Oil prices are quite high, and consumer spending is holding up.
Remember our old “Cash for Clunkers” QE II model? I said that everyone who wanted to sell bonds at all for the next few months would do so before QE II ended. This would result in a natural vacuum of sellers after QE II ended.
I also said there would be the “Godzilla of all bond rallies” post QE II. This is a chart of 30 year yields. Yields are opposite of price. Lower yields mean higher prices.
See that huge red bar at the end? That means a huge rally in bond prices.
Lots of people think the world is ending right now. It looks bad out there, but there should be some appreciation of the fact that the most willing sellers of U.S. Treasuries sold them during the actual time of QE II.
The actual GDP numbers – while anemic – aren’t falling at anywhere near late 2008 levels.
Question: How much of this panic is due to a completely wrong interpration of what’s happening in the oil markets?
People say that lower oil prices means that the economy is tanking, but it’s more likely that the speculative bid under oil just shifted out of oil.
Lower oil prices are great for the real economy, not bad.
The payroll tax cut was designed to help lower income taxpayers get more money, but the tax cut effect has been entirely swamped by higher gas prices. Higher gas prices are stealing our recovery!
I was extremely bullish on the United States economy earlier in the year, when the tax cuts were announced. I thought these specific cuts were going to do wonders for the United States economy.
Unfortunately, the tax cuts have had zero stimulus impact so far. The entire stimulus has been eaten up by higher energy costs.
The payroll tax cuts were expected to add about $110 billion to the pocketbooks of consumers over 2011. This ends up being about .8% of GDP in raw numbers. .8% of GDP is a big boost to the economy. This does not inclue the multiplier effect. If we use an estimated 1.3 as a multiplier, we get over 1% of GDP impact on the economy from the payroll tax cuts. Great!
But then something absolutely wonderful happened- the Libyan Civil war. But, it had horrible side-effects on the U.S. economy. The Libyan Civil war caused a spike in energy and gasoline prices.
The estimated cost to the consumer for the increased energy costs is about $120bn over the course of a year. This number is about the size of the payroll tax cut. The entire years worth of tax cuts was to be worth about $110bn.
Basically, the entire payroll tax cut went to pay for increased energy costs. There was zero stimulative effect due to tax cuts, because they went to pay for increased energy costs.
I do not know why the U.S. government did not open up the Strategic Oil Reserve and pay whatever price necessary to get Saudi Arabia to sell that oil. They should have done this back in March. But they did not open the SOR. So here we are in June, still struggling, while the propagandists at Forbes claim the tax cuts did not work.
Oil is down $4.00 today. A settlement below the old lows breaks a huge level of support, and the next stop is $80 or so.
Why did oil get hammered today? This is an incredible post over at FT Alphaville. The oil markets have plenty of supply, and the only thing keeping oil at a high price is the incredible level of speculation we allow in the oil markets. You’d think for a strategic resource, we’d have a bit more care about making sure the price of oil was low for consumers. But apparently, this is not the case.
But the good news is we are going to see much cheaper oil sometime very soon, perhaps as soon as tomorrow!
Take aways from the post:
- Saudi Arabia is acting nearly completely independently of OPEC
- The U.S. considered and is considering opening the Strategic Oil Reserve to cause prices to fall
- The U.S could be intervening directly in the Brent Crude market with Saudi Arabia
Plus, the only reason the deal fell apart was about the price to be paid for the oil! I cannot believe they let this incredible opportunity go! Oil could have been at $80 a barrel in a matter of days. But it does appear that it is going to $80 anyway.
If oil falls to $80, then expect gasoline to fall by nearly $.80 per gallon from current levels, which are already $.20 below the highs. This will restore $120bn of spending power to consumers, or about .8% of GDP. More on this in a moment.
Oil is very, very heavy today….
Oil price fell today, but they could fall even more tomorrow. Germany has recognized the rebels in Libya as being the official government.
The speculative premium in oil is very high right now, and part of this premium is due to the Libyan revolution.
Oil could be at $85 in just a few days. In a few weeks more, it could be at $70.
Here is a chart of the amount of oil Saudi Arabia is pumping. It’s a significant increase and makes up for nearly the entire amount Lybia is not producing. It is the highest amount of oil they have produced since the financial meltdown nearly 3 years ago.
My thinking is that Saudi Arabia will continue to pump this much oil until the price of oil comes down to $70. The Saudi’s are clearly worried about oil prices being too high.
Much of the inflation worries are due to high oil prices. If we see $3.00 gasoline again, it is totally possible that we will see a big jump in consumer spending.
But keep it coming, Saudi Arabia… we could use it.
We could see the start of a commodity meltdown tonight. The oil market is extraordinarily fragile right now, and commodities are not looking healthy at all.
Of course you’re paying attention to the price of Silver, Gold, and Oil. It’s impossible to fill your gas tank without noticing the huge hit to the wallet. And Silver has been just going crazy until just a few weeks ago.
There is a huge clamor from people who don’t know how money works that the weakness of the U.S. Dollar is due to the actions of the Federal Reserve. Zero Hedge is just one of the nuttiest, but you can find this claptrap everywhere.
It’s undoubtedly the wrong model, but it is the dominant model.
The conventional wisdom model in a paragraph: Quantitative Easing is – must be – shredding the value of the U.S. Dollar. As proof of this astonishing, irresponsible behavior, Commodities are prudently rallying, because commodities are iron clad protection against the inflation that is certainly just around the corner. Commodities are not in a bubble, their dramatic increase in price is a rational response to a near-worthless U.S. Dollar. Other Currencies – the euro, Swiss franc, and Australian dollar, are also rallying because of the irresponsible fed.
It’s a convincing argument when commodities are in rally mode. But Commodities are no longer in rally mode. We could be seeing the start of the crumble right now, tonight.
In the last few weeks, Silver took a serious tumble. A 20%+ drop in 3 days is a huge move for any market. Not only that, but Silver could be forming a “flag” – a technical formation that predicts a further huge decrease in price. This isn’t guaranteed – but it is something to watch.
People are beginning to question if Commodities will last. Perhaps commodities are in a bubble. We have had enough bubbles in the last few years – why not Commodities?
There is ample evidence that Commodities have a large speculative bid.
- Entire warehouses of Copper covered in dust because nobody’s moved it in months and months.
- Copper being used as financing for Chinese real estate and lines of credit instead of actual use
- Huge amounts of speculative open interest in the oil markets.
I focus on oil and copper because these two commodities only make sense to buy them if you are going to use them. If the reason Copper is going through the roof is to prop up what appears to be a massive credit bubble in China, then we need to monitor signs the Chinese Government is cracking down on the practice.
And it appears China is cracking down on the Copper financing practice. In a few months, this source of financing will go away for Chinese companies and speculators. It appears that China has several years worth of Copper imports sitting on the ground being used as a way to borrow money very cheaply.
It makes sense to ask what would happen to the U.S. Dollar if there is a significant correction in the Commodities market.
Would a correction in the Commodities market be a bullish sign for the U.S. Dollar?
The selloff in Silver could be the trigger event that causes a massive selloff in the entire commodities complex. It could cause a total rethink of the market consensus.
We are seeing this in price action today with oil going down, the Euro holding steady, and Swiss franc going through the roof. Commodities are correcting across the board, but the Currency markets are mixed.
If the commodities sell off, the primary proof the U.S. Federal Reserve is out of control will be far less potent. So what happens to the U.S. Dollar?
The conventional wisdom is that the U.S. Dollar must become stronger if commodities become weaker. I am not as convinced about the link between the weak U.S. Dollar and the large increases in Commodity prices.
This is not to say there is no link between Commodities and the U.S. Dollar. If Commodities enter a correction, the U.S. Dollar could rally at least some.
Still, two data points give me pause:
- U.S. Dollar Index and Commodity index out of sync over last decade
- Massive speculation in Commodities covers up moderate real demand
The U.S. Dollar is roughly 8% weaker than it was in late 2005. In December of 2005, the U.S. Dollar index hit 80, vs. a price of 73.10 today. However, the CRB index is 130% higher than it was at the end of 2005. You’d think that when the U.S. Dollar lost a ton of value, the CRB would have risen a proportionate amount. It didn’t. The spectacular rise in the Commodities came long after the U.S. Dollar had its most dramatic losses.
I’ve created a model of currency valuations based on the principles of MMT. The model says the EURUSD should be much higher than it is today – perhaps as much as 20% higher. I have kept the last few years of data of this model to myself.
But why am I talking about this? Because if the Commodities fall but currencies rally, the conventional narrative cannot be true. But some other narrative must be. MMT provides a narrative that accommodates Commodities going down and the USD going down.
The MMT narrative about the Commodity rally is that it is nearly all speculation based. Warren Mosler says much of it is due to the huge inflows into long only commodity funds. I agree with this narrative. But MMT does not have a currency model – at least not a public one. ;) I do have a model, based on MMT, that says most currencies around the world have a reason to be stronger against the USD.
Even the pathetic Euro – that messed up, fatally flawed currency – has a powerful reason to rally against the USD.
This blog is called the Traders Crucible, after all. Some forms of fundamental trading are applied economics. Fundamentals of the currency markets fall into that category.
Government Budget Constraint: I think we put this old horse down. [Update: More here. We cannot tell ex ante if we are violating or holding to the no Ponzi assumption with any certainty. Any violation is and can only be ex post knowledge. We can only act on what we can see today, which is probably inflation and the treasury yield curve. If you think there are unobservable factors and risks, well, how can we know what they are and what should we do about them today besides pray to the gods? If you want to take rational action, you need to act on the observables.]
Solvency vs. Debasement: We Cannot Become Insolvent. We Can Debase the Currency. Even Bill Gross – head of Pimco and the largest bond trader in the world – admits it now.
The TC rule: A simple rule that gives a target budget deficit. It will probably be linked to a floating tax holiday. Needs work – and I have a post/update brewing, but it isn’t all bad as it stands today!
The Meta-Critique: Can we know this information before we make the decision? We cannot make decisions using information we do not know ex ante. Can we know this information at all? I am seeing this pop up over at Matt Rognlie’s place.
Anti-Democratic Conspiracy in Economics: I’ll have more to say on this, but it is everywhere.
We live in bubble land: We live in a world where the economy demands credit bubbles. Mr. Rowe disagrees with my interpretation. but I suspect that real rates, and not an unobservable, unknowable natural rate(ex ante and ex post – thanks JKH!), will prove to be the cause of this.
Shadow stats and the Hyperinflation Hoax: Gaining Traction here too. The myth that we have high inflation right now, but the government won’t report it, is surprisingly common.
Crushing Austrian critiques of MMT: It’s obvious how to do it. Looking at the comments section at The Pragmatic Capitalist (Cullen is doing gods work over there) and Mises.org reminds me how hard it is to think scientifically. Some people – smart, educated, talented, productive people – can miss the subtle differences of scientific vs. logical thought, and there is little we can do to remove the scales from their eyes.
I was thinking along the same lines, but I didn’t have the full day to devote to this. Glad to see I don’t have to now! The price elasticity of Oil is low, and remains low. This means that demand does not change much ever for large differences in price in the short term.
We’re used to pricing oil in USD. But another really good way to look at the oil is “How much of our work is devoted to purchasing energy?” The reason this is a good question is because the amount of energy demanded doesn’t change even when the price for this energy changes. So asking how much “money” this energy costs is not as useful ask asking how much work it costs.
For this, you translate the total cost of oil USD into GDP terms. This is what BAML did! Nice one. It turns out that in terms of Global GDP, the price of oil is already nearing the 2008 highs.
Then they point out that this demand elasticity has a huge kink. It is strongly linear until a point, but at that point the world capitulates and destroys a huge portion of demand. This dynamic was one of the triggers of the 2008 Lehman Crisis – remember $4.50/gallon gas?
Apparently, we are very near that point with the current prices of oil. Ouch.
First, the part that demand elasticity causes huge jumps in price for minor disruptions in demand. (h/t to the FT Alphaville blog):
the price elasticity of global oil demand will ultimately determine how high oil prices go. Broadly, we would argue that a 10% increase in oil prices pushes down global oil demand by about 0.5%. In other words, a 600 thousand b/d production disruption should impact Brent crude oil prices by about 15% or $15/bbl, in our view. This calculation is consistent with the jump observed in recent days in response to Libya’s output disruption. Worryingly, it highlights the risk of further price rises if more production is shut in.
Then worry that we are really close to the discontinuous break point for demand destruction:
In our opinion, if Brent crude oil prices hold at around $110-115/bbl in 2011, energy as a % of GDP would remain close to record levels (Chart 14), suggesting that the point of demand destruction is in short sight.Even when looked at on a quarterly basis, we find that oil prices are already very close to the exceptionally high levels observed in 2008 (Chart 15).
While this suggests to them that we have a spike and crash scenario coming, I think it is already here. I am waiting on the “Crash” part. Combine this with any few random posts from Gregor.us and you can see a spiky future for oil.
By the way – you need to setup an RSS feed for both the FT Alphaville blog and for Business Insider. These are some of the best sources for information on the web. Plus you’ll find a good amount of quality IB reports.