Monday, October 27, 2008


The Calvary bugles can be heard in the distance, relief is on the way. In recent days, consumers have been pleased to spend $20 less on a tank of gas, but the gas that will sell for $2 per gallon is just entering the far end of the pipeline. A few weeks from now, consumers will be pleased to save $40 per tank (20 gallon tank). The sound of other bugles, telling the story of relief can be heard. It is not just the price of gasoline that is coming down.

Saturday a friend in the plastics business mentioned that his company posted a huge price increase in July. At the time, oil was trading around $145 per barrel. My friend admits that his company will hold up prices for as long as they can. The company needs to rebuild its balance sheet before adjusting to the current price. The decline from $145 to $62 is a 57% decrease in his companies prime raw material. Inflation is on the way down!

The 5 year EU Bund has dropped from 4.75% to 3.25% since June! The cost of 5 year EU money is down 32% in 4 months. South Korea just lowered its short rate by the largest move ever. Rates just went from 5% to 4.25%, a 15% decline in one day. The news media is talking about how this recession might last three years but the big drag on the economy, housing, just saw its first year over year sales increase in 30 months. Home sales were up 5.5% in September and up 1.4% year over year. The percentage of homes in foreclosure is falling fast because the foreclosed homes are being dumped on the market rapidly. The banks want these properties off their books. The short term effect is the final drop in average home prices even while prices rise in most communities.

It is worth repeating that based on price moves that have already happened, the average household is going to reduce its spending on fuel, including transportation fuel, by $4,800 per year. Include the savings to the consumer from price decreases of other raw materials and the average household will spend $12,000 less in the next 12 months. This $12,000 increase in the family budget will not be taxable income, it is more like found money.

This cycle was unusual in that the economy stayed very strong even as consumers were pounded mercilessly by higher prices. Now that the higher prices are dissolving, the consumer is going to see times like the 90's, after the last real estate recession. I remind you that after the bottom was made, Best Buy went up 1,400% in less than 3 years.

For some time I have recounting the events that occur during an economic slowdown. Three of the key things expected: 1) a drop in commodity prices, 2) a decline in bond rates 3) a sharp turn around in bank stocks. So far, we have seen 1) a steep drop in commodity prices followed by a minor bounce which lasted for a couple of weeks and then a resumption of the decline, 2) a significant decline in bond rates in the US followed by a minor bounce during which stubbornly high EU Bund rates finally rolled with passion, and 3) we saw a significant V bottom in bank stocks followed by a "correction". Pretty soon, the pace of bank consolidation will pick up and prices will rise.

This morning in London, the financial sector is off 5.8% while the Energy sector is off 6.1% and the Basic Materials sector is off 8.5%. Keep in mind that the EU will not benefit as much from lower fuel prices as will Americans. In the EU, there is much more use of mass transit, but in both countries the sharp decline in fuel prices is just beginning to make its way to consumers. RELIEF is on the way.


While McCain has been accused of using the race card, Obama is set to enjoy the most lopsided and largest turn out of black voters in our history. Obama will likely receive 98% of the black vote. Only in recent days has McCain found the way to get the message out that Obama's policies would push the country back toward the welfare state. More than 200 years ago, Thomas Jefferson lamented that there were too many parasites feeding off the efforts of the industrious. TJ would not be fond of many of McCain's ideas but he would deplore the policies proposed by Obama. Government has gotten control of too much. The recent mistakes made in the housing-banking arena demonstrate again that individuals and small businesses make mistakes but when big business and big government make mistakes the costs are enormous.

The good news is that Obama continues to moderate his positions. When he ran against Hillary, he was a flaming socialist. His most recent proposals reduce the level of pain he would cause the economy because he has reduced the size of the income re-distributions that he would force upon the "rich". The interesting thing is that Obama appears to be headed for a box that is upside down from the box where Bill and Hillary found themselves. Obama might actually be forced to fight proposals pushed by the most liberal of democrats.

In the know republicans are unlikely to admit that an Obama administration will not be as "socialist" as it is being painted during the heat of the election. The danger is the direction because the number of parasites has grown to well beyond majority proportions. Eisenhower warned of the feeding at the trough by the industrial-military complex, however, the over kill of defense spending did not do the kind of harm that will be done if we move back to the policies of the 70's. In his campaign against Hillary, Obama railed against free trade, he supported the union check off system that would take the secret ballot out of the system and he supported the fairness doctrine. I suspect that Obama will not destroy the benefits brought to consumers through free trade; his rhetoric of the past was for the purpose of staying to the left of Hillary during a critical time in the primary. Unfortunately, he will go along with too much support for oppressive labor policies but I doubt that the check off system will be instituted, it is just too anti-democratic to pass or to stand a supreme court review. The fairness doctrine was very harmful and, again, so anti-democratic that I doubt it will be re-instituted. Thoughtful liberals and conservatives hold tight to our rights of free speech.

While Americans have learned that the media is biased, we constantly get taken in by the media. In the old days, there was a stark difference between op-ed pieces and the news. Today, most news is op-ed in disguise. Opposing stories are ignored. The "old media", newspapers, magazines and network TV is dominated by liberals. As always, the market finds its way around impediments. The market place and free speech are like water flowing down a mountain, it will ultimately find its way to the atmosphere, most likely making it into the ocean along the way. Today we have talk radio, cable TV and the Internet serving to counter balance the "old media". And, once again, restrictions on contributing to political campaigns has become a joke. McCain has been hoisted on his own petard while it was Obama who committed to accepting limits before he rejected limits.

Right at this moment, polls suggest that democrats will sweep all three houses and may gain a filibuster proof majority in the Senate, a dangerous combination. I would not bet that McCain pulls out a victory but I would bet that the race tightens greatly. For perhaps the first time ever, polls show that the majority of Americans believe rule by one party is best. I disagree strongly, but the more important point is that a significant number of those who believe one party rule is best are far right republicans. Many independents and moderate democrats are likely to flinch before voting for a democratic house, senate and white house. In North Carolina, Obama has a slight lead in the polls but NC has traditionally (for 25 plus years) voted for a democratic state government and a republican national government. Liddy Dole is running behind as is McCain but I would bet that they pull out narrow victories in NC.

The investment reason to discuss the elections is that the fear of one party, extreme left rule, is over done. In the final days of the campaign, the irrational anxiety will calm down. Just having the election over will be a relief.

At the bottom of the market, there is fear of everything. I chuckle at the fears expressed of hyper inflation that might come come as a result of the surge in money supply. We are seeing record declines in prices for all sorts of goods and yet during a time of panic some folks raise the fear of hyper inflation. Right now, the fear of socialism is more reasonable than the fear of hyper inflation. A good measure of how much money is being printed is the total loans being made. So far, the pattern is very consistent with past cycles, the growth in lending prior to the recession was quite high, growing at better than 14%, but the growth in lending has slowed substantially in recent weeks. The rate fell and then bounced but loan growth should remain slow for a year, two or three after the recession is over.

When I report that the average household will spend $12,000 less on inflated prices, over the next year, I do not mean to suggest that the entire $12,000 will be spent in other ways. The pain suffered by those who paid too much for houses, stocks and SUV's will not go away immediately. Most consumers will use a significant portion of their savings to repair their balance sheets. Many loans will be paid off or at least paid down. The growth in the money supply will be stronger than the past few years but not so strong as to cause great inflation.

The fear of hyper inflation is from those who have noted that the FOMC is suddenly growing the monetary base at a 14% annualized rate. We must remember that the banks are more responsible for printing money than is the FOMC. When banks have tighter lending standards, less money is printed. This is where we are now, the FOMC is actually having to increase the monetary base rapidly because the banks are reluctant to lend, except to top score credits. Indeed, it is clear that the FOMC did not lean hard enough against the banks during the boom times of a few years ago. Now, it is appropriate for the FOMC to lean against the banks by making more money available.

Other doom and gloom projections about the coming great depression are the result of fears that the banks have stopped lending. I say again, existing home sales jumped by 5.5% in September, to 5.18 million units. The average price of those homes was around $200,000. The total value of US housing loans made in September approached the 1 trillion dollar mark. During times of fear, there are boogie men around every corner but the US is the most solid country ever. We make mistakes but we recover from them. The quality of the loans made in September was a far cry from the quality of the loans made in September of 2005 when the congress said bankers would go to jail if they did not loan to the unqualified.

The current problem developed over a long period of time. It will not be solved overnight but our country began taking its medicine three or more years ago. We sent a rider out to Fort Laramie a long time ago. Now we can hear the sound of bugles. Relief is on the way.