Friday, August 01, 2008

The Titanic Didn't Sink -- Inflate Your Tires

The US economy did not sink, the Titanic saved it. Partly as a result of export growth, our economy grew by 1.8% last quarter. The number one US export is industrial engineering, but who wants to write about industrial engineering? Our number two export is films. The new Batman has a shot at flying past the Titanic. The Titanic had gross receipts of 2.5 billion dollars! Americans spent 700 million dollars to view Titanic but the rest of the world paid 1.8 billion dollars. The second Pirates of the Caribbean movie made a few bucks too, taking in 1.5 billion dollars. The Pirates trilogy out ran Titanic.

Pessimist say that all the good jobs are going over seas, but I say Johnny Depp and Leonardo Dicaprio have pretty good jobs (sailing the seas with beautiful women). But Oh My! as evidenced by the death of Heath Legder, these are stressful jobs. Maybe the government should provide free health care counseling to help relieve the stress.

Speaking of health care, it is our fourth largest export. People come from around the world to get care that is not available in their home country. In recent weeks, US researchers have reported results from dozens of projects. For example, it has been learned that cholesterol drugs can be used to repair bone density losses. Another drug has been found that has been nicknamed the "exercise drug". Mice given the drug build strong muscles, without exercising. Mice that take the drug and exercise become superior "athletes". Every major drug company now has a dozen or more drugs (some were researched to cure Parkinson's or Alzheimer's disease) that enhance physical performance (sometimes sexual performance). We may get bent out of shape with ethical concerns, but the reality is that the modern athlete can out run, out jump, out swim and out throw (and out "love") the athletes of old. The coming health care crisis will be healthy 150 year old horny toad men and women (Viagra works for women too).

My two year old grand daughter and I enjoyed viewing Wall-e last week. It was fun and it showed one possible future. Without spoiling the story, I will simply say that Americans have it "too good".

The pessimist say that because we are running out of oil, we should not drill for more. What?! We are running out of oil in the USA so we should not drill for oil in the USA? Nancy Pelosi says she is saving the planet, by forcing oil companies to drill in the Atlantic Ocean off the coast of Nigeria rather than in the Atlantic Ocean 50 miles off the coast of Virginia. The Obama "solution" is even better than Pelosi's. He has even topped the Jimmy Carter plan to wear sweaters in the winter time. Obama has been on the campaign trail telling Americans that we should inflate our tires.

Obama also says the poor in America are getting poorer while the rich are getting richer. Is he blind, ignorant or lying? Has he not noticed that the new billionaires are in Russia, Brazil, Nigeria and other places where the governments permit oil drilling?

Besides, the poor in America are rich and getting richer. In 1919 it took an average of 9.5 hours of work in America to buy a bag of groceries. Today it takes an average of 1.7 hours. In 1920, it took an average of 7.4 hours of work to buy 10 gallons of gas. Today it takes 1.8 hours. (Data from Cox and Alm as mentioned below). Poor people in America own video games, microwave ovens and Nike branded shoes.

Pessimist have the largest ever amounts sitting in money market accounts. W. Michael Cox and Richard Alm posted a chart in the American Magazine that shows the price of this pessimism. In similar circumstances in 1982, the public had record amounts of money in money market accounts. Ten thousand dollars left in those accounts since 1982 is now worth $37,778. Ten thousand dollars invested in the average Dow Jones Industrial Stock in 1982 is now worth $288,163. The same investment in other indexes would be worth several times as much but with more volatility. Note that the $288,163 includes the decline in value of the past year.

Exports are so strong that American businesses do not have enough work area. Business structure spending was up more than 12% last quarter. The business cycle boom is already underway, even as the total world growth rate is slowing.

Brian Wesbury, "We are in control of our own destiny".

Brian Wesbury, Chief Economist at First Trust, is one of my favorite economist. I don't always agree with him but his sharp focus on the US economy is well thought out and consistent. In an exchange of emails this week, he and I discussed the incredible increases in short term interest rates in countries all around the world. For the past year or so, Brian has correctly asked the question, "What recession"? Brian suggests that US monetary policy is really not tight and that inflation is the bigger problem.

While I agree with Brian that the next move by the FOMC should be to tighten rates, my contention is that the sharp increases in short rates, from Columbia to Romania, Russia, India and beyond are slowing the "international inflation rate". Slower growth rates around the world are making the US an all the more attractive place to invest and the US dollar is showing strength, pulling down the cost of imported goods for Americans (including oil). Seven straight months of job losses in America indicates that there is pain in a growing list of industries. On the other hand, with growth in the middle class population of the world of hundreds of millions of people per year, chances are that Wall-e and Batman will do well. In our old time brains we may desire for the US to make cars (we are) but I assure you the profit margins on Wall-e trump the profit margins on car manufacturing by a country mile.

As my old broker mentor, Bill Lienbach liked to point out, international finance is like a big bathtub where the average level of the water does not change all that much in the short run even though there is a lot of sloshing around. The FOMC kept their foot on the short term rate brake for 19 months, which slowed the growth rate in the US and lowered the value of the dollar (despite the popular opinion, high rates do not increase the value of the dollar), now the FOMC offers extra low rates while the rest of the world is standing on the brakes. It is the standing on the brakes that is allowing the economy to transition to the "prosperity" phase of the business cycle.

Since it took forever for commodity prices to start rolling over in this cycle, some have been fooled into believing that we are just now in the early contraction phase of the slowdown. The recent strong moves in financial and consumer cyclical stocks suggest that we are at or close to the end of the late contraction phase. Ironically two other indications that the contraction is long in the tooth are high inflation numbers and a significantly higher unemployment rate.

The truth of the matter is that the US is further through the downturn than the rest of the world. Another truth is that rotations are never smooth. Without looking up the numbers, I can tell you that the total value of energy stocks has become a large percentage of the total stock market, just as technology stocks had become a large percentage of the total market value in 2,000. The difference is that the rotation out of tech stocks was into bonds and then into energy, materials and industrials. This time, there should not be a big move into bonds first because the 10-year treasury yields less than 4%.

In 2001 and 2002, the rotation to bonds got pretty crazy. Long rates got so low, around the world, that hard assets such as homes and commodities became very attractive. To put it another way, money is nothing but a commodity that sits on the other end of the see-saw from "hard" commodities. When money is very cheap, real estate is very affordable. As an aside did you know that cows were used as money for millennium? Cows served the purpose of facilitating trade because the producer of one good, such as barley might not know barley's relative value to hundreds of goods but the owners of hundreds of goods knew the relative value of their goods to the value of a cow or calf. The point is that money is nothing but a way to facilitate the exchange of goods.

A Tough Few Weeks or No?

The immediate future does not look bright. Congress is leaving town without having even voted on a drilling bill. There are resignations on both sides of the Syria-Israeli peace talks. The Iranians deny that there was ever a deadline. Prospects for dramatically lower oil prices seem to have stalled.

On the other hand, real estate, which works from the bottom up, has a new law that gives first time home buyers a $7,000 "tax credit loan". Furthermore, banks are now offering covered bonds which will re-liquefy the mortgage market.

Also, the President of Syria will spend Saturday and Sunday in talks with Iran. Iranian officials who denied that there was a deadline now suggest that the deadline is a couple of days after Saturday. When Sean McCormack, a US spokesperson, said that he "did not count the days", Iranian leaders spoke out to say that he has confirmed a later date.

Over in Iraq, the Bush deadline for a SOFA agreement was not met. However, the vice-president of Iraq, Adil Abd al-Mahdi says that an agreement has been reached. It is not a status of force agreement like the ones the US has with Germany or Korea but it will permit troops to stay in Iraq for some specified period of time as "conditions dictate". The once powerful cleric from Sadr is pleading with the people to oppose such an agreement. He is even willing to rejoin the government if the agreement is turned down. Wow! How magnanimous of him?

The political stalling in Iraq is mindful of the "no drilling vote" in the US. Nancy Pelosi and al-Sadr have a lot in common. al-Sadr has been blocking the Iraq congress from voting. At some point, democracies find their way around the tyranny of the few. The agreement on troops will be made between the executive branches of the Iraqi and the US government. The agreement will avoid certain promises and will thus not be a treaty that is subject to the approval of either congress.

The agreement to keep troops in Iraq is a vital piece to the success to the war on terror. Sunnis in Iraq and several other countries want the assurance that Iran will not reinvigorate its support for terror as soon as America leaves. The thousands of al-Qaeda forces, that left Iraq in order to bolster "the cause" in Afghanistan, can easily return.

Some of the troops that leave Iran should go finish the job in Afghanistan. Yesterday, another al-Qaeda leader bit the dust in Afghanistan. He escaped from an Afghanistan prison 3 years ago. A strike from the heavens sent him home for good.

Iran certainly wants US troops out of Iraq. As does Obama. Russia wanted US troops out of Berlin in 1948. Germans would be speaking Russian today if US troops had not stayed.

Time and Oil Discoveries March On

Even though the US congress has put 85% of projected US oil reserves off the market, drilling is taking place. Yesterday, Chevron announced that the Agbami field off the coast of Nigeria is cranking up with more than 100,000 barrels of production per day. By next year, it should be producing 250,000 barrels per day. The game score is going up to 85.25 million barrels per day.

Back in the USA, record numbers of wells are being completed. The mantra of drill, drill, drill started 5 years ago. Those who are looking for big profits in drilling now are 5 years behind the curve. In a growing number of cases, new wells in America are the very expensive, 4 mile long, horizontal wells, but supplies are being discovered. Americans are paying the extra price at the pump, but the oil companies have done a great job of keeping us supplied. Exxon just released its profit numbers for the past quarter. It did not enjoy nearly the margins of other businesses. In addition, for every $1 of profit it paid $3 in taxes, but the total profits were still great. Of course, the total taxes were three times as great.

India has finished the construction of three new nuclear power plants. The power plant built in Iran by Russia is also ready to go online. One nuclear power plant replaces about 200,000 barrels of oil per day! One ton of natural uranium ore is the substitute for 20,000 tons of coal (before the new efficiencies are included). There are currently 36 nuclear power plants under construction, 93 more on order and 218 planned. This all before the coming votes that will confirm negotiated 123 agreements.

Can you imagine the screaming out of Hollywood if the oil business enjoyed the same profit margins as the movie business?

Inflating our tires is not the answer. Taxing capital to support paying 35% of the cost of unreliable wind mills is not the answer. Turning the rain forest into soybean farms is not the answer. Corn alcohol in internal combustion engines is not the answer. Pessimism is not the answer!