doom letter #1

Wise Readers of Doom,

For someone interested in doom, 2008 was a year full of potential. Soaring energy and commodity prices in the first half of the year lead to a price collapse for oil and several other commodities. The real estate and equity markets took big hits as well, but we may never know the real damage all of this caused. This is because the government (the Treasury Department) and the banks (the Federal Reserve) have borrowed, reallocated and printed money while making up rules as they go along to limit the hit taken by 401K investors.

I didn’t want them to do this, but I understand that they had to do it because we have made it the federal government’s job is to guarantee stability at all costs. That is precisely what they are trying to do. Furthermore, they are doing it because they know the small investor that makes up the back bone of the financial market can only take so much at once. At some point, even the most steadfast “buy and hold” investor will liquidate their holdings – to the extent they can – if the markets continued to deteriorate. That is what happened in September in the financial bailout bill in Congress – then again in December for the Big 3. That is what the Fed has been doing for a few years to no avail. They are changing the rules of the game (most notably, banks no longer have to declare a fair-market value for an asset) and creating ever more complicated monetary instruments in order to paper over the damage. If it will keep investors in the market they know it will keep equity prices artificially inflated.

In the short term, it seems to me that what they have done actually worked. The equity markets have just about leveled off, and volatility has slowed. Confidence has wavered, but it stabilized and I would not be surprised if the indexes go up 20-30% in the first six months of the year. I say this because the market is made by true believers, they want the market to go up. These major market makers will look at history and see a reason for a rebound. Nothing has ever stayed bad for this long. If things recover, the banks and other institutions will be able to wiggle their way out of their junk investment and insurance positions. If somehow they can keep “money cheap” in the form of unrealistically low mortgage rates, the markets might start to rebound.

After all, the American people all need this to happen because they have bet their savings that the economy will grow in the future via speculative equity investments marketed to them as stable sources of wealth generation. They don’t want to hear about doom, and that is totally understandable. Why listen to someone tell you that your dreams for the future are unattainable? Why lend credence to the people that say there is no reason to believe things can continue on as they have for the past 60 years?

There is no good reason for them to do so. They get it, but they won’t admit it. They know intuitively that the whole financial economy is built on the assumption that whoever comes along after you will pay more than you did for investment x, and that will continue on forever. In the end, that is what it all boils down to. The only reason to believe in it is because if it doesn’t work, you are fucked.

Peak Oil

I will be the first to admit that although I should have known better, I was guilty of believing that oil price would be the way that everyone finally “got it” when it comes to peak oil. As oil prices were on the way up in the first half of the year, it was not difficult to find stories in the mainstream media that acknowledged peak oil was a reality. Investment web sites talked about how the market was pricing in a “peak oil premium” and a de facto floor was being created somewhere between $70 and $100/barrel.

I learned my lesson. Oil prices have absolutely collapsed, and may continue to fall. The only floor for the price of a product is $0. That is all there is to it. As far as peak oil and the price of oil goes, it seems that the two are not particularly interested in hanging out together. Like equities and other commodities, oil is priced by traders that look at short term changes to make their money – stuff like oil storage stocks, turmoil in a producing region, etc. They are not looking into the future beyond a couple of quarters at the most. And besides, the same theory about doom in the equity markets applies here. Why would a commodity trader want to include consideration in the price for a set of circumstances that have world changing consequences? There is no incentive to do so. I am sure there will be some whiz investors that make all of the right bets, but the peak oil theory clearly has little to nothing to do with price at the moment.

That said, my understanding of the geological side of it all along with the limits of technology at particular price points, still leads me to believe that peak oil is a real and contemporary problem. The collapse of oil price has nothing to do with supply, and not a whole lot to do with demand either. It is widely claimed that the fall in oil prices has a direct relationship to “unwinding positions” in the futures markets. Earlier in the year, hedge funds and other speculative institutional investors were rolling over their futures contracts to the next front month. Now they are selling them off to cover their margins and payouts to investors. That is the theory from the peak oil camp. I don’t think that adequately explains it, but it may be part of it. Keep in mind that these same people that are calling it “unwinding positions” were the ones earlier in the year saying that speculation in the market did not have a significant impact on price. I don’t think you can have it both ways, either the July price peak was market fundamentals, or it wasn’t.

I am sticking to the contention that it was market fundamentals, given the sets of information that traders were using to determine price. Storage stocks were down, demand forecasts (which were wrong) showed increasing global demand and anticipated production levels of existing projects and new projects showed tightness for at least a few years. Demand has dropped, but not at a rate that would seem to be comparable with the drop in price. Storage stocks are up, and many that are looking for proof that peak oil was a red herring are pointing to this information. Future production seems to be more in doubt at $30/barrel than it would have been at $70 or $80/barrel. Some of the more technology-intensive projects don’t turn a profit at this price and won’t come online or be developed. Cheaper existing production seems as though it is going to continue to decline overall as many fields are “mature” and capital is not available to introduce new technology at lower prices. I don’t know if this summer’s new high water mark for oil production will be the true peak, but it seems all but irrelevant to me. If I were to look for a metric to disprove peak oil, I would say it would be something like 90 million barrels/day sustained for 12 consecutive months. At that point, I would be willing to call it quits in the doom business – I also don’t think that any combination of geology or technology would be able to make this happen at this point, regardless of economics.

2009 could be fairly uneventful in the doom sector, but it could also be a lot of fun. Here are the variables I am interested in watching for next year.

1. Pakistan – Shaky economy, shakier government and nukes can make for interesting viewing. It could even be better than wife swap.

2. Hamas – Does a paragovernmental organization have the ability to make the entire middle east more tumultuous? No way to know for sure, but it looks like it will be interesting. Hamas is only on the list because for some reason oil traders seem to equate stability in Israel with the availability of oil.

3. National Debt and treasury bills – It took W 8 years to almost double the national debt. My guess is O will be able to do it in 4. Treasuries have become quite popular lately, but at some point investors will start looking at the long term solvency of the government and take it into account when deciding whether or not the secondary market will be able to continue to finance treasuries. As an aside, it will also be interesting to watch what will happen to interest rates – which are at record lows – as the stock market starts to rally. The reason I am interested is because a big portion of federal debt is securitized in short term bonds and as interest rates climb, these could get very expensive. Fiscal year 2008 the government gave $450 billion to bond holders in interest payments, and that was with fairly low interest rates.

4. The real economy – At some point, Americans are going to wake up and realize that there will be no further credit extended to them to keep up unrealistic levels of personal consumption. Credit cards are already cutting back up to 40% of their credit lines, car and home loans are in limbo waiting for another shoe to drop. I am interested to see what happens with student loans as I think the higher education racket might be the next bubble to give way. If the economy gets worse and more student loans go into default, something will have to give eventually. I think that will be the point when Americans pick up on the fact that we are overeducated in all the wrong stuff (fewer engineers and agricultural experts, more financiers and specialists in pointless unsustainable fields).

5. Federal stimulus – Although O picked at least two peak oil aware people (Salazar and Chu), I doubt much of the stimulus will be directed toward developing a sustainability sector of the economy. Most of the talk is about helping states with more money for road building and other late 20th century type infrastructure development.

6. Equity markets after July – I believe the hype for the first half of 2009 as a pick me up period for stocks. If everyone is saying it, it seems unlikely that it won’t happen. But I don’t think it is supported by anything but wishful thinking and when real economic indicators continue a trend down it will be interesting to see what happens.

7. National oil companies – With such low prices, and a populace that has grown to expect the fruits of higher prices, what will happen?

8. Big Brother – How will O take to the expanded executive powers he will inherit? There is plenty of buzz from NWO quarters about Biden’s remark about the event that will test O shortly after his inauguration.

9. Angry progressives – As O doesn’t pull out of Iraq, do anything to support gay rights or anything else significant in the progressive agenda, will his loyal supporters turn on him or look past his faults the same way conservatives did with W.

10. Food security – As America continues its slow slide into joining the global south, will we continue to be able to maintain and afford our complex food supply lines?

Welcome to doom,

mike