Energy, Inflation and the U.S. Dollar 9 comments
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With global headline inflation at 7% PIMCO's Bill Gross asks the question: does it make sense that US inflation should be 3-4% less than the rest of the world as reported by the US government? See here.
I would throw in the minor inconvenient fact that the US imports 60% of its oil and the cost of that oil has doubled in the past 12 months. So, of course we all agree that the US government is fudging the inflation numbers. Why? Here's the two main reasons:
- Social security checks, veterans benefits, and inflation indexed securities all get adjusted upwards with rising inflation. Since the US government is in debt up to its eyeballs, it simply cannot afford the higher expenditures while fighting two wars and simultaneously giving tax breaks to the uber-wealthy
- The Fed needs to have a rationale for cutting interest rates in the face of rising inflation. After all, fighting inflation is (supposedly) one of two mandates. Additionally, Bernanke cannot imitate Paul Volker and raise rates to fight inflation, because, unlike Volker's's age, the US consumer is plagued with debt: credit card debt, upside down in their house and car mortgages, and the very low savings rate. To pull a Volker now would be to risk a severe economic recession or very likely a depression.
My conclusion: Despite what Bernanke and Paulson have been pontificating about the last few days, Fed policy will continue to promote negative real interest rates and thus, a lower US dollar. I am sure this was the rationale behind Axel Merk's Merk Hard Currency Fund [MERKX] which is up over 6% YTD. On the other hand, there are people like Steve Forbes who contend all we need to do is shore up the dollar and oil prices will come down. As usual, Forbe's has things back-asswards. It is the rising cost of oil (due to worldwide supply/demand fundamentals) that is causing, in a vicious circle, the US dollar to decline. Does Forbes really believe the rest of the world is not aware of the $650 billion US dollars that leave the US every year to pay for our oil addiction? Please. Did anyone look at the faces of the sheiks in the crowd yesterday while Paulson was speaking? The only question I have is when are the Middle Eastern countries going to get off their US dollar currency pegs? Seriously, they are having to cut their interest rates every time the US does even though inflation is running, in some cases, between 10-20%. They must be very irritated...
We know that jawboning a strong dollar policy (wink-wink) doesn't work. We know the US government will continue fudge inflation data. Barry Ritholtz says the US government's reports inflation data as "inflation excluding inflation".
So, is there no hope for the US dollar? Actually, there is one prudent thing to do. It is also the key to future economic prosperity and addressing global warming: a comprehensive, well-crafted, long term US energy policy. Since the President, Congress, and the media cannot seem to come up with an energy policy, here is one courtesy of the author (free of charge, which is saying something since I don't have a job).
Notable updates since my last energy policy published on Seeking Alpha are:
- 60 mph max speed limit
- 4 day work week
I have no doubt that the US will eventually adopt such an energy policy. However, it may yet be sometime before the idiots in Washington wake up, and it will probably be after the US dollar drops another 25% and oil goes over $200 a barrel. But, let's be optimists and assume an energy policy like the one above does get adopted. From an investor point of view, what are the good plays? I have often written about the straight energy plays. This time, let's look at the alternative energy plays. I'll give brief descriptions, and let the reader do his or her's own in depth research:
- General Electric (GE): wind energy, China infrastructure, compressor and turbines for electrical generation and LNG market. Yielding 4%
- Sasol (SSL): South African based CTL and GTL technology leader
- Air Products and Chemicals (APD): chemical supplier of hydrogen and equipment supplier for chemical processes, oil, power generation, and heat exchangers for LNG terminals.
- Chicago Bridge and Iron (CBI): Netherlands based engineering and construction company heavy in the energy business. Consructure experts in building refineries and LNG terminals.
Disclosures: The author owns none of the above at present. However, he is actively shopping around and could well own one or more of these stocks by the time these words are read.
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This article has 9 comments:
- increased the size of the US government to 30% of GDP
- spent like a drunken sailor and bankrupted the US (plus, we have nothing to show for it)
- devalued YOUR currency 50%
the socialist HAVE been in power, with the exception that all the US treasury money went to the *uber-wealthy socialites*. wake up man! look at the facts of what has been going - most of the real damage being done when the republicans had both house of congress as well!
interesting how an article than advises buying GE can seem socialistic to you. more republican ideological blindness in the face of facts you'd rather not acknowledge. good luck sir!
btw - a am a REAL conservative republican, not this new radical branch of the "conservative republicans" that grow government, rape the treasury, and fund undeclared and unconstitutional "wars".
by the way, i didn't sink to calling you an "idiot", i debated with facts, which is less than what you did. good day sir.
But like a chatroom, more times than not someone launches an off-topic cheap shot over the bow that is entirely irrelevant and many times lacks any logic. Sadly, it displays the level of education that has gotten this country into the predicament it is in. Fitzman, if I were you I wouldn't even dignify it with a response.
If you think oil demand has risen 500% since Jan '01 or 250% since Oct '07, then you might be able to support this point, but would still have a hard time explaining why worldwide demand has had less an impact on the price of oil and gold and copper in Euros, Swiss Francs, or Canadian Dollars.
Forbes is a buffoon but is correct that the tanking Dollar has driven much of commodity hikes. We have been reminded of this again lately as the Dollar strengthened from jawboning by Fed officials, causing expectation of rate hikes to be priced in to futures, and oil and gold have to retreat.
Oil also has a supply and a speculation component to the price, but the weak Dollar accounts for over two thirds of the price increase .
1) a ballooned government and huge fiscal deficits
2) $650 billion leaving the US every year for oil (trade deficits)
these are now systemic US dollar issue. my belief, as i have said many times, is that the current administration's strategy for a strong dollar, which is mostly rhetoric, is doomed to failure in a worldwide market of savy investors. the only fix, in my opinion is:
1) a comprehensive long-term well crafted energy policy like this one: thefitzman.blogspot.co...
and
2) fiscal discipline by our government, that is for instance, raising taxes on the uber-wealthy at a time of "war"
those are the only two rational responses to the twin deficits. i believe the energy policy is the most important and urgent. otherwise, as we continue into a future where worldwide oil supply does not keep up with worldwide demand, oil will increase in price, and the US flow of capital out of the country will not only continue, but grow, and grow rapidly in my opinion. so far, the government is 0-2 on both these points, and we are seeing the effects in our currency, our stock and bond markets, and the devaluation of the US dollar. it all goes back to "oil denial" and, it will lead to a very drastic lowering of the standard of living for most Americans.
wrt raising interest rates: the Fed can't do it. too much consumer debt. to do so meaningfully (enough to strengthen the US dollar and fight the real rate of inflation), would be to push rates up so high the consumer would roll over and we'd have a deep deep recession. that is why i maintain 1) and 2) above are our only hope. and, we should have gotten started on both 4 years ago (or earlier).
as far as speculator's role in oil, sure there is! as there is in gold, wheat, corn, etc. etc. and has been ever since the beginning of US markets. it's funny how the "free market" guys (the same guys that just had the Fed take over Bear Stearns, a publicly traded firm....) are all for free markets as long as they work in their favor. the high price of oil is the BEST thing that could happen to us now - providing we get the hint and enact an energy policy. the smart money in the oil markets know that long term, there is a big supply/demand problem.
I admit that I haven't done in-depth research on this, but I have heard two types of number fudging: exclusion and seasonal adjustment. I suspect both have limitations in the time dimension and tend to put off the measurement into the future.
There must be delayed correlation between energy cost and core inflation. If energy cost stays high, it eventually propagates into the core. Therefore, excluding energy, and food for that matter, will only delay the rise of the core. This would work like moving average, which shows rises and falls in a delayed and smoothened fashion.
Seasonal adjustment would have the same effect. If the real inflation is 1% monthly, and you seasonally suppress the April value down by 1% to make it 0%, in May, you will have 2%. As long as you don't do perpetual adjustment, the suppressed values will pop up at some point sown the road.
Am I missing something?
Inflation in the US is quite low. The commodity bulls are engaged in one entry accounting, as usual. Yes oil prices are up by huge amounts in a classic bubble. House prices are down in a classic bubble bursting. Guess which one is a bigger portion of US household costs?
House prices declining are supposed to be horrible because everyone owns houses, except not everyone does. Oil prices rising are supposed to be horrible because nobody owns oil, except for all of it. In fact every house is owned but also paid for as a consumption item. And every barrel of oil is also owned as well as paid for as a consumption item. Falling house prices still reduce overall consumer costs, just as much as rising oil prices increase them.
See, imagining you know a single net position that can be applied to everyone, then one entry accounting, that is what we get. You see the same thing when the press talks about high gas prices undermining retail sales - without noticing that gas stations are retail sellers and gas buying *is* retail sales.
Next canard in the press is that oil is all about the falling dollar. Um, the dollar hasn't fallen sevenfold, for one. Second, it hasn't fallen at all since March, while oil prices have been in moon-shot blow off. You can measure the correlation between oil and the dollar. It is 0.35 for the period up to March of this year, which is quite weak but some real correlation. After that it is near zero and not statistically significant.
Next canard is it is all because the Fed is inflating recklessly. The Fed directly controls M1, which is the only monetary aggregate that requires Fed reserves, which are determined by the Fed's aggregate open market operations and the size of its own balance sheet. M1 hasn't moved since 2005. Not, hasn't moved in real terms; not, hasn't moved compared to GDP; not, hasn't moved as much as the dollar vs. other currencies, let alone commodities. Hasn't. Moved.
In the late 70s oil shock, M1 was growing at 7% annual rates. It was accurate at that time to describe the situation as the Fed printing more money. The Fed is not printing more money at this time. It hasn't printed more money for 3 straight years, since the start of the tightening cycle that burst the real estate bubble.
Yes the Fed has changed the form of its balance sheet to be accomodative to banks, since last July. But it has sold treasuries into the market for every other security type or loan or repo is has provided. This reduces bank's risk requirement reserves under Basel II. The Fed has engineered low rates and large positive spreads, sufficient that bankers will have to be remarkably stupid in the future to lose money as they managed to in the recent past, chasing narrow spreads at higher leverage. But the Fed has not expanded its balance sheet significantly, and the narrow money supply it controls consequently has not moved.
Yes broader money measures have increased, without higher M1. That is the classic sign of a higher demand to hold money balances for safety purposes. Inflation occurs when there is a lower demand to hold money balances for safety purposes and instead people scramble to get out of money as a savings medium (because monetary authorities have supplied way more than they wish to hold, or their desired holdings have fallen for some other reason), and try to spend it instead. Which they haven't been doing over the last 3 years.
Anybody can find out all these things for themselves easily. Instead we get a million parrots repeating a commodity line of bull they heard on TV or read on a blog.