Oil producers face their ‘life or death’ question

Fear of an imminent peak in demand means companies are less likely to invest. So does that make shortages and a price rise inevitable?

David Sheppard and Anjli Raval in London

© FT montage / Bloomberg

Asked last month by a frustrated investor if, “hand on heart”, Royal Dutch Shell was more concerned about “the sustainability of the company or with the sustainability of the planet”, chief executive Ben van Beurden acknowledged that climate change will be “the defining challenge” facing the oil industry for years to come.

He then went on to describe the benefits of energy for millions of people around the world as “quite often a matter of life and death”. He could have been talking about his own industry, which has only just emerged from a brutal downturn and which, according to some, is facing an even graver challenge: whether to invest in oil at a time when climate concerns could see demand peak as early as the 2020s.

It is a question that dominates the energy industry and will determine what the oil majors, including Shell and BP, look like in the future. Driven by investor pressure and a need to rein in costs after the oil price halved in 2014, the industry has largely abandoned new investment in the type of mega-projects, from Arctic exploration to Canadian oil sands, which were once its forte.

In the second half of this decade total capital expenditure by the large oil and gas groups is projected to fall by almost 50 per cent to $443.5bn from $875.1bn between 2010-15, according to Norwegian consultancy Rystad Energy. Although partly offset by a fall in oilfield development costs, the drop also coincides with the big groups ploughing more capital into shorter-term projects, which pay off quickly, as well as renewable energy. The moves come amid fears that electric vehicles pose a huge threat to oil’s dominance.

Oil chart

In keeping with that Mr van Beurden told investors last month that Shell is no longer an oil and gas group, but is an “energy transition company” — a nod to its shift towards a low-carbon energy system.

It is a statement that would have been unthinkable just a few years ago. But persistent cost-cutting and mounting climate concerns have left many in the sector worried that the industry is making a miscalculation. They fear it is turning its back on many big oil and gas projects before efficiency gains, renewables, electric cars and efforts to conserve fossil fuels are able to cap consumption. The result could be supply shortfalls and price rises, storing up a problem for the global economy.

“It’s not wise to be cavalier about a lack of investment,” says Stewart Glickman, an energy equity analyst at CFRA. “The drop over the past four years eventually will have an impact on crude prices.”

He adds that while investment in US shale has grown as companies look to short-cycle projects, bottlenecks and the declining quality of reserves mean it alone might not be able to fill the gap. “To blithely assume that because [the US shale industry] has been able to generate enough production so far that we’ll be able to continue doing so is a risky expectation,” he says.

Investment cut victims

Project Mad Dog 2 (redesigned)
Company BP
Location US, Gulf of Mexico
Originally scheduled to start producing oil before 2020, the project was put on ice five years ago as cost forecasts ballooned to more than $20bn. BP has come back with a new plan it believes will cap costs at $9bn, with 140,000 barrels a day of output coming on stream in late 2021.

Estimates for when oil demand will peak vary wildly. Some experts say it could happen as soon as 2023, others put it off to 2070. That lack of consensus presents a danger, critics say, that the oil groups are being pushed — against their instincts — into shelving complex long-term investments just as demand for oil nears 100m barrels a day for the first time as emerging economies in Asia and Africa expand.

“There is so much uncertainty,” says Andrew Gould, former chairman and chief executive of oilfield services company Schlumberger. “It’s increasingly difficult now to get boards to sign off on projects that have a 20-25 year life.”

Cost deflation has allowed approval of certain projects such as Mad Dog 2, BP’s deepwater offshore project in the US, while others are on hold or have been scaled back. Such projects would have provided a baseline cushion of supplies to smooth out any future market shortages or additional demand. If that supply is not there, some fear a backlash from consumer countries as oil prices escalate.

Officials in India, which will lead oil demand growth in the coming years, are already anxious after the price hit $80 a barrel earlier this year, while eurozone governments will come under pressure should pump prices rise.

For big energy companies and resource-rich economies reliant on vast oilfields for public spending, the fear of demand hitting a peak is pronounced. That it is being discussed at a time when demand has actually been growing at an average of 1.7m b/d every year since 2014 — double the rate at the start of this decade, when oil averaged close to $100 a barrel — is mystifying to some.

Tony Hayward, the former chief executive of BP who is now chairman of the mining and trading group Glencore, casts doubt on the whole strategy, hinting that placating shareholders was winning out against their better interests.

“I don’t think the supermajors really believe the long-term story of peak demand,” Mr Hayward told the Financial Times last week. “Looking at the trajectory, we’re more likely to have a supply crunch in the early 2020s.”

Investment cut victims

Project Bonga Southwest (delayed)
Company Shell
Location Nigeria
Shell’s plan to develop its Bonga oilfield in deep water off Nigeria has been delayed several times since 2015. Having started pumping crude in 2005, Bonga’s $12bn extension was expected to add up to 175,000 barrels a day to output but its future now depends on cutting costs.

Investors are driving this shift. Mainstream asset managers and pension funds are increasingly concerned about the potential financial impact of global warming and of policies to limit it.

Legal & General Investment Management, one of the biggest owners of BP and Shell shares through the UK pension funds it manages, has led the way in telling them to focus less on the risks of short-term price moves, and prepare instead to manage an industry in decline.

Nick Stansbury, who heads L&G’s strategy in energy and commodity markets, says their argument is that while it is impossible to predict exactly when oil demand will peak, they are now convinced the moment is coming. Electric vehicles, a backlash against plastics and the rise of alternative fuels all threaten to cap oil demand, L&G argues.

Oil groups should therefore, he says, avoid projects that take 10 or more years to become profitable — which used to be the industry standard. Instead they should focus on maximising returns to shareholders, including eventually returning capital rather than trying to transform themselves into renewable companies in which they lack expertise.

Oil chart

“We’re not in the school of thought that says peak oil comes in 2021 or that there’s no need to invest in any new oil projects at all,” Mr Stansbury says. “But what we do want them to commit to doing . . . is become the cash flow engines that fund the energy transition.”

He says such a strategy poses risks for the wider world in the form of volatile oil prices, but argues that funds investing other people’s money in energy companies have to remain focused on any longer-term risks.

It is part of a bigger debate. Investors often deemed the oil majors’ spending programmes were far too wasteful when oil was above $100 a barrel, yielding inadequate returns. The 2014 oil price crash forced an overhaul in their approach to investment.

Brian Gilvary, BP’s chief financial officer, insists it is not just investor fear of peak demand that has seen the company move away from longer-term oil and gas projects. In the wake of the 2014 price drop— triggered in part by the rise of US shale and subsequent supply glut — he argues it is sensible for companies such as BP to focus on the fastest and cheapest projects.

“We’re becoming more efficient at how we deploy capital,” Mr Gilvary says. He adds that BP and other energy groups are ploughing a middle road: raising oil production by using technology to sweat more barrels out of existing fields, while also funnelling smaller amounts of capital into so-called short-cycle projects such as US shale.

Presiding over an era of transition: Shell chief executive Ben van Beurden © Bloomberg

“We are not seeing any indication that there is [a supply crunch] coming, but we understand the fear,” says the BP executive. “We are continuing to grow our business . . . and we still see sufficient activity.”

Chris Midgley, a former chief economist at Shell who is now the head of analytics at S&P Global Platts, believes BP’s approach makes sense but warns that the biggest risk will come in five to seven years when focusing investment largely on existing fields could fail to yield enough baseline production. Even if that led to higher prices, oil companies may not respond.

“If we do get higher prices, unlike previous cycles the [international oil companies] might choose to effectively sit on their hands, saying they’ll use the windfall to accelerate into the energy transition rather than making more [oil] investments,” he says. Any prolonged period of higher prices that might follow would inevitably lead to a curb in consumption. “That would be . . . recessionary for the entire economy,” he says.

Investment cut victims

Project Rosebank (delayed)
Company Chevron
Location UK, North SeaJust off the west coast of Shetland. the Rosebank field was discovered in 2004.
Chevron was examining the feasibility of developing a reported $10bn project shortly before the oil price crash. In 2016 it cancelled a $1.8bn order for a floating production and offloading (FPSO) vessel to service the field. Chevron has said the project remains under consideration and it is working on its design and economics.

For now the strategy appears to be working. According to Wood Mackenzie, an oil consultancy, output growth among the oil majors is expected to rise, on average, by approximately 3.5 per cent a year between 2017 and 2020.

After a more than 40 per cent drop in conventional onshore drilling globally from 2014-16, it has since risen by 17 per cent, says Rystad Energy. In US shale oilfields, drilling dropped by 55 per cent over the same period but has increased by 65 per cent since 2016, illustrating the popularity of short-cycle projects. ExxonMobil, which has been slower to address climate risk than its peers, has said there would still be a need for trillions of dollars of investment in new oil and gas production, even in a world where temperature rises would be limited to 2C.

Meanwhile, the recovery in oil prices has largely been driven by factors outside the energy companies’ control. Demand is strong, Opec and Russia purposely trimmed back production in 2017, and since then output in Venezuela has fallen because of the economic and political crisis gripping the country.

US president Donald Trump’s decision to withdraw from the Iran nuclear deal and reimpose sanctions on the country’s energy exports was the final bump to take oil above $80 a barrel. But since then prices have fallen back to around $74 as Saudi Arabia and Russia discuss releasing additional barrels on to the market — something oil ministers will debate at Opec this week.

Some of the biggest oil traders, however, remain unconvinced that it is possible to keep the market well supplied with short-term investments.

Pierre Andurand, a hedge fund manager who oversees more than $1bn in investor money and bets on oil price moves, says it could hit $150a barrel within two years, partly due to the focus on peak demand while consumption is still rising. Other industry executives and analysts see a lower rise but believe prices will return to above $100 a barrel.

“There is pressure from investors for these companies not to invest too much in oil, but at the same time we don’t see electric cars having a major impact on demand growth for at least another decade,” he says. “It is not obvious to me where this supply growth is going to come from.”

Some dismiss this as scaremongering, saying the industry has shifted from an age of perceived scarcity to abundance, meaning much of the long-term investment into big projects is unnecessary.

For now Mr van Beurden is betting that Shell has made the right calculations. A slightly higher oil price would not be the worst thing in the world for his company as it grapples with the energy transition. After all, no chief executive wants to be left holding multibillion-dollar oilfields the world no longer wants or needs.

Italy’s Quadruple Threat to Europe

Michael J. Boskin

Italys Newly appointed Prime Minister Giuseppe Conte, Italys Interior Minister and deputy Prime Minister Matteo Salvini, Italys Labor and Industry Minister and deputy PM Luigi Di Maio and Italys Undersecretary for Prime Minister Giancarlo Giorgetti

STANFORD – Italy’s new Minister of Economy and Finance, Giovanni Tria, has sought to reassure financial markets that the new Five Star Movement/League coalition government will neither abandon the euro nor blow up the budget deficit in violation of EU fiscal rules. But Europe is not out of the woods. Italy’s populist, Euroskeptic government has further heightened the medium-term risks posed by the country’s banking sector, public debt, labor and migration policies, and growth model.

This November will mark the 25th anniversary of the Maastricht Treaty, which transformed the European Economic Community into the European Union; and next year is the 20th anniversary of the launch of the euro. Each institution has not just survived, but expanded, despite challenges such as Greece’s sovereign-debt crisis and the United Kingdom’s decision to quit the EU. But while the eurozone has weathered these storms, a series of unresolved issues still plagues it.

In recent years, growing nationalist and anti-immigrant sentiment has given rise to populist parties willing to challenge EU rules and defy the bureaucrats in Brussels. And since the 2008 financial crisis, many European banks have been on a wobbly footing, and sovereign, corporate, and household debt levels in a number of European countries remain elevated. Though unemployment has fallen somewhat, it is still double the rate in the United States. And after a recent uptick, Europe’s overall economic growth rate has fallen once again.

Moreover, Europe’s population is aging, but attempts to roll back exorbitant transfers, high taxes, and inflexible regulations have met with only limited success. A perfect example is French President Emmanuel Macron’s proposed pension, tax, and labor-market reforms, which have provoked protests at every turn.

All told, Europe has long suffered from tepid growth, excessive sovereign debt – which will become more burdensome when interest rates finally rise – and weak, inefficient banks. And, looking ahead, further trouble in the banking sector could prove particularly challenging, given that well over half of all credit extended in the EU comes from banks – a share that reaches 70% in Germany and Italy. By comparison, just 35% of credit extended in the US comes from banks.

Moreover, a number of eurozone countries’ continuing economic distress and weak competitiveness reflects their lack of a currency to depreciate. The loss of monetary sovereignty, combined with demographic strains and the migrant and refugee crisis, helps to explain why many voters have flocked to populist and nationalist parties. In Italy, the UK, and other key member states, there is a growing hostility to common fiscal rules and such basic EU tenets as the free movement of people.

Europe’s problems tend to reinforce one another. Anemic growth makes it harder to sort out banks’ non-performing loans, which in turn further impedes growth, fueling public discontent. Even if Italy’s new government has ruled out a showdown over the euro in the near term, it will have to confront these economic issues. Tria claims that spending increases and tax cuts are not in the cards; but that is precisely the policy mix the coalition parties agreed to when they formed their government.

Voters in democracies frequently support spending increases and tax cuts, despite any impact on the country’s debt. But Italy’s public debt, at 130% of GDP, is already the highest in Europe. If the authorities do end up flouting EU budget rules, other member states’ governments may be emboldened to follow suit – especially if there is domestic political pressure to do so. Owing to ultra-low interest rates, Italy has managed to keep its deficit under 3% of GDP, in accordance with the EU’s Stability and Growth Pact. But when borrowing costs finally start to rise, Italy’s debt honeymoon will be over.

Making matters worse, a large share of Italy’s sovereign debt is held by its own wobbly banks. Italians have long been hostile to the EU’s “bail-in” directive – which calls for creditors to take a loss in the case of bank failures – because the ownership of Italy’s banks, which emerged from the country’s historic city-states, is heavily localized. Thus, the collapse of an Italian bank would severely damage the economy of the surrounding region, whereas the effects of a US bank failure would be far more dispersed.

Another area to watch is immigration. Since 2011, 750,000 migrants have arrived in Italy from across the Mediterranean. And now Matteo Salvini, the League party leader and Minister of the Interior, is demanding that other EU countries – particularly France – accept more asylum seekers. After recently turning away a rescue boat carrying some 600 migrants, Salvini wrote on Facebook that, “Rescuing lives is a duty, transforming Italy into an enormous refugee camp is not.”

The Italian electorate’s growing hostility to immigration is part of a larger trend across the EU, from Hungary and Poland to the UK. Just before the Brexit referendum in 2016, then-British Prime Minister David Cameron made a last-minute appeal to German Chancellor Angela Merkel, imploring her to agree to a cap on the movement of people into the UK. Merkel refused, and the Brexit referendum passed by a narrow margin.

The irony is that Merkel is now facing the same anti-immigration backlash that Cameron did in 2016. Immigration tends to be good for an economy over the long term, especially if the ratio of retirees to workers is rising. But when the level of immigration exceeds a country’s capacity to absorb new workers, there can be severe economic and social costs, at least in the short term.

Across the EU, there are growing tensions between conceptions of local autonomy, national sovereignty, and supranational authority. If Europe’s cyclical upturn does not translate into long-term sustained growth, then the quadruple threat of Italy’s banks, debt, immigration backlash, and economic malaise will test the resilience of the single currency – and of European integration generally. Much will depend not just on Italy’s new government, but also on the fate of Macron’s reform agenda.

Michael J. Boskin is Professor of Economics at Stanford University and Senior Fellow at the Hoover Institution. He was Chairman of George H. W. Bush’s Council of Economic Advisers from 1989 to 1993, and headed the so-called Boskin Commission, a congressional advisory body that highlighted errors in official US inflation estimates.

 Emerging Market Crisis Spreads To The Core, Central Banks Face Catch-22  

One of the things giving “data-driven” central banks wiggle room on their pledge to tighten monetary policy is the fact there are several definitions of inflation. In the US the thing most people think of as inflation is the consumer price index, or CPI, which is now running comfortably above the Fed’s target. But the Fed prefers the personal consumption expenditures (PCE) price index, which tends to paint a less inflationary picture. And within the PCE universe, core PCE, which strips out energy and food, is the data series that actually motivates Fed action.

And that, at long last, is now above the 2% target, having risen 2.3% in the past year.
On the following chart, the core PCE is the blue line. Note the steepening slope towards mid-year.

This is clearly a trend with some momentum which, if it continues, will take this index from slightly above target to substantially above.

PCE inflation

A more surprising above-target reading just came from Germany, which didn’t used to have inflation of any kind. But now it does:
(Reuters) – German inflation surpassed the target set by the European Central Bank for the euro zone in June, the second month in a row it has done so, lending support to the ECB’s decision to close its bond purchase scheme at the end of the year. 
Data published by the Federal Statistics Office on Thursday showed that EU-harmonised German consumer prices rose 2.1 percent year-on-year. The same measure had increased by 2.2 percent in May. The yearly figure matched a Reuters forecast.
German inflation

Again, note the pop over the last couple of months. If this is sustained, the European Central Bank will have to speed up its leisurely tightening pace. Right now it’s scaling back its bond-buying but not signaling higher rates – which will definitely have to be on the menu if German inflation stays above 2%.

Emerging Market Crisis

But there’s a tricky dynamic now in play: Higher interest rates and rising currencies in the core of the global financial system cause trouble on the periphery, which then boomerangs right back to the core. Already, since the US Fed began raising rates and the dollar started rising in response, the effects have been dramatic: In just the past quarter:
  • The DXY index, which tracks the US dollar against other major currencies, rose 5%.
  • The Argentine peso and Brazilian real fell 30% and 14%, respectively.
  • The Turkish lira and South African rand each fell nearly 14% versus the dollar.
  • A bunch of Asian emerging market currencies fell 3% – 6%.
  • Europe’s emerging markets weren’t spared. The Hungarian forint (-10.0%), Polish zloty (- 9%), and Czech koruna (-8%) led a long list of EU peripheral currency losers.
  • China’s stock indexes fell by double-digit percentages in the quarter, though that might have more to do the incipient trade war than relative inflation and interest rates.
  • Asian junk bond spreads (their yields versus those of high-grade bonds) widened dramatically.
  • Emerging market bank stocks got crushed, including Banco do Brasil (-30%), Banco Bradesco (- 30%), and Brazil’s Ibovespa stock index, down 27% in U.S. dollars.
  • Last but definitely not least scary, US and European bank stocks fell hard last week, which isn’t surprising since they’re on the hook for untold amounts of the aforementioned emerging market securities and currencies.

Now, all of this might blow over in coming months the way so many other mini-crises have since the beginning of the Great Monetary Experiment in 2009. But if central banks keep tightening in the face of all this carnage, it might blow up instead of over.

Put another way, stopping the current slide towards financial chaos might require a quick about-face by major central banks towards lower rather than higher interest rates, expanding rather than contracting balance sheets, etc.

Which is a bit of catch-22: The peripheral crisis will keep moving towards the core unless stopped by massive central bank ease. But — given the rising inflation now being reported — central banks won’t switch back to massive ease unless the peripheral crisis moves much closer to the core (or something else equally terrifying happens first).

The resolution or lack thereof won’t be long in coming.

In Mexico, Big Challenges Await the Next President

Voters are frustrated with the lack of progress and are demanding change.

On July 1, nearly 90 million Mexican voters will go to the polls to elect more than 3,000 local, state and federal representatives, including the country’s next president. It was six years ago that Enrique Pena Nieto was elected president and introduced the Pact for Mexico, a major plan for reform aimed at improving the country’s economic performance, development, security and government transparency. But despite these efforts, Mexico’s next president will inherit many of the same challenges that Pena Nieto faced in 2012, some of which have grown even more severe over the past six years.

Many voters are thus frustrated with the lack of progress, which largely explains why the candidate representing Pena Nieto’s party, the Institutional Revolutionary Party, or PRI, is currently polling in third place. The front-runner, Andres Manuel Lopez Obrador, who heads the National Regeneration Movement, is a left-leaning nationalist candidate who defies the status quo. He holds a roughly 20-point lead over his closest rival, Ricardo Anaya, who heads the National Action Party, or PAN. 




Though Lopez Obrador appears increasingly likely to win – presidential elections in Mexico are decided in one round, so he needs only a plurality to become president – it’s not a foregone conclusion. Polls in Mexico are notoriously unreliable, and about 20 percent of voters remain undecided. Still, attention in this election campaign has focused on Lopez Obrador, not only because he’s the top contender but also because his election would represent a break from traditional, establishment politics in the country. From 1934 to 2000, Mexico was governed by members of PRI. After 2000, the leading opposition party, PAN, won two terms before PRI once again became the top party in 2012. If Lopez Obrador were to win, it would be the first time since 1934 that a party other than PRI or PAN formed a government.

The popularity of Lopez Obrador is largely a result of the widespread desire for change. There have been some economic changes in the past six years, but for many they have produced few results. Take the energy industry, for example. By many accounts, Mexico’s energy sector reforms have been successful. The government has deregulated the energy markets to encourage more foreign participation and investment. But the drop in oil prices since late 2014 has discouraged investment in the industry worldwide. Lower prices also forced the government to temporarily subsidize oil production and exacerbated the fall in production. State-run oil company Petroleos Mexicanos, or Pemex, has gone from producing 2.88 million barrels per day of light hydrocarbons in 2013 to 2.14 million bpd in 2018. Despite the moderate recovery in oil prices, Pemex production has continued to decline due to a number of factors – resource depletion, insufficient liquidity and investment, lack of technology to address aging fields, the weaker peso relative to the dollar and cash flow shortfalls. These problems have led some, including Lopez Obrador, to call for additional changes and even partial rollbacks of the reforms.

In addition, the new administration will need to tackle the rising dependency on imports to supply the country’s gasoline and natural gas needs. Last year, according to Pemex, Mexico imported about 75 percent of its gasoline, roughly 80 percent of which came from the United States. Mexico imported 570,000 bpd in 2017, and according to estimates, it will import 603,000 bpd in 2018. The increasing dependence on imports is partly due to declining production in Mexico and a severe shortage in refining capacity. Pemex has six aging refineries that are currently at roughly 50 percent capacity. Its refined petroleum production fell from 1.46 million bpd on average in 2013 to 795,000 bpd in 2018. At the same time, demand for gasoline has increased. Thus, imports have more than doubled in the past decade.

Similarly, natural gas supplies are increasingly dependent on imports. Mexico imported 5.14 billion cubic feet per day of natural gas in March this year, accounting for 64 percent of the country’s natural gas consumption. Over 80 percent of the natural gas imports came from the United States. As the trade dispute with the U.S. ramps up, these imports increase Mexico’s vulnerability. To address this problem, the country will need not only to increase oil production but also to work toward expanding refinery capacity and building gas storage inventory and facilities.

Another massive challenge with which the new president will have to contend is violent crime, which has been on the rise since 2015. In 2013, during Pena Nieto’s first year in office, 18,331 violent homicides were reported in the country. Last year, this number reached a record high (25,339), and this year it is on pace to surpass that figure. Efforts have been made in the past six years to reform the criminal justice system and crack down on organized crime, but they have proved rather ineffective.

The violence has had an economic impact. Some companies have been forced to temporarily close facilities because of security concerns, while others are anticipating financial losses. Private sector estimates indicate that investment may fall by up to 5 percent as a result of the violence. There hasn’t yet been a large-scale exodus of companies from Mexico, but the situation will become intolerable when companies operating in Mexico see a hit in profits in the long term.

And it’s impossible to discuss what awaits Mexico’s next president without addressing U.S.-Mexico relations. The U.S. will dominate much of the next administration’s agenda, particularly when it comes to trade and immigration. Trade with the U.S. is actually one area where all three leading candidates are in broad agreement – they all believe that it’s an essential part of the Mexican economy. During the presidential debates, the candidates focused on why they were the best person to negotiate with the U.S., but none actually questioned the benefits of the trade partnership itself. Even if an agreement on NAFTA is reached before the new president assumes office on Dec. 1, he will still have to enforce the agreement and make sure the U.S. does as well. He will also need to address how and to what extent Mexico should diversify its trade in the long term.

As for immigration, Mexico has two challenges. The first is border control. The second is the influx of immigrants from Central America. The government has made efforts to improve the National Migration Institute, the agency that oversees immigration, to better handle the influx. Mexico will have to work with the U.S. and governments in Central America to improve security and limit the flow of people across its southern and northern borders.

Mexico’s next president will inherit a country fraught with deep economic and security problems. The public has grown increasingly dissatisfied with this state of affairs, and the establishment, including the current ruling party, has had its chance to find solutions. Thus far, it has failed. Many voters now appear ready to back an alternative candidate, one who ran for president twice before but was never so close to winning office. Lopez Obrador’s popularity indicates their frustration with the status quo and the desire for change. Elections, after all, are expressions of social undercurrents, not the other way around.

Will Mexico Get Its Donald?

By Bret Stephens

Presidential candidate Andrés Manuel López Obrador waves to supporters at his closing campaign rally in Mexico City on Wednesday.CreditRamon Espinosa/Associated Press

Mexicans go to the polls on Sunday, politically united on just one thing: total contempt for Donald Trump. So why do they seem intent on electing their own left-wing version of him?

That’s the larger question hovering over the expected victory of Andrés Manuel López Obrador, or AMLO, a populist firebrand making his third bid for the presidency. The former Mexico City mayor came within a hair of being elected in 2006, only to be routed at the next ballot in 2012. Now he’s coasting to victory, with Bloomberg’s polling average showing him winning more than 50 percent of the vote in this year’s four-way race.

What’s different this time? Mexicans are mad as hell at a system they see as self-dealing, under-performing and corrupt. That should sound familiar to Americans — not to mention Italians, Britons, and those in every other nation swamped by the populist tide. In Mexico’s case, they’re largely right.

Enrique Peña Nieto, the outgoing incumbent, came to office promising to cut the crime rate in half. Instead, Mexico suffered more than 25,000 murders last year, a modern record. He promised an end to corruption. His administration is suspected of spying on anti-graft investigators, and his wife was caught buying a $7 million mansion from a government contractor. He promised economic growth of 6 percent a year. It hardly ever got above 3 percent. The average wage fell by about $1,000 during the Great Recession and hasn’t recovered since.

All this, while Mexicans have been vilified as rapists and murderers and freeloaders by the American president, who is also on record saying he couldn’t care less whether his policies hurt them. If AMLO wins, Trump will deserve him.

For Mexicans, however, not so much. AMLO’s popularity rests on the belief that he will end corruption, bring down crime, and redistribute ill-gotten gains to the people. How, exactly? Just as Trump declared at the 2016 Republican convention that he “alone” could fix a broken system, AMLO seems to have convinced his base that he can just make things happen. “Everything I am saying will be done” is how he punctuates his pledge to make government fair and honest.

Down with politics and the art of the possible; up with pronouncements and the allure of the prophetic: It’s the way of demagogues everywhere.

Trump promises to build border walls, win trade wars, keep us safe from terrorism, and end Obamacare, all at the snap of a finger (or an executive order). His ardent supporters believe it’ll happen, either because they are depressingly ignorant of checks and balances or secretly committed to doing away with them.

Similarly, AMLO promises to fix social inequities that date back 500 years in a single six-year term. In an interview with The New Yorker’s Jon Lee Anderson, he compares himself to Benito Juárez, Mexico’s answer to Abraham Lincoln. The idea of steady improvement and gradual amelioration isn’t for him. In Mexico’s current anger he seems at last to have found his moment.

Some of AMLO’s skeptics take solace in the fact that in this campaign he has moderated his policies, modulated his tone, reached out to the business community, and promised to work pragmatically with the United States.

But it isn’t clear whether the softer rhetoric is anything more than an attempt to allay the fear (which factored heavily in his previous defeats) that he’s a Mexican Hugo Chávez. If he wins the presidency with big legislative majorities, there won’t be an institutional check on his ambitions. That rarely works out well in fragile democracies, especially when the ambitions run in the direction of economic statism and political populism.

It especially doesn’t work out well when populist policies collapse (as they generally do) on contact with reality. What typically follows isn’t a course correction by the leader or disillusionment among his followers. It’s an increasingly aggressive hunt for scapegoats: greedy speculators, the deep state, foreign interlopers, dishonest journalists, saboteurs, fifth columnists, and so on. That’s been the pattern in one populist government after another, from Viktor Orban’s Hungary to Recep Tayyip Erdogan’s Turkey to, well, Trump’s America. Now Mexico risks being next.

I grew up in Mexico City at a time when the country was a repressive one-party dictatorship almost wholly dependent on oil revenues. Over nearly 40 years I’ve watched it become a multiparty state with a thriving manufacturing base, a growing middle class, and at least a belief in political accountability. That’s progress, and a reminder that Mexico’s myriad discontents, though serious, are also evidence of rising expectations.

I’d hate to think all that will now be thrown away. As Mexicans cast their ballots, I hope they’ll remember that the wages of popular resentment are too often returned in the coin of political ruin. The last thing they need now is a Donald Trump of their own.

Leaderless Europe

By Nora T. Kalinskij


German Chancellor Angela Merkel is in need of an ally, but she’s unlikely to find one in French President Emmanuel Macron. When the two leaders meet June 19, they’ll be trying to do what has eluded both countries for years: chart a path forward for the European Union. Their inability to agree on major EU reform has less to do with Macron’s or Merkel’s personalities than with the conflicting interests of the countries they represent.

France lost its dominant position on the Continent the day Germany unified in 1871. When Germany was divided after World War II, Paris saw the chance to build an international structure that could contain Germany in the future. The European Coal and Steel Community, the foundation on which the European Union was built, was intended to integrate Germany’s coal and steel industries – the critical components of military rearmament – with those of France and a handful of other Western European countries. Integration proceeded and expanded, but France failed in its objective.

Now Germany is divided again – figuratively, this time. Merkel and her party are facing an unprecedented challenge from their sister party in Bavaria, the Christian Social Union, over immigration policy. The CSU leadership has given her two weeks to forge an acceptable EU-wide consensus on reform, vowing to take steps that would force her hand if she fails. It’s a standoff that could bring down her government, but it’s just one of several topics of discussion between Merkel and Macron.

Macron’s proposed reforms are an attempt to put Germany back on a leash and return France to pre-eminence in Europe. He originally laid out a radical position that Germany could not accept: a “two-speed” Europe, whereby willing members would become more integrated and leave those resistant behind, with a joint budget and finance minister. Merkel rejected the proposal, as Macron expected, but it set the stage for compromises the French could accept and came with the bonus of making the Germans appear obstructive to France’s efforts to move the EU forward. In this way, Macron hopes to attract support from EU member states for French leadership in reforming the bloc.

Meanwhile, Germany, Europe’s economic powerhouse, wants to resist reforms that would burden it politically or economically. The most important condition that any reform must fulfill from the German perspective is to keep members committed to the common market and the common currency – without Germany having to pay for it, either literally or through lost sovereignty. More political integration would inevitably hamper Germany’s control over its purse. And Germany, whose economy depends on exports, needs the EU common market and the euro to facilitate trade with the rest of the Continent. Roughly two-thirds of Germany’s exports in 2016 stayed in Europe, and the bulk of that never left the EU. Without those exports, Germany lacks the internal demand to maintain its current level of economic growth and prosperity. 

Germany and France agree on the problems but not the solutions. They agree in principle, for example, on the need to establish a European Monetary Fund, which, in addition to long-term loans, could provide short-term credit to member states with few strings attached. The purpose of these short-term loans would be to help members deal with economic problems before they threaten the stability of the eurozone. Germany’s position is that the EMF should be controlled by member states directly. In this way, the German parliament would retain its ability to veto eurozone aid packages. France, however, would prefer to keep the EMF and financial aid packages separate from the vagaries of individual countries’ politics.

Another point of disagreement is defense. Germany supports the French proposal for a joint European force to intervene in hotspots where the entirety of NATO may not commit (for instance, in West Africa). France suggested a “coalition of the willing” outside of EU structures and dominated by the most powerful military on the Continent – France’s. This coalition would augment France’s military resources, and unlike in NATO – where the U.S. dominates – France would be the ultimate decision-maker. It’s not hard to see why this is unappealing to the Germans. Germany would support this coalition only if it remains within existing EU defense structures and if the German armed forces stay under Germany’s parliamentary control.

None of this would necessarily be a problem in need of immediate resolution were it not for the threat of immigration and financial crises, which are pushing France and Germany toward compromise. The EU is still vulnerable to the same problems that threatened to rip it apart in the past decade. Looming largest is the danger that some member states have massive national debts that they may not be able to service much longer. Despite the common currency, spending is controlled by national governments, which means the policies of one member can still put the rest at risk (as was the case with Greece).

Now the biggest threat to the eurozone is Italy. The new Italian government’s economic plans can be summarized as fewer taxes, more social spending – a recipe for higher government debt. Even if the Italian economy sees growth as a result, that growth is unlikely to cover the costs. Carlo Cottarelli, former director of the International Monetary Fund, estimates that the new government’s plans could cost as much as 126 billion euros ($146 billion). If the time came when Italy needed to be bailed out, it would be the other eurozone members picking up the tab.

It’s a situation France and Germany would prefer to avoid, which means they need to make compromises. Macron, for instance, has given up on a joint eurozone budget and finance minister. Still, the EU needs to make a change, either by giving more power to Brussels or by giving some back to the member states. The latter is not an option because it would weaken the EU to an extent that France and Germany cannot abide. The former is not an option because France and Germany can’t agree. Ultimately, when the EU meets at the end of this month, it will probably have to do what it usually does – adopt watered-down reforms. At best, this might help with some of the symptoms, but it won’t treat the disease.

Meanwhile, hanging over the heads of Merkel and Macron as they talk is the threat that others could start making moves that force the EU’s hand. Austrian Chancellor Sebastian Kurz was busy last week orchestrating an “axis of the willing against illegal immigration” with Italy’s new government and Merkel’s own interior minister (and leader of the CSU). For them, watered-down reform may not be enough. If the EU does not get on with it, its members will get on without the EU.

Ike Was Right!

by Bill Bonner

We wait for the world to fall apart.

The Dow is still more than 1,000 points below its high; so we presume the primary trend is down. Treasury yields—on the 10-year note—are near 3%… twice what they were two years ago. So we presume the primary trend for bond prices is down, too.

If we’re right, we are at the beginning of a long slide… down, down, down… into chaos, destitution, and destruction.

Faked Out

Our working hypothesis is that General Eisenhower was right. There were two big temptations to the American Republic of the 1950s; subsequent generations gave in to both of them.

They spent their children’s and grandchildren’s money. Now, the country has a government debt of $21 trillion. That’s up from $288 billion when Ike left the White House.

And they allowed the “unwarranted influence” of the “military/industrial complex” to grow into a monster. No president, no matter how good his intentions, can stop it.

A corollary to our major hypothesis is that the rise of the Deep State (the military/industrial/social welfare/security/prison/medical care/education/bureaucrat/crony complex) was funded by the Fed’s fake-money system.

Now, investors, businesses, households, and the feds themselves have all been “faked out” by a fraudulent money system. None of them can survive a cutback in credit.

For nearly 30 years, central banks have backstopped markets and flooded the world with liquidity.

But last week, the Fed turned the screws a little further. It now targets a 2% Fed Funds Rate, up from 1.75% today, and claims to be on the path of “normalization.”

And the European Central Bank (ECB) made it official, too; it hasn’t quite begun tightening, but it’s got its toolbox open. And command of the ECB work crew is set to change hands next year anyway, passing on to a German engineer.

Scarred Psyche

The German psyche has been scarred by its awful experience in the last century. Even though today’s Germans didn’t live through it themselves, the entire country seems to have a race memory of it.

Still preparing for hard times, the household savings rate in Germany is at least three times higher than in the sans souci U.S.

Germany’s 20th century apocalypse, too, can be described in Eisenhower’s terms—too much debt (arising from World War I)… and too much influence in the hands of the military/industrial complex.

Debt led to hyperinflation. But the damage done by Germany’s hyperinflation of the early ’20s led to far more than just wiped-out mortgages and billion-dollar cigars.

It discredited the traditional elite of the country—its institutions, its culture, and its politics. Germany had the world’s finest artists, composers, and philosophers. Its writers, engineers, and scientists were second to none.

Even in the early ’30s, Germans could still look to the East—to the madness, purges, and famines of Russia—and say to themselves: “Ah, that couldn’t happen here; we are so much more civilized.”

But by then, civilization was on the run, from the Rhine all the way to Siberia. And in Germany, the old elite was being chased out of leading posts in academia, the military, and the government.

Ruined by hyperinflation and chaos—and hounded by extremists—thousands emigrated from Germany to England and America. Those left yielded to mob spirits and rabble-rousing upstarts—communists, anarchists, and national socialists—who fought it out in the streets.

The national socialists—the Nazis—won. Even though it was prohibited by the Versailles Treaty, they quickly began building up the military/industrial complex.

Then, as Madeleine Albright phrased it, “What good is it having such a powerful military if you can’t put it to use?”

As it transpired, Germany attacked the Soviet Union. By then, the average Russkie may have hated Stalin, but he rallied to defend Mother Russia.

By the end of World War II, eight million Germans would be dead, with millions more condemned to die in prisoner-of-war camps or from starvation.

By 1945, Germany had been bombed so thoroughly that nothing much was left of its once-impressive industrial capacity.

Its farms had been starved of investment (the money went to the military) for the previous 10 years. And the country had been cut in half, with foreign troops ruling over every aspect of life.

And today, 73 years later… there are still foreign troops garrisoned on German soil… and the Germans still fear letting the money system get out of control.

They’re right to be wary of runaway money. It turns honest wage-earners into paupers, while the speculators get rich.

Worse, it gives the meddlers a source of almost unlimited financing. Then, there’s no telling what mischief they will get up to. Revolution? War? Or simply a complete economic collapse?

Greasy Stew

News also came last week that the inflation rate in Venezuela has reached 24,600%. In other words, if you bought a pack of cigarettes for $5 last June, you could expect to pay $1,230 for the same pack today.

When the money goes, everything seems to go with it. The economy, government, order, morality, right and wrong—all sink into a greasy stew where you don’t know which parts are edible and which are poisonous.

This year’s rise in oil prices was supposed to give Venezuela a little break. Oil is the country’s biggest asset and its major export. And the state-owned oil giant PDVSA was supposed to rescue the nation.

But it is too late.

The vernacular—the vast web of thoughts and deals that make up everyday life for everyday people—has been so corrupted and distorted that it can’t react normally. Venezuela can no longer take advantage of opportunities or respond to crises. The New York Times reports:

Desperate oil workers and criminals are also stripping the oil company of vital equipment, vehicles, pumps and copper wiring, carrying off whatever they can to make money. The double drain—of people and hardware—is further crippling a company that has been teetering for years yet remains the country’s most important source of income.

Wages could not keep up with inflation. The NYT highlights the case of a typical rig worker who stayed on the job for the entire month of May, yet earned only enough to buy one chicken.

No longer able to feed their children, workers walk off the job. Or drive off.

Trucks disappear. So do wrenches and copper pipes. Even with a higher oil price, income falls for the company… the state… and the remaining employees.

What’s a man to do?

Leave! Venezuelans are rushing the borders to escape, often taking little more than the clothes on their backs with them.

But wait… Americans are civilized people with full employment, a solid dollar, and a military that is bringing order to a troubled world. What possible significance could Germany 1920–1945 or Venezuela 1999–? have for us?

And Eisenhower was just an old worrywart, wasn’t he?

Stay tuned…