Oct 28 2009

California Enters Inflationary Depression

October 28, 2009

I was surprised to see the following headline in today’s Wall Street Journal: Oil Price Rise Poses Little Threat, Yet, To Economic Recovery. The piece was stitched together with many quotes from economists, saying that oil’s advance to 80.00 was not yet a problem–though it could present a problem if we went any higher. I suppose that in a multi-year data set, and looking at the world in a rather static way, this might be true. But I thought economists at least shared the view that weak economies were more vulnerable to shocks? 80 dollar oil in the Autumn of ‘07 was a very different overlay, than 80 dollar oil right now. And besides, I’m also not sure about the Journal’s use of the phrase economic recovery. From today’s article:

Estimates vary as to when oil prices become a major drag on the economy, but several economists said crude at $90 to $100 a barrel and gasoline above $3 a gallon was the edge of the danger zone. December crude futures were recently up $1.05, or 1.3%, at $79.75 a barrel on the New York Mercantile Exchange. Prices at the pump for U.S gasoline have risen over 6% in the past month to average $2.671 a gallon, according to data from the American Automobile Association. “Eighty dollars a barrel is not a showstopper,” said Brian Bethune, U.S. economist with IHS Global Insights in Washington. “We need to be at $90 to $100 a barrel before things get more serious. The problem is underlying consumption spending is not strong.”

Since my last update on California in mid October, BLS has produced fresh, state by state data on the broader (U-6) measure of unemployment. At the end of Q2, California was recording around 12.0% unemployment in the conservative measure, but had risen to 17.7% unemployment in the broader U-6 measure. BLS has just produced Q3 data, and California has now risen again, this time to 19.6% in the U-6 measure. Meanwhile, although gasoline fell today on higher inventories, the lagged effect has been very much in play the past 8 weeks, and California petrol prices have made their way back now, and are very close to 3.00 dollars a gallon.

You might have seen the headline today that the Bay Bridge in San Francisco had to be closed, on account of falling debris and structural concerns. A vast collection of mid-century infrastructure needs to be upgraded there and most of it is automobile related. Given that the state is broke, that office vacancies in Silicon Valley are approaching 20%, and that Central Valley unemployment is easily at depression levels, I don’t think Californians see “economic recovery.” While 5.00 dollar petrol certainly was crushing in 2008, it seems a lay up that 3.00 dollar gasoline is still quite rough under current conditions, in a state over-leveraged to the automobile. True, the United States is not California and here on the East Coast we have more choices in public transport.

One question I’ve started to ask people is whether they use the word depression, when referring to the country’s situation. And if not, why not.  Alot of the recent data suggests that no sustainable recovery in housing is imminent and, that structurally, unemployment has some permanent qualities to it now, in the sense that many industries in the US are simply not going to return to credit bubble levels. Housing, Automobiles, and Finance just to name the big three. But while housing and wages are deflating, food and energy prices are about to go positive again on an annual basis.

My view is that oil in the previous era, before the peak of Non-OPEC supply, would be trading around 15-20 dollars a barrel right now in the midst of this depression. But oil can’t trade there. And it won’t trade there. The reason is partly the situation with the US Dollar but mainly that 60% of global supply–Non-OPEC supply–cannot really produce oil anymore with prices in the teens. Non-OPEC oil, which is mostly free-market, Western oil, needs prices nearer to 50 just to maintain production, at minimum. The implications of this are not pleasant, for the United States. And in particular California, with its 32 million vehicles. Worse, the California state labor department is now reporting even uglier unemployment numbers than BLS, with the broad measure now rising to 21.9%. 80 dollar oil and nearly 22% unemployment? Feel free to use my own phrase:  inflationary depression.

-Gregor

Further Reading: gregor.us has covered California quite alot this year, with more to come.

• Comments
Author: Gregor Macdonald   Posted in: California   Tagged:            
  • inflationary depression = stagflation

    As the saying goes: "The cure for high oil prices might be higher oil prices". What price of oil will take for US to restructure its economy by taking advantage of its newly found vast natural gas reserves. I am aware that safety of horizontal drilling has been a major theme of concern, but further and more in depth investigation is needed.

    I've noticed that you don't believe that the recent trend of deleveraging and higher consumer's savings is likely to continue. What's your thesis? Higher inflation in some major assets will rob the purchasing power of consumers and even if they want, they won't be able to afford to save more without taking a serious hit on their standard of living?
  • ericcb
    I bet the stock market and RE will go up with the pumping of dollars but will stay behind adjusted for inflation. Time to stock pile essentials.
  • prusso
    View the change in California Unemployment Trends over the last six months using Heat Maps:
    California Unemployment this month (BLS data):
    http://www.localetrends.com/st/ca_california_un...
    versus California Unemployment levels six months ago:
    http://www.localetrends.com/st/ca_california_un...
  • Ian
    Gregor, I'm interested in your thinking behind housing. Why is it a given that housing is going to continue to spiral downward? In many places rent/price ratios have reached or even fallen below historic norms, at least on the low end. Most people point to the homebuyer tax credit as the thing spurring on this little bounce in sales and home prices that we have seen since the spring. But unfortunately we can't really know what would have happened in its absence, and it appears that it is going to be extended. Relative to the costs of some other gov programs, this one seems cheap enough and popular enough that I'm not sure its going to end any time soon. But just because it offends most of the econoblosphere doesn't mean it doesn't exist or isn't having an effect. So house prices have risen a bit in some places, and to say otherwise or not acknowledge it I think is similar to the error of stating factually that we are in a great deflation when in fact the CPI (using whatever measure you want) has risen more or less every month since December is on pace for a +3.6% full year print.
  • gregor.us
    My view is that the activity at the low end of housing is certainly real. It's just that it's artificial and another example of intertemporal missallocation, whereby demand is pulled forward. What's very clean about the data therefore is that the line of demarcation between the segment of the housing market with Gov support is now almost a separate class of RE. Everything above 600K (as a class) languishes. The spread between the two asset classes is wide. IN fact I believe there is data on that. So I'm pretty comfortable assuming there would be no "hot action" in everything up to the 400K level without FHA giving low down originations. And then you've got the FED in the aftermarket cleaning it up.

    My view is that US RE traditionally was a positional asset that gave you a call option on future wage growth and some inflation protection via appreciation in the house and land and depreciation of the mortgage itself. It was a nice post war trade. Thing is I don't see future wage growth as a prospect for Americans relative to the nation's stock of houses. In other words, a house is not the strategic asset it once was.

    I fully expect the 8K housing credit to be renewed at least 2 more times, indeed. However, before it finally expires, it will experience diminishing returns. Besides, with the jobless recovery, some of the new homeowners that started out in this program are likely to be defaulting as soon as next year, when they lose jobs or see wage declines, and realize they never had any skin in the game in the first place.

    My bottom line view is nothing structurally good is going to happen for the US, and we will not get back on the path to wealth creation, until we start leveraging the cheap BTU in our natural gas resources and use it as a competitive advantage. Once that happens, then we will start recycling petrodollars away from global oil producers back into the domestic economy, and that should get us on our way. I figure we can either go this route by choice, or by force, or some combination of the two. Until we get going down that path, I see no single industry or combination of industries that will replace the permanent loss of Housing, Autos, and Finance sectors--which were all themselves in some sense not the best industries on which to build an economy.

    G
  • Housing does indeed look irrational right now; it's the subject of my own blogpost today: http://www.competitivefutures.com/blog/2009/10/...

    There a one, and only one reason why housing is overvalued: wages stayed stagnant, population stayed roughly stable, and prices took off, juiced only by fake liquidity from fractional reserve lending and fraudulent CDOs and CDSs. The houses NEVER SHOULD HAVE INCREASED IN VALUE.

    The whole thing is a group hallucination stemming from a generation of Baby Boomers all finally kicking their kids out of the house and funneling money to Wall Street en masse for their impending retirement. The Banksters had so much liquid coming in for pension funds, they had to show growth. Tech stocks dumped. REAL growth was impossible as we shipped off manufacturing jobs. Houses and equities were the assets most susceptible to being willed higher. And willed higher, they were. But that doesn't mean that the values were real.

    The next act of the play has been surreal. Our political institutions, the White House, Congress, Treasury, and that pseudo institution The Fed, have all conspired to suspend gravity, give banks unlimited capital, and keep the Value Hallucination going. No other actor in our economy has received the divine touch of infallibility in the way that our financial sector has. The endless river of borrowed cash serves to keep the banks from going broke and showing the THOUSANDS OF WORTHLESS REAL ESTATE DEALS ON THEIR BOOKS.

    Which brings us to California. When you're broke you're broke. If you have sufficient cash flow and you can pay off creditors, you're still in the game. When cash runs too tight to keep everybody happy, the faith runs out and people call their loans in. That's the story of California. Somewhere between empty Dot Com Era office space in San Jose and a crumbling Golden Gate, between the CALPERS fund and Medicaid, not to mention that looming Boomer retirement, the future performance likely won't cover past obligations. For everyone else, that's called bankruptcy.

    If your house is worth 50% more, that means someone needs to do 50% more work. If you run 40% deficits, that means somewhere along the way, a currency is worth 40% less. It's no mystery; free markets really do work. We can delay the inevitable, but not avoid it.

    Time to get to work.
  • gregor.us
    FWIW I kicked off Autumn with my view that US residential RE was about to start its next leg down, and that remains my view. I don't have a sense yet as to how strong this next leg will be. It will be primarily in the 500K and above segment of the market. That part of the market of course has little govt support (unlike the low end) and high wage earners have seen and will continue to see an evaporation of all that extra, marginal income that used to come their way in the form of bonuses, partnership profits, etc. We are going to see foreclosures too, in the mid to upper end.

    It will take some time for the decay to really set in in the very high end stuff, but rest assured we'll produce some material for British sytle, Faded Mansions type sitcoms starting about 3+ years from now.

    G
  • john
    And China is adding half a California to its car fleet each year. Nearly all of the 16 million vehicles being sold in China are net additions to the World's fleet of vehicles. What's more, they apparently can afford to buy the gasoline to drive these vehicles--adding at least 400,000 b/d to world oil demand each year. For China, the Auto boom is key to their continued economic recovery and to increasing their domestic consumption to make up for lost export demand. Good luck to California. Raising taxes at the State, Local and Federal levels in the US simply guarantees a further depression. Most new jobs are supplied by small business. As the owner of a small business, I can tell you that healthcare and the Obama administrations plan to boost taxes on anyone making more than 250k is making me trim, rather than boost employment. I doubt we as a nation can afford our current levels of government, much less a bigger one. Great work on the late great state.
  • With their oil dependent economy, their oil dependent infrastructure plays, the devastation of their ecology, the mass poisoning of their people, their huge reserve of soon to be worthless US dollars, their recent acquisitions of gold, China has ensnared itself as the bag holder in more ways than one. Don't look to China for any intelligent planning. Their thinking is always 50 years behind, and today is no different.
  • inegoveritas
    Thanks Gregor for answering my twitter question with a full post. You nailed it on the head with the difference between $80 oil on a vulnerable economy versus last year growing one.

    IEV
  • gregor.us
    I aim to please, if even with a time lag. :-)

    G
  • TJGodel8
    I read that article on WSJ and my first thought was it was terrible writing, then I noticed it has two authors. No real thought or analysis put behind the writing it was stitched together comments as you noted. So if you can imagine both of the authors writing and/or interviewing several economist without questions their assumptions and then the authors mash together their individual work and bingo you have this unredeemable article. As anyone who hasn't been living in a cave for the last two years know this is a major recession unlike anything since the great depression yet at this point in time the analysts and economist are still using metrics from last year's oil peak to talk about today and tomorrow.

    As you rightly stated we are inflationary depression and I would say consumers and businesses are deleveraging also. It's not a pretty economic picture.
  • gregor.us
    I don't know what happened to American Journalism but somehow it developed that having only the most base understanding of the world and in addition having no viewpoint--both of these became badges of honor, somehow. I'm just not sure what happened. Perhaps "schools of journalism" are the problem. Don't know.

    G
  • TJGodel
    I think the problem is both the "schools of journalism" and the decline of printed news. We have fewer dedicated professional journalist due to cuts in print because of declining advertising revenue and fewer independent news sources. The future of journalism seems to be dedicated bloggers who develop a readership by taking a viewpoint and syndicate their content to printed sources.
  • Name
    So if you use the 4% of GDP number as a guide for when oil becomes problematic for the US economy, can we begin to assume any easy/accommodating policy on the FED's part from here on out (thus dollar negative and oil price positive) will act as a hindrance to the broader economy? It seems to me that the FED/US are in a corner here, keep the foot on the pedal and focus on unemployment or back off and hope prices fall pretty much assuring unemployment continues to rise. Another great post, thanks again.
  • gregor.us
    FED very much in a corner of their own making. It's like a declining wedge--just keeps narrowing. You know my view of the circle: Reflationary policy leads to asset inflation(s) which bust then lead to deflationary forces, which are then combated by the FED with more reflationary policy. Looks like the next thing the FED inflates and then busts is their own institution.

    G
  • hpatel
    Gregor, good article. Would like your opinion on one question:

    In late 2000, after the NASDAQ bubble burst and a minor recession occurred, no sane economist would have argued we need to reinflate the NASDAQ bubble to fix the economy. The bubble broke since it was unsustainable.

    Now that the housing bubble has burst, why should it be reinflated? It also broke because it was unsustainable. I hear all this talk about "Fix Housing First" from Realtor groups and such and just don't understand how an intelligent person could believe that.

    Instead of focusing on housing, I think states like California need to focus on employment.
  • gregor.us
    It's very hard to make a good response to a burst bubble. Especially when you helped create that bubble in the first place. Some now say we have a Housing Ideology. What a terrible ideology indeed.

    I advocated for an infrastructure response to the crisis, along the lines of China's StimPackage. Alas, we did not go that route.

    G
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