The top story of 2008 is likely to be the American economy, plus the potential for a financial market panic that could be enormously destructive, arising out of the credit market crisis. We could be facing a full-blown panic, a run on commercial banks, and even a global recession of significant magnitude. Since no one really wants to read about this, I’ve written a detailed article about it, but have not passed it on to Futuresearch subscribers, preferring to let them access it if they wish. You can find this detailed article on my website. Be warned, though, it’s pretty gloomy reading.
Meanwhile, the U.S. economy is already in recession. Recessions are officially defined a by an obscure government group, which takes its time, carefully assesses data that come out with long lag times, and makes extra sure before it makes its oracular pronouncements – usually after the recession is over. However, I remember reading, way back in the 1970s, that a real-time indicator of recessions is to count the number of times the word “recession” is used in news reports. The higher the count, the more likely the reality. Back then, there was no practical way an individual could make such a count. Today, we have Google news. Since I woke up to that realization at the end of 2005, I’ve tracked this (plus other things as well), and that graph makes it quite clear the U.S. economy is in trouble right now. How long it will stay that way is going to depend on how much more bad news comes out of the credit markets (see story above). There are no other major excesses in the U.S. economy right now that would precipitate a recession there. Here’s the graph:
This implies a bumpy year for stock markets, especially in North America. I would not be surprised to see the Dow Jones Industrials hit or even fall through 10,000 before they year is out. And it may well be recovering by this time next year. It’s going to be a wild ride.
A recession in the U.S. strongly implies a slowdown in the Canadian economy, a possible weakening in the price of oil (which I expect anyway), and a drag on the global economy. If things get really bad in the U.S. (which I don’t expect, but which is an outside probability) it could start to have a significant effect on China – after all, America is China’s biggest customer. In any case, much as I know my clients like good news and happy outlooks, as I do myself, I would be doing everyone a disservice if I substituted happy talk for hard-nosed reality. This is going to be a disappointing year.
I’ve been wrong on the price of oil since about $70. I know, from past experience, that higher prices bring on more supply and reduce demand. I’ve been expecting that to start affecting the price of oil and cause it to weaken slightly (although not below $60 a barrel). Yet the price of oil today is not driven by fundamentals, but by market psychology. Markets look at the growth in China, and the unwillingness of rich country consumers to cut back on their consumption, then reflect on Iran’s threatening behavior, the potential disruptions due to terrorism and freak weather, and assume the worst. And the price of oil at $100 a barrel is not really a new high for rich world consumers, once you factor out both inflation, and the steady increases in standards of living since the 1970s. Moreover, it takes time to bring on new production, and particularly new refining capacity, so I’ve underestimated the lags, and hence overestimated the speed with which new supply can come into the market.
Despite this, I may be about to repeat my errors by saying that oil prices are not fundamentally sustainable at $100 a barrel, but belong somewhere around $60. Yet, as John Maynard Keynes observed, markets can be irrational longer than you can be solvent, so betting against them is a chancy business.
Meanwhile, I will repeat something else I’ve said: we are nowhere close to running out of petroleum. Virtually all of the petroleum discovered to date has been on or very close to land, but three-quarters of the Earth’s surface is covered with water. As a result, there is clearly much more oil to be discovered and exploited than we’ve found to date. But it won’t be cheap. The days of cheap oil are passing – which is a good thing, as long as the passing isn’t so sudden that it brings the global economy to its knees.
And the Canadian dollar is too high, as well. The loonie, once known as the Northern Peso from the world’s coldest banana republic, was seen throughout 2007 as a powerhouse petro-currency, which is not unreasonable as Canada has the second largest petroleum reserves in the world after Saudi Arabia. But weakness in the U.S. economy will affect both the demand for expensive Canadian tar sand petroleum, and the demand for other Canadian exports to the U.S., reversing the loonie’s rise against the greenback. I believe that the Canadian is probably fairly valued closer to 90¢ U.S. rather than parity, but currencies hardly ever trade at their real value. Even so, the loonie should weaken.
Absent a disastrous year for the U.S., the global economy should go marching on. True, the U.S. won’t be pulling the cart any more, but China, India, and the rest of the developing world have been contributing the majority of growth in the global economy for several years now, and they have considerable momentum. As a result, the global economy will continue to roll in 2008, making even the U.S. economy stronger than it would otherwise be.
