced it would commit up to $1 trillion to make loans more widely available to consumers.” GM said it was cutting 10,000 jobs...and reducing executives’ pay. Fannie and Freddie are likely to need $200 billion more to stay in business, say regulators. And Tim Geithner’s new bank bailout program may cost $2 trillion. Meanwhile, practically every business and every family in America is looking for ways to cut costs. Unfortunately, one person’s cost-cutting is another person’s income. So, incomes are going down too. Then, people have to cut costs even more. “Let’s not mince words...this looks an awful lot like the beginning of the second Great Depression,” says Nobel-prize winning economist Paul Krugman. Paul Krugman is wrong about a great many things; but he’s right about this. This is not a recession. It’s a depression. What’s the difference? Some economists say a depression takes 10% off the GDP. Some say it is a recession that persists for more than a year. Most have no clue. The real difference is this: a recession is a pause in an otherwise healthy economy. A depression, on the other hand, is when the economy drops dead. There’s no point in putting on the wires or strapping on the inhaler, there has been too much brain damage already. The best you could hope to do is to keep the body alive. But it would be a vegetable. Better to let it go...quickly. But we’re not giving advice to the Obama team. So far, they haven’t asked. Instead, they’ve got the defibrillators in their hands. “TARP II” is how the International Herald Tribune defines Geithner’s new program. Bold in scale. Vague in detail. Geithner says he hopes to bring in private money to fund the bailout. How? We can’t imagine. It’s one thing for government to try to revive a corpse with public (mostly imaginary) money. It’s quite another for private investors to waste their own time and money. ‘What’s in it for me?’ they’re likely to answer. And if there were anything in it for them, they’d already be investing in it. It’s not as if there aren’t plenty of opportunities on the Big Board. The financial sector is down 2/3rds to 3/4s from its high. Anyone who thinks there’s money to be made can take his chances. Instead of buying, investors are selling. Just look at what happened to the Dow yesterday. They’re selling because they think there could be a lot more pain and suffering still to come in the banking sector – and in the economy at large. And they’re right. Nouriel Roubini, who has become a celebrity thanks to his Daily Reckoning -style warnings, says the losses will reach $3.6 trillion. We don’t know what the ultimate figure will be, but it is bound to be a big number. This depression is just beginning. So far, we have only had the shock in the financial industry. The real damage will come in the economy...which is only now reacting to the financial losses. Just wait until we get deeper into this film...that’s when the real blood and gore will come. *** “This strategy will not work,” writes Haag Sherman in Barron’ s . “Asset values will continue to decline, regardless of how much money the government borrows, even it if borrows printed money from the Fed. And in that case, the government risks another, more calamitous crisis – a run on US Treasury securities.” Treasuries are going down. Everyone wonders why. Is it because fear is easing...or increasing? On the one hand, spreads between private debt and federal debt are narrowing. This signals an increase in confidence. Investors are less panicky than they were a few weeks ago. Despite Obama’s “catastrophe” talk, they seem to think we’ll muddle through somehow. So, they figure that they can leave the safety of U.S. Treasuries and venture out where they might be able to earn some money. With 10-year yields at only 3%, investors need to look elsewhere to get any income. Now, they appear to be at least poking their heads up above the trench walls. On the other hand, there is probably a growing fear that the feds’ efforts to create ‘positive inflation’ will blow their heads off. The feds are certainly putting a lot of cash and credit into the system. At some point, the crunch will reach its natural end and then all this unnatural cash will produce a stimulating effect. That is, people will be motivated to get rid of it. When that happens – if not before – you’ll see the ‘run on U.S. Treasury securities’ that Sherman mentions, along with a run on other forms of U.S. paper, notably the dollar. For the time being, we are still in the process of ‘price discovery.’ Last year, investors suddenly realized that debtors couldn’t pay their bills...that assets weren’t worth what people paid for them...that collateral was declining in price, making many erstwhile valuable credits worthless...and that revenue streams were not sufficient to maintain whole sectors of industry and commerce. They panicked. That is why these episodes were called “panics” in the 19th century. Nobody knows which assets are good...and which are bad.... or who’s solvent and who’s not...or which businesses can survive and which can’t. Everyone tries to hold onto to what he’s got...trusting no one and nothing...until the market has time to discover proper prices for things in the new post-bubble era. In the 19th century...up to the Panic of 1921...this all happened fairly quickly. And then the economy got up off the ground, dusted itself off, and went on its way. But since the Hoover Administration, the meddlers have intervened. Now, they try to stop the process of price discovery...by keeping zombie businesses alive...by loaning money to brain-damaged industries...and nursing the cadavers and corpses with trillions in taxpayers’ money. Mr. Sherman continues... “...the US government’s balance sheet looks increasingly like that of a Third World country. America’s debt-to-GDP ratio is more than 100%, including the nationalized debt of the two mortgage giants Fannie Mae and Freddie Mac. Budget deficits of $1 trillion are projected for years to come. Worse yet, America’s pension and medical obligations to the baby-boom generation and those that follow are estimated to be considerably more than $50 trillion. “As the US government prints more money to address the crises, investors will realize that are being repaid in a much diminished currency. For the moment, foreign investors have remained relatively firm. But, at some point, foreign and domestic investors will consider the US government’s terrible fiscal position, and they will start dumping debt.” *** That may happen next week. It may happen years from now. Remember, there are always back-eddies and countercurrents – even in the biggest flood. We’ve had a rebound, but it has been very slight. In the ’30s stocks rallied six times – more than 20% each time – before finally beginning a new bull market. And several times, investors thought the crisis was over...only to see it hit again, harder. Our advice: stay in investments that you will not want to sell in the next ten years. What kind of investments are those? They’re investments with income and/or capital that is reliable. Forests. Down-market retailers. Apartment houses with good tenants. Farms, ranches providing foodstuffs at good prices. Basic service industries with decent revenues. Nothing fancy. The world is moving away from fancy. You want to be the low-cost provider of whatever goods or services people need. And of course, stay in gold. Our favorite yellow metal will prove to be one of the safest bets for a store of wealth in this topsy-turvy economy. Yesterday, while Wall Street was sinking on the news of Geithner’s stimulus plan, investors flocked to their safe haven: gold. After dipping a bit on Monday, gold for April delivery jumped $21.40 to settle at $914.20 an ounce. As we’ve pointed out many times, during a period of economic turmoil, investors increasingly turn to gold as a buffer against market volatility. We don’t know about you, but we have the sneaking suspicion that this ‘volatility’ in the markets is here to stay, at least in the foreseeable future. And in turn, gold will have a lot higher to go. Get in while the price is still relatively low...learn how you can pad your portfolio with this precious metal by clicking here . *** Oh no! The greatest central banker of our time...is going...going...Gono! Reports in the Financial Times this morning tell us that Gideon Gono has been replaced in a “power sharing” move by a fellow named Tendai Biti. Poor Mr. Biti has his work cut out for him. His predecessor made a mess of Zimbabwe’s economy. But Mr. Biti looks like just the man to correct it. He apparently has no training in economics. That’s a definite plus. The paper describes him as a “44-year old lawyer [who] was a student leader active on human rights issues.” Good luck. Until tomorrow, Bill Bonner --- Special Offer --- Legally “Hack” Into Wall Street’s Best-Kept Secret Millionaires have their private jet planes...private clubs...why wouldn’t they have their own, exclusive market? Turns out, they do. And membership costs a pretty penny. Lucky for you, we have a way you can legally ‘hack’ into the “Millionaire’s Market”...and reap the benefits of the ultra-rich. |
| Guest Essay: |
| The Daily Reckoning PRESENTS: 2008 started out so well for the world’s energy industry: high oil prices, strong pace of well drilling and booming oil patches. But, as Byron King points out below, what a difference a year makes. Keep reading for a look at what’s in store for the energy industry in 2009... WHAT’S THE RIGHT PRICE FOR OIL? Last year – 2008 – started out so well for the world’s energy industry. The price of oil was in the $90s and low $100s per barrel, not exorbitant. That is, the price of oil was high enough that people were beginning to change their usage habits, but the price wasn’t bad enough to break the banks (so to speak). The worldwide pace of well drilling was strong, but not unsustainable with the existing fleets of onshore and offshore rigs. Meanwhile, across the world, the oil patches were booming. What a difference a year makes. By about March last year, the price of oil began to spike upward. Eventually, in July 2008, it reached $147 per barrel. And then the price broke. Oil prices slid down into the $100s by Labor Day. Between late September and late December, prices dropped as low as $33 per barrel. Now in January 2009, oil is hovering around the low $40s per barrel, $100 less than back in July, only six months ago. We had a wild ride in 2008. And I believe 2009 will give us some new shocks. First, we are seeing significant companies in the domestic gas drilling business, like Chesapeake Energy, scaling back their drilling programs. And we’re seeing eye-popping fourth-quarter losses from key industry players like Conoco-Phillips (lost $31.2 billion in the last quarter) and Shell (lost $2.8 billion in the last quarter). We will see more reports like that, of operating losses, diminishing reserves, reduced earnings, write-downs and even some shotgun weddings (if not bankruptcies). Remember how Congress spent much of last year licking its collective chops over how it was going to tax those horrible so-called “windfall profits” of the oil firms? Well, not anymore, eh? Also, watch how fast the drilling and oil service industry decelerates. Oil companies that lose money also scale back their capital expenditures. Conoco-Phillips and Occidental are cutting back. We’re seeing layoffs in key parts of the oil service sector. Companies like Schlumberger, Halliburton and Baker Hughes have announced personnel cutbacks just in the past week. And Rowan, a large offshore driller, is canceling new rigs. Across the oil patch, the hiring boom of the past couple of years has halted, while the average age of the current work force just gets older by the day. With less drilling going on, we will soon start to see tighter output for both oil and natural gas. In Russia, oil output decreased by a seemingly small – but telling – 1% toward the end of 2008. You can expect a larger drop from Russia for 2009. Mexican oil output dropped by about 10% in 2008, and is on track to drop even more in 2009. According to figures recently published by the International Energy Agency, about 58% of world oil output comes from just 800 oil fields. And most of those oil fields are in the “mature” category. They were discovered in the 1950s-70s and are past their respective output peaks. So the macro view is grim, out beyond two years or so. Markets work, right? Yes, basically. That’s the idea, anyhow. Unless, of course, they don’t work very well. And if something doesn’t work very well, does it still work? A stopped clock tells the correct time twice a day, right? But what if the clock just stops and starts whenever it gets banged around? To use another cliché, is that any way to run a railroad? Let’s try to figure this out. What’s the difference between oil at $100 in January 2008, $147 that July, $100 in September and $33 in December? Has global demand been changing all that much? (Hint: Worldwide demand was not rising all that much in the first half of 2008. And demand is down over the past six months, but not by large factors.) Is the current oil price – in mid-January 2009 – in the low-$40s per barrel the “right” price? Can we believe the market? One key thing that has changed in recent months is the oil market’s perception of the future. The marketplace is predicting lower oil usage as the world recession unfolds. So oil prices tend to fall with the release of bad economic news. But that perception is just plain myopic. Look at both the amount and the composition of the oil for sale. We’re seeing falling oil prices in the face of flat (at best) world output. And total world oil output includes increasing volumes of natural gas liquids (NGLs) and tar sands from Canada. Let me translate that for you. NGLs are evidence that the oil industry is blowing down the world’s gas caps. And tar sand “oil” is the capital-intensive stuff with low energy return on investment. Tar sands use a lot of water and energy and come out at great capital cost and environmental cost to the North American landscape. Ask yourself a couple more questions. In the near term, will worldwide economic contraction lower the use of oil? Yes, probably. And in the medium-to-long term, will depletion lower the worldwide output of oil? Yes, as well. For now, lower oil demand is trumping stagnant supply. Oil prices are down. Near-term issues are beating out the medium-and-long term issues. But the longer oil prices stay low, the more damage will be inflicted on the world oil and drilling industry. More rigs will not be built. More wells will not be drilled. More prospects and fields will not be developed. More personnel will not enter into an aging industry work force. More of the current infrastructure and human capital will just run down. In short, we are setting ourselves up for a period of severe volatility in oil prices. When demand starts to recover, supply falls below some not-yet-defined volume or perceptions change about the future of oil availability...prices will take off. Until next we meet, Byron W. King |
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