The breathless predictions of $4 and $5 and $6 a gallon gas are making the round again and it is once again time for the analysts to try to one up each other with predictions of imminent doom. What strikes one as somewhat odd is that the average consumer is reacting to this more realistically than some of the analysts. One segment on a national news show had several motorists laughing with a certain amount of resignation and commentary on the fact that these prices seem to go up a lot and come down a little. The point is that the consumer has been through this before and many times.

In the most general of terms there are three factors that change the price of oil. Supply will create the most permanent of shifts as there will be constraints on the amount that can be produced and that bottleneck could last for months. There is no supply issue at the moment and in fact there is an overabundance building as Libya is coming back on line more quickly that originally assumed. The second major factor is demand. If there is too much demand building for the supply on hand, there is an anticipated bottleneck that will provoke the markets to bid prices up in anticipation. There is no demand spike underway and none anticipated for months. Most analysts had been expecting oil prices to decline because demand has been so weak from Europe.  China has slowed down and the US is not near its usual peak levels of consumption.  This leaves the third factor – geopolitics.

Analysis: The per barrel price of oil has jumped again and is now sitting at a nine month high. It is always a little tough to determine THE world price for oil and that task has become that much harder as the US evolves into a serious oil producer. The prices that most are looking at right now are those for March and April delivery and they are both slightly above $105. That is higher than they have been for most of the last year. Oil for delivery six months from now is trading at over $120. The expectation is that tensions in the Middle East could take oil up to as high as $120 for immediate delivery. The even more interesting fact is that there is a wider range between Brent Crude and West Texas Intermediate than has been seen in some months – $27.88.

Iran is the only reason for this run up in price. The game of sanctions chicken may be entering its final phase. There are really only two outcomes at this stage. The worst case scenario will be one that finds a belligerent Iran trying to provoke an attack that galvanizes the oil producers in the region and allows Iran to play the victim. If Israel attacks Iran’s nuclear facilities that strategy will work and oil prices could well spike to levels not seen since the crisis in 2008. The second scenario is that Iran buckles and makes enough concessions to allow the sanctions to weaken. This is still seen as the most likely scenario as the Europeans do not want to complicate their current financial crisis with another one provoked by oil. It will not take much of a concession from Iran to get the Europeans to back down although the US will keep their sanctions.

White House Report Asserts Economic Gains are Imminent

There is nothing quite like an election year to provide opportunities for “interesting” interpretations of economic data.  The aim of the economic analyst is generally to report on what the data actually says but there is small matter of interpretation and that leads to all kinds of value judgment. Is 8.3% unemployment good or not? Obviously this is better than 10.2% – a level reached in the depths of the 2008-2009 recession, but it is certainly not as good as 4.7% – the rate the economy sported in 2005-2006. Does the 8.3% even accurately represent the real employment situation? In the sense that this rate is comparable to the rates of the past it has value. The way that unemployment is calculated is flawed but it is flawed in a consistent way. The fact is that there are millions of people not counted as unemployed as they are judged to be discouraged workers but there have always been discouraged workers that don’t get counted. Are there more today than in the past? Probably but nobody really knows for sure. There are always people who are judged to be underemployed as they would prefer to be working full time but one can’t assume that every part time worker is yearning to work full time. You get the idea.

There are many interpretations as far as growth is concerned as well. When did the recession “end” and what can be considered recovery? Are things better today than they were in 2008 and 2009? Of course they are. Could the economy be in better shape than it is right now? Of course it can. Have the policies that have been pursued thus far been effective? Some have but could there have been better policies in place?  Most likely but then again there could have been worse. That is the challenge of all this.

Analysis:  The White House released its Economic Report of the President last week, all 450+ pages. It is a good bet that few in the media read it and even fewer members of Congress. It is a document for the economists and analysts of the world as it goes into detail on various aspects of the nation’s economic policy and makes a lot of recommendations as to how to make that assessment a lot more accurate in the future. It also comes to some conclusions as to how the economy has been performing and here is where the controversy will concentrate. As one would expect, the conclusions are favorable to the President and the assertions are that the economy has been improving and that it will continue to improve through the rest of this year.

The fundamental argument made by the report is similar to that which has been asserted in previous incarnations of the report. The recession was shallower and shorter than it would have been if the government had not engaged in the various stimulus efforts undertaken. Because this is a report on what the administration is responsible for there is not much focus on the actions of the Federal Reserve although it is acknowledged that Bernanke’s policies paralleled those of the White House in terms of stimulus. The report defends the $800+ billion stimulus bill, the TARP plan, the auto sector bail outs, Cash for Clunkers and all the other efforts to boost the economy through direct and indirect federal activity. Some of these moves were more Congressional than White House based but they were consistent with the goals of the Obama administration.

It is always very difficult to prove that something didn’t happen because of a given action. It is like the joke of the guy carrying a rhinoceros repellant in New York City. It must be working as he has never even seen a rhino – much less been attacked by one. The fact is that attacking a recession generally involves strategy just like that promulgated by the Obama administration, Congress and the Federal Reserve. When the problem with the economy is that it has slowed too much the classic solution is to use government money to prime the pump and hope that the private sector gets untracked and grows. The critics of the Obama policy come from both directions – those who assert that not enough was done to accomplish the stated goal and those who assert the government was too far in debt to use that tactic without creating bigger problems later.

The argument for doing more is based on the fact that the US economy is huge – a $14.4 trillion GDP. How can a $850 billion stimulus be expected to have much of an impact on something that large? The assertion by some at the time was that the US needed to commit more than three times that amount and that it should have been allocated in less than a year. The fact was that $850 billion barely made a dent and then it took far too long to be introduced to the economy. One can also argue that too much of the stimulus simply went towards maintaining the status quo as the bulk of the money ended up with the states so that they could cope with their collapse in tax revenue.

The critics from the other side argue that too little was accomplished for the cost. The massive effort to stimulate the economy has thus far yielded a 2011 GDP growth number of 1.8%. The fourth quarter numbers looked better at 2.8% but most expect these to be revised downward to perhaps 2.5% or maybe lower. The dominant expectation for 2012 growth is less than 2.5% and that seems a poor return for the investment. The critics mostly focus on the fact that the US debt has reached unacceptable levels and the stimulus has done little but add to that debt and deficit. The argument is that the US faces severe constraints in the future due to that debt and the means by which it was accumulated. Too much of the debt is in the hands of foreign investors – especially the Chinese. It has been argued that this debt has weakened the status of the US in the eyes of the investment community and this led to the downgrade of US debt last August. Others point out that this downgrade had little or no impact on the US but the critics assert that at some point there will be a price to pay.

The White House report asserts that better days are coming but that is pretty hard to prove. The assertion is that economic data from the first of the year has been pretty solid. This is true but it was pretty solid last year at this point and then the world began to come apart with the Japanese earthquake, Arab Spring and the rest. Will this year be what last year was not or are we seeing the first of the Black Swan events in Iran right now? The analysts do agree on one thing. If the price of oil skyrockets in the next few weeks the economy will slump and fast.

New Wrinkles in Unemployment Benefits

There were several changes made to the system used to handle unemployment in the US in the bill that passed Congress last Friday. There are provisions that allow more money for training and provisions that allow for drug testing of recipients that have been fired for failing a drug test or have been denied a new job for the same reason. Among the most interesting is a provision that allows unemployment money to be used to supplement incomes when a person is reduced to part time work.

Analysis: This is a system similar to that used in Germany. The idea is to help both the company and the worker. The major issue with the long term unemployed is that their skills have become obsolete and they become less desirable as employees. The new system allows unemployment money to be used to supplement the income of workers who have been made part time instead of full time. This allows the company to hang on to its workforce until economic conditions warrant bringing them back to full time status. The employee stays connected to the company and keeps their skills intact. When there is a return to economic growth, the company can ramp up very quickly as they already have the trained personnel on hand. This has been tried in Rhode Island and has been working pretty well. There are limits in place to keep companies from using the system to subsidize its workforce indefinitely. This system has been credited for keeping German companies competitive and nimble for years.

Greece Looks to Get a March Reprieve

The Finance Ministers of Europe seem on the verge of giving Greece another bailout – one that will allow them to stumble on until the end of March before the whole process starts over again. The fact is that Greece will have had an election by the time this discussion starts up again and if one looks at the polls, the next Greek government will repudiate the current deal and will likely refuse to go along with most of the demands made by the “troika”. The Greek population is violently opposed to the austerity plan that has been imposed in order to get access to this bailout cash and there have been parties from the radical right and radical left who have exploited that fury. If the elections were held today there would be no clear winner but the two sides would agree on one thing – rejection of the European demands. If the Greeks demand to start all over this will be a very long summer indeed.

At the same time that there is intense debate over the current deal, there is controversy regarding the ultimate goal for the Greek economy. It has become an article of faith that Greece has to reduce its debt to the point that it is 120% of its GDP. The prevailing wisdom is that anything over that is wholly unsustainable and that much under that is unrealistic. There are critics of both these assumptions but the majority of those objecting to this plan assert that it is the first assumption that is the most at odds with reality. The Greeks will be very hard pressed to make this goal under the best of economic conditions. It would require Greek growth at a pace that has eluded the country for years and is far higher than the average of the entire EU. Then there is the assertion that nobody really knows where that 120% number even comes from. The IMF has studied debt loads that countries take on and has concluded that it depends a lot on the nation and its economic options. Some can’t realistically sustain a ratio of 80% of GDP while others seem to be able to survive with a debt that is north of 200% of GDP (Japan comes to mind). Greece is more likely to be at the bottom of that list given that there is very little that Greece can do to grow its economy rapidly.

Nations that drag themselves out of this debt or nations that can sustain a high ratio are those with a strong and reactive export sector that is generally based on possession of a key commodity like oil, or a strong manufacturing base. Greece has none of these. The commodities it sells are marginal at best and there is no industrial sector to speak of. This is a nation that relies on tourism and the activity of the Greek shipping industry. Both of these are highly subject to the vagaries of other economies. If Europe is in trouble there is relatively little demand for trips to Greece and the civil unrest that has plagued the nation for the past year has not made the notion of tourism any more appealing.

Analysis: Where does all of this leave Greece? Does the deal that seems to have been struck mean nothing? That would be too harsh as Greece desperately needs the bailout if it wants to keep negotiating a solution to the more fundamental issue. That said, it is not a panacea by any stretch of the imagination. Getting a permanent solution for Greece is a matter of converting Greece into a modern economy that really belongs in the European Union as something other than a permanent ward of the state. To a somewhat lesser degree that is the issue in Italy, Spain and Portugal. These are nations that have more resources at their disposal than Greece but face much the same issue as far as consistent competitiveness. The question as to whether Greece can sustain a budget that is 120% of its GDP is one thing but there is a bigger question than that – can Greece develop something resembling a modern economy that justifies its presence in a European organization at all?

Japan Trade Issues Expected to be Issue All Year

The latest data has caused still more concern in Japan. There is very little to show that Japan is exiting the trade deficit situation it entered last year and that is real heartburn for a nation that continues to depend very heavily on that export market. Not only have exports fallen but the Japanese consumer and the business community is taking full advantage of that higher valued yen and they are buying aggressively from the US and Europe while those currencies are so much weaker than that of Japan. That may be good news for the consumer in Japan but it is miserable for the export community. Japan has always feared that it would be forced to rely on its own market and now that time may be at hand.

Analysis: Japan has tried everything to lower the yen’s value but to no avail at this point. The latest moves by the Bank of Japan helped a little but there are simply very few arrows left in that quiver. The fiscal options are even weaker and all this makes the position of the current Prime Minister precarious. The fact is that the population wants the government to do something which is not within the government’s ability. The economy stutters because it is dependent on other stuttering economies.

Charm Offensive Still Underway

The Tuesday edition of the Executive Intelligence Brief takes a look at the political limitations of the Greek deal. While much of the conversation has taken place in the context of the banking and finance issues there is a more salient threat to the whole plan that comes from the fact that Greeks do not want this plan and seem prepared to vote in those who would reject it. Take a look at the website to get a look at this next week.  www.armada-intel.com  If you have not taken advantage of our trial offer on the Executive Brief we invite you to sign up for some free issues by contacting ksanchez@armadaci.com. The Executive Intelligence Brief is the companion publication to the Business Intelligence Brief. It is part of the Armada Strategic Intelligence System and is more detailed than the BIB. It is our subscription based publication and is available to BIB readers at a discount.

Persistence

Before you proceed much further – be warned. This is another of those cute cat stories that so divide the BIB readership. There are those who groan (and you know who you are Ivan Sanchez) and those who welcome them. Now that we have the disclaimer out of the way I can relate my observations. The two youngest cats compete for my attention in the morning and the efforts can be comical. Generally this is the time set aside for Scoot. She has her routine and it involves getting some lap time and then some further attention as she sits on the desk. That is until and unless Spike elects to challenge the routine by prancing in with a ball in his mouth and his weird little meow-bark. That causes all manner of hissing and growling as Scoot repels his advances. Then they both start to compete.

First Scoot brings the pink ball and I throw it. Spike counters with the fuzzy purple ball and I throw that. Soon Scoot graduates to the mouse because it goes further when hurled and Spike brings out his furry animal as it goes far as well. The counter move from Scoot is the red ball and Spike drags the stick. All of this is accompanied by growls at each other and conversation with me. One flops down to get some attention and the other flops on the other side of the room and gives their best cute look. This goes on for 15 or 20 minutes some mornings before one emerges victorious. That is usually Scoot as Spike goes off in search of my wife.

Scoot has quite clearly staked her claim and I belong to her. She will defend her food dish to a point and there are other occasional claims but with me the battle is not over until she has won. The others get their time with me as well but when Scoot shows up they generally yield – all except Spike. He mostly likes to annoy Scoot and this all gives him an excuse to chase her.

Not that any of us knows what that sound is actually. Maybe something between the screams of people waking up to gas prices that are 15 cents higher than they were when they went to bed and the groans of people looking at their grocery bill. Since the “end” of the recession in the middle of 2009 there has been anticipation of inflation, mostly because that is what usually happens as a recession winds down. In the classic V-shaped recession that most economists dearly love, there is a sharp rebound in the economy after the sharp downturn. The theory holds that all those stimulative actions taken by the Fed and others goose the economy into higher gear and after a while all that activity pushes the economy fast enough to provoke inflation and that pushes the Fed to throttle back on its loose monetary policy. That is not what happened this time.

The economy tanked and the Fed jumped in with lower interest rates. Unfortunately, this was a financial sector led recession and these lower rates were not enough to get the lenders lending and the borrowers borrowing. The V-shaped recession metamorphosed into a check mark recession (sharp fall and very slow gain). That affected the pace of inflation. Without that acceleration from reacting to the stimulus efforts, there was not the usual spike that generally heralds the arrival of some faster growth. Inflation has been building far more slowly and subtly this time.

Analysis: The economic analysts have been noting for some time that all the conditions are in place for some serious inflation issues down the road. The time for that breakthrough may be imminent. There is the fact that banks have started to lend a bit more aggressively and they have plenty of cash on reserve if they decide that the time is right. The corporations that have been holding on to their cash may finally be turning loose of some of it as they see some hope of consumer demand. Even the consumer has shown some willingness to turn loose of their cash if the situation is right. Retail numbers from the last holiday spending period looked decent and there have even been some good months for car sales. If and when all or most of that money starts to cascade into the system again the inflation threat will be much more apparent.

The latest threat has started to come from the rise in food and fuel costs. By now we are all aware that the economists do not figure real inflation when looking at the threat. The focus is on core inflation rates and these do not figure in the volatile prices of food and fuel – at least not directly. What does get figured in to the core rate are the prices that rise because the price of food and fuel have risen – such as the cost of transportation and air travel as well as the cost of restaurant trips. The core rate does not always hike because of changes in the rate of inflation if these industries are not in a position to raise their rates and for the past few years they have not been able to. There is now evidence that cargo rates are rising and so are air fares and restaurant bills. That is a signal that the almost 3% rise in the headline rate is about to show up at the core level as well and that will affect Fed decision making as far as rate hikes are concerned.

Gaps in Measuring the Economy

There is nothing that creates more conversation within the economic community than the need for more accurate and timely data. There has always been the conflict between fast and accurate. The majority of those who are trying to make sense of the economy for the purposes of policy setting or strategic planning need the information as quickly as they can get it. They are trying to determine what to do in the future and they need that information now. The problem is that they also need that information to be accurate if they are going to stake millions and billions on that decision. The challenge is that one can have most data one way or the other. It can be quickly released but then it is mostly an estimate and subject to considerable revision. If one waits until all the revisions are complete, the data could be several months old. The dilemma is at the heart of most economic analysis.

The latest economic report from the White House was issued last week and this nearly 500 page document is not really aimed at the public or even the campaign. It is a publication for the economic analysts of the world and is designed to get deeply engaged in what is known and what remains to be revealed. This publication was like many of the previous efforts as it tried to point out those parts of the economy that are not very well understood and which will require more data to understand fully.

The fact is that economic analysis is always struggling to keep pace with its dynamic subject. This is a study of human behavior and as such it is as subject to the whims of human activity as any other social science. People rarely act in a predictable manner – at least in terms of their detailed response to changes in the economy. Eventually the analysts catch up with these reactions.

Analysis: Almost every chapter of the report highlights some area where additional data would be very useful and would provide a better set of predictive models. The fact that this data would be helpful is not to say that it will be all that easy to collect or that interpretation would be all that simple. There is also the fact that data doesn’t become all that helpful until there is some history to refer back to. To know what happened this month is of very limited interest until one can look to see what happened last month or the same month a year ago and five years ago. That is what allows some trending to develop. The calls for new data in this report would make future analysis more effective but there is little that could be done with new information right away – unless there is access to that historical data right away.

One of the interesting discussions was over the use of Google searches to determine projected consumer demand. The use of the Internet to start a buying process has become common enough to provide some trending data. It has been noted that the number of inquiries about cars will predict the number of consumers that will subsequently come to the showrooms in search of a new car. The same has been noted when it comes to the number of people seeking out real estate professionals. This type of analysis could predict a larger range of items as more people become accustomed to starting their buying process this way. Thus far there is evidence that searches will suggest what kind of restaurant activity there will be. The searches prior to Valentine’s Day this year exceeded the searches last year and there were more restaurant trips this year than last. The analytics that have been developing with the search engines have been used by private industry for years and now there may be enough accumulated to have a bigger statistical impact.

Another area of interest is valuing certain types of service. The example cited in the report is the improved health and life span. What is the economic value of living longer and in better health? There is an obvious cost and benefit in play but thus far it has been hard to quantify – at least from the positive point of view. The cost of having a population that lives longer is captured to some extent in the added expenses attributed to Social Security and Medicare but not enough is known about the spending habits of the new elderly. It is apparent that it is different but nobody quite knows how different.

There are many issues of comparability. This is something we have referenced more than once in the past. The danger becomes far more acute when these comparisons are thrown around during an election. The US debt load is compared to that in Japan and deemed less of a threat because Japan is staring at a debt ration of over 230% of GDP while the US is “only” in the 90s. The differences between the US and Japan are profound in terms of who owns that debt and this makes comparisons much trickier. There are major differences between what nations count as assets and liabilities and how they handle their budgets. It is not that there can’t be lessons learned from the experience of others but it serves little purpose to point to another nation and assume that the US experience will even be all that comparable.

There are also major debates over how to measure some of the most controversial parts of the economic debate – housing, employment and health care at the top of the list. These are not new concerns and many have been voiced by those who are trying to determine appropriate policy. There is immense variability when it comes to mortgage performance depending on whether one is discussing second or first mortgages, primary homes or those that were bought as investments and the reasons that people fell into financial distress. Uncovering these data points can make policy more effective. The same can be said of employment. Who is actually unemployed and why? Where are they, what is the limitation to taking a new job. Many assumptions are made and most are no accurate. To one side the jobless are all victims of the recession and to the other they are all lazy and sponging off the government. If there are to be new training plans or additional resources brought to bear it would be useful to know more about the people looking for work as well as more about the job market they are trying to enter.

Health care is another area that begs for additional information if there is to be any hope of reducing the cost. Who are the most expensive patients in the system and what is the nature of the care provided in the health system? What are the incentives in the current system and what impact do they have on costs? Most importantly – how have advances in one area created problems in another? Does prevention of death from disease that killed people when they were younger mean that people will live long enough to get a more expensive disease later?

Export-Import Bank to be Tool for Increased Trade Competition

The most common tool is use by most nations that seek to boost trade is to provide some kind of financial assistance – through loans, subsidies, insurance and the like. The US has its own set of weapons and has used them to good effect for years. One of the most widely employed has been the Ex-Im bank, the institution that loans money to other nations interested in buying from US producers. It has been pointed out that both Boeing and Caterpillar have been beneficiaries of Ex-Im Bank activity. The latest statement from the White House asserts that the Ex-Im Bank should be given all the additional funding it needs in order to ensure that US manufacturers have a means by which to compete with the programs that other countries and companies can employ.

Analysis: This is part of a series of new efforts to boost exports but the majority of trade analysts have the same reservations they have had since the start of the Obama term. Trade is never a one-way street and the US has to cognizant of its role as importer as well as exporter. For every China that stacks the deck against the US there is a country seeking to trade with the US facing similar barriers.

Sanctions Bite in Iran

In more cases than not, sanctions do not have the desired impact as the targeted nation finds ways to get around the restrictions or too many nations elect not to participate and the only entity that gets hurt is the country that has cut off some element of its trade. This has been the experience the US has normally had when it has tried this economic pressure. To see a sanction policy that has had virtually no impact all one has to do is look at the sanctions that have been in place against Cuba for the last six decades. If the US is ever to see the end of Fidel Castro it will be due to old age. Iran may turn out to be different if the actions of the past few weeks are any indication.

Iran is running out of nations to sell its oil to. At a time when the price per barrel of oil is climbing and has reached levels not seen in months the oil producing nations are reveling in the additional income this represents. Even the most marginal and troubled oil states are seeing solid revenue boosts and the nations that have the most efficient production systems are contemplating a return to some of their more ambitious development schemes. The embargo was designed to cut Iran off from its major European markets and for a while it appeared that the Europeans would waffle enough that Iran would get away with thumbing its nose at the US and Europe over the development of nuclear weapons capability. Then the Europeans entered an economic slump sufficient to allow them to back the sanctions without causing distress. There is plenty of oil available from other sources and Iran’s contribution is covered. Part of the new supply is coming from Libya as they recover far faster than anyone thought possible.

As Iran calculated its ability to withstand the sanctions threat to their primary source of income they assumed that they would have markets in China and India of sufficient size to bolster their economy. That now appears to be a miscalculation and a potentially very costly one. There are three factors at work that have limited what Iran can expect from these nations in the near to mid-term.

Analysis: The first is that China and India have both seen their economies slow. China has been embarked on a deliberate policy of slower growth in order to deal with the looming inflation threats that manifested last year. At the end of 2011 there was headline inflation over 6% and inflation in the all-important food sector was running as high as 11%. The Bank of China pushed through more interest rate cuts and the government stepped in to limit bank activity. There was pressure on export oriented companies as well as those geared to the domestic market. The effort worked and some thought that China would soon resume its growth policy but thus far China has chosen to remain in slow growth mode. India has slowed simply due to falling demand from their major trading partners. The issues in Europe have affected India far more than they have affected China.

The second factor has to do with the way that China works with those nations selling to them – especially those nations that do not have a lot of options. The Chinese bargain very aggressively with the iron ore producers in Australia and Brazil and forced prices down and they have done the same with Iranian oil. They will buy it but on their terms and at their prices. Iran is not selling oil to China at the global price.

India was a reliable partner but they are not enamored of the Iranians right now. The terror attack that was bungled took place in the middle of their capital city of Mumbai. India is hyper sensitive to terror attacks given their history and there has been a reaction already – despite the fact that Iran denies involvement. The accusation was made that this attack was carried out by Israeli agents bent on creating this tension between the two nations but this assertion has been dispelled by those who watch this activity closely. The wife of a high ranking Israeli diplomat was killed in this attack and that is NOT something that happens when the Israeli agencies are involved. All the evidence thus far points back to Iran and that has angered the Indians enough to curtail some business with Iran.

Lack of Credit Spells Disaster in Italy

The debt crisis in Europe has been focused on the negotiations between the “troika” and the Greeks but there are some much bigger concerns on the horizon and one of these is the almost complete collapse of credit in Italy. There is simply no availability of credit to even the largest Italian concerns and the small to mid-sized companies are starting to fail in droves – regardless of the fact that many of them have developed some solid markets and would be in a position to expand if they money to do so. This is the kind of credit crisis that emerged in the US in 2008 and sent the world into severe recession.

Analysis: The banks are not lending because they have no sense of what is going to happen to the bonds they invested in. If they are expected to take losses of close to 80% on these bonds they have shredded their ability to loan. The watchword is extreme caution and the banks are on the verge of hoarding. There have been plans to recapitalize these banks but no real progress has been made on a system and the banks are left in limbo.

What is Going on in the World This Month?

The Global Economic Security Estimate was published last Friday. This is something we produce monthly and it is designed to be a snapshot of what has just happened and what is likely to happen. It is broken down into six global sectors and is structured to be a quick read. Look for this on the website this week. www.armada-intel.com If you have not taken advantage of our trial offer on the Executive Brief we invite you to sign up for some free issues by contacting ksanchez@armadaci.com. The Executive Intelligence Brief is the companion publication to the Business Intelligence Brief. It is part of the Armada Strategic Intelligence System and is more detailed and more far ranging than the BIB. It is our subscription based publication and is available to BIB readers at a discount.

It is Getting Close

I am like many when I say that this is my favorite time of the year from a sports perspective. This has nothing to do with basketball as that is a game that I remain fundamentally uninterested in. No, this the beginning of spring training in baseball and everything is possible. This is my game. I can enjoy a little football and some hockey and get mildly engaged in the weird sports when the Olympics rolls around but baseball captures me every year. It is a game of nuance and subtlety as it is only barely a team game when it comes right down to it. It is pitcher vs. batter and batter vs. fielder in the end. It is game of the tiniest of differences. A pitcher that is a few fractions of an inch off target and a couple of miles per hour too slow gets to watch his effort slammed into the stadium seats. A step too slow and the shortstop misses the catch and a fraction too hesitant and the cut-off throw is missed.

Mostly it is a game that allows for discovery every year. The pitcher that suddenly finds the control they needed, the hitter that adjusts a swing and start to tear up the league. There are certainly players that dominate but there are always new stories of kids coming into their own and veterans that manage to finally put it all together. That leads to the part about all things being possible. Training camp opens soon and for now my Royals are a contender – a team that will get it done this year. Come June I may well be in a funk again but for now hope springs eternal and I just know that better days are ahead.

Stop laughing!

There is nothing quite like the constant wail of an economist who takes being a dismal scientist very seriously. Dr. Ariel Roubini is never going to be mistaken for a Pollyanna. He is ever ready with the direst of forecasts and will reliably focus on the dark cloud regardless of the thickness of the silver lining. There is a method to this approach and it is fairly common with the economic profession. Nobody will get all that upset if one predicts imminent doom and conditions improve – we will all just breathe a sigh of relief. Predict good times and see conditions deteriorate and people get very upset. The bias is always towards the gloomiest of forecasts.

Roubini has outlined the four most pressing threats to the economy at the moment and in all cases he has looked at the worst of the scenarios available. The first is the assumption that Europe is going to enter a deep recession in the very near future and one serious enough to drag the core economies of Germany and France into negative territory for at least three or four quarters. The second threat is China and the rest of Asia will enter a prolonged period of weakness and reduced economic activity based on the erosion of their export markets in Europe and the US. Number three on the list is the assertion that US growth is about to hit another wall. The fiscal tightening at the federal and state level will slam the economy into reverse and the expiration of various tax breaks will interfere with the capital expenditures that have been driving some of the manufacturing momentum. Finally there is his assessment of the problems in the Middle East.

This has been his headline issue of late and the projections are spectacularly grim. He is confident that Israel will attack Iran within weeks and that the OPEC nations will respond with what amounts to an oil embargo in solidarity with their Persian brothers. The oil markets will panic and the per barrel price will soar to previously unheard of levels – between $200 and $250 a barrel. Such a massive hike will cause a tripling of fuel prices and that will thrust the entire global economy into a profound depression that could last for years.

Analysis: It is not that these are inaccurate assessments. All four are very likely to be factors this year and in most cases they already are. It is a matter of degree. Will Europe really slump that badly? Will China really see its growth shrink to 7% or lower? Is the US recovery really that shallow and will the US really sink back close to negative GDP numbers? Will the situation in Iran really trigger more than a doubling of the price of crude oil? Of course this is possible but it is more likely that there is a much less profound reaction that brings an element of these problems without triggering some kind of economic Armageddon.

It is useful to understand that part of the motivation for Roubini is to shape policy decisions with warnings of the consequences. All four of these threats can be affected by political decisions and his dire warnings are partially designed to impress on the decision makers that there are consequences if they make the wrong call at the wrong time.

Why Economists Love Weathermen

There are always those annoying people who actually pay attention to the things people say and then check to see how accurate their predictions turned out to be. Being held accountable is really quite tiresome. The favorite definition of an economist comes to mind about now – the science of explaining tomorrow why the predictions made yesterday did not come true today. At the moment there have been a number of assessments of the 2011 forecasts by the economic profession and most of them were found lacking in one respect or another. This always sets off a flurry of conversations about why this was the case. That process is really more valid than one would assume and is not entirely a matter of self-justification. Every time a forecast is made there are two assumptions that accompany the prediction.

The first is that every forecast is based on the available data and information and the current situation. When there is new data and when the situation changes the forecast has to change to reflect that shift. There is also the assumption that the act of forecasting changes what the economist is looking at. If one forecasts inflation and is believed there will be a reaction on the part of the public based on that assumption. In some cases this becomes a self-fulfilling prophecy and in some cases the forecast provokes reactions that will reverse expected activity. These are not excuses for missing a forecast – just a description of what really happens. In the great scheme of things more is learned from the failures in forecasting than is learned from the successes. If things do not go as expected the question is why and there is an opportunity to understand some new factor that had not been considered previously. Unfortunately the population that is reading and reacting to the prognostications is not interested in how delightful research becomes – they want to know what is happening.

Analysis: The Wall Street Journal assesses the performance of the economic forecasting community each year and they rank the various economists on the accuracy of their analysis – usually looking at five key and broad measures. These include the rate of unemployment, the GDP growth of the country, core rate of inflation, headline rate of inflation, the Fed funds rate. These are the economists who agree to submit their annual prognostications in a survey – many refuse to be evaluated this way but one can extrapolate from what they assert in public. We don‘t do this survey but we have made our assessments of these factors in the past year and if they are plugged into the same system we end up somewhere in the middle of the pack of 52 economists.

The most interesting part of the exercise is determining what sectors most of the analysts got right and which ones proved the most vexing. By and large everybody was close when it came to the employment numbers. The range was pretty narrow as the optimists anticipated rates as low as 7.6% while the pessimists thought jobless rates would remain at 9.5%. The majority of the group had unemployment between 8.3% and 8.8% and that matched up well with actual rate of 8.5% for the year. There was never much of an expectation that unemployment rates would come crashing down and more than a few thought the jobless situation would prove even more vexing than it turned out to be.

There was a much bigger variation when it came to the GDP growth of the country and that is not all that shocking. This is by far the most varied of the statistics and GDP performance is affected by a host of volatile factors. The range between the economists was wide to begin with as some felt the economy was on the verge of expansion and others felt the recession was still impacting the economy – even at the start of 2011 when much of the data was encouraging. The low prediction for GDP growth was 2.4% and of the 52 economists polled only seven thought that GDP would be under 3%. There were nearly as many (6) that thought that GDP growth would be over 4%. The vast majority predicted GDP numbers in the 3% to 3.7% range. At the end of the year the performance was far worse than any of the economists had predicted – 1.6%. At the end of the year there seems to have been a surge as the first interpretation of fourth quarter numbers showed growth at 2.8%. Most assume that this number will be revised downward in the next data release however.

How is that economists were so far off when it comes to the GDP performance of the country? The short answer is that 2011 was the year of the unexpected and unforeseen and none of these developments were positive. The year began with some real optimism and those who were predicting sub-3% growth looked like real killjoys. Then the global economy was staggered by one major event after another. The earthquake and tsunami in Japan was devastating to Japan but the details of the catastrophe affected the rest of the world in a much more profound manner than had been expected. The region hit is not one of the more earthquake prone regions and was considered relatively safe for locating industry. The destruction of these facilities had a massive impact on the supply chain throughout the world and set global growth back by almost 1% (Japan lost 5% off its GDP growth). The nuclear accident that accompanied the initial tragedy further affected the economy as it shook up assumptions on what would be used to produce power in the future.

Next up was the series of uprisings in the Middle East and North Africa. The Tunisians regime fell first and that was shock enough. There were few who thought this would spread so rapidly and successfully to Egypt, fewer still that thought that Muammar Kaddafi would lose control and end his life being pulled from a drainage ditch and shot. Every week brought a new and unexpected threat to the regimes in this region and today there are still three states that are teetering on the edge of disaster. Few will give Syria good odds and most assume that Yemen will see leadership change sooner than later. Even Bahrain is considered highly vulnerable. This ferment translated into a global problem due to the impact this all had on the price of oil. That is still a major concern.

When one looks at the other assessments from the 52 they were all pretty close. Only a handful thought the Federal Reserve would raise interest rates, the majority assumed they would stay right where they were. Most did not assume much in the way of core inflation and there wasn’t much – 1.7% at the end of the year. The consensus view was that core would be at 1.5%. They were a little off with headline inflation as it jumped to 2.6% for the year and most thought it would be less than 2%.

Just for the record – in January of 2011 we thought that unemployment would be at 9% for the year, GDP growth would be at 2.5%, the core rate of inflation would be at 1.6%, headline inflation at 1.9% and we thought the Fed would keep interest rates stable for the year. Not great but not awful either.

Not Making Money is Good For You

This is basically the message being sent to the nation’s bankers by the Fed these days. The loose monetary policy that has been in place since the recession features very low interest rates. In this environment banks are not in a position to make much money. The message from Ben Bernanke is that efforts to bolster the growth of the economy is in the long term best interests of the banks and that should be more important to them than the opportunity to make money right now. In some respects this is an accurate analysis but there is one factor that creates some contention.

Analysis: The lower interest rates set by the Fed mean that banks can’t make much on the loans they issue and that tends to make the banks very cautious about whom they lend to. If there is a bigger margin to work with the bank may be inclined to take some risks but not under the current situation. This creates a set of tricky discussions. Many of the companies that are seeking loans have had some struggles of their own in the recent past and they look a little less creditworthy than they might have been. The banks are in a cautious mood and that limits their willingness to take risks. Perhaps a tighter policy might even prove more stimulating – at least to banks.

Why the Greeks Protest

The battle drags on and Europe continues to teeter on the brink. Every day it seems that a new wrinkle here or an adjustment there will yield the breakthrough desired and the whole of the Eurozone can go about its business. Then something falls through or someone throws a fit and the whole effort looks doomed again. The sense among most is that this is all the fault of the recalcitrant Greeks. What the heck is their problem? Can’t they see that they have no options here?

There are essentially two assumptions at work here. The first is the assumption on the part of the Greek leadership that it can’t sustain the kind of civil strife these policies will provoke. Never mind that these strikes and protests will doom their chances to win election in the next round, the level of anger and frustration could be enough to send all of Greece into a crisis that will not allow any government to rule with any degree of effectiveness. There is no party with even a modicum of authority in the eyes of the public right now. The average Greek understands what the issue is to some degree but they do not understand why they are being made to suffer for something the politicians did. Every person seems able to point to somebody or something that got more from all this than they did and nobody wants to be the whipping boy. The Greek regime is just not sure that austerity this severe is politically sustainable.

The second assumption is that Germany, Holland and the members of the troika have more to lose in all this than the Greeks. If Greece is forced to default the current regime is not sure that this is any worse than what they are being asked to do but they will be able to say that they defied the demands of the evil Europeans and all the Greeks can vent their fury on the outsiders. If Greece defaults the banks in Europe will teeter on the edge of destruction and even Germany will be affected. In fact the banks in Germany are exposed and they are reacting with much slower loan dispersal which is impacting the German economy already. The Greek government thinks that it will be able to cut a better deal in the end if they can wait this out a little longer.

The fact is that Greeks know they have to change and many are more than willing to do so. There have been critics of the profligacy for years and there are political leaders willing to step forward to build the new, more rational Greece. The question is whether they will get a chance. If Greece is forced into utter chaos that results in withdrawal or expulsion from the EU, the rebuilding gets much harder.

Analysis: What breaks this impasse? Is there a means by which one can create a mutually acceptable policy that gives the Germans what they want at the same time that Greece gets a plan that can actually be implemented? Right now the answer to that question would have to be no. The two sides have been essentially probing one another to see if there is a weakness that can be exploited. The Germans think that the politicians in Greece are bluffing and are really only concerned with their political careers. If one listens to some of the German analysts you hear a common refrain. They fully expect the Greeks to cheat on whatever plan they agree to and that is why the desire is to impose a strict plan right from the start so that when the Greeks ignore part of it there will still be some parts that retain their effectiveness. The Greeks are banking on the assumption that Germany does not want to see the Eurozone crumble. If the euro vanishes the German Deutschemark could make a return visit but it would be instantly considered one of the strongest currencies in Europe and the world and that would devastate the export oriented economy of Germany.

What a Difference a Little Weakness Makes

The Bank of Japan took some steps to loosen monetary policy last week. The desire of the BoJ to do this was not in doubt but many felt that the bank really had no ammunition left with which to impact the economy. The steps were not as dramatic as would have been possible if the bank had not already set interest rates at zero some years ago but it was enough to allow the yen to decline a little in value. The small drop has been enough to boost the fortunes of the Japanese exporter and that has been enough to boost the enthusiasm of the Asian markets in general.

Analysis: The Japanese have been pulling out every trick in the book to get the yen to back down. They really have no choice despite the fact that a weaker yen will present the Japanese with a more profound inflation threat at some point. The consumer has been relatively happy with the strong currency but for an export centered economy a strong currency position is a disaster. The disparity has become so great that Japanese carmakers operating in the US can ship a car back to Japan and sell it more cheaply than they can make the car in Japan itself. This is a situation that Japan can’t sustain for long. The actions of the BoJ are part of the reaction but more steps will need to be taken and that creates some additional tension with the US. The policy of the US has been hardening towards the Chinese on the issue of currency manipulation and it makes attacking the yuan policy harder when the Japanese are employing some of the same tactics to lower the value of their currency.

Charm Offensive Still Underway

The Friday issue of the Executive Intelligence Brief is a little different this week. This is the issue we refer to as the Global Economic Security Estimate. It consists of short and focused pieces that emphasize forecasts and assessments of future opportunities and threats. Take a look at the website to get a look at this next week. www.armada-intel.com If you have not taken advantage of our trial offer on the Executive Brief we invite you to sign up for some free issues by contacting ksanchez@armadaci.com. The Executive Intelligence Brief is the companion publication to the Business Intelligence Brief. It is part of the Armada Strategic Intelligence System and is more detailed than the BIB. It is our subscription based publication and is available to BIB readers at a discount.

The Value of a Critic

As I was presenting yesterday there was an outspoken gentleman in the audience that challenged many of the assertions I made and continually peppered me with pointed questions. These were not offered in a hostile manner but they were sharp and to the point. At the end of the presentation he came up and asked a few more and inquired as to whether these bothered me. The conference organizer informed me that my inquisitor had a reputation for being very hard on speakers and had on more than one occasion stormed out of a room if the presenter did not pass muster.

The fact is that I dearly love having someone like him in a session. It allows me to go into detail on parts of the presentation – it allows me to react to the issues of the moment and in general it keeps me on my toes. No two presentations I make are the same but elements of them can be unless there is somebody that allows me to go off on tangents. I watch the audience carefully when these questions and comments start to arise. If the interlocutor is focused too narrowly I can see in their faces that they could not care less and I ask if I can handle those questions privately. When I get looks that show engagement and curiosity from the crowd I am off to the races. This presentation was by far the most fun I have had in a while. It was not that he was a sparring partner but he gave enough pushback that I could expound and explain in a way that would have been awkward otherwise.

It was also nice to have his compliments at the end as he admitted that he has driven some speakers from the podium in the past. He seemed to enjoy the interchange as much as I did and the group as a whole seemed to appreciate the give and take. One takes ones pleasures where one can on the road!