This is a diary with only bad news, all taken from one newspaper (the Financial Times) in a single day of news (today). Each can be expained away individually as a freak, or the result of specific circumstances, but together they point to a very grim outlook for the US economy (and the global one):
- Under-investment
- Inflation fears growing
- Financial jitters following GM and Ford becoming "junk"
- A bellicose international/trade policy
- The still looming oil crunch
Under investment
This is something that I have already written about in the case of the oil industry (see my most recent diary on the topic), but today's article is about another sector which is just as worrying, if not more: transport infrasturcture:
Clogged transport arteries strain US
Executives from several of North America's largest transportation groups told a Bear Stearns conference in New York last week that, despite this year's more moderate rate of economic growth, many US ports and freight carriers were still operating at or near capacity. And they warned that rates continued to rise in response to tight supply, further increasing transportation costs already inflated by record fuel prices.
(...)
There are two main reasons why the system failed to cope: first, under-investment in an ageing infrastructure not designed for the demands of fast-moving, global supply chains; second, an acute manpower shortage that has left truck companies, railroad operators and ports without enough crew.
Critics complain that truck and railroad operators have failed to increase capital spending enough since the steep cuts made during the last recession.
(...)
the four biggest US railroad companies - Union Pacific, CSX, Norfolk Southern and Burlington Northern Santa Fe (BNSF) - have increased capital expenditure this year by just 1 per cent, despite enjoying average revenue growth of 20 per cent and profits growth of 40 per cent last year.
And this is happening despite Congress voting another pork-ridden Transportation Bill which proposes to spend a lot of money to build new highways but apparently not to focus on the real issues that the private sector is not investing in the economy anymore because there are easier ways to make money in the short term - and the short terms seems to be the only thing that US companies care about these days. No investment means more cash-flow, higher profits, and fatter (lower taxed) bonuses and other extra remuneration for the bosses.
This IS beginning to have an impact on the competititivity of the US economy, and it can only get worse as years of neglect and decay will impose growing costs and waste of time.
inflation fears
Meanwhile, the news on the inflation front is not great
US wholesale prices rise 0.6 per cent
A jump in US wholesale prices in April has provided support for the Federal Reserve's focus on inflation risk, but figures released yesterday also provided more evidence of a slowdown in industrial activity.
Producer prices rose more than expected last month, with the headline rate climbing 0.6 per cent and the core rate, excluding food and energy, rising 0.3 per cent, the Labor Department reported yesterday.
(...)
"The average economist does not see the risks to inflation as balanced, even though the Federal Reserve continues to say so in public," Mr Leahey said.
Separately, a report released by the Federal Reserve on Tuesday pointed to a surprising drop in industrial activity last month.
This means that the Fed will continue to increase interest rates at its current rate (a quarter point at each meeting), and that some banks in the market even expect that it could go faster.
As Stephen Roach, Chief Economist of Morgan Stanley (and a long time bear) has long argued, a neutral interest rate would be in the 5.50% range (so, still a long way to go) - without taking into account the recent inflation spike. Higher interest rates mean more pain for debtors, lower house prices as people can borrow less to sustain the current market, and generally less disposable income.
Financial jitters
As the end of cheap money, which has fuelled the boom in various asset classes, looms, expect a lot of pain in the financail markets as they adjust to more expensive funding and it becomes clear that the more reckless investments only made sense in an unrealistic context of permanent extremely low interest rates.
In that context of slow tightening of credit, the recent downgrade of GM and Ford debt to "junk" status, despite being widely expected, is such a momentous event (it impacted close to 500 billion dollars of debt) that it threatens to destabilise a number of players:
Hedge funds rush to sell assets
The cost of buying protection in European and US financial markets against corporate bond defaults has risen sharply in recent days, as hedge funds and other investors seek to offload assets after suffering losses.
This has moved the price of some credit instruments in unusual ways and caused liquidity in some corners of the financial markets to evaporate, according to bankers. While the overall scale of hedge fund selling and their losses is unclear, many observers suspect it will continue to distort the market for some time. Some fear the jitters could worsen, particularly if hedge funds' losses prompt investors to withdraw money at the end of the next financial quarter in June.
Much of the forced selling was triggered by the downgrades of General Motors and Ford to "junk" status by Standard & Poor's. The move had been anticipated, but its timing wrong-footed many investors who had taken positions in GM or Ford bonds or equities, or had made bets about broader trends in corporate credit.
See more in this diary about GM, where I wrote about the dangers of illiquidity and the facts that many of the complex instruments used by hedge funds have yet to be tested in a serious financial storm. Maybe we'll know even sooner than expected...which is not a pleasant prospect, unfortunately. (See also bonddad' recent diary on that topic.)
A bellicose international/trade policy
Meanwhile, in this uncertain context, with the twin deficits (current accounts and budget) in the background, the US administration is busy building up tensions with major trade partners like China and Canada:
US sets currency deadline for China
The US Treasury, in its twice-yearly report to Congress on exchange rates and trade, stopped short on Tuesday of accusing China of currency manipulation but made clear it expected revaluation within six months.
(...)
Mr Snow said on Tuesday a shift in the exchange rate peg was in China's own interest to help prevent protectionist policies in the US Congress.
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Renminbi revalue call a boost for markets
Shares rallied in late afternoon trading after the US Treasury made it clear that it expected China to take steps toward removing the renminbi's dollar peg. The dollar rose and Treasuries were little-moved, after the Treasury report stopped short of accusing China of currency manipulation.
Snow is raising stakes in the global game of chicken played with China, by pressuring the Chinese publicly to make policy moves that they are very reluctant to make, for both internal and external reasons - and the markets in the US are cheering? The Us Administration is taking an aggressive line on one of the biggest purchasers of US Treasuries while making no effort at all to reduce the growing dependence of the US on foreign creditors? How is that a sound foreign economic policy?
And meanwhile, disputes with Canada simmer on:
US beef industry could face `permanent damage'
Mike Johanns, US agriculture secretary, warned on Tuesday that the US beef industry faced the prospect of "permanent damage" if imports of live cattle across the US-Canadian border continued to be blocked.
His comments are a sign of the increasing frustration felt by the US government that continued closure of the border is causing Canada to accelerate the development of its own meat processing capacity.
(...)
The border has been closed to imports of live cattle since Canada discovered its first case of "mad cow disease" - or bovine spongiform encephalopathy (BSE) - in mid-2003.
Canada is still the single largest trade partner of the US, and yet it is often treated contemptuously by the US. I don't see how trade wars with Canada can help the US economy in any way - except for narrow interest groups. How is it sound to let these decide trace policy?
The still looming oil crunch
In this context, relations with Saudi Arabia also matter, and they are growing increasingly bitter, both sides blamng the other for their seeming inability to solve the problem (which is really a problem only for the US) of higher gasoline prices:
Saudis blame US regulation for pushing up oil price
Ali al-Naimi, the Saudi oil minister, yesterday blamed excessive US regulation of oil refining for contributing to the high fuel prices that have become a political headache for the administration of President George W. Bush.
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Mr Naimi said that Saudi Arabia was producing around 9.5m barrels of oil a day and could pump 1.5m barrels a day more. He added, however, that there was no point pumping extra oil if the refining capacity and the demand were not there.
(...)
The cartel added [that] a shortfall in non-Opec supplies would increase the need for its oil later in the year.
(...)
Longer term, Saudi Arabia planned to raise its capacity to 12m barrels a day by 2009 and eventually to 15m b/d.
The point about refining regulations is real, but it is significant only because we are in a context of tight oil supplies, and thus US refiners find it increasingly difficult to find supplies of the kinds of oil they need (the light, higher quality ones). Both sides are right in this.
The most worrying aspect of that last quote is actually the last bits, about saudi Arabia's promises to increase oil production. It has been at least a year since they first said that they would increase production from 9.5 mb/d to 11 mb/d, and they are still promising the same thing. Are they actually able to do it or not? It would appear that not.
Increasing production capacity to 12 mb/d, from a claimed 11 mb/d means only adding 1mb/d in 4 years, when oil demand has been increasing by 2mb/d per year in the past 2+ years. Saudi Arabia is effectively saying that they are unable to increase production significantly in the medium term. The real test will be the second half of this year, when demand is traditionally stronger - we'll see soon enough if supply can cope or if we have to face much higher oil prices.
Higher oil prices feed inflation and thus interest rate increases, they feed the trade deficit and thus calls for "fair trade" and other protectionist policies, and they will dampen consumption. Meanwhile, US companies will gorge on short term profits and Wall Street and the media will be able to keep on saying that the economy is fine.