The world oil economy

Natural gas in North America broke below the $2.00 barrier today, for the first time in ten years. It’s important to remember that, unlike oil, natural gas does not trade at a converged, global price. Accordingly, a million BTU in LNG form currently trades for over $9.00 in the UK, and over $15.00 in Japan. Such low prices for natural gas unquestionably give the US a competitive advantage. But, it will take a resurgence in manufacturing and related industrialism to full capture the price disparity. After all, the US is still very much an oil-based economy.
That said, energy transition will indeed continue–and even accelerate. It is simply unavoidable that any physical process, which could be switched to natural gas from oil, will be overlooked in this economy. Given that the world oil economy is contending with prices for a million BTU in the $17.00 to $20.00 range, we should begin to see an arbitrage that captures the N.A. natural gas advantage at $2.00 per million BTU. How appropriate therefore that the Oil and Gas industry itself should get the ball rolling, in this regard. See this Reuters story – Drillers dropping diesel for cheaper natural gas:
North American oil and gas companies are trying to take the sting out of low natural gas prices by using it instead of costlier diesel fuel to drive their drilling rigs… Apache Corp, the largest U.S. company focused solely on oil and gas exploration and production, is in the process of converting its first rig to run on power generated by liquefied natural gas (LNG). Canada’s Encana Corp’s already has 15 of its more than 40 rigs driven by gas, and plans to convert even more.
I’ve written extensively about the long, and economically painful process of energy transition but it now seems likely that the first five years of such a disruptive transition is now behind us. In the next phase, a longer period which should take at least another 10-15 years, we will see oil cede its primacy first to coal. This hand-off from oil to coal is already very much underway. Natural gas will then start to compete against coal more forcefully by mid-decade, and then later in the decade the fast rate of growth in renewables–taking place from low levels in the background–will break out to the upside and gain significant share of global primary energy supply.

Business investment spending

Bill Dudley, the president of the New York Federal Reserve bank, indicated that he is most likely supporting additional action by the Federal Reserve to speed up the economy.

In remarks at an event in Syracuse, New York on Thursday morning, Dudley argued that "recent growth rates are barely keeping up with our potential."

"The incoming data on the U.S. economy generally has been a bit more upbeat over the past few months, "Dudley said. But it is "still too soon to conclude that we are out of the woods."

Some of the growth in sales and job creation in the first three months of the year may have been due to the mild winter pulling forward hiring and economic activity, Dudley said.

More from the speech:

 William C. Dudley, president of the Federal Reserve Bank of New York.

Extraordinary valuation levels

Bill Gross: One of Our U.S. GDPs Has Gone Missing

[The last fifty years] produced a persistent increase in asset prices vs. nominal GDP that led to an average overall 50-year appreciation advantage of 1.3% annually. That’s another way of saying you would have been far better off investing in paper than factories or machinery or the requisite components of an educated workforce. We, in effect, were hollowing out our productive future at the expense of worthless paper such as subprimes, dotcoms, or in part, blue chip stocks and investment grade/government bonds. Putting a compounding computer to this 1.3% annual outperformance for 50 years, produces a double, and leads to the conclusion that the return from all assets was 100% (or 15 trillion – one year’s GDP) higher than what it theoretically should have been. Financial leverage, in other words, drove the prices of stocks, bonds, homes, and shopping malls to extraordinary valuation levels – at least compared to 1956 – and there could be payback ahead as the leveraging turns into delevering and nominal GDP growth regains the winner’s platform. …Rage, rage, against this conclusion if you wish, but the six-month rally in risk assets – while still continuously supported by Fed and Treasury policymakers – is likely at its pinnacle. Out, out, brief candle.

The outcome for taxpayers will be the same

Would you invest in a financial company that is going bankrupt? Actually, you already have! While you may have been an unwilling investor in FNM, you are continuing to invest every day, like it or not. Your “investment” is also increasing every day in Freddie and the FHA, both on similar trajectories. Welcome to the world of Alice in Wonderland where the solution to a credit-caused bubble is more credit.
The pressures from this nonsense continue to build. The fact that the US government is insolvent doesn’t seem to matter. Our government, the wounded and cornered animal, will do anything to survive. In this case, survival is keeping the game going as long as you can. But this game is Russian Roulette and taxpayers, knowingly or not are participants. No one knows whether the next revolution of the chamber will produce a click or the FINAL BANG.

Most understand economics only experientially

The bailout fiasco is just now starting to show up for the act of desperation that many suspected it was. Instead of allowing markets to resolve a severely over-leveraged and distorted economy, the government decided to try to “bluff” its way through one more time. This strategy has been one used for almost 5 decades. Each time the credit stimulus required is bigger than the last. Each time the distortions to relative prices is made worse. Each time the misallocation of resources becomes greater. Each time the credit levels of individuals and government expand. Each time inflation becomes a bigger problem. Finally, a time comes when malinvestment and credit burdens are too large to be supported. It is probable that we have reached that point. To appreciate how far we have come regarding the abuses of credit creation, one need only note that since the Federal Reserve was created in 1913, the dollar has lost about 96% of its purchasing power. Most of that loss (probably in excess of 90%) has occurred since 1980.
There are still many that believe that government actions will get us out of our predicament. They won’t. When we come out of this mess, it will be in spite of these actions. They will serve to make the problem worse and cause it to last much longer. Japan has been employing similar stimuli for two decades, and its economy has still has not recovered.
As time passes, it will become apparent to all but the dullards that these interventions were non-helpful and actually harmful. Most understand economics only experientially. Events as discussed in the following post by Rolfe Winkler today are what will continue to surface with the passage of time and provide enough instances for the experiential learners.
Besides being a terrible decision that will cost taxpayers dearly, the article also talks about the unintended consequences of drawing deposits away from smaller, solid banks to the weaker GMAC. The unintended consequence is to weaken the stronger banks.

The current economic crisis

A rosy assessment by Bloomberg. Their assessment of growth is reasonable; the statement that “… government stimulus helped bring an end to the worst recession since the 1930s…” is highly unlikely. It appears to be both an early and foolish call. During normal recessions, it is typical to have an intervening quarter or two of growth and then return to negative numbers.
This is no ordinary recession. There can be no recovery until the private sector (more properly called the productive sector) starts growing again. The public sector (better called the non-productive sector) produces virtually nothing, although it can appear to “cause” growth because of the manner in which GDP is defined. The government has no money of its own. It gets money either by taking it from the productive sector or by printing it. To get money from the productive center, it either coercively takes it in the form of taxes or sells bonds. Either way, the productive center has less funds to use. The government cannot produce growth in this fashion because of the dollar for dollar trade-off. Their spending makes us poorer in the sense that they do not spend the

Smooth transition in markets

Below is today’s press release from the Fed. I have emboldened a couple of key statements.
“With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.” While this statement may be true (probably less so than we are led to believe) at the moment, ignore it. It is a “CYA” statement that provides cover for the Fed to continue pumping the economy. This statement or its equivalent will probably be in the Fed’s statement until a month or two before rampant inflation is obvious to everyone.
“The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt. In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010.” This statement is inconsistent with the prior statement. It is either untrue or a diversion. There is no “smooth transition in markets” possible. While it might be possible that the Fed does actually honor this statement in a strict sense, they will merely shift their pumping to a different vehicle. To stop pumping now would mean a collapse of the mortgage market and the economy that will result in a Great Depression.
It is difficult to discern whether the Fed is merely being duplicitous or just plain wrong in their reading of the economy. After all, they have a pretty good track record for both.
If you believe what is in the statement, then I would get out of the stock market immediately. If not, then it is possible that the financial market fantasy can continue for awhile. Regardless of which you believe, be very careful. For me, I want no part in long positions in traditional stocks or bonds. This Ponzi scheme cannot go on much longer.