Oil, Employment, and Growth

By John Mauldin

Dec 16, 2014


Last week we started a series of letters on the topics I think we need to research in depth as we try to peer into the future and think about how 2015 will unfold. In forecasting US growth, I wrote that we really need to understand the relationships between the boom in energy production on the one hand and employment and overall growth in the US on the other. The old saw that falling oil prices are like a tax cut and are thus a net benefit to the US economy and consumers is not altogether clear to me. I certainly hope the net effect will be positive, but hope is not a realistic basis for a forecast. Let’s go back to two paragraphs I wrote last week:

Texas has been home to 40% of all new jobs created since June 2009. In 2013, the city of Houston had more housing starts than all of California. Much, though not all, of that growth is due directly to oil. Estimates are that 35–40% of total capital expenditure growth is related to energy. But it’s no secret that not only will energy-related capital expenditures not grow next year, they are likely to drop significantly.

The news is full of stories about companies slashing their production budgets. This means lower employment, with all of the knock-on effects.

Lacy Hunt and I were talking yesterday about Texas and the oil industry. We have both lived through five periods of boom and bust, although I can only really remember three. This is a movie we’ve seen before, and we know how it ends. Texas Gov. Rick Perry has remarkable timing, slipping out the door to let new governor Greg Abbott to take over just in time to oversee rising unemployment in Texas. The good news for the rest of the country is that in prior Texas recessions the rest of the country has not been dragged down. But energy is not just a Texas and Louisiana story anymore. I will be looking for research as to how much energy development has contributed to growth and employment in the US.

Then the research began to trickle in, and over the last few days there has been a flood. As we will see, energy production has been the main driver of growth in the US economy for the last five years. But changing demographics suggest that we might not need the job-creation machine of energy production as much in the future to ensure overall employment growth.

When I sat down to begin writing this letter on Friday morning, I really intended to write about how falling commodity prices (nearly across the board) and the rise of the dollar are going to affect emerging markets. The risks of significant policy errors and an escalating currency war are very real and could be quite damaging to global growth. But we will get into that next week. Today we’re going to focus on some fascinating data on the interplay between energy and employment and the implications for growth of the US economy. (Note: this letter will print a little longer due to numerous charts, but the word count is actually shorter than usual.)

And now to our regularly scheduled program.

The Impact of Oil On US Growth

I had the pleasure recently of having lunch with longtime Maine fishing buddy Harvey Rosenblum, the long-serving but recently retired chief economist of the Dallas Federal Reserve. Like me, he has lived through multiple oil cycles here in Texas. He really understands the impact of oil on the Texas and US economies. He pointed me to two important sources of data.

The first is a research report published earlier this year by the Manhattan Institute, entitled “The Power and Growth Initiative Report.” Let me highlight a few of the key findings:

1. In recent years, America’s oil & gas boom has added $300–$400 billion annually to the economy – without this contribution, GDP growth would have been negative and the nation would have continued to be in recession.

2. America’s hydrocarbon revolution and its associated job creation are almost entirely the result of drilling & production by more than 20,000 small and midsize businesses, not a handful of “Big Oil” companies. In fact, the typical firm in the oil & gas industry employs fewer than 15 people. [We typically don’t think of the oil business as the place where small businesses are created, but for those of us who have been around the oil patch, we all know that it is. That tendency is becoming even more pronounced as the drilling process becomes more complicated and the need for specialists keeps rising. – John]

3. The shale oil & gas revolution has been the nation’s biggest single creator of solid, middle-class jobs – throughout the economy, from construction to services to information technology.

4. Overall, nearly 1 million Americans work directly in the oil & gas industry, and a total of 10 million jobs are associated with that industry.

Oil & gas jobs are widely geographically dispersed and have already had a significant impact in more than a dozen states: 16 states have more than 150,000 jobs directly in the oil & gas sector and hundreds of thousands more jobs due to growth in that sector.

Author Mark Mills highlighted the importance of oil in employment growth:

The important takeaway is that, without new energy production, post-recession US growth would have looked more like Europe’s – tepid, to say the least. Job growth would have barely budged over the last five years.

Further, it is not just a Texas and North Dakota play. The benefits have been widespread throughout the country. “For every person working directly in the oil and gas ecosystem, three are employed in related businesses,” says the report. (I should note that the Manhattan Institute is a conservative think tank, so the report is pro-energy-production; but for our purposes, the important thing is the impact of energy production on recent US economic growth.)

The next chart Harvey directed me to was one that’s on the Dallas Federal Reserve website, and it’s fascinating. It shows total payroll employment in each of the 12 Federal Reserve districts. No surprise, Texas (the Dallas Fed district) shows the largest growth (there are around 1.8 million oil-related jobs in Texas, according to the Manhattan Institute). Next largest is the Minneapolis Fed district, which includes North Dakota and the Bakken oil play. Note in the chart below that four districts have not gotten back to where they were in 2007, and another four have seen very little growth even after eight years. “It is no wonder,” said Harvey, “that so many people feel like we’re still in a recession; for where they live, it still is.”

To get the total picture, let’s go to the St. Louis Federal Reserve FRED database and look at the same employment numbers – but for the whole country. Notice that we’re up fewer than two million jobs since the beginning of the Great Recession. That’s a growth of fewer than two million jobs in eight years when the population was growing at multiples of that amount.

To put an exclamation point on that, Zero Hedge offers this thought:

Houston, we have a problem. With a third of S&P 500 capital expenditure due from the imploding energy sector (and with over 20% of the high-yield market dominated by these names), paying attention to any inflection point in the US oil-producers is critical as they have been gung-ho “unequivocally good” expanders even as oil prices began to fall. So, when Reuters reports a drop of almost 40 percent in new well permits issued across the United States in November, even the Fed's Stan Fischer might start to question [whether] his [belief that] lower oil prices are "a phenomenon that’s making everybody better off" may warrant a rethink.

Consider: lower oil prices unequivocally “make everyone better off.” Right?

Wrong. First: new oil well permits collapse 40% in November; why is this an issue? Because since December 2007, or roughly the start of the global depression, shale oil states have added 1.36 million jobs while non-shale states have lost 424,000 jobs.

The writer of this Zero Hedge piece, whoever it is (please understand there is no such person as Tyler Durden; the name is simply a pseudonym for several anonymous writers), concludes with a poignant question:

So, is [Fed Vice-Chairman] Stan Fischer's “not very worried” remark about to become the new Ben “subprime contained” Bernanke of the last crisis?

Did the Fed Cause the Shale Bubble?

Next let’s turn to David Stockman (who I think writes even more than I do). He took aim at the Federal Reserve, which he accuses of creating the recent “shale bubble” just as it did the housing bubble, by keeping interest rates too low and forcing investors to reach for yield. There may be a little truth to that. The reality is that the recent energy boom was financed by $500 billion of credit extended to mostly “subprime” oil companies, who issued what are politely termed high-yield bonds – to the point that 20% of the high-yield market is now energy-production-related.

Sidebar: this is not quite the same problem as subprime loans were, for two reasons: first, the subprime loans were many times larger in total, and many of them were fraudulently misrepresented. Second, many of those loans were what one could characterize as “covenant light,” which means the borrowers can extend the loan, pay back in kind, or change the terms if they run into financial difficulty. So this energy-related high-yield problem is going to take a lot more time than the subprime crisis did to actually manifest, and there will not be immediate foreclosures. But it already clear that the problem is going to continue to negatively (and perhaps severely) impact the high-yield bond market. Once the problems in energy loans to many small companies become evident, prospective borrowers might start looking at the terms that the rest of the junk-bond market gets, which are just as egregious, so they might not like what they see. We clearly did not lea rn any lessons in 2005 to 2007 and have repeated the same mistakes in the junk-bond market today. If you lose your money this time, you probably deserve to lose it.

The high-yield shake-out, by the way, is going to make it far more difficult to raise money for energy production in the future, when the price of oil will inevitably rise again. The Saudis know exactly what they’re doing. But the current contretemps in the energy world is going to have implications for the rest of the leveraged markets. “Our biggest worry is the end of the liquidity cycle. The Fed is done. The reach for yield that we have seen since 2009 is going into reverse,” says Bank of America (source: The Telegraph).

Contained within Stockman’s analysis is some very interesting work on the nature of employment in the post-recession US economy. First, in the nonfarm business sector, the total hours of all persons working is still below that of 2007, even though we nominally have almost two million more jobs. Then David gives us two charts that illustrate the nature of the jobs we are creating (a topic I’ve discussed more than once in this letter). It’s nice to have somebody do the actual work for you.

The first chart shows what he calls “breadwinner jobs,” which are those in manufacturing, information technology, and other white-collar work that have an average pay rate of about $45,000 a year. Note that this chart encompasses two economic cycles covering both the Greenspan and Bernanke eras.

So where did the increase in jobs come from? From what Stockman calls the “part-time economy.” If I read this chart right and compare it to our earlier chart from the Federal Reserve, it basically demonstrates (and this conclusion is also borne out by the research I’ve presented in the past) that the increase in the number of jobs is almost entirely due to the creation of part-time and low-wage positions – bartenders, waiters, bellhops, maids, cobblers, retail clerks, fast food workers, and temp help. Although there are some professional bartenders and waiters who do in fact make good money, they are the exception rather than the rule.

It’s no wonder we are working fewer hours even as we have more jobs.

Oil in 2015

With all that as a backdrop, let us return to our original task, which was to think about what will impact the US and global economies in 2015. I’ve been talking to friends and contacts who are serious players in the energy-production sector. This is my takeaway.

The oil-rig count is already dropping, and it will continue to drop as long as oil stays below $60. That said, however, there is the real possibility that oil production in the United States will actually rise in 2015 because of projects already in the works. If you have already spent (or committed to spend) 30 or 40% of the cost of a well, you’re probably going to go ahead and finish that well. There’s enough work in the pipeline (pardon the pun) that drilling and production are not going to fall off a cliff next quarter. But by the close of 2015 we will see a significant reduction in drilling.

Given present supply and demand characteristics, oil in the $40 range is entirely plausible. It may not stay down there for all that long (in the grand scheme of things), but it will reduce the likelihood that loans of the nature and size that were extended the last few years will be made in the future. Which is entirely the purpose of the Saudis’ refusing to reduce their own production. A side benefit to them (and the rest of the world) is that they also hurt Russia and Iran.

Employment associated with energy production is going to fall over the course of next year. It’s not all bad news, though. Employment that benefits from lower energy prices is likely to remain stable or even rise. Think chemical companies that use natural gas as an input as an example.

I am, however, at a loss to think of what could replace the jobs and GDP growth that the energy complex has recently created. Certainly, reduced production is going to impact capital expenditures. This all leads one to begin thinking about a much softer economy in the US in 2015.

What If We Just Need Fewer Jobs?

We must balance this problematic analysis against research that Harvey Rosenblum (whom we met at the top of the letter) and my good friend (and likewise Maine fishing buddy) John Silvia, the chief economist at Wells Fargo, have just produced. John is a very solid economist who has his head on straight (in addition to being a really nice guy).

John asked the question, “What if we just need fewer jobs?”:

Job growth is a function of both the supply of and demand for labor. With labor force participation having fallen sharply since the Great Recession and growth in the working-age population slowing, growth in the supply of labor, measured by labor force growth, looks to have downshifted in recent years. As a result, the number of new jobs needed each month to keep the unemployment rate steady has also declined. We estimate that from 2015 to 2020, payroll growth of around 65,000 jobs per month should be sufficient to absorb new entrants into the labor force and to exert neutral pressure on the unemployment rate. This marks a notable downshift from a trend of around 150,000 in the 1980s and 1990s, and even the early 2000s when trend employment growth slowed to around 120,000.

Harvey and I talked about this research, and while we are probably going to ask John for the spreadsheets and more details as to his basic assumptions, anyone who studies demography knows that a serious falloff in the number of new babies began some 23 years ago. And while I don’t think that Baby Boomers are going to retire following the same patterns that we saw in previous generations, there will certainly be an increase in those who think of themselves as retired, reducing the participation rate.

An immediate takeaway from this analysis is that if job growth continues to bump along in the 200,000 range, it will not be too long before there is wage pressure, especially in skilled jobs. That would be good news for workers. If we couple that pressure with a change in the silly rule that says that anyone working more than 30 hours is considered to be full-time and move the number of hours considered to be full-time work to 40 (I think that has a good possibility of passing next year), it will mean that workers (especially those who are younger) get more hours, more income, and better jobs. It will also mean that the unemployment rate will trend down, even if employment growth is not up to historical standards. And let’s make no mistake, it has not been.

Putting today’s rather pathetic job growth in context, George Will writes this week in the National Review:

The euphoria occasioned by the economy adding 321,000 jobs in November indicates that we have defined success down. In the 1960s, there were nine months in which more than 300,000 jobs were added, the last being June 1969, when there were about 117 million fewer Americans than there are now. In the 1980s, job growth exceeded 300,000 in 23 months, the last being November 1988, when there were about 75 million fewer Americans than today.

To demonstrate how young people “are not getting the kind of start others got,” Camp offers a graph charting the “fraction of young adults living with older family members.” Beginning in the middle of the last decade, the line goes almost straight up, to almost 46 percent. For those 25 to 34, median household income plunged 8.9 percent between June 2009 and June 2012, the first three years of the recovery.”

We’re going to stop here before the letter runs too long. Next week we really will get to the global economy and especially the dollar story. We will have to address the very sad question, “Are we really going to have to focus on Greece again?” And while I tend to vigorously disagree with Paul Krugman’s policy analysis and prescriptions, he pretty much gets it right in talking about the problems of Greece in his latest New York Times column “Mad as Hellas.” It is all so very sad.

He ends up talking about the rise of protest parties all over Europe. That is something I have addressed in this letter as well, and it is a disconcerting phenomenon. He concludes with the comment:

But there’s a reason they’re [protest movements] on the rise. This is what happens when an elite claims the right to rule based on its supposed expertise, its understanding of what must be done – then demonstrates both that it does not, in fact, know what it is doing, and that it is too ideologically rigid to learn from its mistakes.

And I totally agree with that statement. I think that’s precisely the lesson we should learn from the 2014 US elections, as well. The irony is that many of us would consider Paul Krugman to be part of that elite. Just saying.
On a very personal note, everyone is aware of the “We Can’t Breathe” protests that are taking place in response to a very tragic incident in New York. Reasonable people can disagree on what the response should be or on how to interpret the facts of that particular incident, but it is not difficult for me to understand the frustrations of the African-American community.

I have two adopted black sons (now adults) along with my five other children (two of them Asian-American). I can tell you that my experience has been that as teenagers they were far more likely to be pulled over and harassed or arrested for things my white children would have been simply told to stop doing and then sent on their way.
For the police it seemed to be a problem for my black sons to drive my car around my (admittedly mostly white) neighborhood. There were clearly double standards, both in some of the public and private schools my children attended. I had to be careful not to put them in certain situations that would cause them frustrations. To pretend there is still not a double standard in our society is to whistle past the graveyard. That said, I don’t want to seem like I’m giving a pass to what is clearly all too often a broken family structure and cultural acceptance of certain inappropriate behaviors among young black men. The frustrations of all parties stem from very real problems. There are no simple answers, and much of the really hard work needs to be done in local communities.

The whole racial issue has vastly improved since I was young. Projections are that by 2020 around 10% of people in the US will be biracial. That is expected to grow to 20% by 2050 and is clearly going to change the way that we (and especially our children) interact with each other. I will have my fifth biracial grandchild sometime later this month. I hope the world they grow up in is considerably different from the world I grew up in or even today’s world. But recent events demonstrate that we still have some miles left on the journey to a truly colorblind system. Rather than defending a system that clearly still has issues that need to be dealt with, we need to face the problems and figure out how to make a world we want all of our children to grow up in.

And on that note, it’s time to hit the send button. Have a great week.

Your working on his Christmas shopping analyst,
John Mauldin
John Mauldin

The dark side of the oil shock

Gavyn Davies

Dec 14 14:46

The financial markets saw only bad news in the oil shock last week. Despite extremely strong US consumer data, there is a reluctance to recognise the shock for what it is - a long-lasting structural change, with mostly beneficial consequences for aggregate demand in the developed economies.

As John Authers explains, weak Chinese data are causing concern, but there is little evidence that China has been the main cause of falling oil prices. Global oil demand has been fairly stable as supply has surged, and it is surely revealing that the latest oil price drop followed the Saudi decision to maintain oil output after the November OPEC meeting.

Like investors, economists have been thrown into confusion. Almost no-one in the profession (including myself) predicted the oil price collapse in advance. After the shock, it took months for oil price forecasts to be brought into line with the new reality. Futures prices in the oil market have performed no better: predicting oil prices can be a mug´s game.

More surprisingly, there has also been a disinclination to accept the potential benefits in the oil shock. Some economists have said it largely reflects an adverse demand shock in the global economy, so it is axiomatically bad news. Others have said that, even if it is a supply shock in the oil market, which would normally be beneficial, this time will be different, because it will be deflationary, and will therefore raise real interest rates.

There are some honourable exceptions, like Martin Wolf and David Wessel who have viewed it mainly as a supply shock with net beneficial consequences. But the pessimists have thrown up a lot of noise, reminding me of Professor Deirdre McCloskey´s maxim:

Pessimism sells. For reasons I have never understood, people like to hear that the world is going to hell, and become huffy and scornful when some idiotic optimist intrudes on their pleasure.

If the pessimists have a case, it is in oil producers in the emerging world, especially Russia. But, among oil importers in the developed world, it is hard to see too much of a dark side.

Let´s start with what Basil Fawlty would call "the bleeding obvious". A fall in oil prices redistributes income away from oil producers, of whom there are relatively few, towards oil consumers, of whom there are very many. To a first approximation, the long run effect of this income transfer on the global economy should be small, but beneficial. The beneficial part comes from permanently lower production costs, which allow central banks to target lower unemployment rates while still hitting their inflation targets. This is a long run supply-side gain that is the direct opposite of the stagflation that occurred in the 1970s.

However, there are also some important time lags at work. Some of the gainers, mainly "credit constrained" households, may adjust their spending upwards almost immediately in line with their higher incomes. The losers may be less constrained by their short term income, so they can take longer to adjust their spending. For example, even Russia can draw on its $419 billion foreign exchange reserves, which it has been doing. The net effect of these time lags is to provide a further boost to global demand and GDP growth.

These results have been established fairly conclusively over many previous oil shocks in both directions, so why should it be any different this time?

A new factor is the growing importance of oil producers within the developed world, notably in the US. It is unavoidable that there will be a large hit to oil producing regions, like Texas, which have accounted for much of the GDP growth in the US in recent years. But the hit to these regions should be more than compensated for by the gains to household spending elsewhere in the economy, as Bill Dudley of the New York Fed said recently.

What about the dangers of a financial shock? In June, about 10.3 per cent of the US equity market, and 15.9 per cent of the high yield corporate bond market, was in the energy sector.

There could certainly be further market disruption from highly leveraged oil producers in that sector, but it is hard to imagine these effects being large enough to affect the market as a whole.

So far, the financial market effects have remained localised in the energy sector. The combination of extreme leverage, opaque financial instruments and interconnectedness between institutions that turned subprime debt into a major global crisis does not seem to exist this time.

What about the euro area, which has virtually no indigenous oil production? Even there, pessimists (like the ECB) have found a reason to worry: the unhinging of inflation expectations.

If this did occur in a sustained manner, it would be no trivial matter. As we have seen in Japan, permanently lower inflation expectations translate into lower nominal wage and price increases, and at the zero lower bound for interest rates, that makes high levels of public and private debt less sustainable.

This chain of events is, however, far from inevitable. It is more likely that a decline in headline inflation will take short term inflation expectations down for a while, but core inflation will fall much less, and inflation expectations will subsequently rebound, especially if the ECB eases monetary policy markedly.

Furthermore, wage increases seem largely independent of either expected price inflation or the tightness of the labour market at present. Assuming that wage increases are unaffected by lower oil prices, this will amount to a much needed increase in real disposable income, which will make it easier, not harder, to service existing debt. A temporary spike in short term real interest rates will not be enough to offset these real income gains.

If there is a really dark side to this oil shock, it is likely to stem not from the developed economies, but from its destabilising effects on Russia (as Paul Krugman has argued) and some other oil producers in the emerging world. That is what transpired, eventually, in the oil shock of 1997/98.

A collapse of the Russian economy, with its dangerous political consequences, is the most important reason to worry that the "idiotic optimists" will be wrong about the beneficial market impact of the 2014 oil shock.

Op-Ed Columnist

Wall Street’s Revenge

Dodd-Frank Damaged in the Budget Bill

DEC. 14, 2014

The Masters of the Universe, it turns out, are a bunch of whiners. But they’re whiners with war chests, and now they’ve bought themselves a Congress.
Before I get to specifics, a word about the changing politics of high finance.

Most interest groups have stable political loyalties. For example, the coal industry always gives the vast bulk of its political contributions to Republicans, while teachers’ unions do the same for Democrats. You might have expected Wall Street to favor the G.O.P., which is always eager to cut taxes on the rich. In fact, however, the securities and investment industry — perhaps affected by New York’s social liberalism, perhaps recognizing the tendency of stocks to do much better when Democrats hold the White House — has historically split its support more or less equally between the two parties.
But that all changed with the onset of Obama rage. Wall Street overwhelmingly backed Mitt Romney in 2012, and invested heavily in Republicans once again this year. And the first payoff to that investment has already been realized. Last week Congress passed a bill to maintain funding for the U.S. government into next year, and included in that bill was a rollback of one provision of the 2010 financial reform.
In itself, this rollback is significant but not a fatal blow to reform. But it’s utterly indefensible.

The incoming congressional majority has revealed its agenda — and it’s all about rewarding bad actors.
So, about that provision. One of the goals of financial reform was to stop banks from taking big risks with depositors’ money. Why? Well, bank deposits are insured against loss, and this creates a well-known problem of “moral hazard”: If banks are free to gamble, they can play a game of heads we win, tails the taxpayers lose. That’s what happened after savings-and-loan institutions were deregulated in the 1980s, and promptly ran wild.
Dodd-Frank tried to limit this kind of moral hazard in various ways, including a rule barring insured institutions from dealing in exotic securities, the kind that played such a big role in the financial crisis. And that’s the rule that has just been rolled back.

Now, this isn’t the death of financial reform. In fact, I’d argue that regulating insured banks is something of a sideshow, since the 2008 crisis was brought on mainly by uninsured institutions like Lehman Brothers and A.I.G. The really important parts of reform involve consumer protection and the enhanced ability of regulators both to police the actions of “systemically important” financial institutions (which needn’t be conventional banks) and to take such institutions into receivership at times of crisis.
But what Congress did is still outrageous — and both sides of the ideological divide should agree.
After all, even if you believe (in defiance of the lessons of history) that financial institutions can be trusted to police themselves, even if you believe the grotesquely false narrative that bleeding-heart liberals caused the financial crisis by pressuring banks to lend to poor people, especially minority borrowers, you should be against letting Wall Street play games with government-guaranteed funds. What just went down isn’t about free-market economics; it’s pure crony capitalism.
And sure enough, Citigroup literally wrote the deregulation language that was inserted into the funding bill.
Again, in itself last week’s action wasn’t decisive. But it was clearly the first skirmish in a war to roll back much if not all of the financial reform. And if you want to know who stands where in this coming war, follow the money: Wall Street is giving mainly to Republicans for a reason. 

It’s true that most of the political headlines these past few days have been about Democratic division, with Senator Elizabeth Warren urging rejection of a funding bill the White House wanted passed. But this was mainly a divide about tactics, with few Democrats actually believing that undoing Dodd-Frank is a good idea.
Meanwhile, it’s hard to find Republicans expressing major reservations about undoing reform. You sometimes hear claims that the Tea Party is as opposed to bailing out bankers as it is to aiding the poor, but there’s no sign that this alleged hostility to Wall Street is having any influence at all on Republican priorities.
So the people who brought the economy to its knees are seeking the chance to do it all over again. And they have powerful allies, who are doing all they can to make Wall Street’s dream come true.

HSBC fears horrible end to Japan's QE blitz as Abe wins landslide

The warning came as Mr Abe won a sweeping victory in Japan’s snap elections over the weekend, consolidating his power in the Diet and giving him a further mandate for deep reforms.

By Ambrose Evans-Pritchard

6:26PM GMT 14 Dec 2014

Japanese fans cheer prior to the World Cup group E soccer match between Japan and Cameroon at Free State Stadium in Bloemfontein, South Africa, Monday, June 14, 2010.  (AP Photo/Hussein Malla)

The ruling Liberal Democratic Party is seeking a mandate to pursue some of the most radical changes in Japan's modern history Photo: AP
HSBC has warned that Japan’s barely-disguised attempt to drive down the yen is becoming dangerous and may spin out of control, leading to an exchange rate crisis next year and a worldwide currency storm. 
“It is entirely possible that the Yen decline becomes disorderly and swift,” said the bank, in one of the starkest criticisms so far of Japan’s radical stimulus policies.
David Bloom and Paul Mackel, HSBC’s currency strategists, voiced growing concern that premier Shinzo Abe is backing away from fiscal retrenchment and may pressure the Bank of Japan (BoJ) to fund policies aimed at boosting household spending.
“The temptation to drift towards increasingly generous fiscal programmes could grow. We do not expect a ‘helicopter drop’ of income into every household, but the yen would react very badly to any sign that the government is heading down a route of overt monetisation,” they wrote in a report entitled “The Year of Living Dangerously”.
The warning came as Mr Abe won a sweeping victory in Japan’s snap elections over the weekend, consolidating his power in the Diet and giving him a further mandate for deep reforms.

"I promise to make Japan a country that can shine again at the centre of the world," said Mr Abe. 
Japan's recovery has faltered. Mr Abe's Thatcherite shake-up, or Third Arrow, has yet to get off the ground, though he is now in a much stronger position to break monopolies and confront vested interests.
The economy slumped back into recession in the middle of this year after a rise in the sales tax from 5pc to 8pc, a move that was clearly premature.


The Abenomics experiment still depends largely on the BoJ's asset purchases, running at 1.4pc of GDP each month, the most extreme monetary blitz ever attempted in a modern economy.

Economists are deeply divided over whether this alone can overwhelm the fiscal shock, and lift the economy out a 20-year stagnation trap.
HSBC said Mr Abe may succeed in driving up wages, setting off a "wage-inflation spiral". This may not necessarily lead to a bond rout since the Bank of Japan is effectively holding down bond yields. However, the exchange rate might take the strain instead.
The worry is that this could set off a beggar-thy-neighbour devaluation process across Asia, eventually sucking in China. "The tentacle of the currency war would spread," said the report.
HSBC said China is determined to avoid joining this debasement game as it tries to wean its own economy off export-led growth, but there may be limits. The Chinese economy is slowing and is already in deep producer price deflation. Japanese exporters have been switching to a new strategy over the last six months, cutting export prices to gain market share as the yen falls, rather than pocketing the windfall as extra profit.
"There are grounds to argue that China would join the currency war and devalue the yuan if currency moves elsewhere became disorderly," it said. The warnings have raised eyebrows since HSBC has close policy ties with the Chinese authorities.
The report sketched an unsettling scenario in which capital flight from Japan flows to the US, setting off an "explosive" rise in the dollar. This may combine with "reignited European break-up fears" as political risk spreads, most immediately in Greece.
Such a combination would put immense strain on those emerging markets that have borrowed heavily in dollars.The Bank for International Settlements says cross-border loans to developing economies have soared from $3 trillion to $9 trillion in a decade, creating systemic risk.
HSBC warns that the potential trifecta of a yen crash, a euro slide, and an emerging market crisis could lead to a dollar spike that the US authorities "would be powerless to prevent". This would "destroy the world" as we know it. The report stressed that this is not a forecast but a tail-risk that cannot be ignored.
Takeshi Fujimaki, a Japanese banker and former adviser to George Soros, has also issued a string of warnings. “Once investors see through the BOJ’s camouflage, the yen will spiral out of control to Y200 (to the dollar) and beyond,” he said.
The BoJ has already driven down the yen by 50pc against the dollar to $119 over the last two years, and by the same amount against the yuan. While this was welcomed by Japanese firms at first, it risks going too far. Protests are rising from those who rely on imports.
The central bank's governor, Haruhiko Kuroda, stepped up the pace of QE in October in a bid to push up inflation and reignite the damp wood of the Japanese economy. The move was fiercely resisted by four of the BoJ’s nine voting members.
The unstated purpose is to raise nominal GDP growth from past rates of zero to nearer 4pc or 5pc. This is deemed the safe required to stabilize the ratio of public debt to GDP – now 245pc – and avert a debt-compound trap.
The BoJ is currently soaking up the entire bond issuance of the government, forcing down the real interest rate to deeply negative levels. It has accumulated $2.14 trillion of state debt so far, equal to 47pc of GDP. This is rising fast, fuelling suspicions that Mr Kuroda’s true objective is to whittle away the debt burden by printing money.

The Bank of Japan is almost tripling the size of the balance sheet from 2013 to the end of 2015

The HSBC view is unusually gloomy. Mr Kuroda said the bank will "approach" its 2pc inflation target in 2015 and there are signs that business investment is picking up.
The Daiwa Instititute says real wages are poised to rise as the tax shock fades. "Signs of a virtuous cycle are definitely emerging," it said. The yen may stabilize once the economy has adapted to a new nominal GDP trajectory.
Ryutaro Kono from BNP Paribas said Abenomics ran aground in late 2013 but may now have been rescued by the slump in oil prices. Japan imports almost all its fuel. The effect is worth a tax cut of 1pc of GDP. "Its a godsend for Abe," he said.
Yet Japan is clearly at a critical moment. Moody's downgraded the country's debt one notch to A1 earlier this month with an explicit warning: Japan cannot stabilize its debt ratio unless all elements come together at once.
These are fiscal and pension reforms, higher taxes, higher productivity growth, an end to deflation, and nominal GDP growth above 3.5pc. If any one of these falls short, Mr Abe's great gamble may fail.

Op-Ed Columnist

Why 2014 Is a Big Deal

DEC. 13, 2014

Thomas L. Friedman

I WAS just about to go with a column that started like this: When they write the history of the global response to climate change, 2014 could well be seen as the moment when the balance between action and denial tipped decisively toward action. That’s thanks to the convergence of four giant forces: São Paulo, Brazil, went dry; China and the United States together went green; solar panels went cheap; and Google and Apple went home. 

But before I could go further, the bottom fell out of the world oil price, and the energy economist Phil Verleger wrote me, saying: “Fracking is a technological breakthrough like the introduction of the PC. Low-cost producers such as the Saudis will respond to the threat of these increased supplies by holding prices down” — hoping the price falls below the cost of fracking and knocks some of those American frackers out. In the meantime, though, he added, sustained low prices for oil and gas would “retard” efforts to sell more climate-friendly, fuel-efficient vehicles that are helped by high oil prices and slow the shift to more climate-friendly electricity generation by wind and solar that is helped by high gas prices.
So I guess the lead I have to go with now is: When they write the history of the global response to climate change, 2014 surely would have been seen as the moment when the climate debate ended. Alas, though, world crude oil prices collapsed, making it less likely that the world will do what the International Energy Agency recently told us we must: keep most of the world’s proven oil and gas reserves in the ground. As the I.E.A. warned, “no more than one-third of proven reserves of fossil fuels can be consumed prior to 2050” — otherwise we’ll bust through the limit of a 2-degree Celsius rise in average temperature that scientists believe will unleash truly disruptive ice melt, sea level rise and weather extremes.

Technology is a cruel thing. The innovators who’ve made solar panels, wind power and batteries so efficient that they can now compete with coal and gas are the same innovators who are enabling us to extract oil and gas from places we never imagined we could go at prices we never imagined we would reach. Is a third lead sentence possible? There is. In fact, there is an amazing lead waiting to be written. It just takes the right political will. How so?
Let’s go back to my first lead. The reason I thought we were decisively tipping toward action was, in part, because of news like this from the BBC on Nov. 7 in São Paulo: “In Brazil’s biggest city, a record dry season and ever-increasing demand for water has led to a punishing drought.” When a metropolitan region of 20 million people runs dry because of destruction of its natural forests and watersheds, plus an extreme weather event scientists believe was made more intense by climate change, denialism is just not an option.

Then you have the hugely important deal that President Obama and President Xi Jinping of China struck on Nov. 12 under which the United States will reduce its carbon emissions 26 percent to 28 percent below 2005 levels by 2025, and China will peak its carbon emissions by or before 2030.
China also committed to build by 2030 an additional 800 to 1,000 gigawatts of clean power — or nearly as much new renewable energy in China as all the electrical capacity in America today. That will greatly spur innovation in clean tech and help do for solar, wind and batteries what China did for tennis shoes — really drive down global prices.
Also, last February, Google bought Nest, for $3.2 billion. Nest makes a $250 smart thermostat that can save homeowners tons of money by learning their temperature preferences and automatically managing their air-conditioners and home heating systems for the greatest efficiency. Also this year, Apple announced the development of the Apple HomeKit, which will enable customers to remotely manage their appliances and home energy systems on their iPhones. When Apple and Google start competing to make homes more energy efficient, watch out. We will likely see nonlinear improvements.
“U.S. roads are crumbling,” said Verleger. “Infrastructure is collapsing. Our railroads are a joke.”
Meantime, gasoline prices at the pump are falling toward $2.50 a gallon — which would be the lowest national average since 2009 — and consumers are rushing to buy S.U.V.’s and trucks. The “clear solution,” said Verleger, is to set a price of, say, $3.50 a gallon for gasoline in America, and then tax any price below that up to that level. Let the Europeans do their own version. “And then start spending the billions on infrastructure right now. At a tax of $1 per gallon, the U.S. could raise around $150 billion per year,” he said. “The investment multiplier would give a further kick to the U.S. economy — and might even start Europe moving.”
So there is a way to make 2014 that truly decisive year in confronting both climate and rebuilding America, but only our political leaders can write that lead.

Gold And Silver: Physical Demand Is A Signal Prospects Are Looking Up

 by: Andrew Hecht            

  • Gold is stable on the year.
  • Silver is showing signs of life.
  • An inverse correlation - gold versus the dollar.
  • Physical demand.
  • Hard assets and real money.
Precious metal prices moved higher across the board last week. Gold moved $32.10 higher on a week on week basis while silver gained 79.9 cents per ounce. Even platinum and palladium were up on the week, finishing $12 and $13.85 better, respectively. All eyes in the commodity market focused on oil, which continues to sink, losing another $8.03 or 12.2% on the active month January NYMEX futures contract for the week. Perhaps precious metals took a lead from the US dollar index, which finished last week around 1% lower after running into some long-term resistance.

Gold is stable on the year

As this year is almost over, it is highly likely that the high and low is in place for gold in 2014. Gold closed 2013 at $1238.60. It traded to a high of $1392.60 during the week of March 17 and a low of $1130.40 on November 7. As of the close of business Friday, December 12, gold is down 1.3% on the year. It has been a quiet year in the gold market.

Recently interest in gold has been decreasing, perhaps due to the intense daily action in crude oil.

(click to enlarge)

As the chart illustrates, gold has made a nice recovery since making the lows for the year in November. Since the bullish key-reversal on November 7, gold has made a series of higher highs and higher lows. There were many shorts in gold prior to the reversal. Open interest data (the number of open long and short positions) shows that the majority of those shorts have closed their positions.

Open interest now stands at 368,521 contracts, the lowest since September 1, and has dropped by 21.4% since November 21.

With all said and done, thus far in 2014, gold has been stable; it has held its value.

Silver is showing signs of life

Silver is another story. So far, silver has had a rough time in 2014, mirroring action in many other commodity sectors. Silver closed 2013 at $20.211 and as of the close of business Friday, December 12, is down 15.6% for the year. Silver traded to a high of $22.20 in late February and a low of $14.155 on December 1. Over the past five weeks, silver has made a series of bullish key reversal patterns on the daily chart.

(click to enlarge)

Silver, like gold, has made an impressive recovery from the lows. Silver has rallied from a low of $14.155 two weeks ago and closed Friday 20.5% above that low. Like gold, the silver market had numerous shorts looking for lower prices. Open interest is currently at 147,536 contracts, which is the lowest since May and 15.6% below the level on November 21. Those shorts closed positions during the recent rally.

Silver has had a tough year in 2014, but recent action has invigorated the market. A close above $16.69 at the end of this month will signify a bullish key reversal on the monthly chart, a bullish long-term signal.

An inverse relationship - gold versus the dollar

Historically, gold has an inverse relationship with the US dollar. When the dollar appreciates relative to currencies like the euro, yen, Swiss franc and others, the dollar price of gold tends to decrease as the price of the yellow metal in other currencies appreciates. Interestingly enough, this year gold has remained stable, down only 1.3% while the US dollar index is up 9.4% on the year. While gold is down marginally in dollars, it is up 7.7% in euros thus far in 2014.

Gold has shown incredible resilience in the face of a rallying dollar in 2014, perhaps signaling intrinsic strength. Gold has also displayed strength this year when compared to the performance of other precious metals and commodity prices in general. Platinum is currently trading at a $10 premium to gold. At the beginning of 2014, platinum was at almost a $180 premium to gold. The decrease in platinum's premium points to relative strength in gold.

Finally, the silver-gold ratio closed 2013 at 61.5-1, or 61.5 ounces of silver value in each ounce of gold value. That relationship is currently trading at 71.67-1 in another testament to gold's fortitude.

Physical demand

Physical demand is always a key indicator of the price direction for precious metals. There are some signs that demand for gold and silver is starting to percolate.

The Indian government recently lifted restrictions on gold imports, which will surely cause a pickup in physical buying. There has been good and steady official sector buying in gold in 2014. According to the World Gold Council, "signs are that 2014 will be another solid year of strengthening reserves with gold." The Russians have been notable official sector purchasers.

This makes a great deal of sense given sanctions levied on Russia by the US and Europe. I sense that given these sanctions, it is not just the Russian Central Bank buying gold. The ruble has moved 77% lower since the beginning of 2014 on a confluence of events. Sanctions coupled with dramatically lower crude oil prices, the Russian economy is highly dependent on crude oil revenues, has caused the currency to tank. Fearing further devaluations and the potential for hyperinflation, I suspect that Russians will be exchanging their rubles for as much gold as possible. The Russians are scrambling to put assets into stable vehicles.

Finally, lower crude oil prices are a shot in the arm for China, which has been suffering from sluggish growth in 2014. Any pickup in the Chinese economy will increase demand for physical gold.

Silver demand has been strong lately. Sales of silver eagle coins have set a record in 2014.

Additionally, silver ETF products have been attracting investors lately. Low prices in silver generally attract bargain hunters who look to add to physical holdings as prices move lower. Silver demand earlier this month spiked as prices rejected lows at $14.155. Rising industrial applications for silver also promise steady future demand.

The global picture for physical gold and silver demand looks good.

Hard assets and real money - fundamentals

It has been a rough year for commodities. Prices for crude oil, iron ore, grains and other raw materials have moved dramatically lower. The US economy has seen a nice rebound in 2014.

Europe has been a completely different story. European economies have deteriorated. Greece is on the verge of a major default. Fitch just downgraded France's debt this past Friday. Europe's traditional trading partner, Russia, is under myriad sanctions, which has had a negative effect on European trade.

Although the dollar is strong, interest rates around the world remain low, as fears of deflation have gripped Central Bankers. The prospect for a continuation of low yields is excellent going into the New Year. This is a positive for precious metal prices.

Gold and silver are hard assets; they have intrinsic value and they have been a means of exchange for a much longer time than any paper currency currently used in the world. In a world with so much uncertainty and tension, the prospects for gold and silver going into 2015 look better than they have in some time. Gold's stability and silver's recent rebound could be signs that these metals will reassert themselves in the coming year. Watch silver, it led gold down in 2014 and a close above $16.69 at the end of this month will present a bullish technical signal that will carry the metals into next year on a positive note.


Exclusively for everybody

The modern luxury industry rests on a paradox—but is thriving nonetheless, says Brooke Unger

Dec 13th

AT THE TRANG TIEN PLAZA shopping mall in Hanoi, Vietnam’s capital, on some evenings a curious spectacle unfolds. Couples in wedding finery pose for photographs in front of illuminated shop windows, with Salvatore Ferragamo, Louis Vuitton and Gucci offering the sort of backdrop for romance more usually provided by the sea or the mountains. The women are not wearing Ferragamo’s Vara pumps, with their distinctive bows, or toting Vuitton’s subtly monogrammed handbags. They cannot afford them. Tran Van Cuon, who assembles mobile phones at a Samsung factory, posed with his fiancée in a brown suit and bow tie that cost him the equivalent of $150. Some day he hopes to become a customer in the mall. Until then, he will proudly display the photos in his home.

To stumble across an outpost of European luxury in a relatively poor and nominally socialist country is not all that surprising. Luxuries such as silk have travelled long distances for many centuries, and even modern luxury-goods makers have been pursuing wealth in new places for more than a century.

Georges Vuitton, son of Louis, the inventor of the world’s most famous luggage, showed off the company’s flat-topped trunks (better for stacking than traditional round-topped ones) at the Chicago World’s Fair in 1893. The oil-rich Middle East has been a magnet for expensive foreign trinkets since the 1960s. The Japanese became insatiable consumers in the 1970s.
Today, two in five Japanese are thought to own a Vuitton product. And now it is China’s turn to lap up luxury.
As luxury-goods sales have expanded geographically, they have also spread across the social scale. When Coco Chanel created her No. 5 perfume in the 1920s she reserved it for her best couture clients, but in the following decade she sold it in smaller bottles so that more women could afford it.
Cartier’s “Les Must” jewellery in the 1970s put the brand within reach of consumers who could only yearn for Panthère necklaces and Tank watches. Many other brands followed Cartier’s sortie du temple (descent from the temple), seeking to broaden their appeal while retaining their cachet. Not all succeeded.

Over the past 20 years the number of luxury-goods consumers worldwide has more than trebled to 330m, according to Bain & Company, a consulting firm. Their spending on expensive jewellery, watches, clothing, handbags and so on has risen at double the rate of global GDP.

Most of these new buyers are not the very rich but the merely prosperous, with incomes of up to €150,000 ($188,000). Shares of listed luxury companies have far outperformed those of other companies (see chart).

Consumers’ rush to quality has created billionaires at a rate that Silicon Valley might envy, especially among the main shareholders of luxury conglomerates that have gathered together many of the best-known brands. They include Bernard Arnault, a French tycoon who controls LVMH, owner of Louis Vuitton, Moët & Chandon champagne and a host of other brands, and his rival François-Henri Pinault, whose Kering group owns Gucci, a big Italian leather-goods maker. Nick Hayek’s Swatch Group and Johann Rupert’s Richemont (Cartier’s owner) are powerhouses in watches and jewellery.

Among the owners who have made fortunes from selling stakes to investors in the past few years are Brunello Cucinelli, whose eponymous company makes casual-chic clothing at serious prices, and Remo Ruffini, a fellow Italian who floated Moncler, a maker of down jackets.

Personal luxury goods are just one small corner of this empire of opulence. Upmarket options can be found in industries from health care to banking, though most analysts leave such things out of their reckoning. Using consumers’ own perception of what constitutes luxury goods and services, the Boston Consulting Group reckons that $1.8 trillion was spent on such items in 2012. The biggest category is travel, followed by cars and then personal luxury goods. Bain comes up with a smaller sum for a similar spread of sectors (see chart). But luxury’s boundaries are fuzzy and hotly disputed.

This special report will concentrate on personal goods, which face the tricky task of trying to achieve global scale while maintaining the artisan roots that give them rarity appeal. Ultra-expensive cars will make only a brief appearance, and yachts will just sail by on the horizon: globally, only 14,000 people are able to afford a really big one. But the report will include such fast-growing “experiential” sectors as hotels and wine, which are growing faster than things to buy and own.

To view the world through the lens of luxury is to see it subtly altered. Some of the normal rules do not apply to luxury-goods makers, even though in many ways they are similar to other consumer-goods companies. The cost of production is not usually a prime concern and capital investment is generally modest, except for watches. A really prestigious item can be a “Veblen good”, named after an American economist born in the mid-19th century who noticed that demand for some goods actually rises as they get more expensive because they confer yet more status. And the margins even on lesser luxury goods are much better than on mass-market items.

Luxury companies like to set their own agenda. Their creative directors oversee both the development of new products and the way they are presented in magazines, shop windows and online. “We are not going to let people influence the vision,” says Patrick Albaladejo, deputy managing director of Hermès, a French luxury house so august it claims not to have a marketing department.

Luxury companies often get the most attention for the things they sell least of. Karl Lagerfeld, Chanel’s creative director, made headlines this year by sending his models down a catwalk decked out as a grocery shop. But “the bread and butter of the company are chemicals,” explains Armando Branchini of the Altagamma Foundation, which represents Italian luxury firms. Luxury perfumes and cosmetics are thought to account for over half of Chanel’s business.

Diageo, a big drinks company, has a “Reserve” division that gives special attention to its priciest tipples, such as Johnnie Walker Blue Label whisky. They are marketed through the patient cultivation of the coolest bars and influential “advocates”. “You need to be a black belt in relationships when it’s about luxury,” says James Thompson, who runs the division.

Luxury’s lens does odd things to the map as well. Europe is still the pre-eminent maker; its brands account for 70% of the world’s luxury consumption. Germany matters in cars and yachts, but the real powerhouse is Italy, which serves as the workshop for French fashion and leather goods as well as its own. Luxury is “one of the few industries where Europe has a sustainable competitive advantage”, says Michael Ward, managing director of Harrods, a posh London department store. America is both an underexploited market, given its wealth, and a base for brash competitors such as Coach, Michael Kors and Kate Spade, which are challenging established European brands with a more affordable take on luxury. China, already a voracious consumer, is just beginning to stir as an exporter.

The pope doesn’t wear Prada
Of late, though, the champagne has gone a bit flat. The war in Ukraine and the sanctions imposed on Russia in response have put off rich citizens of that country, among the giddiest new consumers. The Japanese went on a spree early this year ahead of a rise in value-added tax, then stopped spending.

The Ebola epidemic in Africa and pro-democracy protests in Hong Kong, where Chinese mainlanders do much of their shopping, have unnerved consumers. Most important, slower economic growth and the anti-corruption campaign mounted by Xi Jinping, China’s leader, have dampened the spirits of Chinese shoppers, who now account for nearly a third of the global demand for personal luxury goods. The share prices of recently listed luxury companies have fallen by a quarter this year. After two decades when annual growth averaged nearly 6%, the rate this year will be just 2%, predict Bain and Altagamma.

These passing crises come on top of more profound changes. One of them is a shift from “having” to “being”, especially in rich countries, where the well-off are becoming less keen on owning and more interested in experiencing things. Consumers in China are turning from monogrammed showiness to subtler elegance. Younger people everywhere have their own ideas about how to consume luxury, helped by social media and e-commerce. Inequality is a growing concern from Berlin to Beijing. Last year a pope whose red shoes were widely (but wrongly) thought to have been made by Prada, an Italian fashion house, gave way to one who shuns the Apostolic Palace for a guesthouse. That captures the mood and contributes to it.

Sobriety has bypassed some sectors, including fine wine and expensive cars. Yacht sales, too, are buoyant again after a period in the doldrums in the late 2000s, and today’s yachtsmen often add a helicopter or two to their order. But mostly substance is winning over style.

In some ways, today’s preoccupation with sustainability plays into the hands of luxury-goods makers. With their ample margins, they can afford to reduce the environmental damage they cause. “Luxury can show the path that answers the major issues of our century,” argues Marie-Claire Daveu, Kering’s sustainability chief. By and large, makers of luxury goods employ European workers rather than sweatshop serfs in Bangladesh. The key trend now, says Diageo’s Mr Thompson, is “away from show for its own sake towards knowledge, appreciation, craft and heritage—something with a story.”