from the hip

New York Times just reported the oil prices has dropped to under 50 dollars a barrel for the first time in 22 months. NYT writes:

The drop in prices comes as stock and bond markets fell because of fears about the health of the financial system, and a flurry of new indicators showed how badly the economy was faring.

Just as a booming global economy had steadily driven up commodity prices for six years, the current meltdown means the world needs less oil, and is sharply driving down prices.

It is a stunning — and sudden — reversal that has taken aback many experts. Oil futures on the New York Mercantile Exchange fell $3.04 to $50.58 a barrel in morning trading. At one point, crude oil was down $3.71, to $49.91 a barrel. Oil futures have lost more than two-thirds of their value after settling at a peak of about $145 a barrel in July.

Some analysts predict oil could fall to $30 to 40 a barrel as the world economy worsens.

Also, the dollar is for the moment strengthening in international markets.
Another sign of the strength of the oncoming depression?

See also: Times: Shares fall as US jobless adds another 542,000

American newspapers, most notably New York Times, have now started to wonder why American consumers aren’t spending. And in the financial sector, stock brokers and real estate agents seem to expect that it will happen next week or so, judging from the advise they are giving. That really doesn’t seem very likely at this point.

Why do American consumers spend less?

Well. The financial system in the US is still not completely shored up. AIG just reported a loss of 25 billion dollars for the third quarter and will be receiving a 150 billion aid package. Fannie Mae lost 29 billion dollars. Circuit City is going down. Airlines are in trouble. GM and the whole American car industry is in deep trouble.

As for the overseas markets, most indicators are down there as well. Every time the numbers are revised, they get worse. Right now, according to Wall Street Journal, they indicate a deep recession in Europe as well. IMF (see figure) now assumes that 2009 will be worse than 2008 for the world as a whole.  For 2009   IMF predicts a decline in GDP in the advanced economies of 0.3 percent. If this happens, it will be the first time during the periode following the Second World War.  For the US IMF predicts a decline of  0.8 percent, and for the Euro-area 0.7 percent for 2009. So there will be little pull from overseas markets for American businesses.

Now, add to this that the banking system isn’t working, loans are hard to get, unemployment is on the rise and millions of jobs are threatened.  Consumer confidence is at the lowest ever.

Also, factor in a negative wealth effect. The positive wealth effects, the effect of people getting richer on paper when housing prices were rising, were key to the growth the last 5-7 years. Now this operates exactly in the opposite direction, and serves to limit peoples spending up and above the effects of other factors.

So, what does it mean?

So how likely is it that consumers will start spending in the near future? Not very. Let’s assume for a moment that consumer spending will continue as today for a while.

Consumer spending is down 30 percent on cars, and 3 percent on the average across all sectors. Consumer spending appears likely to fall next year for the first time since 1980. Perhaps by the largest amount since 1942.

If it stays the way it has been for the last three months for a full year, that means demand for goods and services from consumers in America will be down about 1200 billions. And, spending is still dropping. As well, demand from businesses is dropping. And, as I wrote above, demand from abroad is falling as well. And right now, American businesses have just barely started to adjust to these new numbers and levels. And this adjustment will mean more lay offs and more negative earnings reports. That is simply how it works. And it is hard to see any “quick fixes” that can act as a miracle cure and lift us out of this situation in the short term. Rather, the adjustments will have to work their way through the system.

As far as American consumers are concerned, I notice people using words like “lacking trust” or “fear” as reasons for the decline in consumption. These words suggest that consumers are driven by psychological factors, emotions, beliefs and sentiments. Such words, I think, are the wrong ones in this case. Right now, I think American consumers act very rational - markets are turbulent, times are getting harder, uncertainty is high, so the rational response is to buckle down, sit still and wait for the fog to clear up.

So, for the moment, and for a while, it is just going down, I think. We are nowhere near the bottom. I don’t think we will see new growth for at least 18 months.

That’s what I think.

See also:

• Yahoo Finance: Home values drop for 7th straight quarter
• New York Times: Best Buy Lowers Its Outlook for 2009
• Washington Post: Why GM Stalled
• Washington Post: Obama Asks Bush to Back Rescue of Automakers
• New York Times: A Town Drowns in Debt as Home Values Plunge
• Wall Street Journal: Indicators Across Europe Point to Deeper Recession
• New York Times: Jobless Rate at 14-Year High After Big October Losses
• Times:First full-year slump since 1940s, says IMF

While the economic downswing is still making itself felt in the US, it is now also hitting several European countries hard. And inflation is soaring, and hit a record high of 4.1 percent last month.

“There’s no obvious trigger for strong economic growth in Europe until the end of 2009,” says David Owen, chief European economist at Dresdner Kleinwort in London. “Massive [financial] imbalances need to be worked out, and the corporate sectors in many countries remain in a substantial deficit.”

Consumer confidence for the euro area has fallen to negative 29.7, the lowest it has been since 1993. And the news about the plunge in factory orders in Germany, led to the following comment, reported in the New York Times:

“It now looks likely that the euro zone will be the first major economy to fall into recession,” Jonathan Loynes, the chief European economist for Capital Economics, wrote after the report of sagging orders in Germany.

Great Britain

Royal Bank of Scotland, Britain’s second-largest bank, recently posted its first loss in 40 years after taking a £5.9bn hit from the credit crunch. And Barclays, the third-biggest bank, took a fresh £2.8bn write-down. Also, the price of houses are dropping rapidly, according to Guardian

the Halifax said house prices last month were 11% down on a year earlier - the first double-digit decline since its monthly healthcheck of the market was first published 25 years ago.

House prices back to 2006 and still falling, says Times. And new housing orders are down 33%. And, of course, home repossessions surge.

Business groups and City analysts warned that deep and rapid cuts in the cost of borrowing would be needed next year to pull Britain out of its first recession in more than 15 years. House prices are falling more rapidly than they were in the property crash of the late 1980s and early 1990s

It would seem a possible recovery in Britain will not be aided by increased consumer spending in the short term!

Recession in Germany?

Spiegel online writes that the German economy may have shrunk in the second quarter, according to early reports, and that the outlook for industrial production isn’t lively. Germany could slide into recession, and the German economy may have shrunk by around one percent. They also note that:

German factory orders were down by 2.9 percent in June from May, and orders from abroad for German goods plunged by 5.1 percent. Production at German factories rose by 0.2 percent in June — less than expected

Spain in deep trouble

Portugal, Italy, Greece, and Spain all face severe challenges. In Spain, the imploding domestic housing market has pushed the unemployment rate to 10.7 percent. The number of bankruptcies in the building sector is exploding, and one third of the job losses stems from the construction sector. As well, the housing market is stalling. The inflation is about 5 per cent.

The US

The credit cruch is still being felt, and so is the reversal of the wealth effect and high oil prices. In addition to bad news from the banking sector, Fannie Mae, Freddie Mac, Indy Mac, and so, in the latest sign of the deepening troubles, G.M. recently reported a second-quarter loss of $15.5 billionfollowing a loss of $8.7 billion reported earlier by Ford. Car sales are dropping, especially sales of American cars.

Guardian notes that:

The US mortgage finance empire Freddie Mac yesterday predicted the worst housing slump since the Great Depression as it set aside $2.5bn (£1.28bn) to cover credit liabilities caused by delinquent loans and foreclosures.

And in New York Times, Peter S. Goodman recently wrote (August 1) that “More Arrows Seen Pointing to a Recession”.

Overall

Pretty gloomy still. The most positive piece of news is the slight drop in oil prices. But still serious signals of a slowdown of growth and possibly recession both in Europe and the US.

A new study from Harvard University lends considerable support to what I have previously written here about the crisis in the US housing market. The study predicts that

housing woes will continue as the economy wavers from the sharp drop in home building, credit and stock market turmoil, and a slowdown in consumer spending.

The study also adresses the negative wealth effects of the current situation in the housing market:

“Further price declines will not only increase the probability that mortgage defaults end in foreclosure, but also put a tighter squeeze on consumer spending,” the report stated.

As well, the report states that if the economy plunges into a severe recession, housing demand could fall even further. Many factors seem to still point in this direction. There are a number of negative indicators:

American Express experiences late card payments increasing

House prices dropping

Consumer confidence still dropping

The oil price is still rising

And so on and so forth. At the same time, inflation is on the rise, and while the Fed now is expressing strong concerns about this, they have still not really adressed it. My sense is that they will soon have to.

The American airline industry is in trouble. They were already in it, when the oil prices started to rise. And then the rising costs of fuel just made it worse. And since increasing fuel prices coincided with the economic downswing in the US – which in itself meant less demand for travel – things got a lot worse.

But all the principal actors – all the airlines – still work on the assumption that they all have a future in the skies. I doubt if that is the case, but still, that is - naturally - their working assumption.

So now they seem to be in a state of panic. Most of them, at least. And so they are looking for ways to save money, big and small, as well as ways of increasing revenue. Of course.

Panic sometimes results in great ideas. There is nothing like need to make people think and organizations act. However, it is rarely the case that all ideas born of need are great ideas. And this is definitely not the case for the new fees for checking luggage that several of the hardest hit airlines are now introducing.

That, to me, is a ridiculous idea. The reason the airlines introduce it, is that not a single one of them have the guts to raise prices enough to make their operations profitable. And the reason they feel they can’t, of course, is that there is excess capacity. Which means that they fear they will lose passengers if they increase prices. Then the rational, and perhaps also the only viable long-term strategy, is to reduce capacity.

But the airlines are afraid to do that too, because they’re not sure how long the price of fuel is going to stay high, nor are they sure how long the economic downturn in the US is going to last. So they tell themselves that they are in for the long haul, and that it is important to position the companies for the next boom.

However, doing stupid things and making customers even angrier is rarely a great positioning strategy. And regardless of 15 bucks here and there for suitcases (which it will cost the airlines 10 bucks to organize, administer, and collect), as well as create chaos inside the planes, the fact remains that the US airline industry has far too many companies and far too much capacity. And, of course, most customers are quite capable of adding 15 bucks times two to the price of a round trip ticket!

The US airline industry is going to crash. And 15 dollars will not cushion the fall. Rather the opposite.

Every week I receive several offers for American credit cards. And the offers are basically so wild they are completely silly. Mostly I am pre-approved, whatever that means. Now, I am lucky - since I am not an American I don’t have to use any of them. And I don’t.

All of them, of course, have zero interest on something or other and/or have no annual fee. So far all is well. But then the craziness starts.

Wild terms

Stuff like cash-APR 20.9%-26.9%. What? And 3% of the US dollar amount on transactions that are made abroad. Why? Are they nuts? I buy for 2000, they want 60 bucks for doing exactly what?

And then, of course, a so called “finance charge”, up and above the interest rate charged, of 3-5% - depending on the offer - for cash advances. WHAT? So, I take out 1000 dollars in cash, and the buggers want 50 for doing exactly what? Having a machine count bills? Come on!

What to do?

So, on one level my conclusion is: American credit cards are all scams - don’t use them! On another level - for Christ’s sake don’t use them abroad - use cash or travelers cheques!

Efficiency in the credit industry

But then - and this is far more serious: How can the US and Americans tolerate this? An efficient banking and credit industry reduces transaction costs across the board - improves the efficiency for every sector in the economy!

My thinking is that electronic payments are much more efficient than other types. So America must want 99.99% of payments to be electronic. But how can you persuade people to go electronic when the banks and the credit card industry make a scam out it? Well, I don’t think you can.

But other countries have achieved that. And those countries are competitors of the US in the world market. So as long as the US doesn’t sharpen it’s act and get efficient, the competitors have a competitive edge.

Regulation needed

And as far as making consumers and businesses go electronic is concerned: It’s easy to achieve! Just takes some federal regulation. Since the costs of electronic payments, ATM cash advances, and so on, are very close to 0, all the regulators need to do it to impose some low maximum rates.

Say 1 US $ max for cash advances, 2 max if abroad, max interest rate 10% above the Fed’s rate, no charges for over-limit (they can be almost eliminated with modern online technology), but instead allow credit providers to terminate the contract in cases of over the limit. All transfers to the credit card account to be debited within 12 hours.

Does this sound outlandish? Well, it is. I have terms like this on my cards. I can’t thank my bank for it - it’s not because they have chosen to give me terms like this. I have these terms because they have been forced to. But they have no problem complying to them. And they still make excellent money.

See also: Plastic Card Tricks (NYT)
               The World’s Worst Credit Card (it is American, of course!)
               FTC Crack down

The Bureau of Labor Statistics today reported that 80.000 jobs had been cut in the US in March. While officials and even newspapers in the US seem reluctant to use the word “recession”, more and more indicators show that the US is in a recession, or extremely close to being in one.

In an article in the New York Times, Andrew Stettner called for an increased focus on the job market in the US:

“People have been focused on the housing crisis, and rightly so,” said Andrew Stettner, a policy analyst at the National Employment Law Project, “but now the deterioration in the job market should be demanding much more attention from policy makers.”

The job cuts so far in the US seem to be fairly consistent with the early stages of a period with a reversal of the wealth effect. According to Washington Post the distribution of job cuts was:

The numbers are far worse than economists were forecasting, and they solidify the case that a serious economic downturn is underway.
….

The report shows clearly how the problems in the housing and financial markets are rippling through different sectors, showing the deep interconnections between seemingly separate parts of the economy.

The number of construction jobs, which has been falling steadily for 18 months, continued its rout. That sector shed 51,000 positions, as fewer residences are being built.

Fewer houses mean less construction and building materials; the number of manufacturing jobs fell by 48,000, with some of the steepest losses among makers of lumber, drywall and other materials. Automakers also shed jobs. With their homes less valuable, Americans seem to be holding off on big-ticket purchases.

Consumers pulling back means stores need fewer workers; the number of retail jobs fell by 12,400. The steepest losses were in sellers of building materials and appliances, both of which are highly tied to the housing business.

The branches of the economy, of course, are not seemingly separate. They are visibly interconnected. Job cuts are most severe in construction and associated industries. Then there are wealth effect consequences in the auto industry and consumer retailing. Its logical and as expected.

As to the depth and duration of this crisis, this is what Ian Shepherdson had to say in NYT today:

Many forecasters argue that the economy will rebound by the fourth quarter, a view rejected by Ian Shepherdson, chief domestic economist for High Frequency Economics.

“We are in for a much longer recession than Wall Street thinks,” he said. “This particular downturn is driven by a rare contraction in consumer spending, and that is starting to hurt a broader range of people than those hurt by the mortgage crisis.”

In my previous post about the American recession I wrote about the structural causes of the current crisis. I stated that the housing market fell because it finally burnt itself out, after having been too hot for too long due to low interest rates in the US.

The fall in the housing market, which is likely to last for quite a while - I think well into 2009 - has another disturbing effect. It reduces the value of property in America. Thus, the wealth effect - everybody getting “richer” because the value of their houses and apartments have increased, and spending some of that newfound wealth on consumption - is reversed. Now there is a negative wealth effect.

A negative wealth effect means that this time increased spending will not be fuelling the economy and lifting it out of recession.

The effects of the reversal of the wealth effect are now slowly becoming visible in the US. Automakers are adjusting their sales expectations down:

Dismal Year Is Forecast for Car Sales

writes New York Times. And it doesn’t stop there:

Slump Moves From Wall St. to Main St.

In Seattle, sales at a long-established hardware store, Pacific Supply, are suddenly dipping. In Oklahoma City, couples planning their weddings are demonstrating uncustomary thrift, forgoing Dungeness crab and special linens. And in many cities, the registers at department stores like Nordstrom on the higher end and J. C. Penney in the middle are ringing less often.

… Many economists forecast that overall consumer spending will slip 1 percent for the first three months of the year.

“That’s a wow,” said Robert Barbera, chief economist for the trading and research firm ITG. “Outright declines for real consumer purchases are unusual.”

What is shaping up as the second recession of the 2000s is the product of declines in home values, which play a far bigger role in most Americans’ personal finances than the stock market. Households have borrowed against the increased value of their property to buy cars, send their children to college and add home theater systems.

What all the stories of declining demand point back to, is of course the wealth effect. And in months to come, it will increasingly be reinforced by imported inflation, making the crunch on the dollar increasingly felt by the consumers as well.

Indeed - all the charts for the US look bad for the moment: Jobless claims up, consumer sentiment down, housing starts down, retail sales down, industrial production down, dollar down. Meanwhile, the stock market will continue to be turbulent.

To me, it seems a rough ride is ahead!

More to come.