Thursday, November 29, 2007

US Dollar Fate

Gazprom May Switch Oil, Gas Sales to Rubles as Dollar Weakens
By Dan Lonkevich
Nov. 29 (Bloomberg) -- OAO Gazprom, the world's largest natural-gas exporter, may start selling its crude and gas production in rubles rather than dollars and euros after the U.S. currency weakened.
``We are seriously thinking about selling our resources in rubles,'' Alexander Medvedev, Gazprom's deputy chief executive officer, told reporters today in New York. He didn't give a specific timeline for the decision.
The switch would happen ``sooner, rather than later,'' Gazprom Chief Financial Officer Andrei Kruglov told the same gathering of reporters.
To contact the reporters on this story: Dan Lonkevich in New York at dlonkevich@bloomberg.net .
Last Updated: November 29, 2007 14:04 EST
It is interesting to note that a primary concern other countries have with the drop in the US dollar relative to their currency is the fear that their trade export position, and consequently,thier export driven ecomonies would suffer. In the case of Gazprom, referenced above, considering repricing in rubles rather than US dollars signals a perception of the decreasing significance of ruble strengthening relative to the dollar. It suggests when the demand is relatively inelastic for an export, such as energy, the concern about the likelihood of decreased exports is diminished. Moreover, it is somewhat of a two edged sword. As the ruble strengthens the purchasing power, and consequently the real wealth of ruble holders increases. It is a win on two fronts, increased purchasing power and increased accumulation through continued export driven growth.
Absolutely brilliant. Wait until some of the other petro powers catch on to this.
Ryan Darwish
Author of The Emperor's Clothes: A Look at the MegaTrends Affecting Your Financial and Investment Decisionshttp://www.investmentmegatrends.com/

Friday, November 23, 2007

Economic Decoupling

Nouriel Roubini, an eminent global economist, has made the point that if the US experiences an economic slowdown, other countries, such as China, would also experience a slowdown because our economies are dependent upon one another.[1] This is known as being coupled together. There has been ongoing discussion which suggests the alternative hypothesis, that economic decoupling has occurred, and the rest of the world is not economically dependent upon the US anymore.

While there are many well made points in Roubini's, as usual fine analysis, I believe there is something lacking in several respects. The idea of decoupling is contextualized as a black and white issue; either other countries have decoupled, or they have not. The preponderance of evidence, a posteriori, is that those other countries now have more developed economies, and by extension greater internal, as well as intra-regional, demand. The statement “"For now it is clear that it is still the case that when the US sneezes the rest of the world gets the cold.” may be an overstatement. I see little evidence to support this conjecture. It appears more likely that a more accurate representation would be "the rest of the world gets something between a sniffle and a cold". Whether the rest of the world gets more of a cold than a sniffle remains to be seen.

I see several possible mitigating factors which were not mentioned in this analysis. One factor would be how rapidly US demand deteriorates relative to geo-specific, intra-regional, and country specific internal demand increasing. Another factor are those elephants in the living room known as sovereign wealth funds, and country specific economic stabilization funds. It is no secret that a number of countries who have been beneficiaries of petro-dollar and trade surplus dollars have strategically identified the risk of a US slowdown. It may be a gross under-estimation of the intelligence of these entities to assume that they have not factored in contingency planning. Considering the infra-structure build-out needs of these emerging economies, a hypothetical alternative to being dragged down by a declining US economy would be to redeploy surplus reserves, and/or borrowing capacity, to developing, for example, their economic and physical infrastructure such as roads, telecommunications, environmental cleanup, etc. The US, in fact, presents a model of such an endeavor during the early 20th Century with the Civilian Conservation Corp. A major difference, nowadays, is that the US is financially broke, while these other emerging economies are relatively financially flush.

Ryan Darwish
Author of The Emperor’s Clothes: A Mosaic Look at the MegaTrends Affecting Your Financial and Investment Decisions
http://www.investmentmegatrends.com/

[1] http://www.rgemonitor.com/content/view/228535/85/

Friday, November 16, 2007

A Hard Landing or Stagflation?

Predicting a "hard landing" recession is not much more than making the observation that the horse is already out of the barn. It is also an intellectual hedge, to not go too far out on the limb, from making the observation that what we are facing is not just an economic "hard landing", but a period of stagflation. Looking at escalating food and energy costs, while not core items in "Fed Think", are certainly core items in living. Moreover, the pervasiveness of the dependency of the pricing of other goods on the production and availability of food and energy, suggests a very ugly outlook. This is compounded by increasing demand in the context of supply limitations for these items. It begs the question to hold the position that a slowing economy will dampen the demand for these goods. Externalities such as weather, geopolitical unrest, and strategic hoarding of vital resources, at the very least, cast doubt upon the premise of decreased demand because of slow, or recessionary, economic growth.

Author of The Emperor's Clothes; A Look at the Megatrends Affecting Your Financial and Investment Decisions
www.investmentmegatrends.com

Wednesday, November 07, 2007

The Current Financial Crisis and its Likely Outcome

As the current credit market crisis continues to unfold, it goes from bad to worse. Credible commentaries are now emerging in the mainstream press citing estimates as high as $500 billion(1) of losses that financial institutions may incur before it runs in course. It is unclear to me what the actual implications will be of a systemic loss of this magnitude, and indeed, since none of us has a perfect crystal ball, it can only be the subject of conjecture and speculation. That there will be an increase in insolvencies, massive economic displacement, and economic restructuring is appearing to be more and more a given. We appear to be at a global economic watershed point. If history is any guide, previous bouts of monetary folly have resulted in hyperinflationary environments, followed by collapse(2). In the past, however, there was relative economic containment because of the absence of the degree of globalization and economic integration we currently have in the world, with the exception, possibly, of the Great Depression era. In any event, an economic crisis of the magnitude we are currently facing, quickly becomes a political crisis. In considering possible strategies which may be attempted, short of the transparent charade recently proposed of the SIV Super Bailout fund, it appears the corner strategy will be monetization of the debt through hyperinflation. Indeed, we have already seen the evidence of this occuring, and it is well known that it is not a peripheral strategy for Ben Bernanke.

If we assume, for purposes of discussion, that this is the direction in which economic history will move, it becomes useful to consider some of the implications of this scenario for asset deployment purposes. While there is a great deal of discussion regarding the demise of the US dollar, it is often followed by considering other currencies as a safe harbor refuge. This may be a false sense of security. Considering that one of the reasons for the US dollar's problem is the lack of monetary discipline because of the fiat nature of the currency, the same problem exists with other currencies. There appears to be an inherent instability with a fiat monetary system. Consequently, in my opinion, it is a mistake to believe that other currencies might be anything other than a temporary refuge.

Let us also consider the question of debt. The initial reaction is to want to minimize indebtedness in a financial crisis. This may well, generally, be the prudent course to take. However, as circumstances amoung market participants differ, holding a fixed liability during a time of hyperinflation can become an asset as long as the ability to service the debt remains in place. For example, if I have a mortgage of $300,000, a hyperinflationary environment will reduce the value of that liability, in real terms, while at the same time possibly increasing the value of that asset in nominal terms. If I have a fixed mortgage payment of $1,500 per month which I can continue to service, a hyperinflationary environment may reduce that nominal figure in real terms, ie adjusted for inflation.

Let us also consider assets which might best retain or increase in value. It seems clear, and current market behavior suggests there is growing recognition of this, that assets which have a real use value, such as commodities, energy, food, water, etc. will continue to be in growing demand. At the same time, the constraints on the supply of these resources continues to grow. Economics 101 would suggest that a highly probable way to successfully deploy assets would be to own assets which are in growing demand and diminishing supply.

Traditonally, institutional creditors would be the one's to lose big time in inflationary environments. Nowadays, these institutions also appear to be some of the biggest debtors.


(1) Banks Face $100 Billion of Writedowns on Level 3 Rule, John Glover Nov. 7 (Bloomberg)
(2) Manias, Panics, and Crashes, A History of Financial Crises, Charles Kindleberger.

Monday, November 05, 2007

Moral Hazards and Free Riders

"High concentrations of money and power provide trigger points for economic calamity that can be brought about by relatively few individuals or institutions. The potential harm which can arise from acts of malfeasance represents a moral hazard in our investment environment. Some financial theorists would argue that this risk is “priced in” to our investments so that what we invest in is fairly valued with respect to its risks. I see little sound rationale to accept this point of view. Risks that can be perceived and quantified can perhaps be priced in to arrive at an estimate of fair value for an investment. Many risks, such as the moral hazard of malfeasance, cannot be effectively quantified. The media, institutional, and governmental approach to representing these types of risks to the general investor seems to be to marginalize these risks. This approach gives a false sense of security and the impression that these risks are non-significant. This may be necessary to manage the perceptions of the general investor and retain confidence in the financial markets. From the perspective of the individual, this approach breeds complacency where there should be vigilance in the wise management of one’s assets."

Excerpt from: The Emperor's Clothes: Megatrends Affecting Your Financial and Investment Decisions
http://www.investmentmegatrends.com/