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Catching a Falling Financial Knife

Catastrophic Economic Crunch Will Be Oil Mastitis: Set to Hit USA Just Like 2008

Economics / Crude Oil Aug 31, 2011 - 09:10 AM GMT

By: Andrew_Butter

Economics

Diamond Rated - Best Financial Markets Analysis ArticleEveryone was waiting with baited breath for the news about QE-3. But perhaps the number to watch was Q-3 nominal GDP, coming soon!!

The important message Ben Bernanke had in Jackson Hole was that the Federal Reserve cannot, on its own, create economic growth in America (or jobs), simply by making it more or less attractive for banks to lend; and thus for Americans and foreigners to borrow. Or by printing money to buy over-priced toxic assets so the ATM’s still work, or to help the Treasury improve the structure of their debt, by buying long bonds real cheap from Bill Gross…Hey Bill, that was a patriotic thing to do!


But Mr. Helicopter wasn’t very specific about who’s job that was, although one would have thought that in a free-market democracy that would be the job of either the “free-market”, or the elected representatives, or a combination of both?

Either way, both of those have been conspicuously MIA (Missing-in-Action) for quite some time, like since the time Gerald Ford was in charge; Allan Greenspan correctly characterized him as the only “decent and sane” American President he had any dealings with; “the man who vetoed everything stupid that Congress put out” (I paraphrase).  

Then after a few partially-sane ones, they got the “blow-job” chap, and then the chap who according to Pravda took a special delight inserting explosives into the anuses of toads when he was a teenager and grew up to recreate the Crusades for fun. And now there is the poet who seems to do not much except talk on-and-on about “consensus”. The lunacy is sounding more and more like the fiddling of Roman Emperors.

Meanwhile America mutates into a quasi-fascist state where the population must serve at the pleasures of a small minority of super-rich. Who enjoy the luxuries of the protection of their wealth that is provided by the Law (particularly the one about three-strikes-and you are out), plus the huge investment in military power. Make no mistake; America spends half of what the whole world spends on defense to keep the wealth of 1% of the population “safe”, not to keep ordinary Americans, the ones who serve the rich…”safe” (guess who’s side I’m on).

Meanwhile in Belgium there was a conference to discuss whether or not the gyrations in the price of oil over the past few years, were due to (a) speculation or (b) something else.

http://www.marketwatch.com/story/speculation-can-destabilize-oil-prices-cftc-told-2011-08-26

There are three schools of thought:

1: There is a (fairly recent) idea that when the amount of money the world pays for oil (in nominal dollars) gets above 3.3% of world GDP (also in nominal dollars), the extra input cost slows world GDP, but when it is less than that, it has no effect; i.e. high oil prices slow GDP growth but low prices don’t particularly speed it up.

I was intrigued by the number 3.3% because that is exactly the same number that I came up with by two (other) separate approaches to try and figure out what is the fundamental price of oil, i.e. the price of “equilibrium” on the demand side of the equation.

Like an Err…SNAP moment!!

Although me I call that process “Parasite Economics” and the fundamental “market equilibrium” I’m interested in is just how much milk you can suck out of Daisy before she keels over with a nasty dose of mastitis.

http://www.marketoracle.co.uk/Article24849.html

That red line, which I call the valuation estimate of the “fundamental”, is defined by the equation which one day I suspect may eventually replace E=MC2 and the General Theory of Economics (as proposed by Keynes), and can be expressed:

FOOT = 3.3 x TOAD/OIK
Where:

FOOT = Fundamental Of the price of Oil Today
TOAD = TOtal Of All De (the) nominal GDP in the world
OIK     = Total of all the OIl Konsumed.

2: Another school of thought has it that there are now constraints in production of oil, and prospects of further constraints as oil is currently getting discovered and developed, slower than the rate at which it is being used.

Another way of saying that is that the replacement cost, i.e. the cost of finding new oil and bringing it to market, is what determines the correct (i.e. fundamental) price. I would like to emphasize that “replacement cost” is not the cost of pumping oil that has already been found out the ground, it is the cost of finding an equal quantity of oil that hasn’t been found yet, and pumping that to the market.

And thus the gyrations of the market reflect a flip-flop between pricing the current value of replacement cost, which is hard to know…the head of Exxon says it is $75, the BP disaster suggests it might be more; and what the buyers can afford before they start to suffer from mastitis. The essential instability to finding equilibrium there is the conflict between the luxury of governments subsidizing imports of oil, which is something that both USA and China do, and the un-sustainability, long term of financing current expenditure on the luxury of cheap gasoline, by borrowing, rather than by investing in infrastructure to lower costs in the future.

That’s a simple chart – it’s not a big secret, you can look the numbers up on Wikipedia if you don’t believe me, USA and China need over twice as much oil to generate a unit of GDP that countries that have policies to increase the return on investment on every barrel they burn.

The main policy there is taxation:

Source OPEC: http://www.opec.org/opec_web/en/data_graphs/333.htm

I remember years ago asking someone how the population put up with Franco. He told me “It’s simple, cigarettes and alcohol are cheap”… in USA it’s the same deal, except over there the fascists use gasoline prices to keep the masses happy.

If USA had the same tax on oil as Europe, that would generate another $500 billion a year, which is, if you think about it, enough to run a descent sized war, even these days.

3: A third school of thought has it that speculators are manipulating the market, which is what the Saudis have been saying all along (they said it was a Zionist Plot). You have to give credit to the Saudi’s role of “fairy-godmother of last resort” in this whole scenario, when there is a bubble they pump, and the reason they give is that if they don’t the world economy will stall.  They could be right:

Put this one on your iPhone and weep:

So you say the financial collapse was caused by Lehman? Oh yeah…but something happened before that, nominal GDP growth in USA was half-way to the bottom before Lehman hit.

The red line there by the way is a rough & ready estimate of the “fundamental” as defined by FOOT = 3.3% x TOAD/OIK, assuming that over that period the supply was pretty much constant (i.e. the line is defined by nominal GDP).

What that all says to me is that (a) on one hand as argued in my previous article the fundamental is driven by the line of nominal GDP when supply is more or less constant (b) but equally nominal GDP (or growth of that) is driven to some extent by the degree of departure of the price from the fundamental, so there is a feedback-loop working there, and as we all know from Engineering-101, when you have feedback loop you get oscillations, and sometimes those can shake your contraption to bits…like now.

Oh yeah, you thought I was asleep, nope…I know about the spread between WTI and Brent, but that only started recently, and what America pays to import oil is dictated more by Brent and the OPEC basket which more or less tracks that.

How about this one:

 

Looks suspiciously like when USA starts to have to borrow over $125 billion a quarter from foreigners so they can pay for their “habit”; the train goes off the rails.

I haven’t updated that chart, but the excess over “fundamental” paid by America in the current oil bubble, is more than they paid out (borrowed) in the last one.

So how about this one:

Looks suspiciously like the departure of oil prices over the fundamental correlates pretty well with a drop in nominal GDP growth in America. Make no mistake, it’s not “real-GDP” that matters in a time of deflation, it’s nominal, how much of the nominal is inflation is something to worry about later.

Watch out below like Err…looks suspiciously like mastitis here we come!

By Andrew Butter

Twenty years doing market analysis and valuations for investors in the Middle East, USA, and Europe; currently writing a book about BubbleOmics. Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2011 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Andrew Butter Archive

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Catching a Falling Financial Knife