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Thursday, June 12, 2008

Initial Claims And The Future

While investors with half a brain start to worry a bit about China, US lawmakers should start getting serious about the domestic situation. The wave of a pretty hefty consumer downturn is just about to break.

The first shot across the bow comes in today's initial claims release. At this time of year school systems begin shutting down, and in some states those employees are eligible for unemployment over the summer break. Therefore SA is the best number, and it showed an increase of 25,000 to 384,000 claims. NSA and SA continuing claims are rising as well. On an NSA basis, YoY continuing claims have increased over 560,000. That is a lot of people without money to spend this summer. The June employment report is going to be a shocker.

The retail sales report headline trumpets an increase above economist's assumptions. Except that the details in the report are ominous; the apparent sales increases are all due to inflation, and in fact retail sales YoY increases are now well below the inflation rate. The Memorial holiday came early this year, which shifted some June spending into May. When you look at the report (Table 2b) and compare May 2008 to May 2007, it seems clear that spending is steadily being shifted to the essentials:
Total: +3.0%
MV dealers: -9.1%
Food & Bev: +8.0%
Groceries: +8.5%
Gasoline +15.3%
The effect this will have on employment will be quite dramatic over the next six months. A lot of retail jobs are going away. The fact that groceries increased more than food and beverages is an indication of real trouble this month. Expect restaurants to begin shutting down and a wave of specialty retail bankruptcies. Mind you, the stimulus checks had hit quite a few of the consumers for this period.

By August, northern consumers will be directing a great deal of free cash toward winter heating bills. That is when the full pulse of the fuel shock will hit the economy, and it will be a brutal one indeed.

The Fed will not be raising interest rates this year. It won't have to, because enough capital is going to come into the US to support the dollar.

The EU is set for trouble this summer, I think, and others are beginning to share my view:
``Some weakness could be in store for euro-zone industrial production in May,'' said Marco Valli, an economist at UniCredit in Milan. ``Hard data for the second quarter have just started to come through, but so far they seem consistent with our view that GDP growth will come to a complete halt in the second quarter.''

Valli said part of the second-quarter slowdown in economic expansion ``needs to be seen as payback after the amazingly strong first quarter,'' when growth in gross domestic product accelerated to 0.8 percent from 0.3 percent.
Chances of a global recession in 2009 are over 80%.

US lawmakers need to stop with the posturing and pass unemployment extensions for the states hit hardest, like Michigan. However the Dems need to stop with the BS - extended unemployment benefits should only be available to the long-term employed, and should not be granted to every state. The US economy is growing in sectors and declining in sectors.

Another very important step would be to revise government policy and open up the oil sands for development, plus allow ANWR drilling, and review the coastal drilling restrictions. The US has a very clear choice. It can either go through a three or four year recession, or it can wake up to reality and implement a realistic energy policy. At prices approximately 20% below current, US consumption is restricted. Eventually, the biggest Asian countries will run into the wall and have to bring pricing up to levels that factor fuel constraints into economic decisions. If they don't, most of them will bust their currencies and see inflation rise to sky-high levels.

While changing US policy wouldn't immediately affect supply, it would generate extremely rapid internal growth in the form of capital investment, jobs and development. It would support the economy IMMEDIATELY. It would also scare the speculators a bit and tend to bring energy prices down somewhat.

One of the problems with fuel supply is that some of the countries with large reserves (such as Venezuela) have completely dysfunctional economies and can't get it out of the ground. Right now we are not in a peak oil scenario, but in a stupid-government scenario. Ours is among the stupidest.

Most of the US economic problems really trace back to energy policy. Congress is bleating about suing OPEC as just a diversion from their own failures.

Whichever party gets serious about fundamental economic issues first will establish a near hegemony in US politics, but the presidential pick matters far less than congressional policy. US presidents. Right now, neither party is even close to grappling with the economic realities. Congress is so far out of tune with its constituents that it appears to be seated on Mars, still trying to get the fuel sample into the chamber.

For the long term, the US simply must move heavily into nuclear power. That is the only way to generate the electricity necessary. If we had the electricity, we could shift to electric-gas hybrids for a majority of light passenger use. We have to have oil for trucking, freight, military and industrial vehicle purposes. All the blah-blah about biofuels is inoperative at the present time. It is possible that fundamental energy costs have shifted enough to make algae-based biodiesel production economically effective, but it has not been demonstrated.

The situation for the BRIC countries is not good at all. They now have to face worsening circumstances while reshaping their energy strategies. It will not be easy, and they need some margin to do it.

In terms of global distribution of the shock:
EU - depends on government policies, mostly. Currently it appears that they are not dealing with reality, but if they cut fuel taxes, the EU could still slog through this with only a mild recession. Will they? I doubt it. They have created a very unwieldy instrument in the EU government. I suppose the individual countries could rebel.

China - Big worry. Not only does China have to raise energy costs pretty shortly, it is spending a lot to guard the oilfields (such as in Sudan and Nigeria) that it depends on. I suspect that there is more trouble than we see. They've made great strides, but consumer demand for many of their products is not going to be growing in the developed world, and they seem to have run into a brick wall internally in distributing and investing wealth.

India - It should have a good future, but this is a real test for its economy and its government. Over the short term, per capita income growth is not going to keep pace with inflation. How does it handle the tensions and the shock?

US - the best so far, but Congress can make it or break it. The speculative boom was relatively larger in many other countries, and the US preserves high growth potential. I can't see any way in which the US dollar shouldn't strengthen on its own over the next six months, and after that, it will be a matter of whether the next election brings a focus on basics or an excursion into lala land. So far, Pelosi type organic-cafe thinking is predominating. When that ends, the economic pain should begin to lift. It is largely self-inflicted.

The bottom line for the world economy is that it grew a lot, but much of the wealth was shunted into speculative, poorly grounded investments globally, and little attention was paid to the balance of trade and energy needed to sustain world growth. The last few years of massive Asian growth have been largely a chimera based on non-recognition of fundamental input costs. Therefore the focus has to shift back to producing food and energy, in which field the US can do very well indeed.

South America - every non-lunatic country can do pretty well. Unfortunately, lunacy in South America governments is a long and strong tradition with deep cultural roots.

Japan - their own sources seem to feel that they are headed for a recession or near recession due to declining demand and internal inflationary pressures. Japan as a country is extremely sensitive to food and fuel costs, because it just cannot grow enough food to feed its population.


Let's face it -- like so many issues, the energy issue is framed as only two choices that are polar opposites. Nukes? No way. ANWR drilling. Over my dead body. Burn coal -- murder the planet with carbon and acid rain. Oil sands -- pollute the water table. Build more highways? No more sprawl. Drive smaller cars? SUV is non-negotiable. Telecommute? You need to be in the office. Shared trips? My freedom to do as I please is non-negotiable. Walk to the grocery store? We don't need no stinkin' sidewalks. A 2000 sq.ft. house? No, I need a gift wrappang AND scrapbooking room.

By polarizing the debate, it makes it appear that EVERY option (at least ones that will work in the short-mid term) are off the table. We're really not going to run the US on used french fry oil.

Here's an easy one to implement -- have employees at large companies in major metro areas work 4 10 hour days with 25% of the work force off at least one day per week (so if you had 100 employees, 75 in on Monday, 75 in on Tuesday, etc). That would cut traffic in many areas -- Cut your commute 20% per week and save time(since most highways in major metropolitan areas are at or substantially over capacity)and would result in a HUGE fuel savings... C'mon, how hard is that?

But our current "policy" is comparable to wanting to lose weight while ruling out any change to diet or exercise. Since we refuse to diet or exercise, and we have to lose weight, we're going to get unrequested bariatric bypass surgey via oil prices.

Great post. In some ways, I almost hope for $250/barrel oil as it would FORCE the US to make some hard choices. I don't think that absent real pain that we'll ever pull together a coherent energy policy.
I read a comment on some blog that high-end restaurants are already starting to bounce checks to their liquor suppliers, who are starting to demand cash up front.

Think we'll have even-odd gasoline rationing, or need-based rationing cards that will be coopted by the Gaia huggers?
Daniel - I think some British group proposed a carbon rationing system for British citizens recently. Given the amount of energy that goes into farming, I'm sure they'll try.

Anon - Yes, almost everyone seems to be grounding their positions on radical and/or hysterical beliefs. When historians look back on this period, we will not look very rational.
Anon 4:38,you can lose weight without exercise or changing your diet.Tapeworms...And MoM congress is on Pluto,not Mars.They are Plutocrats,after all.Tom Stone
I noted in the New Yorker a week or two ago that Nathan Myhrvold is committed to developing a power source based on thorium. As he's engaged competent help, we may see an alternative to U234/235 technologies in a few years which is far less problematic in a number of ways

As it's a private, for-profit enterprise, and well capitalized, perhaps it will work out.

Article is "In the Air" by Malcolm Gladwell.
MOM - I work as a consultant with oil sands companies and imho the pace of development is about as fast as we can make it. Municipal and regional infrastructure are maxed out, engineering and trades resources are spread thin, costs are sky high, productivity is low and we have an airshed and a watershed whose limits are being stretched just with the existing operations.

High oil prices have already sent the signal to the oil industry to develop the oil sands as fast as possible. They are also beginning to exert their influence on consumers. The biggest waste is if prices are further inflated by taxes. I would much rather that oil companies made windfall profits than governments. I can buy shares in an oil company, and I can expect the company to look for more oil. Not so with government.
Great summary, MOM.

High energy prices are the most immediate concern. If Congress would just do as you say and open up the offshore areas and ANWR for drilling, it would take some of the speculative pressure off. There are 40 billion newly discovered barrels of oil in this hemisphere. That will start coming to market in two more years, but we still need to go after the unexplored areas as well as opening up oil shale for development. That is all future stuff, but, unfortunately, the future arrives all too quickly.

Anons talk about diets is most appropriate here. This economy runs on a diet of energy. (Gasoline, diesel, jet fuel, coal, a smidge of nuclear, and even less of renewables.) High costs will put us on a diet we will not enjoy.
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