War and Money

Could oil hit $100 a barrel? Sure it could – even if the US doesn’t invade Iraq. John Myers of Outstanding Investments notes that, adjusted for inflation, oil trading at 1980 prices would be $94 a barrel today. The question for investors seems not to be "if"…but "when"?

"For U.S. investors Saudi Arabia is one of the most important countries in the world. It is the largest oil exporter containing somewhere between 25% and 30% of the known world oil supply. When Saudi Arabia sneezes, U.S. investment markets catch pneumonia."

Richard J. Maybury The Thousand Year War

If you don’t succeed the first time, try and try again. That must be the motto in the Bush family as George W. prepares to take on Saddam Hussein 12 years after his father had the Iraqi army in ruins and let it limp home.

But this war will be vastly different for the United States, as it will influence which direction the United States will take in its role as a "superpower" – determining whether America’s power is in ascent or decline. Certainly, what happens over the next six months will determine much about the investment markets…and may even finally answer the inflation/deflation argument.

My mother used to say, "You can’t kill two birds with one stone." She was wrong. In fact, the U.S. government has an opportunity right now to kill three birds with one stone – and I will be shocked if they don’t seize it.

If George W. Bush invades Iraq, only three things seem certain: (1) Saddam Hussein will be ousted, (2) Muslims worldwide will have a different opinion of the United States, and (3) there will be a major shift in the balance of power in the Middle East. At stake is not only the attempt to eliminate Arab-sponsored terrorism but also the keys to the richest landmass in the world – the Persian Gulf.

The Persian Gulf holds more than two-thirds of the world’s dwindling petroleum reserves and the nations that control this region control the future price of energy and the fortunes of the world’s economies. Let there be no mistake; software may be the brains of the information age, but petroleum remains its engine.

Oil makes up 40% of the energy Americans consume and accounts for 97% of the transportation fuels. It is affordable oil that keeps America’s transportation sector healthy and our obsession with the automobile alive.

Did I say oil is affordable? It might not seem that way at the gas pump, but the truth is that if you adjust the price of oil for inflation it is cheap. Consider the fact that for a brief period in 1980, oil prices hit $40 a barrel. If we account for inflation, oil prices today would have to hit $94 to represent the same true cost!

That is more than a 300% gain from where oil prices currently stand. As you might imagine, such an explosion in the price of crude would propel oil stocks upward the way 100-plus-octane gasoline propels an airplane at takeoff.

Is $100 per barrel of oil possible? The short answer is yes, IF the war against Iraq draws in either Israel or other Arab nations or IF a U.S. invasion into Iraq incites the overthrow of the Saudi Royal Family. Under those two scenarios oil could easily rise beyond $100 a barrel, which in turn would not only have us lining up at the gas pumps again, but would also condemn us to watching the purchasing power of our earnings wither month after month. One thing that the stock – and especially the bond – markets can ill afford is rising inflation.

Losses on the 10-year Treasuries issued this past year – with their near-record low yields – would be monstrous, and would likely insight foreign investors to move out of dollars [more aggressively than they have been], thereby putting even more pressure on the greenback.

Certainly it is a high stakes game that the Bush administration is playing. You can almost hear Bush’s little mind reeling – the U.S. Army will roll over Iraq the way the Germans blitzkrieged Poland; Saddam’s army and his cache of chemical weapons will be eliminated with "extreme prejudice" as well as Saddam himself; in place a new Iraqi government will come to power, one friendly to the United States.

If that scenario unfolds, it would certainly cause a huge downward correction in oil prices that could keep crude below $20 a barrel for years. Furthermore, a quick and decisive victory would cement America’s military and financial position as the world’s sole superpower for years to come.

Another gulf victory would not only help in the fight against terrorists but would take care of the Bush administration’s first economic priority following the election – securing cheap and plentiful energy for America’s future.

Victory in the Middle East would allow the Bush administration to reflate the U.S. economy. Wars, after all, stimulate economies, don’t they? Even the limited war on terrorism is allowing federal spending to soar, with rarely a criticism by anyone inside the Beltway.

All in all, the plan is perfect, the Beltway mind believes…it’s a terrific way to rein in terrorism and boost federal spending and at the same time assure access to the oil elephants that dot Saudi Arabia, Iran and Iraq.

One problem. Wars rarely work out the way they are planned. This war may have little resemblance to the war in 1990 when the U.S., backed by a collision of nations, repelled Iraq after it invaded Kuwait.

Apart from the fact that there is no consensus about this war, not even within the administration itself, the only foreign backing the U.S. can count on comes from Great Britain. And barely that.

Furthermore, the politics of the region has changed. The Saudis are desperately tying to calm a growing radical population that sees the U.S. as the enemy.

Meanwhile Iran and Iraq have come closer together, one generation after their bloody war. Iran has warned the United States that it would be making a grave mistake to put troops in the region. And who knows what Israel will do…they are much more of a wild card today than in 1990. It doesn’t take a genius to figure out that the region is a tinderbox, one that could easily explode, driving oil prices through the ceiling.

Either way, North American oil companies with large reserves of oil per share will be a terrific way to catch the explosive potential of this market. Convenient, no?


John Myers
for The Daily Reckoning
August 27, 2002

Editor’s Note : John Myers – son of the great goldbug C.V. Myers – has been helping readers earn surprisingly lucrative returns in stocks largely unknown to Wall Street’s wunderkinder since his early 20s. Our man on the scene in Calgary, John has his fingers on the pulse of natural resource profits – including oil, gas, energy and gold. To begin making money using John’s experience and profitable insights, you can subscribe to:

Outstanding Investments

We’re still waiting…

Yesterday, stocks headed down in the morning…but late in the day a sudden wave of orders came in and the Dow ended the day up 46 points.

It goes without saying, there are a whole lot of people – in the Fed and on Wall Street – who don’t want to see this rally come to an end. The Dow is up 15% since July 23rd and they want to see it stay up.

The American economy is closer to what economists call a "liquidity trap" than at any time since the Great Depression. It sounds like something you find under the kitchen sink, but a ‘liquidity trap’ is what happens when prices fall and people decide to stop spending – realizing that things will just get cheaper as time goes by.

It’s a trap because it is very hard to get out of. The Fed can "create" money…but only so long as people are willing to borrow and spend. Otherwise, the credit just sits on the Fed’s books as harmless as a virus in a petri dish, never infecting the economy. When this happens, the Fed is trapped…just as the Japanese central bank has been stuck for the last half dozen years.

"But can’t the Bureau of Printing and Engraving just print money," people ask? Well, yes. A couple of years ago, one analyst helpfully suggested a cure for Japan’s trouble: just print up billions of yen and drop them over Tokyo, he wrote.

It’s a sad day when a central bank can’t destroy its own currency, but it happens. Even printing and carpet bombing dollar bills can’t save the situation…because it risks adding hyperinflation to depression, making the situation worse rather than better.

But people like to think that someone, somewhere, somehow is in control. "Greenspan wouldn’t permit a bear market," they said a couple of years ago. "The Fed won’t allow deflation," they say today.

But "error is the rule; truth is an accident," as Clemenceau put it. Greenspan has only been right twice in the last 16 years…and both times, perhaps by accident. He noticed that stock buyers were "irrationally exuberant" in 1986. Then, in 2002, he remarked that "infectious greed" could be a problem.

Apart from that, he had been wrong about everything. (About which more…today, below, and next week, when your editor returns to work on Monday.)

The gods of the market don’t care what Greenspan – or anyone – says. They just do whatever they want. People – even very powerful people – may try to tempt them or menace them towards one direction or another. Other people – even very smart people – try to figure out what they are planning. But, in the end, they keep their own counsel…and do what they do for reasons of their own.

Yesterday, the price of gold rose $2.70 – for no particular reason.

New figures showed investors took a record amount out of equity funds in July – $50 billion.

And poor Jack Grubman. It was not enough that the man resign his $20 million per year job as celebrity analyst; the hacks and harpers still won’t leave him alone. Business Week had called him the "Michael Jordan of analysts." Now, the Toronto Star says he has "single- handedly…taken his entire profession on the road to perdition."

And guess who else is back in the news? Remember Michael Saylor’s Micro-Strategy? Saylor was among the most flamboyant hallucinators of the Information Age. Information, we recall him saying, "wanted to be free." It should run like water, he opined, in a delirious moment, and make us all rich.

But then his stock fell from $300 down to nearly a dollar and Saylor went into a funk. Only a few weeks ago, in an attempt to avoid delisting, the company engineered a reverse split. And…whoa…the stock took off, rising 138% since the middle of July…to close at $12.37. And the message boards are whooping it up…hoping the stock will rise to $50 in this rally.

How likely is that? Well, the gods of the market can do what they want. But the company has only $37.3 million left…and is expected to burn through $20 million of it before the end of the year.

*** Micro-Strategy needs to get with the program. All over corporate America, businesses are cutting costs. Alas, cutting expenses can improve one company’s bottom line, but for the whole economy, expense cutting is just another major step towards a liquidity trap.

Even the International Herald Tribune understands the problem:

"Few economists acknowledge this dynamic. Corporate cost-cutting and labor-saving layoffs appear in the forecasts as the golden road to greater productivity and rising profit.

"Never mind that we have just fired the workers and extinguished the salaries that would have been spent on the merchandise and services that fatten the profit. With revenue failing to rise, we cut costs more. The process feeds on itself – until there are not enough workers and salaries left to generate sales and profit.

"There is hyperbole in this description, but not much. The United States is caught in the strangest and perhaps most perilous recovery since the Depression – featuring a dynamic that William Dudley, chief domestic economist at Goldman Sachs, characterizes as "the corporate paradox of thrift."

"If everyone tries to cut costs and save more, no one saves more," he said. "If you and everyone else cut costs, costs do indeed go down, but revenue also goes down, so profits eventually go down, too. Collectively, we can’t cut our way to prosperity."

*** It’s still raining here in Paris. The summer vacation doesn’t end until next week, but it seems like it is already over. But who knows? The weather gods can do what they want to…maybe they will give us some nice weather before next Monday.

*** Elizabeth has become passionate about horses; your editor has become a horse widower. He holds the horses responsible and resents them, but occasionally finds them amusing.

On Saturday, Elizabeth invited a youngish couple and their children for lunch. Claude had become the mayor of a small town by accident. Everyone thought the socialists would win. He put his name on the ballot as a conservative and was as surprised as everyone else when he won.

Claude entertained us with local politics. His wife, Celine, chatted with Elizabeth about the school system.

All was well until Elizabeth decided the kids would enjoy a horseback ride. So, your editor led the smallest of the horses around the yard, holding onto little Leopold at the same time. He had noticed that the horse was irritated by something and seemed to be on the verge of a nervous breakdown. If things went badly, he reasoned, at least he could pull Leopold off the horse’s back without any serious damage being done.

But then, just as our guests were getting ready to leave, Henry, 12, mounted up and took the reins in his own hands. Henry is a good rider. But even a good rider is no match for a bad horse. No sooner had Henry gotten into the saddle then the horse deliberately backed up close enough to the mayor’s wife to give her a solid kick with both feet.


The poor woman started to go down but was caught by her husband and helped into the kitchen for close inspection. No bones were broken, he determined. In fact, she was able to walk, with assistance, to her car…and bravely say "au revoir."

The Daily Reckoning