Crash!

Down went markets yesterday.  Up went the price of oil.     

It was a day of carnage.  A day when shares in the world’s largest automobile maker fell to their lowest level in 33 years.    A day when Libya said there was too much oil in supply and it was to CUT production.    A day when the Bank of England governor Mervyn King called for us all to “face up to reality,” and said he had no idea how much house prices were going to fall.    In banking land, Tim Bond, chief equity strategist at Barclays Capital said: “We are going into tortoise mood and are retreating into our shell.”

But here is the strangest comment of the day.  On the BBC web site it was said: “Some analysts believe a bear market, in which shares fall for a prolonged period, has already taken hold.”

It’s just words:  correction, bear market, crash.  A correction is defined as when shares fall by more than 10 per cent.  A bear market, when shares are more than 20 per cent down from a recent high.  A crash is normally considered to have occurred when prices are more than 30 per cent down.

But the truth is this.  The bear market began at the end of the last century.   At close of play last night the FTSE was 1,400 points, or 20 per cent, lower than the level it stood at on the 31 December 1999.

Not only did the Dow fall by 358 points yesterday, the second-biggest daily fall in this year of extraordinary volatility, not only did it fall to the lowest level in 21 months, but the Dow also fell below the Dotcom boom peak of 11,722 set on 14 January 2000. 

In other words, both the FTSE 100 and Dow Jones Industrial average are below levels set eight years ago.

This is no new bear market, it is the continuation of an old one.

But we were fooled into believing it had ended, we were fooled by the most transitory of illusions, rising house prices.

Some idiots have laughed off the dotcom crash and said prices just got out of hand; and described the housing boom as a proper boom based on solid fundamentals.

This analysis was wrong.

The dotcom boom promoted innovation.  And it’s the innovation sparked off during that period which gives the best hope for today.

Robert Solow, a famous Nobel prize winning economist, credited as being one of the leaders in the theory of economic growth, once said: “Technology is everywhere but in productivity.”  In other words, we had witnessed a period of dramatic change in technology, but it was not being shown up in the productivity statistics.    Mr Solow was not wrong, but he seemed to have failed to grasp the time lags involved.    The boom of the late 1990s, which took place many years after Solow’s observation, was down to technological innovation finally showing up in the productivity data.  

And that’s what it all boils down to.  Productivity is what creates wealth.    The comings and goings of economic cycles, or bull and bear markets, are like whispers on the wind.    Prosperity is down to how much we produce, and how much we produce is determined by innovation.

The last few years have seen countries such as India and China piggy back on innovation that had already occurred.    The next few years will see the recent strides made in technology filter through into genuine wealth creation.

But right now, we are simply in the midst of an economic period that began when dotcoms crashed. 

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Inflation is everywhere, just not here

It all started innocuously enough.

After choosing to leave interest rates on hold the Fed put out a statement which said: “The committee expects inflation to moderate later this year and next year.” 

The Fed’s optimism on inflation builds on the belief that wage inflation is firmly in check.   It is like that in the UK too, of course.    Yesterday, data from the Industrial Relations Services, here in Blighty, revealed that company salary awards rose from 3.2 to 3.3 per cent in the three months to the end of May – hardly the stuff inflation is made of.

The mildly good news continued with data from the US on existing house sales.  There was a 2 per cent jump in sales in May.    House sales have been pretty stable now for 7 months.   Sure, sales are well down on the levels seen, say, in 2005 – in September 2005 annualised sales were 7 million; in May just gone, 4.99 million.   Sure, inventory levels are such that it will be at least a year before the backlog is cleared – meaning prices are sure to fall for another 12 months, but that is not news.    The only news yesterday on house prices was that sales were up. Light is there at the end of the tunnel, albeit a long tunnel.

Meanwhile, in the UK, Mervyn King and chums were talking to MPs.

They talked tough on inflation. Paul Tucker, who is the executive director for financial markets at the Bank of England, talked about “the inflationary genie”, and how it is essential we don’t let it out of the bottle.

Merv gave another warning about pay rises, saying that if wages rise above inflation then we will see a “very prolonged and deep slowdown in activity.”

But in the UK and US, unions don’t have the muscle they used to.  The threat to jobs is very real.    A repeat of the 1970s inflationary spiral still seems unlikely.

On this track, the Telegraph quoted Sheila Attwood from the said Industrial Relations Services: “With below-inflation pay awards now a reality for the majority of workers in both the public and private sectors, our data suggest that employers have gained the upper hand in pay negotiations.”

Yet, not everyone is convinced inflation is licked.   Warren Buffett, for example, said: “I think inflation is really picking up.” Interviewed on CNBC, he added: “It’s huge right now, whether it’s steel or oil.  We see it everywhere.”

Maybe that’s the problem.  On one hand you have got gurus from the world of central banking saying: “Yes we have to watch inflation, but we think this is just temporary.” On the other hand, you have the Big Daddy of all financial gurus, the world’s richest man, saying inflation is “everywhere.”

Maybe the reality is this.   They are all right.

Inflation, that’s real 1970s inflation, is everywhere.   It is in India, where the wholesale price index recently hit 11.1 per cent, a 13-year high, and where its Finance Minister P Chidambaram says inflation is his biggest concern.

Inflation is in China, where the World Bank thinks it will reach 7 per cent this year.  It is in Russia too; in fact, latest estimates suggest Russian inflation is now 12 per cent.

Capital Economics has predicted that global inflation this year will be 5.5 per cent.

But the point is this.  Capital Economics reckons inflation in the G7 will be 3.3 per cent.

In other words, yes, it is true inflation is everywhere – it is just that it really isn’t such a danger in the UK, US, Eurozone or Japan.

And that surely is one of the key reasons behind it all.

In the developed world, asset prices are crashing; that’s house prices and, now, we can say equities too.    In the West, a shortage of credit should lead to deflationary pressures down the line.

In the developing world, growth has been so rapid, just like it was in Europe in the 1950s and 1960s, that inflationary pressures are building.

Yes, it is like the 1970s in China, India, Russia and the rest of the developing world.

In the West, the similarities are much closer to 1929, or to Japan when its lost decade began.

The snag is this.  The dollar and euro are, in effect, the world’s currencies.   China et al still like to keep their currencies in line with the dollar.

The Fed and European Central Bank are, in a way, the world’s central banks.

The world needs higher interest rates to stop inflation.

In a way, we are seeing the debate on the euro magnified and applied to the world.

Should Britain join the euro?   There is no right rate of interest for the eurozone; Germany and Spain, France and Ireland, they all need interest rates that are quite different.  The UK needs another level.

But, in a way, on a global level, there are only two currencies.     That is why the current financial crisis is so intractable.

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Oil: shock, awe and then good sense

Shokri Ghanem, chairman of Libya’s National Oil Corporation, put his spoke in.  The world is oversupplied with oil he said, and in any case, Libya is so put out by US action in Iran that it is considering reducing its supply of oil.   

So the day has come when Libya plans economic sanctions against the US.

Meanwhile, OPEC president Chakib Khelil, speaking on French television, said he thought the price of oil could hit $150 or even $170 a barrel.

And yet, more evidence emerged to suggest oil will fall back, eventually.

In the UK, bus and train company Stagecoach talked about a “Renaissance” on the railways.  The last year has seen a 3.6 per cent jump in the number of passengers using its buses, but more to the point, it enjoyed a 13.6 per cent rise in like-for-like sales on its rail franchisees.

Maybe Jimmy Savile was right: “This is the age of the train.”

Then, Morgan Stanley suggested the high price of oil could put an end to global imbalances.

The argument goes like this.    The Chinese and Indian growth story has been based on exports, which in turn have relied upon Western borrowing.

But, as the price of oil goes up, the cost of transporting goods rises too.  “In the short run, this is clearly a negative shock to Asia, and for Asian assets, including currencies,” said Morgan Stanley’s Stephen Jen.  “In the long run, however, this shock could accelerate the move away from exports.”

But surely Mr Jen’s argument has another implication.    Just as the high cost of petrol has been forcing us onto the buses and trains, it is also likely to lead to less flow of goods across the seas.

These are just two examples of why demand for oil is set to fall. 

There are plenty of other reasons too.  The fall in GM shares to a 33-year low yesterday, shows how much customers want fuel efficiency now.

Ironically, though, if energy producers believe oil is a bubble and will crash in price, they are less likely to spend money on ramping supply and on finding alternatives.   This will in turn keep price high. If they believe the high price of oil is here to stay, they will invest in alternatives and oil will then fall in price.

For that reason, oil in excess of $130 must appear to become entrenched, before it can fall.

Cycles are like that.    Booms go too far when people foolishly believe it can carry on for ever.  Crashes occur when people equally foolishly think there is no hope.

Yet, ironically, it is the foolishness of markets that creates innovation.    
 

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Yet digital future gives light at end of tunnel

But in adversity there is opportunity.  While all around markets crash, there are still opportunities lurking.

Above, it was argued above that we are witnessing the continuation of events first started when dotcoms crashed.

Maybe it will end when the next technological revolution begins.

And that is quite interesting, because according to KPMG, content creation in digital entertainment is set to expand; in fact, some go further than that and say it is set for takeoff.  

Venture capitalists are set to increase their investment into these areas too, with 52 per cent of respondents to a KPMG survey believing venture capital investment in digital content creation will increase over the next two years.  More to the point, 25 per cent of those anticipate investment increasing by more than 20 per cent.

Fifty-nine per cent reckon merger and acquisition activity will rise.

“Digital entertainment is a rapidly evolving sector, which has had a tremendous impact on consumer habits,” said David Elms, Media Partner at KPMG, “and despite the economic downturn, investors continue to seek opportunities to invest in companies at the cutting edge of technologies driving the evolution in how we communicate, and access information and content. It is particularly interesting that investors are hedging their bets regarding backing user-generated or professional content, an illustration that there is all to play for as the sector evolves.”

Thirty-one per cent of respondents indicated that mobile applications will receive the most significant portion of increased investment, 26 per cent say technology enablers and 20 per cent indicated social media services.

When asked which mobile entertainment applications would dominate market revenue in 2009, 31 per cent of respondents felt that social networks would, followed by gaming (20 per cent), video (14 per cent), music downloads (20 per cent) and user-generated applications (10 per cent). Additionally, 60 per cent of respondents believe mass adoption of mobile video consumption will take off in the next three years.

“The survey findings clearly indicate that the mobile sector has become a significant area of opportunity for venture capitalists,” said Tudor Aw, Convergence Partner at KPMG, “largely due to the increasing number of consumers who prefer to receive content via their mobile devices.”

When asked about monetising, almost 50 per cent of respondents believe advertising is where the money lies, while 19 per cent believe, much like texting, it is the transport. While perspectives on what is going to truly monetise social media differ, 93 per cent believe that the networks will significantly monetise their online viewership in five years or less.

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Chart of the day

markets 2008

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markets

markets

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oil, gold, pound, euro dollar, 2008-06-26

Rates Close Change
Oil 134.2 -2.89
Gold 889 -1.4
$ to £ 1.9744 0.0048
€ to £ 1.2589 -0.0059
$ to € 1.5684 0.0112

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ftse, dow, nasdaq, 2008-06-26

Index Close Change
FTSE 100 5666.1 31.4
Dow 11811.8 4.4
NASDAQ 2401.3 33

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Wind power: hot air, or can we sail to victory over climate change and expensive oil?

Wind is in the news this morning, with the government due to announce renewable energy plans. Is wind a partial answer, or just hot air? There is so much contradictory evidence out there, it is difficult to decide. Yet few questions are more important. In this article we drill down to the key issues.

When Christopher Columbus, that’s the sailor, not the film director, set out in 1492, he not only discovered the Americas, he also provided a lesson on how we can slash the cost of travel and go some way at least to winning the war against the terror of climate change.

Think about how he got there.  He sailed, under the power of wind.   But here is the big flaw; he, just like the other great explorers, Vasco De Gama,  Walter Raleigh, Captain Cook, etcetera, often got stranded, out at sea, waiting for the breeze.    

And that, in a nutshell, says it all.  Wind can provide much of our energy, but wind power is hugely expensive because it is intermittent… unreliable.

According to some, wind power is at least a partial solution to one of our biggest ills, but according to others, the development of wind power is a fool’s errand, destined to fail.

There is no doubt about it.  The arguments against wind make a long list, and at face seem convincing.    But the criticisms overlook one key point, a key point that was best expressed in 1966 by a man who co-founded Intel, a certain Gordon Moore.

According to a report produced for the Centre of Policy Studies – “Wind Chill: why wind energy will not fill the UK’s energy gap” by Tony Lodge – wind power is expensive, very expensive.  It gives as an example Denmark. 

You may know, Denmark has invested heavily in wind power, to the extent that there is a wind turbine in Denmark for every 900 or so people.   According to the CPS report, in 2002 wind turbines provided Denmark with 19 per cent of the energy the country used.  “In theory,” says the report, “at peak output, the Danish wind farms could account for nearly 64 per cent of Danish peak power demand.”

Here is the rub.  The report says: “Not a single conventional power plant has been closed in the period that Danish wind farms have been developed. Because of the intermittency and variability of the wind, conventional power plants have had to be kept running at full capacity to meet the actual demand for electricity and to provide back-up.”

One of the arguments put forward by the pro-wind farm brigade is that you can fire up power stations every time the wind drops. No wind, turn on the traditional power stations.  When it’s windy, turn them off.  But, says the CPS report: “Danes have found that it is not practical for large baseload plants to be turned on and off as the wind dies and rises: indeed, the quick ramping up and down of those plants, such as coal, would actually increase their output of pollution and carbon dioxide (the primary greenhouse gas).”

It says: “Baseload stations have to keep running so that they can ‘shadow’ wind turbines due to their intermittency. So when the wind is blowing perfectly for the turbines, the power they generate is usually a surplus and sold to other countries at an extremely discounted price; or the turbines are simply shut off.”

The report then cites the Copenhagen newspaper Politiken, which claimed that: “Wind met only 1.7 per cent of Denmark’s total demand in 1999.   And in 2003, for example, 84 per cent of western Denmark’s wind-generated electricity was exported (at a revenue loss).”

It says that: “The Danish grid used 50 per cent more coal-generated electricity in 2006 than in 2005 to cover wind’s failings. The increase in the demand for coal, needed to plug the gap left by underperforming wind farms, meant that Danish carbon emissions rose by 36 per cent in 2006.”

So that is pretty damning stuff.

There is another snag with wind.  According to David J.C. MacKay, Professor of Natural Philosophy, Department of Physics, Cambridge University: “If we covered the windiest 10 per cent of the country with windmills, we might be able to generate half of the energy used by driving a car 50 kilometers per day each. Britain’s onshore wind energy resource may be “huge,” but it’s not as huge as our huge consumption.”  In his book “Sustainable Energy – without the hot air” he said: “I should emphasize how audacious an assumption I’m making. Let’s compare this estimate of British wind potential with current installed wind power worldwide. The windmills required to provide the UK with 20 kWh/d per person are fifty times the entire wind hardware of Denmark; seven times all the windfarms of Germany; and double the entire fleet of all wind turbines in the world.”

Then there’s the cost of wind turbines.   CPS says: “The construction of wind farms in the UK, both onshore and offshore, is facing large cost increases as the raw materials required to build them become harder to obtain. Turbine costs alone have risen by about 30 per cent in recent years. Siemens, which makes turbines, has no spare capacity.”

CPS says the cost of electricity generated by onshore wind is around three times more than electricity generated by nuclear power.

So let’s just give up then.  Forget wind. Let’s focus on nuclear power instead.

It is just that these arguments overlook the key point.

Technological progress is a function of the resources we invest, and time.

When the US government charged the Advanced Research Projects Agency (ARPA) with the task of investigating how to protect data stored on computers in the event of an attack, ARPA developed a computer network, which it launched in 1969.  This network evolved into the Internet.

The point is this: the very act of developing technology, advances our knowledge with unpredictable, but often far reaching and hugely beneficial, consequences.  That is why we are what we are today, and not still scavenging for a living in the Rift Valley.

Wind power is like computers in another way.  Wind  turbines are produced in massive quantities, and relatively quickly, unlike nuclear power stations that take decades to be built.  This quick turnaround increases the rate of technological advance.  In short, wind turbines are subject to their own kind of Moores’ Law.

And they are getting better.  According to this week’s Economist, Victor Abata, General Electric’s vice-president says that in 2002, GE’s wind turbines were out of commission for 15 per cent of the time; now it is more like 3 per cent of the time.

Sure, there is a spike at the moment in the cost of wind turbines.  Spikes occur.  Computer chips don’t always go down, there are occasions when they are in short supply and price goes up.  This happened in the early 1990s. But, over the longer-term, the trend is down, a long way down.

As more and more wind turbines are built, economies of scale will set in.  They won’t get more expensive.  To say they will get more expensive as more are built goes against the fundamental theories of economics. 

The anti-wind brigade talk about the law of diminishing returns.   In practice, examples of returns diminishing with greater production in industry are rare.    That is why globalisation is producing so much economic development.

It seems more likely that, once we get over the current bottleneck, wind turbines will get cheaper, and more efficient.

The larger the area wind turbines are spread over, the better.   Denmark is a small country.  The weather probably does not vary much across the land on any one day.    It is not like that in the UK.  It may be calm in Sussex, but blowing a gale in Scotland.  By spreading wind farms across the UK, energy generated by wind becomes more predictable.  This is even more the case if wind turbines are spread across Europe.

But the truly exciting side of this story is this. If you can combine wind energy with information technology, a new opportunity awaits.

Moving forward, computers will be able to apply the appropriate energy source to different appliances. 

So, things that require electricity in a more flexible way could draw their energy from the wind.  Storage heaters that heat up using electricity, then store the heat, releasing it gradually, are one example.  Another might be air conditioning.   If you go to bed and leave your mobile phone battery on charge, then all you really care about is that it is charged up when you wake up.  You don’t care if it charges in intermittent bursts throughout the night.

The same applies, by the way, to the laptop computer this article was written on; it was charged up last night.

But, and this is the truly exciting bit, think about electric cars.

You can’t have failed to notice, electric cars are in the news.  They are supposed to be many times more fuel efficient than petrol, and for people who travel no more than 50 or so miles a day, can provide all the energy required.

And when can you charge up electric cars? When you are not using them.   Wind generated electricity may be ideal.

In a way then, it will be as if our cars will be able to sail down the motorway.  But there is one big difference with sailing.

No doubt Christopher Columbus would have loved to capture all the excess energy in a storm and use it when the wind stopped.    Well, thanks to the potential for spreading many wind farms out across a huge area, linked via a grid, and thanks to batteries that can store energy, especially the batteries that will sit in electric cars, Columbus’s wishes may soon be granted.
 

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Speculators! Are they evil, or just modern day soothsayers?

When Ken Livingstone was in New York a few years ago he was asked why London was doing so well.  He replied: “Two words, Sarbanes Oxley.”

London’s financial markets are not keen on regulation.  Okay, there is regulation, but it’s nothing like the draconian measures seen in the US.    And that is why London is such a success.

Sometimes it seems as if London’s unique selling point is US politicians.    They overreact so.   They put the kybosh on Middle Eastern investors buying US assets, so they buy British assets instead.    Enron and WorldCom go bust, so Congress imposes a straitjacket on US corporations.  The result: chances of another Enron are diminished, but then the money flowing into New York’s stock exchanges diminishes too, and it flows into London instead.

Of course this is not unique to US politicians.  Overreactions seem to be the way us humans do things.     Someone leaves the stable door open, the horse bolts, so Farmer Giles gets a new solid steel door, with a state-of-the-art security system, when all he really needed was a less-forgetful stable boy. 

But now, the focus is on oil speculators.     Are they to blame?  OPEC puts the high price of oil down to speculation.     In the US, senators are spitting feathers. And London is in the spotlight.

So, are speculators to blame for the price of oil?   And while we are busy blaming them for oil, why not see if we can think of some other things to blame them for, such as the price of food, the credit crunch, England’s failure to qualify for the European Championship, all that rain we have been having lately; oh, and why not blame them for sterling getting kicked out of the ERM in 1992. 

Sorry, I forgot.  These days, people seem to think the UK’s ejection from the ERM was a good thing.    George Soros, once vilified as the man who beat the Bank of England, is now a hero for hastening the day the UK was able to step out of the straitjacket that was the ERM.

Yesterday, on Capitol Hill, Daniel Yergin, who is one of the leading energy analysts throughout the entire US of A, spoke to the US Joint Economic Committee.  “In such circumstances as these, there is a tendency to seek a single explanation,” he said.  “History, however, demonstrates that changes of this scale and significance result not from a single cause, but rather from a confluence of factors.”

“Phew,” said the speculators, but then Mr Yergin added: “Financial markets are today playing an increasingly important role in price formation – responding to, accentuating, and exaggerating supply and demand, geopolitics and other trends… As prices go up, this psychology becomes self-reinforcing – at least until the market turns.”

Others put it more strongly.  London Metal Exchange Chief Executive Officer Martin Abbott told Bloomberg: “It would be very foolish of any government to stifle participation in markets.”  He added: “Why would an elected politician have a better idea of what the price is than the summation of the entire world’s oil industry trading across an open exchange?… For a government to try and determine a good price for something is nonsense.”

Writing in the FT, Martin Wolf was just as dismissive. He talked about this: “silly idea that price jumps [in] oil or food are the result of ‘wicked’ speculation’ – a fantasy promoted by dangerous populists across the globe.”

Writing in The Times, Carl Mortished said: “Those pilgrim puritans are at it again, threatening to ban, regulate and smother all forms of risk-taking. After adultery, booze, ciggies and online poker, Americans have invented a new vice and its home is New York’s Mercantile Exchange.”

Warren Buffett once said: “Financial derivatives are weapons of mass financial destruction.”   But futures markets also enable business people to insure against risk.

More to the point, speculators don’t lean against the wind.   They only bet on prices going up if they think underlying factors will drive price up. They only go short if they think there is a good reason for price to fall.

As such, they can provide a counterbalance to the rubbish put forward to vested interest groups.

If you had followed spread betting trends, you would have known the City expected a house price crash when the property industry itself was still saying prices would go up this year.

When the government tried to protect sterling’s unsustainable exchange rate, Soros knew it wouldn’t work. 
 
What do you do when there is bad news ahead?  Bury it?  Pretend it is not there?  That is what governments try to do. Speculators merely tell the truth, and they speak the truth with their wallets; and the truth is then there to anyone that wants to listen.

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