When Alan Greenspan predicted three percent economic growth showing up in the reported figures for the third quarter of 2009, did he mean executive compensation packages? Maybe the lesson here is: don't ask a crackhead to predict the future supply of crack. Greenspan's greatest success may be to drive economics into such disrepute that it will be cut loose from the universities and only be taught by mail order or internet subscription from the same outfits that offer PhD's in astrology. That is, before the universities themselves go broke.
The predicament that the USA finds itself will not be "solved" at the scale of operation that we're accustomed to, and we should just stop wasting precious time and dwindling resources in the idle hope that it will be. The failure to recognize this dynamic is the most impressive part of the meltdown. The only thing that the federal government is likely to prove in the process is the ineffectiveness of its actions as applied to any of the raging current problems from the killing burden of hyper-debt to the brushfires of geopolitics. Congress will only make the health care system more complex. Both congress and President Obama will do everything possible to keep housing prices unaffordable -- in a quixotic effort to protect the collateral of the big banks. Capital will continue to vanish in the black hole of default.
Something's got to give in the remaining three months of 2009. My guess is that attention will shift overseas for a while. This will not be due, as many probably think, to a cynical effort by the government to divert attention from the financial fiasco, but because the intrinsic tensions in the Middle East are reaching the snapping point. Iran is being called out on its nuclear program. If, from the start, it had just maintained the need for electric generating power in the face of dwindling fossil fuel reserves, they might have gone unchallenged. As it happened, though, the elected leader of Iran made too many intemperate remarks about wiping other nations off the face of the earth, and this has only prompted the leaders of other nations to take his remarks at face value and presume that Iran's nuclear program was devoted to armaments, not electric power generation.
So, now the USA has picked up the gauntlet. If Iran doesn't act to demonstrate the de-activation of its bomb-making capacity, then the USA will try to impose sanctions depriving Iran of necessary imported supplies. (Iran actually imports gasoline, due to inadequate refineries.) For sanctions to be effective, support will be required by other nations, including Iran's chief gasoline supplier, China. What a delicate calculus this will be! I rather imagine that China would not like to see the Middle East blow up. I'm not so sure about the nations of the Middle East though, or at least major parties in certain nations. The rulers of Saudi Arabia would probably enjoy seeing Iran get into big trouble, since Iran is Saudi Arabia's most active antagonist, working tirelessly to destabilize the Kingdom. Al Qaeda interests dispersed in many nations would certainly cheer any mayhem. The Taliban would love anything that takes the spotlight off them in Afghanistan. The Russians are conflicted between the wish to enhance their own leverage in world affairs and their need to discipline Islamic maniacs along their own borders. Europe is probably scared to death of anything that might threaten their energy lifeline. Pakistan is too tormented to have a position, but its radical Islamist factions are probably on the side of disorder -- as the best remedy for the status quo. If any of that spills over on India, as in the Mumbai bombing, then that flashpoint could turn to conflagration very quickly. We forget about Turkey, which was the hegemonic player in the region for centuries until its swift decline after 1914, but it has potent military capability and very mixed feelings about the the Jihad to ruin the West (since it is partly of the West). And finally there is Israel, the object of Iran's intemperate public statements.
This is a dangerous situation. I'm not so sure that Israel could launch an effective attack on Iran's nuclear infrastructure, but it might try anyway, especially if a US-backed sanctions effort fails to coalesce quickly. I'm not sure Israel would seek permission from the US to do this, though the US would certainly be tasked with defending the shipping lanes in the Persian Gulf. Iran might succeed in sinking more than a couple of US ships-of-the-line with sunburn missles and other toys, and this would lead to the bigger danger of oil supplies being choked off to the rest of the world. The US air response would be impressive, but possibly not effective against hardened targets. The leaders of Iran might exult even if the Iranian people were swept into a maelstrom. I imagine that what followed would be a very extravagant military frenzy amounting to World War Three, with European air forces and navies dragged in, with Hezbollah and Syria striking back at Israel, India and Pakistan possibly incinerating each other, and mayhem galore among the bystanders in Iraq, Egypt, Saudi Arabia, and Afghanistan. There could easily be internal mischief in the UK, France, and Germany from angry immigrant populations, and "sleepers" could work some overdue hoodoo in the USA. I don't know what Turkey would do, but it could be the biggest beneficiary of a bad regional meltdown, providing the only effective governance what remains in the region. China and Japan would probably just gape at the spectacle in wonder and nausea from the sidelines as they saw their energy supplies for years-to-come go up in flames.
The G-20 nations would be crippled as global oil supplies were choked off indefinitely. And if anyone -- Iran, or its friends inside the Kingdom -- managed to pull off a stunt such as blowing up the Ras Tanura oil terminal -- then a darkness will spread across places that were used to being lighted and they will stay dark a long time.
I don't know if any of this will come to pass, but as I said, tensions have reached a breaking point, including the greater tensions of history, which seem to require periodic release no matter how poignant the Pete Seegar songs are. It is perhaps, just another prime symptom of "overshoot," the world's way of shedding some of the toxic organisms that are making it so unhappy -- Gaia in a really bad mood.
If nothing develops along these lines on the geopolitical scene, the USA is still stuck in its predicament of trying desperately to maintain an overscaled living arrangement, with no coherent public discussion of downscaling, re-scaling, or re-arranging things. My guess is that this kind of restructuring only occurs when all other options have been exhausted. The last time the USA found itself in an intractable economic morass, World War Two came along and it made things all better here (after considerable sacrifice for us and catastrophe elsewhere). After World War Two, we ruled the world for a couple of generations. The outcome of World War Three would not be so favorable for us. At the very least, it would leave us attempting to run things on about one-quarter of the oil we're used to. That does not suggest a seamless transition between how we behave now and how the future will require us to behave differently.
Wednesday, 7 October 2009
Peak Oil: The End Of the Oil Age is Near, Deutsche Bank Says
Here’s an intriguing thought: Global oil supplies are indeed set to peak within a few years, and no, that is not bullish for oil. Quite the contrary—it will spell the end of the “oil age.”
That’s the take from Deutsche Bank’s new report, “The Peak Oil Market.” In a nutshell: The oil industry chronically under invests in finding new supplies, exemplified both by Big Oil’s recent love of share buybacks and under-investment by big oil-producing nations. That spells a looming supply crunch.
That will send oil to $175 a barrel by 2016—and will simultaneously put the final nail in oil’s coffin and send prices plummeting back to $70 by 2030. That’s because there’s an even more important “peak” moment on the horizon: A global peak in oil demand. That has already begun in the world’s biggest oil-consuming nation, Deutsche Bank notes:
US demand is the key. It is the last market-priced, oil inefficient, major oil consumer. We believe Obama’s environmental agenda, the bankruptcy of the US auto industry, the war in Iraq, and global oil supply challenges have dovetailed to spell the end of the oil era.
The big driver? The coming-of-age of electric and hybrid vehicles, which promise massive fuel-economy gains for short-hop commuting but which so far have not been economic.
Deutsche Bank expects the electric car to become a truly “disruptive technology” which takes off around the world, sending demand for gasoline into an “inexorable and accelerating decline.”
In 2020, the bank expects electric and hybrid vehicles to account for 25% of new car sales—in both the U.S. and China. “We expect [electric propulsion] will reverse the dynamics of world oil demand, and spell the end of the oil age,” the bank writes.
But won’t cheaper oil in the future just lead to a revival in oil demand? That’s what’s happened in every other cycle. Au contraire, says the bank: Just as the explosion of digital cameras made the cost of film irrelevant, the growth of electric cars will make the price of oil (and gasoline) all but irrelevant for transportation.
In a report filled with interesting tidbits, one in particular stands out: The cost of the Iraq war at the pump. Deutsche Bank figures the cost of the war at $1.5 trillion. Amortized over 20 years, that works out to $75 billion a year. “If the US government taxed US gasoline consumers purely to reflect the financial cost of the war in Iraq, gasoline prices should be some 54 cents per gallon higher,” the report notes.
And then there were five—defections from the U.S. Chamber of Commerce over its climate-change policy, that is.
Apple today resigned its membership in the Chamber “effective immediately.” That’s a harsher tone than the other departures—three utilities said they’d let their membership lapse at the end of the year, and Nike simply quite the Chamber’s board of directors.
At issue, again, is the Chamber of Commerce’s opposition to the Obama administration’s climate policy, most notably the Environmental Protection Agency’s decision to regulate greenhouse-gas emissions.
Apple has recently been on a green crusade to catch up to tech rivals Dell and Hewlett-Packard which have a shinier environmental reputation. And of course, Al Gore is on the Apple board.
From Apple government affairs vice-president Catherine Novelli’s letter to Chamber of Commerce boss Tom Donohue:
We strongly object to the Chamber’s recent comments opposing the EPA’s effort to limit greenhouse gases…Apple supports regulating greenhouse gas emissions, and it is frustrating to find the Chamber at odds with us in this effort. We would prefer the Chamber take a more progressive stance on this critical issue and play a constructive role in addressing the climate crisis. However, because the Chamber’s position differs so sharply with Apple’s, we have decided to resign our membership effective immediately
The Chamber of Commerce says that it is not opposed to action on climate change, just the actions that have actually been proposed in Congress, or floated by the EPA. Still, Apple’s departure is just the latest sign of how quickly the U.S. business community is fracturing over the climate issue.
The U.S. Chamber believes that climate change must be addressed. The Chamber is a consensus-driven organization and welcomes input from any company that wants to work on a comprehensive approach to reduce greenhouse gases. While we’ll continue to represent the broad majority of our membership on this goal, we recognize that there are some companies who stand to gain more than others with the current options on the table.
That’s the take from Deutsche Bank’s new report, “The Peak Oil Market.” In a nutshell: The oil industry chronically under invests in finding new supplies, exemplified both by Big Oil’s recent love of share buybacks and under-investment by big oil-producing nations. That spells a looming supply crunch.
That will send oil to $175 a barrel by 2016—and will simultaneously put the final nail in oil’s coffin and send prices plummeting back to $70 by 2030. That’s because there’s an even more important “peak” moment on the horizon: A global peak in oil demand. That has already begun in the world’s biggest oil-consuming nation, Deutsche Bank notes:
US demand is the key. It is the last market-priced, oil inefficient, major oil consumer. We believe Obama’s environmental agenda, the bankruptcy of the US auto industry, the war in Iraq, and global oil supply challenges have dovetailed to spell the end of the oil era.
The big driver? The coming-of-age of electric and hybrid vehicles, which promise massive fuel-economy gains for short-hop commuting but which so far have not been economic.
Deutsche Bank expects the electric car to become a truly “disruptive technology” which takes off around the world, sending demand for gasoline into an “inexorable and accelerating decline.”
In 2020, the bank expects electric and hybrid vehicles to account for 25% of new car sales—in both the U.S. and China. “We expect [electric propulsion] will reverse the dynamics of world oil demand, and spell the end of the oil age,” the bank writes.
But won’t cheaper oil in the future just lead to a revival in oil demand? That’s what’s happened in every other cycle. Au contraire, says the bank: Just as the explosion of digital cameras made the cost of film irrelevant, the growth of electric cars will make the price of oil (and gasoline) all but irrelevant for transportation.
In a report filled with interesting tidbits, one in particular stands out: The cost of the Iraq war at the pump. Deutsche Bank figures the cost of the war at $1.5 trillion. Amortized over 20 years, that works out to $75 billion a year. “If the US government taxed US gasoline consumers purely to reflect the financial cost of the war in Iraq, gasoline prices should be some 54 cents per gallon higher,” the report notes.
And then there were five—defections from the U.S. Chamber of Commerce over its climate-change policy, that is.
Apple today resigned its membership in the Chamber “effective immediately.” That’s a harsher tone than the other departures—three utilities said they’d let their membership lapse at the end of the year, and Nike simply quite the Chamber’s board of directors.
At issue, again, is the Chamber of Commerce’s opposition to the Obama administration’s climate policy, most notably the Environmental Protection Agency’s decision to regulate greenhouse-gas emissions.
Apple has recently been on a green crusade to catch up to tech rivals Dell and Hewlett-Packard which have a shinier environmental reputation. And of course, Al Gore is on the Apple board.
From Apple government affairs vice-president Catherine Novelli’s letter to Chamber of Commerce boss Tom Donohue:
We strongly object to the Chamber’s recent comments opposing the EPA’s effort to limit greenhouse gases…Apple supports regulating greenhouse gas emissions, and it is frustrating to find the Chamber at odds with us in this effort. We would prefer the Chamber take a more progressive stance on this critical issue and play a constructive role in addressing the climate crisis. However, because the Chamber’s position differs so sharply with Apple’s, we have decided to resign our membership effective immediately
The Chamber of Commerce says that it is not opposed to action on climate change, just the actions that have actually been proposed in Congress, or floated by the EPA. Still, Apple’s departure is just the latest sign of how quickly the U.S. business community is fracturing over the climate issue.
The U.S. Chamber believes that climate change must be addressed. The Chamber is a consensus-driven organization and welcomes input from any company that wants to work on a comprehensive approach to reduce greenhouse gases. While we’ll continue to represent the broad majority of our membership on this goal, we recognize that there are some companies who stand to gain more than others with the current options on the table.
Banks brace for Latvia's collapse
The Baltic states are once again in the eye of the storm after leaked reports that Sweden is bracing for a full-blown economic and political "breakdown" in Latvia.
The Svenska Dagbladet newspaper said Sweden's finance minister Anders Borg had told banks secretly that Latvia's political order was unravelling, advising them to prepare for the collapse of Latvia's rescue talks.
Latvia has failed to deliver draconian spending cuts agreed to secure the next tranche of its €7.5bn (£6.85bn) bail-out from the EU, the International Monetary Fund, and Sweden, balking at 20pc cuts in pensions and a further 15pc cut in public wages.
The People's Party, the largest group in the coalition, voted against austerity measures last month, raising concerns that the country is ungovernable.
Mr Borg said the world's patience is running out. "It will be very hard to continue with these international programmes if they don't fulfill the spirit and the content in the agreements they have signed."
Latvia's economy contracted by 18.2pc in the twelve months to June, trumped only by Lithuania at 20.4pc. "Latvia's currency peg is back on the agenda, " said Hans Redeker from BNP Paribas. "The government has to relax policy for social reasons. The hardship this winter is going to be unbelievable."
Youth unemployment in Latvia is already 31pc, and concentrated among ethnic Russians. Premier Valdis Dombrovskis said his chief task is to "preserve social peace".
Neil Shearing from Capital Economics said the appetite for austerity has been exhausted. Latvia is "more likely than not" to devalue, toppling pegs in Estonia and Lithuania. "Financial markets elsewhere in the region are likely to be hit by contagion, with Hungary, Romania, and Ukraine most vulnerable."
The area is better able to cope with shocks than during the panic this Spring. The G20 tripled the IMF's fire-fighting fund to $750bn in April, chiefly as an insurance for Eastern Europe. This has greatly reduced risk of a liquidity crisis. It does not alter the slow-burn damage of rising defaults.
The Baltic trio financed property booms in euros (and swiss francs) because rates were lower. It was taken for granted that eventual euro entry had eliminated the exchange risk. This has become a trap. They need to devalue to break the cycle of depression, but cannot do so because of euro mortgages. Instead they hope to claw back lost competitiveness through wage deflation. This takes years, and discipline.
Mr Shearing said Latvia's economy would shink by 30pc whether it devalues or not. The peg merely draws out the agony, and slows the pace of inevitable defaults.
Washington's Center for Economic and Policy Research said the IMF is enforcing a"pro-cyclical contractionary policy" in Latvia. Foreign banks (mostly Swedish) are being rescued at the cost of local taxpayers. The IMF deal equals 34pc of GDP. Latvia is piling up debt to defend its peg. The policy may backfire in any case. Fiscal contraction is causing tax revenues to implode, feeding a vicious circle.
Lars Christensen from Danske Bank said Latvia's political class is chiefly responsible for clinging to the peg. "It's their choice, but if they want the bail-out money, they must do what they promised. They don't seem to understand that the IMF and EU are willing to walk away now that the global economy has improved and spill-over risks have been reduced," he said.
Prospects are grim whatever happens "There is absolutely no sign of stabilisation. The economy is still contracting. It's paralysis," he said.
The Svenska Dagbladet newspaper said Sweden's finance minister Anders Borg had told banks secretly that Latvia's political order was unravelling, advising them to prepare for the collapse of Latvia's rescue talks.
Latvia has failed to deliver draconian spending cuts agreed to secure the next tranche of its €7.5bn (£6.85bn) bail-out from the EU, the International Monetary Fund, and Sweden, balking at 20pc cuts in pensions and a further 15pc cut in public wages.
The People's Party, the largest group in the coalition, voted against austerity measures last month, raising concerns that the country is ungovernable.
Mr Borg said the world's patience is running out. "It will be very hard to continue with these international programmes if they don't fulfill the spirit and the content in the agreements they have signed."
Latvia's economy contracted by 18.2pc in the twelve months to June, trumped only by Lithuania at 20.4pc. "Latvia's currency peg is back on the agenda, " said Hans Redeker from BNP Paribas. "The government has to relax policy for social reasons. The hardship this winter is going to be unbelievable."
Youth unemployment in Latvia is already 31pc, and concentrated among ethnic Russians. Premier Valdis Dombrovskis said his chief task is to "preserve social peace".
Neil Shearing from Capital Economics said the appetite for austerity has been exhausted. Latvia is "more likely than not" to devalue, toppling pegs in Estonia and Lithuania. "Financial markets elsewhere in the region are likely to be hit by contagion, with Hungary, Romania, and Ukraine most vulnerable."
The area is better able to cope with shocks than during the panic this Spring. The G20 tripled the IMF's fire-fighting fund to $750bn in April, chiefly as an insurance for Eastern Europe. This has greatly reduced risk of a liquidity crisis. It does not alter the slow-burn damage of rising defaults.
The Baltic trio financed property booms in euros (and swiss francs) because rates were lower. It was taken for granted that eventual euro entry had eliminated the exchange risk. This has become a trap. They need to devalue to break the cycle of depression, but cannot do so because of euro mortgages. Instead they hope to claw back lost competitiveness through wage deflation. This takes years, and discipline.
Mr Shearing said Latvia's economy would shink by 30pc whether it devalues or not. The peg merely draws out the agony, and slows the pace of inevitable defaults.
Washington's Center for Economic and Policy Research said the IMF is enforcing a"pro-cyclical contractionary policy" in Latvia. Foreign banks (mostly Swedish) are being rescued at the cost of local taxpayers. The IMF deal equals 34pc of GDP. Latvia is piling up debt to defend its peg. The policy may backfire in any case. Fiscal contraction is causing tax revenues to implode, feeding a vicious circle.
Lars Christensen from Danske Bank said Latvia's political class is chiefly responsible for clinging to the peg. "It's their choice, but if they want the bail-out money, they must do what they promised. They don't seem to understand that the IMF and EU are willing to walk away now that the global economy has improved and spill-over risks have been reduced," he said.
Prospects are grim whatever happens "There is absolutely no sign of stabilisation. The economy is still contracting. It's paralysis," he said.
Program to Buy Bad Assets Nearly in Place, U.S. Says
WASHINGTON — The Treasury Department said on Sunday that its scaled-down program to help banks unload their troubled mortgages and mortgage securities would begin operating at full strength by the end of this month, more than a year after Congress authorized $700 billion for that purpose.
Treasury officials said that five out of the nine money-management firms it selected to buy up unwanted mortgage-backed securities had raised the minimum amount of money from private investors — $500 million each — to qualify for matching investments and loans from the federal government.
Administration officials said they expected the remaining four firms to complete their financing by the end of this month.
Three of the biggest investment firms — BlackRock, a group led by the Wellington Management Company and a group led by AllianceBernstein — closed deals for private financing totaling about $1.9 billion. Two other firms, Invesco and the TCW Group, lined up their private investors last week.
At issue is the Public-Private Investment Program, the Obama administration’s attempt to carry out what the Bush administration had originally told Congress would be the main purpose of the $700 billion rescue program for financial institutions.
The initial idea was to have the government clear out the banking system’s pipelines of bad mortgages and nearly unsellable mortgage-backed securities. The Treasury secretary under President George W. Bush, Henry M. Paulson Jr., argued that the government could revive trading in the mortgage market, restore investor confidence and let banks remove troubled assets from their books.
But Mr. Paulson reversed course almost as soon as Congress approved the plan, deciding instead to have the government inject money directly into banks by buying up special nonvoting shares of their preferred stock. The revised plan, known as the Troubled Asset Relief Program, was eventually used to prop up banks, bail out companies like the American International Group, subsidize loan modifications for troubled homeowners and rescue the automobile industry.
The International Monetary Fund estimated last week that financial institutions worldwide still held about $2.8 trillion in troubled mortgages and securities, and that they had booked losses on less than half that amount so far. A big share of those assets is in American banks.
The Public-Private Investment Program would acquire only a tiny fraction of those assets, amounting to $12 billion. All told, the Treasury said, the five firms have thus far raised $3.07 billion in private equity. The Treasury will match that amount, dollar for dollar, with its own equity investment. It will also provide up to $6.13 billion in financing guaranteed by the government.
In effect, the money-management firms will be able to buy about $12 billion in troubled assets. The firms will split any profits evenly with the Treasury, but taxpayers would ultimately be on the hook if the investments lost money.
The program has been hindered by several obstacles. It took government officials months to come up with a plan that they thought would take the greatest advantage of the government’s investment. Investment firms, meanwhile, were worried they might irk Congress, potentially subjecting them to tight restrictions on executive compensation.
Also, banks, the institutions that are expected to do most of the selling of troubled assets, have been reluctant to do so at the bargain-basement prices that investors have been demanding.
But Treasury officials said the program could have important effects on the capital markets, even if it is comparatively small, because it will help establish market prices and restart trading in what had been unsellable assets.
Treasury officials said that five out of the nine money-management firms it selected to buy up unwanted mortgage-backed securities had raised the minimum amount of money from private investors — $500 million each — to qualify for matching investments and loans from the federal government.
Administration officials said they expected the remaining four firms to complete their financing by the end of this month.
Three of the biggest investment firms — BlackRock, a group led by the Wellington Management Company and a group led by AllianceBernstein — closed deals for private financing totaling about $1.9 billion. Two other firms, Invesco and the TCW Group, lined up their private investors last week.
At issue is the Public-Private Investment Program, the Obama administration’s attempt to carry out what the Bush administration had originally told Congress would be the main purpose of the $700 billion rescue program for financial institutions.
The initial idea was to have the government clear out the banking system’s pipelines of bad mortgages and nearly unsellable mortgage-backed securities. The Treasury secretary under President George W. Bush, Henry M. Paulson Jr., argued that the government could revive trading in the mortgage market, restore investor confidence and let banks remove troubled assets from their books.
But Mr. Paulson reversed course almost as soon as Congress approved the plan, deciding instead to have the government inject money directly into banks by buying up special nonvoting shares of their preferred stock. The revised plan, known as the Troubled Asset Relief Program, was eventually used to prop up banks, bail out companies like the American International Group, subsidize loan modifications for troubled homeowners and rescue the automobile industry.
The International Monetary Fund estimated last week that financial institutions worldwide still held about $2.8 trillion in troubled mortgages and securities, and that they had booked losses on less than half that amount so far. A big share of those assets is in American banks.
The Public-Private Investment Program would acquire only a tiny fraction of those assets, amounting to $12 billion. All told, the Treasury said, the five firms have thus far raised $3.07 billion in private equity. The Treasury will match that amount, dollar for dollar, with its own equity investment. It will also provide up to $6.13 billion in financing guaranteed by the government.
In effect, the money-management firms will be able to buy about $12 billion in troubled assets. The firms will split any profits evenly with the Treasury, but taxpayers would ultimately be on the hook if the investments lost money.
The program has been hindered by several obstacles. It took government officials months to come up with a plan that they thought would take the greatest advantage of the government’s investment. Investment firms, meanwhile, were worried they might irk Congress, potentially subjecting them to tight restrictions on executive compensation.
Also, banks, the institutions that are expected to do most of the selling of troubled assets, have been reluctant to do so at the bargain-basement prices that investors have been demanding.
But Treasury officials said the program could have important effects on the capital markets, even if it is comparatively small, because it will help establish market prices and restart trading in what had been unsellable assets.
Twilight of Pax Americana
Since the end of WWII, the world has depended on the United States for stability. But with American military and economic dominance waning, capitalism and global security are threatened.
The international order that emerged after World War II has rightly been termed the Pax Americana; it's a Washington-led arrangement that has maintained political stability and promoted an open global economic system. Today, however, the Pax Americana is withering, thanks to what the National Intelligence Council in a recent report described as a "global shift in relative wealth and economic power without precedent in modern history" -- a shift that has accelerated enormously as a result of the economic crisis of 2007-2009.
At the heart of this geopolitical sea change is China's robust economic growth. Not because Beijing will necessarily threaten American interests but because a newly powerful China by necessity means a relative decline in American power, the very foundation of the postwar international order. These developments remind us that changes in the global balance of power can be sudden and discontinuous rather than gradual and evolutionary.
The Great Recession isn't the cause of Washington's ebbing relative power. But it has quickened trends that already had been eating away at the edifice of U.S. economic supremacy. Looking ahead, the health of the U.S. economy is threatened by a gathering fiscal storm: exploding federal deficits that could ignite runaway inflation and undermine the dollar. To avoid these perils, the U.S. will face wrenching choices.
The Obama administration and the Federal Reserve have adopted policies that have dramatically increased boththe supply of dollars circulating in the U.S. economy and the federal budget deficit, which both the Brookings Institution and the Congressional Budget Office estimate will exceed $1 trillion every year for at least the next decade. In the short run, these policies were no doubt necessary; nevertheless, in the long term, they will almost certainly boomerang. Add that to the persistent U.S. current account deficit, the enormous unfunded liabilities for entitlement programs and the cost of two ongoing wars, and you can see that America's long-term fiscal stability is in jeopardy. As the CBO says: "Even if the recovery occurs as projected and stimulus bill is allowed to expire, the country will face the highest debt/GDP ratio in 50 years and an increasingly unsustainable and urgent fiscal problem." This spells trouble ahead for the dollar.
The financial privileges conferred on the U.S. by the dollar's unchallenged reserve currency status -- its role as the primary form of payment for international trade and financial transactions -- have underpinned the preeminent geopolitical role of the United States in international politics since the end of World War II. But already the shadow of the coming fiscal crisis has prompted its main creditors, China and Japan, to worry that in coming years the dollar will depreciate in value. China has been increasingly vocal in calling for the dollar's replacement by a new reserve currency. And Yukio Hatoyama, Japan's new prime minister, favors Asian economic integration and a single Asian currency as substitutes for eroding U.S. financial and economic power.
Going forward, to defend the dollar, Washington will need to control inflation through some combination of budget cuts, tax increases and interest rate hikes. Given that the last two options would choke off renewed growth, the least unpalatable choice is to reduce federal spending. This will mean radically scaling back defense expenditures, because discretionary nondefense spending accounts for only about 20% of annual federal outlays. This in turn will mean a radical diminution of America's overseas military commitments, transforming both geopolitics and the international economy.
Since 1945, the Pax Americana has made international economic interdependence and globalization possible. Whereas all states benefit absolutely in an open international economy, some states benefit more than others. In the normal course of world politics, the relative distribution of power, not the pursuit of absolute economic gains, is a country's principal concern, and this discourages economic interdependence. In their efforts to ensure a distribution of power in their favor and at the expense of their actual or potential rivals, states pursue autarkic policies -- those designed to maximize national self-sufficiency -- practicing capitalism only within their borders or among countries in a trading bloc.
Thus a truly global economy is extraordinarily difficult to achieve. Historically, the only way to secure international integration and interdependence has been for a dominant power to guarantee the security of other states so that they need not pursue autarkic policies or form trading blocs to improve their relative positions. This suspension of international politics through hegemony has been the fundamental aim of U.S. foreign policy since the 1940s. The U.S. has assumed the responsibility for maintaining geopolitical stability in Europe, East Asia and the Persian Gulf, and for keeping open the lines of communication through which world trade moves. Since the Cold War's end, the U.S. has sought to preserve its hegemony by possessing a margin of military superiority so vast that it can keep any would-be great power pliant and protected.
Financially, the U.S. has been responsible for managing the global economy by acting as the market and lender of last resort. But as President Obama acknowledged at the London G-20 meeting in April, the U.S. is no longer able to play this role, and the world increasingly is looking to China (and India and other emerging market states) to be the locomotives of global recovery.
Going forward, the fiscal crisis will mean that Washington cannot discharge its military functions as a hegemon either, because it can no longer maintain the power edge that has allowed it to keep the ambitions of the emerging great powers in check. The entire fabric of world order that the United States established after 1945 -- the Pax Americana -- rested on the foundation of U.S. military and economic preponderance. Remove the foundation and the structure crumbles. The decline of American power means the end of U.S. dominance in world politics and the beginning of the transition to a new constellation of world powers.
The result will be profound changes in world politics. Emerging powers will seek to establish spheres of influence, control lines of communication, engage in arms races and compete for control over key natural resources. As America's decline results in the retraction of the U.S. military role in key regions, rivalries among emerging powers are bound to heat up. Already, China and India are competing for influence in Central and Southeast Asia, the Middle East and the Indian Ocean. Even today, when the United States is still acting as East Asia's regional pacifier, the smoldering security competition between China and Japan is pushing Japan cautiously to engage in the very kind of "re-nationalization" of its security policy that the U.S. regional presence is supposed to prevent. While still wedded to its alliance with the U.S., in recent years Tokyo has become increasingly anxious that, as a Rand Corp. study put it, eventually it "might face a threat against which the United States would not prove a reliable ally." Consequently, Japan is moving toward dropping Article 9 of its American-imposed Constitution (which imposes severe constraints on Japan's military), building up its forces and quietly pondering the possibility of becoming a nuclear power.
Although the weakening of the Pax Americana will not cause international trade and capital flows to come to a grinding halt, in coming years we can expect states to adopt openly competitive economic policies as they are forced to jockey for power and advantage in an increasingly competitive security and economic environment. The world economy will thereby more closely resemble that of the 1930s than the free-trade system of the post-1945 Pax Americana. The coming end of the Pax Americana heralds a crisis for capitalism.
The coming era of de-globalization will be defined by rising nationalism and mercantilism, geopolitical instability and great power competition. In other words, having enjoyed a long holiday from history under the Pax Americana, international politics will be headed back to the future.
Christopher Layne is a professor of government at Texas A&M and a consultant to the National Intelligence Council. Benjamin Schwarz is literary and national editor of the Atlantic.
The international order that emerged after World War II has rightly been termed the Pax Americana; it's a Washington-led arrangement that has maintained political stability and promoted an open global economic system. Today, however, the Pax Americana is withering, thanks to what the National Intelligence Council in a recent report described as a "global shift in relative wealth and economic power without precedent in modern history" -- a shift that has accelerated enormously as a result of the economic crisis of 2007-2009.
At the heart of this geopolitical sea change is China's robust economic growth. Not because Beijing will necessarily threaten American interests but because a newly powerful China by necessity means a relative decline in American power, the very foundation of the postwar international order. These developments remind us that changes in the global balance of power can be sudden and discontinuous rather than gradual and evolutionary.
The Great Recession isn't the cause of Washington's ebbing relative power. But it has quickened trends that already had been eating away at the edifice of U.S. economic supremacy. Looking ahead, the health of the U.S. economy is threatened by a gathering fiscal storm: exploding federal deficits that could ignite runaway inflation and undermine the dollar. To avoid these perils, the U.S. will face wrenching choices.
The Obama administration and the Federal Reserve have adopted policies that have dramatically increased boththe supply of dollars circulating in the U.S. economy and the federal budget deficit, which both the Brookings Institution and the Congressional Budget Office estimate will exceed $1 trillion every year for at least the next decade. In the short run, these policies were no doubt necessary; nevertheless, in the long term, they will almost certainly boomerang. Add that to the persistent U.S. current account deficit, the enormous unfunded liabilities for entitlement programs and the cost of two ongoing wars, and you can see that America's long-term fiscal stability is in jeopardy. As the CBO says: "Even if the recovery occurs as projected and stimulus bill is allowed to expire, the country will face the highest debt/GDP ratio in 50 years and an increasingly unsustainable and urgent fiscal problem." This spells trouble ahead for the dollar.
The financial privileges conferred on the U.S. by the dollar's unchallenged reserve currency status -- its role as the primary form of payment for international trade and financial transactions -- have underpinned the preeminent geopolitical role of the United States in international politics since the end of World War II. But already the shadow of the coming fiscal crisis has prompted its main creditors, China and Japan, to worry that in coming years the dollar will depreciate in value. China has been increasingly vocal in calling for the dollar's replacement by a new reserve currency. And Yukio Hatoyama, Japan's new prime minister, favors Asian economic integration and a single Asian currency as substitutes for eroding U.S. financial and economic power.
Going forward, to defend the dollar, Washington will need to control inflation through some combination of budget cuts, tax increases and interest rate hikes. Given that the last two options would choke off renewed growth, the least unpalatable choice is to reduce federal spending. This will mean radically scaling back defense expenditures, because discretionary nondefense spending accounts for only about 20% of annual federal outlays. This in turn will mean a radical diminution of America's overseas military commitments, transforming both geopolitics and the international economy.
Since 1945, the Pax Americana has made international economic interdependence and globalization possible. Whereas all states benefit absolutely in an open international economy, some states benefit more than others. In the normal course of world politics, the relative distribution of power, not the pursuit of absolute economic gains, is a country's principal concern, and this discourages economic interdependence. In their efforts to ensure a distribution of power in their favor and at the expense of their actual or potential rivals, states pursue autarkic policies -- those designed to maximize national self-sufficiency -- practicing capitalism only within their borders or among countries in a trading bloc.
Thus a truly global economy is extraordinarily difficult to achieve. Historically, the only way to secure international integration and interdependence has been for a dominant power to guarantee the security of other states so that they need not pursue autarkic policies or form trading blocs to improve their relative positions. This suspension of international politics through hegemony has been the fundamental aim of U.S. foreign policy since the 1940s. The U.S. has assumed the responsibility for maintaining geopolitical stability in Europe, East Asia and the Persian Gulf, and for keeping open the lines of communication through which world trade moves. Since the Cold War's end, the U.S. has sought to preserve its hegemony by possessing a margin of military superiority so vast that it can keep any would-be great power pliant and protected.
Financially, the U.S. has been responsible for managing the global economy by acting as the market and lender of last resort. But as President Obama acknowledged at the London G-20 meeting in April, the U.S. is no longer able to play this role, and the world increasingly is looking to China (and India and other emerging market states) to be the locomotives of global recovery.
Going forward, the fiscal crisis will mean that Washington cannot discharge its military functions as a hegemon either, because it can no longer maintain the power edge that has allowed it to keep the ambitions of the emerging great powers in check. The entire fabric of world order that the United States established after 1945 -- the Pax Americana -- rested on the foundation of U.S. military and economic preponderance. Remove the foundation and the structure crumbles. The decline of American power means the end of U.S. dominance in world politics and the beginning of the transition to a new constellation of world powers.
The result will be profound changes in world politics. Emerging powers will seek to establish spheres of influence, control lines of communication, engage in arms races and compete for control over key natural resources. As America's decline results in the retraction of the U.S. military role in key regions, rivalries among emerging powers are bound to heat up. Already, China and India are competing for influence in Central and Southeast Asia, the Middle East and the Indian Ocean. Even today, when the United States is still acting as East Asia's regional pacifier, the smoldering security competition between China and Japan is pushing Japan cautiously to engage in the very kind of "re-nationalization" of its security policy that the U.S. regional presence is supposed to prevent. While still wedded to its alliance with the U.S., in recent years Tokyo has become increasingly anxious that, as a Rand Corp. study put it, eventually it "might face a threat against which the United States would not prove a reliable ally." Consequently, Japan is moving toward dropping Article 9 of its American-imposed Constitution (which imposes severe constraints on Japan's military), building up its forces and quietly pondering the possibility of becoming a nuclear power.
Although the weakening of the Pax Americana will not cause international trade and capital flows to come to a grinding halt, in coming years we can expect states to adopt openly competitive economic policies as they are forced to jockey for power and advantage in an increasingly competitive security and economic environment. The world economy will thereby more closely resemble that of the 1930s than the free-trade system of the post-1945 Pax Americana. The coming end of the Pax Americana heralds a crisis for capitalism.
The coming era of de-globalization will be defined by rising nationalism and mercantilism, geopolitical instability and great power competition. In other words, having enjoyed a long holiday from history under the Pax Americana, international politics will be headed back to the future.
Christopher Layne is a professor of government at Texas A&M and a consultant to the National Intelligence Council. Benjamin Schwarz is literary and national editor of the Atlantic.
Why metals stocks haven't peaked
Is it too late to buy into the boom in metals stocks -- everything from gold to silver to copper to iron to zinc? After all, flashy gold stock Goldcorp (GG, news, msgs) is up 130% or so in the last 52 weeks, and traditional, plodding copper stock Phelps Dodge (PD, news, msgs) isn't far behind, with a 90% return.
Or does the current boom in metals have longer to run, making this a good time to buy despite gains like these?
Investors looking to answer questions like those should take a clue from the boom in oil prices and particularly from a theory called Peak Oil. The analogy isn't perfect -- the commodity markets for metals are much smaller and much more speculative than the market for crude oil. But applying a theory that I'm calling "Peak Metal" argues that while short-run risks have risen recently, the boom in the prices of metals and metal stocks is a long, long way from over. Over the long term, the only thing likely to derail it, in fact, is a big slowdown in the global economy -- and therefore in global demand. And that doesn't look likely in either 2006 or 2007.
See the news
that affects your stocks.
Check out our
new News center.
The supply squeeze at work
Peak Oil is a controversial theory that argues that, sometime soon, global oil production is due to hit a peak. After that point, no matter how much money oil companies spend on exploring for new oil and developing new reserves, global oil production won't go up. After a period of stagnant production, global production will indeed start to decline.
Most of the controversy about Peak Oil involves shouting matches about when -- if ever -- this peak will occur. Estimates range from now to 2008 to 2020 to never.
Related news and commentary on MSN Money
Related resources image
• Why gold stocks should go higher
• Oil patch is drowning in cash
• 3 stocks for a worldwide sugar rush
• Leave the new oil ETF to the pros
• Gold's big run is almost over
To me, predicting the date for peak production is an interesting parlor game. Given the immense ignorance we have about the true levels of production and reserves in major oil producers such as Saudi Arabia and Russia, I simply don't think it's possible to come up with a specific year.
But I find the mechanisms that Peak Oil theory has developed to explain the direction of oil prices and the operation of the oil market immediately applicable to the metals sector.
Here's how those mechanisms work for oil: As oil production moves toward the peak, oil also becomes harder to find. Discoveries are smaller and in less-accessible regions or geologic formations. And it costs more to produce the crude from these discoveries.
Producing oil from existing fields also gets more expensive: It's never possible to recover 100% of all the oil in a field, and recovering the last barrel of oil also requires more technology, more equipment, and more dollars than recovering the first barrel. Peak Oil theory also notes that extracting oil from a field damages the field by allowing water to infiltrate the oil pools, by leading to the collapse of rock or sand formations, and the like. That happens even if the oil producer has put adequate capital into the infrastructure of the field, which most oil producers haven't done over the last decade or two.
The price of oil rises as the peak approaches for both reasons.
It's at this stage that opponents of Peak Oil theory often object that Peak Oil doesn't take into account the effect of those higher prices on oil production. As oil prices go up, it becomes profitable to exploit oil deposits, such as Canada's huge oil sands reserves. And it becomes profitable to find substitutes for oil -- such as ethanol or bio-diesel. This postpones the day of Peak Oil, perhaps indefinitely.
But this counterargument, ironically, actually validates the key insight of Peak Oil. As the production peak approaches, the price of oil rises -- even as unconventional sources of oil and substitutions come to market -- because these new sources and substitutes are more expensive to produce than oil used to be. If they weren't, they would have been put into production during the days of cheap oil. In effect, the rise of oil prices in Peak Oil theory creates a price floor for these new sources. As the floor moves up -- to $40 oil from $30 oil, for example, and then to $60 oil -- new sources and substitutes become profitable. That slows the price rise predicted by Peak Oil. But it doesn't reverse it
Twin peaks?
Now look at the three similarities between Peak Oil and Peak Metal:
* Its becoming harder and harder to find significant new deposits of everything from gold to copper. Gold production in South Africa, traditionally the worlds biggest gold producer, is now just one-third of its peak because the country's deep underground mines are exhausted and mining companies haven't been able to find enough new gold deposits to make up the difference. Global gold production has actually tumbled as gold prices have spiked. After peaking in 2001 at 2,621 metric tons when gold sold for less than $260 an ounce, gold production fell in 2005 to under 2,500 tons.
* When new deposits are discovered, they are in politically riskier countries. In gold and copper, that's meant replacing production from South Africa and the United States with production from Peru and Indonesia, for example.
* Production costs are higher in newly discovered deposits. Part of that's a result of location: It's more expensive to produce copper if you have to build roads, railroads and ports from scratch in remote Indonesia than it is to produce copper from Arizona. And part of that is a result of the poorer quality of newly discovered deposits. Costs are rising at many gold-mining companies because the grade of ore -- the amount of gold per ton of rock -- is lower in newly discovered deposits than in older mines.
To those, I'd add these factors that could produce even sharper and more sustained price increases for Peak Metal than for Peak Oil.
* Mining companies are even more conservative about adding new production than oil companies. Oil companies, initially hesitant to invest when oil hit $30 because they were worried that oil prices would fall back to $20 or less, have started to factor $30- or even $40-a-barrel oil into their long-term capital-spending plans. Mining companies, scarred by the boom-and-bust cycle of an industry that is even more cyclical than oil, are so far sticking by their pre-boom projections for the prices of their commodities. Freeport-McMoRan Copper & Gold (FCX, news, msgs), for example, recently reaffirmed its decision to use projected copper prices of 80 cents to 90 cents a pound in making its decisions on capital spending to increase production. "Metal prices, like all commodities ... are cyclical," CEO Richard Adkerson told the Financial Times this month, "and I don't see any reason to change the long-term planning price because prices are higher." Copper now trades at $2.70 a pound.
* Oil producers have been able to exploit new technology to drill deeper, to force oil and gas out of stubborn geologic formations, and then bring vast new types of reserves -- oil sands and oil shale, for example -- into production. Nothing comparable has occurred in the metals sector. The last big technology shift -- from deep, underground shaft mining to vast, open-air pit mining -- is decades old. (The next big things -- genetically engineered bacteria and viruses that excrete metals from even the lowest grade deposits -- are now just smears on laboratory Petri dishes.)
All these Peak Metal factors make me want to rush out and add more metals stocks to my portfolio.
But one difference between the markets for oil and metals gives me pause: The commodity markets for metals are so much smaller than the commodity market for oil that it is much, much easier for speculative demand to drive up the price of gold, silver, copper, etc., than it is to drive up the price of oil
Not that the price of oil hasn't moved up and down as speculative cash has flooded in and out of the oil market. The price of a barrel of West Texas Intermediate hit an intraday high of $70.85 on Aug. 30, 2005, as traders bid up the price of oil on speculation that Hurricane Katrina -- which made landfall on Aug. 29 -- would shut down a significant part of oil production and refining in the Gulf of Mexico to drive up oil prices. On Nov. 1, the price was down to $58.30, despite Hurricane Rita's landfall on Sept. 24 and the damage it caused, as traders sold the storms. Despite crude inventories at high levels, oil prices have bounced back in the last two months, on speculation that something in Nigeria or Iran or Venezuela would disrupt supply. Crude oil in New York closed at $70.40 a barrel on Monday, its first close ever above $70.
But it took the anticipation of two huge hurricanes -- and then the passing of those storms -- plus the prospects of major geopolitical upheaval to produce a 10% to 15% swing in oil this year and last. In the much smaller gold and silver markets, all it takes is the launching of an ETF or two. First gold and now silver have been driven higher on the projected launch of funds that let retail investors buy the commodity. The launch of gold ETFs pushed gold prices up 12% in the 90 days before the ETFs were actually launched. (Prices fell 10% in the 90 days after trading in the ETFs began.) Silver is now going through the same process. Not surprising since Barclays Global Investors, the backer of the silver ETF, estimates that demand for its ETF will require it to buy 12% -- 130 million ounces -- of global silver demand.
Waiting for the metals to cool
So where do I come down?
Yes, in the long term I believe the metals boom will run for the rest of the decade -- or until a downturn in the global economy puts the kibosh on demand for all commodities. So, for the long term (or until the day of economic reckoning), I'd like to own shares of metals producers.
Jim Jubak's newsletter
Get the latest from Jim Jubak. Sign up to receive his free weekly newsletter.
Your e-mail address:
Learn more about newsletters
And, yes, in the short term, I believe that flows of speculative cash have pushed the prices of all the metals, but especially silver and copper, to heights where they've become unglued from the positive long-term fundamentals. (Gold, the first choice of investors in any crisis, is as always a special case.) In the jargon of Wall Street, they're ahead of themselves. I wouldn't sell positions in this sector that I own -- the froth will get frothier over the next few months in the aftermath of copper strikes in Mexico and the election in Peru -- but I wouldn't add new positions just yet.
For that I'd wait for a sharp little correction. Nothing too big, mind you. But enough to take gold and silver off the front page of The Wall Street Journal for a while.
3 big threats to Chinas economic miracle
Here's the headline from April 17, 2006: "China sees GDP grow by more than 10%." Read deeper into the story and the news turns into a very mixed bag. Good for investors in the shares of international commodity producers. Bad for investors worried that China's economy will first overheat and then blow up. According to preliminary and unofficial numbers, China's economy grew by 10.2% in the first quarter of 2006 on the backs of higher exports and increased inflows of investment capital. To the degree exports fueled that level of growth, slightly above expectations, it just about guarantees that the bull market in the commodities that China buys most to fuel its economy -- iron, copper, oil, nickel, and zinc -- will keep going. However, the portion of that growth that has been fueled by inflows of investment capital marks a big step backward for a Chinese government that has been trying to dampen bank lending and growth in the money supply. Chinese banks made $137 billion in new loans in the first quarter -- that's nearly halfway to the government's target for all of 2006. Money supply grew at a 19% annual rate, well ahead of the 16% government target. Runaway money-supply growth fuels inflation in China, and abundant loan money makes it harder for the government to shut down money-losing inefficient factories. One way for the Chinese government to fight this problem would be to let the yuan climb in value against the dollar. So far, however, the government has kept the yuan on a tight leash, allowing appreciation of just 3% against the dollar since the country officially un-pegged the yuan from the dollar last year.
Or does the current boom in metals have longer to run, making this a good time to buy despite gains like these?
Investors looking to answer questions like those should take a clue from the boom in oil prices and particularly from a theory called Peak Oil. The analogy isn't perfect -- the commodity markets for metals are much smaller and much more speculative than the market for crude oil. But applying a theory that I'm calling "Peak Metal" argues that while short-run risks have risen recently, the boom in the prices of metals and metal stocks is a long, long way from over. Over the long term, the only thing likely to derail it, in fact, is a big slowdown in the global economy -- and therefore in global demand. And that doesn't look likely in either 2006 or 2007.
See the news
that affects your stocks.
Check out our
new News center.
The supply squeeze at work
Peak Oil is a controversial theory that argues that, sometime soon, global oil production is due to hit a peak. After that point, no matter how much money oil companies spend on exploring for new oil and developing new reserves, global oil production won't go up. After a period of stagnant production, global production will indeed start to decline.
Most of the controversy about Peak Oil involves shouting matches about when -- if ever -- this peak will occur. Estimates range from now to 2008 to 2020 to never.
Related news and commentary on MSN Money
Related resources image
• Why gold stocks should go higher
• Oil patch is drowning in cash
• 3 stocks for a worldwide sugar rush
• Leave the new oil ETF to the pros
• Gold's big run is almost over
To me, predicting the date for peak production is an interesting parlor game. Given the immense ignorance we have about the true levels of production and reserves in major oil producers such as Saudi Arabia and Russia, I simply don't think it's possible to come up with a specific year.
But I find the mechanisms that Peak Oil theory has developed to explain the direction of oil prices and the operation of the oil market immediately applicable to the metals sector.
Here's how those mechanisms work for oil: As oil production moves toward the peak, oil also becomes harder to find. Discoveries are smaller and in less-accessible regions or geologic formations. And it costs more to produce the crude from these discoveries.
Producing oil from existing fields also gets more expensive: It's never possible to recover 100% of all the oil in a field, and recovering the last barrel of oil also requires more technology, more equipment, and more dollars than recovering the first barrel. Peak Oil theory also notes that extracting oil from a field damages the field by allowing water to infiltrate the oil pools, by leading to the collapse of rock or sand formations, and the like. That happens even if the oil producer has put adequate capital into the infrastructure of the field, which most oil producers haven't done over the last decade or two.
The price of oil rises as the peak approaches for both reasons.
It's at this stage that opponents of Peak Oil theory often object that Peak Oil doesn't take into account the effect of those higher prices on oil production. As oil prices go up, it becomes profitable to exploit oil deposits, such as Canada's huge oil sands reserves. And it becomes profitable to find substitutes for oil -- such as ethanol or bio-diesel. This postpones the day of Peak Oil, perhaps indefinitely.
But this counterargument, ironically, actually validates the key insight of Peak Oil. As the production peak approaches, the price of oil rises -- even as unconventional sources of oil and substitutions come to market -- because these new sources and substitutes are more expensive to produce than oil used to be. If they weren't, they would have been put into production during the days of cheap oil. In effect, the rise of oil prices in Peak Oil theory creates a price floor for these new sources. As the floor moves up -- to $40 oil from $30 oil, for example, and then to $60 oil -- new sources and substitutes become profitable. That slows the price rise predicted by Peak Oil. But it doesn't reverse it
Twin peaks?
Now look at the three similarities between Peak Oil and Peak Metal:
* Its becoming harder and harder to find significant new deposits of everything from gold to copper. Gold production in South Africa, traditionally the worlds biggest gold producer, is now just one-third of its peak because the country's deep underground mines are exhausted and mining companies haven't been able to find enough new gold deposits to make up the difference. Global gold production has actually tumbled as gold prices have spiked. After peaking in 2001 at 2,621 metric tons when gold sold for less than $260 an ounce, gold production fell in 2005 to under 2,500 tons.
* When new deposits are discovered, they are in politically riskier countries. In gold and copper, that's meant replacing production from South Africa and the United States with production from Peru and Indonesia, for example.
* Production costs are higher in newly discovered deposits. Part of that's a result of location: It's more expensive to produce copper if you have to build roads, railroads and ports from scratch in remote Indonesia than it is to produce copper from Arizona. And part of that is a result of the poorer quality of newly discovered deposits. Costs are rising at many gold-mining companies because the grade of ore -- the amount of gold per ton of rock -- is lower in newly discovered deposits than in older mines.
To those, I'd add these factors that could produce even sharper and more sustained price increases for Peak Metal than for Peak Oil.
* Mining companies are even more conservative about adding new production than oil companies. Oil companies, initially hesitant to invest when oil hit $30 because they were worried that oil prices would fall back to $20 or less, have started to factor $30- or even $40-a-barrel oil into their long-term capital-spending plans. Mining companies, scarred by the boom-and-bust cycle of an industry that is even more cyclical than oil, are so far sticking by their pre-boom projections for the prices of their commodities. Freeport-McMoRan Copper & Gold (FCX, news, msgs), for example, recently reaffirmed its decision to use projected copper prices of 80 cents to 90 cents a pound in making its decisions on capital spending to increase production. "Metal prices, like all commodities ... are cyclical," CEO Richard Adkerson told the Financial Times this month, "and I don't see any reason to change the long-term planning price because prices are higher." Copper now trades at $2.70 a pound.
* Oil producers have been able to exploit new technology to drill deeper, to force oil and gas out of stubborn geologic formations, and then bring vast new types of reserves -- oil sands and oil shale, for example -- into production. Nothing comparable has occurred in the metals sector. The last big technology shift -- from deep, underground shaft mining to vast, open-air pit mining -- is decades old. (The next big things -- genetically engineered bacteria and viruses that excrete metals from even the lowest grade deposits -- are now just smears on laboratory Petri dishes.)
All these Peak Metal factors make me want to rush out and add more metals stocks to my portfolio.
But one difference between the markets for oil and metals gives me pause: The commodity markets for metals are so much smaller than the commodity market for oil that it is much, much easier for speculative demand to drive up the price of gold, silver, copper, etc., than it is to drive up the price of oil
Not that the price of oil hasn't moved up and down as speculative cash has flooded in and out of the oil market. The price of a barrel of West Texas Intermediate hit an intraday high of $70.85 on Aug. 30, 2005, as traders bid up the price of oil on speculation that Hurricane Katrina -- which made landfall on Aug. 29 -- would shut down a significant part of oil production and refining in the Gulf of Mexico to drive up oil prices. On Nov. 1, the price was down to $58.30, despite Hurricane Rita's landfall on Sept. 24 and the damage it caused, as traders sold the storms. Despite crude inventories at high levels, oil prices have bounced back in the last two months, on speculation that something in Nigeria or Iran or Venezuela would disrupt supply. Crude oil in New York closed at $70.40 a barrel on Monday, its first close ever above $70.
But it took the anticipation of two huge hurricanes -- and then the passing of those storms -- plus the prospects of major geopolitical upheaval to produce a 10% to 15% swing in oil this year and last. In the much smaller gold and silver markets, all it takes is the launching of an ETF or two. First gold and now silver have been driven higher on the projected launch of funds that let retail investors buy the commodity. The launch of gold ETFs pushed gold prices up 12% in the 90 days before the ETFs were actually launched. (Prices fell 10% in the 90 days after trading in the ETFs began.) Silver is now going through the same process. Not surprising since Barclays Global Investors, the backer of the silver ETF, estimates that demand for its ETF will require it to buy 12% -- 130 million ounces -- of global silver demand.
Waiting for the metals to cool
So where do I come down?
Yes, in the long term I believe the metals boom will run for the rest of the decade -- or until a downturn in the global economy puts the kibosh on demand for all commodities. So, for the long term (or until the day of economic reckoning), I'd like to own shares of metals producers.
Jim Jubak's newsletter
Get the latest from Jim Jubak. Sign up to receive his free weekly newsletter.
Your e-mail address:
Learn more about newsletters
And, yes, in the short term, I believe that flows of speculative cash have pushed the prices of all the metals, but especially silver and copper, to heights where they've become unglued from the positive long-term fundamentals. (Gold, the first choice of investors in any crisis, is as always a special case.) In the jargon of Wall Street, they're ahead of themselves. I wouldn't sell positions in this sector that I own -- the froth will get frothier over the next few months in the aftermath of copper strikes in Mexico and the election in Peru -- but I wouldn't add new positions just yet.
For that I'd wait for a sharp little correction. Nothing too big, mind you. But enough to take gold and silver off the front page of The Wall Street Journal for a while.
3 big threats to Chinas economic miracle
Here's the headline from April 17, 2006: "China sees GDP grow by more than 10%." Read deeper into the story and the news turns into a very mixed bag. Good for investors in the shares of international commodity producers. Bad for investors worried that China's economy will first overheat and then blow up. According to preliminary and unofficial numbers, China's economy grew by 10.2% in the first quarter of 2006 on the backs of higher exports and increased inflows of investment capital. To the degree exports fueled that level of growth, slightly above expectations, it just about guarantees that the bull market in the commodities that China buys most to fuel its economy -- iron, copper, oil, nickel, and zinc -- will keep going. However, the portion of that growth that has been fueled by inflows of investment capital marks a big step backward for a Chinese government that has been trying to dampen bank lending and growth in the money supply. Chinese banks made $137 billion in new loans in the first quarter -- that's nearly halfway to the government's target for all of 2006. Money supply grew at a 19% annual rate, well ahead of the 16% government target. Runaway money-supply growth fuels inflation in China, and abundant loan money makes it harder for the government to shut down money-losing inefficient factories. One way for the Chinese government to fight this problem would be to let the yuan climb in value against the dollar. So far, however, the government has kept the yuan on a tight leash, allowing appreciation of just 3% against the dollar since the country officially un-pegged the yuan from the dollar last year.
Potential end of dollar-based oil deals helps gold shine
TOKYO (MarketWatch) -- Growing speculation over the potential end to dollar-based trading in the oil market may be part of the reason gold prices have rallied beyond $1,020 an ounce to stand near their highest level in 18 months.
And the strength was kept even as several top officials, including Saudi central bank chief Muhammad al-Jasser, denied the report.
Gulf Arab states, along with China, Russia, Japan and France, are planning to put an end to dollar-based trading in the oil market, according to an exclusive report published Tuesday in the U.K. by The Independent.
"News on gold's expected future role in oil transactions between these trading partners has sent the price past $1,020," said Peter Spina, chief investment analyst at GoldSeek.com.
In place of the greenback, the nations plan to use a basket of currencies, including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar, the report said.
The Independent said the plans were confirmed by both Gulf Arab and Chinese banking sources in Hong Kong.
Several top Gulf central bankers immediately dismissed the talk, and the vice chairman of China's central bank made no mention of such a move in a speech.
The report is "absolutely bullish," for gold, said Peter Grandich, a metals writer at Agoracom. "I've not see gold's fundamentals this bullish in years."
The December contract for gold, the most-active on the Comex division of the New York Mercantile Exchange, closed Monday with a gain of $13.50, or 1.3%, at $1,017.80 an ounce. By the morning in London, December gold was up $2.80 to $1,020.70.
In mid-September, futures prices had climbed past $1,025 to hit a fresh 18-month high. The record intraday price for a front-month gold contract is $1,033.90, set on March 17, 2008.
Many analysts had attributed the gains Monday to higher demand in the face of more weakness in the U.S. dollar. See Metals Stocks.
But, as Spina pointed out, trading gold and other currencies in exchange for oil would "establish gold as a recognized medium of exchange, returning it a step closer to its role as money on a world trade system."
So the price of gold "should continue to find upward price pressures on this news," he said.
At the same time, "the domination of the U.S. dollar is further removed and really, it has been the pricing of oil in dollars for trade that has given it a huge boost in its demand globally," said Spina.
If the dollar is presently being used to transact oil between these nations, then they must use many billions of dollars to do so, he explained.
"If they will switch away from the U.S. buck, then all that demand disappears, the need for the U.S. dollar diminishes, and its value should reflect this," he said.
At last check, one U.S. dollar bought 88.97 Japanese yen, down from 89.49 yen in late New York Trading Monday. One euro bought $1.4726, up from $1.466.
"Transacting in gold will boost demand [for gold] as the U.S. dollar's role diminishes," said Spina.
All in all, "this news is certainly bullish for gold's prospects for further use in international trade going forward," he said.
And the strength was kept even as several top officials, including Saudi central bank chief Muhammad al-Jasser, denied the report.
Gulf Arab states, along with China, Russia, Japan and France, are planning to put an end to dollar-based trading in the oil market, according to an exclusive report published Tuesday in the U.K. by The Independent.
"News on gold's expected future role in oil transactions between these trading partners has sent the price past $1,020," said Peter Spina, chief investment analyst at GoldSeek.com.
In place of the greenback, the nations plan to use a basket of currencies, including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar, the report said.
The Independent said the plans were confirmed by both Gulf Arab and Chinese banking sources in Hong Kong.
Several top Gulf central bankers immediately dismissed the talk, and the vice chairman of China's central bank made no mention of such a move in a speech.
The report is "absolutely bullish," for gold, said Peter Grandich, a metals writer at Agoracom. "I've not see gold's fundamentals this bullish in years."
The December contract for gold, the most-active on the Comex division of the New York Mercantile Exchange, closed Monday with a gain of $13.50, or 1.3%, at $1,017.80 an ounce. By the morning in London, December gold was up $2.80 to $1,020.70.
In mid-September, futures prices had climbed past $1,025 to hit a fresh 18-month high. The record intraday price for a front-month gold contract is $1,033.90, set on March 17, 2008.
Many analysts had attributed the gains Monday to higher demand in the face of more weakness in the U.S. dollar. See Metals Stocks.
But, as Spina pointed out, trading gold and other currencies in exchange for oil would "establish gold as a recognized medium of exchange, returning it a step closer to its role as money on a world trade system."
So the price of gold "should continue to find upward price pressures on this news," he said.
At the same time, "the domination of the U.S. dollar is further removed and really, it has been the pricing of oil in dollars for trade that has given it a huge boost in its demand globally," said Spina.
If the dollar is presently being used to transact oil between these nations, then they must use many billions of dollars to do so, he explained.
"If they will switch away from the U.S. buck, then all that demand disappears, the need for the U.S. dollar diminishes, and its value should reflect this," he said.
At last check, one U.S. dollar bought 88.97 Japanese yen, down from 89.49 yen in late New York Trading Monday. One euro bought $1.4726, up from $1.466.
"Transacting in gold will boost demand [for gold] as the U.S. dollar's role diminishes," said Spina.
All in all, "this news is certainly bullish for gold's prospects for further use in international trade going forward," he said.
Gold hits record $1,045 on report of dollar's demise
NEW YORK (MarketWatch) -- Gold finished at a new record closing level on Tuesday, after earlier hitting a record intraday high of $1,045 an ounce, as the dollar slumped on a report suggesting the end of dollar-based oil trading and as Australia hiked interest rates.
A report in the U.K.'s Independent newspaper said that Gulf-area oil producers, along with China, Russia, Japan and France, are planning to eventually end dollar-based oil pricing.
Gold hits record high
Gold rallied to a new high Tuesday on concerns about the weakness of the U.S. dollar. Brian Hicks, portfolio manager with U.S. Global Investors, says he's raising his target on the metal. MarketWatch's Stacey Delo reports.
With the greenback under selling pressure, investors moved into dollar-denominated commodities such as gold.
Gold for December delivery gained $21.90, or 2.2%, to end at $1,039.70 an ounce, a new record closing level. It earlier reached a high of $1,045.0 an ounce, topping the previous record of $1,033.90 in March 2008.
Gold's new high is "very significant," says Brien Lundin, editor of the Gold Newsletter, published by Jefferson Financial. "Reaching $1,100 by the end of the year is now a conservative estimate."
A report in the U.K.'s Independent newspaper said that Gulf-area oil producers, along with China, Russia, Japan and France, are planning to eventually end dollar-based oil pricing.
Gold hits record high
Gold rallied to a new high Tuesday on concerns about the weakness of the U.S. dollar. Brian Hicks, portfolio manager with U.S. Global Investors, says he's raising his target on the metal. MarketWatch's Stacey Delo reports.
With the greenback under selling pressure, investors moved into dollar-denominated commodities such as gold.
Gold for December delivery gained $21.90, or 2.2%, to end at $1,039.70 an ounce, a new record closing level. It earlier reached a high of $1,045.0 an ounce, topping the previous record of $1,033.90 in March 2008.
Gold's new high is "very significant," says Brien Lundin, editor of the Gold Newsletter, published by Jefferson Financial. "Reaching $1,100 by the end of the year is now a conservative estimate."
Byron King: Peak Gold + Weak Dollar = $2,000+
A highly regarded resource sector expert who discusses his field fervently whenever possible and whose writings include the top-ranking Outstanding Investments, Byron King brings his views direct to The Gold Report audience in this exclusive interview. Unconvinced that the recession is behind us, he is equally sure that the "bottomless pit" mentality of stimulus spending will wreck the dollar. Those are among the reasons he sees $2,000-per-ounce gold on the not-too-distant horizon.
The Gold Report: We've seen quite a rebound in the markets since we spoke in May, and governments across the world have begun releasing some positive economic news. Are we out of the recession as Bernanke has told us?
Byron King: I don't agree with that all. It's like at the funeral home where they put really good makeup on the corpse and people walk in and say, "Oh, he looks so good." Then you think to yourself, "Wait a minute. If he looks so good, why is he dead?" That's where we are now, I think, with our economy. We're still in the recession, it has been well-masked.
Let me digress and say that yes, the stock market rebounded. The "sell in May, go away" thing didn't work this year. So if you stayed in the market, you probably benefited very well from the market recovery. But it was a recovery not rooted in fundamentals. Part of it is that we've had a banking recovery, too. But that was because of massive infusions of new liquidity out of the Federal Reserve and the Treasury Department into the financial sector. That's not the prescription for long-term health.
As with someone really sick in the hospital, the problem isn't putting him on life support; the problem is getting him off the respirator. Now the question is how to stop hemorrhaging public money into the system, and in fact, begin pulling some of it back out.
TGR: Let's assume for now that the government isn't prone to taking the patient off the respirator. Do you expect diminishing returns in terms of less recovery seen for every dollar the government puts into the system?
BK: That's a great point. We're there, at the point of diminishing returns in terms of what it takes to get another dollar of real GDP. It doesn't matter how much green ink they use down at the Bureau of Engraving and Printing or how many ones and zeros they create in the Federal Reserve. At the end of the day, how much have we improved? How much have we built our economy? Look at numbers like new business formations, numbers that indicate the health of growing businesses—hiring, recalls, overtime—certain types of gross output figures, job creation. You're not seeing healthy numbers for those things in the economy.
TGR: And unemployment.
BK: Absolutely. Unemployment may be a lagging indicator, but it's lagging like an anchor chain on your boat, especially when the numbers get up in the 9% and 10% range nationally. And then look at certain critical states. California, Michigan, Illinois, New York and Pennsylvania are all big, populous, busy states with lots going on and high unemployment rates. Where do you go with your economy when you've got that level of unemployment?
And what we're seeing is the nice numbers. There's a lot of ugliness behind them. If you look at the shadow statistics, you may as well add 50% or 75%. You know, 10% unemployment could really be 15% or 17% if you looked at who's really not working. Look at numbers of people applying for early Social Security or disability. They're up 45% and more this year. These are people at the bow wave of the Baby Boom, exiting the workforce, and entering a life of government dependency.
TGR: In a consumer-based economy, can you really have a jobless recovery?
BK: No, I don't think you can. And that's one of our problems. The consumer consumption component of GDP is something like 70% as opposed to what it was historically. In, say, the 1950s, the economy was maybe 55% consumption versus a 45% level of production. At today's 70%-to-30% ratio of consumption, with high unemployment and income insecurity, you can't get economic traction.
A report that just came out within last couple of weeks indicates that something like 70% of households are living paycheck to paycheck. And something like 35% or 40% of households that make more than $100,000 a year are living paycheck to paycheck. Think about that. Almost half of the top income demographic is one paycheck away from being broke. Suppose you get laid off, you get sick, you get injured, some problem comes up, a death in the family, a divorce, or some other big hit comes along. If you don't get paid for a pay period, all of a sudden you're behind on your bills. You burn through your savings, if you have any savings. You miss two pay periods, you're really behind. Three pay periods, there goes the house, there goes the car.
TGR: It's somewhat ironic, but we do hear that people are saving more.
BK: We are seeing big numbers in terms of the savings. The national savings rate has gone from negative to something like 7% since the start of 2009. That's an excellent savings number in the long term. That's a good number for the individuals who are doing the savings, good for them. But in a macro-sense, it's a very asymmetrical type of savings. People at the very high end have cut back on discretionary spending. They're not buying the new Cadillac, they didn't take the fancy vacation, they didn't buy that second house. I think those cuts are what's driving that savings rate up, and they take big consumption dollars out of the economy.
It's not the secretaries, the paralegals, medical assistants or cashiers at the shopping malls. Those folks aren't saving more money than before, not in any gross aggregate kind of way that would move the economy.
TGR: Early on, you said the government's doing a great job of masking the recession. What happens when people see what's been so well-disguised? What will be the impact on the markets?
BK: I think we are living with a very vulnerable stock market. If large numbers of people were to come to the same opinion that I hold, a lot of them would probably want to take sell out. Would it be a meltdown like last year's? I don't think we'd see an overnight crash, but I do think the market would drift down as people take money off the table. I think it'll vary by sector, though, because some sectors are doing well for the right reasons while other sectors are doing well for the wrong reasons.
TGR: For instance?
BK: Sectors depending on the discretionary income I was talking about—high-end home building, entertainment, travel and leisure—those kinds of things have had what I'd call a false recovery. It's a recovery based on antibiotics and steroids. On the other hand, the energy sector and certain parts of the mining sector have done well because there's been an underlying strengthening of demand for the product and a realization that while the dollars in your bank account or your wallet may not hold their value over time, that oil or ore in the ground will protect value. It will hold value over time.
TGR: That's a pretty smooth segue into gold. Can you give us an overview of what's in your Gold $2,000 report and your thoughts about of the sector now that gold's passed that $1,000 trading barrier?
BK: I wrote that report when gold was at about $850, so we're moving in the right direction. I think that gold could be $2,000 an ounce, and I'm not alone. Rob McEwen, for instance, is making predictions of $1,500 to $1,600 an ounce within about three years.
I think we're looking at the long-term loss of value in the dollar, what with the tremendous levels of government expenditure—this so-called stimulus. It's the bottomless pit mentality that Congress has toward the money that the federal government spends. It's wrecking the dollar. All around the world people are looking for alternatives.
In China, 15 years ago it was illegal for the average citizen to own gold except maybe for a little gold chain. Today, the Chinese government encourages its people to buy gold. Almost every bank or post office in China now sells gold coins.
If the Central Bank of China ever says, "We're buying gold. We're going to buy as much as we can and put it in the state coffers," the world gold price would spike through the roof. But if the Chinese government tells a billion of its people, "Okay, take a little bit from your paycheck every week or every month, save it up and then every now and then, go down to the bank or the post office and buy a gold coin," all of a sudden they've got a stealth rally going. China will build up its gold reserves, but do it in a distributed way. They're not putting all that accumulating gold in a Chinese version of Fort Knox. They're putting it in safe deposit boxes all across the country. Look around the world and you see people accumulating gold. I think that what we see in China is a harbinger of things to come.
TGR: Are they accumulating gold as a hedge against the U.S. dollar, or as a hedge against their own economy? What's in it for the Chinese government to make that recommendation to the citizens?
BK: It's a way of getting a lot of gold inside the boundaries of China. I'd say that the government wants its citizens to do the buying so as to keep something of a lid on gold prices. They're reinventing the U.S. monetary economy of 100 years ago. The United States used to be a gold standard country. We had a lot of gold and gold was in the hands of the people. And then in 1933 Franklin D. Roosevelt issued a presidential directive essentially confiscating all privately held.
TGR: Might the Chinese government do something like that?
BK: They could if they wanted to, but I think part of it is somewhat like the concept of a "fleet in being"—it's not that you deploy a lot of battleships at once, but if you add individual ships together, you have a rather formidable military force. I would liken the Chinese approach to "Fort Knox in being." They have a Fort Knox in China except that it's not all in one place. It's scattered around in millions and millions of households. If the Chinese government ever needed all that gold in one place for some reason, they would cross that bridge once they got to it.
TGR So if we're looking at this multi-year, dispersed approach to accumulating gold while keeping a lid of gold prices, why would gold go to $2,000?
BK: Because we're in a world that appears to have encountered peak gold as well as peak oil. If you look at historical production, worldwide gold output reached a top right around the year 2000–2001. Overall output has declined and we're not replacing output from the big mines of the past. Despite discoveries here and there, miners have to dig deeper and deeper into the reserves. In a big mining country such as South Africa, for example, some of the deepest mines now are at 4,000 meters. That's 13,000 feet.
TGR: So your view is that scarcity rather than a weakening U.S. dollar will drive the increase in the gold price?
BK: Well, it's really both. More and more dollars are chasing less and less gold. You're piling the monetary inflation coming out of Washington, D.C. on top of the dwindling production coming out of the mines of the whole world. Beyond that, a lot of what kept gold prices down and the dollar strong for years was the impression that the United States had its act together and would pull through over the long term, despite all of its various flaws and faults. In the eyes of the world, we've somehow managed to blow off a lot of that impression and I don't know what it will take to recover it. It took winning World War II the last time.
TGR: How would you characterize prospects for silver?
BK: I think that silver has more opportunities to appreciate percentage wise than gold. If gold goes from $1,000 to $1,500, that's a 50% gain. If silver's at $15 and goes to $30, there's a 100% gain. Silver is a monetary metal, but it also has more industrial-type uses than gold. We're seeing more and more silver go into the electronics industry, even into biotech. With uses at both the monetary end and the industrial end, there are a lot of good opportunities in silver.
TGR: Since their March lows, stocks in some senior and junior mining stocks—both silver and gold—have doubled or even tripled, while the metals themselves have not climbed nearly so steeply. Does the rapid appreciation in these mining company shares leave any investment opportunity remaining for the equities?
BK: I think you have to be very careful. You have to pick and choose where you're going to go with small companies, medium companies, large companies. A lot of gold and silver, for example, are produced as byproducts of copper mining. If you want to see some of the biggest silver producers in the world, you're also looking at some of the big copper producers.
TGR: Thank you, Byron. We appreciate your good humor as well as your good advice.
A self-described "old rock hound," Byron King earned his bachelor's degree in geology (with honors) at Harvard, and then worked as a geologist in the exploration and production division of a major oil company. He "earned his wings" in the U.S. Navy and the U.S. Naval Reserve, logging more than 1,000 hours of flight time in tactical jet aircraft and recording 128 aircraft carrier landings. Based in Pittsburgh, Pennsylvania—site of the historic G20 Summit last week— Byron practiced law there after earning his Juris Doctor credentials at the University of Pittsburgh School of Law. A prolific author and popular speaker with a gift for wrapping historical context around his observations, Byron contributes to Agora Financial's Daily Reckoning, Whiskey and Gunpowder and Penny Sleuth. He also edits Energy and Scarcity Investor and Outstanding Investments newsletters.
Streetwise - The Gold Report is Copyright © 2009 by Streetwise Inc. All rights are reserved. Streetwise Inc. hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.
The GOLD Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report.
From time to time, Streetwise Inc. and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
Streetwise Inc. does not guarantee the accuracy or thoroughness of the information reported.
Streetwise Inc. receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.
Participating companies provide the logos used in The Gold Report. These logos are trademarks and are the property of the individual companies.
The Gold Report: We've seen quite a rebound in the markets since we spoke in May, and governments across the world have begun releasing some positive economic news. Are we out of the recession as Bernanke has told us?
Byron King: I don't agree with that all. It's like at the funeral home where they put really good makeup on the corpse and people walk in and say, "Oh, he looks so good." Then you think to yourself, "Wait a minute. If he looks so good, why is he dead?" That's where we are now, I think, with our economy. We're still in the recession, it has been well-masked.
Let me digress and say that yes, the stock market rebounded. The "sell in May, go away" thing didn't work this year. So if you stayed in the market, you probably benefited very well from the market recovery. But it was a recovery not rooted in fundamentals. Part of it is that we've had a banking recovery, too. But that was because of massive infusions of new liquidity out of the Federal Reserve and the Treasury Department into the financial sector. That's not the prescription for long-term health.
As with someone really sick in the hospital, the problem isn't putting him on life support; the problem is getting him off the respirator. Now the question is how to stop hemorrhaging public money into the system, and in fact, begin pulling some of it back out.
TGR: Let's assume for now that the government isn't prone to taking the patient off the respirator. Do you expect diminishing returns in terms of less recovery seen for every dollar the government puts into the system?
BK: That's a great point. We're there, at the point of diminishing returns in terms of what it takes to get another dollar of real GDP. It doesn't matter how much green ink they use down at the Bureau of Engraving and Printing or how many ones and zeros they create in the Federal Reserve. At the end of the day, how much have we improved? How much have we built our economy? Look at numbers like new business formations, numbers that indicate the health of growing businesses—hiring, recalls, overtime—certain types of gross output figures, job creation. You're not seeing healthy numbers for those things in the economy.
TGR: And unemployment.
BK: Absolutely. Unemployment may be a lagging indicator, but it's lagging like an anchor chain on your boat, especially when the numbers get up in the 9% and 10% range nationally. And then look at certain critical states. California, Michigan, Illinois, New York and Pennsylvania are all big, populous, busy states with lots going on and high unemployment rates. Where do you go with your economy when you've got that level of unemployment?
And what we're seeing is the nice numbers. There's a lot of ugliness behind them. If you look at the shadow statistics, you may as well add 50% or 75%. You know, 10% unemployment could really be 15% or 17% if you looked at who's really not working. Look at numbers of people applying for early Social Security or disability. They're up 45% and more this year. These are people at the bow wave of the Baby Boom, exiting the workforce, and entering a life of government dependency.
TGR: In a consumer-based economy, can you really have a jobless recovery?
BK: No, I don't think you can. And that's one of our problems. The consumer consumption component of GDP is something like 70% as opposed to what it was historically. In, say, the 1950s, the economy was maybe 55% consumption versus a 45% level of production. At today's 70%-to-30% ratio of consumption, with high unemployment and income insecurity, you can't get economic traction.
A report that just came out within last couple of weeks indicates that something like 70% of households are living paycheck to paycheck. And something like 35% or 40% of households that make more than $100,000 a year are living paycheck to paycheck. Think about that. Almost half of the top income demographic is one paycheck away from being broke. Suppose you get laid off, you get sick, you get injured, some problem comes up, a death in the family, a divorce, or some other big hit comes along. If you don't get paid for a pay period, all of a sudden you're behind on your bills. You burn through your savings, if you have any savings. You miss two pay periods, you're really behind. Three pay periods, there goes the house, there goes the car.
TGR: It's somewhat ironic, but we do hear that people are saving more.
BK: We are seeing big numbers in terms of the savings. The national savings rate has gone from negative to something like 7% since the start of 2009. That's an excellent savings number in the long term. That's a good number for the individuals who are doing the savings, good for them. But in a macro-sense, it's a very asymmetrical type of savings. People at the very high end have cut back on discretionary spending. They're not buying the new Cadillac, they didn't take the fancy vacation, they didn't buy that second house. I think those cuts are what's driving that savings rate up, and they take big consumption dollars out of the economy.
It's not the secretaries, the paralegals, medical assistants or cashiers at the shopping malls. Those folks aren't saving more money than before, not in any gross aggregate kind of way that would move the economy.
TGR: Early on, you said the government's doing a great job of masking the recession. What happens when people see what's been so well-disguised? What will be the impact on the markets?
BK: I think we are living with a very vulnerable stock market. If large numbers of people were to come to the same opinion that I hold, a lot of them would probably want to take sell out. Would it be a meltdown like last year's? I don't think we'd see an overnight crash, but I do think the market would drift down as people take money off the table. I think it'll vary by sector, though, because some sectors are doing well for the right reasons while other sectors are doing well for the wrong reasons.
TGR: For instance?
BK: Sectors depending on the discretionary income I was talking about—high-end home building, entertainment, travel and leisure—those kinds of things have had what I'd call a false recovery. It's a recovery based on antibiotics and steroids. On the other hand, the energy sector and certain parts of the mining sector have done well because there's been an underlying strengthening of demand for the product and a realization that while the dollars in your bank account or your wallet may not hold their value over time, that oil or ore in the ground will protect value. It will hold value over time.
TGR: That's a pretty smooth segue into gold. Can you give us an overview of what's in your Gold $2,000 report and your thoughts about of the sector now that gold's passed that $1,000 trading barrier?
BK: I wrote that report when gold was at about $850, so we're moving in the right direction. I think that gold could be $2,000 an ounce, and I'm not alone. Rob McEwen, for instance, is making predictions of $1,500 to $1,600 an ounce within about three years.
I think we're looking at the long-term loss of value in the dollar, what with the tremendous levels of government expenditure—this so-called stimulus. It's the bottomless pit mentality that Congress has toward the money that the federal government spends. It's wrecking the dollar. All around the world people are looking for alternatives.
In China, 15 years ago it was illegal for the average citizen to own gold except maybe for a little gold chain. Today, the Chinese government encourages its people to buy gold. Almost every bank or post office in China now sells gold coins.
If the Central Bank of China ever says, "We're buying gold. We're going to buy as much as we can and put it in the state coffers," the world gold price would spike through the roof. But if the Chinese government tells a billion of its people, "Okay, take a little bit from your paycheck every week or every month, save it up and then every now and then, go down to the bank or the post office and buy a gold coin," all of a sudden they've got a stealth rally going. China will build up its gold reserves, but do it in a distributed way. They're not putting all that accumulating gold in a Chinese version of Fort Knox. They're putting it in safe deposit boxes all across the country. Look around the world and you see people accumulating gold. I think that what we see in China is a harbinger of things to come.
TGR: Are they accumulating gold as a hedge against the U.S. dollar, or as a hedge against their own economy? What's in it for the Chinese government to make that recommendation to the citizens?
BK: It's a way of getting a lot of gold inside the boundaries of China. I'd say that the government wants its citizens to do the buying so as to keep something of a lid on gold prices. They're reinventing the U.S. monetary economy of 100 years ago. The United States used to be a gold standard country. We had a lot of gold and gold was in the hands of the people. And then in 1933 Franklin D. Roosevelt issued a presidential directive essentially confiscating all privately held.
TGR: Might the Chinese government do something like that?
BK: They could if they wanted to, but I think part of it is somewhat like the concept of a "fleet in being"—it's not that you deploy a lot of battleships at once, but if you add individual ships together, you have a rather formidable military force. I would liken the Chinese approach to "Fort Knox in being." They have a Fort Knox in China except that it's not all in one place. It's scattered around in millions and millions of households. If the Chinese government ever needed all that gold in one place for some reason, they would cross that bridge once they got to it.
TGR So if we're looking at this multi-year, dispersed approach to accumulating gold while keeping a lid of gold prices, why would gold go to $2,000?
BK: Because we're in a world that appears to have encountered peak gold as well as peak oil. If you look at historical production, worldwide gold output reached a top right around the year 2000–2001. Overall output has declined and we're not replacing output from the big mines of the past. Despite discoveries here and there, miners have to dig deeper and deeper into the reserves. In a big mining country such as South Africa, for example, some of the deepest mines now are at 4,000 meters. That's 13,000 feet.
TGR: So your view is that scarcity rather than a weakening U.S. dollar will drive the increase in the gold price?
BK: Well, it's really both. More and more dollars are chasing less and less gold. You're piling the monetary inflation coming out of Washington, D.C. on top of the dwindling production coming out of the mines of the whole world. Beyond that, a lot of what kept gold prices down and the dollar strong for years was the impression that the United States had its act together and would pull through over the long term, despite all of its various flaws and faults. In the eyes of the world, we've somehow managed to blow off a lot of that impression and I don't know what it will take to recover it. It took winning World War II the last time.
TGR: How would you characterize prospects for silver?
BK: I think that silver has more opportunities to appreciate percentage wise than gold. If gold goes from $1,000 to $1,500, that's a 50% gain. If silver's at $15 and goes to $30, there's a 100% gain. Silver is a monetary metal, but it also has more industrial-type uses than gold. We're seeing more and more silver go into the electronics industry, even into biotech. With uses at both the monetary end and the industrial end, there are a lot of good opportunities in silver.
TGR: Since their March lows, stocks in some senior and junior mining stocks—both silver and gold—have doubled or even tripled, while the metals themselves have not climbed nearly so steeply. Does the rapid appreciation in these mining company shares leave any investment opportunity remaining for the equities?
BK: I think you have to be very careful. You have to pick and choose where you're going to go with small companies, medium companies, large companies. A lot of gold and silver, for example, are produced as byproducts of copper mining. If you want to see some of the biggest silver producers in the world, you're also looking at some of the big copper producers.
TGR: Thank you, Byron. We appreciate your good humor as well as your good advice.
A self-described "old rock hound," Byron King earned his bachelor's degree in geology (with honors) at Harvard, and then worked as a geologist in the exploration and production division of a major oil company. He "earned his wings" in the U.S. Navy and the U.S. Naval Reserve, logging more than 1,000 hours of flight time in tactical jet aircraft and recording 128 aircraft carrier landings. Based in Pittsburgh, Pennsylvania—site of the historic G20 Summit last week— Byron practiced law there after earning his Juris Doctor credentials at the University of Pittsburgh School of Law. A prolific author and popular speaker with a gift for wrapping historical context around his observations, Byron contributes to Agora Financial's Daily Reckoning, Whiskey and Gunpowder and Penny Sleuth. He also edits Energy and Scarcity Investor and Outstanding Investments newsletters.
Streetwise - The Gold Report is Copyright © 2009 by Streetwise Inc. All rights are reserved. Streetwise Inc. hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.
The GOLD Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report.
From time to time, Streetwise Inc. and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
Streetwise Inc. does not guarantee the accuracy or thoroughness of the information reported.
Streetwise Inc. receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.
Participating companies provide the logos used in The Gold Report. These logos are trademarks and are the property of the individual companies.
Subscribe to:
Posts (Atom)
-
By Chris Nuttall in San Francisco Published: January 21 2009 23:24 | Last updated: January 22 2009 01:26 A consumer love affair with Apple ...
-
Downturn Severe Despite Some Stabilizing SLIDESHOW Previous Next Eddie McNeely, 40, looks over paperwork in a prepara...
-
In Rolling Stone Issue 1082-83, Matt Taibbi takes on "the Wall Street Bubble Mafia" — investment bank Goldman Sachs. The piece has...
