Friday, January 14, 2011

Slack in the System, Commodity Prices, and the Rate of Change

Fascinating things are going on in the economy and in the markets.

I don't need to tell you folks... Wall Street price mechanisms have disconnected from Main Street's employment and income projections... All asset classes, even those that in the past had inverse correlations (move in opposite directions) are now fully correlated...  Commodity prices have rocked while Real Estate and Wages have not.

What the heck is goin' on?

Well, that's more complicated than any Think-Tank could answer, let alone a lone blogger... still...

It would seem that the U.S. and the West had a great deal more slack in many of their systems than any of us realized.  As bad as things are economically, I thought they would have been somewhat worse, and I think this has to do with "slack" in various systems and the impact that slack has on the rate of change. To my mind, the rate of change is EVERYTHING... we can adjust to just about any environment change if the rate is slow enough... In no particular order here are slack items to consider:

Money printing has caused price inflation in the commodity sector, but there is little to no inflation elsewhere in the economy.  Awful lot of slack in the money supply... of course, this might just be a lull in the action.

Housing.  As I have said a Gizzilion times... we don't have a housing crisis... we have a housing finance crisis.  In a long ago comment "Coal Guy" paraphrased someone and said "When this is all over the houses will still be there, and the people will live in them".  The Fed and other central banks were able to buy, and then "write off", the various banks' bad loans and recapitalize the system because of the slack mentioned about above on money printing.  So the banking system has survived, something I was not particularly sanguine about just 12 months ago.  There will be fits and starts, and markets could get very tough... what I was worried about was contra party risk... the risk that the guy on the other side of the trade is not there to effect delivery.  We seem to have gotten over that hurdle. (With plenty of risks to be sure.  The CDS market is the silliest and most dangerous thing man could have conceived of if he wanted a deadly virus to be perpetually floating around the body of the financial system, to say nothing of sovereign debt risks...)

Oil imports are down, 20% or so in 5 years. 20%!  Yea, things are tough... I thought it would have been a great deal worse.  This does not mean that imports won't continue to decline and approach essentially zero in 10 or 15 years (with the exception of Canada)... but efficiencies will develop and domestic production of Nat Gas and Oil has increased nicely, North Dakota alone will be 700k bpd by 2020, up from zero over the past 5 years.  With our new found Nat Gas production capabilities the rate of change should be manageable PHYSICALLY.  Politically and then the politics of economics?  Well, I am not so hopeful there... The point is that we will likely have the time necessary to work on Mass Transportation and more efficient living arrangements without having tens of thousands of people freeze to death one winter soon, something else I thought could very well have happened and that risk has been eliminated for the next decade given our new-found Nat Gas resources (and no, at some point they won't be cheap... but better to be expensive than not have it).  We have been given a reprieve, not a pardon.  We will need to a great many things from shrinking to insulating to mass transiting, if you will... but these things CAN be managed if the rate of change is not overwhelming.  This is not to say that our car centric life will continue unchanged... we will be driving a great many fewer miles. The point is we will adjust and life can and will go on.

Food. The Federal Government has approved a plan to go to 15% ethanol in our gasoline... not sure where the ethanol is going to come from, as we already consume nearly half of the U.S. corn crop to supply 10% of our "gasoline".  The mirror image of this is that we have plenty of grain for food!  All we have to do is consume less gasoline. How this all balances out, your guess is as good as mine... I would bet even money that some kind of disaster would happen first to bring about a dose of sanity, and THAT is disconcerting... but on the other side of that the issue will be what it always was - WEATHER.

There are real risks in the food supply, but they are not the simple sh#! you hear tell from the doomers.  Like plane crashes, it would likely be a series of unfortunate problems that compound themselves into trouble... with the the final compounding effect being WEATHER.  Let me give you a scenario:

TPTB see a supply crunch coming in liquid petroleum, and trying to survive the next election they endeavor to bring ethanol up to 15% of gasoline consumption by volume.  In doing so, they deplete the West's grain reserves to a point not seen in our history.  They survive the election.  They are sworn in in January. YAY! Kum Bi Ya!  The northern hemisphere planting season starts out normal enough.  Corn prices are $11 a bushel because inventories are so low, farmers are slaughtering livestock because they can't afford to feed them, meat prices plunge as a result, and crop farmers plant corn at the expense of wheat and soybeans because of the price and because they were bribed by the government to do so.  It is now April/May and 80% of the corn crop has been sown.  By June, it is apparent that the U.S is in the grips of a 1936 style drought and heat wave. Unfortunately, so is Ukraine.  By harvest, the U.S. crop is down 60% from projections and the Ukraine crop is down 40%.  Corn is $40 per bushel, and the Western economies have been destroyed by high Oil prices along with high food prices...

Farmers across the continent saw their worst harvest on record, causing corn and wheat prices to rise quickly. Droughts and heat waves were common in the 1930s. The 1930s are remembered as the driest and warmest decade for the US (the Dust Bowl years) and the summer of 1936 was the most widespread and destructive heat wave to occur in the Americas for centuries.

Or something like that.  The point is, if an issue in that space were to materialize it won't be something as simple as a single event, i.e Peak Oil. It will be a compounded event, and the fact is that grain inventories have never been lower than they are today in the post WWII period in terms of days of usage, and the world is one really bad weather event away from catastrophe... and that has ALWAYS been the case.  Any body who is not a "prepper" has rocks in their head.  Its just probability theory.  Given enough rolls of the dice, every possible outcome will be realized eventually.

So? So things are not as bad as they could be.  Life goes on, the wine will flow, and there will be much rejoicing.  Odds are we get through all this alive and well, but with a great deal of economic pain... which is really calibrated against our outrageous expectations. But there will be a year's worth of food in my pantry. 1936 will absolutely, positively happen again - just hopefully not during my lifetime.

21 comments:

DaShui said...

I think I found your slack: 20%+ U6.

westexas said...

An item linked on Drudge:

90 girls at one high school are, or were, pregnant (20% of the girls in the high school):

http://www.wmctv.com/Global/story.asp?S=13833438

Greg T. Jeffers said...

DaShui:

Certainly some slack there... more soon. I've been obsessing over this and will have more to say.

Dextred1 said...

That quote you use from Coal Guy is what my old man and I have been talking about. Just like the built housing, we could of took the 3.54+ trillion wasted on welfare/bailouts/unions/state payouts/etc and invested it in factory's, farm equipment or any other productive thing we could have used as a source of revenue over the coming yrs and increased real employment. We did not do this and now we are another 3.54+ trillion in debt and have nothing to show for it. The cut in SS taxes in the new tax cut is a bad idea, you will now see the debt go up and not down. The revenue gain from increased economic growth will not offset the debt incurred by the SS tax cut. They should have cut the benefits by the same amount as they reduced the taxes. DUMB, DUMB, DUMB!!!

Dextred1 said...
This comment has been removed by the author.
Dextred1 said...

IF you go to the Debt clock they have a function to push out the debt based on CBO and then on current rate. At the current debt growth rate we will be at 22.087 trillion by 2015. IF go with CBO projections 16.985 Trillion by 2015. That is some scary stuff.

Greg T. Jeffers said...

Dex:

Well.... sort of... that's the supply side...for better or worse, the world as presently economically constructed is in a state of serious overcapacity EXCEPT for Oil and certain other capacities.

bureaucrat said...

I have no reference but I could have sworn I heard the planting for 2011 is going to be huge worldwide. Likely no shortages of corn or much else.

Also, GM must be making those Chevy Volts darn slow as the only place I've heard them being seen is in the Detroit area. They were supposed to have been available late last year.

Dextred1 said...

Jeffers,

It is not theory though. We actually blew 3.5 trillion dollars. Farming is on the uptick. I would of rather took and bought new equipment for every farmer with that money. You could of paid off 1/3 of all housing debt with that money. I guess my point is that we wasted it.

PioneerPreppy said...

I wonder what percentage of the houses will still be there when it is all said and done. Houses decay very fast when left abandoned after a few years (and it has already been a few in some areas) they will be un-inhabitable and complete write offs.

If the government is going to put out incentives to plant corn for this coming year they will need to kick it in high gear here very soon. Depending on rotations and the like farmers will need to begin prepping depending on their situation from last year if they plan on focusing on corn.

While oil imports have been down growth has been down as well. Without the growth the financial pressure is put off from today to other areas like pensions and the like for tomorrow. I believe that is where most of the lag comes in. The commodities and other holdings go up since the cash is staying with the big finance companies and being used to gamble. This is turn keeps the pensions in "growth" of a type as well. Yet there is no substance behind it.

It's like a tornado that has skipped into the air. It is still going but the high speed ground air is gone so it is feeding on itself. Maybe it will touch back down or maybe it will die out.

Plenty of companies are reporting profits but the few I follow are reporting profits from different areas. Radically different areas. With consumer sales falling from 50% or more to less than 10% of total over the last three years, while institutional profits are up from the 20's to 40's. That is stimulus spending and it is going nowhere except back into the market and it is dying out this quarter.

Will be interesting to see what the next move ends up being.

Greg T. Jeffers said...

Pioneer:

Quit stealing my thunder!

Just kidding.

More coming on pensions.

Dan said...

A lot of those profits are from FASB rule changes. In the not too distant past your accounting had to be “rational and consistent”, today your financial assets, inventory, accounts receivables, intellectual property, etc. can all be market to bull shit. Two years ago you could get the full treatment for this. (For any action deemed illegal you may be: arrested, prosecuted, convicted, imprisoned and sued.)

This means for instance; a bank can hold an underwater dud loan on its books at full value because it might be cured regardless of odds. Then mark the payments in arrears as a receivable again because it might be cured, and finally mark any CDS on the property at full value since the property is in default. Of course this isn’t just limited to banks, any corperation can hire “top talent” to get “creative” and find “hidden profits.”

Also when did a upside-down loan become a underwater loan? It’s sort of like original signature suddenly morphing into wet ink signature. WTF is a wet ink signature? So if I print it on an ink jet is it all good? I can’t help but wonder is it because a search on wet ink signature will bring up some recent articles by banking industry shrills; while long established case law, fireproof file cabinets, and over 800 hundred years of English common law; go down the memory hole for lack of a proper search term? Perhaps Loughner was on to something, if you can control the lexicon you can control the past, and if you can control the past you can control the future.

Donal Lang said...

To me it seems like this;

You're printing lots of money so the dollar (and pound, and euro)is devaluing, so it buys less and domestic inflation increases and import inflation increases.

However other currencies are either tied to the dollar (by mechanisms like China, or by commonalities like the Euro) so the import inflation isn't as bad as it should be if it wasn't for the dollar being the reserve currency.

However ALL major currencies are devaluing, and there is increasing demand due to increasing world population and increasing wealth in developing countries, so there is worldwide commodity inflation due to that increasing demand...

just at the time when many of these commodities are in constrained supply....

Add to that the first indications of Peak Oil and the commensurate increases in anything which 'contains' the energy which commes from oil, or from any other energy source because all are price-connected to oil...

and oil makes food, so there is an increasing food shortage in the developing world...

and whether its climate change or not, our climate is getting to be very good at killing people and destroying crops...

causing starvation, migration and dissent in vulnerable countires...

Then add in that the West has now spent all its previously garnered wealth and has been borrowing against an economic future that no longer seems possible...

and everyone has expectations that cannot possibly be met...

and baby-boomers are all retiring at the same time, taking their wealth with them...

Apart from that, I think 2011 will be just fine. Happy New Year! :-/

Dextred1 said...

Donal,

We agree today. Good post. I am with you on the inflation thing. I just read somewhere today that if we calculated inflation like we did in 1979-80 we would be at 10%. Mish and a few others make good point about deflation, but everytime I go to the store it costs much more. I guess as long as I don't eat, use gas or buy clothes there is no inflation.

Greg T. Jeffers said...

Donal:

All excellent points... Given all of the above, it is quite astonishing that things are not much worse! And that begs the question as to why?

Among other things... people do not need the total goods and services that they thought they needed... there's some slack....

our system is what it is, and we now have bandaid on top of bandaid... and that was probably the right thing to do at the time...

If you made me the Fed Chairman, I would resign. They have no terribly appealing options left... same if you said "here, the Sec of the Treasury".... I quit. I have been noodling all of their possible moves and I don't like any of the them.

Still, I am pretty impressed that things are not completely FUBAR... not that that cannot change... I was only musing as to why that seems to be the case...

Now, all bets are off if Oil remains here or heads higher... OIl has to come in or the economy will sh#! the bed at some point... that's a technical term meaning to contract painfully....

Greg T. Jeffers said...

I should say the economies of the Oil importing West will Sh#! the bed... for the world economy it is a zero sum game...

Donal Lang said...

Hey Dex, your comment really worried me. I had to read my post again to see where I'd gone wrong! ;-)

Greg, I think the short term 'saviour' is just Q.E. which has borrowed from the future to support asset prices in the short term. I know we both agree that it can't last, its just put off the inevitable. Once Wile E Coyote looks down ......

The thing is, this has been going on for a long time. Real incomes for the bottom 95% of Americans has been falling since 1990 and the difference in spending power (to maintain the retail economy) has been based on extended credit supported by house inflation. That's just an early form of Q.E.

The shit was always going to hit the fan sometime, Q.E. is just extending the deadline in the hope that a 'real recovery' is just around the corner. Peak Oil says its not.

Hmmm. i was feeling quite happy until I wrote all that!

Greg T. Jeffers said...

Donal:

I don't disagree with your assertions... I am still fairly amazed at how well things are holding together... the absolute KEY to all of this is the Rate of Change.

If TPTB can engineer are much gentler slope in the Rate of Change they have truly earned their keep... if not, then not... or as my grandmother would have said - "Az nischt, is nischt".

John said...

Our nation is already at 10% ethanol production (of gasoline), at 12 BB per year. More non corn is going into ethanol,(biomass, and sorghum). If we can survive the next ten years we can finish bio -engineering plants to increase yields and create nearly finished products. The long term answer is not ethanol.
This year's cropping plans for most producers, are already in place. You will see a lot of soybeans, because they cost less to produce, and the returns are now nearly as good as corn. The yields will be better than last year because of the 11 year solar cycle. We just experienced the worst of it last year, so statistically, it should be better. That does not mean there will be enough to go around, and the rest of the world is way behind the USA in quality, and yield. Hope for the best and prepare for the worst.

confederate miner said...

Greg with the spread being so large between cushing and brent crude. How big would it have to be before some of it gets shipped?

Greg T. Jeffers said...

Confederate:

Should be happening as we speak... probably in the form of products...