Block’s Indicator of Sustainable Growth

by Ray Block

Over a number of years, investment bankers in America and England created toxic securities, almost as deadly as weapons of mass destruction, and the consequences are now tipping the world economy into a severe and prolonged recession.

The immediate countries engulfed are United States, United Kingdom and European Union. The S&P Case-Shiller home price index in 10 major US metropolitan areas fell by a record 17.5 per cent in July 2008 from a year ago level, and there are more price falls to come. Home prices are also tumbling in the UK, Spain and Ireland.  

The secondary consequences involve a slow down in China and India, as European and American customers reduce demand for imported goods. In turn, metal commodity prices are falling steadily with commodity suppliers Russia, Brazil, Canada, Australia, and South Africa being affected as well. Agricultural prices fell again in August, with the FAO food price index falling nearly 6 per cent, and if this trend is repeated in September, the whole world will feel the ill winds of recession.

The US Congress will ultimately pass a taxpayer bailout to banks of US$ 700 billion. With $300 billion already outlaid by the US government on Fannie Mae, Freddie Mac and American International Group, and write offs by banks already of $500 billion, these sizeable funds are still not enough to stabilise the world economy.

International trade is slowing. The Baltic Dry index, which measures dry bulk shipping costs plunged by nearly a quarter last week, 10per cent on September 30 alone. The index has become very volatile, twice doubling and then falling back within 15 months. The slide also reflects a weakening in Chinese raw material demand.

Chinese prices for key steel products have been falling 15 per cent to 20 per cent in the last two months. Indian steel prices are similarly falling. Some base metal prices have fallen by more than 50 per cent. The Chinese and Indian economies slowed in the June quarter, and this trend of further slowing is expected in coming months.

Indeed, the single most dramatic indicator of slowdown in Asia has been China’s reversal of its previous monetary policy. Instead of the Chinese central bank constantly raising interest rates to curb excess demand and inflation, September 2008 has seen for the first time in six years interest rates falling, and banks have been allowed to set aside smaller reserves, as weakening export demand slows the economy.                                                                                                                                                                                                 

The consequences of the world downturn is that countries will slow their efforts to reduce greenhouse gases (GHG). We will all be the losers for that. The inevitable result is that the pace of cutting GHG emissions will be substantially lower than what scientific advisers are constantly urging, and almost pleading.

The chances of a successful world agreement on cutting emissions at the Copenhagen meeting in November 2009 are not very high.

But not all hope is lost. There is a way out. If other countries were to follow the lead of the US in introducing investment tax credits on installation of renewable energy solutions, there is no need to sit idly by as greenhouse gases gets steadily worse.

Investment tax credits, available to homeowners and businesses that invest in solar power equipment, and the production tax credits based on kilowatt hours of energy produced by wind, solar, geothermal, biomass and other renewables have been the catalyst for the US to grow its renewable share of electricity consumed.

The result has seen dramatic increases in installation of wind power and solar energy technology in the US over the last two years, thanks largely to the investment tax credits. But because the tax credits require yearly renewal in Congress, there is no consistency in US growth of renewables.

The US Congress allowed the credits expire in 2000, 2002 and 2004. In those three years, wind capacity installation dropped 93 per cent, 73 per cent and 77 per cent respectively from the previous year.

A consulting company advising on renewable energy technology estimated that US investments in wind and solar power in 2009 would amount to $26.6 billion with tax credits, but fall to $7 billion without them. These credits are expected to total $334 million, according to congressional estimates.

by  Ray Block

While commodity prices remain in long term uptrend, the short term cyclical outlook is dramatically down. The speculators are at it again, driving prices down with the same intensity as they were doing, when commodity prices were being pushed up to extreme levels earlier in the year.

The fast money people, including hedge funds are testing out how far down they can go in pushing oil prices lower, given that no one seems to know the floor price. The price charts are in breakdown mode.

But accompanying the speculators, there is an economic downturn gathering pace in an increasing number of countries, as they head into recessionary conditions. The credit crisis engulfing international banks now 13 months old continues to grind on showing no sign of ending over the next 18 months.

The economic blog, RGE Monitor (August 3 2008) said that a group of countries is “navigating towards (or through) recession. The list included the US, Canada, Spain, Ireland, Italy, UK, the small Baltic countries and New Zealand. And moving closer to zero growth are the two heavyweights of the European Union – Germany and France, and Japan is in the same boat.

The only good news is that the commodity price falls should help to puncture the high level of international inflation.

Motor gasoline demand has been in decline since the last quarter 2007, and with consumption still down in the second half of 2008, even demand in 2009 is expected to further shrink. In August 2008, despite a slide in oil prices, US auto sales tanked 15.5 per cent from a year ago, with demand for SUVs and truck pickups are still in the doldrums.

Crude oil prices have tumbled to $108 a barrel since it peaked six weeks ago. The International Energy Agency on August 11 cut its estimate of US oil demand by 6 per cent. With speculators eyeing $100 a barrel as a likely level, it is a long way down from July 2008’s high of $147.27. Oil consumption is contracting not only in the US, but in Europe as well, with sharp falls in Italy and Spain.

Iran is now demanding that the OPEC cartel should shore up prices by cutting production levels, and Saudi Arabia, OPEC’s most powerful member, which had increased its crude production to more than 9.5 million barrels a day in July may well agree to a cut.

The oil price slide triggered off a broader fall in commodity prices such as copper, corn and soybeans, with the Reuters-Jefferies CRB raw materials index, about 18 per cent down from July’s peak. In another sign of commodities in downturn, the Baltic Dry Index which measures the cost of shipping dry bulk commodities fell almost 5 per cent, the lowest level since February 2008.

Of the 21 commodities tracked by Deutsche Bank, only four – live cattle, lumber, sugar and pork bellies showed positive returns so far in the second half of this year. In three of the commodities- live cattle, lumber and sugar, the increase was 10 per cent or less. But in pork bellies, the rise has been quite dramatic, increasing by 30 per cent over the two months to August 2008.

Steel is the latest commodity to show weakness in demand and prices. Arcelor Mittal, the world’s largest steel group announced that it would cut prices in South Africa, as much as 8 per cent across all its steel products, because of lower international prices. The cut will start on October 1 2008. The lower steel outlook has been echoed in China, which collectively accounts for more than 35 per cent of world steel production.

Steel consumption in China, which grew by 16 per cent in the June half 2008 is forecast to increase by only half this level in the December half. Paul Waldmeir in Shanghai for Financial Times (September 3 2008) says that major Chinese industries consuming steel- such as construction, household appliances and car production are all showing signs of weakness. Steel prices have been sliding since July.

In Eastern Europe, the price for hot-rolled steel has fallen about 30 per cent in less than two months. In the US, the Wall Street Journal reported (September 3 2008) that prices of domestic hot-rolled and cold-rolled steel are off about 8 per cent. The three month price of nickel has fallen 23 per cent on the London Metal Exchange (LME), and along with the fall in demand for stainless steel, the substantial rise in stockpiles augurs unfavourably for further price weakness.

Aluminium is at a seven month low on the LME. In food commodities, wheat, soybeans and corn are well off their 2008 highs, with soybeans and corn more than 20 per cent lower than their 2008 highs.

Accompanying the commodity price falls, the commodity driven dollar currencies of Australia, Canada and New Zealand, along with the South African rand are all in retreat, and even the emerging market Asian currencies are also trending down.