Category Archives: Oil

FT: Letter to the editor

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Published letter to the editor in FT.

Expect public-sector deficits and oil prices to go on rising

by Prof Philip Arestis, Dr John McCombie and Mr Warren Mosler.

Sir, Public-sector deficits and crude oil prices will probably both continue rising. Chris Giles’ reports, “Treasury to reform Brown’s fiscal rules” and “Treasury sees storm clouds gathering” (July 18), recognise the inevitability of growing deficits due to economic weakness while also implying public-sector deficits are per se a “bad thing”.

What the articles fail to appreciate are three dimensions to the argument: the first is that public-sector deficits do not present a solvency issue, only an “inflation” issue. Second, public-sector deficits equal total non-government (domestic and foreign) savings of sterling financial assets and are the only source of non-government accumulation of sterling net financial assets. Third, public-sector deficits provide the net financial equity to the non-government sector that supports the private-sector credit structure.

It is the case that the public-sector deficit will increase in one of two ways. The “nice” way would be pro-actively with sufficient tax cuts or spending increases (depending on one’s politics) that support demand at desired levels. The “ugly” way is from a slowing of demand that reduces tax revenues and increases transfer payments. If, instead, the government tries to suppress the current deficit with any combination of tax increases or spending cuts, the resulting accelerated slowdown of the economy will then increase the deficit the “ugly” way.

In any case, the current “inflation” is the result of Saudi Arabia acting as swing producer as it sets the oil price at ever-higher levels and then supplies all the crude demanded at that price. Our institutional structure then passes these prices through the entire economy over time, and there is nothing interest rates or fiscal policy can do to change these dynamics.

The ability to set crude prices can only be broken by a sufficiently large supply response, such as in the early 1980s when net supplies increased by more than 15m barrels per day, helped considerably by the US deregulating natural gas production, which allowed substitution away from crude oil products.

In sum, the deficit will go up either the nice way or the ugly way, as it always does when markets work to grant the private sector the desired net financial assets, which can come only from government deficit spending. “Inflation” will continue higher as long as the Saudis remain price-setter and continue to post ever-higher prices to their refiners.

Philip Arestis,
University Director of Research,
Cambridge Centre for Economic and Public Policy

John McCombie,
Director,
Cambridge Centre for Economic and Public Policy

Warren Mosler,
Senior Associate Fellow,
Cambridge Centre for Economic and Public Policy,
University of Cambridge, UK


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Re: Oil as a % of global GDP

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(an email exchange)

>   
>   On Sun, Jul 20, 2008 at 10:46 PM, Russell wrote:
>   
>   Brad Setser, at Follow the Money, presents a couple of graphs on changes in
>   oil export revenue: The Oil Shock of 2008.
>   
>   The following graph shows the Year-over-year change in oil exports as a
>   percent of world GDP (and in billions of dollars).
>   
>   

>   
>   Year-over-year change in oil exports
>   
>   This calculation assumes that the oil exporters will export about 45 million
>   barrels a day of oil.
>   
>   Each $5 increase in the average price of oil increases the oil exporters’
>   revenues by about $80 billion, so if oil ends up averaging $125 a barrel this year
>   rather than $120 a barrel, the increase in the oil exporters revenues would be
>   close to a trillion dollars.
>   
>   Assuming oil prices average $120 per barrel for 2008, the increase in 2008 will
>   be similar to the oil shocks of the ’70s.
>   
>   

Right, the notion that oil is a smaller % of GDP and therefore not as inflationary was flawed to begin with and now moot.

Two more thoughts for today:

First, the second Mike Masters sell-off may have run its course. The first was after his testimony in regard to passive commodity strategies which I agree probably serve no public purpose whatsoever. The second was last week as markets expect Congress to act to curb speculation this week, which they might. Crude isn’t a competitive market (Saudi’s are the swing producer) so prices won’t be altered apart from knee jerk reactions, but competitive markets such as gold can see lower relative prices if the major funds back off their passive commodity strategies.

Second, just saw a headline on Bloomberg that inflation is starting to hurt the value of some currencies.

Third, the Stern statement will continue to weigh on interest rate expectations up to the Aug 9 meeting.

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Crude sell off

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Seems like a sale ahead of possible Congressional action to limit ‘speculation’.

Not sure how big the dip might be, but yet another buying op as the choice remains – pay the Saudis their asking price or shut the lights off.

The price only goes down if the Saudis cut price, or if there is a supply response of more than 5 million bpd that dislodges them from being swing producer.


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Deflation forecast

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This is the deflation argument.
(See below)

Never seen a split quite like this with calls for both accelerating inflation and outright deflation.

Which will it be?

My guess is inflation for the US as our friendly external monopolist continues to squeeze us with ever higher crude prices.

The political process is ensuring they will be passed through as sufficient government ‘check writing’ (net government spending) is sustained to support real growth.

(Bear Stearns, housing agencies, fiscal rebates, fiscal housing package, etc.)

And the dollar continues to adjust to the sudden, politically induced shift in foreign desires to accumulate USD financial and domestic assets.

Various private Q2 GDP estimates are now up to 2% – more than sufficient to support demand and pass through the higher headline prices.

Government is never revenue constrained regarding spending and/or lending.

The limit to government check writing is the political tolerance for inflation, which grows with economic weakness.

This inflation looks to me to be far worse than the 1970s.

Back then, we were able to muster a 15 million bpd positive supply response in crude that broke OPEC by deregulating natural gas.

We don’t have that card to play this time around.

From HFE:

July 14, 2008

WORLDWIDE:

  • Global Disinflation Is Going To Be The Next Big Move For The Bond Markets – Weinberg
  • Commodity And Oil Prices Cannot Rise Forever… There Is No Inflation – Weinberg
  • Bonds To Benefit – Weinberg

UNITED STATES:

  • STOP PRESS: Treasury, Fed To Make Credit Available To GSEs; Treasury To Seek Authority To Buy Their Stocks – Shepherdson
  • This Is A Lifeboat, Not a Bailout; Aim Is To Prevent Uncontained Failure – Shepherdson

CANADA:

  • We Cannot Rule Out A Rate Cut Tomorrow – Weinberg

EURO ZONE:

  • Core CPI Shows No Medium-Term Inflation Risks – Weinberg
  • Production Data Will Be Really Soft – Weinberg

GERMANY:

  • Core CPI Still Under 2% And Steady, ZEW At New Record Low – Weinberg
  • … Tighter Money Is Unhelpful Here – Weinberg

UNITED KINGDOM:

  • Starting Point For August QIR Forecasts To Emerge In This Week’s
  • Reports: Most Inputs To The Forecasts Will Be Stronger – Weinberg

FRANCE:

  • Not-Too-Scary Inflation Report Exported: Core Prices Are Steady – Weinberg

JAPAN:

  • Three Soft Report This Week Will Keep Investors Moving Out Of Stocks, Into Bonds – Weinberg

AUSTRALIA:

  • CPI Report For Q2, Due Next Week, May Rekindle Inflation Worries – Weinberg

CHINA:

  • Exploding Foreign Borrowing Diminishes Foreign Currency Reserve Adequacy; Trends Suggest Further Decay – Weinberg
  • GDP Will Be Below Recent Trend In This Week’s Report – Weinberg


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US Energy Consumption as % of GDP

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US Energy Consumption as Percent of GDP

Interesting how the price hikes get us back to the 1970s ratio. One of the arguments that it was different this time around was that crude is a lower percentage of GDP than it was then.

The pass-throughs to the rest of the price structure are just getting started, and I expect them to persist well past the peak in crude prices.

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The Independent: UK Bank deputy chief warning

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Bank deputy chief warns of market trouble to come

by Ben Russell, Political Correspondent and Sean O’Grady

Britain is facing the risk of renewed turmoil in the financial markets, the new deputy governor of the Bank of England warned yesterday.

Professor Charlie Bean, the deputy governor for monetary policy and a former chief economist at the Bank, raised the prospect of a slowing global economy triggering a new round of problems with corporate loans and said that the impact of the credit squeeze could be greater than Bank projections.

Yes, but unlike the Eurozone, the BoE is permitted to ‘write the check’ as in the treasury.

National solvency is not an issue in the UK as it is in the Eurozone when weakness is addressed.

He told members of the Commons Treasury Select Committee that Britain faced “major conflicting risks” threatening the Government’s inflation target from the problems of a slowing economy and rising commodity prices.

Yes, the twin themes of weakness and inflation.

In a memorandum to the committee, Professor Bean warned that the “dislocation” in the financial markets “probably has further to run, especially if a slowing economy here and abroad generates a second round of write-downs, this time associated with corporate loans. Moreover, the impact of the tightening in the terms of availability of credit could prove greater than is embodied in the central case in our most recent set of projections”.

Agreed. And while ‘writing the check’ can readily address these issues with no risk to government solvency, it will also support the higher prices he next discusses:

He said that increasing oil and other commodity price rises would lead to higher inflation becoming “embedded in the economy”, warning that people might seek to offset price increases by making higher wage demands. He said: “There is no doubt that the UK economy presently faces the most challenging set of circumstances since at least the early 1990s and probably earlier.”

Professor Bean said oil prices could continue to rise for another two years and cautioned that Britain faced the danger of a pay-price spiral if workers tried to compensate by pushing up wages. He said: “It certainly poses a significant challenge. There is no doubt about that at all. It may be a relatively unlikely event but it could be particularly unfortunate if it happened, if households and businesses start losing faith in the idea that inflation will stay low, round about the target, they start building it into their pay and prices and inflation becomes much more embedded into the system… Provided pay growth remains subdued, the current pick-up in inflation will be temporary.”

Living standards, the deputy governor stressed, will inevitably be lower because of the global inflation in commodity prices.

Agreed. It’s all about real terms of trade, which have also been declining rapidly in the US as evidenced by the drop in growth of GDP and the drop in non-oil trade deficit.

My guess is the most likely political response in the US and the UK is proactive deficit spending from the treasury to address the weakness and higher interest rates to address the inflation.

Unfortunately the deficit spending that supports domestic demand will also support crude consumption (as well as housing) and ‘monetize’ the ever higher crude prices being set by the Saudis, thereby supporting ‘inflation’ in general.

And this will trigger ever higher interest rates from the Central Bank as inflation trends even higher.

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Bloomberg: Saudi Arabia not willing to see crude at discount

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Saudi Arabia Not Willing to See Crude at Discount, Naimi Says

by Fred Pals
(Bloomberg) Saudi Arabia, the world’s largest oil exporter, is not willing to sell crude oil at a discount to the normal market price for its grades of oil, the kingdom’s oil minister said.

The country plans to increase production for a third straight month this month. Analysts including the London-based Centre for Global Energy Studies have said Saudi Arabia may need to lower its prices to find sufficient buyers.

“No,” Oil Minister Ali al-Naimi said when asked about his willingness to sell crude at a discount. “Not even for heavy crude. That is not the way the market works. We have said we don’t like high prices. We have nothing to do with where the price is today. Where is the buyer? We would be very happy to sell.”

Al-Naimi spoke to reporters today at the World Petroleum Congress in Madrid.

Right, you can have all you want at their price.

Simple monopoly.

Good luck to us – we don’t even know it’s happening.


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2008-06-23 Valance Weekly Economic Graph Packet

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Real GDP

Can you find the recession? Year over year will be reasonable until last year’s large Q3 number drops out without similar sized q3 this year.

   

Capacity Utilization, ISM Manufacturing

Down but not out as GDP muddles through.

   

Philly Fed Index, Chicago PMI, ISM Non-Manufacturing, Empire Manufacturing Index

Limping along, but off the lows
The survey numbers seem to be depressed by inflation.

   

Retail Sales, Retail Sales Ex Autos, Total Vehicle Sales, Redbook Retail Sales Growth

   

Personal Spending, Personal Income

Apart from cars and trucks, retail muddling through, and getting some support from the fiscal package.

Non-farm Payrolls, Average Hourly Earnings, Average Weekly Hours, Unemployment Rate

Certainly on the soft side, but still positive year over year, earnings still increasing, and unemployment still relatively low (the last print was distorted a couple of tenths or so by technicals).

Total Hours Worked, Labor Participation Rate, Duration of Unemployment, Household Job Growth

Help Wanted Index, Chicago Unemployment, ISM Manufacturing Employment, ISM Non-Manufacturing Employment

Philly Fed Employment, Challenger Layoffs

Most of the labor indicators are on the weak side, but not in a state of collapse. And GDP is picking up some from the fiscal package which should stabilize employment.

NAHB Housing Index, NAHB Future Sales Index

Housing Starts, Building Permits, Housing Affordability, Pending Home Sales

Leveling off to improving a touch.
Housing is still way down and could bounce 35% at any time.
And still be at relatively low levels.

MBA Mortgage Applications

Mortgage apps are down but they are still at levels previously associated with 1.5 million starts vs today’s approx 1 million starts (annual rate).

Fiscal Balance, Govt Public Debt, Govt Spending, Govt Revenue

It’s an election year, and here comes the Govt. spending which is already elevating GDP.

CPI, Core CPI, PCE Price Index, Core PCE

PPI, Core PPI, Import Prices, Import Prices Ex Petro

Export Prices, U of Michigan Inflation Expectations, CRB Index, Saudi Oil Production

The ‘inflation’ is only going to work its way higher as it pours through the import and export channels.
And with Saudi production completely demand driven, there’s no sign of a fall off of world demand for crude at current prices.
Yes, the world’s growing numbers of newly rich are outbidding America’s lower income consumers for gasoline, as US demand falls off and rest of world demand increases.

Empire Prices Paid, Empire Prices Received, Philly Fed Prices Paid, Philly Prices Received

All the price surveys are pretty much the same as ‘inflation’ pours in.

ABC Consumer Confidence, ABC Econ Component, ABC Finance Component, ABC Buying Component

And all the surveys look pretty much the same as ‘inflation’ eats into confidence

10Y Tsy Yield

And with all the weakness rates have generally moved higher as it seems inflation is doing more harm than ultra low interest rates are helping, perhaps causing the Fed to reverse course.

10Y Tips

The TIPS market has been discounting higher ‘real’ rates from the Fed.

Dow Index

Even as stocks look to test the lows

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Saudi Iran OIL Update

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Saudis say they will pump more if markets want more.

They post prices to their refiners and then fill all orders at their posted prices.

Their posted prices and spreads have also been moving in their favor lately.

Can it be more clear that the Saudis are ‘price setters?’

And with excess capacity very near zero, Russia and Iran are also price setters, and anyone else with more than a million bdp of output.

Price goes to the higher of where any of the price setters set their prices.

And the FOMC now knows this and will give the possibility of continuous price increases a lot more weight in their decisions.

Good luck to us!

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