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

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.

The price of oil has now reached a new record high (in US dollar): 129.31.

Some experts think that a continued belief in even higher oil prices among some American investment banks and hedge funds is a major factor in driving the oil price higher and higher.

Also, the new record high for oil has been cited as a major reason for the drops in the major European stock markets Tuesday.

msnbc/AP writes that:

The June contract for light, sweet crude traded as high as $129.60 on the New York Mercantile Exchange before settling at $129.07, up $2.02 from Monday’s record high. The imminent expiration of that contract, which ended with the close of Tuesday’s trading, created additional volatility in the market.

They see no reason why oil should not hit 140 dollars a barrel.

See also (for a little fun): The Coming Oil Crash (LOL)
An Overview of Oil Prices from DOE
The Oil Price Conspiracy

PS: For the record - I share the view expressed in the first of these postings - about the oil crash - that oil prices will crash. But not in the very near future, I think. And only when the dollar starts to rise against other currencies, and then as a function of the strengthening of the dollar!

I am frequently surprised by the ability of American media to explain away or minimize the role of domestic factors in the current recession in the US. Washington Post provide the most recent example of this kind of foolishness. Today it featured the following headline:

Exports Not Hurt by Euro’s Strength, Official Says

BRUSSELS, April 15 — Most European exporters are not yet feeling the pain of the strong euro, a European Union official said Tuesday — even as aircraft maker Airbus, which sells its planes in U.S. dollars, called the level “unbearable.”

Now, if the euro was strong, this would be ok. However, if it is the dollar that is weak, then businesses in the EU don’t really have any big problems. Then it is only sales in the US that are affected.

From a business point of view it matters a lot whether it is the dollar that is weak or the euro that is strong - it is only for trade between those two areas that it does not matter which is what. But for all other trade - and an increasing proportion of world trade falls in that category - it matters.

And really, the Euro has strengthened somewhat versus a number of currencies, but the US dollar has weakened by 30-40% against virtually all currencies that count. Therefore it is much more appropriate and correct to speak of a weak dollar than a strong euro!

Competitively speaking, that means raw materials and goods that are imported have become comparatively cheaper for the EU and other countries, while they have become comparatively more expensive for the US.

Thus, the low interest rates in the US and the recession feeds back on the competitive situation of the US in the world economy.

American media continue to focus on the rising price of oil, and how they drive inflation and increase energy costs.

While this is true, it is only true in an indirect sense. It’s not the oil that is extremely expensive - it was much more expensive in 1980, if measured in other currencies - it is the dollar that is weak.

Here’s that chart for the USD versus the Euro for the last 12 months:

Here is the Brent spot price for the same period:

Adjust oil prices for the dollar slip, and there is still a price increase, but it is actually not all that huge.

The dollar is weak because the US interest rate is low - actually negative when adjusted for inflation - and because the US banking system and credit markets are shaky. And the stock marked is in for a rough ride, whether Americans want to believe it or not. So investors, both inside and outside the US, go into oil and commodities.

This, of course, means the causes for the high oil price to a large extent is found in policy failures within the US. There really isn’t all that much cause to blame the Arabs or the rest of the world, certainly not for the current recession in the US, and only to a limited extent for the current oil prices.

The real interest rate in the US after the last rate cuts by the Fed - the interest rate adjusted for inflation - is negative. Is that good or bad? Seems to me, reading about this in New York Times, that both Obama and Clinton hold much to narrow views on the crisis, and think it is mostly a financial crisis that can be solved by stimulating the economy and regulating the credit market.

Every time the rate has been cut in the last six months, the stock market has reacted positively. And the Fed has been looked upon as an institution that actually does something to reverse the current crisis in the American economy. The rate cuts have been said to stimulate the economy, and so on.

And, yeah, guess what, lower interest rates are great for the stock market. Always have been, always will be. Simply because lower rates means that on the average, and everything being equal (ceteris paribus, it’s often called), and all of that, stocks become more attractive as investment instruments compared to other instruments.

So, if the crisis facing the US had been a financial crisis, that would have shored up things neatly. But the current crisis is not financial - it only has some financial aspects. The crisis in 2008 is structural (I’ve discussed this a bit in previous post, and will get back to it as well in later posts).

Structurally, for the real economy, negative interest rates may be bad news, even if they are good for the stock market and for financial institutions in trouble.

If you think about if, you will quickly realize that negative interest rates simply mean that almost any investment that have a yield equal to the rate of inflation becomes a profitable investment. So, the lower the interest rate, the stupider the investments, so to speak.

And low interest rates were one of the main causes of the current housing crisis (quote from Bonfire of the Builders, Business Week):

A diverse cast of characters combined to launch the once-in-a-lifetime housing boom of the past five years. Traditional mortgage companies and banks unleashed a barrage of loans, many to borrowers with iffy credit histories who didn’t bother to read the fine print about upwardly mobile interest rates. Wall Street egged on the often-reckless underwriting by buying vast quantities of home loans for repackaging as securities. Now that the boom has fizzled and foreclosure rates are rising, the important role of large homebuilders as lenders is also coming into sharper focus.

In addition to spitting out subdivisions, many of which now stand half-empty, builders jumped into the mortgage business to a degree they never had. Wall Street provided the same encouragement it offered other lenders. Even as the housing supply began to exceed demand last year, builders kept sales brisk by pushing adjustable-rate, interest-only, and other risky loans. In some cases they attracted clientele who couldn’t afford conventional mortgages.

So now, with low interest rates, there is the risk of fueling the same speculative building spree again. And also, to make investors spend precious capital on low-yield projects that look good today, but will surely be bad once interest rates come up again.

In my opinion, and I’ll say more about this later, the American economy currently need high interest rates (something like a real interest rate of +3-4%) to ascertain that capital is spent on smart projects and to reduce non-productive speculative investments.

The price fall in the US continues and accelerates. According to The Independent:

The price of the average home was 11 per cent lower than a year ago, the S&P Case-Shiller index showed yesterday, as repossessed homes flood the market – and economists predict that the price adjustment may belittle more than half over.

…. “It does not look like early 2008 is marking any turnaround in the housing market,,” said David Blitzer, S&P index committee chairman. “Home prices continue to fall, decelerate and reach record lows across the nation. No markets seem to be immune from the housing crisis.”

Other indexes point in the same direction. But actually all these indexes most likely underestimate the problems in the housing market for the moment. The reason for this is that a large number of sellers are holding back. So at the same time the market has slowed down (New York Times):

Sales of new U.S. single-family homes fell to the slowest pace in 13 years

On the other hand, real interest rates are now negative. And the Fed is pumping liquidity into the market. So it’s easy to think that the housing market will pick up relatively soon.

However, I don’t think that’s the case. Given the huge structural imbalance in the housing market and the time it will take to achieve balance, on one hand, and the need the Fed has to also look at factors in the much bigger recession picture on the other hand, they can’t and shouldn’t maintain negative real interest rates for an extended period of time. And smart buyers, I think, know this.

Because the bigger picture is a federal budget out of control, a foreign trade deficit that is monumental, a continued weakening of the dollar as a result of low interest rates, low productivity (see NYT, Feb. 7) growth in the economy (see also OECD), cautious lending by the banks (reacting to the current uncertain situation), and the danger of a substantial imported inflation.

Then add to all this that a negative real interest rate most likely is exactly the opposite of what the American economy needs over the slightly longer term, as cheap capital will lead to decline in productivity.

Taken together, these factors should imply that a negative interest rate - which just is plain stupid but may momentarily be necessary - will and should only be maintained until the financial institutions are over the worst.

More to come!

Every day in American news media there are several commenter saying that the crisis will soon be over. And among the most positive are the real estate agents and real estate firms.

No wonder. They make most of their income when the housing market is bullish. But is it going to be up this year? Is it over? Is it really only a crisis in the sub-prime loan market and some associated financial instruments, so that all it takes is a few write downs, a reduction in the interest rates, and a little time, and then it will all be over?

Well. It depends a little on what you mean by a few write downs then.

An article in the Financial Times, entitled America’s economy risks mother of all meltdowns, refers to Prof Roubini, who states:

Step one is the worst housing recession in US history. House prices will, he says, fall by 20 to 30 per cent from their peak, which would wipe out between $4,000bn and $6,000bn in household wealth. Ten million households will end up with negative equity and so with a huge incentive to put the house keys in the post and depart for greener fields. Many more home-builders will be bankrupted.

So, yeah, if 4.000 to 6.000 bn, or something even near that, is a little. Or, compare that to the following from Wall Street Journal:

Merrill Lynch economist David Rosenberg, one of the most bearish Wall Street economists, says to look past the 1990-91 recession as a guide to the current downturn. The key difference: the depth of home-price declines.Mr. Rosenberg says in a note to clients that the current downturn is hitting more broadly than the credit crunch and real estate meltdown in the 1990-91 recession, which lasted eight months (as did the mild 2001 contraction). Home prices today are falling in 85% of the country vs. 40% during that period, he notes. When prices hit bottom in 1992, the inventory of new and existing homes for sale was at 7 months of supply. Now it’s at 10 months’ supply “with no improvement in sight,” says Mr. Rosenberg, who was among the first economists to forecast a 2008 recession. He sees average prices nationwide dropping 20% to 30% more, on top of the 11% decline since the 2006 peak.

And this, of course, is really the start of it all. Both talk about 20-30% drop in housing prices. That’s pretty substantial. And, this is when the negative wealth effect kicks in, because people that have lost 3.000, 4.000 or 6.000 bn dollar are not going to be spending quite as much as they did before they lost their money.

I think 2008 will not see any improvements at all. Rather I think we have only just begun to see the bad news of 2008.

The danish newspaper Poltiken reports that small currency exchange offices in Amsterdam in the Netherlands now refuse to change american dollars (USD).

American tourists in Amsterdam report that “A dollar is worth nothing over here” (Mary Keller, american tourist to Reuters).  ”It’s hard to find a place to exchange. We have to go downtown, to the central station or post office.”

The dollar is falling so rapidly, and futher drops in the exchange rate is expected. Small exchange operations therefore do not want to lose money on changing greenbacks. The dollar hovered near record lows on Monday, with one euro worth around $1.58 versus $1.47 a month ago.

This is part of the problem currently facing Americans. For the moment, the crisis in America creates problems even for Americans abroad.

The price of Bush is becoming steeper every day now.