Wednesday, June 24, 2009

Wrenches thrown into the (uncertain) speed of economic recovery

Nobody ever said that a recession was easy; but it looks like the recovery is going to be a little rocky, too. Renewed optimism has brought about increasing mortgage rates and gas prices - both factors have the potential to cripple an economic recovery, as households are thrown back to the economic wolves.

In light of recent economic reports, major banks are revising their outlooks - the World Bank recently downgraded its US GDP growth outlook to -3.0% in 2009 and +1.8% in 2010, while the OECD now expects US GDP growth to register -2.8% in 2009 and +0.9% in 2010. As such, the trajectory for 2010 growth seems to be very much up for debate.

To be sure, without stimulus coming from monetary policy (short term rates are near zero), further declines in home values expected, and a banking system that remains very much in flux, the recovery this time around will likely be much slower than the "V-shaped" recovery that would be expected given the depth of the recession. But who really knows?

Let's take a look at energy

The chart to the left illustrates the Energy Information Administration's (EIA) forecast for crude oil consumption in 2008 presented at the Macroeconomic Advisers Quarterly Meeting in June 2008 (I attended this).

In Q2 2008, the EIA expected overall consumption to grow over the year (which is the demand number of the EIA's World Oil Balance estimates). Driven primarily by China and the developing world, 2008 net global consumption of crude oil was expected to rise by 1 million barrels per day in 2008. Oh, and the forecast for oil prices was somewhere in the range of $120-$130/barrel. But it didn't.

It fell by 0.46 million barrels per year. Here is how the 2008 consumption numbers actually played out (plus revisions to previous years).

The chart above illustrates the actual consumption growth through 2008, as estimated by the EIA. US demand completely retrenched, and China's oil consumption slowed dramatically. Oil prices fell to the floor, and recently, an uptick in China's global demand has renewed the market for crude.

Now, the US household is faced with rising gas prices...again! And according to a recent Gallup poll, Americans believe that gas prices are going back up to $3.39/gallon (national average is currently $2.69/gallon). Oh, man. Don't worry, the EIA forecasts oil to remain in the $67/barrel price-range, helping to cap gas prices at $2.33/gallon. But we know the EIA's track record...

You know, the one truth in this whole economic mess, is that nobody really knows. I tend to be more optimistic about the outlook, going against the wind that is the "deleveraging" view, which is is bringing down the "consensus" (see Martin Wolfe's chart of the week). Eventually, positive economic news will manifest itself into the economy, driving up demand in the opposite spiral that brought the economy down.

But again, who really knows? All we really have is a long list of banking crises to determine an "average" outcome - please see the research done by Reinhart and Rogoff, this paper in particular - but it's just a average, folks.

Rebecca Wilder


  1. Hi Rebecca --

    The EIA's projections are always taken with a grain of salt, but their data on volumes is, flawed as it is, the best in the world.

    Three fairly big name petro-economists have suggested recently that the price of crude is likely to fall in coming months. Verleger's latest Notes at the Margin argues that the price will fall to $20/b by the end of the year on inventories, essentially. Takayuki Nogami, a senior economist at Japan Oil, Gas and Metals National Corporation, suggested that oil was likely to fall to $45/b by the end of July after economic optimism evaporates in the face of large inventories. And Fereidun Fesharaki suggested that there would be a $20/b drop in price in the middle of Summer due to the inventory build-up. I also think that Ed Morse is likely in that camp, though I haven't seen his latest projections.

    No one knows, as you rightly point out, but I have a lot of respect for those guys, three of whom have over three decades of experience watching the oil markets each. It may be that the price will stall household consumption growth as it sticks between the $65-75/b range, then falls to $40/b or so, providing some support to the developed economies' stimulus programs.

    Love your blog. -- FB

  2. When I hear about oil prices keeping us down, I just think we need more subsidies for plug-in hybrids and wind power. (By the way, people who say wind is bad because of intermitency are ... completely ... wrong.

  3. thats what everybody says & you and everyone else is wrong

    & hybrids can't climb mountain roads

    The transactions concept of money velocity (Vt) has its roots in Irving Fischer’s equation of exchange (PT = MV), where (1) M equals the volume of means-of-payment money; (2) V, the rate of turnover of this money; (3) T, the volume of transactions units. The “econometric” people don’t like the equation because it is impossible to calculate P and T. Presumably therefore the equation lacks validity. Actually the equation is a truism – to sell 100 bushels of wheat (T) at $4 a bushel (P) requires the exchange of $400 (M) once (V), or $200 twice, etc.

    The real impact of monetary demand on the prices of goods and serves requires the analysis of “monetary flows”, and the only valid velocity figure in calculating monetary flows is Vt. Income velocity (Vi) is a contrived figure (Vi = Nominal GDP/M). The product of MVI is obviously nominal GDP. So where does that leave us? In an economic sea without a rudder or an anchor. A rise in nominal GDP can be the result of (1) an increased rate of monetary flows (MVt) (which by definition the Keynesians have excluded from their analysis), (2) an increase in real GDP, (3) an increasing number of housewives selling their labor in the marketplace, etc. The income velocity approach obviously provides no tool by which we can dissect and explain the inflation process.

    To the Keynesians, aggregate demand is nominal GDP, the demand for serves (human) and final goods. This concept excludes the common sense conclusion that the inflation process begins at the beginning (with raw material prices and processing costs at all stages of production) and continues through to the end.

    Admittedly the data for Vt are flawed. So are nearly all economic statistics, but that does not preclude us from using them. An educated estimate is better than no estimate at all. For example, we know that the international balance of payments balances – debits equal credits, payments equal receipts, etc. The Department of Commerce statistics do not prove this, so in order to make their statistics balance, they put in an “errors and omission “balance figure. The triumph of good theory over inadequate facts.

    The Fed first calculated deposit turnover in 1919. It reported weekly until 1941. The figure “other banks’’ was used until 1996. Prior to this revision Vt included all banks located in 232 SMSA’s excluding N.Y. City. This was the best that could be done to eliminate the influence on prices of purely financial and speculative transactions. Obviously funds used for short selling do not contribute to a rise in prices. T

    The Fed calculates these velocity figures by dividing the aggregate volume of debits of these banks against their demand deposits.

    But we do know that to ignore the aggregate effect of money flows on prices is to ignore the inflation process. And to dismiss the concept of Vt by saying it is meaningless (that people can only spend their income once) is to ignore the fact that Vt is a function of three factors: (1) the number of transactions; (2) the prices of goods and services; (3) the volume of M.

    Inflation analysis cannot be limited to the volume of wages and salaries spent. To do so is to overlook the principal "engine" of inflation - which is of course, the volume of credit (new money) created by the Reserve and the commercial banks, plus the expenditure rate (velocity) of these funds. Also overlooked is the effect of the expenditure of the savings of the non-bank public on prices. The (MVt) figure encompasses the total effect of all these money flows.

    Some people prefer the devil theory of inflation: “It’s (Peak Oil’s or Peak Debt's) fault. This approach ignores the fact that the evidence of inflation is represented by 'actual' prices in the marketplace.

    The “administered” prices of the oil producing countries would not be the “actual” market prices were they not “validated” by (MVt)

  4. Ron Paul? Is that you?

    Hybrids can climb mountain roads, and plug-in hybrids have an even easier time of it. The roads up to Galt's Gulch may be steep, but I'm more concerned about the lack of oxygen up there.

  5. you can't drive or forecast

  6. I assure you I have the utmost respect for the actuarial sciences.

  7. Hi Freude Bud, Thanks for the info! Do you have links for any of their work? I suspect that there is something going on in the inventory build that is not being priced in to the futures market.

    Thanks for your comments, Rebecca

  8. Hi Rebecca -

    Most of their stuff is not free, so you get their views via news reports. You can find links to those on my site ... searching for the names should give a small number of returns.

    Sometimes they put some of their prognoses up on their websites for free.

    Almost every MSM reported "cause" of what's driving the futures market makes absolutely zero sense, far as I can tell. (The far end of the curve is much more sticky than the near months, which may suggest that most folks in the market think that in 5-8 years the price is going to be much higher, but, theoretically anyways, that should have nothing to do with front month.)

    Cheers, -- FB


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