Thursday, July 24, 2008

When and how do we know this thing is over?

I think we are in a watershed event that is going to lead to depression around the world, but even that situation will have an end. The Great Depression lasted 20 years, even though historians seem to gloss this fact over with nonsense about the New Deal and other socialist programs that basically were make work, survival programs and little else. But, even in that vein, one of the great bull markets in history occurred between 1932 and 1937, where gains were in the area of 400% on the Dow. What followed was a bear market that was also one of the worst. There was a difference then in the sense that they at least could debase the local currencies and leave gold for international settlement. That end of the game is over and the only thing left to do is move the currencies to zero as a solution. I doubt TPTB will allow that to occur, as it would mean everyone was bankrupt. Also, the impact of intentional deficit spending isn't new any more and won't have the impact it might have had then. the only solutions so far are to sustain prices and demand at unsustainable levels and massive resistance to let the situation finish adjusting and put the problems behind us, thus the heartburn might just turn into a heart attack.
The US is the demand for the world. Robert Rubin undertook this path in the late 90's in order to attempt to finish the Asian crisis and we forgot to stop it. Trade deficits exploded with the stock bubble, then florished with the housing bubble. It hasn't seemed to sink into the average Joe's head or the average analyst what impact this trade deficit going away is going to have on the rest of the world. This is demand fueled by credit from the US. It might be money loaned back by other countries, but the credit is made in the US and that system is reversing itself fast. I believe this mess has the capacity to balance the US trade deficit and there isn't 5 countries combined in the world that could replace the $600 billion or so in excessive demand that the US brought to the table and if there are, it is only due to the fact that the US is running deficits with them right now. This amount of credit would suck China dry in about 2 years. They won't be able to expand or maintain trade by shrinking the value of the medium of trade.
The idea of Peak Oil might turn out correct not because potential production has peaked, but because consumption has peaked. I think people now will be shocked to see how much less gasoline is used, how much less paper towel is used and so on and so on. Take away pricing pressure and you will soon see the shitcan the Arabs have put themselves into with all their financial commitments. India implodes and the financial backing in China disintegrates. Commodities collapse and the commodity exporting contries go with it.
It will be worldwide and the signs are already showing worldwide. One of signs of this will be oil and what is right now being viewed as a bullish development, the price coming down, is either a temporary respite or a sign that what I am illustrating is starting to occur. The price of oil in this area has been there too short a time to have caused much of the economic grief that has shown up on the scene and much lower prices would have to appear before there was any impact on the current conditions. Bullish or not, oil is a limiting factor on economic expansion due not to price but to supply.
If demand for oil is indeed falling and price follows, then at some price there will be a need to sell more oil, not less oil due to financial necessity. At what price does this occur? I am guessing under $70 and maybe under $55. Remember if you were there, that in 1980, we were never going to see oil at $13 again and yet we did on and off for the next 19 years. I think $55 is a much more substantial price than $13 was 25 years ago, due to the direction other assets are headed and the relative financial position of the exporters. It is also substantial in that instead of allowing consumers to keep there cash and pay down debt, it keeps the money in circulation and in bank accounts. The main reason oil prices are inflationary at this time is they keep the money coming, but the consumer can only send out so much before they are tapped.
I would guess the best way to tell that my prognosis is wrong is if the bull win enough rounds to keep this from occuring is that home prices quit falling and home starts tick up(this is probably a nonsense sentence, but I didn't know how else to write it and I hope you know what I mean in the form of demand). As long as these are inclusive of each other, this game is going to go on and it isn't a housing crisis to start, but a housing bubble. Without price increases, construction increases only prolong and make the problem worse. I think the other thing is that oil demand remains high. As long as the demand and price for oil are high, the bulls are still in the game, contrary to the news. The most bearish news right now is if oil keeps coming down. The bulls didn't need lower prices, they just needed a price where it would stop going up. I believe that if China isn't in full financial crisis by this time next year or apparently headed for it, depression will probably be avoided. I would watch to see how much it slips. A legitimate boom continuing in China probably precludes a depression, but I have to believe for the time being that China is booming toward over expansion that won't be profitable. There is a lot of money from around the world chasing Chinese assets that outsiders really cannot own. The return will be zero.
Now if you followed me closely, I might have made sense. But, if you got lost by your follow the press logic, you might be more confused than before I wrote this. I think most of us bears believe the US credit system has run its course and this will take down the world economy, but at the same time, we have our eyes on 2002. This time is different, as all the financial companies have impaired financial positions and there isn't any home equity left to leverage. The hedges are fully leveraged and before long there won't be a counter party to buy what they have to liquidate.

1 comment:

Pete Murphy said...

Our enormous trade deficit is rightly of growing concern to Americans. Since leading the global drive toward trade liberalization by signing the Global Agreement on Tariffs and Trade in 1947, America has been transformed from the weathiest nation on earth - its preeminent industrial power - into a skid row bum, literally begging the rest of the world for cash to keep us afloat. It's a disgusting spectacle. Our cumulative trade deficit since 1976, financed by a sell-off of American assets, is now approaching $9 trillion. What will happen when those assets are depleted? Today's recession may be just a preview of what's to come.

Why? The American work force is the most productive on earth. Our product quality, though it may have fallen short at one time, is now on a par with the Japanese. Our workers have labored tirelessly to improve our competitiveness. Yet our deficit continues to grow. Our median wages and net worth have declined for decades. Our debt has soared.

Clearly, there is something amiss with "free trade." The concept of free trade is rooted in Ricardo's principle of comparative advantage. In 1817 Ricardo hypothesized that every nation benefits when it trades what it makes best for products made best by other nations. On the surface, it seems to make sense. But is it possible that this theory is flawed in some way? Is there something that Ricardo didn't consider?

At this point, I should introduce myself. I am author of a book titled "Five Short Blasts: A New Economic Theory Exposes The Fatal Flaw in Globalization and Its Consequences for America." My theory is that, as population density rises beyond some optimum level, per capita consumption begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (per capita output, which always rises), inevitably yields rising unemployment and poverty.

This theory has huge ramifications for U.S. policy toward population management (especially immigration policy) and trade. The implications for population policy may be obvious, but why trade? It's because these effects of an excessive population density - rising unemployment and poverty - are actually imported when we attempt to engage in free trade in manufactured goods with a nation that is much more densely populated. Our economies combine. The work of manufacturing is spread evenly across the combined labor force. But, while the more densely populated nation gets free access to a healthy market, all we get in return is access to a market emaciated by over-crowding and low per capita consumption. The result is an automatic, irreversible trade deficit and loss of jobs, tantamount to economic suicide.

One need look no further than the U.S.'s trade data for proof of this effect. Using 2006 data, an in-depth analysis reveals that, of our top twenty per capita trade deficits in manufactured goods (the trade deficit divided by the population of the country in question), eighteen are with nations much more densely populated than our own. Even more revealing, if the nations of the world are divided equally around the median population density, the U.S. had a trade surplus in manufactured goods of $17 billion with the half of nations below the median population density. With the half above the median, we had a $480 billion deficit!

Our trade deficit with China is getting all of the attention these days. But, when expressed in per capita terms, our deficit with China in manufactured goods is rather unremarkable - nineteenth on the list. Our per capita deficit with other nations such as Japan, Germany, Mexico, Korea and others (all much more densely populated than the U.S.) is worse. In fact, our largest per capita trade deficit in manufactured goods is with Ireland, a nation twice as densely populated as the U.S. Our per capita deficit with Ireland is twenty-five times worse than China's. My point is not that our deficit with China isn't a problem, but rather that it's exactly what we should have expected when we suddenly applied a trade policy that was a proven failure around the world to a country with one sixth of the world's population.

Ricardo's principle of comparative advantage is overly simplistic and flawed because it does not take into consideration this population density effect and what happens when two nations grossly disparate in population density attempt to trade freely in manufactured goods. While free trade in natural resources and free trade in manufactured goods between nations of roughly equal population density is indeed beneficial, just as Ricardo predicts, it’s a sure-fire loser when attempting to trade freely in manufactured goods with a nation with an excessive population density.

If you‘re interested in learning more about this important new economic theory, then I invite you to visit my web site at where you can read the preface for free, join in the blog discussion and, of course, buy the book if you like. (It's also available at

Please forgive me for the somewhat "spammish" nature of the previous paragraph, but I don't know how else to inject this new theory into the debate about trade without drawing attention to the book that explains the theory.

Pete Murphy
Author, Five Short Blasts