DONALD COXE September 9 2002


DONALD COXE September 9 2002




The slowdown is getting slower as the Iraq factor pushes up the price of oil

ALTHOUGH Soon-To-Be-Sir Alan Greenspan won’t admit it, the U.S. economic recovery born last December seems to have gone from bumptious boyhood to septuagenarian sloth without pausing in adulthood en route. Yes, that can happen: there is a very rare human disease, called progeria, in which the afflicted die of the symptoms of old age by the time they reach their early teens.

There are pockets of youthful vigour. Consumers are going into debt so fast that the unwary might assume the economy is booming. Ned Davis reports, for example, that home equity loans (a.k.a. second mortgages) have grown in the last three months at a 53 per cent annualized rate. New automobiles continue to sell briskly, as consumers snap up those three-, fourand even five-year free financing deals. (Those who cite the sales strength as proof that the American love affair with the automobile has not ended may be distorting the data: what Americans love above almost all else is cheap credit, freely available. The updated Declaration of Independence avers that All Americans have an unalienable right to the Good Life and liberal credit for the pursuit of happiness.)

One problem is that so much of this borrowing goes to buy foreign-made goods. America’s trade deficit continues to exceed US$1 billion a day. (When the U.S. economy was booming, most economists assured us that the trade deficit was proof of American strength; now that the economic pulse rate is that of a hibernating frog, the economists are out of explanations. What is undeniable is that U.S. consumers are borrowing heavily to buy foreign-made goods—hardly a recipe for economic boom.)

Democrats blame the Bush tax cuts for the slowdown, alleging that the federal deficit has driven up interest rates, strangling the economy. Far be it from me to praise fiscal deficits, but I cannot resist

noting that U.S. rates for short-term borrowing, home mortgages and 10-year treasury bonds are at or near their lowest levels in 40 years.

Most seers blame the stock market. Not only has it vaporized $6 trillion or so of value in American stocks, but it has exposed the seamy, stock option-driven side of Big Business, eroding Americans’ faith in the system. (Some really dour observers say that business’s loss of legitimacy is just part of a bigger decline in confidence in major U.S. institutions, including the FBI, the CIA, Major League Baseball and the Catholic Church.)

I agree that the bursting of the technology bubble caused the recession and most of the problems of the stock market. I also agree that any fall on that scale has profound impact on the economy. This wasn’t a great tree falling in a remote forest.

What makes a bad situation worse is the continuation of high oil prices. Apart from a brief pullback to US$24 a barrel in June, crude oil has been trading between $27 and $30. Given the flaccid global economy, crude should be trading close to $21. The difference, everyone agrees, is the Iraq premium: oil buyers hear talk of war every day, and they stock up in case an invasion disrupts supplies from other producers in the region.

That would be the case if Saddam, seeing he was doomed, were to unleash some of his reputed weapons of mass destruction on other oil states in an Arab Götterdämmerung. Loss of Iraq’s own production would not be significant for

The economy has an over-dependence on consumers with an overdependence on debt, driving SUVs with an over-dependence on gas

world oil prices: Iraq exports about 1.5 million barrels a day, which the Saudis have promised to make up instantly if war stops supplies of Saddamoil. No other producing country is threatening a boycott if Iraq is attacked.

A $1 increase in oil prices costs the world’s consumers roughly US$28.5 billion annually, with American users paying about $6.5 billion of that. So the current spread of around $7 amounts to a “tax” of roughly $45 billion on U.S. consumers. That’s painful.

What makes the energy situation so enervating for the economy at large is that natural gas prices are now rising smartly as well, up to US$3.50 per thousand cubic feet from $2.80 in early August. Gas prices are supposed to be weak now because we’re a long way from heating season and there are near-record supplies in the pipeline. However, the effect of a lengthy period of cheap gas prices on U.S. drilling has been predictable: the rig count is down by more than one-third from the same time last year, which means production will soon be falling sharply. Because of the 39 per cent annual rate of decline in output from existing U.S. wells, the industry needs to drill furiously just to keep production constant. (Potential good news: if an El Niño is confirmed, then, according to the Chicago Tribune, there is a 74 per cent chance of another warmer-than-normal winter in the upper Midwest, which would hold down gas prices.)

High energy prices would not, of themselves, be a serious problem if the rest of the economy were exuding high energy. But this OPEC tax comes at a tough time for the U.S. and global economies. Corporations continue to cut back on both workers and capital spending, so the economy has an over-dependence on consumers who have an over-dependence on debt, and who drive SUVs with an over-dependence on gasoline.

The only fast-growing sector of the U.S. economy is the military. Gearing up for Saddam is expensive. If the U.S. takes out Saddam quickly and surgically, oil prices will plummet.

Root for Rumsfeld.

Donald Coxe is chairman of Harris Investment Management in Chicago and of Toronto-based Jones Heward Investments. His column appears every week.