Sunday, January 15, 2006

As the Global Economy Crumbles (Part II)

Since I wrote Part I, the price of gold has continued to reach new highs - surpassing US$545 to break 25 year records. Such rapid appreciation of this commodity is quite unusual to say the least, but it seems that we are in unusual times (or "interesting" as the Chinese might call them!).

There has been much financial chatter in the last quarter over the cooling of the housing market. , along with while Wall Street bonuses soar ever higher:
Wall Street bonuses will set a new record of $21.5 billion in 2005, surpassing the previous record of $19.5 billion set in 2000 during the peak of the last bull market, according to a forecast released today by State Comptroller Alan G. Hevesi. This translates into average bonuses of $125,500 — also a new record. …

After a disappointing first half, profits for member firms of the New York Stock Exchange improved during the third quarter and industry reports suggest an even stronger fourth quarter. Although 2005 profits could be less than last year's level, many bonuses are tied to industry revenues, which have been exceptionally strong this year. Profits have been held down by rising interest rates, which increased the cost of doing business.

Revenues at Wall Street firms grew by 44.5 percent through the first three quarters of 2005 — reaching the highest level since the stock market peaked in 2000. Merger and acquisition activity account for most of the surge in revenues, which is expected to be up 28 percent over last year's level and to exceed $1 trillion for the first time since 2000. Given the surge in merger and acquisition activity, investment bankers received the largest increases and bonuses just like last year.

One out of every 53 households in the United States filed for bankruptcy protection in 2005. That's the headline on this CNN story, released the same day as Hevesi's statement on the bonuses.

Bankruptcy filings soared 31.6 percent in 2005. Luckily for the ruling class, new laws will severely curb that number, because it now is harder for ordinary Americans to file Chapter 7 proceedings to get a "fresh start."


Corporate America, of course, continues to take advantage of generous bankruptcy laws. Halliburton, for example, took various thriving and profitable units through bankruptcy court to rid itself of asbestos-litigation burdens. And as I just pointed out last week, vultures like Sago coal mine owner Wilbur Ross love to take companies into bankruptcy to escape having to pay for workers' pensions and health-care benefits.
Despite these ever-vastening profits for the megacorporations, it could be quite significant that UK business leadership predicts 2006 will be a year of economic pain:
In the survey of more than 100 FTSE top executives, MORI found that two thirds, 66 per cent, expect the economy to worsen in 2006, while only one in 25, 4 per cent, believe it will improve.

With analysts expecting rampant US growth to stutter in 2006, little sign of a recovery in the eurozone, and consumer spending at home still under pressure from rising taxes, businesses have plenty of reasons to be nervous about the year ahead.

Despite their pessimism about the general outlook, most senior executives expect their own company to be able to ride the storm in 2006. More than half - 57 per cent - thought business would improve over the next year, while only 11 per cent expected things to get worse.

Larger firms were particularly negative about the future, as were those based outside the capital. Perhaps surprisingly, bankers and financial services executives were generally as depressed about their fortunes as others, despite a bumper 2005, with a rash of deals that have put City staff in line for the most lavish bonus season since the boom years of the late Nineties. [...]

In his pre-Budget statement last month, when he admitted that his forecasts for 2005 were badly awry, the Chancellor blamed record oil prices for the consumer spending squeeze, which dragged growth to its weakest rate since the early Nineties recession.

But when business leaders were asked about the biggest problem for their businesses, it was red tape that came top of most of the lists. Three in 10 executives cited legislation, regulation or bureaucracy as a problem - almost twice as many as mentioned the next most bothersome issue, the general economic climate.

The Treasury has promised a bonfire of regulation, but business leaders do not seem to be feeling the benefits. The chairman of one major international bank complained of 'regulation, political interference and lack of qualified people'.

The chairman of a major property developer singled out the much-criticised planning regime, saying 'securing planning permissions is becoming more tortuous', and adding 'there is more interference and it is taking longer and even when we are assessing a site it is very difficult to be able to establish what the conditions, and therefore the costs, of the planning would be.' Smaller firms were the most likely to complain about regulation.

The economic climate worried 17 per cent of executives, with the chairman of a leading mining and natural resources company citing 'uncertainty in the pattern of economic development in China', as a concern.

Another troubling issue, reported by 16 per cent, was the skills shortage: 'Lack of workforce, labour costs,' was mentioned by the CEO of one retail property company, while the head of a chemical firm blamed 'energy prices, economics, pensions and the continuing malaise in the manufacturing industry'.

Manufacturing suffered in 2005 as demand from the eurozone economies remained weak, and high-energy prices took their toll. By the end of October, manufacturing output was no higher than it was in 2002.
Note the comment about manufacturing suffering due to demand from Eurozone economies remaining weak. I am skeptical of this being the real reason, as the key factor in the decline of the manufacturing sector in the US economy - the "model" that other first-world countries have been trying to emulate - has been the outsourcing of manufacturing to countries like China, which have an abundant supply of cheap labor. I find this a more realistic reason, given the tight business cultural relationships between the US and UK.

The comment also brings another key economic factor into focus - consumer spending. An article entitled "Time to Pay the Bill" in the Guardian discusses the ongoing splurge in debt-driven lifestyle in the UK:
The dynamics of Britain's consumer-driven economy are similar to Johnny Sixpack's. As we manufacture less at home but still want the glitter and glamour of consumerism, we have taken to debt as the natural way to finance our spending addiction. Total borrowing in Britain topped £1 trillion last year, just a bit under £5,000 for every man, woman and child in the country.

Now, five grand may not seem a big sum, and most of us would be able to handle that amount of indebtedness, but look at it a different way. Personal debt per household has soared over the past 20 years, from around 80 per cent of household income to the present level of 150 per cent. It has been rising throughout the 21st century as banks have been aggressively pushing their financial products, mainly credit cards and loans. We have been only too ready to take up their generous offers.

Increasingly, some people have been unable to handle it. In the coming year, there will be something like 20,000 personal insolvencies, the highest number since records began in the 1960s. It used to be that insolvency followed on from the failure of a family business venture, but these days, it is increasingly high levels of personal indebtedness that triggers the plug-pulling.


This government has rightly, I would say, taken much of the shame out of bankruptcy, on the grounds that risk-taking entrepreneurs would be deterred from starting up wealth-creating businesses if they were faced with the life-long shame of Carey Street.

But the intention of that was certainly not to allow people to build up huge levels of personal debts, on which they could then renege in a relatively painless bankruptcy.

There is much muttering among the big banks which provide all this credit that guidelines will have to be tightened to prevent this spiral getting out of control, but in many cases it is too late. Consumer organisations regularly see individuals with £100,000 of personal debt through loans and credit cards, with one case involving a couple who had built up £350,000 in plastic debt.

The future is certainly not all doom and gloom, though. There is a great comfort factor at work in the form of bricks and mortar. The reason so many people feel sanguine about running up huge bills on their flexible friends is because so many of have substantial capital, acting as security, in the form of their homes.

Property prices have enjoyed years of steady growth, and if they are now on some kind of plateau for the foreseeable future, as most experts agree, it is nowhere near the negative-equity days of the last serious recession in the early Nineties.

So should we be worried? The problem is the sheer interdependency of the modern consumer economy. Growth is dependent as never before on our willingness to go to the shops and spend, which, in turn, is reliant on the feelgood factor of historically high property prices. High levels of disposable income - or credit - keep the economic wheels turning, but what happens when one of them falls off?

This is the background against which to see the full import of November's solemn pre-budget review. Chancellor Gordon Brown was forced to admit that he had got the sums wrong on growth, and that the economy would have to make do with less than 2 per cent annual growth, rather than the 3 per cent plus that he had hitherto been expecting. It was a chilling admission, but we will only see how chilling in 2006. [...]
Yes indeedy, property prices have enjoyed steady growth - the UK has a housing "bubble" similar to the one in the US. It's not all bad news for the British though, with BP making record profits despite hurricanes. Gee, those oil companies never seem to have a bad year, do they?

Moving back to the USA, it seems that despite the record levels of corporate profit, government spending continues unabated, with the US Treasury Secretary warning Congress to raise the debt ceiling 'or else':
WASHINGTON — Treasury Secretary John Snow said yesterday the United States could face the prospect of not being able to pay its bills early next year unless Congress raises the government’s borrowing authority, now capped at $8.18 trillion.

Snow, in a letter to lawmakers, estimated that the government is expected to bump into the statutory debt limit around the middle of February.

“At that time, unless the debt limit is raised or the Treasury Department takes authorized extraordinary actions, we will be unable to continue to finance government operations,” Snow wrote.
Anyone who has been observing US government spending over the years of the Bush administration will not be too surprised at the above article, nor will they be surprised when Congress vote to either raise it once more, or to do away with it altogether and sail the USA into an economic "perfect storm" at full steam ahead.

Australia looks set for hard economic times as well; Bill Buckler at The Privateer reveals some of the hard facts regarding this. The following is a small quote from his newsletter - well worth the subscription fee for those interested in real economic news:
AMONGST THE POPPING CORKS - THE COMMODITY CYCLE POPS TOO
First came the sudden break in the bulk carrier freight rates late last year. Orders from China for world raw resources, though still very high, suddenly decelerated. Ocean freight rates were first to get hit.

Next, and this is happening now, came the hard falls in world coal prices, as China lowered its orders for the raw material that makes electricity and steel. The result has surfaced in the recently completed coal price talks in China, where Australian coal producers have accepted prices for semi-soft coking coal of $US 50-55 per tonne. That is a drastic fall from last year's $US 75-80 a tonne. Rest assured the Aussie coal producers tried to get all that they could, but they did not get anywhere near last year's prices. Thermal coal itself now commands prices of about $US 44 per tonne delivered free on board (FOB) from Aussie ports. Back in June 2004, the price was $US 63 per tonne.

After The Commodity Cycle Comes The Business Cycle:

In any business cycle upswing caused by a credit expansion, first comes the start of the business cycle as businesses respond to the increases in demand for their products, even if only with borrowed money. Businesses start calling for more resources of all kinds. Next, as all the supply chains of such commodities get pulled tighter, comes the upswing in commodity prices. Last comes a sudden spike and surge in bulk carrier ocean freight rates. That's the top of the cycle, already behind us. All global ocean freight rates have now done steep dives. And now, here come the breaks in the basic commodity prices.

The global businesses cycle, with some nations in front of the curve and others lagging behind, starts to go down next. In Australia, we will see that happening around mid 2006. That's when the lower global prices will start hitting local coal and other resource producers. That, in turn, will have effects in the Aussie national economy beginning about mid-2006 and affect general business in late 2006.
Some of the bigger investment names are also warning of problems to the global economy - for instance, George Soros predicts recession in 2007. It never hurts to keep an eye on what the big boys of finance are saying and (especially) doing.

One final thing that I want to make special mention of is that the US is going to discontinue reporting the M3 money statistic on March 23, 2006. Curiously enough, this coincides very closely with Iran's start-up of an oil trading market denominated in Euros (on March 30). This means that the nations of the world will then no longer have to purchase US dollars in order to buy oil. An excellent short article (with plenty of charts) by Robert McHugh outlines the possible impact on the US dollar, and where the M3 statistic figures into this.

Of course, Iran is upsetting the US in more ways than the purely economic at the moment, and some are hinting at ominous preparations being made for war. Let's just hope the "Ides of March" remain purely a figure of speech this year...

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