Energy and Natural Resources Market Radar (May 21, 2012)

Saturday, May 19th, 2012

Energy and Natural Resources Market Radar (May 21, 2012)

Strengths

• According to the Shanghai Futures Exchange, its copper inventory fell 9,178 metric tons to 187,449 metric tons.
• China’s steel product output rose 7.9 percent last month to 81.1 million metric tons from a year ago, according to the National Bureau of Statistics.
• China imported a record high 25.05 million metric tons of coal in April, up 90.1 percent year-on-year, Platts reported, citing preliminary customs figures. Chinese year-to-date coal imports rose 69.6 percent year-on-year to 86.55 million metric tons of coal.

Weaknesses

• Stocks and commodities fell this week as the likelihood of a Greek exit from the eurozone has increased significantly during the past two weeks.
• Oil prices fell 4.8 percent this week. The current bout of concerns had arisen from the resurgent fears about the Spanish and Italian banking systems and speculation that Greece may have to exit the euro. Since then, for oil in particular, news reports suggesting that President Obama is seeking G8 cooperation on an oil stock release have compounded the depressing effect.
• Reuters reported that Chinese steel mills defer iron ore shipments owing to slowness in the steel market. Some Chinese steel mills are said to have postponed iron ore deliveries from suppliers such as Vale, given the slow steel markets. Producers are also expecting a further drop in prices.

Opportunities

• Global inflation might have already pushed the costs of exploring and producing oil from new most expensive projects, known in the industry as the marginal cost of production, above $100 per barrel, according to JBC energy consultancy. That compares to $50-$75 prior to the 2008 financial crisis. A decade ago, oil companies such as BP were saying they would start a project if oil traded above $17-$20. Even the International Energy Agency, which represents consuming nations, says production costs have gone up sharply. “There is not a single drop of oil in the world that cannot be produced at a price of oil of $85-$90,” IEA’s chief economist Fatih Birol told a summit.
• The Chinese government announced a new batch of new subsidies to promote the consumption of energy-efficient home appliances and autos on Wednesday. RMB6bn will be provided to fuel-efficient vehicles with engines below 1.6L, and an RMB26.5bn financial subsidy will be provided for energy-efficient appliance products, including all the major white goods products. This appears to be a clear signal of the government’s commitment to shift domestic demand toward more personal consumption and away from fixed asset investment.
• Oil industry executives and bankers are assuming oil prices will stay above $100 a barrel in the year ahead, despite mounting economic worries, as any fall below that level would trigger a cut in Saudi Arabia’s output and force closures at high-cost projects around the world. A Reuters straw poll of oil executives, traders, bankers and fund managers showed seven respondents predicting Brent crude trading at $100-$120 a barrel in the next 12 months.
• Boart Longyear, the world’s biggest provider of mineral drilling services, expects demand to remain strong as large mining companies proceed with projects. “We still see very strong demand, particularly from the majors,” Craig Kipp, CEO of the company said. “We haven’t heard from a lot of the majors outside of Australia that there’s a change in their plans or in their budgets. We haven’t seen any change in market dynamics – we’re operating all over the world,” Kipp said. “We do see that juniors, the second-tiers, have had problems getting financing,” he added.

Threats

• In a Wall Street Journal article last year at this time, Chief Executive Marius Kloppers said BHP would invest $80 billion by the end of 2015 to expand further. The eurozone crisis, slower Chinese growth, and falling metals prices are forcing BHP to now say it will be cutting those spending plans. Falling commodity prices and rising operating costs put its cash inflows at risk and, by extension, its commitment both to raising its dividend and keeping its single-A credit rating. BHP’s plans need to become clearer if it wants to reverse the 28 percent fall in its share price since a year ago.
• Agrimoney reported that the Federal Reserve has warned, “The surge in U.S. farmland prices, which in parts of the Plains achieved their strongest run of growth on record, may be about to fade, sapped by the worsened outlook for agricultural profits.” Farmland values posted sharply higher gains in states around Kansas in the year to the start of last month, reflecting higher crop prices and an easing in the drought which has plagued much of the area since 2010. “Strong farm incomes continued to fuel demand for farmland,” the Federal Reserve System’s Kansas City bank said, noting that values had now risen by more than 20 percent for two consecutive years for the first time since it began collecting data in the 1970s. Prices in Nebraska, which avoided drought, were particularly strong, with values of irrigated land soaring 41 percent.

Tags: Banking Systems, Bureau Of Statistics, Chinese Year, Coal Imports, energy, Energy Consultancy, International Energy Agency, Marginal Cost, Market Radar, Million Metric Tons, National Bureau Of Statistics, National Bureau Of Statistics China, Oil Prices, Oil Stock, Platts, Shanghai Futures Exchange, Steel Market, Steel Markets, Steel Mills, Steel Product, Stocks And Commodities
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“Eat People” (Andy Kessler)

Friday, February 18th, 2011

by Andy Kessler, via John Mauldin

This week’s Outside the Box is a little unusual, even for me. But it will be fun, informative, and thought-provoking. My friend Andy Kessler has written another irreverent, gonzo book called Eat People: And Other Unapologetic Rules for Game-Changing Entrepreneurs. He has graciously allowed me to copy his introduction as this week’s missive.

Andy gives us 12 Rules and a Bonus Rule that characterize game-changing companies. They are: Scale, Waste, Horizontal, Edge, Productive, Adaptive, Eat People, Markets, Exceptionalism, Market Entrepreneur, Zero Marginal Cost, Virtual Pipe, and Highest Return. Find a company that embodies these rules early, and you get in on the ground floor of the next Apple or Microsoft.

Andy has done that. He turned $100 million into a billion for his investors, then got out more or less at the top. He is the real deal and I take every moment I can get with him. Now he just looks for the Next Big Thing for himself, but in Eat People he shares the rules for finding them, or even creating your own next big thing.

You can get his book at http://www.amazon.com/Eat-People-Unapologetic-Game-Changing-Entrepreneurs/dp/1591843774 for a cheap $13.48 or on your iPad or Kindle. You can read it in a few hours. Make notes.

And get some of his other books while you are there. I think How We Got Here is one of the best, most readable books on the history of technology and the markets I have seen. His latest fiction work, called Grumby, takes a lopsided look at the whirl of technology as he shows how a product can go from nothing to millions almost overnight.

Read the following and think. And enjoy it.

I am trying to get over serious jet lag from Bangkok. Amazing place, but a long way from Texas, both literally and figuratively. I have been to over 55 countries, but way too little of Asia. That is going to change. By the way, some of the peppers in Thailand should be labeled as Weapons of Mass Destruction. Have a great week.

Your “my mouth is still numb” analyst,

John Mauldin, Editor
Outside the Box

Eat People

by Andy Kessler

“This place is spectacular.”

It was, but I wasn’t about to let on.

“Amazing.” I stifled a yawn.

“And the artwork is something else,” Nancy, my wife, continued. “Now this is the way to live.”

Paris is one of my favorite places in the world—one giant museum. The food, the wine, the artwork; even the people are nice, some of them anyway. After a quick connection with the gargoyles at Notre Dame—one of them reminds me of a kid I went to high school with—it was time to find things my wife Nancy and I hadn’t seen before. No fan of wandering through trendy neighborhoods or doing mindless shopping, I hit on the idea of visiting a bunch of the smaller museums, set in once private homes like the Frick Museum in New York. Frick made his money turning coal into coke for making steel, later hooking up with Carnegie to form what would become U.S. Steel. He deserved a nice house.

My ploy worked, so it was off to Boulevard Haussmann and some wealthy dead French guy’s house stuffed with beautiful paintings and sculptures and furnishings—the Jacquemart-André or the Cognacq-Jay. Or the André Jay?

“And over here is the living room, where formal entertaining for the close associates of Monsieur . . .” the guide droned on.

I could see a plate on a side table inscribed with “Liberté, Égalité, Fraternité.” How very French. I was starting to go stir crazy. It was time to mix it up.

“Where are the speakers?” I whispered to Nancy.

“What?”

“Some nice B&O speakers and a decent subwoofer would do this room just right. Even just a PC running iTunes, or geez, at least a measly iPod.” She shushed me.

“Look at that carpet,” she suggested. “Hand woven, I’ll bet.”

“This rug’s from Persia,” I said, doing my best Eddie Murphy from the movie Trading Places. “But who cleans that? Do you think he had a Dirt Devil?”

“Be nice.”

“If you’ll step this way, we enter the family living quarters. This drawing room is where the family spent evenings, reading by candlelight, telling stories . . .”

“You could probably shoehorn a nice fifty-two-inch plasma over that dresser. I wonder if they had DirecTV then? If not, I wouldn’t want to be this guy.”

“Shhhhh.”

“The bureau is a Louis XV, and the chairs are quite appropriate for the time period.”

“They look really uncomfortable,” I remarked. “You think they recline?”

“Would you be quiet?” Nancy said with a laugh. “I don’t know you.” I finally had her in the right spirit.

“The air conditioning bills must have been killer, at least five hundred a month.”

“Stop.”

“I can’t. This guy has some nice art on the walls, but I wouldn’t trade places with him for even a second.”

“But he was an elite in Paris during their golden age,” Nancy cooed.

“He’s got nothing. I haven’t seen one Blu-ray player, let alone a refrigerator, toaster oven, or espresso machine.” I was on a roll. Why stop there? “If he had a garage, it smelled like horseshit, instead of sporting a four-hundred-horsepower, seven-passenger Suburban. How could he get to his country home in a couple of hours? It must have taken a full day in a carriage. And we flew here in nine hours on a 777—it would have taken him nine months to get to California. I guarantee he never made it for a visit.”

“Yeah, but . . .”

“But nothing. This guy was poor. No computer, no Internet, no search engine, no YouTube videos. This guy has never seen Star Wars, for god’s sake!”

“That’s living?”

“Damn right. Should I go on?”

“Don’t.”

“Cell phone. GPS. Xbox. World of Warcraft. Métro. And,” I paused to catch my breath, “I can almost guarantee le dude never used Twitter.”

I got the eye roll from Nancy. I was pushing this beyond the point of no return.

“Let alone antibiotics, stents for heart attacks—he either died young of tuberculosis or, worse, watched as one of his kids died young. This guy was one of the richest in the world but he’d be considered living under the poverty line in our day.”

“I’m going to the next museum by myself.”

The experience got me thinking. I’ve been around the investment business for way too many years, trying to understand business cycles and product cycles, assessing management, picking stocks that go up, avoiding those that go down, but it wasn’t until I gawked my way through Monsieur Elite’s home off Boulevard Haussmann that I put my mind to the creeping change over the last one hundred years. You and I are nowhere as rich, on a relative basis, as this guy was, the envy of all, but in almost every other way, we have and do things every day that all the riches in the world back then couldn’t buy. Damn, I forgot to mention microwave ovens, or Orville Redenbacher, or . . .

Somewhere along the way, you were probably force-fed some economics. An economy is about commerce and trade and me buying bread from the baker who buys meat from the butcher who buys candlesticks, blah, blah, blah. Econ 101 and all the macro mumbo jumbo of “price is where supply meets demand,” and marginal costs meeting marginal utility, doesn’t explain why I can find cheap flights on Southwest Airlines to Salt Lake City to go skiing, or why I can even afford to go skiing in the first place. Something creates all that wealth that the richest in the world never had, including Kevlar parabolic skis.

How about this line: Economics is about allocating scarce resources. Well, I guess that could work, but that implies there are only so many resources to go around, and that those who pay the most get the scarcest ones. But where did the jet come from, or the Kevlar, or the online travel agent? That definition is unsatisfying.

There is only one definition of an economy I’ve ever been comfortable with: a system that increases the standard of living of its participants. Period. Everything else from credit to money supply to quarterly earnings releases to minimum wages is just a tool or else a meaningless characteristic of an economy. Without that “increasing living standards” thing, you and I would still be living in caves, chasing squirrels and shoveling shit and dying young from minor infections.

Increasing standards of living doesn’t happen automatically. It’s not a gift from heaven. Someone has to invent the future.

But how do you find the next big thing?

How do you find things that go up and to the right and keep going up and up and up? How do you find companies to work for or to invest in that will let you create some real wealth? And how do you do well by the world?

Thirty years ago, as I started my so-called career, not a single person told me that computers and technology would get so cheap that they would practically end up being given away in boxes of Cheerios. Or that Wall Street and banking and money management would be turned inside out, uncorking money buried inside the musty trust departments of sclerotic banks. Instead of gathering dust, this money went fleeing to the higher returns from money market and mutual funds, thus allowing anyone with an idea to either invest or get access to capital to build a company of their own, go public, and create enormous wealth.

Just one little mention at a cocktail party, from someone, anyone, telling me about this, would have done me wonders. Not a peep!

On top of that, no one told me that tons and tons of jobs would be destroyed—and even more created. Who knew? Yet that’s the world I had to navigate.

Today, the economy may have blown up, but the underlying principles of wealth creation still exist. Maybe even stronger than ever. How to tap them is not so obvious. But it’s never obvious. You have to figure out how to create the future yourself.

The only way to truly succeed over time is to use your head, think out long-term trends, figure out where productivity exists (and therefore wealth is being created) in the economy, and invest your mind or your money alongside it.

I’ve seen it happen so many times. Someone comes up with a great idea and changes the world. The next big thing.

I met Michael Dell by phone in his dorm room where he was selling PCs and then met him in person well before Dell Inc. completely changed how personal computers were sold. By getting rid of an entire swath of middlemen, and lowering prices for all of us, he turned himself into a multibillionaire.

I met Steve Jobs as he was getting thrown out of Apple, and once more as he headed back in, when he expanded the company’s mission from designing computers to MP3 players and then smart phones and tablets that have made it easier for all of us to get information by voice or by Web wherever we might find ourselves. He got rich—and you and I got richer lives.

I met Ed Catmull while sitting on the floor at LAX waiting for a delayed flight back to SFO. Pixar was working on its first feature film, Toy Story, which pioneered a whole new way to tell compelling stories. He (and Steve Jobs) got rich, but the rest of us got to see spectacular movies for ten bucks. Quite the bargain.

I met Carl Rosendahl, whose Pacific Data Images was doing similar things for Jeffrey Katzenberg and DreamWorks with a project called Shrek.

I met Larry Ellison as he was selling databases to corporations, when it wasn’t so obvious that he was going to completely transform their back offices, squeezing out costs in their finance and supply chains and making them much more productive. Oracle saved businesses a fortune, and they passed the savings along to the rest of us in the form of everything from cheap goods at Walmart to cheap trades at Charles Schwab. Sure, Larry got rich—after all, he saved these companies a ton of money. But he made the rest of us rich, too. As costs go down, all of us get wealthier.

I’ve met Bill Gates many times, first after Microsoft went public. Gates was pitching Wall Street about upgrading to Windows from DOS (without much luck). Eventually, Wall Street discovered spreadsheets, which lowered their costs and made it vastly easier to do things like take two companies or two financial instruments and merge them into something financeable.

I met Gordon Moore and Andy Grove and Bob Noyce, the founders of Intel, just as they almost lost out to cheap Japanese memory makers—before turning the massive company on a dime to sell processors (at high margins) to the IBMs and Compaqs and then Dells of the world, driving faster and faster computers so better and better graphics could make computers easier to use for business and making all of us more productive—well, except for those of us who love video games.

I heard Sergey Brin and Larry Page speak to a small group a few years before Google went public. They wanted to know what you were going to search for before you even knew yourself.

I met Rupert Murdoch in the early nineties when he almost lost News Corporation under a siege of debt, and when he began transforming the entire media space, from newspapers to TV to film.

I met Mark Cuban when he and his partner Todd Wagner were peddling AudioNet to anyone in Silicon Valley who would listen, before they sold the audio and video streaming company to Yahoo! for $5.7 billion.

I met Mark Zuckerberg just as Facebook was crossing a few million users; he talked about lowering the cost of communications between groups of people. Today, a good chunk of the planet logs in to the site regularly to keep in touch with friends and family.

I can go on. Meg Whitman when she was at eBay, Jeff Bezos at Amazon, even a few telecom folks who were billionaires for a moment in time.

The cool thing about all these folks is that no one did them any favors. There was no government contract that guaranteed them success. No secret handshakes or sweetheart deals or smoky room concessions.

For the most part, society didn’t do them any favors—each of them started small, but saw something big on the horizon and created a process to constantly improve, constantly innovate, and constantly sell exactly what was needed and then identify the next big thing on the new horizon.

Wouldn’t you like to have their vision?

How do you find the next big thing?

Yeah, sure, none of them discovered penicillin or cured polio. But these folks increased my standard of living, your standard of living, half the world’s standard of living, on par with any scientist or philanthropist. They created wealth for themselves, yes, but also for society as a whole, by making all of us more productive.

I don’t care about and certainly don’t idolize those billionaires, beyond what I’ve learned from them about how to find and create and leverage the next big things.

So, how was I lucky enough to meet all these folks?

Well, it was my job. I worked on Wall Street trying to find the next big things. It really was my job to find billionaires well before they hit it big so my investors and I could go along for the ride. And I made tons of mistakes, believe me. But eventually, I got good at it. It was not just finding driven people with the character and focus and guts to succeed. It was also about being in the right zip code, finding the next big applications and companies and industries well before they took off, when you could invest on the cheap and then sell when they were dear.

Along the way, I learned that those things that made me the most money were not so coincidentally the very same things that made society richer and the world a better place.

I call them Free Radicals. We’ve seen them throughout history.

Charles Curtis’s 1903 steam turbine generator electricity to the masses. Using that electricity, in 1907, James Spangler, a janitor with asthma, invented an electric suction-sweeper, today’s vacuum cleaner. William David Coolidge’s thermionic X-ray tube of 1913 changed medicine. That same year, the Walker brothers in Philadelphia invented the first electric dishwasher. In 1916, Clarence Birdseye perfected the flash-freezing process (and Birds Eye potato puffs). In 1928, Thomas Midgley, Albert Henne, and Robert McNary synthesized the first chlorofluorocarbons (trademarked as Freon in 1930), ushering in safe refrigerators and air conditioning (other coolants eventually replaced Freon). Paul M. Zoll created the cardiac pacemaker in 1952. And Percy L. Spencer in 1945 watched a magnetron melt candy, leading to the invention of microwave ovens.

Lots of housecleaners lost their jobs to vacuum cleaners. Lots of servants weren’t hired or husbands yelled at because of electric dishwashers. Freezers and Birds Eye frozen food put a lot of cooks out of work and on and on.

Free Radicals found situations to combust and destroy, but in the end, it was only to make room to build the new—disrupt the status quo, do more with less, advance society, drive progress rather than have progress drive them.

A Free Radical is someone who gets wealthy inventing the future by helping others live longer and better. Rather than be a burden on society or tax society or milk society for all it’s worth, a Free Radical improves society and is paid handsomely for doing so.

Rather than building huts in Costa Rica, a Free Radical invents cheaper building materials, improves the logistics of getting materials where they need to be, creates a market to discover the right prices for materials and labor, educates Costa Ricans, hires them to do twenty-first-century work well beyond the grueling labor in sweatshops of the Far East—and in the end, they can afford to build their own homes. A Free Radical doesn’t even have to set foot in Costa Rica to be a hero, though likely an unsung one.

Create wealth and change the world. It sounds oxymoronic. Do good by doing well. It sounds like a rationalization for someone getting rich, but you’ve seen it just like I have. Ted Hoff invented the microprocessor and has changed billions of lives for the better. Lloyd Conover invented the antibiotic tetracycline and has probably saved a billion lives from early demise. Larry Page and Sergey Brin perfected search and created wealth not only for themselves but for everyone who plugs into their electronic ecosystem.

Free Radicals, all of them. It’s not the only way to get wealthy, but it’s the most rewarding for the rest of us.

You can be one too. I’ve laid out a set of Rules – or criteria to help entrepreneurs or investors or job hunters figure out where the upside is. 12 Rules and a Bonus Rule (I once worked in a bakery and still love fresh bread to this day!) They are: Scale, Waste, Horizontal, Edge, Productive, Adaptive, Eat People, Markets, Exceptionalism, Market Entrepreneur, Zero Marginal Cost, Virtual Pipe and Highest Return. You’ll have to read the book to see what I mean.

But I’ve got to tell you—if all you want to do is take over some old-line company and milk it for all it’s worth, I can’t help you. Or if you insist on pursuing some protected franchise in banking or insurance or medicine or whatever—forget it, you’re on your own. You may get rich milking the rest of us, but society won’t get rich along with you.

But if you want to make something for nothing, help the world be more productive, create wealth for the masses beyond anyone’s imagination . . . I can steer you in the right direction whether you’re an entrepreneur or an investor or just looking for the right career.

Just be warned. This is not some get-rich-quick scheme. You won’t find tips on flipping properties in these pages. What I’m talking about is a process that works over years and decades to keep generating wealth for those who sell and those who buy. And that is what generates progress. And wealth.

I know. I’ve seen it happen. As I said, I’ve gone along for the ride many times.

Disclaimer

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staffs at Millennium Wave Advisors, LLC and InvestorsInsight Publishing, Inc. (InvestorsInsight) may or may not have investments in any funds, programs or companies cited above.

PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN MANAGED FUNDS. WHEN CONSIDERING ALTERNATIVE INVESTMENTS, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.

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Tags: Amazing Place, Amazon People, Andy Kessler, Fiction Work, Friend Andy, Gold, Gonzo, History Of Technology, Horizontal Edge, Ipad, Jet Lag, John Mauldin, Marginal Cost, Market Entrepreneur, Missive, Readable Books, Real Deal, Weapons Of Mass Destruction, Whirl, Www Amazon
Posted in Credit Markets, Gold, Markets | 1 Comment »

QE2 Is Likely to Be More Successful than QE1

Friday, November 5th, 2010

QE2 Is Likely to Be More Successful than QE1
November 4, 2010

by Paul Kasriel and Asha Bangalore, Northern Trust

On November 3, the FOMC announced that it would increase the quantity of its outright holdings of securities by a net $600 billion by the end of the second quarter of 2011. Thus, the Fed has re-embarked on a policy of quantitative easing. Its first real “voyage” of quantitative easing, QE1, started at the end of November 2008 and ended in March 2010. The expected (hoped for?) outcome of a quantitative -easing policy is increased nominal demand for goods and services. Under normal circumstances when the commercial banking system is not constrained by actual or expected capital inadequacy, the Fed is able to stimulate the nominal demand for goods and services by lowering its key policy interest rate, the federal funds rate. The federal funds rate is the one-day cost of immediately available funds in the financial system and, therefore, represents the marginal cost at which banks can fund themselves. As banks’ cost of funds goes down, due to competition, banks pass on their lower cost of funds to their loan customers. The decline in loan rates leads to an increase in the quantity demanded of bank credit. The increase in bank credit supplied leads to increased nominal spending on goods, services and assets. When the banking system is constrained by actual or expected capital inadequacy, banks collectively are unable to increase their supply of credit even though their marginal cost of funds has fallen. This actual or expected banking- system capital inadequacy has been hampering the effectiveness of the Fed’s low interest-rate policy in stimulating the nominal demand for goods, services and assets. Thus, the Fed is now turning to a second round of quantitative easing.

There has been much misinterpretation in the media of how quantitative easing “works.” Indeed, we are not sure that even the Federal Reserve fully understands how quantitative easing works. The typical explanation of how quantitative easing works is that the Fed’s purchases of longer-maturity securities will bring down the interest rates on these securities. The lower interest rates on longer-maturity securities will then induce the nonbank private sector to borrow and spend more. Also, the lower interest rates on longer-maturity securities will make equities more attractive investments at the margin, thereby causing a rally in equity prices, which, in turn, will induce the private sector to increase its current spending on goods and services via a wealth effect. Lastly, the lower interest rates on longer-maturity securities and the expectation that the Fed will hold short-term interest rates at a very low level for a extended period of time will weaken the foreign –exchange value of the dollar, thereby making U.S. exports more price competitive in global markets. All else the same, we do not dispute that interest rates on longer-maturity securities would fall, that equities would become more attractive and that the foreign-exchange value of the dollar would decline with the implementation of quantitative easing on the part of the Fed. What we do dispute is that these are the main channels through which quantitative easing operates to stimulate the nominal demand for goods, services and assets.

Have you noticed by now that whenever we mention quantitative easing, we italicize quantitative? We have done this to emphasize that the main channel through which quantitative easing stimulates the nominal demand for goods, services and assets is through the quantity of credit created by the combined Federal Reserve System and commercial banking system, not the price of credit (the interest rate), not the price of equities and not the price of foreign exchange. If one were to review Econ 101 text books, one would discover that central banks are able to create credit figuratively “out of thin air.”

The important implication of this is that the recipients of central bank-created credit are able to purchase goods, services and assets without any other entity in the economy having to cut back on its current purchases of goods, services and assets. The Federal Reserve, of course, is the U.S. central bank. If one were to read a little further in the Econ 101 text, one would discover that the commercial banking system, not an individual bank, also is able to create credit figuratively “out of thin air,” providing that the central bank supplies the “seed money” for this to the commercial banking system. The important implication of the creation of credit by the commercial banking system, is the same as that of the creation of credit by the central bank: the recipients of this credit created by the commercial banking system are able to purchase goods, services and assets without any other entity in the economy having to cut back on its current spending on goods, services and assets.

Thus, if combined central bank and commercial banking system credit increases, there is a presumption that current nominal aggregate spending on goods, services and assets will increase. That same presumption with regard to an increase in nominal aggregate spending cannot be made when credit is granted by the nonbank sector. In this case, the presumption is that the grantors of credit will decrease their current nominal spending, transferring purchasing power to the recipients of the credit. Thus, when the nonbank sector extends credit, the presumption is that nominal aggregate spending does not increase. The exception to this presumption would occur if the quantity of currency and bank liabilities desired to be held by the nonbank public were to fall by an amount equal to or greater than the amount of nonbank credit extended.

Tags: Asha, Assets, Bangalore, Banking System, Banks, Decline, Federal Funds Rate, Federal Reserve, Fomc, Inadequacy, Interest Rate Policy, Loan Rates, Marginal Cost, Misinterpretation, Northern Trust, oil, Paul Kasriel, Policy Interest, Qe1, Qe2, Second Quarter
Posted in Energy & Natural Resources, Markets, Oil and Gas, Outlook | Comments Off