Real & Paper Economies Have to Meet in the Middle; Right?

RichardSchwartz — Wed, 16 Apr 2008 13:32:00 GMT

THE REAL ECONOMY VS. THE PAPER ECONOMY The Real Economy. Oil at a record, rice too. Gold hitting $1000 an ounce, silver way up. Corn prices boosted by ethanol demand. Food riots in Haiti, Guatemala, Argentina and more. 24 countries dropping food import tariffs because they are seeing food shortages. A two page color article in this morning’s New York Post comparing food prices this year to last; milk up +26%, eggs up +41%, flour up +32%, grapes up +35%. I mean we all use gasoline, most of us anyway, and the price is through the roof. And we all need food, right? With the great increase in global prosperity, mainly coming from developing countries, over the last decade or so, the demand for energy, minerals, foodstuffs is way up. This is the real economy, right? Other facets and prices of the food chain of the real economy also remain strong. The US, Canada, Australia and other countries are exporting food and energy and minerals, etc. to all parts of the world where they are needed. Thus trade is thriving. Which means transportation systems like tankers and railroads remain strong as well. Regions of the world which have benefited handsomely from the great rise in overall commodity demand and thus prices have lots of money to spend and are doing so. The Middle East is in a building boom. Dubai’s growth amazes everyone who sees it first hand or even on TV. The professional golf tours play there now and Tiger Woods is building a golf course there. Horse racing is now global and big races were just held in Dubai. Some are even predicting the current building and skyscraper frenzy there will lead to an eventual bust. Probably, but when? Russians who got rich after the collapse of communism are now moving to London, calling it Londongrad. Other Russians go skiing at certain resorts in Switzerland and compose most of the traffic. Eastern Europeans are gaining access and working in western Europe. Millions of Latin American’s are working in the US and are sending money home. More millions of Chinese now compose the “factory floor” of the world and have moved up into the middle class. And on and on. There’s a global wide infrastructure boom going on in Latin America and Africa and other places as well what with China making deals to build roads, ports, etc. in return for its voracious demand and need for oil, gas, copper, soybeans, wheat, etc. Schwartz View: In other words, the global real economy is doing well and causing increased demand for food and energy to hold strong. This after a long period of underinvestment in the search for new supplies of such. Commodity and China advocate and long term super successful investor and long range seer extraordinaire, Jim Rogers says the global commodity demand/supply equation is way out of whack and won’t get back in balance for many years yet as overall commodity supplies are extremely low, be it copper, sugar, oil, cotton, corn, silver, etc., etc., etc. since no one’s invested in the search for new supplies for a couple of decades. His studies show commodity bull markets, once started and this one began in 1998/9, last about 16 to 20 years, thus he’s projecting this one out to 2015+. And now that global demand is surging, ala the grand entrance of China onto the world economic scene with its entrance into the World Trade Organization back in December 2001, the global commodity system is being stressed by much increased demand and years of underinvestment. The Paper Economy. Then, on the other hand, we now have Wall Street’s big problems spreading worldwide. Wall Street always pushes hard for maximum profits. And the longer a bull market runs, the more insulated from trouble Wall Street feels it is and thus the harder they push. This time around, the bull market ran much longer than normal, five full years making it way past the top of the normal bell distribution curve and a very “old man” bull market. Thus Wall Street pushed extra hard for extra long. And along the way, as is its norm, developed new ways to invest and max profits. This time around Wall Street invented the “securitization” and “globalization” means of investment. Since this bundling of any and all loans together and then marketing them globally is so new, the kinks haven’t been worked out of the system. Thus Wall Street ran with the ball, ignored what was an unknown amount of risk, caved into competitive pressures to perform and rationalized that if things went wrong, they’d all go down together. Eventually, when the indexes invented to value these opaque investments became the standard, it backfired on Wall Street. When last August 9^th, BNP Paribas said it had asset-backed losses to write off, based on this new indices I believe, everyone else had to start marking-to-market and the unraveling began. Now the paper economy is in big trouble. Huge investment losses are reverberating backward and real job losses in these paper shuffling firms are becoming more and more ubiquitous. This morning I read about the size and scope of these job eliminations. Swiss banking giant UBS is projected to cut 10% of its workforce, London’s financial center is looking at upwards of 40,000 firings, investment banks in general are cutting payroll at their fastest pace in years according to Challenger Gray & Christmas, the tracking firm, the first quarter firing rate was triple previous years’ first quarters. Last year, financial services firms cut over 150,000 jobs. Wachovia Bank, a multi-bank holding company, based in North Carolina just posted an unexpected loss. Washington Mutual, a large western-US based financial services firm is expected to cut 3000 jobs soon. Some quotes today are: “Financial services are at the center of this recession,” by Challenger, Gray CEO John Challenger. Chief executive Kerry Killinger of WaMu (Washington Mutual) says: “Northing of this scale has happened since the Great Depression.” And: “This is the toughest credit cycle I have seen in my years in the industry.” In other words, now the huge billions in paper losses are causing much turmoil in employment in the paper economy. In brokerage firms, asset managers, in investment banking, at hedge funds, at money center banks, at investment banks. And the trouble has rippled out further and to the far outposts of the paper economy. First the credit services companies like Moody’s, Fitch and Standard & Poor’s came under attack. Then the commercial paper market, the auction-rate market, jumbo loans. Fannie Mae and Freddie Mack fell hard and got their share of the blame. Former Federal Reserve Chairman Alan Greenspan, the leader of the paper economy, is being criticized heavily. We have many mortgage brokers going under. And now the ripple effects and feedback loops are kicking in. States and cities, like New York city, are looking at their upcoming budgets and groaning. Some are turning a blind eye like new New York Governor Patterson (no pun intended) to upcoming drop offs in incoming tax revenues and are just hoping things will miraculously improve or figure they will handle big budget deficits another day. Schwartz Summary: No use me going on and on. We all know the paper economy is in big trouble. And we all know where this trouble is going to lead. To trouble for the real economy, the goods and services producing part. With some type of lag. Many are now warily watching the shippers, Wal-Mart, the emerging markets, oil inventories, the price of gold, for some indication when and how much these big problems in the paper economy will spread out to the real economy. The question I’m now constantly asking myself is when do these two economies meet in the middle? So far we haven’t seen that much damage. Prices of commodities remain fairly strong although tremors have shaken the real economy from time to time. The latest being back on March 17^th when silver fell some 25% in just 48 hours after a bearish call by an influential guru, Bob Prechter, Jr. of Elliot Wave fame of the past. But generally commodity prices have held firm. Oil, as we all know, seems now devoid of all fundamentals, seemingly. At least the near term fundamentals. We always have the Jim Rogers identified scenario of an out of whack longer term demand/supply equation in the back of our minds. My best guesstimate is that the troubles in the paper economy are surreptitiously spreading out to the real economy, globalization or not, and will show up down the road. Sort of similar to the 1973-1974 Papa Bear market period, whereby the first year of the big bad bear market, energy held firm. Only this time around since we have the whole world waking up to the fact that there is global competition to secure our energy future and secure enough food to feed our peoples, demand should stay stronger, longer than most expect. Bottom line investors while keeping a low profile should get their existing portfolios overweighted to and supported by the real economy. Not totally jump ship too soon.

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Real & Paper Economies Have to Meet in the Middle; Right?