Thoughts From The Frontline : Trade Deficit

The Paradox of Deficits

John Mauldin — Sat, 23 May 2009 20:44:50 GMT

Things That Go Bump in the Night
A Trillion Dollars as Far as the Eye Can See
The Global Recession Gets Worse
Where Will the Money Come From?
The Paradox of Deficits
Naples, London, and Eastern Europe

From ghoulies and ghosties

And long-leggedy beasties

And things that go bump in the night,
Good Lord, deliver us!

--Old Scottish Prayer

There is something that is bumping around in my worry closet. The bond market is not behaving as if there is deflation in our future, and the dollar is getting weaker. Unemployment keeps rising, but most of all, the US government deficit looks to be spinning out of control. This week we look at all of this and take a tour around the world to see what is happening. There is a lot of interesting material to cover.

But first, I am proud to announce that thanks to your donations the net proceeds from the Richard Russell Tribute Dinner totaled $17,000! A donation was made in that amount to the Autism Society of America, San Diego County Chapter, in Richard Russell's name.

The evening was captured in both video and photographs, and we would like to share those with you. We have put together a DVD that captures all the wonderful moments, including tributes from Richard's longtime friends and family, an entertaining skit by Richard's daughter Daria, and another touching tribute by Richard's daughter Betsy. Perhaps the best speech, however, came from Richard himself -- which is of course included on the video. For those who could not attend in person, we have already made copies of the video and will mail it to you as soon as you order it. The cost is $29.95, and that includes shipping. You may order as many copies as you like.

To order the video, please visit: http://www.johnmauldin.com/russell-tribute-dvd.html

The photographs were placed on Shutterfly, an online gallery where you may view them and choose the ones you would like to order. We have created a web page specifically for these photos. To access that page, please use this link: http://richardrusselltributedinner.shutterfly.com or you can link from the page above. Now, let's jump right into the letter.

A Trillion Dollars as Far as the Eye Can See

As of this week, total US debt is $11.3 trillion and rising rapidly. The Obama Administration projects that to rise another $1.85 trillion in 2009 (13% of GDP) and yet another $1.4 trillion in 2010. The Congressional Budget Office projects almost $10 trillion in additional debt from 2010 through 2019. Just last January the 2009 deficit was estimated at "only" $1.2 trillion. Things have gone downhill fast.

But there is reason to be concerned about those estimates, too. The CBO assumes a rather robust recovery in 2010, with growth springing back to 3.8% and then up to 4.5% in 2011. Interestingly, they project unemployment of 8.8% for this year (we are already at 8.9% and rising every month) and that it will rise to 9% next year. It will be a strange recovery indeed where the economy is roaring along at 4% and unemployment isn't falling. (You can see their spreadsheets and all the details if you take your blood pressure medicine first, at www.cbo.gov.)

Just a few quick thoughts. This year the proposed administration plan is to borrow 50% of every dollar spent. The CBO projects than nominal GDP will grow by about 50% over the next 10 years (which is historically reasonable), but also that revenues will double, which suggests massive tax increases in relation to GDP. Interestingly, the International Monetary Fund says growth next year will be tepid at best (more below). The deficit in 2010 is almost 10% of GDP. The average proposed deficit is almost a $1 trillion average for the next ten years. Ten years from now, the deficit is projected to be $1.2 trillion. And that is if government costs do not go up and inflation only averages 1.1% for the next six years.

The Global Recession Gets Worse

Let's take a quick trip around the world. In the first quarter, the German economy fell by 14%, Japan by 15%, Mexico by 21%, and England was down almost 8%.

Global trade is simply collapsing. The chart below is the ugliest it has ever been. Chinese exports are down 41%, Japanese exports down 38%, Germany's down by 32%, and so on. (chart courtesy of www.variantperception.com )

Let me quote from the very interesting study the team at Variant Perception did.

"As we have repeatedly said, Spain is set for a long, painful deflation that will manifest itself via a spectacularly high unemployment level, a real estate collapse and general banking insolvencies. Consider this: the value of outstanding loans to Spanish developers has gone from just €33.5 billion in 2000 to €318 billion in 2008, a rise of 850% in 8 years. If you add in construction sector debts, the overall value of outstanding loans to developers and construction companies rises to €470 billion. That's almost 50% of Spanish GDP. Most of these loans will go bad.

"Spanish banks are now facing a very bleak outlook. Spain's unemployment rate reached over 17% last month; there are now four million unemployed Spaniards and over one million families with not a single person employed in the family. Spain and Ireland had the worst housing bubbles in the world and now Spain has as many unsold homes as the US, even though the US is about six times bigger.

"Why are Spanish banks not insolvent? Spanish banks are not marking their real estate loans to market. We've often wondered how it is that our thesis for Spanish real estate and industrial collapse has not created more victims. The answer is simple according to an article in Expansion, the Spanish equivalent of the Financial Times, from the 19th of April titled 'Spanish banks control half of all real estate appraisals.' You can't make this stuff up. We haven't even begun to see the worst in Spain yet."

European banks are in far worse shape than their US counterparts. That is because they utilize far more leverage, on an average about 30 times leverage. How can that be, in what is supposed to be a conservative industry?

"European banks were only restricted on the basis of risk-weighted assets, unlike the US where it is the total leverage ratio that matters, so most European banks bought assets that were rated by Moody's and S&P, who couldn't rate their way out of a paper bag, and for anything that wasn't highly rated, they bought credit default swaps or guarantees from AIG and MBIA. Because of that European banks were able to lever up a lot more than their US counterparties. Given the much higher leverage levels and general worsening of collateral values, we think that all the shoes in Europe have not dropped."

European banks have assets of about 330% of their GDP, compared to US banking assets, which are about 50%. They have over $700 billion in loans to Asian businesses (which are watching their exports collapse) and $1.3 trillion in loans to Eastern Europe, which is in a very serious recession, and so many of those loans are simply not going to be worth anything. Simply put, there is going to be a need for massive amounts of money to bail out European banks, or we'll watch their economies simply implode.

Where is the money for the bailouts going to come from? Germany? That will be a tough sell politically in a country that is in a much worse recession than the US. How do you tell your citizens you need to bail out banks in other countries with their tax dollars? Italian and Austrian banks are going to need a lot of capital, more than their governments can pay. It is going to be a very tough problem.

Governments around the world are responding to the global recession by running massive deficits. In addition to the US, the UK, Japan, Russia, Spain, and Ireland are all running deficits of over 10%.

And, as in the case of the US, these are not going to be one-time deficits. The IMF predicts that England will shrink again next year and the recovery in the US will be modest at best. The US economy is expected to grow by 0.2% (far from the optimistic projections of various US government agencies), the 16-nation eurozone will eke out a modest gain of 0.1%, and the Group of Seven (G7) leading industrial economies will, as a whole, only grow by 0.2 percent. They project that Japan's economy will stagnate next year.

Where Will the Money Come From?

And now let's look at what is bumping in my worry closet. The world is going to have to fund multiple trillions in debt over the next several years. Pick a number. I think $5 trillion sounds about right. $3 trillion is in the cards for the US alone, if current projections are right.

Just exactly where is that money going to come from? The US trade deficit is now down to under $350 billion a year. The Fed can monetize a trillion. Maybe. Look at the yield curve on US government debt below (Bloomberg). US savings are going to go up, but where is the incentive to buy ten-year debt at 3.5%? Four-year debt under 2% doesn't do much for your savings growth. Even with monetization and the Chinese buying our debt with the dollars we send them, that still leaves the bond market about $1.5 trillion short, give or take $100 billion.

The world is deleveraging. Debt is being drawn down. Securitization of various types of debt has seriously slowed. Banks are cutting back on lending. Home prices are dropping all over the world. Commercial real estate is rolling over, and banks all over the world are exposed. "Recession turns malls into ghost towns" is the headline in today's Wall Street Journal. Personal savings are rising and retail sales are flat to down. Unemployment is rising.

All this should be massively deflationary. Interest rates should be falling or at least not rising. But a funny thing is happening. In the past two months, the yield on the ten-year bond has risen by 1%. It has moved 0.38% or almost "4 big handles" in just two weeks. Look at the chart below. What is happening?

According to Merrill Lynch, the size of the world bond market is estimated to be approximately $67 trillion, with the shares of US, Euroland, and Japanese securities each representing less than 50 percent of this total. (PIMCO)

England has been put on negative watch for its debt rating. Bill Gross said yesterday that it is not unthinkable that the US could lose its AAA rating. I think the bond market is looking at the mountain of debt that will have to be somehow sold and wondering where such a colossal sum will come from. Where do you find $10 trillion in the next ten years for US debt?

And that is just for US government debt. $5 trillion for new global debt in the next two years? In a deleveraged world? How much will the other countries need? What about money needed for businesses and mortgages and credit cards and so on?

If you add $10 trillion to the current $11.3 trillion (including Social Security trust funds, etc.), that totals $21 trillion in 2019. Let's be generous and suggest that interest rates will only be an average of 5%. That would be an interest-rate expense of over $1 trillion. That is 25% of projected revenues and 20% of expected expenses. And that assumes you have nominal growth of over 4% for the next ten years. If growth is less, tax revenues will be less. It also assumes massive tax increases from carbon credits.

The Paradox of Deficits

I think the bond market is looking a few years down the road and saying that $1-trillion deficits are simply not capable of being financed. And if the debt is monetized, then inflation is going to become a very serious issue.

When you run deficits that are 4-6-8% or more than nominal GDP, at some point things simply back up. Can we ride along for a few years? Certainly. Japan is getting ready to see its debt-to-GDP ratio rise to almost 200%. But everybody can't do it all at once.

Call it the Paradox of Deficits. We have been running a large trade deficit in the US for years, because the people (China, Japan, and the Middle East) who wanted to sell us "stuff" were kind enough to turn around and invest the money in our bonds. This in turn created Greenspan's conundrum, as it helped keep down US (and global) interest rates. Combine that with a massive increase in leverage, a few bubbles, and we now arrive at a true crisis.

Deficits are not necessarily a bad thing if kept in check and restraint is shown. But everyone cannot run deficits at the same time. If we don't buy $700 billion in goods, then that money cannot be recycled back to our debt. It is that simple.

(Sidebar: And now, China and Brazil are moving to do their trades in their own currencies rather than dollars. Very smart on their part.)

Europe, Japan, and the US cannot try to borrow $5 trillion in the next two years without a serious distortion of the bond market, not to mention the entire economic landscape.

I have long thought that "crunch time," the end game, would show up around 2013-14. But I never in my wildest imaginings thought we could run an almost $2 trillion deficit. That crazy guy on the corner telling us "The end is nigh"? He may be right.

Long before we get to 2015, let alone 2019, I think the bond markets will have called a halt to $1 trillion deficits. There will be a real crisis. The deficits will not be funded at anywhere close to an interest rate that will not break the budget. Taxes will get raised beyond what they were in the Clinton years. And Obama's budget makes some very optimistic judgments about how much will be saved in medical costs, as if no one has tried to rein in medical costs before. The crisis may come much sooner if his universal health-care bill is passed as proposed without offsetting cuts somewhere else.

Watch the bond market. Rates should be going down, not up. The bond market is telling us the deficit simply can't be financed down the road. Now, maybe a few cool heads in the Democratic Party will prevail in the US Senate and the deficits will be brought under control. (The Republicans have so far seemed as clueless as they are impotent.) We could (theoretically) run $400 billion deficits for a very long time, as GDP would be growing somewhat faster.

It would be best to run budget surpluses, but the game does not end if there are reasonable deficits. It ends with deficits that cannot be funded except by monetization. And that will tank the dollar, except against all the other countries that are monetizing their debt.

I am increasingly inclined to think that as the world comes out of its current malaise – and it will – US investors should think more globally with their investment portfolios. That is something we will explore over the coming year. But that's enough for today.

Naples, London, and Eastern Europe

Next Friday I go to London to speak at a conference for my friends at Jyske Bank. International investing expert Gary Scott will be there, as well as my friend and business associate Steve Blumenthal. It should still be possible to attend, if you would like. You can see more at www.jgam.com. And then, in theory, I will be home all of June.

The plan now is for me to return to London on July 15^th. I will co-host CNBC London Squawk Box on July 17^th, see clients, and then be with London business partner Niels Jensen for his 50^th birthday party on the 18^th. (And here's wishing him a speedy recovery from his back surgery last week!)

And then I am actually going to take a vacation. I am slowly trying to expand the list of countries I have been to. This year I am thinking of venturing further into Eastern Europe. Romania and Bulgaria are on the top of the list, and perhaps Slovenia? I would love to hear from readers in those countries, or from others who have visited them. I will have about 12 days and want to be able to see the sights and relax as well.

Then I come back, go to Maine with young son Trey for our annual get together with all the guys at the Shadow Fed fishing trip run by David Kotok, and get back in time for daughter Amanda's wedding on the 22nd. It is going to be a full, fun summer.

And speaking of Trey, he turns 15 on Wednesday. He is the last of my seven in the house. The rest are all out and (more or less) on their own. But then I get three new grandkids between now and the end of the year, so the next generation is starting.

These are interesting and serious times we find ourselves in, but we should all try and remember to enjoy life as much as possible. I am grateful that I am so busy, and count it as a blessing when so many are not. Have a great Memorial Day, and take a few moments to remember those who have sacrificed so that we can be free.

Your looking forward to summer analyst,

John Mauldin

Earnings and Mr. Bear

John Mauldin — Sat, 26 Jul 2008 04:25:00 GMT

Earnings and Mr. Bear
Earnings Before Bad Stuff
How Ugly Can it Get?
A Lean Mean Reversion Machine
Some Thoughts on Energy
Oregon, Maine and a Wedding

"The stock market is a voting machine in the short run and a weighing machine in the long run." - Benjamin Graham

The voting part of the equation is tempered by fear and greed. It is largely emotional, although investors like to think of themselves as rational players. That emotion is driven by views of the future. If you can be confident of large and growing returns, you are less likely to be swayed by the erratic movements of a stock. But as confidence wanes? Well, that is the stuff that bear markets are made of.

Because at the end of the day, what the market weighs is earnings and the ability of a company to reliably produce them. This week we look at what earnings are likely to be over the next year and see if we can discern what that suggests for the markets. We also take a look at the energy markets, the possibility of a further drop in the price of oil, and muse on what a sane energy policy for the world would look like. There is a lot to cover, but it should make for an interesting letter.

But first, a quick announcement. I have recently agreed to do a regular interview each issue with the editors of EQUITIES Magazine, which will be in the magazine and on their web site. They are also going to feature me on their web-site home page with my latest writings, under the title "Guru Blog." I am excited to be associated with a magazine that has been around for 57 years.

In return, they have agreed to give any reader of mine a free subscription to EQUITIES Magazine. You can go to http://www.equitiesmagazine.com/mwi and simply register and get the magazine sent to your home. There is also a link to an interview I did in April with them. They have a lot of content and free resources like real-time stock quotes and portfolio managers. Check it out!

Earnings and Mr. Bear

A theme in this letter for many years has been that over time markets of all descriptions revert to the mean. The classic definition of mean reversion is "the behavior of a variable in which the values for that variable move towards the long-run average value for that variable." Prices, indexes, and all types of economic variables tend to fluctuate around their long-term averages.

Profits as a percentage of nominal GDP is one of the more significant mean reversion examples. Last year we saw pre-tax profits as a percentage of nominal GDP climb to a 55-year high of 14%, which is really rather astounding. Why? Because over time, profits track nominal GDP. In the post-World War II era, nominal GDP growth has averaged 7.1%, while profit growth has averaged 7.4%. Profits over the long term as a percentage of GDP have not changed significantly for generations. Or put another way, profit growth has matched GDP growth. We will examine later what might happen if profits reverted to their long-term average (think ugly).

Now, in the short term, the difference between corporate profits and nominal GDP can vary wildly. But in the fullness of time, economic pressures will work to bring corporate profits back to the mean. This can come in the form of higher or lower wages, changes in productivity, higher or lower taxes, recessions, or growth booms. All of these and more affect corporate profits.

Let me give you one more way to look at it. If the economy is growing at 7% (nominal), then corporate profits cannot continue to grow for more than a few years at 15%. If that growth trend continued, then at some point in the future the entire GDP would consist of corporate profits, as each year the percentage of corporate profits in the GDP would increase. Since trees cannot grow to the sky, nor can corporate profits become larger than the economy, and so logic dictates that there will be an adjustment in the future. And we are beginning to see that logic play out. Let's look at a few numbers.

Trailing as-reported 12-month corporate profits on the S&P 500 peaked in the second quarter of 2007 at $84.95. In March of 2007, S&P forecast 2008 earnings would be $92. Then the economy began to run into trouble and S&P began to drop their 2008 forecasts, as the table below shows. (By the way, this is not to pick on S&P. Nearly every major forecast had similarly optimistic views.)

What actually happened? 2007 earnings actually came in at $66.18, following a lot of ugly write-offs in the last quarter. The estimate for 2008 is $72.01, as you can see above. Interestingly, they project lower earnings for 2009, down to $67.66. At today's closing price of 1257, that projects to a lofty price to earnings (P/E) ratio of 18.55, well above long-term averages and well above trend for periods of poor or no growth. For the record, there is no record in history of a bull market starting at a P/E of 18.

Earnings Before Bad Stuff

One other interesting statistic that caught my eye: Reported earnings are what you pay taxes on. They are what you really made. S&P also estimates operating earnings, or as I characterize them, Earnings Before Bad Stuff, or Earnings Before BS. There has been a lot of Bad Stuff of late. Operating earnings for 2007 were almost 25% higher than reported (real) earnings, and about 15% (so far) for 2008.

But the analysts at S&P must expect a lot of Bad Stuff in 2009, because they project a difference of almost 45% in 2009. Remember that they project real earnings to be $67.66 in 2009? Well, they project operating earnings to be a whopping $108.60. That will be a growth in earnings of almost 25% in 2009.

Before we get into whether such earnings growth is likely, think about an environment where company after company keeps reporting large write-downs every quarter. Of course, they will tell you it is just this once, so don't sell us - now is a buying opportunity. Long-time readers know that I have written on several occasions about how continuing earnings disappointments are what create a bear market. Typically it takes at least three to really get the attention of analysts and investors, who begin to lower their projections for both profits and price targets.

How Ugly Can it Get?

David Rosenberg, the North American Economist at Merrill Lynch, is one of my favorite analysts. He is a mainstream economist who is most definitely not a cheerleader. He can be quite bullish as times, and when he thinks the times call for it, he can be rather bearish. As we will see below, he is quite bearish of late. I am going to quote from his opening remarks in a commentary dated July 25, where he is changing his forecast. Remove sharp objects from your nearby vicinity.

"Forecast addendum: Adjusting to the new reality

"Just like consumers, who are insulating their windows and making fewer trips to the malls, we are adjusting our economic forecast to the new high-oil price reality not to mention the latest round of trauma in the mortgage markets. Though fiscal stimulus [rebate checks] will provide a lingering boost to 3Q we expect GDP to plummet 2.5% in 4Q and see a similar decline in 1Q. In all, we have shaved our 2009 GDP forecast to -0.5%, a full percentage point lower that where it was previously, while 2008 is broadly unchanged at 1.5%.

"Less consumer, more unemployment, profit squeeze ahead

"The scenario we ran last May, when we shocked the model with higher oil prices, now appears to be playing out as predicted. With rebate check delivery winding down, there is now little shielding the consumer from the full force of $4+ gasoline, deflating real estate and equity markets and rising unemployment. The new reality means a deeper downturn for consumers, higher headline inflation, more belt-tightening from businesses and a mammoth profit squeeze. It also keeps the odds squarely in favor of more rate cuts from the Fed, in our view.

"Back to the 1970s

"Once the last of the rebate money is spent, in either July or August, consumer spending is expected to roll over, and hard. The oil shock we're experiencing is on par with the spike in the mid-1970s and consumer spending will see a similar downturn, in our view. The unemployment rate will probably crest at about 7.0% in mid-2009, a half percentage point higher than our previous outlook. We're expecting a 3.0% decline in PCE in 4Q 2008 and 1Q 2009 does not promise to be much better. We look for savings to rise, as consumers adjust to the tighter credit environment by building their savings rate up to 2-3/4% by the end of 2009.

"2008 stimulus - round two?

"The deeply disappointing retail sales report this week only serves to underscore how far behind the curve consumer is financially and a grim foreshadow of what lies ahead once the rebate checks are all spent. Flat spending was all consumers could muster in July with three quarters of the $106 billion total rebate checks in their bank accounts. We take consolation from the notion that the folks in the Beltway are doing the same math we are and thus the drumbeat of another round of stimulus is getting louder all the time.

"Housing still in the weeds

"The good news is that we're probably more than half way through the real estate correction. The bad news is that we've likely still got at least another 15% down on home prices to go before we reach bottom. Moreover, housing starts still need to breach the 700,000 mark to deal with the mountain of new and existing homes with for-sale signs on them. The supply situation will not be helped by the latest fractures in the mortgage securitization market, which will only slow the pace that homes can be sold and inventories can be cleared."

Below is a table with some of his forecasts. You can read the whole report at http://www.realclearmarkets.com/The%2520Market%2520Economist%252007%252018%252008.pdf .

Can you say Muddle Through?

A Lean Mean Reversion Machine

Remember a few pages up when we were talking about the mean-reverting qualities of corporate earnings? If corporate earnings fell to their long-term average, that would mean a drop of about 50% from the peak, which would mean $45 in operating earnings, and even lower for reported earnings. You could easily see a P/E ratio north of 25 or 30 if the market did not move down. Quoting from another Rosenberg commentary:

"To put this into perspective, the four-quarter trailing EPS figure in the 2001 recession hit a trough of around $38; in the 1991 recession, the trough was just over $18. That means that we are not talking about Armageddon [projecting $45 earnings], but rather offering up some analysis highlighting the risks to the outlook. We will bottom at levels much higher than the troughs in the past; that is the good news. The not-so-good news is that the level of the S&P 500 in the past that tended to coincide with $45 earnings was right around the 1,000 mark; and if we were to slap on a typical trough multiple of 10-12x on that earnings stream, then ... well, you do the calculation."

I highlight this analysis because it illustrates the point I have been making for a long time. Recessions do ugly things to corporate bottom lines. They savage earnings, and that is what ultimately drives the stock market lower. For you to be bullish today, you have to believe that the recession is over and that earnings are going to rise, not fall.

A 15% drop from where we are today would not be out of historical character. It would be a merely average bear market in an average recession. Given the extremes to which profits rose in the last cycle, it would be strange indeed if they did not revert to the mean or go below. The Dow below 10,000 is not unrealistic, or the S&P below 1,000.

I clearly do not know the future, and the market does as much as possible to make me look bad. But I simply believe that the risk is to the downside. And if Rosenberg is anywhere near right, then it could get a lot worse. Continued earnings disappointments, combined with ever increasing write-offs implied by the S&P numbers, is not the environment for a renewal of the bull market. The current run-up is a bear market rally, in my opinion. It is a time to lighten up, if you have not already.

Some Thoughts on Energy Policy

The US Geological Survey said the Arctic may contain as much as 90 billion barrels of untapped crude oil and 1.67 quadrillion (with a "Q"!) cubic feet of natural gas. This is equal to approximately 13% of the world's undiscovered oil and 30% (!) of the undiscovered natural gas. There is yet more offshore oil and gas off the coasts of the US that is not being utilized. And that is assuming current technological methods. You have to know technology is going to improve recovery rates.

There are debates about energy policy, as to whether we should go to solar, wind, or bio-fuels, drill for more oil and gas, build 45 nuclear plants, etc. I don't get it. I would like to check a box that says all of the above.

The reality is that the world is going to demand more oil as the developing nations want more cars and energy. Oil production is declining in Mexico and Russia and other countries where we get our fuel. While proper drilling and better political climates could make up for declining production of older fields, it is not the long-term solution.

In the short term, we need to drill in the Arctic and offshore. Even though I am going to show why oil could go back to $100 in the near term, in the long term (3-5 years) it could easily go to $200 and $6 a gallon if we do not do something now, and maybe even if we do. It will take years for any oil or gas to come from offshore and Arctic sources. If we are going to have that energy in five years, we need to drill now.

And it can be done safely. A large portion of the oil and gas for the US comes from the offshore fields of Texas and Louisiana. There was a class 5 Hurricane Katrina which ripped through these offshore rigs a few years ago, and not one of them had even a minor environmental problem. These rigs are built solid and safe.

To drill in the Alaskan Natural Wildlife Arctic Reserve means drilling on a few square miles of land which is basically wasteland. No beautiful scenery. No tourists. Very few caribou. We have been drilling in Alaska for a long time without problems, and technology has improved.

Oil coming online in a few years will help hold down prices today. That is the way markets work. Every year we wait will mean higher prices and more money sent outside of the US. But drilling for oil is not the long-term solution.

T. Boone Pickens has been running TV ads talking about a plan to divert natural gas to automobiles and reduce our need for oil. A key point is that we are sending $700 billion out of the US each year for oil. Over ten years it could be over $7 trillion. It is the largest transfer of wealth in history. It is unsustainable. It will be a serious drag on the dollar, which will make things even worse.

Look at this graph from my friends at GaveKal. It shows the US trade deficit, but the black shows the percentage of the deficit that is related to oil. Note how it has risen in the last few years, even as we have imported less in non-oil items. We have an oil deficit that is close to 3% of GDP, when ten years ago it was less than 0.5%. And the gap is rising as oil prices increase.

Pickens is a big proponent of wind power (and is putting his own money into wind, so he is "talking his book"). But there is a strong logic to what he says. Slowly converting our power grid to 15-20% wind (or even 5%) would be useful. You can see a quick presentation at YouTube: http://www.youtube.com/watch?v=Avt8Yo2WE14&feature=user

The July 21 Fortune has a great article on the rush to build solar power plants in the deserts of California, Arizona, and Nevada. Applications have been filed to build plants that would generate a theoretical 60 gigawatts of electricity. To put that into perspective, California only uses 33 gigawatts. And the biggest and richest firms are lining up to get land to build solar. These are not small start-ups. And that energy projection is using current technology, not even assuming what we will have in 5-10 years.

Note that California has over 10% of the population of the US, so there are people who actually want to use their money to build solar plants to provide 20% of the US demand for electricity. That is not a trivial pursuit.

Ironically, there are radical environmentalists who are planning to sue to stop this solar production because some desert animal's habitat might possibly be disturbed. Seriously? These are the people who think humans should leave the planet so that animals can live in peace and harmony with nature. And they are dictating our energy policy. Yes, we are talking about covering a great deal of uninhabitable desert with solar and thermal panels. And the government is taking its sweet time processing the applications. But we need to change the laws so that we can start the process. Allowing a few radical environmentalists to abuse the laws to prevent one of the best chances for renewable energy is just crazy.

You can read the well-written article by Todd Woody at http://greenwombat.blogs.fortune.cnn.com/2008/07/15/the-solar-land-rush/.

Senator John McCain wants to build 45 nuclear plants. Yes, that will take some time, but that means we need to start now. Within 15 years, and probably 10, our cars will be electric. We need to start building the power systems to meet increased demand for electric transportation.

And let's not forget clean coal technologies. All of the above can be done and still reduce our carbon footprint. But the point is that whoever gets elected next November needs to have a plan and put someone in place to actually lead and stop the bickering. It should not be either/or. It should be all of the above, because some of the ideas will not work out as predicted.

Either we are going to see the economic life sucked out of this country, or we can respond by doing everything that is in our power. There is not a shortage of energy. There is a shortage of leadership to produce the energy we need. A real energy policy would also have the benefit of boosting the beleaguered dollar.

T. Boone Pickens may be able to make energy policy the #1 election issue. And with another major effort by Pete Petersen, who is going to spend $1 billion telling the US how bad our Social Security and Medicare problems are before the election, maybe we can get enough people upset enough to demand some action. Maybe. Hopefully.

And speaking of the price of oil. It is $123, down from almost $150. Supplies are building and demand is being destroyed by high prices. Which of course reminds us that the cure for high prices is high prices.

How low could oil go? Data maven, uber trader, and good friend Greg Weldon recently developed a number of charts showing how supplies of oil-related products are rising and spreads are tightening. If we are in a correction, how low could oil go?

I must confess, I do not understand the fundamental aspect of something called a Fibonacci retracement, but the pattern keeps repeating itself over and over, so you have to pay attention. These are numbers based on work done by Leonardo Fibonacci in the 1200s. Basically, when a market starts to correct, it tends to go to certain points for support. Traders use them so much that they become psychologically important, which may be why they are useful.

Look at the chart below. It shows that if oil goes to its Fibonacci retracement levels, it could drop to $110 or below $100. That would not, as Greg notes, violate the longer-term bull market trend, but it could be seen as a normal correction. Just food for thought.

Oregon, Maine, and a Wedding

Tomorrow I fly out for a meeting in Portland, Oregon and back on a ridiculously early flight Tuesday morning. (What was I thinking?) And then Thursday I fly to Maine for David Kotok's Annual Shadow Fed Fishing Event. My youngest son Trey (now 14) and I fly to Bangor and then take a float plane to Leen's Lodge to meet with 30+ people. There will be several Fed economists, and some well-known names like Paul McCulley of Pimco, Martin Barnes of Bank Credit Analyst, Barry Ritholtz, John Silvia of Wachovia, and some very sharp traders and analysts. Right now, Steve Leesman of CNBC and a crew are slotted to come in, or so I am told. Everyone basically ships in a case of their favorite wines, so it is a very fun event. I can tell you that some of the participants go all out in their choice of wine, and I look forward to tasting scores of different wines.

But the conversation and comradery are the best part. We get up every morning and go out on the lake with local guides to fish, then meet for lunch on an island, eat what we caught, talk shop, tell lies, and drink lots of wine. Then we go out again and come back for a gourmet dinner, and drink even more wine and maybe some of Martin's Scotch. Then get up and do it again. And repeat. And the best part for Trey is that he always seems to catch twice as many fish as I do, as well as the biggest.

On Saturday night, everyone gathers in the lodge to place small bets (typically $10) on where the markets will be one year hence. Last year I asked those of my readers who wanted to, to also make predictions. We will go back this week and see how you did, and the best will be sent a copy of some book that I like. (Besides one of mine. Though I assume you already have those.) And I already know I have won one bet, so I will be a winner again this year. It will be interesting to see how close I came in the other bets. I will write this up in a later letter.

And then I come back for Wedding Week. The wedding is August 8. I spent Thursday with Tiffani and Ryan, meeting with wedding planners, musicians, caterers, fireworks managers (sigh), and a legion of people coordinating an event that has grown beyond the original vision. But what fun. And to see your daughter so happy? Priceless.

The weeks seem to go by so fast this summer, and now it is late and time to hit the send button. Have a great week.

Your hoping he can catch more fish this year analyst,

John Mauldin

Do Trade Deficits Matter? part 2?

John Mauldin — Fri, 12 May 2006 06:24:00 GMT

Introduction This week we look at the links between the US trade deficit, the low savings rate in the US, home prices, and interest rates, all in an effort to answer the question: "Do trade deficits matter?" I think I will offer a few practical...(read more)

Smoot-Hawley Lives

John Mauldin — Fri, 10 Mar 2006 06:42:00 GMT

Introduction This week we look into my worry closet and ponder whether the Dubai port debacle is a one-off thing or does it signal a rise in protectionism. The recent polls suggest I will upset about 90% of you, but I look at the deal from the very negative...(read more)

Do Trade Deficits Matter?

John Mauldin — Fri, 16 Dec 2005 06:18:00 GMT

Introduction "I don't know whether change will come with a bang or a whimper, whether sooner or later. But as things stand now, it is more likely than not that it will be a financial crisis rather than a policy foresight that will force change...(read more)

The Trade Deficit End-Game

John Mauldin — Fri, 11 Mar 2005 23:59:00 GMT

Introduction This week we finish with our series on the US trade deficit. When will we see a real problem? What are the likely results from a balancing of global trade? Where are the investment opportunities, and where are the pitfalls? It should make...(read more)

Why Trade Deficits Matter

John Mauldin — Fri, 04 Mar 2005 23:54:00 GMT

Introduction We have been looking at the US trade deficit and the global trade imbalance for the past two weeks. It is currently an unsustainable trend, and thus will stop at some point. The questions are when and how? We will conclude this series today...(read more)

The Problem of the Endgame

John Mauldin — Sun, 16 Jan 2005 05:35:00 GMT

Introduction Last week we looked at my 2005 Forecast. This week, we ponder the far more interesting question of where I could (or will be!) be wrong and why and what would be the consequences. This week's topic came about as I was talking on Tuesday...(read more)

Forecast 2005: The See-Saw Economy

John Mauldin — Sun, 09 Jan 2005 03:04:00 GMT

Introduction Once again it's time for me to demonstrate the foolhardy part of my nature by putting to electronic pen my forecast for 2005. I spend more research time on this one letter than on any four or five combined, simply reading hundreds of...(read more)

Things That Go Bump in My Worry Closet

John Mauldin — Sun, 21 Nov 2004 02:14:00 GMT

Introduction From ghoulies and ghosties And long-leggedy beasties And things that go bump in the night, Good Lord, deliver us! --Old Scottish Prayer Coming back from Canada this morning, where the Canadian dollar is on a breath-taking rise, and reading...(read more)

Premise #3: A Falling Dollar

John Mauldin — Sat, 30 Oct 2004 20:16:00 GMT

Premise #3: A Falling Dollar In March of 2002, I wrote an e-letter entitled "King Dollar and the Guillotine," which as the title suggests was a quite negative view of the future prospects for the dollar. Two weeks earlier, I had written a bullish...(read more)