Thursday, February 28, 2008


They say the opera ain't over until the fat lady sings but Hillary does not need to stick around to hear the last song. To win the nomination, Hillary needed big wins in the big delegate states of Ohio, Texas and Pennsylvania and that was before the super delegates started swinging over to Obama. The race in Ohio is tightening and her lead in Texas is gone! Miracles do happen but Hillary is going to need divine intervention to pull out a win.


Obama is the very good politician who, ironically, mastered the Bill Clinton play book. Obama has promised to spend massive amounts of money on all sorts of government programs. As a big city democrat it should be no surprise that in his eyes it should be the federal government building and supporting local trains, buses, subways and L ways. His biggest source of funding? Like Bill Clinton's, "the peace dividend". In Bill's case, the failure of Hillary's massive health care program and his reduction of military spending, allowed him to spend a lot of government money on a lot of domestic programs while making a lot of "friends". Bill was certainly not the first politician to "pay off" the people who voted him into office but he was certainly one of the most prolific. Hillary has been reluctant to show her tax returns because she would have to show how much money Bill has collected from "friends". It is sad to know that CEO's of corporations and successful politicians do not need to worry about what their tax bracket is, provided they continue to have close "friends" in high places.

One of the many ironies of Bills term in office is the fact that it was the enormous size of Hillary's health care plan that scared the congress over to republican control for the first time in 40 years and it was this switch that enabled Bill to become a President of great accomplishment. The republican congress and Bill lowered the capital gains tax, passed several major free trade reforms and passed welfare reform. Hillary ran into the tricky problem of trying to take credit for the economically successful Clinton years while having to run against most of his "republican" policies. It is easier for Obama to attack NAFTA and in his next breath express his support for free trade than it is for Hillary to do the same when she is on record for trying to take credit for this great accomplishment of her husband.

The impossible task for Obama is to spend "the peace dividend" several times over when there is no peace. Withdrawing from Iraq is not the route to peace but only the route to bigger war. The situation is similar to the days when Hitler "annexed" Austria with the tacit "permission" of Roosevelt. It is better to confront early and often rather than to wait for the war to become a World War.


The USA has plans to tighten the noose around Ahmadinejad's neck. The UN security council continues to drag its feet, giving Ahmadinejad every chance to "make a deal", even so the vote will likely take place next week and even Russia is ready to vote yes. Once these latest sanctions are imposed, the US is prepared to tighten the noose again by adding the Iranian central bank to the list of sanctioned banks. This will make international commerce for Iran very difficult and thus put severe pressure on the country leadership to "make a deal". The citizens are already unhappy with a weak economy, rationing of goods and high unemployment. If the second richest oil country is in bad economic shape during a time of $100 oil, the sanctions must be working.


Financial market observers continue to be totally confused by the contrast of the slowing world economy and booming commodity markets. Many observers are using the word stagflation to describe the current situation. They believe the economy is dying a slow death while inflation is out of hand, as is evidenced by the housing slump in the USA and the price of gold and oil. Part of what they miss is that inflation is a very late indicator which means that by the time inflation shows up, the economic slow down is over.

One of the commodities "trades being put on" is the stagflation trade which is to buy gold and to sell oil short. The idea being that inflation continues unabated, the price of gold will rise and if the economy slows the price of oil will drop. The opposite commodities trade is the "peace dividend trade" in which gold is sold short and oil is bought long. The idea here is that if a deal is made with Iran, the price of gold will fall like a stone while the world wide economy and the price of oil will strengthen.

The average fellow is not long one and short the other. The average fellow is afraid that the tightening of the noose on Ahmadinejad will cause a provocative response. If there is going to be an oil embargo or a war with Iran, it makes sense for gold and oil to be very high and for the dollar to be very low. There is no conundrum here! Here again, the extra cheap dollar is giving a strong boost to the US economy. Isn't the invisible hand of Adam Smith wonderful? How about the law of unintended consequences? We have the fear of war pushing the dollar down which is increasing US exports and boosting profits while causing others to fear an economic collapse because they see the dollar going down!

The timing is about right in terms of the business cycle. The Chinese Yuan hit a low in early 1995 about the same time as the dollar hit its low (the Chinese attempt to peg the Yuan to the dollar). By late in the year 2000, the Yuan had rallied from 75 to 110. It bottomed at 90 in 2005 and is now back to 103 and probably headed to 130 by the peak of the coming boom. Today, it took $1.50 to buy one Euro and at one point you could buy one for 78 cents! While the dollar has bounced along the bottom about a year, the Yuan has been rising, however, the dollar will catch up in a hurry and then some when a couple of things occur: when "a deal is made" with Iran or when US rates get so low that the US economy begins to soar.


The previous big declines in US short rates have given small banks the license to print money. After suffering for 19 months of yield curve inversion, small banks are about to enjoy an economic "sweet spot". They will enjoy steady loan demand from small businesses while enjoying low cost deposits. The Russel Small Cap Value Index is heavily loaded with small bank stocks and it is an option in most 401-K plans. The index has underperformed the market for a couple of years. I would be aggressive and move the bulk, if not all of my 401-K money to the index.


The Bush administration has no good reason to discuss how close we are to a deal with Iran. By keeping the negotiations on the "QT", if there is a deal, the Bush team wins but if not nobody knows the difference. With or without a deal, the demand for oil is about to "go elastic" as "stuff" starts to fall into place.

The "stuff" includes every thing from electric cars, hybrid electric cars, and "share cars" to extra oil from here there and everywhere. Big and steady improvements are being made in battery technology at the same time that large numbers of new power plants are being built. The beauty of a battery powered car is that it can give up electricity during peak load times and accept electricity during off peak times. While environmentalist do not like coal fired power plants, one plant is far more environmentally friendly than the 1000s of internal combustion cars it can replace. In the mean time, car companies are moving up the hybrid learning curve and down the cost curve very quickly. In 2004 there were 10,000 hybrids on the road in America and in 2008 there are over 80,000. Better batteries means more units will plug in to the grid and that engines will be smaller. With more than half of the worlds population now living in big cities, the electric models make sense for a lot of people. The "share a car" systems are growing quickly. The average city dweller who sells his car and joins a "share a car" program, reduces his annual auto mileage from over 5,000 to less than 400. City people can take the bus or subway to work but they need a car for the occasional evening outing.

Honda is the first to have started limited commercial production of a hydrogen powered fuel cell car. The most interesting part of their system is the "home hydrogen appliance". These appliances are hooked to the electrical grid and to a natural gas line. They use electricity during off peak time to convert natural gas into clean burning hydrogen. The hydrogen is used as the fuel for home and cars.


Dozens of existing refineries are being built and dozens of older refineries are being expanded. It took a few years to get new oil fields developed but now that several are coming on line, the new refineries are being built to accommodate the extra crude.


At the turn of the mid cycle turn of the 1980's, oil did not decline in price, it crashed. I see a similar event on the horizon. A deal with Iran would certainly surprise the great majority. Just remember, the opera ain't over until the fat lady sings and the noose is around the skinny chickens neck!