In the Aftermath, Part II
In the final installment of this two-part essay, Justice Litle explains what effect this year’s volatile hurricane season will have on consumer and government spending.
"Everybody came in here with every car they had and took everything we had in the ground."
– Kip Neuhart, Chevron station manager, Marietta, Ga.
As the linchpin of the global economy, much depends on the American consumer. With consumer spending representing more than two-thirds of U.S. economic activity, and consumer import consumption the engine that keeps Asia humming, money to spend and willingness to spend it are critical for turning the fiscal merry-go-round. In this regard, Katrina has had a sharp financial and psychological impact.
Consider the shift in perception of gasoline prices. An editorial cartoon from a few months back does a good job of illustrating the difference between then and now. A carefree motorist fills up his SUV at the gas pump, whistling aimlessly, with electrodes attached to the back of his head. Two scientists observe from behind a one-way mirror. One is manipulating a large dial – the price of oil listed in $10 per barrel increments – as the other takes notes. The first scientist has a look of surprise and concern as he tentatively turns the dial toward $60. The second scientist frantically observes, "It’s not having any effect!"
Fast forward to the present: That carefree, "what-me-worry" mood is long gone. It has been replaced with anger, anxiety and fear as prices break the $3 per gallon mark nationwide, with outliers as high as $6 reported at gas stations in the Southeast. There is real pain at the pump. The governor of Georgia has publicly denounced gas gouging, President Bush has asked drivers not to horde gas and fears of shortage become self-fulfilling prophecy as anxious drivers blitz their local filling stations and run them dry. The long lines of the ’70s have returned, and a few illiterate politicians from Hawaii and Florida have even called for the reinstatement of price controls. (Hopefully, they will be muzzled or ignored.)
Things were already looking precarious before Katrina, with the consumer savings rate in negative territory, discretionary income dwindling and energy prices high enough to cause fresh concern. The disruption of Gulf Coast production did not create a new problem. It merely kicked an existing one into overdrive.
While gasoline prices will ease a bit as initial panic dies down and excess driving is curtailed, there is another psychological bogeyman waiting in the closet: natural gas.
Natural gas futures were already challenging all-time highs before the disaster struck. They have since gone into orbit on concerns that commercial storage inventories may not be enough for a cold winter ahead.
From a psychological perspective, the unknown often generates more anxiety than the known. Consumers are already dealing with shock and awe as they fill up their gas tanks. Now they have to endure a more frightening question: How high will the heating bills be this winter? It’s impossible to know, and there are many months to dwell on the question…before we find out just how cold the coming winter will be.
Hurricane Katrina and Gasoline Prices: Consumer Anxiety and Government Spending
As consumers adjust to these new realities, the instinct to cut back may finally kick in. We are likely to see the savings rate tick up over the next few months, as anxious consumers brace themselves for a further body blow this winter. This shift in sentiment could put further pressure on the retail sector as discretionary income erodes, and a slowdown in import consumption may put economic pressure on Asia, as well. Of course, if China starts to feel the pain due to consumer slowdown, the complimentary Treasury purchases that have kept interest rates low and home values high may grind to a halt.
"At some point, the sense of confidence in capital markets that today so benignly supports the flow of funds to the United States and the growing world economy could fade. Then some event, or combination of events, could come along to disturb the markets, with damaging volatility in both exchange markets and interest rates."
– Paul Volcker, "An Economy on Thin Ice"
"What we are looking at… is one of the biggest U.S. public finance projects of all time."
– Joe Mysak, Bloomberg columnist
As a result of Katrina, the pace of government spending will increase rapidly. At the same time, the Federal Reserve is facing increased political pressure to pause in its campaign of interest rate hikes. This combination is likely to weigh heavily on an already weakening dollar, as foreign creditors look on with growing concern. (All this with a vulnerable Asia in the background, no longer so anxious to provide vendor financing.)
This is not a criticism of the coming rebuilding efforts, or a denial of the need for federal assistance in time of disaster. It is simply an observation that the bill is coming due at a time when U.S. finances are decidedly shaky. Government officials have promised whatever it takes in terms of federal funds, and estimates have consistently estimated, with some suggesting Katrina could ultimately cost more than the wars in Iraq and Afghanistan combined. This comes on top of more than $100 billion in estimated economic damage, with long run energy costs still unclear. Not to mention federal assistance for a million displaced individuals. Meanwhile, fiscal conservatives are disgusted with the lack of political will to cut back pork in other areas as we are hit with these massive expenditures.
It is hard to play the role of fiscal hawk in the face of human suffering. The natural moral instinct is to give with compassion and expect the government to spare no expense in restoring order. The problem is not the financial realities of disaster relief, but rather the fiscal excesses that came beforehand, putting the country in such an untenable financial position in the first place. Nothing has been put aside for a rainy day. The credit card of last resort is already loaded with charges. Nature’s misfortune has compounded the ill winds of poor financial planning.
Hurricane Katrina and Gasoline Prices: Every Financier for Himself
At the end of the day, America has essentially borrowed $2 trillion from the rest of the world and spent it in mostly nonproductive ways. The Fed fueled this binge and facilitated a gold rush in paper assets (what else do you call $400,000 condos that don’t yet exist?). To the degree that real estate appreciation is fueled by borrowed dollars, the appreciation is not real wealth, but rather a temporary loan from overseas creditors. Consumers are not using these generous loans to start productive businesses with an aim for future return on investment. They have been swapping houses, monetizing their mortgages and living it up on the proceeds. When that money has to be paid back, America will have little to show for it. The only way out will then be to manage the dollar downward, which in turn triggers a deliberate erosion of purchasing power for all those holding dollars and dollar-linked assets. The consequences of fiscal profligacy may be long delayed, but ultimately cannot be denied.
The inevitability of a managed dollar descent is not in question. In fact, it is a key piece of the "optimistic" scenario for a soft landing. America has all but admitted that its fiscal rehabilitation plan hinges on inflating its way out of trouble, a "burn the bag holder" scenario. Only an issuer of the world’s reserve currency could get away with such a brazen plan – and probably not more than once.
Reserve currency or not, no credit line reaches to the sky.
It is a foregone conclusion that America’s net borrowings from foreigners will eventually cease, and then head into reverse as fiscal imbalances sort themselves out. When this happens, the dollar will begin its slide in earnest, and moneymen the world over will pray that the descent is an orderly one.
No central bank stands to gain from a free-fall scenario in which the world reserve currency plummets. But if things start getting precarious, it could easily become every financier for himself. As Jesse Livermore dryly noted, in times of crisis, the bankers do not stand around saying, "After you, my dear Alphonse."
Hopefully, the destabilizing event that former-Fed Chairman Volcker hypothesized was not a natural disaster. Hopefully, we are not already making our way down the slippery slope.
for The Daily Reckoning
October 11, 2005
P.S. Still, if the final-straw event (or combination of events) has not yet arrived, the hour is surely coming, and Katrina may have hastened it.
Justice Litle is an editor of Outstanding Investments. He has worked with soybean farmers, cattle ranchers, energy consultants, currency hedgers, scrap metal dealers and everything in between, including multiple hedge funds. Mr. Litle also acted as head trader for a private equity partnership, and made contributions to Trend Following: How Great Traders Make Millions in Up or Down Markets, a popular trading book by Mike Covel (FT/Prentice Hall).
Cogito, ergo ignoramus.
The more we think, the less we know. In fact, the only thing about which we become surer is that the people who think they know something are swindlers or hallucinators.
Not that we have anything against them. They are often charming, intelligent and persuasive. And who knows, they could even turn out to be right!
"Yes, but Delphi is an old, unionized industry," came the answer from one of them.
It came in response, not to a question, but to an observation we made over dinner: Some of America’s most important industries are going broke. This fact did not bother the group of fund managers at the table. It merely confirmed what they already knew: It’s a new era. Old industries, old rules and old principles are no more interesting than day-old bread. That’s why the trade deficit no longer matters…why debt levels no longer count…and why people can get rich without making anything.
Delphi makes auto parts. It employs 180,000 people around the world. When Delphi went belly up, it signaled the beginning of, "inter-generational warfare facing much of the industrialized world," says a Financial Times commentary. If old workers insist on being supported in the style to which they’ve become accustomed, it will put the younger workers out of a job. Our old industries cannot compete – not with the ball and chain of union contracts, health care and pensions attached to their ankles. But so what? They can get jobs as stockbrokers and real estate agents!
"What do they make in England?" one of the fund managers asked. "Nothing. And yet look around you…this city is booming. England is rich. It is prosperous. It is growing. Did you know that the City (equivalent to New York’s Wall Street) is now a quarter of the entire nation’s economy?"
The money shufflers are getting rich, we have no doubt about that. You can see it just by walking around South Kensington. But what do they add to mankind’s wealth? It is hard to say. And can an entire nation of people flourish by financing each other’s consumption?
"The trouble with you perma-bears," our host continued, "is that you are like the Physiocrats of the 18th century. They believed that all value came only from the land…that is from agriculture. They could not believe that the Industrial Revolution would create a new kind of value.
"Well, now we have a new kind of value being created. You can see it. While the old, unionized industries in America – like the auto industry and the airlines – go bankrupt, there are new industries being invented all the time. They don’t need to build factories. Whatever they want to sell, they can design and put out for bids. They don’t need factories and they don’t need unionized labor. That era is gone."
That may be, we protested, but that is the era that made the United States and Europe the richest part of the world. Now, you can talk about how inventive and smart Americans are all you want, but just look at the national chart of accounts. We lose money every day.
"The biggest mistake most economists make," he continued, "is in treating the national accounts as though it were a company. This is the mistake that Buffett makes, too. He thinks that a nation with a current account deficit is like a nation that is in the business losing money. It is nothing of the sort. The deficit in America’s current account is merely a sign that people all over the world want to hold U.S. assets. Why do they want to hold them? Because they are safe."
Some of the brightest people in the financial world believe it, including our companions at dinner last night. The world has changed, they say. You no longer need to save money, or to build factories, in order to prosper. Now, what you need is brains and information. And those are the two things that America has in abundance.
"The Anglo-Saxon empire has peaked out? Are you kidding? What would replace it? China? Not a chance. China is booming, but it is also ready to blow up at any moment. And smart people know it. That’s why they take their money out of China and invest in the United States. Yes, foreign ownership of U.S. assets may be increasing, but so what? We advise our clients to buy more assets in the United States and we’re very bullish on the dollar."
This is why, dear reader, we turn to the essentials. Smart people can find good reasons for anything. Often, they are right. But which smart people are going to be right about which thing? And what is it that makes the dollar "safe" – except that a lot of smart people think so?
More news from the gang at The Rude Awakening…
Dan Denning, reporting from Colorad
"America’s oil shale reserves are enormous, totaling at least 1.5 billion barrels of oil. That’s five times the reserves of Saudi Arabia! And yet, no one is producing commercial quantities of oil from these vast deposits. All that oil is still sitting right where God left it, buried under the vast landscapes of Colorado and Wyoming."
Bill Bonner, back in London with other various opinions…
*** And the news just keeps getting better for goldbugs.
"Gold has reached a 17-year high, its highest level since 1988 overnight with the overall weakening of the dollar," our currency counselor, Chuck Butler reported.
"That pushes gold’s return this year to 9.1%. But my longtime friend, Doug Casey, believes that this is still just the tip of the iceberg with regards to the gold price increase!"
*** After a series of natural calamities, the world is getting edgy. Avian flu could cause an economic collapse similar to the Great Depression, says one analyst. It might bring a period of, "chaos worldwide for over a year," says an article in Foreign Affairs. We might have to impose quarantines, says President Bush.
*** "What we admire about you Americans," said a middle-aged French woman over the weekend, "is how fluid your society is. I mean, especially the educational system. You can go all the way through university without really deciding what you are going to do for a living. Here in France, we are much more rigid. There is less flexibility. People act the way they are supposed to."
The occasion for these remarks was a dance party, held by parents so their teenage children would learn how to conduct themselves. Called ‘rallys,’ these events are similar to ‘cotillons’ in America. We had already run Jules through a rally or two and should have had enough experience with them to know better. But now it is Henry’s turn. So, we made the trip back to Paris last weekend.
Three of the mothers, including Elizabeth, had organized the event; the fathers, including your editor, were on hand to wash dishes and toss out unwelcome intruders. Boys and girls – about 50 of them – arrived on time. The boys were all dressed alike, in blue blazers and ties. The girls wore dresses. All greeted the host parents politely and took their places on the dance floor, where a group of professional teachers were exhibiting the mechanics of the "French rock."
They danced to the same music as Americans, but not the same way. As in everything they do, they dance in a way that is more rational, more stylized, more Cartesian. Hands are held in a way that would make a universal joint jealous. With each beat, the couple assumes a new posture – his arm over her head, then her arm behind his back, then her left arm under his right arm, pulled behind his head…in just a few seconds the knot is tangled. It would take a sharp sword or a chiropractor to straighten them out, we think to ourselves. But then, the complex figures are resolved.
Henry and the rest of the children seemed to pick it up pretty quickly. We did not even try.
After the dance, instructors left, the teenagers returned to nature, which is to say, they gathered in groups of boys and groups of girls and did not dare to talk to each other. The music continued, signaling to the entire quartier that a party was on. A group of older teenagers in jeans and sweatshirts appeared at the door. Your editor was drawn out of the kitchen to send them on their way; he has learned to be very intimidating to 17-year-olds.
"This is terrible," said Elizabeth. "They’re not dancing anymore."
We wandered over to our son:
"If you don’t invite one of these girls to dance, your mother and I are going onto the dance floor ourselves."
Henry had a look of mortification on his face. He would have preferred at that very moment to have the entire planet destroyed by an asteroid rather than have his parents make fools of themselves by not only dancing – dancing in the American style – in front of his friends.
With only a groan in response, the poor boy went over to a girl with a cup of Coca-Cola in her hand. Soon, they and a few friends were dancing.
"It’s true that American society is more flexible and more open," Elizabeth observed. "But there is a lot to be said for restraints and manners. Liberty is fine, as long as you have strong cultural guidelines. These people have a very clear idea of how they should behave. It creates a very agreeable society – as long as you aren’t crushed by it."