Author: ColinTwiggs

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Oil market showdown: can Russia outlast the Saudis?

Dalan McEndree writing in Oilprice.com :

While the sharp decline in crude prices has saved crude consuming nations hundreds of billions of dollars, the loss in revenues has caused crude exporting countries intense economic and financial pain. Their suffering has led some to call for a change in strategy to “balance” the market and boost prices. Venezuela, an OPEC member, has even proposed an emergency summit meeting.

In practice, the call for a change is a call for Saudi Arabia and Russia, the two dominant global crude exporters, which each daily export over seven-plus mmbbls (including condensates and NGLs) and which each see the other as the key to any “balancing” moves, to bear the brunt of any production cuts…….

Despite the intense pain they are suffering in the low price Crudedome, both the Russian and Saudi governments profess for public consumption that they are committed to their volume and market share policies.

This observer believes the two countries cannot long withstand the pain they have brought upon themselves — and this article only scratches the surface of the negative impact of low crude prices on their economies. They have, in effect, turned no pain no gain into intense pain no gain and set in motion the possibility neither will exit the low price Crudedome under its own power.

Read more at Oil market showdown: can Russia outlast the Saudis? | Oilprice.com

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Containment 2.0 [podcast]

Always interesting to listen to James Sherr of Chatham House discuss global geo-politics.

http://www.rferl.org/audio/27310324.html

Can the West contain a Russia that is determined to upend the international order — but which at the same time is deeply integrated into the global economy?

The latest Power Vertical Podcast tackles these questions with guests James Sherr, an associate fellow with — and former head of — Chatham House’s Russia and Eurasia program, and Daniel Drezner, a professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University and author of the books Theories Of International Politics And Zombies and the recently published The System Worked: How The World Stopped Another Great Depression.

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Why Japan Should Rearm by Brahma Chellaney | Project Syndicate

….It is Japan’s security, not its economy, that merits the most concern today – and Japan knows it. After decades of contentedly relying on the US for protection, Japan is being shaken out of its complacency by fast-changing security and power dynamics in Asia, especially the rise of an increasingly muscular and revisionist China vying for regional hegemony.

….China has not hesitated to display its growing might. In the strategically vital South China Sea, the People’s Republic has built artificial islands and military outposts, and it has captured the disputed Scarborough Shoal from the Philippines. In the East China Sea, it has unilaterally declared an air-defense identification zone covering territories that it claims but does not control.

With US President Barack Obama hesitating to impose any costs on China for these aggressive moves…..the reality is that ensuring long-term peace in Asia demands a stronger defense posture for Japan.

….Would Japan need to become a truly independent military power, with formidable deterrent capabilities like those of the UK or France?

The short answer is yes. While Japan should not abandon its security treaty with the US, it can and should rearm, with an exclusive focus on defense…..

Read more at: Why Japan Should Rearm by Brahma Chellaney | Project Syndicate

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Weak US retail sales belie strong fundamentals

Lucia Mutikani at Reuters writes:

U.S. retail sales barely rose in September and producer prices recorded their biggest decline in eight months, raising further doubts about whether the Federal Reserve will raise interest rates this year. The weak reports on Wednesday were the latest suggestion that the economy was losing momentum in the face of slowing global growth, a strong dollar, an inventory correction and lower oil prices that are hampering capital spending in the energy sector. Job growth braked sharply in the past two months.

Readers of the headline Weak U.S. retail sales, inflation data cloud rate hike outlook could be forgiven for believing the US economy is headed for recession. After all, retail sales growth has slowed to a crawl.

Retail Sales

And the producer price index is declining sharply on the back of lower oil prices.

Producer Price Index

But if we strip out food and energy prices, PPI remains close to the Fed’s 2% inflation target. And low energy prices will eventually feed through as a stimulus to the global economy.

Hourly earnings in the manufacturing sector are starting to grow.

Average Hourly Earnings Growth: Manufacturing and Total Private

Deeper in the Reuters article, we find a more objective view:

“The overall message is that consumer spending has remained extremely strong. If sentiment had indeed shifted, it would be hard to explain why sales of cars, certainly among the more expensive items, jumped in September to their highest level since July 2005,” said Harm Bandholz, chief economist at UniCredit Research in New York.

Light vehicle sales continue their upward trajectory.

Light Vehicle Sales

And construction spending is decidedly bullish.

Construction Spending

Not much here to keep Janet Yellen up at nights. When it comes to rate rises, the sooner we get the economy back on a sound footing the better, I say. Otherwise we encourage further capital misallocation and dependency on Fed stimulus. There are no free lunches from central bankers. Everything comes at a price.

It is always important in matters of high politics to know what you do not know. Those who think they know, but are mistaken, and act upon their mistakes, are the most dangerous people to have in charge.

~ Margaret Thatcher: Statecraft (2002)

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Aussie big four banks overpriced

Australia’s big four banks have raised significant amounts of new capital as the realization finally dawned on regulators that they were highly leveraged and likely to act as “an accelerant rather than a shock-absorber” in the next downturn.

Chris Joye writes in the AFR that the big four have raised $36 billion of new capital in the 2015 financial year:

Before Westpac’s $3.5 billion equity issue this week, the big banks had, through gritted teeth, accumulated $27 billion of extra equity over the 2015 financial year through “surprise” ASX issues, underwritten dividend reinvestment plans, asset sales and organic capital generation via retained earnings. If you add in “additional tier one” (AT1) capital issues (think CBA’s $3 billion “Perls VII”), total equity capital originated rises to about $32 billion, or almost $36 billion after Westpac’s effort this week.

The effect of deleveraging is clearly visible on the ASX 300 Banks Index [XBAK].

ASX 300 Banks Index

Having broken primary support, the index is retracing to test resistance at 84. Bearish divergence on 13-week Twiggs Money Flow, followed by reversal below zero, both warn of a primary down-trend. Respect of resistance at 84 would strengthen the signal, offering a (medium-term) target of 68* for the next decline.

* Target calculation: 76 – ( 84 – 76 ) = 68

Matt Wilson, head of financial research at the $10 billion Australian equities shop JCP Investment Partners, says the bad news for those “long” the oligarchs is that “we are still only halfway through the majors’ capital raising process at best”.

Chris calculates the remaining shortfall to be at least $35 billion:

Accounting for future asset growth, I calculated the big banks will need another $35 billion of tier one capital if the regulator pushes them towards a leverage ratio of, say, 5.5 per cent by 2019, which is still well below the 75th percentile peer.

One of the big four’s most attractive features is their high dividend-yield and attached franking credits, but Chris compares this to the far lower dividend payout ratios of international competitors and quotes several sources who believe the present ratios are unsustainable.

JCP’s Wilson does not think payout ratios are sustainable and accuses the big banks of “over-earning”. “Bad debts of 0.15 per cent are running at a 63 per cent discount to the through-the-cycle trend of 0.40 per cent,” he says. “Should we see a normal credit cycle unfold, then payouts will be cut significantly due to the pro-cyclicality of risk-weighted assets calculations and bad debts jumping above trend.”

He concludes:

Aboud [Stephen Aboud, head of LHC Capital Fund] reckons artificially high yields also explain why the big banks’ “2.5 times price-to-book valuations are miles above the 1-1.5 times benchmark of global peers”, which he describes as “a joke”.

Plenty of food for thought.

Read more from Chris Joye at Hedge funds that shorted the big banks | AFR

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Gold breaks trendline

Treasury yields remain weak, with the 10-year yield testing support at 2.0 percent. Declining interest rates improve demand for gold but a subdued inflation outlook has the opposite effect.

10-Year Treasury Yields

The Fed has stopped QE, with total assets leveling off around $4.5 Trillion. Expansion of excess bank reserves on deposit with the Fed, which softened the inflationary impact of QE, halted a little earlier.

Fed Total Assets compared to Excess Reserves

The latter is contracting at a slightly faster pace, so the net effect (change in Total Assets minus Excess Reserves) remains stimulatory. Reversal below zero on the chart below would warn of a contraction.

Fed Total Assets minus Excess Reserves

The Dollar is weakening in line with interest rates, with the Dollar Index headed for a test of support at 93. 13-Week Twiggs Momentum crossed below zero, warning of a primary down-trend. Breach of primary support at 93 would confirm.

Dollar Index

A weaker Dollar would drive up gold. Spot gold broke its long-term descending trendline and is headed for a test of resistance at $1200/ounce. Recovery of 13-week Twiggs Momentum above zero would suggest a primary up-trend, but it would be prudent to wait for confirmation from a trough above zero and breakout above $1200.

Spot Gold

* Target calculation: 1200 – ( 1400 – 1200 ) = 1000

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Weak US retail sales belie strong fundamentals

Lucia Mutikani at Reuters writes:

U.S. retail sales barely rose in September and producer prices recorded their biggest decline in eight months, raising further doubts about whether the Federal Reserve will raise interest rates this year. The weak reports on Wednesday were the latest suggestion that the economy was losing momentum in the face of slowing global growth, a strong dollar, an inventory correction and lower oil prices that are hampering capital spending in the energy sector. Job growth braked sharply in the past two months.

Readers of the headline Weak U.S. retail sales, inflation data cloud rate hike outlook could be forgiven for believing the US economy is headed for recession. After all, retail sales growth has slowed to a crawl.

Retail Sales

And the producer price index is declining.

Producer Price Index

But if we strip out food and energy prices, PPI remains close to the Fed’s 2% inflation target. And low energy prices will eventually feed through as a stimulus.

Hourly earnings in the manufacturing sector are starting to grow.

Average Hourly Earnings Growth: Manufacturing and Total Private

“The overall message is that consumer spending has remained extremely strong. If sentiment had indeed shifted, it would be hard to explain why sales of cars, certainly among the more expensive items, jumped in September to their highest level since July 2005,” said Harm Bandholz, chief economist at UniCredit Research in New York.

Light vehicle sales continue their upward trajectory.

Light Vehicle Sales

And construction spending is decidedly bullish.

Construction Spending

Not much here to keep Janet Yellen up at nights. When it comes to rate rises, the sooner we get the economy back on a sound footing the better, I say. Otherwise we encourage further capital misallocation and dependency on Fed stimulus. There are no free lunches from central bankers. Everything comes at a price.

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Niall Ferguson: The Real Obama Doctrine – Real Daily Buzz

Niall Ferguson on US strategy in the Middle East:

Henry Kissinger long ago recognized the problem: a talented vote-getter, surrounded by lawyers, who is overly risk-averse. Even before becoming Richard Nixon’s national security adviser, Henry Kissinger understood how hard it was to make foreign policy in Washington. There “is no such thing as an American foreign policy,” Mr. Kissinger wrote in 1968. There is only “a series of moves that have produced a certain result” that they “may not have been planned to produce.” It is “research and intelligence organizations,” he added, that “attempt to give a rationality and consistency” which “it simply does not have.”

Two distinctively American pathologies explained the fundamental absence of coherent strategic thinking. First, the person at the top was selected for other skills. “The typical political leader of the contemporary managerial society,” noted Mr. Kissinger, “is a man with a strong will, a high capacity to get himself elected, but no very great conception of what he is going to do when he gets into office.”

Second, the government was full of people trained as lawyers. In making foreign policy, Mr. Kissinger once remarked, “you have to know what history is relevant.” But lawyers were “the single most important group in Government,” he said, and their principal drawback was “a deficiency in history.” ……..

It is clear that [Barack Obama’s] strategy is failing disastrously. Since 2010, total fatalities from armed conflict in the world have increased by a factor of close to four, according to data from the International Institute of Strategic Studies. Total fatalities due to terrorism have risen nearly sixfold, based on the University of Maryland’s Study of Terrorism and Responses to Terrorism database. Nearly all this violence is concentrated in a swath of territory stretching from North Africa through the Middle East to Afghanistan and Pakistan. And there is every reason to expect the violence to escalate as the Sunni powers of the region seek to prevent Iran from establishing itself as the post-American hegemon.

Today the U.S. faces three strategic challenges: the maelstrom in the Muslim world, the machinations of a weak but ruthless Russia, and the ambition of a still-growing China. The president’s responses to all three look woefully inadequate……

Some things you can learn on the job, like tending bar or being a community organizer. National-security strategy is different. “High office teaches decision making, not substance,” Mr. Kissinger once wrote. “It consumes intellectual capital; it does not create it.” The next president may have cause to regret that Barack Obama didn’t heed those words. In making up his strategy as he has gone along, this president has sown the wind. His successor will reap the whirlwind. He or she had better bring some serious intellectual capital to the White House.

Source: Niall Ferguson: The Real Obama Doctrine – Real Daily Buzz

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Effect of long-term unemployment on the labor participation rate

Alan B. Krueger is Bendheim Professor of Economics and Public Affairs at Princeton University and an NBER research associate. Here he discusses the effect of long-term unemployment on the declining labor participation rate:

….The SIPP [Survey of Income and Program Participation] data indicate that, irrespective of the business cycle, the probability that an unemployed worker will be “steadily” employed in a full-time job for at least four consecutive months a year later is strikingly low and declines further as the duration of joblessness rises. Even in the strong job market of the late 1990s, the chance of a long-term unemployed worker finding steady, full-time employment after a year was only around 20 percent. This likelihood did not change very much during the 2001 recession, and it didn’t change substantially during the Great Recession. Conversely, the likelihood that an unemployed worker will leave the labor force a year later increases substantially as the duration of joblessness rises. According to the SIPP, 35 percent of workers who became long-term unemployed during the Great Recession were out of the labor force by 2013.

Why does long-term unemployment have such an adverse effect on workers? There has been a long, unresolved debate in the economics profession about whether the job finding rate is lower for the long-term unemployed because of either unobserved heterogeneity in the characteristics of such workers or something about the nature of unemployment that adversely changes people. Although this is an inherently difficult question to answer, the literature suggests that duration dependence plays a larger role than unobserved heterogeneity in explaining this phenomenon….. Much research suggests that long-term unemployment has a negative impact on both the supply side and the demand side.

On the supply side, an individual’s mental health and self-esteem can be affected by the experience of long-term unemployment. Till von Wachter has done good work showing that one’s physical health and mortality are adversely impacted by joblessness. Andy Mueller and I did a longitudinal study where we asked workers who were receiving unemployment insurance about the intensity of their job searches. We found that job search activity tends to decline the longer people are unemployed. We also found that the long-term unemployed tend to be socially isolated…… Furthermore, long-term unemployment tends to be associated with repeated job loss and lower re-employment earnings. All of these findings point to a decline in human capital and disengagement from the labor market as a result of long-term unemployment.

On the demand side, studies have shown that employers discriminate – at least statistically – against the long-term unemployed. Kory Kroft, Fabian Lange, and Matt Notowidigdo conducted a study in which they sent out resumes with varying gaps of joblessness, and they found that the likelihood of receiving an interview depended upon the duration of unemployment. Rand Ghayad also found similar results.

My take on the evidence is that the experience of being unemployed makes it harder for people to get back on their feet, and that even a strong economy doesn’t solve this problem. In addition, once a person leaves the labor force, he or she is extremely unlikely to return. The labor force flows data from the CPS bear this out (Figure 6). According to CPS data, the monthly rate for transitioning from out of the labor force to back in the labor force is unrelated to the business cycle. We didn’t see a wave of people returning to the labor force either in the late 1990s or earlier in the 2000s, and we’re not seeing one now……

Conclusion
To conclude, I will briefly comment on policies to address the problem of long-term unemployment. One of the overriding lessons that I take away from this body of research is that, if left untreated, long-term unemployment can have hysteresis-type effects on the labor market. A cyclical recovery does not cure the problems created by long-term unemployment. Going forward, I think one of the lasting legacies of the Great Recession is that the labor force participation rate will be about one percentage point lower than it otherwise would have been. This analysis argues in favor of using “overwhelming force” in a deep recession to prevent those who lose their jobs from becoming long-term unemployed in the first place.

Since long-term unemployment has been so widespread throughout sectors of the economy, “industry-specific” policies are insufficient to solve the problem. In 2012, for example, only 10 percent of long-term unemployed workers were from the construction sector, and only 11 percent were from manufacturing, despite the fact that these industries were hit particularly hard by the Great Recession.

Instead, I would prefer more targeted measures geared specifically toward helping the long-term unemployed stay in the labor force and find employment, such as a tax credit for employers who hire the long-term unemployed or direct employment. There also has been some research to support the notion that volunteering can help jobless workers make new connections, learn new skills, and stay engaged in the labor force. In the United States, job search assistance has typically been found to be effective in helping workers regain employment. I also think wage loss insurance might be worth considering, especially for older long-term unemployed workers.

Lastly, given that many of the long-term unemployed have already left the labor force, we should consider policies that address the structural decline in labor force participation. For example, more family-friendly policies might help greater numbers of women either enter or remain in the labor force. Likewise, reforms to the disability insurance system could possibly prevent some workers from permanently exiting the labor force.

Source: NBER Reporter Online

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