Inflation Will Be A Surprise

Earlier this week, the Labor Department reported declines in both the Producer Price Index (PPI) and the Consumer Price Index (CPI). Various economists and television commentators believe that these declines are proof that slack in the economy is creating deflation and more than offsetting the inflationary impacts of government stimulus spending and money-printing by the Federal Reserve.

A deeper look at the CPI report shows a different picture:


Source: Department of Labor

The far right-hand column shows that the "All items" CPI headline data declined 0.4% over the past twelve months. This figure is what the deflationists are citing as evidence of deflation. However, the "All items less food and energy" figure rose 1.8%. The whopping 23% decline in energy led to the overall decline in prices or "deflation" that economists cite. It is worth nothing that it took a 23% drop in energy prices to create a 0.4% decline in CPI when energy prices are still so high compared to the last couple of decades.

Prices in the broader economy are not falling despite the worst recession since the 1930's because of the government's programs and the mind-boggling increase in the Federal Reserve's balance sheet. Velocity of money (spending and business transactions) has slowed due to the weakness in the economy. However, as reflected in the chart below, holdings of cash are exploding. As people in the deflation camp alter their deflationary forecasts, holders of cash will rightfully become nervous about their loss of purchasing power. As a result, the velocity of money will rise despite the weak economy - a theme quite common for highly indebted countries. To believe that there is deflation today and to assume it will continue into the future is to misunderstand the definition of inflation.





Market dislocations occur at major turning points when markets falsely forecast the path of inflation versus deflation. For example, in 1982 the market was incorrectly fearful of inflation, which meant stock and bond prices were quite low and provided for outstanding gains if the inflation fear was unfounded. As is now known, inflation had ended and thus it was a great time to buy stocks and bonds.

Today, the market is counting on deflation. As a result, gold is undervalued and US stocks and bonds are overvalued because the market believes deflation will persist until only mild inflation replaces it. As Peter Schiff says, "A little inflation is like being a little pregnant." Stock P/E's contract and interest rates rise during high inflation. As reflected in the chart above there is a huge amount of cash on the sidelines. When fear of deflation subsides and the harsh reality of inflation sets in, cash will flow to commodities and hard assets and thus lead to higher consumer prices rather than higher stock prices (until we have hyperinflation, which clearly is not on the market's mind).

In summary, stocks are rallying and investors believe in deflation. As of March 2009, the CPI is helping to inflate the deflation story. However, at some point, markets will either begin to discount that CPI will turn higher or there will be a rude awakening when the data is released. Either way, inflation will be a surprise because the markets are incorrectly discounting the future.

http://www.safehaven.com/article-13111.htm

Is the US heading for a depression?

The sharp contraction of the US economy accelerated in the last three months of 2008, with official figures showing GDP shrinking at an annualised rate of 3.8%.

With forecasters already predicting the worst US recession since World War II, how big a danger is there that the US economy will slip into a depression similar to the 1930s?

The latest figures paint a gloomy picture of the US economy.

Consumer spending, which makes up two-thirds of the economy, fell for the second quarter in a row, by 3.5%.

US enters recession


This drop was led by a 22% drop in spending on durable goods like automobiles and washing machines. The decline in motor vehicle production was so great that it alone contributed 2% to the fall in GDP.

Businesses hit

Businesses as well as consumers have been hit hard by the slowdown.

Exports, which had helped boost GDP earlier in the year, fell sharply, by 19.7%, as foreign markets for US products were hit by their own recessions.

Investment fared even worse.

Residential investment fell 23.6% as the glut of foreclosed properties reduced new home sales. Business investment was down 19.1%, led by a 27.8% drop in purchases of equipment and software.

Business inventories of unsold goods mounted. If the inventory build up - which is likely to be temporary - is excluded, GDP fell at an annualised rate of 5.1%.

"For all the talk of this being a consumer-led downturn, the credit crunch is hitting businesses even harder," said Paul Ashworth of Capital Economics.

Consumers save

The economic uncertainty does seem to be changing consumer behaviour. People are saving more in preparation for the coming downturn.

The personal savings rate rose to 2.9%, more than double the 1.2% rate in the previous quarter. Mr Ashworth predicts the savings rate will double again, to 5%.

Consumers are being hit by a triple whammy: rising unemployment, which could rise from 7% to 10% of the workforce by the end of the year; restricted access to credit; and falling asset values.

The fall in stock markets and house prices has reduced household wealth by 20%, from the middle of 2007. This alone has reduced consumption by around 1%, some economists estimate.

It may make sense for consumers to save instead of spend, but in an economy as reliant on consumer spending as the US, this does add to recessionary pressures.

How long?

The key question in whether this will turn from a recession to a depression is how long the slowdown will last.

In the 1930s, output declined for four years, with GDP cut by half while unemployment soared to one-quarter of the workforce.

Despite the New Deal, output did not recover to its 1929 level until World War II when there was a massive boost in government spending.

At the moment, most economic forecasters are predicting that the US slowdown will last around two years, with the economy returning to weak growth by 2010.

The National Bureau of Economic Research says the current economic slowdown actually began at the end of 2007 and is likely to be the longest post-war recession.

The non-partisan Congressional Budget Office (CBO) estimates a drop in real GDP for 2009 of 2.2%, followed by a rise of 1.5% in 2010, while the IMF predicts a fall of 1.6% this year, following by a recovery of 1.6% in 2010.

But economic forecasts have changed frequently in the past year. It is unclear what will happen after 2010, said the IMF's chief economist Oliver Blanchard.

Government rescue?

The only thing currently boosting the US economy is Federal government spending, which rose 5.8% in the quarter.
The government may have to help the millions who have lost their homes


But even if Mr Obama gets rapid approval for his $800bn stimulus plan - which has passed the House of Representatives and is currently being considered by the Senate - it will take some time for the money to be felt in the economy.

Only $170bn will be spent before 1 October 2009, representing just over 1% of US GDP, according to the Congressional Budget Office.

The bulk of spending (including tax cuts) would occur in 2010 ($354bn) and 2011 ($174bn).

Individual states may not be able to rapidly increase spending on infrastructure projects which make up a large part of the stimulus package.

It is also unclear how many jobs will be created: President Obama aims to create 3.5 million new jobs, but others say the stimulus package could create between 1.2 and 3.6 million more jobs.

The other big uncertainty is whether the financial sector can be restored to health and at what cost.

There is now $2.2 trillion of toxic bank debt worldwide, the IMF says, $500bn more than it estimated a few months ago. The collapse of financial markets in the autumn had a dramatic effect on consumer and business confidence.

There are plenty of reasons why growth might be even less than forecast, the IMF's Olivier Blanchard said, not least if banks have so many bad debts, they will further drag down the real economy.

The Obama administration still has $350bn left of the $700bn bailout for banks approved in October last year. It may need to ask for more.

If it gets the money it needs and if the money is spent promptly and wisely, the US might just escape with a relatively mild recession.

But given the extraordinary events of the past six months, most economists are still hedging their bets.

Link

Oil's going straight back up to new highs

There are 70,000 oilfields in production worldwide; however, the bulk of our production comes from 20 super-giant oilfields, which account for over 25% of daily world production. Of even more concern, the vast majority of these fields were discovered 50–70 years ago.

In addition to the dearth of new discoveries, depletion rates are rising as old fields mature and decline. Remember, newer discoveries over the last two decades have been fewer and smaller, and many of them have been offshore. Smaller oilfields and offshore oilfields deplete at much faster rates than some of the "old giants."

In its latest World Energy Outlook, the International Energy Agency (IEA) estimated that the average observed decline rate worldwide is currently 6.7%, and is projected to increase to 8.6% by 2030. Decline rates for the super-giants are 3.4%, 6.5% for giant oilfields, and 10.4% for large fields. Moreover, natural decline rates (a natural decline rate strips out ongoing investment in new production) are estimated at 9% for post-peak fields. The implication of these large and accelerating decline rates is alarming: "The implications are far-reaching: investment in 1 mbd of additional capacity—equal to the entire capacity of Algeria today—is needed each year by the end of the projection just to offset the projected acceleration in the natural decline rate"

More at Jimbo

What’s Really Going On? or…

Why Did I See it Coming and “They” Didn’t?

Steve Keens critique of current economic models is a must read.

Unemployment by industry: The US must Brace for Impact

Friday the Labor Department disgorged a mountain of ugly unemployment data. Another``surprising'' jump in joblessness made headlines.

iTulip has observed and analyzed changes in the US economy for over ten years. In the current economic cycle, since 2006, we have focused on median duration of unemployment to give us early warning of rising unemployment.

Here we extend that analysis to point us to where unemployment is headed overall and also delve into 14 major industry sectors, including one you work in, to fine tune our forecast.

There is no doubt in our minds that this is The Big One -- a depression is all but certain unless the US develops and executes a post WWII scale stimulus plan starting in 2009, but the structure of that stimulus is critical to avoid turning the US into a sclerotic economy dominated by large corporations and big government. In any case, we forecast 10 million jobs lost by the end of next year.

charts itulip

Make way for the Chinese giant

By Walter T Molano

The emergence of China as a global superpower occurred much faster than anyone imagined. China is the new giant on the block, with enormous resources at its disposal. An exporting powerhouse, China displaced the United States last year as the largest exporter to the European Union.

Chinese exports to the EU jumped 21% year on year in 2006, reaching 255 billion euros (US$336 billion), versus an 8% year-on-year increase in US exports, which totaled 176 billion euros. Chinese exports continue to expand aggressively, driving up shipping prices around the world. The Dry Freight Index on the Baltic Exchange was up 41% year-to-date, with no end in sight. The earnings from trade are becoming a headache for the Chinese central bank. International reserves recently passed the $1.3 trillion mark. China's current-account surplus is expected to reach $400 billion this year - representing 12.8% of gross domestic product (GDP). The heady expansion of the Chinese economy is putting it in a leadership position, allowing it to move to center stage in the global arena.

China is having a positive effect on the global economy, which in 2006 grew 5.4% year on year. Developed countries expanded 3.1% year on year, while non-Japan Asia grew more than twice as much - expanding 7.9%. China's GDP growth was 10.7% year on year and India expanded 9.2%. The Chinese effect on the developing world was remarkable. The former member states of the Soviet Union surged 7.7% year on year, sub-Sahara Africa expanded 5.7% and Latin America grew 5.5%.

The commodity boom is changing the economic landscape across the developing world. The volume of global trade rose 9.2% year on year in 2006, and emerging-market countries increased their international reserves by $738 billion. This explains the emerging-market boom. This is not a fad or a reflection of global liquidity. The $256 billion of net private inflows into the emerging markets reflect the credit strength of these economies and their ability to grow.

At the same time, the United States is withering away under the weight of its enormous debt load and various asset bubbles. The US economy grew an anemic 1.3% year on year during the first quarter of 2007. Unemployment is picking up and the dollar is collapsing. The unemployment rate in the US increased to 4.5% in April. Indeed, April saw the weakest pace of job creation in two years. The impact of the housing slowdown is starting to appear in the employment data. The tightening of lending standards is reducing the availability of mortgages, forcing further slowdowns in the construction sector.

The economic slowdown in the US is accompanied by serious concerns about the health of the financial sector. With more than $700 trillion in derivative contracts floating in the marketplace, and much of it tied to the mortgage market, an accident is definitely on the way. Some analysts attribute the steady rise in gold prices to concerns about a looming crisis in the US financial sector.

The changes in the global economic order are also realigning the planet's geopolitical structure. China is starting to set the tempo in the international arena. It has the indisputable lead in Africa, committing $20 billion over the course of the next three years to develop infrastructure and trade. It is shepherding the reconciliation between North and South Korea, easing tensions on its eastern flank.

The growing irrelevance of the multilateral institutions, such as the World Bank, International Monetary Fund and World Trade Organization, is providing a greater opportunity for China to exert a more prominent role without appearing to be a usurper of power. Fortunately, the changes are for the better, at least for most emerging-market countries. China's insatiable appetite for commodities is breathing new life across the developing world.

Last of all, China is providing a bonanza of cheap manufactured goods to developing nations - fueling an unprecedented consumer frenzy. The Chinese behemoth is rapidly displacing the US as the world's main source of capital, manufacturing and commodity demand, leading to a decoupling of the waning North American giant from the rest of the marketplace.