As the summer heats up, is the recovery getting too pooped to pop? Comments from Milton Ezrati, Vitaliiy Katsnelson and others, plus what data is coming out this week.

OIL SHOCKS, From Milton Ezrati, Partner and Senior Economist and Market Strategist, Lord Abbett
Though oil price swings always exaggerate and often disguise the fundamentals, the movement during the past four to six weeks has even less to do with the fundamentals than usual. It seems that the initial signs of economic recovery in May—the so-called “green shoots” in recent parlance—convinced refiners to prepare for an active driving season this summer. Accordingly, they refined more of their crude inventories into gasoline, drawing down crude stocks overall by nearly 10 percent. But since the extra gasoline demand never materialized, the refined product simply went into inventories, causing conventional gasoline stocks to rise by 14 percent. Still, the drop in crude inventories spooked futures markets, even though inventories remained well above normal limits, prompting the sudden June uptick in crude prices, until, of course, the reality of the situation sank in, and prices could revert back toward their May levels.

Now, beyond such temporary lurches, the future does offer fundamental reason to look for oil prices to rise, though only modestly. On the side of upward adjustments, the International Energy Agency (IEA) expects fuel demand to increase with a global economic recovery. On the side of only a moderate rise, the agency points out that conservation efforts, even in places such as India and China, should keep the growth in oil demand slower than general rates of economic expansion. Even relatively rapid world growth of 5 percent a year will, the agency explains, generate oil demand growth of only 1.4 percent a year, and still less if, as is likely, the global economy grows at a slower pace. A further powerful argument against an extreme price surge lies in the fact that oil demand, having already fallen sharply in 2009, will likely take until 2012 at the earliest to surpass the old 2008 highs of 85.76 million barrels a day.

Looking beyond 2012, questions of capacity haunt the analysis—not the old “peak oil” scares of last year but the more prosaic issues of maintenance. The declines in price and demand during the past year have already put much exploration on hold, delayed development spending, and discontinued several projects. Cash-strapped Russia, in particular, has cut out just about all exploration, though recently Moscow did invite Royal Dutch Shell to participate in new leasing in the Sakhalin Island development. Even more significant, perhaps, is that Russia has neglected the maintenance of existing fields, which will limit the draw from those fields for years to come. In North America, the development of Canada’s huge reserve of tar sands faces indefinite delay. Even if development were to turn around suddenly next year, which is hardly likely, it would take a long time to affect supply—so long, in fact, that the IEA expects a modest supply decline from non-OPEC sources after 2012. All else equal, prices after that date should rise above the expected $80 level, but, of course, by then, much else will also have changed.


EUROPE’S FIZZLING DEMAND, From Axel Merk, President and CIO, Merk Investments
At Thursday’s meeting the Governing Council of the European Central Bank (ECB) kept the interest rate on the main refinancing operations of the Eurosystem at 1.00%.

In the press conference following the announcement, ECB President Trichet repeatedly stressed that just because recent economic data have been encouraging ("the pace of contraction is slowing"), a sustainable economic recovery in the near term is far from certain.

In particular, while some supply issues in the banking system remain, i.e. some banks being reluctant to extend credit, the predominant force in the market is a continued demand destruction: businesses and consumers are not borrowing as a response to the deteriorating economic environment. It is the classic central bank problem that one can provide an unlimited amount of liquidity, but if there are no takers, the money will not flow into the economy. Trichet says the ECB will not bypass the banking system and lend directly to businesses or consumers (although the recently enacted covered bond purchase program, albeit small, can be considered as such).

We share the concern about continued demand destruction. In our assessment, money supply growth in recent months in both the U.S. and Europe suggests the economic recovery may be fizzling. We are particularly concerned that any nascent economic recovery will receive another blow this fall should massive refinancing requirements, particularly in the public sector, push up interest rates.

CHINA'S GROWTH AN ACCOUNTING MIRACLE, From Vitaliy N. Katsenelson, CFA, director of research at Investment Management Associates  

Now we are learning how China has achieved its "miracle growth." The country showed positive GDP growth while its electricity consumption declined in the beginning of 2009 – creative accounting that makes Enron’s accountants appear as dilettantes. A paper published by John Makin at American Enterprise Institute explains it well:

"Once China had announced its 8 percent growth target, it began to disburse funds directed at a sharp increase in public works spending. It is important to understand that the disbursal of funds is recorded as GDP growth. So the government can easily control the pace of growth by the pace at which it releases funds that have already been allocated in the stimulus package to the creation of higher production or growth numbers. Funds disbursed for fixed-asset investment by state-owned enterprises or provincial governments are counted as having been spent when they are disbursed. In fact, the funds go out to the state-owned enterprises and provincial governments and may be held until actual projects are identified and undertaken." (Emphasis is mine.)

But wait, it gets worse:

"...Ambitious planners count shipments [consumer products] as retail sales while end-use demand may be absent. In such cases, the “sales” are made to happen by virtually giving away the products that have already been produced and counted as GDP growth."

I am not convinced if China will have inflation in the long run. It appears that deflation is a more likely scenario as China is ridden with overcapacity – the country was geared for much higher global growth. I can, however, see inflation erupting in a very short timeframe as money has been thrown at the consumer/companies, and we are seeing this in the stock market and real estate. But in the long run, inflation appears an unlikely outcome: overcapacity and slower demand from the US and Europe will force Chinese producers to cut prices to increase utilization and stimulate demand.

Lately, we've started hearing whispers of the Chinese renminbi contending for the status of the world’s reserve currency. On the surface it more or less makes sense. The US is struggling and Europe has structural problems.

China on the other hand is chugging along. I heard (though not confirmed) the Chinese stock market now has a greater market capitalization than Japan’s. Though the Chinese economy has the size of a global currency contender, it lacks one not-so-little element that the global economy will require for renminbi to become the world’s currency – political stability. We forget that China is still not a democracy. I am not sure what to call the political system of the People’s Republic of China but I don’t think it's the “people’s” nor is it a "republic." The rule of law is a nascent concept in China. Something is only legal if the government thinks it is legal.

And finally, I'm sure China doesn’t want the renminbi to be the world’s currency as it would drive up the value – a suicide for an export-based economy.


WASHINGTON WATCH, From Bruce Thompson, Managing Director, Head of Global Public Policy at Clearbrook Investment Consulting

 
SUMMERS RETIREMENT SPEECH

White House Chief Economic Adviser Larry Summers is scheduled to deliver a speech on retirement issues on Monday.  The speech will be given at a Retirement Research Consortium presented by the National Bureau of Economic Research.  Summers is expected to discuss the need to help the millions of Americans, as many as half of all working people, not covered by employer retirement plans.  The Administration has proposed expanding the Saver’s Credit and requiring employers who do not provide a retirement plan to offer an automatic IRA option to their employees.  The Administration has said these two steps would help millions of additional workers to begin saving for retirement.

FINANCIAL REGULATORY REFORM

The Treasury Department distributed a set of talking points to Members of Congress leaving for the August recess to try to increase support for the President’s financial regulatory reform plan.  The materials focused on the Administration’s proposal to create a Consumer Financial Protection Agency, a proposal which has run into opposition from community banks, bank regulators, and other business interests.  The documents include talking points on how the new agency would protect consumers, investors, and taxpayers, and a fact sheet on how community banks will benefit from the consumer agency.  The material also contained a 4-page paper disputing “six myths” about the new agency.  House Financial Services Committee Chairman Barney Frank had hoped to win approval of the Consumer Financial Protection Agency before the August recess.  He hopes to build up enough support for the new agency to pass it when Congress returns in September.

MIDYEAR BUDGET UPDATE

The White House Office of Management and Budget will release sometime this month its midyear economic and budget update.  The annual midyear update is required by law and is usually released in mid-July to very little attention.  This year’s report, however, will likely receive a great deal of attention.  The report will update the economic assumptions in the budget, showing slower growth and higher unemployment.  The result will be less revenue, more spending, and higher budget deficit projections.  The White House will point out that the President inherited a declining economy and a growing deficit from President Bush.  But a recent Rasmussen poll found that 71 percent of the public believe that the President’s policies have driven up deficits.


REPORT CALENDAR

Monday, August 10

• Corporate Earnings: Dish Network, Dyegy, Liberty Media