Here’s what we know. Prices for both gold and oil were moving upward for most of the spring and well into summer. Then prices hit a peak. Gold touched $980 per ounce. Oil topped $146 per barrel. Now prices are falling.

Back when oil was in the $140s, I said — in both print and broadcast interviews — that oil prices were running up too far, too fast. I predicted that oil prices would decline to $100-110, based on the fundamentals. Well, we’ve seen the decline and we’re almost there.

High oil prices have caused big changes in patterns of consumption. Indeed, the U.S. Department of Energy just announced that U.S. oil demand fell by about 800,000 barrels per day during the first half of 2008, compared with the same period last year. This is the biggest volume decline in 26 years, since the recession of the early 1980s.

Sure, some headlines describe what’s going on as something like the “oil bubble” or “commodities bubble” popping. Some people are talking and acting as if we were going back in time to the last era of cheap energy, cheap gold and cheap commodities. But don’t believe it. Don’t bet on it. And don’t play the markets that way.

A Correction Was Due

What’s going on? We are in the midst of a short- to medium-term correction in the trends for energy and resources. Keep this in mind: This is a CORRECTION, not a fundamental change in the long-term correlation of things.

The long-term trends are still upward, in terms of value and pricing. But for now, the money is leaving energy and resources for pastures that look greener.

What pastures are greener? Well — speaking of green — the U.S. dollar is strengthening. It turns out that the euro is not the powerhouse currency that a lot of people believed it was. So the dollar has been strengthening against the euro for the past couple of weeks.

The Euro Can Go Down

And it turns out that euroland has its own economic problems. In fact, the euro can go down against the dollar, as well as up. That’s exactly what has happened. Euro down, dollar up. So in consequence, we are seeing the dollar going up, and oil and gold going down.

There is more to the equation. The economists are describing a recession occurring in parts of the euroland economic space. Germany — with Europe’s largest economy — has been hard hit, so there’s been quite a bit of drag on the euroland economy.

And then there are indications that the long-awaited U.S. recession is finally just around the corner. Really, we are just in the middle innings of the banking meltdown and housing crash in the U.S. The recent stock market turnaround may just be the seventh- inning stretch. I expect to see more large banks and investment houses either fail or get bailed out before the end of 2008.

So with two of the world’s largest economies about to enter the doldrums, world markets are seeing demand for energy and commodities slacken.

Thus, we have monetary issues with the dollar. And there are demand issues with economic slowdown in two of the world’s largest economic blocks. Prices for benchmark items like gold and oil are falling.

But looking in the long-term gold and oil are headed back up, for all the familiar reasons. Really, it’s not like anyone is finding new large gold or oil deposits out in exploration land. Indeed, a whole lot of looking is leading to not very much finding in the exploration patch.

The big gold miners are pulling ore out of the ground. But generally, they are not replacing their mined reserves through reserve growth or resource expansion. To the extent that the mining companies are expanding reserves in the short term, it’s by digging deeper. And that raises the cost structure for production.

Rising production costs are eating into profitability. So in the medium to long term, the big guys will have to find new reserves by digging on Wall Street, if not on the TSX Venture Exchange. There is already some takeover activity occurring, but it has been hamstrung by the broken world banking system.

It’s the same thing with the large Western oil companies. It’s a rare oil company that replaces its annual output with new reserves.

Until we meet again…
Byron W. King
August 20, 2008

P.S.: I truly do believe that we are seeing nothing more than a market correction when it comes to oil. The fundamentals are still all there for another rise in prices. But that’s not all. There is a lot more to the story that hasn’t hit the mainstream press yet. But when it does, expect the price of oil to shoot well past $150. How far could it go?

Gold and Oil Prices was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The housing and mortgage crisis is far from having burnt itself out. The oil price crisis also started in August 2007, when the oil price was only $70 per barrel, half what it now is. The price of other commodities, particularly foodstuffs, has moved with the price of oil. Equity markets behaved as though they were immune from the recession. That pretense lasted until last October.

Since that time, the U.S. stock market has fallen by 20%. Only the art market seems to be exempt, with billionaires buying conceptual art at speculative prices. This may reflect the sheer weight of billionaire money, or it may follow the precedent of the art market being the lagging indicator among all asset classes.

Everyone would like to know how long — and, implicitly, how deep — the 2007 recession is going to be. There are always commentators who think that the end of recession is about six months away. In 2007, there were those who expected a recovery in the second half of 2008; that expectation has now shifted back into 2009, with the recovery starting in the second half of next year and persisting through 2010. Hardly anybody now expects even the first signs of a recovery to appear before the November presidential election in the United States, the fist big political date. If the American voters follow precedent, they will elect a Democrat as president; since the classic case of Herbert Hoover in 1932, economic depression has usually led to the incumbent party being turned out.

In the 1930s, the slump led to almost every democracy turning out the party in power, starting in Britain with the massive defeat of the Labor Party in 1931 and following with the election of Franklin Roosevelt in 1932 and the change of the German regime, with the election of Adolf Hitler in 1933. It looks now as though the present recession will lead to the defeat of the Republicans in 2008 and the defeat of the Labor Party in Britain in 2010. Other European governments must regard themselves as at risk.

Recessions can be short, medium or long, and they can be mild, medium or severe. It is already clear that this is not going to be a short and mild recession, but we cannot yet be sure — for lack of evidence — whether it will be medium or long and severe. Of course, it will not take the same form in different countries. As in the California fire, some districts will largely be spared, but others will suffer square miles of conflagration.

The original basis of the recession was financial, linked to housing and banking. The banks are still in trouble, with Bradford & Bingley in trouble in Britain. I have worked with Rod Kent, the chairman of Bradford & Bingley. He is not the chief executive whose business plan has collapsed, but is one of the best bankers I have ever come across. If this can happen to him, it can happen to anybody. The trouble is that the business plan of global banking as a whole was unsound, in Switzerland or New York as much as in London.

In Britain, we have had a forecast that the housing crisis has further to fall in asset value, and it may last for 20 years. The first forecast is almost certainly correct, the second almost certainly false. Britain has a genuine shortage of housing, caused by the breakup of marriages, which led to the formation of new households, and the strict planning laws, which act as a cartel. In five years, it is possible that this unsatisfied demand will have resurfaced, but the market still has some way to fall before it reaches affordable values.

I am writing at a point at which the world’s stock markets are in a rather belated adjustment. At such a moment, it is difficult not to be drawn into the feeling of incipient panic. I would think that an early stock market recovery, or an early fall in the oil price, is very unlikely, and I do not expect anything better than a bear market rally before 2010. The global economy is in a bear market that is still only one year old. It is little comfort to be able to say that many of us saw it coming.

Regards,
Lord William Rees-Mogg
July 9, 2008

The Coming Recession was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“Every morning, when you look in the mirror, I want you to think, ‘What am I going to do today to increase the money supply?’”

— John Ehrlichman, assistant to President Richard Nixon,
apocryphally speaking to Charles Pardee,
a Federal Reserve governor,
sometime in the early 1970s

SO WE’RE ALL AGREED, THEN.

“This is clearly the worst financial problem we’ve had since the Great Depression,” as Joseph Stiglitz said on a radio show in New Zealand on Wednesday morning. (He’s there attending a conference.)

The Nobel-winning economist lined up behind Countrywide Financial (July ‘07), Wells Fargo (November ‘07), former Treasury adviser Nouriel Roubini (December ‘07), the National Association of Homebuilders (March ‘08), and pretty much everyone else in saying this is as bad as it gets.

As in, the worst ever — like finding nothing besides Of Mice and Men to order from Amazon and nothing but Seabiscuit to rent at Blockbuster.

The men now pulling the Fed’s monetary levers sure agree. And while Ben Bernanke might see the shadow of depression where the rest of us glimpse a shade, liquidating the malinvestments of 2002-2007 is certainly hurting.

Imagine the U.S. Treasury paid your wages each month; you’d jump to increase the money supply every chance you got, too. See, it’s the only way to stop the Nazis from taking over. Or the commies.

Or maybe even — oh, horror! — the Democrats…

“Involuntary unemployment,” as John F. Kennedy put it way back in 1962, “is the most dramatic sign and disheartening consequence of underutilization… We cannot afford to settle for any prescribed level of unemployment.”

Barely a generation after the worst recession in U.S. history, backing labor over capital like this — and thereby nabbing labor’s far weightier vote — meant JFK got to kick Richard Nixon around at the ballot box.

When his turn at the top finally came around at the end of the ‘60s, Tricky Dick didn’t forget the kicking. In fact, “I [already] knew from bitter experience how, in both 1954 and 1958, slumps which hit bottom early in October contributed to substantial Republican losses in the House and Senate,” as Nixon himself wrote in 1962.

So come December 1968, when Herbert Stein first met with Nixon as head of his Council of Economic Advisers — and Nixon asked Stein to name the biggest problem they faced — “I started with inflation,” said the economist.

“[Nixon] agreed, but immediately warned me that we must not raise unemployment,” Stein was to recall nearly 15 years later. “I didn’t at the time realize how deep this feeling was or how serious its implications would be…”

Fast-forward to the brink of Easter ‘08, and the “serious implication” of the Great Depression once again is the cost of not acting to prevent it. Or so everyone says.

And I mean everyone…

“[The liquidationists] turned the 1930 recession into a slump,” says Ambrose Evans-Pritchard for The Daily Telegraph here in London:

“They insisted with Puritan zeal — or malice — that speculators should be driven to the wall amid a cathartic purge of the Roaring ‘20s.

“Among them were top bureaucrats at the U.S. Federal Reserve and some of Europe’s central banks.

“The consequence was the Bruning deflation in Germany, ushering in the Nazis. Democracies snapped across half of Europe. If it had not been for the towering figure of Franklin Roosevelt, America might have splintered into a bedlam of prairie populists, Coughlin fascists and Huey Long extremism.”

Better anything — even a bailout of Wall Street’s hated bankers today — than jackboots and Benzedrine addicts with Chaplin moustaches, right? And where better to start in getting the voters onside than with Ben Bernanke’s complete collection of The Waltons, seasons 1-9, on DVD…?

“During the major contraction phase of the Depression, between 1929-1933,” as Bernanke said in a speech in 2004, “real output in the United States fell nearly 30 percent.

“During the same period, according to retrospective studies, the unemployment rate rose from about 3 percent to nearly 25 percent, and many of those lucky enough to have a job were able to work only part time.”

By comparison, the 1973-75 recession — “perhaps the most severe U.S. recession of the World War II era,” according to Ben “John-Boy” Bernanke — real output fell 3.4 percent and the unemployment rate merely doubled, from four percent to nine percent.

So never mind about the double-digit inflation. Never mind that by the end of the ‘70s, “every business decision [had become] a speculation on monetary policy,” as J. Bradford DeLong put it in a 1996 essay. Never mind that business can’t function if money becomes a flickering variable, making the trade-off between inflation and jobs…bailouts and growth…a loser both ways.

“Other features of the 1929-33 decline included a sharp deflation,” Bernanke went on in his speech, soup ladle in hand and a Baker Boy flat cap on his head, “prices fell at a rate of nearly 10 percent per year during the early 1930s — as well as a plummeting stock market, widespread bank failures, and a rash of defaults and bankruptcies by businesses and households.”

So no matter the cost, deflation must be defeated long before it arrives. Indeed, the higher the cost, the better!

“In 1938, Congress enacted the Fair Labor Standards Act,” writes David Hackett Fischer in The Great Wave — his sweeping review of history’s longest inflations — “which set the first national minimum wage. It also briefly considered a maximum wage, but that idea was quickly forgotten.”

Over the next 30 years, this upward bias in wages — all floor and no ceiling — was “built into the American economy,” Hackett Fisher goes on. “Floors under wages, pensions, and compensation for the unemployed; floors beneath farm prices, steel prices, liquor prices, and milk prices; floors for airline fares, trucking charges, doctors’ bills, and lawyers’ fees…”

Come Nixon’s first term, the high cost of living was mandated by government, corporations, unions, and householders alike. Falling prices could not be allowed (“You remember the ‘30s, don’t you?”) and — as yet — rising prices were no more than a puzzler at the grocery store every Saturday morning.

Convinced by economists of a trade-off between rising prices and jobs, governments everywhere watered and tended inflation, thinking they could always prune it if the foliage got out of control. And feeding its roots, deep below ground, was the rich, manure mulch of the Great Depression.

“At the surface level,” DeLong explains, the destruction of money during the ‘70s happened because no one in power “placed a high enough priority on stopping inflation.” Worse than that, Nixon and his successors — Gerald Ford and then Jimmy Carter — inherited “painful dilemmas with no attractive choices.” The ‘60s battle to grow jobs at the expense of sound money had already locked in that problem.

Look deeper again, and “no one had a mandate to do what was necessary,” our Berkeley professor goes on. “It took the entire decade for the Federal Reserve as an institution to gain the power and freedom of action necessary to control inflation.”

But at the very deepest level, “the truest cause of the 1970s inflation was the shadow cast by the Great Depression,” DeLong concludes. “It took the 1970s to persuade economists and policymakers that ‘frictional’ and ‘structural’ unemployment were far more than 1-2 percent of the labor force. It took the 1970s to convince [them] that the political costs of even high single-digit inflation were very high.”

In short, the developed world balked at the chance to “liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate” — as U.S. Treasury Secretary Andrew Mellon had urged in the ‘30s — when the liquidation wouldn’t have washed so deep or so hard at the start of the ‘70s.

Scared by the ghost of a Greater Depression instead, the West pushed ahead with big budget deficits, negative real interest rates, and a destruction of money that almost bankrupted Treasury bond holders. The runaway inflation that failed to back off when Richard Nixon nudged the Fed about defending jobs before the dollar (for what else is “inflation” if not a loss of purchasing power?) proved a hard-won lesson all told.

Reaching double digits across the developed world and causing a flight into commodities that in turn led to a huge bubble of malinvestments in the early 1980s, the “sustained spurt” of ‘70s inflation equaled the worst wartime price increases by the time double-digit interest rates could be used — with broad voter approval — to kill it off.

It all ended — guess what! — with a forced liquidation at the start of the ‘80s. And today?

“Ben Bernanke is smarter than I am and thinks about this 24/7, which I do not,” says Bradford DeLong on his blog this week. “He leads a superb committee. He is backed by the best monetary policy technical economic staff in the world. If I disagree with Ben’s FOMC on an issue of monetary policy, I am probably wrong.”

Either that, or Bernanke’s still stuck on Walton’s Mountain nostalgia…just as TV audiences were back in the ‘70s.

Regards,
Adrian Ash
BullionVault
March 21, 2008

The Dangers of Inflation was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“The U.S. recession is sure to send inflation to zero — just as it didn’t in four of the last five recessions.”

WORRIED ABOUT INFLATION? Oh, stop your carping and set an extra place at dinner for the fast-looming recession instead.

See, your cost of living can’t possibly keep rising now that Europe and the United States are plunging into a credit-led slowdown. Inflation is dead, killed by the slump. The value of money is going to stop sliding, even as interest rates fall.

Says who? Says just about everyone.

“A U.S. recession is now an even bet as job losses and the housing contraction jeopardize the longest-ever expansion in consumer spending,” says Bloomberg, reporting its latest survey of professional number crunchers.

“The world’s largest economy will grow at a 0.5% annual rate from January-March, capping the weakest six months since the last economic slump in 2001, according to the median estimate of 62 economists polled from Jan. 30-Feb. 7.”

And your cost of living can NEVER go up during a recession, right?

Oh, sure, inflation in U.S. consumer prices accelerated by one-half during the recession of 1973-75. It then hit an all-time peak during the short recession of 1980.

Inflation went on to beat its previous 30-year average during every month of the 1981-82 recession. (Don’t misread that “fall” from 10% to 5% year on year; the dollar’s buying power still shrank by almost one-tenth inside 16 months.) And the cost of living then spiked higher again when recession next struck, in 1991.

But this time, well…this time it’s just going to be different, OK? Think 2001, rather than the four previous U.S. recessions. And not just in the United States, either.

“The eurozone economy is now clearly slowing down,” says Michael Hennigan, founder and editor of Finfacts, the leading financial news site in Ireland. “Oil prices are also off their peak, [so] combined, these factors should act to dampen inflationary pressures in the economy. In particular, it should help prevent excessive wage increases that could endanger price stability.”

Here in the United Kingdom — the world’s fourth or fifth largest economy, depending on how you count China’s boom — growth just slid to 0.5% in the three months ending January, says the National Institute of Economic and Social Research. And that slowdown, the worst rate of growth since 2005, gives the Bank of England “room for further cautious reductions in interest rates,” reckons Martin Weale, the NIESR’s director in London.

“I don’t see the risk of inflation being a constraint.”

Back across the Atlantic, “The economy is rapidly slowing on all fronts, Wal-Mart [is] slashing prices again, and rising unemployment and delinquencies are going to further restrict bank lending,” says Mike Shedlock in his Global Economic Trend Analysis blog.

Hands down, inflation — properly defined as an increase in the money supply — continues to rise. Growth in the M2 measure “is running at almost a 6% year on year,” admits David Rosenberg at Merrill Lynch. But “Of course it is,” he then spits.

“Most of [this new money] is situated in nontransaction savings accounts, and these are up almost 8% from a year ago. So transaction balances are falling and precautionary balances are rising — what does that tell you about consumer spending and saving behavior?

“This is all, from our lens, very deflationary. Not the other way around.”

Big picture, even the euro-crats of the European Central Bank agree: Slower growth will result in lower inflation — even if the ECB did sit on the eurozone’s 4% interest rates once more on Thursday. Pressured to repeat the magic words “vigilant on inflation” at the press conference that followed, Jean-Claude Trichet managed instead to send the euro plunging to a near three-week low by hinting at cheaper money to come.

“Some of the menace behind [his] anti-inflation comments in previous months seems to have been softened,” as David Brown at Bear Stearns noted to Thomson Finance, “and there appears to be greater stress on the downside risks to growth.”

Put another way, lower growth — if not recession — will take the heat of prices. Because lower growth means falling demand. And only rising demand can ever push prices higher. Or so everyone says. Which is odd, given the facts.

“Few empirical regularities in economics are so well documented as the comovement of money [supply] and inflation,” as Mervyn King, now governor at the Bank of England in London, said in a late 2001 speech.

And the world’s supply of money is surging right now, even as “deflation” hits U.S. housing and stocks:

“Over the 30 year horizon 1968-98,” King went on back in 2001, “the correlation coefficient between the growth rates of both narrow and broad money, on the one hand, and inflation, on the other, was 0.99.”

Narrow money means cash in circulation, but as King said, the relationship with cost-price inflation holds just the same for “broad money” (shown above) — meaning all notes and coins; cash on deposit; and short-term bills, notes and bonds.

0.99 is as near perfect as you’ll find in any pair of data. An absolute 1.00 only ever exists for the very same thing measured against itself — say, the cost of living mapped onto the cost of living, or gold prices correlated with gold prices, for example.

Yet if we now race back to the present, and reappoint Mervyn King for his second term running U.K. monetary policy, “The disruption to global financial markets has continued,” explained the Bank of England — with King at the helm — when it cut U.K. rates on Thursday.

“Credit conditions for households and businesses are tightening,” the BoE explained. “Consumer spending growth appears to have eased…Output growth has moderated to around its historical average rate, and business surveys suggest that further slowing is in prospect.”

In sum, “These developments pose downside risks to the outlook for inflation.”

Phew! And to think that five- and 10-year bond yields had finally shot higher just before the credit crunch bit in summer 2007 because inflation — whether in prices or the money supply — had finally became the No.1 worry for fixed-income investors.

“Underscoring inflation concerns, the benchmark 10-year U.S. Treasury note last week had its biggest decline in price in more than two years, as investors abandoned projections the Fed would need to lower rates by year-end to stimulate growth,” reported Bloomberg on June 11.

“Mounting concerns about U.S. inflation levels have sent short-term bond yields in Australia to their highest level since mid-2002,” said The Australian Financial Review on June 20.

“The global economy in 2007 is still expected to register close to 5% growth for the fourth year in a row,” added Fidelity Investments on July 20. “In response to this rapid growth, central banks around the world have continued to tighten their monetary policies, with the eurozone, United Kingdom, Japan, China, and India all raising short-term rates.”

You might wonder whether that sudden surge in bond yields sparked the banking crisis of August. But either way, here in Feb. ‘08, “Persistent fears over a possible U.S.-led global slowdown [have] fueled further profit taking in crude oil,” as one London analyst told Agence France-Presse at the start of this week.

And here starts the chain of logic linking the housing slump to falling inflation and bypassing the impact of monetary inflation altogether.

“Between January 2003-January 2008 alone,” as the Financial Times quotes Goldman Sachs, “the world price of metals rose by 180% and of energy by 170%…in good part because of China’s demand.” That demand in turn came thanks to America’s credit-led bubble in consumer spending, but now the U.S. consumer’s tapped out — and his house keys are back with the lender.

So China can’t grow, because the U.S. can’t shop. Therefore, oil prices and base metals will sink and inflation worldwide will now vanish.

Who knows? Things might just pan out that way. But ignoring the flood of money — first created as credit and now stacked up in Treasury bonds across the emerging economies — would mean ignoring the connection between growth in the money supply and inflation in prices.

• The People’s Bank of China is rumored to want money supply growth of 15% per year, down from the current 18% plus
• India’s broad M3 money supply is rising 22.4% per year
• Singapore’s money supply increased by 14% in 2007
• Britain’s broad M4 measure of money has expanded by 12.3% since Jan. ‘07
• Western Europe is “enjoying” monetary inflation of 11.5% per year, three times the central bank’s target
• Last year saw 16% money supply growth in Australia, 13% in Canada and 22% in Saudi Arabia
• The U.S. money supply — if the Fed still reported M3 — is now guesstimated to be showing 15% annual expansion.

Remember, that near-perfect connection between money supply growth and consumer-price inflation is one of the few clearly established facts in economics. Over a 30-year horizon, they match each other almost exactly. Which is to say they won’t necessarily move together this week or next.

Similarly, the last time runaway inflation hit, the cost of living for Western consumers raced ahead AFTER raw commodity prices had begun to slow down:

During the inflationary ‘70s, the price of commodities — as measured by the Reuters/CRB continuous index — peaked out in November 1980. For the next 21 years, it was then downhill all the way.

Adjusted for inflation, however, the price of raw materials had, in fact, been falling since February 1974. That was when the rate of U.S. consumer-price inflation overtook growth in the CRB index, surging on the previous commodity price hikes and feeding into service prices and wage demands. Inflation in the cost of living finally peaked out in April 1980, hitting an all-time record high of 14.7% year on year.

How did consumer-price inflation keep soaring for more than five years after commodity-price inflation began slowing? No doubt things really are different today, starting with the fact that the current bull market in commodity prices — beginning in 2002 — represents the only real secular bull run for raw materials since the Reuters/CRB index began in 1956.

The 1973 doubling of commodity prices came thanks to the first OPEC oil shock. Might the Federal Reserve be taking things a little too coolly — not least with the value of dollars — by saying it “expects inflation to moderate in coming quarters” as it cuts the returns paid to dollar holders?

“The OPEC [oil cartel] would trim output if oil prices slip to $80 per barrel,” according to a Bloomberg report. It cites one unnamed OPEC delegate for the price target; two other members told the newswire that $70 would be “unacceptable.”

Says Johannes Benigni of JBC Energy in Vienna, “It wasn’t OPEC’s fault it moved above $80, but now it’s there, they justify keeping it.”

And then there’s the pile of dollars stashed away by the central bank in Beijing…up from $156 billion at the start of 2000 to more than $1.5 trillion at last count. If the sorry demise of the U.S. consumer really does dent the buying power of China, might the Chinese government not step in — and bid for crude oil, copper, soybeans and grain — to keep the fastest growing economy growing just as fast as it can?

Conjecture and guesswork are no substitutes for an answer, of course. And for as long as gold prices keep screaming that somewhere something is amiss between inflation and bond yields, that dumb lump of metal might just keep finding a bid.

Gold has now risen in 18 of the last 24 weeks. On Friday alone, it hit new record highs against both pounds sterling and euros.

Still, nothing to worry about. The U.S. recession is sure to send inflation to zero — just as it didn’t in four of the last five recessions.

Regards,
Adrian Ash
BullionVault
February 13, 2008

Inflation During Recession was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

I lived in Germany for much of my life and I can assure you that the Germans are very self-critical. Unless it’s not the very best, it can’t be good. As long as there is room for improvement things deserve to be criticized. I recommend that in order to get a correct picture of Germany, don’t listen to what Germans say about their economy; they are consistently negative. Also, don’t read German newspapers to learn about the German economy; they are always pessimistic. To get a more accurate picture, check the economic stats and compare them with stats from other countries.

It is true that after the end of the European unification boom in the late 1990s, the German economy experienced malaise until 2003. The high cost of unification put a huge burden on the people. Domestic demand was weak. Yet in these years of slow growth, German companies did their homework. Today, the German industrial sector is at the top of the world when it comes to modern capital equipment. Infrastructure in East Germany has been has been brought up to Western standards.

German carmakers are household names. So are chemical and electronics multinationals like BASF and Siemens. But these large companies represent only a part of the German economy; mid-sized companies are its backbone. These companies possess very specialized technological know-how. They are extremely competitive and industrial companies all over the world seek their products.

These mid-size companies are behind Germany’s consistently good export performance. Germany’s competitive position rests with companies that seek to continually improve a specific technological niche. Often privately owned, the owner/entrepreneur plays a central role in business decisions. Most of these companies are so specialized that they must have an international focus. They often possess know-how that makes them a worldwide quasi-monopolist in their area of expertise.

Many of these so-called “Mittelstand” companies produce tangible capital equipment. Linked together by a well-established network of cooperation, they are capable of executing large-scale projects — including the planning and construction of whole factories.

The competitive position of “Mittelstand” companies helps them cope with cost increases. Currency appreciation does not hurt them as much as it hurts most other export-oriented companies. The recent strength of the euro has barely affected demand for the products of these companies. This was also the case in the past when the German mark was in a decade-long uptrend.

The German economy will continue to profit from the investment boom in emerging economies. Demand from Asia is only part of the story. German companies are in a leading position when it comes to infrastructure projects in Eastern Europe, Russia, and the Former Soviet Union. Oil rich countries are showing little price sensitivity in their capital equipment orders from Germany. Demand from the Middle East and elsewhere is so high that the order books of many German capital equipment producers are full for years to come.

For these German mid-size companies, a quick hire and fire system is out of the ordinary. Intensive in-house employee training provides the specialization these companies need. Company loyalty is relatively high. Performance hinges on a culture of trust that runs from the top to the bottom.

Nevertheless, structural problems plague the German economy. The welfare state is overextended and the population is aging. There is a shortage of young engineers. Social contributions and taxes are high. The steep cost of labor has driven German companies to invest in technology and equipment that enhance worker productivity. Like the United States, the market for specialized German labor is tight. German unemployment may be relatively high, but it mainly affects less skilled workers.

An aging population limits the chance that Germany will experience a new “economic miracle.” Domestic demand should remain relatively soft. And most economists think Germany is too dependent on exports.

Yet they seem to ignore the worldwide appeal of German exports. One can also argue that the boom in emerging market infrastructure is far from over; in fact, it may boom for years and even decades to come. German capital equipment producers enjoy a strong reputation among their emerging market customers. In the eyes of foreign multinational companies, Germany has even regained its position as an attractive place to build manufacturing plants.

If the U.S. downturn worsens, this would hurt German capital equipment makers far less than it would hurt carmakers.

Unlike the U.S. and a few other European countries, a housing bust does not plague Germany. In fact, it had a short housing boom immediately after unification. Since the late 1990s, German real estate has been flat. Some observers criticize Germany for its stagnant domestic consumption. But this was actually a blessing in disguise. Resisting the temptation to artificially stimulate the economy, the government opted for structural reforms instead. High household savings and a more flexible labor market have helped improve the efficiency of the German industrial sector.

Bank credit and the stock market are not as important to the German economy as they are to the U.S. The fallout from the current credit squeeze shouldn’t have much effect on German industrial companies. The same holds for a stock market decline. Among the major industrialized countries, Germany’s economy may be the best equipped to weather the coming storms.

Even if the U.S. officially enters recession, the global economy will not stop in its tracks. The BRICs (Brazil, Russia, India, and China) in particular have a lot of cash to spend. These countries have clear plans to modernize their infrastructure and make their factories more efficient. One major area of investment in these countries will be in environmental protection. German companies are world leaders in the area of environmental technology:

The German stock market, measured by the DAX index, performed well in 2007. This index rose more than 20% even as the euro gained 10% against the U.S. dollar. In the years to come, many a top performers can be found among the smaller companies, even if the major index should decline.

So why things may seem bad here, don’t believe that they are all going wrong fro everyone. The Germans might not be the most chipper people in the world, but don’t let their pessimism fool you, things in Germany are all right.

Regards,
Antony Mueller
January 30, 2008

Germany’s Stable Economy was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

SO THERE IS TO BE NO LETUP OR TRUCE in the war between debt and recession.

The cannon fodder of consumer credit — the battle-weary consumers themselves — must push ahead with the Christmas offensive. The United States, standing shoulder to shoulder with its partners in Britain, will stay in the trenches until the job is completed.

All boom, no bust! Gordon Brown — now the U.K. prime minister — has promised no less for more than 10 years. And this is no time to quit the field.

But beating the credit cycle won’t be easy, even if it proves possible. Indeed, this war of attrition will take just as long as the never-ending war against terror.

“Some borrowers took out loans they knew they could not afford,” said President Bush on Thursday, before he slipped into the present tense and tried to wind back the clock.

“To compound the problem, many mortgages are packaged into securities and sold to investors around the world.

“So when concerns about subprime loans begin to mount — began to mount — uncertainty spread to the broader financial markets.”

Out in the field, the commander in chief knows he’s lost the high ground, but that “uncertainty” was never a threat. Adjustable-rate home loans made it clear, right from the get-go, what would happen in 2007-2008 and beyond.

They “usually begin with 7-9% rates that [then] reset to between 11-13%,” as Bloomberg explains. But that was precisely the problem.

Can you imagine it? An interest rate that moves up and not down?

“What we are talking about is having these loans modified so they continue for a longer period of time at the starter rate,” said John Reich, director of the Office of Thrift Supervision, of the Hope Now initiative last week.

Will flat rates be enough to keep the big guns pounding the enemy? After 25 years of ever-cheapening credit, the bond market certainly wants rates to go down — not least after bond yields reached a half-decade high at the start of this summer.

Piling into short-dated bonds, in fact, Wall Street has priced in recession already. Three-month bond yields have slumped by more than 200 basis points since mid-June, the fastest rate of decline since May 2001.

Two-year bond yields have slumped by 219 points inside six months — a 15-year record — going from 5.1% to below 3% in short order.

2001 marked the shortest and shallowest U.S. recession on record. At least 1992 got to dent housing and jobs, unwinding debt and forcing households to save and not borrow.

It must never happen again!

“Uncertainty about the effects of the credit crunch, together with rising oil and food prices, seems to be affecting feelings about jobs and the future economic situation,” said Fionnuala Earley, chief economist at Nationwide — the U.K.’s biggest mortgage lender — last Wednesday.

“With that in mind, it is natural that consumers would think about tightening their belts this Christmas, and this is reflected in the weaker spending index.”

But this “natural” response — cutting back spending after a record decade of credit growth — can’t be permitted. “At least two cuts” to U.K. interest rates were now needed, Earley told the Telegraph “to take the pressure off [household] finances.”

The Bank of England delivered one cut on Thursday, pretending that inflation will slow just because consumer demand is receding. Put another way, and on the other side of the pond, “Policymakers appear fully engaged in stanching the financial turmoil and ensuring that the economy avoids recession,” says Mark Zandi of Economy.com for Moody ’s.

“The Federal Reserve has aggressively lowered interest rates in recent weeks, and Congress and the administration are working to aid the hard-pressed mortgage market. More help will be needed, but policymakers appear ready to provide whatever is necessary.”

Can whatever it takes keep recession pinned down forever and ever? There’s been only one winner so far in this war waged by debt — and gold prices look set to keep winning as consumer debt pushes ahead as the economy slows.

The global boom in all asset prices that now seems to be tipping over the top came thanks to one major bear market — the bear market in the value of money.

Government led and central bank sanctioned, it has cut the value of U.S. dollars by two-thirds versus a gold bullion investment. It’s pushed the British pound sterling to new all-time record lows and even cut the euro in half, when measured in gold.

Call it liquidity if you must, a flood now washing the ink out of the central bank promises to pay. The bubble also pushed oil, base metal, and food prices sharply higher — but even if they somehow slip back as the U.S. economy slows, the outlook for gold prices might still hold good in 2008.

Dr. Copper — the metal with a Ph.D. in forecasting economic growth or recession — has broken down even as gold prices have continued to surge, notes the Bank Credit Analyst.

Comparing the two metals over the last 17 years, “The copper-gold ratio plunged when central banks fell behind the deflation curve,” the BCA says. The ratio then surged “when rates were normalized or policymakers were struggling to cool growth.”

“The current breakdown in the copper-gold ratio suggests that more liquidity is needed to reflate the global financial system and keep the economic expansion on track,” the BCA adds. And more liquidity means more money, of course.

So wheel out the big guns of debt! The last time the U.S. defeated recession, real interest rates dropped below zero; the gold market doubled in the following three years.

If the Fed cuts again, down to 3.5% (Bill Gross’s forecast at Pimco) or right down to 1% (the Greenspan Fed’s answer to the 2001 dip), just how far might gold go — even without rising inflation?

“Monetary policy in the three main areas [the U.S., Europe, and Japan] should remain on hold,” reckons Jorgen Elmeskov, chief economist at the Organization for Economic Co-Operation and Development (OECD). Indeed, if inflation picks up — and it just hit 3% in Europe, despite the surging eurozone currency — he thinks it would be “necessary to pay a price in terms of lower activity in the short term” to keep the cost of living in check.

The European Central Bank broke ranks last week, doing just what the OECD said and keeping eurozone rates on hold. But the Fed and Bank of England?

Neither is charged with growing the economy. Both are supposed to avoid destroying their currencies and letting inflation run wild. But as Clive Briault, a managing director of the Financial Services Authority — the U.K.’s investment watchdog — said last week, “There is a very real prospect that conditions will worsen further, raising some important risks for consumers.

“If their financial plans depend on cheap and abundant credit, the absence of those conditions is likely to cause significant consumer stress.”

Stress means a slowdown, and a slowdown might now mean recession. It cannot be allowed, whatever the costs.

What might that cost be to cash savers without gold?

Regards,
Adrian Ash

December 13, 2007

The Battle Between Debt and Recession was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.