Economy watch - again

Last week I noted that the drop in commodity prices caused by China's economic woes was beginning to affect not only companies, but national economies around the world.  The problem appears to be getting worse very quickly.  Bloomberg reports:

The rout in commodities deepened with prices touching the lowest since 2002 ... Raw materials are losing favor with investors as the dollar gains amid signals from Federal Reserve Chair Janet Yellen that the central bank may raise rates this year on the back of an improving U.S. economy. Higher borrowing costs curb the attractiveness of commodities such as gold, which doesn’t pay interest or give returns like assets including bonds and equities.

The Bloomberg Commodity Index dropped as much as 1.4 percent, falling for a fifth day in the longest stretch of declines since March. Gold futures sank to the weakest in more than five years while industrial metals, grains, Brent crude and U.S. natural gas also slid as a measure of the dollar climbed to the highest since April 13.

There's more at the link.

Casey Research points out:

A strong US dollar is one big reason commodities are struggling. The dollar is up 21% this year versus an index of major currencies. When the dollar goes up, the price of “stuff,” like oil, gold, and corn, usually goes down. As you can see, that’s exactly what’s happening...  (Click the graph for a larger view)

Again, more at the link.

What many people fail to take into account is that the commodities crisis involves many different components that 'feed on' each other in a downward spiral, making things progressively worse for everyone.  To put it in relatively simple terms:

1. Demand for Country A's exports falls.
2. Manufacturers in Country A therefore buy less commodities to supply their assembly lines.
3. Country B, which supplies those commodities, finds that demand has slackened, so companies there now make less money than before.
4. Those companies must now lay off workers and spend less on infrastructure and equipment in order to survive.
5. That reduction in employment and corporate expenditure means that there's less money circulating in Country B's economy, which means it can no longer afford to import as much in the way of manufactured goods as it did before.
6. Country B's lower demand for manufactured goods has a 'rebound' effect on manufacturers in Country A, who must reduce production even further in response.
7. Therefore, Country A buys even fewer commodities from Country B, forcing the latter's producers to reduce production even further . . . and so the cycle continues.

Ironically, the collapse in commodity prices looks set fair to hurt Iran worse than most exporters.  Oil prices have plummeted, and there's a glut on the market - so much so that supertankers (almost alone among commodity shipping vessels) are in high demand and producing excellent profits for their owners.  The Financial Times reports:

After suffering five years of flatlining rates and shrinking profits, operators of Very Large Crude Carriers (VLCCs) are enjoying strong trading conditions for the first time since the financial crisis, when a glut of new tankers came on the market just as demand collapsed.

Since the turn of the year, the cost of hiring a VLCC has jumped more than 50 per cent, with the rate for shipping oil from Saudi Arabia to Japan — the benchmark supertanker route — rising to almost $90,000 a day, a seven-year seasonal high.

For the big tanker companies such as Euronav, DHT Holdings, Teekay Tankers, Frontline and Nordic American, the oil market rout that started in 2014 is a boon, which could allow them to pay down debt, invest in new vessels and reward shareholders that have stuck with them through the lean years.

“It’s a very favourable environment for ship owners,” said Svein Moxnes Harfjeld, joint chief executive of DHT Holdings, a New York-listed tanker company. “Companies like ours are generating a lot of cash.”

A cyclical and volatile industry prone to booms and busts, the tanker market has three main drivers: demand for oil; the distance between producing and consuming regions; and the supply of new ships. They are all positive at the moment.

For operators who have only small debts and low operating costs, analysts estimate profits could be as high as $40,000 per tanker a day on the routes to China, as producers and traders try to find customers for a surplus of oil estimated at 2m barrels a day.

Even though output from high-cost oil producers is expected to slow next year, forecasts published this week by Opec, the cartel of oil producing nations, indicate the market will remain oversupplied by at least 1m b/d before adding higher supplies from Iran after this week’s nuclear deal.

The near halving in oil prices has helped increase shipments as China and India use the downturn to fill strategic oil reserves. Many oil refineries are also running flat out as cheaper crude oil has boosted profit margins for selling gasoline, diesel and jet fuel.

“A clear pattern has emerged in the past couple of months of very aggressive Chinese buying of Middle East crude,” said Georgi Slavov, head of research at Marex Spectron, a commodities brokerage.

The huge oil glut has also redrawn traditional supply routes for many tanker operators as producing countries are forced to ship their crude longer distances to find customers. This is most evident in the Atlantic Basin, where shipments to the US have plummeted because of rising supplies brought about by the shale revolution.

“West African oil used to be sold into the US Atlantic coast. That was a 5,000-mile voyage. Now it is being sold in the Asia-Pacific region — that’s a 10,000-mile voyage,” said Paddy Rodgers, chief executive of Belgium’s Euronav, the world’s largest independent tanker company.

More at the link.  Bold underlined text is my emphasis.  It means that the lifting of economic sanctions against Iran, as a result of the nuclear deal with that country, will mean it's about to re-enter an oil market already awash in over-production.  The mullahs won't be pleased to find they can only sell their oil at bargain basement prices - and even if they find a market, they may not be able to obtain tankers to get their oil there.

World markets are in a turbulent state right now.  My concerns about the global economy remain very high indeed, and I think the second half of 2015 has the potential to be disastrous if things go badly.  I'm not alone in that:  Michael Snyder (whose views are more alarmist than mine) has issued a 'Red Alert' for the last six months of 2015.  Go read his views for yourself.

Perhaps the clearest illustration of why I think the US economy is in serious trouble comes from Sprott Money.  This may seem far-fetched to you, but I assure you, if you factor in real (as opposed to 'official') rates of inflation (about which I've written here many times before), it isn't far from the truth.  The author is more alarmist than I am, but he backs up his assertions with some very thought-provoking statistics.  Judge it for yourselves, particularly by following the links he provides in the text.

A retail sales number which is not adjusted for inflation (by subtracting the rate of inflation) only tells us how much depreciating money the people spent, not how many goods and services they actually purchased.

In June of this year, the month just reported; U.S. retail sales are estimated by the government to have fallen (month-over-month) by 0.3%, a seemingly insignificant number. But this is before we adjust that number for inflation. What is the rate of inflation, the real rate?

Our governments hide that secret with statistical falsifications too numerous to list, and in many cases too complex to explain to those without a formal background in economics. But we can see this real inflation, in our own lives. Food and shelter, the two most-important categories of consumption, are soaring at the most-rapid pace seen in our lifetime, somewhere above 20% per year.

Other categories of “consumer goods” have increased in price at a much lower rate, but here’s the point. As more and more of our populations descend to the economic status of Working Poor (or lower), food and shelter become the only categories of consumption. Thus, for this growing majority of our populations, the “inflation rate” for food-and-shelter becomes THE inflation rate: 20+% per year.

John Williams of Shadowstats.com estimates inflation to be near (but not above) 10%. But he calculates that inflation rate honestly using the “basket of goods” of a Middle Class society (the Middle Class of the United States). That society no longer exists. In the basket of goods of the Working Poor; there is only food and shelter.

. . .

For statistical convenience ... let’s assume a conservative, overall inflation-rate of 12% per year.

Now let’s return to the unadjusted number for retail sales reported by the U.S. government. The monthly decline of 0.3% becomes a plunge of 1.3% once we subtract the monthly inflation rate (12% per year, divided by 12 months). But we’re used to seeing statistics expressed as annualized numbers.

If we take this monthly plunge in retail sales and “annualize” it; we see that U.S. retail sales fell in June at an annualized rate of 15.6%, once adjusted conservatively for inflation. In a consumer economy that is a sickening rate of decline. Now it’s time to look at the Big Picture. Here we see that U.S. retail sales have been falling not just this month, or just this year. Adjusted for inflation, U.S. retail sales have been falling every year, and nearly every month – cumulatively.

If we go back to the end of 2007, to the bursting of the U.S. housing-bubble, and the collapse of the U.S. economy first became visible/painful for the American people; since that time U.S. retail sales have plummeted by roughly 50%. Let me repeat this; in this consumer economy, U.S. retailers are selling roughly half as many goods (and services) as they were selling less than eight years ago.

This relentless, severe decline in retail sales is not the symptom of some mere recession. A collapse of this magnitude and duration – in a consumer economy – can only be the symptom of a Greater Depression. Here it must be understood that the term “consumer economy” itself is nothing but an economic euphemism for a dying economy.

What does an economy do when it no longer produces enough goods to pay its own bills? It “consumes”, meaning it cannibalizes (i.e. consumes) all of the accumulated wealth of that society. And when the “consumer economy” has cannibalized all that wealth? It turns to debt.

As a matter of arithmetic; no entity can pile-up more and more debt forever, not even according to the voodoo economics of charlatan economists. What happens when a dying, consumer economy has mooched/borrowed all the debt it is capable of absorbing? We get the U.S. economy.

More at the link.

As Karl Denninger concludes:

That damage [caused by debt], unless we stop this ****, is permanent and once that maximum [economic] growth rate drops below zero, which it will within the next five to seven years (10 if you believe the optimistic CBO estimates), there is utterly nothing we can do to prevent what is happening in Greece right now from happening here.

Word.

Peter