Quite simply the Bush Administration did not solve anything. Instead they acting in a defensive way and decided to punt. They gave the automakers enough money for a couple of months and now the Obama Administration has to decide what to do. The simple fact is they should have let them go into bankruptcy. It would have been better for the country in the long run.
But what about all the auto workers and other people in the auto industry? Dramatic changes have to occur in the auto industry. The industry in the US has been very sick for many years. The recent events have just pushed them over the edge and are not a temporary state of affairs. If the problem were temporary or one-time, a bailout would have been a good plan. But the fundamental problem is the US auto industry has not been competitive for many years. How do you get people to change? Unfortunately the only way to get millions of people to change is a very dramatic action. It takes a bankruptcy to really force change on management and the blue collar workers. Without bankruptcy the management stays the same (note the President of GM is not resigning) and the auto workers are also not changing. More importantly while the culture of Detroit is under pressure, it will not change without bankruptcy. You have to change a culture that has produced such a string of lemon cars.
In the past few months it has become clear many people don’t understand the capitalist system. The simple fact is humans make mistakes. How do you get them to change and stop making the mistakes? The capitalist system forces people who do not provide a good product at a reasonable price into bankruptcy. The capitalist system is not touchy-feely, but brutally honest. If you don’t have the goods, you fail. Many people don’t like this feature of capitalism. But it is critical for an economy and a society to dump the process or products that don’t meet a need. The Soviet system was great at producing products, but many people did not want them! Just producing cars or any product without regard to style, cost and reliability has to be stopped. The capitalist system uses bankruptcy to FORCE changes. When a government steps in and limits change, they harm the economy and the future economic growth.
Sunday, December 21, 2008
Wednesday, December 17, 2008
The Recent Fed Announcement
The Federal Reserve has come out with an incredible announcement. (see http://online.wsj.com/mdcapp/public/page/2_3024-info_fedparse_shell.html) While the headline number of 0 to 25bps interest rates that banks can borrow is important and unusual, it is not the heart of the release. What is dramatic is that the Fed is going to target longer term interest rates. While I am not a macro economist, this is going to be interesting to see if they can achieve such targeting.
The problem is that to drive interest rates lower, they must purchase long-dated loans by printing money. At some point, the amount of money in the system will increase prices. At that point, any investor who purchases say 10-year treasuries is going to receive far less money than the original principle. For example, you buy $1 million of 10-year treasuries. Inflation increases by 10% per year in the very last year. All other years inflation is zero and the interest rate is 3%. That means for nine years you get 3% rate of return and the last year you get a negative 7%. That is not a good investment and you will suffer a loss (if not in raw cash, in a net present value sense.) Thus, the idea that the Fed can control long rates is questionable. In the entire history of the world, no central bank has been able to control long rates for more than very short (weeks) periods of time. At some point the very act of trying to control long rates is counter-productive.
What conclusions can you reach about the FED statement? They are really worried. They are throwing everything including the kitchen sink into the fight. They are using every bullet they have and are borrowing a few from others! What happens if something else happens? What else can the FED do? THey have used everything to fight the current battles and they are risking something even more important- their credibility. If the economy does not respond quickly, their might be a really significant fall in the stock market as there is nothing left for the FED to do. As more than a few people have said: They are ALL IN. Nothing left to do but execute. That has to be scary for every investor.
The problem is that to drive interest rates lower, they must purchase long-dated loans by printing money. At some point, the amount of money in the system will increase prices. At that point, any investor who purchases say 10-year treasuries is going to receive far less money than the original principle. For example, you buy $1 million of 10-year treasuries. Inflation increases by 10% per year in the very last year. All other years inflation is zero and the interest rate is 3%. That means for nine years you get 3% rate of return and the last year you get a negative 7%. That is not a good investment and you will suffer a loss (if not in raw cash, in a net present value sense.) Thus, the idea that the Fed can control long rates is questionable. In the entire history of the world, no central bank has been able to control long rates for more than very short (weeks) periods of time. At some point the very act of trying to control long rates is counter-productive.
What conclusions can you reach about the FED statement? They are really worried. They are throwing everything including the kitchen sink into the fight. They are using every bullet they have and are borrowing a few from others! What happens if something else happens? What else can the FED do? THey have used everything to fight the current battles and they are risking something even more important- their credibility. If the economy does not respond quickly, their might be a really significant fall in the stock market as there is nothing left for the FED to do. As more than a few people have said: They are ALL IN. Nothing left to do but execute. That has to be scary for every investor.
Thursday, December 4, 2008
Why Natural Gas will not go below $4 MCF.
1) Natural gas supply from Canada is falling and will continue to fall for the next few years. Until the BC shale play gets pipe, it will fall a bcf or more in 2009. Look at the past several years and you can see the decline WITH a great natty price. In the meantime, Alberta has significantly increased taxes, the overall price has fallen and costs have skyrocketed. According to market analyst Martin King of FirstEnergy
Capital, "at current prices, little in the way of new natural gas
production is economic in Western Canada." As a result every player is reducing cap ex by 30-50%. This will decrease production by a significant amount (10%?)
2006 2007 2008 2009
Oct 17.21....16.71....16.18 15.?
2) If the price is low, LNG will continue to be low. Several simple cost addition show you need a price well above $5 for LNG to be economic. In other words, the cost of transporting and getting the LNG to natty costs about $4+. With a price below $5, it does not pay anyone to ship the gas.
3) For some reason electric generation has been killed this fall. This is giving many a signal that the natty market is oversupplied. But a decrease in demand for natty from generation is likely to be temporary. All signs point towards more electricity being used in transportation and other energy sources. Coal will be 'killed' by new co2 regulations at the very time electric demand will increase. Thus, to argue that electric demand is going to continue to be lower than normal is risky.
4) Demand is a concern in a recession. Fertilizer and other products that use natural gas are clearly decreasing output. As a result the demand for natty is going to be down YOY ignoring weather. Thus, the price of natty will be down from lower demand.
5) THE BIG ONE: Supply from the new shales. Everyone agrees that the new technologies have increased production from unconventional sources. But several important factors limit the amount of production increase in 2009:
a) Pipelines- EOG's Papa has argued strongly that pipeline capacity is going to limit production increases. You have to have pipelines to deliver the gas to markets. When you are talking about a bcf a day, that requires a lot of pipe. Many have ignored the huge constraint in production of pipelines.
b) Credit: With out credit, many shale producers are scaling back ALL capital expenditures. Look at CHK's dramatic decrease in cap ex. The leasing prices have fallen through the floor. Once the current leases get developed, production levels will fall. But even more important to the short run projection is the lack of credit to drill all the current leases. In order to drill all the wells, significant capital must be in place (local pipelines, processing equipment etc). The net call on cash will be too great for all but the largest operators.
c) Why produce a well now at <$6 mcf, when you can wait and produce it later? With a clear economic signal that we have enough natural gas, many producers will delay drilling for better prices. Many leases are held by production or are so expensive, it may pay to drop or re-lease.
d) Permits and other government approvals will be more difficult. With the new administration, any permits not granted by Jan 20, will be at the least delayed and at the extreme rejected. Colorado is going to see a large decrease in drilling because of permits. Even if you have all of the previous comments covered, you have to have a permit. That is not going to be easy after Jan. 20th.
From all of these factors, drilling after the 20th of January is going to drop significantly from prior years levels. I would not be surprised to see 750+ less rigs drilling for natural gas than last year. At that rate, depletion of 15%+ will have an impact on production.
Of course, if we get a very warm winter, then prices can go below $4. But with a reasonable winter, prices will not be less than $4.
Capital, "at current prices, little in the way of new natural gas
production is economic in Western Canada." As a result every player is reducing cap ex by 30-50%. This will decrease production by a significant amount (10%?)
2006 2007 2008 2009
Oct 17.21....16.71....16.18 15.?
2) If the price is low, LNG will continue to be low. Several simple cost addition show you need a price well above $5 for LNG to be economic. In other words, the cost of transporting and getting the LNG to natty costs about $4+. With a price below $5, it does not pay anyone to ship the gas.
3) For some reason electric generation has been killed this fall. This is giving many a signal that the natty market is oversupplied. But a decrease in demand for natty from generation is likely to be temporary. All signs point towards more electricity being used in transportation and other energy sources. Coal will be 'killed' by new co2 regulations at the very time electric demand will increase. Thus, to argue that electric demand is going to continue to be lower than normal is risky.
4) Demand is a concern in a recession. Fertilizer and other products that use natural gas are clearly decreasing output. As a result the demand for natty is going to be down YOY ignoring weather. Thus, the price of natty will be down from lower demand.
5) THE BIG ONE: Supply from the new shales. Everyone agrees that the new technologies have increased production from unconventional sources. But several important factors limit the amount of production increase in 2009:
a) Pipelines- EOG's Papa has argued strongly that pipeline capacity is going to limit production increases. You have to have pipelines to deliver the gas to markets. When you are talking about a bcf a day, that requires a lot of pipe. Many have ignored the huge constraint in production of pipelines.
b) Credit: With out credit, many shale producers are scaling back ALL capital expenditures. Look at CHK's dramatic decrease in cap ex. The leasing prices have fallen through the floor. Once the current leases get developed, production levels will fall. But even more important to the short run projection is the lack of credit to drill all the current leases. In order to drill all the wells, significant capital must be in place (local pipelines, processing equipment etc). The net call on cash will be too great for all but the largest operators.
c) Why produce a well now at <$6 mcf, when you can wait and produce it later? With a clear economic signal that we have enough natural gas, many producers will delay drilling for better prices. Many leases are held by production or are so expensive, it may pay to drop or re-lease.
d) Permits and other government approvals will be more difficult. With the new administration, any permits not granted by Jan 20, will be at the least delayed and at the extreme rejected. Colorado is going to see a large decrease in drilling because of permits. Even if you have all of the previous comments covered, you have to have a permit. That is not going to be easy after Jan. 20th.
From all of these factors, drilling after the 20th of January is going to drop significantly from prior years levels. I would not be surprised to see 750+ less rigs drilling for natural gas than last year. At that rate, depletion of 15%+ will have an impact on production.
Of course, if we get a very warm winter, then prices can go below $4. But with a reasonable winter, prices will not be less than $4.
Wednesday, December 3, 2008
What are some early indicators that the economy is starting to turn around?
It may be too soon to look at the economy turning around, but everyone wants to know what to look at. What data points will show the economy has hit bottom and starting to rebound?
1) Delinquency rates on home loans falls. The delinquency rates are reported by several sources and should be one of the first indicators that the economy has bottomed. When the delinquency rate actually falls, the economy may shortly hit bottom. But if the delinquency rate is rising, more pain will surly follow.
2) Electric generation has to increase by a nice percentage. One of the key indicators in a service economy is electric generation. If people are using lot's of new computers or making things, it will require electricity. So on a weather adjusted basis, electric generation needs to increase at a nice pace.
3) Private Employment shows a good positive growth. While the unemployment number grabs the headlines, one key growth indicator is a good increase in the overall number of jobs. During the current recession the actual number of jobs should fall. When we see the number of PRIVATE jobs (excluding the public sector) go up, then a recession may have hit bottom.
4) A new industry takes off. By it's very definition you cannot predict what the new growth industry will be, but every downturn has a NEW industry leader. While it can be an old industry, it has to have reinvented itself. Just a bigger or newer adjustment is not enough. It must be a radical change from the past. I have no idea what this will be, but it will be the best investment opportunity anyone can make.
5) Inflation returns and interest rates on Treasury bills increase. Without some inflation, the money supply may actually be falling. Thus, given the large government deficits, without a good amount of inflation, the economy is still very very sick.
6) The VIX falls. Stock market volatility is a sign the market has no clue what is going to happen. Until the market settles down, there can be no bottom in the economy. The longer the stock market is going up and down by 5oo points a day, the longer the recession will be. I would like to see the VIX back to historical norms before we can even talk about a real economic recovery.
While there may be other indicators, this is a good start. International economy is different and the following are some indicators:
1) Internationally, the Baltic Freight Index is a key indicator. Until this rate increases from it's current record lows, international trade is low and a severe drag on the world economy. Clearly the amount of new ships will impact the rate, but until the rate rises to a break even cost level, the world economy will be in recession.
2) The price of oil. Until the price of oil goes above $75, we are in a world recession.
3) The price of copper and other metals. Without an increase in metal prices, the world economy is in a recession.
Given the lower economic level of most of the world, the more traditional measures of economic activity will show the world's economic progress.
With these indicators as a start, everyone can look for signs of the economic turnaround. But I am not optimistic the signs will appear in the 1st half of 09.
1) Delinquency rates on home loans falls. The delinquency rates are reported by several sources and should be one of the first indicators that the economy has bottomed. When the delinquency rate actually falls, the economy may shortly hit bottom. But if the delinquency rate is rising, more pain will surly follow.
2) Electric generation has to increase by a nice percentage. One of the key indicators in a service economy is electric generation. If people are using lot's of new computers or making things, it will require electricity. So on a weather adjusted basis, electric generation needs to increase at a nice pace.
3) Private Employment shows a good positive growth. While the unemployment number grabs the headlines, one key growth indicator is a good increase in the overall number of jobs. During the current recession the actual number of jobs should fall. When we see the number of PRIVATE jobs (excluding the public sector) go up, then a recession may have hit bottom.
4) A new industry takes off. By it's very definition you cannot predict what the new growth industry will be, but every downturn has a NEW industry leader. While it can be an old industry, it has to have reinvented itself. Just a bigger or newer adjustment is not enough. It must be a radical change from the past. I have no idea what this will be, but it will be the best investment opportunity anyone can make.
5) Inflation returns and interest rates on Treasury bills increase. Without some inflation, the money supply may actually be falling. Thus, given the large government deficits, without a good amount of inflation, the economy is still very very sick.
6) The VIX falls. Stock market volatility is a sign the market has no clue what is going to happen. Until the market settles down, there can be no bottom in the economy. The longer the stock market is going up and down by 5oo points a day, the longer the recession will be. I would like to see the VIX back to historical norms before we can even talk about a real economic recovery.
While there may be other indicators, this is a good start. International economy is different and the following are some indicators:
1) Internationally, the Baltic Freight Index is a key indicator. Until this rate increases from it's current record lows, international trade is low and a severe drag on the world economy. Clearly the amount of new ships will impact the rate, but until the rate rises to a break even cost level, the world economy will be in recession.
2) The price of oil. Until the price of oil goes above $75, we are in a world recession.
3) The price of copper and other metals. Without an increase in metal prices, the world economy is in a recession.
Given the lower economic level of most of the world, the more traditional measures of economic activity will show the world's economic progress.
With these indicators as a start, everyone can look for signs of the economic turnaround. But I am not optimistic the signs will appear in the 1st half of 09.
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