Monday, May 22, 2006

Commodity Deflation? Not Likely.

If the dollar collapses (say it corrects on the USX index down to the 70s) who knows what that will do to commodities? Commodities are priced internationally in dollars. It will throw the markets into utter confusion if no one really knows what a dollar is worth (if anything). Could commodity markets be created in other currencies? Yes, but these markets will be regional markets, not global ones.

Several writers, including MorganStanley's august Stephen Roach, have been making the case that commodity prices are in an unsustainable bubble. A correspondant emailed me an (unlinkable) Wall Street Journal article about money manager and commodity trader Dwight Anderson now tentatively bearish on commodities.

Anderson simply says demand will drop (i.e. a global recessionary slowdown?) and supply will kick in. Roach says commodities will drop because (a) China can't continue to grow so fast and (b) it "looks like a bubble in commodities", and that speculators are pushing the market.

I totally agree with Roach's first point about China having to slow down, but I'm not convinced the result will be falling commodity prices. Commodities priced how? In dollars or in gold? The dollar looks very weak and is being attacked on all fronts now. China and Russia both want to increase state gold reserves. Multiple energy trading markets are proposed, several to tade in alternative currencies to the dollar. Norway intends to sell oil only for euros. Russia will sell their huge energy and mineral commodity surpluses only in rubles soon.

The euro doesn't look strong enough to float global trade, and the European Central Bank doesn't want the doomed role of managing the enormous monetary inflation required. In several years time we may have several regional currencies, all similar to the euro. China and Japan are now negotiating the creation of a pan-asian currency. This is very significant. The pan-asian, the euro, the ruble, the loonie could all survive, with none needing to be the One Big Global Reserve Currency. I predict a South American currency (the Che Guevara!?) will launch also. The US dollar will be simply irrelevant. Gold will be very important, functioning as the ultimate meta-commodity, that all currencies and commodities are judged against. Because it is expensive to move and store, especially over long distances, it will create a worldwide recession. With regional currecies dominating trade, most commodity markets will be regional in scope.

It is very hard to predict the cost of producing any particular commodity. One reason is that a large portion of the cost of mining or wellhead production is the energy needed for that production. Energy is extremely volatile in price, and generally surging upward. Look at the dirt cheap natural gas we have now. Look at the high oil. These conditions could so easily reverse, or both could easily rise. Some commodities need lots of natural gas for production, some need lots of diesel fuel. Some can use either, and can switch as needed. Everything that goes into pricing is a moving target, including the dollar itself. But mostly, the dollar is moving down and energy moving up. So these things will drive commodities strongly upward, even as demand for commodities softens.

The other problem with Roach and Anderson's analyses is that neither of them factor, or even acknowledge, the existence of depletion. The largest copper mines are slowly becoming less and less productive. Depletion! Replacing big mines with smaller ones, at huge capital investment, will not bring down copper prices. The world will shortly face peak oil, peak gold, you name it. We don't have to "run out" of any commodity for it to become far more expensive, just for some mines or wells to become too expensive to operate because of declining yields, higher energy costs, and higher capital costs.

And wars. And nationalization. These are the children of depletion. They will remove large sources of production off of open markets. Nationalization is an unstoppable trend. Protecting a strategically important resource will become even more important than getting the best price and highest production for that resource. I predict even the United States will nationalize mineral and energy resources someday, if only to keep them out of the hands of our creditors. Wars for resources and nationalization are both indicators and consequences of depletion. We are seeing these things every day, on every continent. War requires nations to try to acquire strategic commodites at virtually any cost, or risk defeat.

Economists need to start admitting that these things are not anomalies, and that depletion exists. It is the trend. It is formenting nationalization and war. So, even if China goes into recession, I think it is possible for some commodities to rise in price, even relative to gold. Commodities will trade regionally, not globally. Some commodites may rise astronomically, in places, if there is a shortage.

Friday, May 19, 2006

Friedman is optimistic. So what?

Here is a long quote from Thomas L. Friedman's recent column, published behind the New York Times' firewall:
“I was recently interviewing Ramalinga Raju, chairman of India's Satyam Computer Services. Satyam is one of India's top firms doing outsourced work from America, and Mr. Raju told me how Satyam had just started outsourcing some of its American work to Indian villages. The outsourcee has become the outsourcer.

Mr. Raju said: "We told ourselves: if business process outsourcing can be done from cities in India to support cities in the developed world, why can't it be done by villages in India to support cities in India. ... Things like processing employee records can be done from anywhere, so there is no reason it can't be done from a village." Satyam began with two villages a year ago and plans to scale up to 150.

There is enough bandwidth now, even reaching big Indian villages, to parcel out this work, and the villagers are very eager. "The attrition level is low, and the commitment levels high," Mr. Raju said. "It is a way of breathing economic life into villages." It gives educated villagers a chance to stay on the land, he said, and not have to migrate to the cities.

A short time later I was interviewing Katie Jacobs Stanton, a senior product manager at Google, and Krishna Bharat, founder of Google's India lab. They told me that Google had just launched Google Finance, but what was interesting was that Google Finance was entirely conceived by the Google team in India and then Google engineers from around the world fed into that team — rather than the project's being driven by Google headquarters in Silicon Valley.

If more countries can get just a few basic things right — enough telecom and bandwidth so their people can get connected; steadily improving education; decent, corruption-free economic governance; and the rule of law — and we can find more sources of clean energy, there is every reason for optimism that we could see even faster global growth in this century, with many more people lifted out of poverty.”
Friedman sees the global economy optimistically all right. But what is America's role in it (other than consumption, over consumption, and conspicuous consumption)? That Indian employee records processing firm that is planning huge expansion — whose employee records will they be processing anyway? Probably employees from the surging industrial economies of the world: China, Eastern Europe, Brazil, and India itself. US payrolls are not expanding.

Then Friedman talks about Google, how Google is employing not only engineering teams in India, but also project management and business developement. No doubt their payroll is done in India, and the rest of the admin. If the legal team is not largely Indian, it will be soon, with enormous cost saving. There does not need to be very much of the company left in America at all. If I were in Google senior management I might be getting a little nervous. The higher up the corparate ladder you go, the bigger the cost savings of outsourcing. And at some point the center of gravity of the company shifts from California to Bangalore.

When an American firm hires Indian labor, that is an Indian payroll, not a US one. The paycheck is made out in rupees, cashed in India, drawn from an Indian bank. The Indian economy benefits, not the US economy. The global economy won't look nearly so rosy if we are shut out of it. We have un-competitive labor, over-priced real estate, ludicrous executive compensation, a failing currency, and an infrastructure designed to waste the maximum amount of energy. It will be hard for America to participate. I don't think it is pessimistic to point out that these facts.

Its not that I think Friedman is wrong about globalization that bugs me, but that he doesn't see an urgent need for America to get its shit together and fix its dire problems. He casually notes the need to find new sources of energy, without any sense of the risk or high stakes involved. The whole optimism vs pessimism thing is annoying anyway. Niether one is logical.

Wednesday, May 17, 2006

US Dollar Faces The Firing Squad

Ben Bernanke's Federal Reserve has lost control of the dollar. Even long time friends of the dollar, like the IMF, have turned against it. Imagine how it would work if the entire world used Weimar reichmarks to trade goods and commodities? How about Zimbabwean dollars? Laughable, except that it is very real.

In the past 6 weeks the dollar has been falling like a bomb. We are awaiting the crash when it hits the ground. This is the real nuclear bunker buster, and it is aimed at us, not Iran. Gold has been accelerating it's climb. If we had the power to stop it we would.

Vladimir Putin has said Russia will soon require payment for their energy exports in rubles, not dollars. This is the trend. Norway says it will sell only in euros soon. China, Japan and most other asian nations are now negotiating the terms of a pan-asian currency, similar to the euro. I personally predict a South American regional currency to launch. The Chinese have also stated they will quadruple their gold reserves, from 600 to 2500 tons. This is a shot across the bow of the US Federal Reserve. Resource nationalization, of base and precious metals, and energy, is spreading worldwide. Colombia announced nationalization of its oil fields only yesterday, joining with Venezuela and Bolivia. Some day even the United States will have to nationalize mines and energy fields on US soil and waters. This will be an attempt to stay solvent, and defend our remaining resource wealth from foreign ownership.

These ominous signs point to huge shifts in the global economy that have barely begun to affect our daily lives, but will soon. There are only two options. One is an organized dis-assembly of the global economy, as governments come to grips with the fact that the US dollar can no longer function as the world reserve currency. Nations can find fixes, substitutes for the US dollar, work-arounds, etc, but it will take years. In that time the entire global order will shift. This will not be a slight change, more like a 180 degree re-alignment.

The other option is panic selling, driven by some crisis such as war or catastrophe, where foreign nations are forced to liquidate US treasury bills, or endure default. We should hope for the first option. Few things are certain, except one, and that is that none of the coming changes will benefit the United States.

Sunday, May 07, 2006

Ideology and armaments fight wars, but fuel and money win them

I have hope that war with Iran will not happen. For the simple reason that Iran is already to strong to attack. I suppose it is possible for Israel to attack Iran, even though the Israeli generals must know that it would be a doomed enterprise. Much like the Japanese generals who launched the first strike on Pearl Harbor even though they knew it would bring ruin to Japan. Optimism may make no more sense than pessimism, but I still have hope there won't be another war.

Iran now has all the power that they have been seeking for so long. They have tough friends, in Russia and China. Israel may have advanced military hardware, but it is not enough. They are vulnerable to oil supply disruption. I don't know what the state of their finances are, but with America and Britain both as close to bankruptcy as they are, how can Israel go to war? Israel has always relied on US and British financial backing (credit) and energy supplies.

In the 1980s Russia had a lot of highly advanced military hardware. When they went broke, they were not able to use it, and it didn't do them any good. Britain went into WWI when it was technically bankrupt, although few knew it. They were only able to fight because they had the US to bankroll them, and supply fuel.

Now it is Russia, China, and Iran that have lots of cash and fuel supplies. No matter who wins the initial skirmish, they will eventually prevail. The Central Asian nations, Kyrgystan and Kazakhstan, etc, also have critical energy resources and are strategically important. Russia, China, and Iran are building a huge integrated pipeline network, for both oil and gas, and it crosses all over Central Asia. It feeds China, and Europe, and soon India. These nations' futures are linked and they will support each other. Europe, including Britain, is now utterly dependent on Russian natural gas, and Russia can cut this supply line, as Putin recently demonstrated. All energy importing nations are counting on receiving a slice of the Kazakh oil pie (although there is clearly not enough to go around). So, I believe no European nation can support a US/Israeli attack on Iran. India is waiting in line, hoping to receive Iranian and Kazakh oil and gas. They won't support the US. Australia is having fiscal pressures of its own, similar to the balance of trade problems, and real estate bubble problems that the US has. They have made important energy deals to supply liquified natural gas to China. Australia will not support us. South America will not support us either, gloat is more likely.

As for Israel, I do think they are in trouble, and they won't be able to fight their way out of it. For that matter, Taiwan is also in trouble. We will not be able to defend them either when China finally comes to retrieve her “stray province”. The world is changing. People should deal, not fight.

Thursday, May 04, 2006

Oil Trading In Weimar Reichmarks?

News item: Iran Oil Bourse Next Week. This issue does not go away. I quote:
Oil Minister Kazem Vaziri Hamaneh said on Wednesday that the establishment of Oil Stock Exchange is in its final stage and the bourse will be launched in Iran in the next week...

It does not go away because it is part of the worldwide trend. Not just Iran, but also Dubai, Qatar, and Norway are among the countries that are planning to open energy trading bourses. Both Qatar and Dubai have stated they will trade in US dollars. Norway prefers Euros, and seems to have the support of Russia. It looks like the days when Britain and the USA were the only market makers in oil (and other commodities) are nearly over.

These new bourses are not in themselves an immediate threat to the dollar. The dollar is heading for a train wreck all on its own. The new bourses may be part of a solution. Not a solution from the United States' perspective, but a solution for the rest of the world. If there is a dollar crisis, it will throw the whole global commodities trading system into crisis. They will have to switch to either euros or gold, no matter what governments prefer. Imagine that the Reichmarks of Weimar Germany were the worldwide trading currency. And that Weimar was trying to bully the globe into supporting it.

Could a dollar crisis be averted? Yes. If the USA immediately withdrew its foreign military forces, and launched a crash energy conservation program. Obviously this sort of thing will not happen. I don't have much confidence in the euro either. The ECB inflated the Euro supply at 8% last year, about the same as the US dollar. The pound inflated at 12%! Thus gold will regain status as the de facto world currency.

Tuesday, May 02, 2006

Peak oil and peak money?

Capital flight has begun. See it in the commodities boom. Real stuff is looking a lot more solid than virtual stuff these days. The US dollar index is falling. It is going down compared to other currencies, such as the Yen, the Pound, the Euro. But they are all losing purchasing power too, because of their own inflation.

The innovation of fiat currency only became possible because of the huge supplies of energy that became available in the 20th century. Paper money was tried many times before throughout history, but only in times of national emergency (like war) and it always resulted in depression afterwards. The rapid economic expansion of the 20th C was powered by cheap energy, and it made fiat currency possible. Both are historical anomalies.

The oil-driven economic expansion needed fiat currency. With gold backed currency, the huge sums of capital required in the industrial and information age economies would not have been available. This is because gold production could not be expanded as fast as the economy. Cheap energy and fiat money go together, and they will peak and decline together. We are clearly seeing this. Right now capital is so cheap they are practically giving it away. Interest rates for banks are negative. The interest banks pay on a loan, from the Fed, or from the Japanese central bank, is less than the real rate of inflation. And the central banks make this cheap cash available in vitually unlimited quantities.

The interest we suckers pay on a loan is far higher of course. No wonder banks have so much cash to lend. No wonder they pass out credit cards like sticks of bubble gum, and call us at dinner time asking if we would like a few grand to remodel our kitchens. This high pressure cash machine (that we call the global economy) works beautifully as it expands. Thus the Keynesian dictum that a central bank can, and must, inflate the money supply only as fast as the economy grows. But now the machine is running out of gas. The economy can no longer grow without a cheap energy supply. How the economists can think that the growth can go on forever baffles me.

Interest rates, in all currencies, are on a rising trend, as they try in vain to keep up with accelerating price inflation. High rates and high debt will make banking very unprofitable. In the coming depression it will be nearly impossible for anyone to get a loan for anything. Energy costs and food costs will rise at a hyperbolic rate. The oil will be gone. The money will be gone.