Tuesday, April 15, 2008


For three days, I have battled horrible, no good intestinal bugs. No fun!

Meanwhile, the market has gone absolutely bonkers. Food and fuel are being hoarded. In a world where food and fuel represents 60 to 90% of the cost of living for billions of people, the steady rise in prices has caused panic. Those who have a dollar to spare are buying next weeks rice today and some who don't are rioting in the streets. Whole nations are hoarding. India, for example, has barred the exportation of rice. (Before the green revolution India was a major importer of rice but the wonder of science had made this country an exporter until the ethanol shock hit the world.) The near term futures price of a barrel of oil has soared to very high levels relative to the price of a contract for oil 8 months away. This rise in the short term does not say we are running out of oil but that people want to "buy now before the price goes up". Speculators are buying oil rather than stocks or bonds. Tonnes of paper is being created that represents barrels of oil in the future. Where will the balance of the speculators money go once the spike in oil has passed?

Manufacturing statistics out this morning once again show that we are in the middle of a phony recession. The world GDP is growing at about 4%. US products are cheap. US exports contribute about 14% to the US economy. Housing currently contributes less than 4%. With exports growing at more than a 20% annual rate, the surge in US manufacturing is more than offsetting the decline in housing production. As we learned the other day from the Cafe Hayek blog site, the US production of manufactured goods has TRIPLED since 1970. The "political news double talk" is what it is. Right now the main reason there is an economic slow down in the works is because the consumer is being frightened into believing there is "big trouble in River City". One of the truths of the current situation is that there is speculation in the oil and food markets but, we cannot get around the fundamental fact that energy prices have gone up because of increased demand, in other words, because the world economy is strong.

Is the increase in fuel demand ever going to be over taken by an increase in supplies? China expects to increase coal production this year by 19%! While the full story out of Brazil will not be known until much more exploration is done, the size of deep water deposits in the area could easily become the third largest oil field of all time. While the "news" out of Russia this morning is that oil production has fallen for the first time in many years, the fact is that Russia should complete one of many mega-projects expected to be completed in 2008 and it should see 800,000 barrels per day of new production from this project. Oil producers are coy about depletion rates and some fields that should have been "empty" 30 years ago are still producing so it is not known how much new oil Russia needs to just stay even but an 800,000 barrel per day project is big.

According to data posted on the Oil Drum site, other mega-projects to be completed in 2008 are:

Saudi Arabia 1,100,000 bpd
Nigeria 600,000 bpd
Iran 400,000 bpd
Angola 200,000 bpd
Qatar 200,000 bpd
Canada 600,000 bpd
Brazil 500,000 bpd
Mexico 500,000 bpd
USA 400,000 bpd

The amount of money being invested to bring more energy to market is astounding. The money going into Canadian Tar Pits, while only a small piece of the global story shows the magnitude of the investments. About 8 Billion US dollars will be invested in this area in 2008. To complete the planned projects, in 2009 an additional 12 billion will be invested, another 12 Billion in 2010, and another 15 Billion in 2011. Looking backward, the investments made in from 2004 through 2007 of 23 Billion are already producing results. Two years ago, I suggested that the turn in the price of oil would happen before the presidential election. I still believe it.


The formula for GDP is P x Q (the price of goods times the quantity of goods). When a business cuts back, it cuts back at the margins. It cuts back on selling goods that are only marginally profitable. It cuts back on the quantity of goods it makes available. It cuts back on promotions. As a result of cutbacks, the quantity of products sold by a company declines but the average price of the goods sold tends to go. Using the airline business as an example, the recent tickets that have been eliminated were the $10 tickets. The elimination of 10,000,000 of these $10 tickets per year only represents a decline in revenues of $100,000,000 but it is still a reduction in the airlines "GDP". It does not represent a loss of profitable business and, indeed, the bottom line of the "airline business" will be improved by the elimination of this non-profitable revenue.

The concern about inflation and recession get piled on top of one another when the national numbers include this decline in revenues of $100,000,000 accompanied by inflating prices. In other words, recessions are all about stopping doing stupid stuff. The peak of the Consumer Price Index hit in December of 74 which was 3 months before the recession ended and long before the recession officially happened. More importantly, it was a month after the big stock market turn. Other recessions tell similar stories. Another peak in CPI was in March of 1980 5 months before the end of the recession. Other peaks in CPI include October of 1990, 5 months before the end of recession, March 2001 9 months before the end of recession, and November of 2007 X months before the end of the recession. The fact is that a great time to own stocks was during the second half of the average recession. In order to sell lots of news, the "bad news press" must always present the current problems as if they are the worst. As you can see from the above list, it is quite normal for a spike in inflation to occur as businesses cut out their "mistakes".

Cutting out the stupid business is a good thing. Once this is done, resources are freed up to go after profitable business. With the value of the US dollar where it is today and with the world economy in need of US goods, US businesses are set up for a great run!