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With Spanish sovereign bond yields hitting record lows – marginally above those of the US – one might be surprised to learn that unemployment is at record highs, suicide rates are at record highs, youth joblessness is at record highs, and now, to top it all off, Spanish bad loans are at record highs once again (at 13.6% of all loans). Of course, not deterred by the uncomfortable reality, Economy Minister Guindos is out in full propaganda mode:
- *GUINDOS SAYS BAD LOANS RATIO SEEN MODERATING IN NEXT QTRS
However, given the 17.7% rise in the last 12 months – the most in a year – we are struggling to see signs of the turning point he is so confident of.
The data – Guidos argues – reflects “recognition of reality” in what seems like an admission that all the spin and hoopla about marginal improvements til now have been based on entirely unreal data…
Did Spanish banks kitchen sink it? We highly doubt it as unemployment levels strongly suggest the worst is yet to come.
Submitted by James Stafford via OilPrice.com,
The potential for a golden age of gas comes along with a big “if” regarding environmental and social impact. The International Energy Agency (IEA)—the “global energy authority”–believes that this age of gas can be golden, and that unconventional gas can be produced in an environmentally acceptable way.
In an exclusive interview with Oilprice.com, IEA Executive Director Maria van der Hoeven, discusses:
- The potential for a golden age of gas
- What will the “age” means for renewables
- What it means for humanity
- The challenges of renewable investment and technology
- How the US shale boom is reshaping the global economy
- Nuclear’s contribution to energy security
- What is holding back Europe’s energy markets
- The next big shale venues beyond 2020
- The reality behind “fire ice”
- Condensate and the crude export ban
- The most critical energy issue facing the world today
Interview by. James Stafford of Oilprice.com
Oilprice.com: In 2011, the IEA predicted what it called “the golden age of gas,” with gas production rising 50% over the next 25 years. What does this “golden age” mean for coal, oil and nuclear energy—and for renewables? What does it mean for humanity in terms of carbon emissions? Is the natural gas boom lessening the sense of urgency to work towards renewable energy solutions?
IEA: We didn’t predict a golden age of gas in 2011, we merely asked a pertinent question: namely, are we entering a golden age of gas? And we found that the potential for such a golden age certainly exists, especially given the scale of unconventional gas resources and the advances in technology that allow their extraction. But the potential for a golden age of gas hinges on a big “if,” and we elaborated on this in 2012 in a report called “Golden Rules for a Golden Age of Gas”. Exploiting the world’s vast resources of unconventional natural gas holds the key to golden age of gas, we said, but for that to happen, governments, industry and other stakeholders must work together to address legitimate public concerns about the associated environmental and social impacts. Fortunately, we believe that unconventional gas can be produced in an environmentally acceptable way.
Under the central scenario of the World Energy Outlook-2013, natural gas production rises to 4.98 trillion cubic metres (tcm) in 2035, up nearly 50 percent from 3.38 tcm in 2011. But we have always said that a golden age of gas does not necessarily imply a golden age for humanity, or for our climate. An expansion of gas use alone is no panacea for climate change. While natural gas is the cleanest fossil fuel, it is still a fossil fuel. As we have seen in the United States, the drastic increase in shale gas production has caused coal’s share of electricity generation to slide. Of course, there is also the possibility that increased use of gas could muscle out low-carbon fuels, such as renewables and nuclear, from the energy mix.
OP: When will we see “the golden age of renewables”?
IEA: Although we have not yet predicted a “golden age” of renewables, the current, rapid growth of renewable power is a bright spot in an otherwise bleak picture of global progress towards a cleaner and more diversified energy mix. Still, the investment case for capital-intensive, low carbon power technologies carries challenges. We need to distinguish between two situations:
• In emerging economies, renewable power often provides a cost-competitive alternative to new fossil based generation and are perceived as part of the solution to questions of energy supply, diversification, and economic development. In China, for example, efforts to reduce local pollution are stimulating major investments in cleaner energy.
• By contrast, in stable systems with sluggish demand, no technology is competitive with marginal electricity prices, due to overcapacity. Governments are nervous about increasing investment in low-carbon options which impact on consumer prices, and this is causing policy uncertainty. But long term energy security and environmental goals need to be kept in mind.
The overall outlook for renewable electricity remains positive, even as the outlook can vary strongly by market and region. However, the electricity sector comprises less than 20% of total final energy consumption. The growth of renewables in other sectors such as transport and heat has been more sluggish. For a golden age of renewables to materialise, greater progress is needed in these areas, for example, with the development of advanced biofuels and more policy frameworks for renewable heat.
OP: How is the shale boom reshaping the global financial and economic system? Who are the winners and losers in this emerging scenario?
IEA: One of the key messages of our World Energy Outlook-2013 is that lower energy prices in the United States mean that it is well-placed to reap an economic advantage, while higher costs for energy-intensive industries in Europe and Japan are set to be a heavy burden.
Natural gas prices have fallen sharply in the United States – mainly as a result of the shale gas boom – and today they are about three times lower than in Europe and five times lower than in Japan. Electricity price differentials are also large, with Japanese and European industrial consumers paying on average more than twice as much for electricity as their counterparts in the United States, and even Chinese industry paying almost double the US level.
Looking to the future, the WEO found that the United States sees its share of global exports of energy-intensive goods slightly increase to 2035, providing the clearest indication of the link between relatively low energy prices and the industrial outlook. By contrast, the European Union and Japan see their share of global exports decline – a combined loss of around one-third of their current share.
OP: The IEA has noted that the US is no longer so dependent on Canadian oil and gas. What could this mean for pending approval of TransCanada’s Keystone XL pipeline? How important is Keystone XL to the US as opposed to its importance for Canada?
IEA: The decision on the Keystone matter is one that must be taken by the United States Government. I am afraid it is not for the IEA to comment.
OP: With the nuclear issue taking center stage in Japan’s election atmosphere, is Japan ready to pull the plug entirely on nuclear, or is it too soon for that?
IEA: This year’s World Energy Outlook, which we will release in November 2014, will carry a special focus on nuclear energy, so please stay tuned. While I won’t discuss what Japan should do, I will say that every country has a sovereign right to decide on the role of nuclear power in its energy mix. Nevertheless, nuclear is one of the world’s largest sources of low-carbon energy, and as such, it has made and should continue to make an important contribution to energy security and sustainability.
A country’s decision to cut the share of nuclear in its energy mix could open up new opportunities for renewables, particularly as some phase-out plans envision the replacement of nuclear capacity largely with renewable energy sources. However, such a decision would also likely lead to higher demand for gas and coal, higher electricity prices, increased import dependency on fossil fuels and electricity, and a more difficult path towards decarbonisation. Such a scenario would therefore make it much more difficult for the world to meet the 2°C climate stabilisation goal, and have potentially negative impacts on energy security.
OP: What is the key factor holding back European energy markets?
IEA: Europe has quite a few advantages but also many hurdles to overcome. If I had to pick one key factor that is holding back European energy markets, I would say it is the lack of cross-border interconnections. Let me explain what I mean. As we showed in WEO 2013, Europe’s competitiveness is under pressure, as energy price differences grow between Europe and its major trading partners – the US, China and Russia. High oil and gas import prices combined with low gas and electricity demand, following the recession, are impacting European economies.
Europe should accelerate the use of its indigenous potential and reap the social and economic benefits from energy efficiency, renewable energies and unconventional oil and gas. In open economies, there are significant advantages to be gained from free trade and a large energy market. One example: Today, we cannot make use of competitive electricity prices across the EU, as physical trade barriers exist and markets remain national. Europe is failing to achieve its potential. The electricity grid and system integration is very low, which also serves as a barrier to the full and efficient exploitation of renewable energy potentials. This is why addressing the issue of cross-border interconnections is so important.
OP: Where do you foresee the next “shale boom”?
IEA: According to WEO projections, there will be little non-North American shale development before 2020 due to the much earlier stage of exploration and the time needed to build up the oil field service value chain. Beyond 2020, we project large-scale shale gas production in China, Argentina, Australia as well as significant light tight oil production in Russia. The current reform proposals in Mexico have the potential to put Mexico on the top of that list as well, but they need to be properly implemented.
OP: What is the realistic future of methane hydrates, or “fire ice”?
IEA: Methane hydrates may offer a means of further increasing the supply of natural gas. However, producing gas from methane hydrates poses huge technological challenges, and the relevant extraction technology is in its infancy. Both in Canada and Japan the first test drillings have taken place, and the Japanese government is aiming to achieve commercial production in 10 to 15 years.
One thing I always mention when I am asked about methane hydrates is this: It may seem far off and uncertain, but keep in mind that shale gas was in the same position 10 to 15 years ago. So we cannot rule out that new energy revolutions may take place through technological developments and price incentives.
OP: Have we hit the “crude wall” in the US, the point at which oil production growth may end up slowing due to infrastructure and regulatory constraints?
IEA: In January 2013, the IEA’s Oil Market Report examined the possibility that as surging production continues to move the US closer to becoming a net oil exporter, there may come a time when various regulations, particularly the US ban on exports of crude oil to countries other than Canada, could have an adverse impact on continued investment in LTO – and thus continued growth in production. We called this point the “crude wall”.
A year later, in our January 2014 Oil Market Report, we noted that with US crude oil production exceeding even the boldest of expectations in 2013 by a wide margin, the crude wall now seems to be looming larger than ever. Having said that, challenges to US production growth are not imminent. Potential US growth in 2014 seems a given, even against the backdrop of resurgent non-OPEC supply growth outside North America.
OP: How is this shaping the crude export debate and where do you foresee this debate leading by the end of this year?
IEA: You are better off asking my friends and colleagues in Washington! This is obviously a sensitive topic. Different people feel differently about it, often very strongly. Oil policy always is the product of multiple, sometimes-competing considerations.
OP: What would lifting the ban on crude exports mean for US refiners, and for the US economy?
IEA: Many refiners and other major oil consumers have said they support keeping the ban amid worries that allowing exports would result in higher feedstock costs and erode their competitive advantage, or shift value-added industry abroad. On the other hand, oil producers have in general come out in favour of lifting the ban, arguing that the “crude wall” may become so large that it cannot be overcome; they see the possibility of a glut causing prices to slump and thereby choking off production. We have not produced any detailed analysis on the economic impact of lifting the ban, so I cannot comment on that part of your question.
OP: Are there any other ways around the “crude wall” aside from lifting the export ban?
IEA: As we wrote in our January 2014 Oil Market Report, much of the LTO is produced in the form of lease condensate, which is most optimally processed in a condensate splitter. There is currently only one such facility in the United States, although at least five others are in various stages of planning and construction.
I mention this issue because one could imagine a scenario under which lease condensate is excluded from the crude export restriction. The US Department of Commerce, which enforces the export ban, includes lease condensates in the definition of crude oil. However, this definition could be changed, or the Commerce Department could simply issue lease condensate export licenses at the behest of the President.
OP: How will the six-month agreement to ease sanctions on Iran affect Iranian oil production? And if international sanctions are indeed lifted after this “trial period”, how long will it take Iran to affect a real increase in production?
IEA: The deal between P5+1 and Iran doesn’t change the oil sanctions themselves. The oil sanctions remain fully in place though the P5+1 agreed not to tighten them further. Relaxing insurance sanctions doesn’t mean more oil in the market.
As for the second part of your question, I am afraid I can’t answer hypotheticals and what-ifs.
OP: What is the single most critical energy issue in the US this year?
IEA: I think that if you take the view that the energy-policy decisions you make now have ramifications for many decades to come, and if you believe what scientists tell us about the climate consequences of our energy consumption, then the single most critical energy issue in the US is the same issue for every country: what are you going to do with your energy policy to mitigate the risk of climate change? Energy is responsible for two-thirds of greenhouse-gas emissions, and right now these emissions are on track to cause global temperatures to rise between 3.6 degrees C and 5.3 degrees C. If we stay on our present emissions pathway, we are not going to come close to achieving the globally agreed target of limiting the rise in temperatures to 2 degrees C; we are instead going to have a catastrophe. So energy clearly has to be part of the climate solution – both in the short- and long-term.
OP: What is the IEA’s role in shaping critical energy issues globally and how can its influence be described, politically and intellectually?
IEA: Founded in response to the 1973/4 oil crisis, the IEA was initially meant to help countries co-ordinate a collective response to major disruptions in oil supply through the release of emergency oil stocks to the markets.
While this continues to be a key aspect of our work, the IEA has evolved and expanded over the last 40 years. I like to think of the IEA today as the global energy authority. We are at the heart of global dialogue on energy, providing authoritative statistics, analysis and recommendations. This applies both to our member countries as well as to the key emerging economies that are driving most of the growth in energy demand – and with whom we cooperate on an increasingly active basis.
A few short months after Putin cornered the US state department into a disastrous foreign relations dead end with the false flag Syrian escalation which achieved none of the predetermined nat-gas-to-Europe pipeline ambitions, instead alieanting the US from both staunch allies Saudi Arabia and Israel, the Russian president has just managed to inflict yet more pain on US foreign policy this time by infuriating (even more) a core US ally in Europe – Angela Merkel. Just two days after the phone recording of Victoria Nuland emerged in which she not only made it explicitly clear it was the US who was the puppetmaster behind the Ukranian opposition with the traditional CIA tractics as was expected all along, but also explained just how the US freels toward the EU with the now infamous “Fuck the EU” comment, Angela Merkel called the obscene remark “absolutely unacceptable.”
And then, Nuland not knowing when to stop, proceeded to insert foot in mouth just a little deeper: “”I am not going to comment on private diplomatic conversations. But it was pretty impressive tradecraft. The audio was extremely clear,” she told reporters during a visit to Kiev.”
At least she indirectly complemented Putin on being smart enough to not only intercept what appears to have been an unencrypted phone call, but to release it at just the right time as the entire world’s attention turns to Russia and by extension, the Ukraine.
Because in retrospect Putin does deserve praise: having won the Ukraine over Europe’s cries of horror, he has also managed, in the past year, to alienate the US from Israel, Saudi Arabia and now, Germany. And all this without saying a single word, let along firing a shot.
So now that we know the apriori winner, the loser has no choice but to engage major damage control, which is borderline delusional. From Reuters:
[Nuland] said she did not foresee damage to relations with opposition leaders, saying they “know exactly where we stand in respect of a non-violent solution to the problem.”
Of relations with Russia, she said Washington and Moscow had “very deep, very broad and complex” discussions on a range of international issues including Iran and “frank and comradely discussions” on Ukraine.
U.S. officials did not deny the authenticity of the recording and said Nuland apologized to EU colleagues for the comment.
Angela Merkel, already furious with Washington for several months over reports that U.S. officials bugged her own phone, found Nuland’s remarks “totally unacceptable”, a spokeswoman for the German chancellor said.
Yet, it’s one thing to delude oneself that the US is still the undisputed world’s superpower, it is far worse to express the kind of hubris that Nuland did, when she communicated and discussedconfidential US geopolitical strategy on an unencrypted phone line – traditionally a fireable offense, if not worse.
In Washington, U.S. officials said Nuland and Pyatt apparently used unencrypted cellphones, which are easy to monitor. The officials said smart phones issued to State Department officials had data encryption but not voice encryption.
In Nuland’s call, apparently recorded about 12 days ago when Ukrainian opposition leaders were considering an offer from Yanukovich to join his cabinet, she suggested that one of three leading figures might accept a post but two others should stay out. In the end, all three rejected the offer.
The biggest loser here, however, continues to be the Ukraine, whose people are facing a cold winter without assurances they will have Russian nat gas, and a government that is a chess piece in an ongoing power play between Europe and Russia, now that the CIA has taken a back seat. Incidentally, Russia made it quite clear that it demands Ukraine’s full allegiance and as Russian finance minister Anton Siluanov told reporters overnight, Russia would withold its second loan payment to the troubled nation unless the Ukraine, which owes a “not insignificant” sum for natgas, makes the payment.
In other words, just like Greece has become a money “tolling” intermediary for the ECB and German banks, in which Europe pretends to bail out the crushed country when in reality it is just funding debt payments to its own banks, so the Ukraine has now become an intermediary, in which loan payments from Russia go to pay… Russia’s Gazprom. And in the process Russia pulls the Ukraine from the European sphere of influence and back into that of the New Normal USSR.
Game, set, match Putin. Again.
But wait, there’s more. Because Putin, unsatisfied with simple making a mockery of the US State Department, decided to rub it in some more. The Hill reports:
Rising animosity between the former Cold War powers was on full display Friday when Russia chose a former figure skater who tweeted out a racially charged picture of President Obama for the symbolic lighting of the Olympic cauldron.
Russian President Vladimir Putin hoped hosting the first Games since the 1980 Moscow Olympics, which the U.S. boycotted, would showcase a “new Russia” emerging from the ashes of the Soviet Union as he enters his 15th year in power.
Instead the U.S. and its western allies have consistently painted the picture of a corrupt autocracy.
The media’s focus on the persecution of gays in Russia, terrorism and Russia’s lackluster infrastructure – many hotels don’t have potable water even though the Games are estimated to have cost more than $50 billion, the most ever – have further infuriated the Kremlin.
“I understand how the press here works. They need hot issues in order to be read, to have high circulation,” Sergey Kislyak, Putin’s envoy to Washington, told The Washington Diplomat last month.
That’s ok – as long as the US population can keep itself distracted from the sheer implosion of US standing internationally by looking at tweeted images of decrepit toilets and busted Sochi plumbing from a self-indulgent US press corps, and continue feeling good about itself, then all is well. After all, that’s just what Putin wants.
In 1928, just as income inequality was surging, stocks were soaring and monetary distortions were rearing their ugly head, the now infamous words “a chicken in every pot and a car in every garage” were integral to Herbert Hoover’s 1928 presidential run and a “vote for prosperity,” all before the market’s epic collapse. Fast forward 86 years and income inequality is at those same heady levels, stocks are at recorderer highs, the President is promising to hike the minimum wage to a “living wage” capable of filling every house with McChicken sandwiches and now… to top it all off – Maserati unveils their (apparent) “everyone should own a Maserati” commercial. It would seem that chart analogs are not the only reminder of the pre-crash era exuberance and its recovery mirage and massive monetary distortions.
The last time the top 10% of the US income distribution had such a large proportion of the entire nation’s income was the 1920s – a period that culminated in the Great Depression and a collapse in that exuberance.
“Wealth effect” – check
“Today there is a tremendous amount of monetary distortion, on par with the 1929 stock market and certainly the peak of 2007, and many others,” warns Universa’s Mark Spitznagel.
and “a Maserati in every garage”
It’s a great looking car and emotionally imploring but… did they really just suggest (subliminally of course) that such luxury is to be had by all?
Perhaps a gentle reminder of the reality for 99.99% of Americans…compared to the Maserati buyer…
As Mark Spitznagel warned:
The reality is, when distortion is created, the only way out is to let the natural homeostasis take over. The purge that occurs after massive distortion is painful, but ultimately, it’s far better and healthier for the system.
While that may sound rather heartless, it’s actually the best and least destructive in the long run.
Look what happened in the 1930s, when the actions of the government prolonged what should have been a quick purge. Instead, the government prevented the natural rebuilding process from working, which made matters so much worse.
“The ‘Recovery’ Is A Mirage” Mark Spitznagel Warns, “With As Much Monetary Distortion As In 1929” | Zero Hedge
“Today there is a tremendous amount of monetary distortion, on par with the 1929 stock market and certainly the peak of 2007, and many others,” warns Universa’s Mark Spitznagel.
At these levels, he suggests (as The Dao of Capital author previously told Maria B, “subsequent large stock market losses and even crashes become perfectly expected events.”
Post-Bernanke it will be more of the same, he adds, and investors need to know how to navigate such a world full of “monetary distortions in the economy and the creation of malinvestments.” The reality is, Spitznagel concludes that the ‘recovery is a Fed distortion-driven mirage‘ and the only way out is to let the natural homeostasis take over – “the purge that occurs after massive distortion is painful, but ultimately, it’s far better and healthier for the system.”
Via Investments & Wealth Monitor:
On the “recovery” in the United States…
Spitznagel: The somewhat improved economic activity that we’re seeing is based on a mirage—that is, the illusion created by artificial zero-interest rates.
When central banks lower interest rates in hopes of stimulating the economy, that intervention is not the same as a natural move in interest rates.
A genuine drop in interest rates is in response to an increase in savings, as consumers defer consumption now in order to consume later. In a high-savings environment, entrepreneurs put their capital to work to become more roundabout,1 layering their tools and intermediate stages of production to become increasingly productive. The time to make these investments is when consumers are saving, so that entrepreneurs can be in an even better position to make the products that consumers want, when they want them.
In an artificial rate environment, however, that’s not what’s happening. Instead of consumers saving now to spend later, they are spending now.
But because interest rates are artificially lower, entrepreneurs are being fooled into investing in something now that they will have to back out of later—building up what the Austrians call “malinvestment.” Therefore, the illusion is unsustainable, by definition. The Fed can’t keep interest rates low forever.
From an investor perspective, people are trying to extract as much as they can right now. Consider the naïve dividend investment argument: “I can’t afford to be in cash right now.” Investment managers have to provide returns today.
Whenever investors sell a low dividend-paying stock to buy a higher-dividend stock, some piece of progress is sapped from our economy. (The cash needed to pay that higher dividend isn’t going to capital investment in the company.)
This is the exact opposite of entrepreneurial thinking that advances the economy. Consider the example of Henry Ford, who didn’t care about paying dividends today. He wanted to plow as much capital as possible back into making production more efficient for the benefit of the consumer who would pay less for a higher-quality product.
In summary, a major message of my recent book, The Dao of Capital, is recognizing the distortions that come from central bank intervention. Because of the Fed’s actions, interest rates are no longer a real piece of economic information. If you treat them like they are, you will simply do the wrong thing.
After all, when the government tries to manipulate things, the inverse of what was intended usually happens. On that point, history is entirely on my side.
On The Government & Federal Reserve’s “Interventions”…
Spitznagel: The reality is, when distortion is created, the only way out is to let the natural homeostasis take over. The purge that occurs after massive distortion is painful, but ultimately, it’s far better and healthier for the system. While that may sound rather heartless, it’s actually the best and least destructive in the long run.
Look what happened in the 1930s, when the actions of the government prolonged what should have been a quick purge. Instead, the government prevented the natural rebuilding process from working, which made matters so much worse.
I draw a parallel to forest wildfires. Fire suppression prevents small, naturally occurring wildfires from error-correcting the inappropriate growth, and thus prevents the system from seeking its natural homeostatic balance—its natural temporal structure of production, if you will. Instead, everything is allowed to grow at once, as if more resources exist than actually do, and the forest actually gradually consumes itself. When fire inevitably does break out, it is catastrophic. This is a perfect analogy for the market process. We simply do not understand the great homeostasis at work in markets that are allowed to correct their mistakes.
Suppression that makes the cure that much worse than the initial ill, until exponentially more damage is done, calls to mind the wry observation made by the great Austrian economist Ludwig von Mises: “If a man has been hurt by being run over by an automobile, it is no remedy to let the car go back over him in the [opposite] direction.”
As the Mises protégé Murray Rothbard would say, the catharsis needed to return to homeostatic balance “is the ‘recovery’ process,” and, “far from being an evil scourge, is the necessary and beneficial return” to healthier growth and “optimum efficiency.”
It is unfair to call the Austrians heartless because of these views. The Keynesians are the ones who got us into this mess in the first place—just like those who advocated for the suppression of natural forest fires are the ones who created the tinder box that puts the forest at risk.
On The Yellen Fed… (hint – no change)
Spitznagel: Post-Bernanke it will be more of the same. Therefore, investors need to know how to navigate a distorted world—and post-Bernanke the world is likely to get even more distorted—until the markets, ultimately and inevitably, flush out that distortion. This is why I rely on the Austrian school so much.
Austrian business cycle theory (ABCT) shows us what is really happening behind the curtain, so to speak, from monetary distortions in the economy and the creation of malinvestment. When the economy is subject to top-down intervention from the government and especially the central bank, investors need to read the signs in order to protect themselves—as well as still find a way to own productive assets.
People can avoid becoming trapped into chasing immediate returns along with the rest of the ill-fated crowd.
A far better approach is to wait for the return to homeostasis that will prevail even in the midst of pervasive distortion. In that way, investors can embrace roundabout investing by avoiding the distortion and, thus, have all the more resources later for opportunistic investing.
On investing (for retail inevstors)…
Another option for investors is a very simplistic, “mom-and-pop” strategy that starts with recognizing when you are in a distorted environment. For this I use what I call the Misesian stationarity index, which describes the amount of distortion in the economy.
This simple, back-of-the-envelope strategy would be to buy when the index is low and sell when it is high. In other words, people should stay out of the market when it is distorted and thus preserve their capital to deploy after the inevitable purge and correction, when productive assets become bargain-priced. Such an approach has resulted historically in an annualized 2-percent outperformance of stocks. Logically it makes sense, and when you look at it empirically, it’s incontrovertible.
Yet, admittedly, in the world of investing, sitting with one’s arms folded and not taking advantage of a rising market pumped up with distortion, is difficult—even though avoiding the enticement leads to better intermediate means for positional advantage to be exploited later.
It is difficult to do and may even feel anticlimactic. Nonetheless, the disciplined Misesian approach is healthier for one’s portfolio.
On the worst case scenario…
the Fed keeps winning and the illusion continues. The equity markets keep ripping along.
On extreme monetary distrortion and the Q-Ratio…
In simplest terms, the equity Q ratio is the total corporate equity in the United States divided by the replacement cost. Another way to think about it is the appraised value of existing capital in the United States divided by what it would cost to replace or accumulate all that capital.
This ratio has tremendous meaning from an Austrian standpoint, as it reflects what the markets are saying about the state of distortion in the economy.
This aptly illustrates Mises’s concept of “stationarity.” (In a stationary economy, in the aggregate, balance is achieved between the return and replacement costs.) The farther the ratio moves above “1,” the more monetary distortion there is in the economy. For this reason, and as a tip of the hat to the man who gave us the Austrian business cycle theory, I call this ratio the Misesian stationarity index, or MS index for short. When the MS index is high, subsequent large stock market losses and even crashes become perfectly expected events.
Today there is a tremendous amount of monetary distortion, on par with the 1929 stock market and certainly the peak of 2007, and many others (except the 2000 peak, which got a bit more ahead of itself). And all were caused by monetary distortion. As the Austrians show us, the business cycle is a Fed-induced phenomenon.
Submitted by Ben Hunt of Epsilon Theory
It Was Barzini All Along
Tattaglia is a pimp. He never could have outfought Santino. But I didn’t know until this day that it was Barzini all along.
— Don Vito Corleone
Like many in the investments business, I am a big fan of the Godfather movies, or at least those that don’t have Sofia Coppola in a supporting role. The strategic crux of the first movie is the realization by Don Corleone at a peace-making meeting of the Five Families that the garden variety gangland war he thought he was fighting with the Tattaglia Family was actually part of an existential war being waged by the nominal head of the Families, Don Barzini. Vito warns his son Michael, who becomes the new head of the Corleone Family, and the two of them plot a strategy of revenge and survival to be put into motion after Vito’s death. The movie concludes with Michael successfully murdering Barzini and his various supporters, a plot arc that depends entirely on Vito’s earlier recognition of the underlying cause of the Tattaglia conflict. Once Vito understood WHY Philip Tattaglia was coming after him, that he was just a stooge for Emilio Barzini, everything changed for the Corleone Family’s strategy.
Now imagine that Don Corleone wasn’t a gangster at all, but was a macro fund portfolio manager or, really, any investor or allocator who views the label of “Emerging Market” as a useful differentiation … maybe not as a separate asset class per se, but as a meaningful way of thinking about one broad set of securities versus another. With the expansion of investment options and liquid securities that reflect this differentiation — from Emerging Market ETF’s to Emerging Market mutual funds — anyone can be a macro investor today, and most of us are to some extent.
You might think that the ease with which anyone can be an Emerging Markets investor today would make the investment behavior around these securities more complex from a game theory perspective as more and more players enter the game, but actually just the opposite is true. The old Emerging Markets investment game had very high informational and institutional barriers to entry, which meant that the players relied heavily on their private information and relatively little on public signals and Common Knowledge. There may be far more players in the new Emerging Markets investment game, but they are essentially one type of player with a very heavy reliance on Common Knowledge and public Narratives. Also, these new players are not (necessarily) retail investors, but are (mostly) institutional investors that see Emerging Markets or sub-classifications of Emerging Markets as an asset class with certain attractive characteristics as part of a broad portfolio. Because these institutional investors have so much money that must be put to work and because their portfolio preference functions are so uniform, there is a very powerful and very predictable game dynamic in play here.
Since the 2008 Crisis the Corleone Family has had a pretty good run with their Emerging Markets investments, and even more importantly Vito believes that he understands WHY those investments have worked. In the words of Olivier Blanchard, Chief Economist for the IMF:
In emerging market countries by contrast, the crisis has not left lasting wounds. Their fiscal and financial positions were typically stronger to start, and adverse effects of the crisis have been more muted. High underlying growth and low interest rates are making fiscal adjustment much easier. Exports have largely recovered, and whatever shortfall in external demand they experienced has typically been made up through an increase in domestic demand. Capital outflows have turned into capital inflows, due to both better growth prospects and higher interest rates than in advanced countries. … The challenge for most emerging countries is quite different from that of advanced countries, namely how to avoid overheating in the face of closing output gaps and higher capital flows. — April 11, 2011
As late as January 23rd of this year, Blanchard wrote that “we forecast that both emerging market and developing economies will sustain strong growth“.
Now we all know what actually happened in 2013. Growth has been disappointing around the world, particularly in Emerging Markets, and most of these local stock and bond markets have been hit really hard. But if you’re Vito Corleone, macro investor extraordinaire, that’s not necessarily a terrible thing. Sure, you don’t like to see any of your investments go down, but Emerging Markets are notably volatile and maybe this is a great buying opportunity across the board. In fact, so long as the core growth STORY is intact, it almost certainly is a buying opportunity.
But then you wake up on July 9th to read in the WSJ that Olivier Blanchard has changed his tune. He now says “It’s clear that these countries [China, Russia, India, Brazil, South Africa] are not going to grow at the same rate as they did before the crisis.” Huh? Or rather, WTF? How did the Chief Economist of the IMF go from predicting “strong growth” to declaring that the party is over and the story has fundamentally changed in six months?
It’s important to point out that Blanchard is not some inconsequential opinion leader, but is one of the most influential economists in the world today. His position at the IMF is a temporary gig from his permanent position as the Robert M. Solow Professor of Economics at MIT, where he has taught since 1983. He also received his Ph.D. in economics from MIT (1977), where his fellow graduate students were Ben Bernanke (1979), Mario Draghi (1976), and Paul Krugman (1977), among other modern-day luminaries; Stanley Fischer, current Governor of the Bank of Israel, was the dissertation advisor for both Blanchard and Bernanke; Mervyn King and Larry Summers (and many, many more) were Blanchard’s contemporaries or colleagues at MIT at one point or another. The centrality of MIT to the core orthodoxy of modern economic theory in general and monetary policy in particular has been well documented by Jon Hilsenrath and others and it’s not a stretch to say that MIT provided a personal bond and a formative intellectual experience for a group of people that by and large rule the world today. Suffice it to say that Blanchard is smack in the middle of that orthodoxy and that group. I’m not saying that anything Blanchard says is amazingly influential in and of itself, certainly not to the degree of a Bernanke or a Draghi (or even a Krugman), but I believe it is highly representative of the shared beliefs and opinions that exist among these enormously influential policy makers and policy advisors. Two years ago the global economic intelligentsia believed that Emerging Markets had emerged from the 2008 crisis essentially unscathed, but today they believe that EM growth rates are permanently diminished from pre-crisis levels. That’s a big deal, and anyone who invests or allocates to “Emerging Markets” as a differentiated group of securities had better take notice.
Here’s what I think happened.
First, an error pattern has emerged over the past few years from global growth data and IMF prediction models that forced a re-evaluation of those models and the prevailing Narrative of “unscathed” Emerging Markets. Below is a chart showing actual Emerging Market growth rates for each year listed, as well as the IMF prediction at the mid-year mark within that year and the mid-year mark within the prior year (generating an 18-month forward estimate).
Pre-crisis the IMF systematically under-estimated growth in Emerging Markets. Post-crisis the IMF has systematically over-estimated growth in Emerging Markets. Now to be sure, this IMF over-estimation of growth exists for Developed Markets, too, but between the EuroZone sovereign debt crisis and the US fiscal cliff drama there’s a “reason” for the unexpected weakness in Developed Markets. There’s no obvious reason for the persistent Emerging Market weakness given the party line that “whatever shortfall in external demand they experienced has typically been made up through an increase in domestic demand.” Trust me, IMF economists know full well that their models under-estimated EM growth pre-crisis and have now flipped their bias to over-estimate growth today. Nothing freaks out a statistician more than this sort of flipped sign. It means that a set of historical correlations has “gone perverse” by remaining predictive, but in the opposite manner that it used to be predictive. This should never happen if your underlying theory of how the world works is correct. So now the IMF (and every other mainstream macroeconomic analysis effort in the world) has a big problem. They know that their models are perversely over-estimating growth, which given the current projections means that we’re probably looking at three straight years of sub-5% growth in Emerging Markets (!!) more than three years after the 2008 crisis ended, and — worse — they have no plausible explanation for what’s going on.
Fortunately for all concerned, a Narrative of Central Bank Omnipotence has emerged over the past nine months, where it has become Common Knowledge that US monetary policy is responsible for everything that happens in global markets, for good and for ill (see “How Gold Lost Its Luster”). This Narrative is incredibly useful to the Olivier Blanchard’s of the world, as it provides a STORY for why their prediction models have collapsed. And maybe it really does rescue their models. I have no idea. All I’m saying is that whether the Narrative is “true” or not, it will be adopted and proselytized by those whose interests — bureaucratic, economic, political, etc. — are served by that Narrative. That’s not evil, it’s just human nature.
Nor is the usefulness of the Narrative of Central Bank Omnipotence limited to IMF economists. To listen to Emerging Market central bankers at Jackson Hole two weeks ago or to Emerging Market politicians at the G-20 meeting last week you would think that a great revelation had been delivered from on high. Agustin Carstens, Mexico’s equivalent to Ben Bernanke, gave a speech on the “massive carry trade strategies” caused by ZIRP and pleaded for more Fed sensitivity to their capital flow risks. Interesting how the Fed is to blame now that the cash is flowing out, but it was Mexico’s wonderful growth profile to credit when the cash was flowing in. South Africa’s finance minister, Pravin Gordhan, gave an interview to the FT from Jackson Hole where he bemoaned the “inability to find coherent and cohesive responses across the globe to ensure that we reduce the volatility in currencies in particular, but also in sentiment” now that the Fed is talking about a Taper. Christine Lagarde got into the act, of course, calling on the world to build “further lines of defense” even as she noted that the IMF would (gulp) have to stand in the breach as the Fed left the field. To paraphrase Job: the Fed gave, and the Fed hath taken away; blessed be the name of the Fed.
The problem, though, is that once you embrace the Narrative of Central Bank Omnipotence to “explain” recent events, you can’t compartmentalize it there. If the pattern of post-crisis Emerging Market growth rates is largely explained by US monetary accommodation or lack thereof … well, the same must be true for pre-crisis Emerging Market growth rates. The inexorable conclusion is that Emerging Market growth rates are a function of Developed Market central bank liquidity measures and monetary policy, and that all Emerging Markets are, to one degree or another, Greece-like in their creation of unsustainable growth rates on the back of 20 years of The Great Moderation (as Bernanke referred to the decline in macroeconomic volatility from accommodative monetary policy) and the last 4 years of ZIRP. It was Barzini all along!
This shift in the Narrative around Emerging Markets — that the Fed is the “true” engine of global growth — is a new thing. As evidence of its novelty, I would point you to another bastion of modern economic orthodoxy, the National Bureau of Economic Research (NBER), in particular their repository of working papers. Pretty much every US economist of note in the past 40 years has published an NBER working paper, and I only say “pretty much every” because I want to be careful; my real estimate is that there are zero mainstream US economists who don’t have a working paper here.
If you search the NBER working paper database for “emerging market crises”, you see 16 papers. Again, the author list reads like a who’s who of famous economists: Martin Feldstein, Jeffrey Sachs, Rudi Dornbusch, Fredric Mishkin, Barry Eichengreen, Nouriel Roubini, etc. Of these 16 papers, only 2 — Frankel and Roubini (2001) and Arellano and Mendoza (2002) — even mention the words “Federal Reserve” in the context of an analysis of these crises, and in both cases the primary point is that some Emerging Market crises, like the 1998 Russian default, force the Fed to cut interest rates. They see a causal relationship here, but in the opposite direction of today’s Narrative! Now to be fair, several of the papers point to rising Developed Market interest rates as a “shock” or contributing factor to Emerging Market crises, and Eichengreen and Rose (1998) make this their central claim. But even here the argument is that “a one percent increase in Northern interest rates is associated with an increase in the probability of Southern banking crises of around three percent” … not exactly an earth-shattering causal relationship. More fundamentally, none of these authors ever raise the possibility that low Developed Market interest rates are the core engine of Emerging Market growth rates. It’s just not even contemplated as an explanation.
Today, though, this new Narrative is everywhere. It pervades both the popular media and the academic “media”, such as the prominent Jackson Hole paper by Helene Rey of the London Business School, where the nutshell argument is that global financial cycles are creatures of Fed policy … period, end of story. Not only is every other country just along for the ride, but Emerging Markets are kidding themselves if they think that their plight matters one whit to the US and the Fed.
Market participants today see Barzini/Bernanke everywhere, behind every news announcement and every market tick. They may be right. They may be reading the situation as smartly as Vito Corleone did. I doubt it, but it really doesn’t matter. Whether or not I privately believe that Barzini/Bernanke is behind everything that happens in the world, I am constantly told that this is WHY market events happen the way they do. And because I know that everyone else is seeing the same media explanations of WHY that I am seeing … because I know that everyone else is going through the same tortured decision process that I’m going through … because I know that everyone else is thinking about me in the same way that I am thinking about them … because I know that if everyone else acts as if he or she believes the Narrative then I should act as if I believe the Narrative … then the only rational conclusion is that I should act as if I believe it. That’s the Common Knowledge game in action. This is what people mean when they say that a market behavior of any sort “takes on a life of its own.”
For the short term, at least, the smart play is probably just to go along with the Barzini/Bernanke Narrative, just like the Corleone family went along with the idea that Barzini was running them out of New York (and yes, I understand that at this point I’m probably taking this Godfather analogy too far). By going along I mean thinking of the current market dynamic in terms of risk management, understanding that the overall information structure of this market is remarkably unstable. Risk-On / Risk-Off behavior is likely to increase significantly in the months ahead, and there’s really no predicting when Bernanke will open his mouth or what he’ll say, or who will be appointed to take his place, or what he or she will say. It’s hard to justify any large exposure to public securities in this environment, long or short, because all public securities will be dominated by this Narrative so long as everyone thinks that everyone thinks they will be dominated. This the sort of game can go on for a long time, particularly when the Narrative serves the interests of incredibly powerful institutions around the world.
But what ultimately saved the Corleone family wasn’t just the observation of Barzini’s underlying causal influence, it was the strategy that adjusted to the new reality of WHY. What’s necessary here is not just a gnashing of teeth or tsk-tsk’ing about how awful it is that monetary policy has achieved such behavioral dominance over markets, but a recognition that it IS, that there are investment opportunities created by its existence, and that the greatest danger is to continue on as if nothing has changed.
I believe that there are two important investment implications that stem from this sea change in the Narrative around Emerging Markets, which I’ll introduce today and develop at length in subsequent notes.
First, I think it’s necessary for active investors to recalibrate their analysis towards individual securities that happen to be found in Emerging Markets, not aggregations of securities with an “Emerging Markets” label. I say this because in the aggregate, Emerging Market securities (ETF’s, broad-based funds, etc.) are now the equivalent of a growth stock with a broken story, and that’s a very difficult row to hoe. Take note, though, the language you will have to speak in this analytic recalibration of Emerging Market securities is Value, not Growth, and the critical attribute of a successful investment will have little to do with the security’s inherent qualities (particularly growth qualities) but a great deal to do with whether a critical mass of Value-speaking investors take an interest in the security.
Second, there’s a Big Trade here related to the predictable behaviors and preference functions of the giant institutional investors or advisors that — by size and by strategy — are locked into a perception of Emerging Market meaning that can only be expressed through aggregations of securities or related fungible asset classes (foreign exchange and commodities). These mega-allocators do not “see” Emerging Markets as an opportunity set of individual securities, but as an asset class with useful diversification qualities within an overall portfolio. So long as market behaviors around Emerging Markets in the aggregate are driven by the Barzini/Bernanke Narrative, that diversification quality will decline, as the same Fed-speak engine is driving behaviors in both Emerging Markets and Developed Markets. Mega-allocators care more about diversification and correlations than they do about price, which means that the selling pressure will continue/increase so long as the old models aren’t working and the Barzini/Bernanke Narrative diminishes what made Emerging Markets as an asset class useful to these institutions in the first place. But when that selling pressure dissipates — either because the Barzini/Bernanke Narrative wanes or the mega-portfolios are balanced for the new correlation models that take the Barzini/Bernanke market effect into account — that’s when Emerging Market securities in the aggregate will work again. You will never identify that turning point in Emerging Market security prices by staring at a price chart. To use a poker analogy you must play the player — in this case the mega-allocators who care a lot about correlation and little about price — not the cards in order to know when to place a big bet.
In future weeks I’ll be expanding on each of these investment themes, as well as taking them into the realm of foreign exchange and commodities. Also, there’s a lot still to be said about Fed communication policy and the Frankenstein’s Monster it has become. I hope you will join me for the journey, and if you’d like to be on the direct distribution list for these free weekly notes please sign up at Follow Epsilon Theory.
Before the “shale revolution” many considered that the biggest gating factor for US economic growth is access to cheap, abundant energy abroad – indeed, US foreign policy around the world and especially in oil rich regions was largely dictated by the simple prerogative of acquiring and securing oil exposure from “friendly” regimes. And while domestic US crude production has soared in recent years, making US reliance on foreign sources a secondary issue (yes, the US is still a major net importer of crude) at least as long as the existing stores of oil at domestic shale sites are not depleted, marginal energy watchers have shifted their attention elsewhere, namely China.
Recall that as we reported in October, a historic event took place late in the year, when China (with 6.3MMbpd) officially surpassed the US (at 6.24MMbpd) as the world’s largest importer of oil. China’s reliance on imports is likely only to grow: “In 2011, China imported approximately 58 percent of its oil; conservative estimates project that China will import almost two-thirds of its oil by 2015 and three-quarters by 2030.”
Which means that the question that most were focused on before, i.e., where the US gets its oil, and what is the US energy strategy, refocuses to China.
We have some answers.
The graphic below summarizes all the known Chinese energy import transit routes.
Some additional color from the 2013 Annual Report to Congress on all key developments relating to China:
China’s Energy Strategy
China’s engagement, investment, and foreign construction related to energy continue to grow. China has constructed or invested in energy projects in more than 50 countries, spanning nearly every continent. This ambitious investment in energy assets is driven primarily by two factors. First, China is increasingly dependent upon imported energy to sustain its economy. A net oil exporter until 1993, China remains suspicious of international energy markets. Second, energy projects present a viable option for investing China’s vast foreign currency holdings.
In addition to ensuring reliable energy sources, Beijing hopes to diversify producers and transport options. Although energy independence is no longer realistic for China, given population growth and increasing per capita energy consumption, Beijing still seeks to maintain a supply chain that is less susceptible to external disruption.
In 2011, China imported approximately 58 percent of its oil; conservative estimates project that China will import almost two-thirds of its oil by 2015 and three-quarters by 2030. Beijing looks primarily to the Persian Gulf, Africa, and Russia/Central Asia to satisfy its growing demand, with imported oil accounting for approximately 11 percent of China’s total energy consumption.
A second goal of Beijing’s foreign energy strategy is to alleviate China’s heavy dependence on SLOCs, particularly the South China Sea and the Strait of Malacca. In 2011, approximately 85 percent of China’s oil imports transited the South China Sea and the Strait of Malacca. Separate crude oil pipelines from Russia and Kazakhstan to China illustrate efforts to increase overland supply. A pipeline that would bypass the Strait of Malacca by transporting crude oil from Kyuakpya, Burma to Kunming, China is currently under construction with an estimated completion time of late 2013 or early 2014. The crude oil for this pipeline will be supplied by Saudi Arabia and other Middle Eastern and African countries.
Given China’s growing energy demand, new pipelines will only slightly alleviate China’s maritime dependency on either the Strait of Malacca or the Strait of Hormuz. Despite China’s efforts, the sheer volume of oil and liquefied natural gas that is imported to China from the Middle East and Africa will make strategic SLOCs increasingly important to Beijing.
In 2011, China imported 14.3 billion cubic meters (bcm) of natural gas, or 46 percent of all of its natural gas imports, from Turkmenistan to China by pipeline via Kazakhstan and Uzbekistan. This pipeline is designed to carry 40 bcm per year with plans to expand it to 60 bcm. Another natural gas pipeline designed to deliver 12 bcm per year of Burmese-produced gas is under construction and estimated for completion in late 2013 or early 2014. This pipeline parallels the crude oil pipeline across Burma. Beijing is negotiating with Moscow for two pipelines that could supply China with up to 69 bcm of gas per year; discussions have stalled over pricing differences.
As for China’s Top Crude suppliers as of 2011:
Finally, from a previous Zero Hedge post on this topic, here is why China’s increasing reliance on Crude imports means that the ascent of the Petroyuan is assured, and why by implication the days of the Petrodollar may be numbered: an outcome which the US will hardly be pleased with.
So what does this shift in oil imports mean?
More than anything else, it is a sign that China will increasingly depend on global markets to satisfy its ever-growing oil demand. This necessitates further engagement with the international system to protect its interests, encouraging a fuller integration with the current liberal order. This will have effects on both China’s approach to its currency and its diplomatic demeanour.
Derek Scissors wrote last week that this shift might usher in a world where oil is priced in RMB as opposed to solely in USD. This transition could only occur, however, if the RMB was made fully convertible and Beijing steps back from its current policy of exchange rate manipulation. Earlier this year, HSBC predicted that the RMB would be fully convertible by 2017, a reality that is surely hastened by its position as the single largest purchaser of foreign oil. A fully convertible RMB would be a “key step in pushing it as a reserve currency and enhancing its use in global trade, saidSacha Tihanyi, a strategist at Scotia Capital.
On the diplomatic side, while the United States is unlikely to withdraw from its role as defender of global oil production or guarantor of shipping routes, an increasing reliance on foreign oil will push Beijing toward a more engaged role within the international community. It is likely that we will see a change in Beijing’s approach to international intervention and future participation in multilateral counterterrorism initiatives—anything to ensure global stability. In the future, anything that destabilizes the oil market will increasingly harm China more than the United States. While Beijing views this increased import reliance as a strategic weakness, it a boon for those hoping to see Beijing grow into its role as a global leader.
Bottom line: as Chinese oil imports grow, Beijing will become increasingly reliant on the current market-oriented global system—this is nothing but good news for those that enjoy the status quo.