Bright Current Economic Signals Are Spurious

The market rejoiced on Dec. 5 when the Bureau of Labor Statistics reported that 321,000 new U.S. jobs had been created. The general consensus is that the 3.9% third-quarter Gross Domestic Product (GDP) growth is the harbinger of a brighter trend. The Economist’s team of forecasters has U.S. growth at 3% in 2015, up from 2.3% in 2014, while the International Monetary Fund (IMF) forecasts global growth up from 3.3% to 3.8%. Happy Days Are Here Again—except that they’re not. The benefits of the $40 per barrel fall in global oil prices are emerging ahead of the costs.

The oil price decline will lead to a consumer resurgence, especially in Japan and the EU, where few jobs depend on the energy-extraction sector. In the U.S., gasoline at $2.50 a gallon should free up consumer purchasing power quickly. Fifteen or $20 saved on a tank of gas can be spent on other things, especially around Christmas when spending demands are high and controls lax. That is not immediately offset by loss of purchasing power in the oil sector. Companies have cash reserves, and existing drilling and production programs mostly continue as planned in the hope of an early recovery in oil prices.

In Europe and Japan there is little or no offsetting loss from lower oil prices, so consumption increases and the lethargic economies of the eurozone and Japan flicker once more into a pallid semblance of life. Part of their problems in 2009-11 were caused by the rapid run-up in oil prices to more than $100, so that loss is regained, and those countries’ GDP figures show a couple of quarters of above-trend growth. In China, the wind-down of the immense property bubble continues, but the loss of purchasing power, which a decade of malinvestment is beginning to cause, will at least be postponed for a quarter or two.

Overall, therefore, the first couple of quarters of lower oil prices will look pretty satisfactory worldwide. Because it’s unlikely the Fed or other stimulus-obsessed monetary authorities will begin to raise interest rates (for them, there is always some excuse not to do so), we will hear six months of annoying Keynesian rejoicing as “stimulus” spending addicts and monetary quacks proclaim their remedies to have succeeded, finally producing the faster growth which Keynesians had predicted half a decade ago.

This column has been anticipating the collapse of markets buoyed to infinity by misguided “stimulus” for several years now; the only uncertainty was how long the collapse would be delayed. The latest developments suggest a timeframe for the financial Armageddon. Once the positive effects of the oil price decline have worked their way through the system, the negative effects will arrive, and they will be powerful enough to reverse the upward trend in the markets and the global economy.

As discussed in detail last week’s column, the principal negative effect of the sharp drop in oil prices is the value destruction of billions of dollars of energy-sector investment and the consequent damage to banks and bond markets. This does not happen immediately, which is why the effect of the oil price decline is initially asymmetric. However, the payment cycle in the sector is not longer than a couple of months, many of the highly leveraged companies carry limited amounts of cash and projects in mid-construction suffer especially high cash outflows (though some of the latter’s costs may be reduced by the elimination of the sector’s overheating).

Then there are the oil-exporting countries. Venezuela is already a basket case, desperately trying to figure out a way to raise enough dollars to provide its people with basic necessities, almost all of which have to be imported in that benighted economy. Russia is almost in the same boat, although with $419 billion of foreign exchange reserves (if that figure is not fictitious), it has a certain amount of wriggle room. Even Saudi Arabia, the largest oil exporter, has allowed its welfare budget to explode with the rise in oil prices and will start to struggle pretty quickly with oil prices in the $60-65 range, even though its oil production costs are well below that level.

The timing for the adverse effects of the price drop is fairly clear: it will take about six to nine months, enough for the more leveraged, high-cost oil producers to run out of money and their banks to run out of patience. We will then see a flow of bankruptcies, affecting not only the oil sector itself but also the banking system and the junk-bond market. At the same time, the redundancies that the energy sector has produced will begin to show up in the unemployment figures, and the production destroyed will show up in the GDP figures. These effects can be very substantial and long-lasting.
The similar downturn in gold prices since 2011 has now caused Anglo American to announce it will suffer 60,000 redundancies by 2017. Needless to say, the oil sector is much larger than the gold sector, and prices had previously been on a plateau rather than rising continuously as had gold before 2011. Consequently, the redundancies will appear more quickly and be more severe.

Autumn is the traditional time for market crashes and economic upsets, and it seems likely that this timing will recur on this occasion, with the autumn of 2015 being a very difficult period indeed for the market. Doubtless the market, lulled by the euphoria of the initial favorable economic data, will see a further rise in the first half of 2015, maybe with the S&P 500 reaching 2,500. Adverse statistics and the first bankruptcies will begin to appear about July, but the downward slide will not gather momentum until after Labor Day.

If we are very lucky, the Fed may have increased its federal funds target interest rate by a quarter of a percent or so by the time the crisis hits. That will enable the Fed to fight the crisis by reducing the rate again, while the Obama administration will use the crisis as an excuse to attempt to pump yet more worthless “stimulus” spending into the economy. With a Republican Congress, it is to be hoped that the waste can be stopped, as it was not in 2001, 2008 and 2009.

The U.S. budget deficit will be only $600 billion or so in the year to September 2015, after current negotiations have added a chunk of extra spending, while the good economy of the first half of 2015 will cause the fiscal position to outperform expectations. However, once the downturn hits, after the usual lag the budget deficit will widen inexorably from its bloated (by former standards) base. Its projection for the year to September 2017 will be well above $1 trillion by the time the President’s 2017 Budget is announced in February 2016. In reality the deficit for that year will probably reach $2 trillion by the time that fiscal year is finally tallied in October 2017, with the usual election-year slippage, but with no extraordinary spending “stimulus” since the Republican Congress will prevent it.

If this trajectory is correct, the 2016 election looks very good for the Republicans (provided they can avoid their usual election-year pastime of nominating an idiot as Presidential candidate). For the U.S. economy, the trajectory after the downturn hits is less clear. If monetary policy remains under the control of Janet Yellen and her acolytes, we may have to go through yet another cycle of monetary “stimulus” even though the painful recession and the wreckage of the past half-decade’s malinvestment will be massive evidence of the failure of over-stimulative monetary policies.

Since Yellen cannot be replaced until January 2018 it unfortunately seems that at least the beginning of the next cycle will be conducted with the same monetary policy as the present one, suppressing savings for yet more years and de-capitalizing the U.S. economy still further. Only a massive burst of inflation, causing the Fed to panic and raise rates, can save us from this fate. At present no such burst appears to be in the offing, and indeed the decline in oil prices will initially work against the appearance of such a phenomenon. Conventional monetary theory says we should already be in substantial inflation, as M2 money supply has increased substantially more rapidly than nominal GDP for the last five years. Conventional monetary theory is thus pretty obviously wrong, and it’s not clear with what we should replace it.

Globally, it seems likely that a market crash will hit at the same time as the U.S. crash next September/October, and that this will lead to another recession, as it did in 2008-09. Global malinvestment is roughly as prevalent as in the U.S., although it is concentrated in a few areas, such as London and Chinese property. However, the most likely non-U.S. trigger of crash is Japanese government bonds. Even though Japan is a major beneficiary of the oil price decline, the budget deficit in Japan is so large, the debt level so high and the current policies so misguided that a crash seems unavoidable. That crash might naturally occur in 2016 or 2017 rather than 2015, but a global stock market and economic downturn ought to be sufficient to trigger it a year or so early, giving the 2015-16 recession/crash a very nasty second downward leg.

Overall, the economic prognostication is little changed from a few weeks ago, but the timing is perhaps now clearer.

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About the Author:  Martin Hutchinson is the author of “Great Conservatives” (Academica Press, 2005) which examines the British governments of 1783-1830. He was formerly Business and Economics Editor at United Press International. Martin’s weekly column, The Bear’s Lair, is based on the rationale that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. This article originally appeared on the economics website “The Prudent Bear” and is republished here with permission.

Drone Transport Ships, Automation, and the Bubble Economy

Editor’s Note:  This article by Mike Shedlock leads off with a report on “drone transport ships,” but moves on to explore a provocative and very pertinent question:  Are policies that create the “bubble economy,” i.e., artificially inflated asset values, partly motivated by a desire to counter the deflationary pressures caused by automation? We have explored this issue most recently in “Pension Funds and the Asset Economy,” and also in a post from 2013 entitled “Exponential Technology and the Role of Unions.” Shedlock may not have all the answers here – who does – but he is asking a question that must challenge anyone serious about promoting effective policies to stimulate sustainable economic growth. And Shedlock’s basic point – intervention to counter “good deflation” is futile, if not counterproductive – is consistent with the lessons of history. Every innovation ever conceived of was deflationary; only by deflating the value of existing services can you free up capital to invest in the next wave of innovation.

Here is the question of the day: Are drone, workerless ocean freight transport ships coming?

If shippers can pull it off, the cost saving would be immense. But what about the job losses? Insurance? Inflation?

Let’s explore the questions with a look at the Bloomberg article Rolls-Royce Drone Ships Challenge $375 Billion Industry.

“In an age of aerial drones and driver-less cars, Rolls-Royce (RR/) Holdings Plc is designing unmanned cargo ships.

Rolls-Royce’s Blue Ocean development team has set up a virtual-reality prototype at its office in Alesund, Norway, that simulates 360-degree views from a vessel’s bridge. Eventually, the London-based manufacturer of engines and turbines says, captains on dry land will use similar control centers to command hundreds of crewless ships.

Drone ships would be safer, cheaper and less polluting for the $375 billion shipping industry that carries 90 percent of world trade, Rolls-Royce says.

The European Union is funding a 3.5 million-euro ($4.8 million) study called the Maritime Unmanned Navigation through Intelligence in Networks project. The researchers are preparing the prototype for simulated sea trials to assess the costs and benefits, which will finish next year, said Hans-Christoph Burmeister at the Fraunhofer Center for Maritime Logistics and Services CML in Hamburg.

Even so, maritime companies, insurers, engineers, labor unions and regulators doubt unmanned ships could be safe and cost-effective any time soon.

Crew costs of $3,299 a day account for about 44 percent of total operating expenses for a large container ship, according to Moore Stephens LLP, an industry accountant and consultant.

The potential savings don’t justify the investments that would be needed to make unmanned ships safe, said Tor Svensen, chief executive officer of maritime for DNV GL, the largest company certifying vessels for safety standards.

While each company can develop its own standards, the 12-member International Association of Classification Societies in London hasn’t developed unified guidelines for unmanned ships, Secretary Derek Hodgson said.

“Can you imagine what it would be like with an unmanned vessel with cargo on board trading on the open seas? You get in enough trouble with crew on board,” Hodgson said by phone Jan. 7. ‘There are an enormous number of hoops for it to go through before it even got onto the drawing board.'”

100% Guaranteed to Happen

Anyone who does not think drone, workerless ships will happen, cannot think clearly.

Skeptics did not think the auto would replace horses or trains. Skeptics thought flight was impossible. Even simple constructs we now take for granted such as coffee on airplanes was once considered ridiculous.

So yes, driverless cars and workerless ocean ships are 100% guaranteed. The only question is “what timeframe?”

I do not have an answer to that question, but let’s not bury our heads in the sand over what is inevitable.

Furthermore, it’s likely workerless ships arrive before driverless trucks hit mainstream.

After all, the ocean is a vast place and there are no road or other constraints except in docking. If landing is a major concern, how difficult would it be to helicopter in crews specifically for the final landing?

What About Jobs?

Let’s get a grip on the problem of jobs. Yes, many will vanish. But others will appear. I cannot name one technological advancement in history that did not ultimately create more jobs than it destroyed.


  • Lightbulbs replaced candles
  • Cars replaced horses
  • Trains replaced the Pony Express
  • Personal computers
  • Internet replacing libraries

Can someone tell me why it’s supposed to be different this time?

What About Inflation?

Therein lay the problem. Driverless cars, the internet, and other price-deflationary advances have outstripped central banks ability to inflate prices and wages.

Try as they might, central banks have only managed to foster asset bubbles (they don’t even see) not the 2% price inflation they want.

Yet they keep trying. Prices went up but not as much as central banks want. Wages rose less than prices, especially for those on the bottom end. Home prices soared so Congress initiated countless affordable home programs. Then home prices crashed and Congress and the Fed acted to prop up home prices.

No one really wanted affordable homes, they just wanted ill-advised affordable home programs. Now people scream about income inequality and for higher minimum wages.

This all stems from one bad idea – central banks fostering inflation.

One Bad Idea Leads to Another, and Another

In the effort to produce 2% inflation, One Bad Idea Leads to Another, and Another

That construct is corollary number six of the greater “Law of Bad Ideas“.

Can the Fed Prevent Boom-Bust Cycles? 

Heck no, the Fed causes them! For details, see Bubblicious Questions: What Causes Economic Bubbles? When Do Bubbles Burst? Can the Fed Prevent Bubbles?

Also consider Deflation Theory Reality Check.

Losing Battle

Such are the challenges the Fed faces, and they are losing the battle because the advancement of technology is inherently price-deflationary. Technollogy has overtaken the Fed’s (central bankers in general) ability to inflate consumer prices.

Here’s the irony: Ridiculous efforts to prevent price-deflation cause asset bubbles that inevitably collapse, which in turn bring the very conditions central banks wish to prevent.

About the Author:  Mike Shedlock is the editor of the top-rated global economics blog Mish’s Global Economic Trend Analysis, offering insightful commentary every day of the week. He is also a contributing “professor” on Minyanville, a community site focused on economic and financial education.