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How is the economy doing?

July 10th, 2008 · No Comments

Well, let’s take the temperature anew. Now that the markets have finally succumbed to reality, which was a lot worse than they seemed to suggest a couple of months ago, is there any change in that reality?  We try to search the net for stories that can shed light on the situation and give you a summary and an assessment.

1) First up, foreclosures. A central variable because it’s a major driver in the housing market, and the housing market is a major driver of wealth, credit markets, and consumption. The news is still not good, in fact, it’s downright ugly. It really doesn’t look like the worst is behind us:

The foreclosure problem is getting worse and will stay with us well into the next decade,” Mark Zandi, chief economist for Moody’s in West Chester, Pennsylvania, said in an interview. “The job market is eroding and homeowners have less equity. Lenders are much less willing to work with you if you’ve got negative equity, and you’re more likely to give up your house if you’re deeply underwater.”

“The year-over-year increase of more than 50 percent indicates we have not yet reached the top of this foreclosure cycle,” James Saccacio, chief executive officer of RealtyTrac, said in the statement. Bank repossessions, which increased 171 percent in June, are rising at a “much faster pace” than default notices and auction notices, he said.

About 53 percent of borrowers with subprime loans, those with poor or incomplete credit histories, will have negative equity in their homes at the end of the year, and the number will rise to 63 percent in 2009, New York-based analysts at Credit Suisse led by Rod Dubitsky said in an April 23 report.

The housing beyond the sprawl is going to suffer another serious leg down because of high oil prices,” Peter Navarro, professor of economics and public policy at the University of California at Irvine, said in an interview. “A lot of people went out there to get cheaper homes, but this is going to take a big bite out of their mortgage.”

Hmm, that’s not good. In fact, we can now also add the stockmarket as another wealth distructor. No wonder consumer confidence is close to an all-time low (despite a little spike in consumer spending due to tax rebates).

2) Oil prices peaking at least that’s what we argued yesterday. Some of the news points to continued demand from power hungry China, but it’s hitting physical limits, for instance:

China’s biggest aluminum producers, the largest in the world, agreed to cut output by as much as 10 percent to ease a power shortage, sending metal prices to a record.

The reductions may help alleviate a sixth year of power shortages in the world’s fourth-largest economy and curb Chinese aluminum exports that jumped 43 percent in June. The energy used by China’s aluminum smelters each week is enough to provide power for more than 2 million people for a year.

So, China seems to be supply constraint for it’s power needs, one has to realize that it’s mostly a shortage of coal which seem to be the major bottleneck:

Government control of power prices means utilities can’t afford to buy enough coal. Aggravating the shortfall, the government has shut thousands of small and unsafe coal mines.

And, if coal is in short supply, wouldn’t it be a good idea for utilities to switch to power plants that work on other fuels, like oil and natural gas (with the added advantage that these are much cleaner fuels, but the disadvantage of increasing imports)? It would, but that will take time.

One would argue that another solution would be just to import more coal (which would be good for dry bulk shipping rates and hence DRYS, a company we’re following),  but it looks like the power pricing is really the problem, and it’s not terribly likely that foreign coal would be significantly cheaper compared to their own coal.

3) American interest rates. Well, here some scaremongering from a couple of Fed people.

The Federal Reserve should raise interest rates toward their “neutral” setting as quickly as reasonably possible to prevent high inflation taking root, a top Fed policy-maker said on Wednesday. “To the extent that the economy as we watch it … avoids recession, and to the extent that you watch commodities, you do want as quickly as possible to get back to neutral,” said Federal Reserve Bank of Kansas City President Thomas Hoenig.

This could actually be interpreted both negatively and positively (isn’t economics wonderful?). Negatively as higher rates would be less helpful in combatting a recession, but positively as Fed officials (Janet Jellen made similar utterings yesterday) apparently deem the economy strong enough to be able to withstand higher rates. Not this official though:

“The goal is to get to neutral without tanking the economy. I think that it is important that we do that as reasonably soon as we can,” he said, speaking in his 14th floor corner office of the bank’s imposing new headquarters, about 1-1/2 miles from downtown Kansas City. However, he does not anticipate a speedy return to strong U.S. growth. The economy will be subdued this year and into 2009, and Hoenig said it might be 2010 before it achieved trend-like levels around 2.5 percent.

Hoenig said the timing of rate hikes depends to a degree on financial institutions resuming normal lending practice as markets regain their poise and consumer confidence returns.

That timing looks like not anytime soon, so, in fact, we think that the best reading is thoroughly negative. It’s words to give the impression that the Fed is watching the inflationary problem and prepared to take action while they’re not daring to actually take that action (increase interest rates, if you hadn’t guessed by now). That’s a sign of weakness, and it’s an awkward policy dilemma which we’ve discussed here a couple of times already.

4) The global economy. Here some words from the IMF’s top man, hardly a reason to rejoice:

It is hard to know how far the global financial crisis still has to run, with the extent of further credit losses hinging on what happens to the U.S. housing sector, IMF chief Dominique Strauss-Kahn said on Wednesday. “What is sure is that the consequences for the real (economy) sector of the financial crisis are still in front of us,” Strauss-Kahn, the International Monetary Fund’s managing director, said in an interview.

Apart from the fact that this neatly corroborates what we wrote above (1) on the importance of the US housing market, note as well (it’s hard not to, we put the emphasis) the gloomy prediction that the effects on the real sector (by which he means production, so affecting global growth and employment) are still in front of us. The only consoling bits we have to offer you is that the IMF is not always right in their predictions.

But we fear this time they are..

Tags: The Markets