Tell Us Sweet Little Lies

The Daily Reckoning PRESENTS: People come to believe whatever they must believe when they must believe it. And right now, according to James Kunstler, the American people need to believe that the world is simply awash in energy and prosperity. Read on…


Whenever somebody complains about “the lies that George Bush & Co. told to get us into the Iraq war” (as Frank Rich did in The New York Times recently), I wonder how those lies compare to the lies that the American public tells itself every day – for example, that we could run America without oil from the Middle East, or that hybrid cars will save Happy Motoring, or that we can have an economy without producing anything of value.

Meanwhile, the Dow Jones index went up over a hundred points the same day that 32 people were massacred on a university campus. And bear in mind that the massacre did not occur late in the day but literally around the same time that the New York Stock Exchange rang its opening bell – so that as the body counts mounted through mid-day, the stock markets only went higher! Then, the rest of the week, while the cable news Mommy-Daddies went through the familiar rituals of bewildered hand-wringing, and NBC released the trove of farewell videos sent in by shooter Seung-Hui Cho between killings, the Dow piled on another 250 points to close at an all-time record high just under 13,000.

Could the financial markets be more detached from reality, from life on the ground (or in a free-fire-zone classroom) in this nation?

Doug Noland over at Prudent is right: we’ve entered a euphoric phase of financial arbitrage capitalism with extreme Ponzi overtones, a pyramid scheme of revolving credit rackets and percentage spread plays completely abstracted from any reality of fruitful activity. The reason we don’t even call “money” by its former name anymore is precisely because we realize at some semi-conscious level that “liquidity” is not really money. Liquidity is a flow of hallucinated surplus wealth. As long as it flows in one direction, into financial markets, valve-keepers along the pipeline, like Goldman Sachs, Citibank, or the hedge funds, can siphon off billions of buckets of liquidity. The trouble will come when the flow stops – or reverses! That will be the point where we will rediscover that liquidity really is different from money, and if we are really unlucky we’ll discover that our money (the U.S. dollar) is actually different from real wealth.

Noland and others recognize the severe distortions in the finance sector, and they are surely correct to flag the implied dangers. But even these clear-eyed observers survey the disturbing finance scene without factoring the global energy situation. In a nutshell: world oil production seems to have peaked about 10 months ago. Being just past peak, there is still a huge amount of oil going into world economies. But being just past peak we are now seeing how complex systems proceed toward instability and breakdown when the underlying energy flow turns toward contraction.

The situation in finance is particularly sensitive and acute because an overall contraction in available energy means the end of industrial expansion (a.k.a. “growth”) at “normal” rates of three to seven percent annually. More to the point, it means that certificates, contracts, deals, plays, and rackets pegged to the expectation of growth will lose their legitimacy. Meaning, stocks, bonds, collateralized debt obligations, hedges – anything that represents the hope and expectation for more-of-anything – will no longer be understood to represent real value.

The current euphoric hysteria should therefore be viewed as a form of disorder in its own right. The players in the markets are making their moves based on misunderstood signals. They think the world is awash in energy and prosperity. They believe Cambridge Energy Research Associates (CERA) and the Chairman of the Federal Reserve. They believe that the mortgage fiasco and the associated imploding housing bubble are just a couple of temporary zits on the handsome face that Wall Street presents to the world. In the background, though, feedback loops are aligning to rock the systems we depend on for daily life in the real world. Capital will become unavailable. Food will grow scarce. Trade will be interrupted. Mobility will be constrained. And an awful lot of pissed-off people will be poised to fight over the table scraps of industrial civilization.

I got a letter last week from a reader complaining bitterly that the stock market hasn’t crashed and blaming me for predicting that it would. He didn’t say, but I hope he hadn’t been out there on a shorting spree. In case any of you haven’t noticed, 2007 is not over yet.

The markets have been on an extraordinary spring run. The Dow finished 23 out of the last 26 days on the upside – some of them pretty way on the upside. This is the biggest U.S. stock market up-streak since a 19 for 21 streak in July of 1929, prior to the October crash. Bill Fleckenstein points out a similar run on the Tokyo exchange – 32 upside trading days out of 38 – just prior to its 1989 tanking.

While this kind of behavior seems ominous, I’m not claiming it necessarily has predictive value. One can say that the financial markets per se are running in an impressive state of structural distortion and imbalance and that systems way out of balance do not stay that way forever. But I risk more opprobrium by stating the obvious.

I think the persistence of this gross imbalance can be accounted for in large part by the current global energy situation. The world is at peak energy, peak oil especially, and the world runs on oil. Peak is peak. The most. There are about 84 million barrels of oil a day flowing around the industrial economies of the world. It is running a lot of activity.

Now, I happen to think that oil production probably peaked about a year ago, but we are still so close to it that the net available energy remains immense. Even if 2007 averages out to 83.5 million barrels a day instead of 84 million, it will still seem like a lot. Markets may be dumber than we think. All they see is a vast amount of cheap energy for manufacturing plastic salad shooters, for powering tourist jet charters to Cancun, for running Wal-Mart, Walt Disney World, and Taco Bell. All that energy is here right now.

Among the many tragic elements in the human condition is this tendency toward short-term thinking, the inability to imagine how our arrangements will work in a time that is not right now.

Interestingly, the main effect of post-peak oil on markets and economies is that it will produce shocking instabilities in complex systems dependent not just on the energy itself, but on the expectation for continuity of the energy. Financial markets are especially sensitive because they operate on sheer expectations. The Dow Jones doesn’t manufacture salad shooters, or haul tourists to the Mexican beaches, or build suburban houses. It just relays a dumb signal that says “we expect more” and investors respond. The trouble will start when the signal changes to “we don’t expect more.” That moment will be when the recognition of peak oil galvanizes the public’s attention. It will manifest as a simple societal binary switching mechanism. When that happens, the markets will exhibit the dumb herd behavior that they are famous for.

Of course, I have argued previously that the stupendous run-ups of market indexes themselves represent a kind of instability (those distortions and imbalances), as do also the supernatural flows of “liquidity” and I would stick to that observation. After all, if the world is “high” on oil – and I would argue that it is zonked out of its mind – then it would naturally spring way up off the diving board before swan-diving into the empty pool below.

Me, I’m keeping my eye on things like the production figures coming out of Mexico, the North Sea, and the Kingdom of Saudi Arabia. They’re all sliding down. Mexico is especially interesting because it is our Number 3 source of oil imports and its production is crashing so hard that a couple of years from now it may not be able to send us a single drop of oil. What do you think of that? Maybe the Walton family will buy Iowa so they can keep Wal-Mart running on ethanol.

Meanwhile, U.S. oil refineries are running above 90 percent production capacity to keep up with the gasoline demand for Happy Motoring. The stress on these complex operations is unprecedented. It gives them no slack time for routine repairs. The results are liable to be interesting, too, between the Fourth of July and Labor Day.


James Howard Kunstler
for The Daily Reckoning
May 9, 2007

Editor’s Note: It’s no secret that a viable alternative to crude oil is going to become increasingly necessary in the coming years – but is ethanol that alternative? Not a chance…or as Charlie Munger put it at the recent Berkshire Hathaway annual meeting, “The idea of running cars on corn has got to be the dumbest idea I’ve ever heard.”

James Kunstler has worked as a reporter and feature writer for a number of newspapers, and finally as a staff writer for Rolling Stone Magazine. In 1975, he dropped out to write books on a full-time basis.

His latest nonfiction book, “The Long Emergency,” describes the changes that American society faces in the 21st century. Discerning an imminent future of protracted socioeconomic crisis, Kunstler foresees the progressive dilapidation of subdivisions and strip malls, the depopulation of the American Southwest, and, amid a world at war over oil, military invasions of the West Coast; when the convulsion subsides, Americans will live in smaller places and eat locally grown food.

You can get more from James Howard Kunstler – including his artwork, information about his other novels, and his blog – at his Web site:

When money talks, we listen. But we expect money to return the courtesy.

For many months now, we’ve been warning money. “You’re getting a little out of control,” we’ve been saying. “You’re becoming reckless,” we warned. “Watch out…you’re over-paying…you’re taking too many risks…you don’t know what you’re doing.”

But Mr. Moolah never listened.

And now we’re no longer listening. Why should we? The poor fellow’s off his head – raving, screaming, and talking nonsense. But the lumps still pay attention.

On Sunday, three state-run newspapers in China ran cautions similar to ours. Zhou Xiaochuan, governor of the People’s Bank of China, gave the people a warning; when asked whether a bubble was forming in Chinese stocks, he said ‘yes.’ Nothing very subtle about it.

But what do the people do? They ignore their leaders and bid up Chinese shares another 3% – to a new record high, at 43 times trailing earnings. Last year, the Shanghai Composite index rose 130%. It’s up another 50% so far this year. And so many people are making so much money that they’re not about to pay attention to either the Daily Reckoning or the Peoples’ Daily.

The Chinese are famously frugal. They are said to save 25% of their earnings. What are they going to do with the money? The Central Bank also sets interest rates, and at the moment, savers earn just 2% on their deposits. In a country with about 5% consumer inflation, that gives them a net return of minus 3%.

So the poor Chinese are damned if they do and damned if they don’t. But our guess is that a 3% loss on savings accounts will look like found money when the stock market crashes…as it is likely to do.

Meanwhile, across the broad Pacific, investors are as deaf as the Chinese. Stocks have had a winning streak not matched since before the crash of ’29. Also, similar to the ’29 period – stock margin accounts are up. Here’s a report from USA Today:

“The NASD, a brokerage regulator, recently sent out an ‘alert’ to investors outlining the risks associated with margin. Through the end of March, the latest data available, the amount of debt taken on by investors to buy stocks totaled $317.7 billion. And while that was a bit below the $321.2 billion record hit in February, it still surpasses the $300 billion in March 2000 at the top of the tech-stock bubble.

“‘If you’re borrowing money from your broker to buy stocks, you’re basically speculating,’ says Chris Johnson, investment strategist at Johnson Research Group.

“A sharp rise in margin debt means investors are eager to own stocks. And such spikes are often associated with market tops, as was the case in 1929 and 2000.

“Sure, investors have a chance to boost returns by using other people’s money – a technique called leverage – to buy more shares than they could on their own. But buying on margin is just another form of debt, another IOU, another buy-now-pay-later transaction.

“‘We’re not trying to set off alarm bells,’ says Elisse Walter, senior executive vice president at NASD. ‘But with margin debt (near record levels), we felt it was a good time to remind retail investors what margin is, how it operates and what the risks are.'”

Warn all you want. Money is deaf…and very dumb. Despite our warnings, the Dow has been up for five weeks in a row.

More news:


Addison Wiggin, reporting from Los Angeles…

“‘Excluding housing, the U.S. economy is doing just fine.’

“That’s what supporters of the Bush administration’s tax cut strategy say. A 4.6 percentage point cut in the top marginal tax rate and 5-point reduction in the top capital gains rate will protect the economy from any and all ills.”

To read the rest of this story, including how our own Mike “Mish” Shedlock weighs in on the situation, check out today’s issue of The 5 Min. Forecast


And more thoughts…

*** Should the people pay any attention to official warnings?

Didn’t Alan Greenspan famously warn of ‘irrational exuberance’ in 1996? And didn’t it turn out that the exuberance wasn’t so irrational after all? The Dow went up for four more years…corrected in 2000-2002…and has been going back up ever since.

And remember when Carlos Menem, president of Argentina, told the world that it had nothing to worry about with the peso. “One peso, one dollar. Full stop.” We were just there; we got three pesos to the dollar.

“When the authorities tell you to do something, you should probably do the opposite,” says our neighbor, Pierre. But what if…occasionally…the authorities didn’t lie? Yes, it would be a dirty trick…but we wouldn’t put it past them.

*** And here’s a non-warning. The National Association of Realtors says problems in the residential property market are worse than it thought. Instead of the average, existing house declining 0.7% this year as it predicted, the drop is likely to be closer to 1%, says the NAR. Not since the ’30s has this happened, it noted.

And ‘if it weren’t for a favorable economic backdrop,’ the situation would be much worse.

A one-percent fall doesn’t sound to us like something anyone would worry about.

Meanwhile, foreclosures in April were twice their level in 2006. Warren Buffett says these problems are big problems for the people who are in the middle of them, but they’re not likely to affect the rest of the nation.

We suppose it’s a bit like being in a big battle. It’s probably exhilarating and interesting – as long as you’re not one of the people who gets killed. And even if you aren’t on the front line, you should still be prepared.

*** Poor ‘Sarko.’ The man just gets elected President of France and already the media, the whiners, and the sore-losers are giving him a hard time.

What did he do? He took his victory holiday on a rich man’s yacht. It’s a “form of arrogance and even insult,” said Ségolène Royal’s press secretary.

And, according to some, Sarkozy’s politics stem from his aristocratic family history in Hungary before he immigrated to France. During the war, the communists burned down the family chateau.

But all of that would go against one of the chief pillars of the democratic, egalitarian myth, which is that the elected jefe is supposed to be just like anyone else. Remember when George Bush senior expressed surprise at automated tellers in supermarkets? Ooops! We were supposed to believe he shopped for his own groceries, just like the lumps who voted for him.

And in almost every election campaign in Britain, a politician is bushwhacked by a journalist who asks him the current price of milk. The president is supposed to be a ‘man of the people,’ not a tool of the rich and powerful. Which is why George Bush, the younger, in his presidential campaign, played up his Texas ties…his cowboy boots…his ranch and his good ol’ boy yahoo connections – rather than his elite, East-Coast background…his rich family…or the fact that his father was head of the CIA, the Vice-President, and later the President.

And here is Nicholas Sarkozy now leaning so hard on the pillar he’s threatened to knock it down.

*** Oh…and here comes another fraud – this time on art lovers. At the head of the pack in the running for this year’s Turner Prize is Mark Wallinger. And there on page five of today’s Financial TIMES is the opus for which he is slated to win.

The FT describes it: “a controversial reconstruction of peace campaigner Brian Haw’s Iraq war protest.”

And there is the artist…sitting in front of various hand-made banners.

“No More War,” says one. “Australians say NO to war in IRAQ,” says another. “SANCTIONS/BOMBS KILL 200 + IRAQI KIDS UNDER 5 EACH DAY,” announces another.

You could find thousands of those banners on any corner in any antiwar demonstration.

Well, what do you expect? Previous winners include Damien Hirst, who pickled a sheep, and Chris Ofili, who piled up elephant dung.

Stay away from this trash, we warn. But who listens?


The Daily Reckoning