August 22, 2011

Texas Drought and Climate Change

The latest data from the Palmer Drought Severity Index (PDSI) for July 2011 shows the Texas drought to be right about the worst in the historical record. It is extremely tempting to attribute the drought to climate change, but the graphic suggests it got just as bad in 1918 and 1956. Stuart Staniford, who reproduces the chart from the National Aeronautic and Space Administration, notes that the drought isn't over and that "it could well be the worst Texas drought ever before it's done," but also that we don't "have license to attribute it to climate change yet, since there's no overall trend in the Texas PDSI data (in contrast to California) and the drought is not yet bad enough to argue that we've crossed some kind of threshold into an ahistorical climate state." Since "the current event is not outside the envelope of historical events back when climate forcings where a lot smaller, . . . you cannot use droughts in Texas as any kind of evidence that climate change is happening or is bad. This is quite apart from the fact that any single event is hard to use as evidence - there simply is no trend, suggesting that Texas droughts are not sensitive indicators of climate change (in contrast say to Antarctic glaciers or polar ice sheets or probably even droughts in California all of which evince clear change in the climate-change-expected direction that cannot be explained by the respective null hypotheses)." That could change if the drought got a lot worse, adds Staniford, but not yet.

The other hypothesis, which the cautious Staniford does not investigate, is the theory of divine perturbation. The Almighty has been taxed previously by bad behavior from Texans, after all, but never so much as recently. Working circumspectly and with all deliberate speed, so as not to draw attention, but taking cognizance of Texas's rotten record and of the sinfulness and hypocrisy of its leaders, He has just thrown in the towel. He has decided that nothing is better deserved for the Lone Star state than earthly proximity to hellish fires. He is not listening to their stupid prayers for rain; He is past caring.

God, to be sure, is also extremely upset over the budget deficit and the behavior of American politicians, especially Democrats. As Michelle Bachman, a noted authority on God's thinking, recently declared: "I don't know how much God has to do to get the attention of politicians. We've had an earthquake; we've had a hurricane. He said, 'Are you going to start listening to me here?'"

Update: The Bachman camp says she was joking, according to one of my students. By contrast, I am entirely serious.

Weighing in on my side is Senator James Inhofe of Oklahoma: “Well actually the Genesis 8:22 that I use in there is that 'as long as the earth remains there will be springtime and harvest, cold and heat, winter and summer, day and night.' My point is, God’s still up there. The arrogance of people to think that we, human beings, would be able to change what He is doing in the climate is to me outrageous.”

This graphic from the Chicago Tribune, reporting data from Texas A&M, estimates the costs of the Texas drought at more than $5 billion.


h/t Desdemona Despair

August 20, 2011

Private Job Growth Crashes Over Last Decade

This amazing and depressing graphic comes from Stephanie Pomboy of MacroMavens, whose work is often featured by Alan Abelson in Barron’s. As the chart shows, private wage growth has fallen precipitously in the last ten years. Once the envy of the world, notes Abelson, the great American job machine “has suffered a serious breakdown.”

The crash in private job creation is paralleled by the huge shift in returns to capital and labor, unprecedented in the post World War II period.

A new form of capitalism—sort of like the old form, on steroids—has emerged in the United States. While concentrating wealth in a sliver of the population, it creates a larger class of marginal people just scraping by, if at all.

Does the high level of corporate profits betoken a permanent change? I think that is unlikely. Probably that level will revert back closer to the mean.

It is not clear, however, what will bring it back to the mean. Political remedies to do so seem exhausted. Corporations have shown they know how to extract a profit and have un-moored themselves from the communities in which they were once embedded.


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Source for Employee Compensation chart: Charles Hugh Smith
Source for Food Stamp Participation: Zerohedge

August 16, 2011

China's Pressure on Grain Markets

From the Wall Street Journal, an analysis of China's huge move into world agricultural markets, focusing on the demand for corn:

China's need for corn—which forms the basis of sweeteners, starch and alcohol as well as feed for livestock—was on stark display in July when the nation ordered 21 million bushels of U.S. corn in one hit, more than the U.S. government thought the country would buy in a year. The purchase surprised the market and came as an intense July heat wave was shrinking the potential size of the Midwest crop. China bought another 2.2 million bushels of U.S. corn early this month. . . .

China's influence on corn demand underlines how its fast-growing economy is reshaping global commerce. The nation, with its growing population of 1.3 billion people, has been a major player in commodities markets in recent years.

China already buys about a quarter of all U.S. soybeans. But its sudden demand for corn caught many off guard. China, which hadn't been a net importer of corn for 15 years until last year, has a vast corn belt of its own and for many years strove to be self-sufficient. And because China is secretive about the levels of commodities it holds in its strategic reserves, the rest of the market can only guess what its supply needs are.

Many attribute the larger-than-expected demand to a growing middle class that is changing its tastes more quickly than anticipated. As the Chinese population becomes wealthier, for example, it is eating more pork. And the Chinese government is pushing its farmers to adopt Western methods of raising their pigs, including feeding them more corn. Citizens are also slurping up juices and other products that include corn-based sweeteners: Coca-Cola Co. said that its volume in China spiked 21% in the second quarter. . . .

The changes have created big shifts throughout the food chain, including U.S. companies and farmers putting in place infrastructure that will enable massive shipments of grains and other products to Asia.

Many U.S. traders and economists believe the recent purchases signal U.S. sales will grow so rapidly that China could become the biggest foreign buyer of U.S. corn within five to 10 years, dethroning Japan, which bought about 610 million bushels of U.S. corn last year. . . .

To be sure, Western executives have been wrong before about China's appetite for foreign corn. A sudden surge of Chinese buying in the mid-1990s sparked talk of a trade boon for U.S. farmers, but it was a blip. While China's middle class is far bigger now, and its gross domestic product grew a blistering 9.5% in the second quarter, economists predict turbulence. Much of China's breakneck growth is fueled by government-led investment, not entrepreneurs, and China's housing market appears to be overheating.

Still, the threat of instability might well work in the favor of U.S. farmers. China's ruling Communist Party worries in particular about food inflation, which could put social stability at risk. In an effort to preserve domestic supplies, the government has already stopped construction of factories that convert Chinese corn into ethanol fuel. . . .
For now, the amount of Chinese business confirmed by Washington is relatively small alongside America's total foreign sales. The U.S. exports about 1.8 billion bushels of corn globally.

While nobody in the West knows for sure how much corn China will want to import and how soon, the possibilities fascinate grain traders. According to Michael Swanson, a Wells Fargo & Co. economist, doubling of per-capita meat consumption in China so that it matches the U.S. level would require the country to use an additional 24 billion bushels of corn, or about twice what the U.S. produces in a year. "There's not enough grain in the world for them to do that," Mr. Swanson says. "But just moving in the direction is staggering to consider."

August 11, 2011

The Deflationist Case

The following is a brilliant exposition of a deeply pessimistic view of our current economic predicament. The steep drop in equity markets raises again the specter of 2008, of runaway financial crisis built on the foundations of an unfair and unstable system. The Automatic Earth, the blog from which the following comes, has had many posts dealing with these matters, but none so powerful as this. In effect, says Stoneleigh, the Minsky Moment of 2008-09, distinguished by the liquidation of risky assets and the mad dash to preserve capital, is upon us again.



















Widening credit spreads will send the interest rates payable on the debts or ordinary people, companies, banks and lower levels of government through the roof, even as the rate payable on the debts perceived to be safest falls and remains low. At the same time, monetary contraction, credit destruction, spiking unemployment, benefit cuts and skyrocketing bankruptcies will increase the burden that debt represents.









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What makes this piece so interesting, apart from the sheer doom and gloom of the thing, is the combination of systemic analysis and immediate market prognostication. But I have some reservations. 

First off, the immediate crisis in the markets. I think US Treasury bonds are grossly overbought and that a reversal will come soon. They've basically reached the levels of late 2008 and in some cases (2 year treasuries) gone beyond them. To buy them here would be chasing outsized moves. While the earnings of corporations may be overstated if seen in relation to five year averages, there is still a huge disparity between the measly 2% yield on ten year Treasury notes and the earnings power of stable corporations.There is no telling what further ranges panic may explore before confidence is restored, but I don't believe we will just slice through the floor, as in the fall of 2008. Generally speaking, it is seldom wise to sell into a panic, and you shouldn't be in a position (if you're in a position to care about these things) where you are compelled to sell because over-leveraged.

If we cast our sights not on the debt-burdened industrialized countries but on the world more generally, I also find it difficult to credit the forecast of protracted deflation and reduced demand. The hungry mouths will demand to be fed, and economic activity will proceed, even if at a reduced pace. Worldwide coal consumption grew 7.5% last year, to take one example of the secular increase in demand for energy and commodities. It would take some kind of gigantic bust to derail this world historical locomotive.

The interaction between the economic system and the energy system is complex. There have been signs since the spring of 2011 that the 2008 experience might be repeated, even if on a reduced scale. The rise in oil prices would inevitably produce a contraction in economic activity, such that the rise in prices would decrease demand for other goods and services (with our crack-induced financial markets magnifying these shifts). This oft-repeated pattern clearly should be viewed as greatly significant, but does it portend the collapse of the economic system and of the entire model of economic growth? I doubt that. 

The more general problem from the vantage point of this blogbook is whether the limits to economic growth are to be found more in resource constraints or the dynamics of debt deflation (such as was described by Irving Fisher in the 1930s, and whose model The Automatic Earth implicitly embraces). Basically, the great problem of contemporary political economy is whether there are political, economic, or technological cures for those two conditions.

Stoneleigh is exactly right in insisting that the immediate effect of the downgrading of US debt by Standard and Poor's is on Europe. If the US is downgraded, why not France? Such has been the question of the hour for the markets. Stoneleigh may also be right in insisting that no political will exists in the European center (i.e., Germany) to bail out peripheral nations; at the same time, there is little question that it is in Germany's interest to lead a rescue. What is needed is a European bond, raised on the authority of the EU, to backstop the governmental bond market in Europe. That should be combined with haircuts to creditors. This was the principle on which "Brady Bonds" were introduced in the 1980s to deal with the debt of insolvent South American governments, and it provides a good model for dealing with today's crisis.

Back then, it was the United States government (together with the IMF and others) that stood behind the Brady bonds. What would stand behind such a European bond today? While many observers have proffered some variant of the following answer--"fiscal federalism," or the creation of a United States of Europe--it seems to me that a more limited set of steps might be sufficient. Instead of moving toward a European system with a general power of taxation, such as was created by the U.S. Constitution, specific taxes--amounting, say, to 3 to 4 % of Europe's GDP--might instead be pledged to the European bond. The taxes pledged would be a "sinking fund" for the debt (to use the eighteenth century expression).

Without descending too far into particulars, let us estimate that Europe's total gdp is around $15 trillion, about the same as the United States. A 30 year European bond worth $1 trillion, at a 4 percent rate of interest, would require monthly payments of $4.8 billion, or $57 billion a year. That works out to about 3.8 % of Europe's GDP (taking a fraction of the $15 trillion figure, which is only approximate.)  Taxes on energy consumption could be pledged to the common fund, involving commensurate reductions in energy taxes at the national level. In conjunction with the United States and Japan, a small tax on financial transactions would also serve well as a general fund for the EU. Whatever the precise details, a common European tax to support a common European bond is a logical next step for Europe.

Europe lacks the institutions to come up with such a remedy overnight; in the absence of such institutions, it must rely on German leadership.

The German public is royally sick of the idea that it should bailout the rest of Europe, though its banks hold a significant percentage of the dodgy debt (making any "bail out" of the periphery a "bail in" of the big European banks). The forces poisoning the relationship--German resentment against deadbeats, and the resentment against Germany for the terms that come with German bailouts--are all too real. At the same time, it seems no less true that Germany cannot prosper if its European neighborhood is on fire, and that the peripheral nations like Greece and Ireland cannot afford to let their resentment get the better of their interests. The Europeans are bound together in a doomed relationship, as in some tragic Italian opera. Within that dysfunctional relationship, it is Angela Merkel who must "man-up" and propose a limited but forceful European solution.

The larger question is whether America and China will join Europe in "turning Japanese," with deflation conquering growth and leading to the collapse of equity markets. It would be foolish to rule out that grim prospect, given the experience since 2008, but I think it would constitute a fear-driven and irrational response, unless we are postulating the end of our economic system. We are also most unlikely to get there, if that is indeed our final destination, in a straight line. Here is an extract from Jeff Saut, the investment strategist, whom I have slightly edited [in brackets] to make my own related points. Saut notes that earnings estimates for the S and P 500 are
nestled around $100 and pushing towards $114 for 2012. If those estimates prove correct, at last week’s intraday low (1168.09), the SPX was trading at a PE multiple of 10.3x next year’s earnings, with an Earning’s Yield of ~9.8% ($114 ÷ 1168), leaving the Equity Risk Premium for stocks at ~7.4% (Earnings Yield – 10 year T’note yield of 2.4%) for the highest ERP in a generation. . . .
When asked how he made his money, [Jim] Rogers answered, “I sell euphoria and buy panic.” The way he determines that is to wait until prices are “gapping” in the charts. Gapping on the upside is “euphoria,” while gapping on the downside is “panic.” Currently, gold and Treasuries [plus Swiss franc and Japanese Yen] are gapping on the upside; and, stocks are gapping on the downside. The implication . . . suggests positions should be sold in [precious] metals [and Treasury bonds, Japanese yen, and Swiss francs!] and the freed-up cash should be used to buy sound stocks with decent dividend yields. . . . The time to panic, and raise cash, was months ago. Now it is time to selectively redeploy that cash into select equities.
I think Saut overdoes the earnings picture--the 2012 estimates are in all probability seriously inflated--but his overall point is valid and convincing. Because of the surge in prices for gold, bonds, yen, and francs, "safe" assets have become risky; because of the collapse in equity values, "risky assets" have become much safer.

Update: Via Felix Salmon, this chart from Reuters on the divergence in yields between stocks and Treasury bonds speaks volumes:


August 2, 2011

Water Wars and China's Control of the Tibetan Plateau
