Last week, I agreed to do an interview on OilPrice.Com. The initial interview was conducted over the phone, with follow-up emails.
The interview first appeared on OilPrice and is repeated below.
Introduction:
As markets continue to yo-yo and commentators deliver mixed forecasts, investors are faced with some tough decisions and have a number of important questions that need answering. On a daily basis we are asked what’s happening with oil prices alongside questions on China’s slowdown, which commodities or instruments will provide safety in the current environment, will the Euro-zone split in the future and what impact the presidential election is going to have on the economy and markets?
In the interview, Mish discusses:
• Why global trade will collapse if Romney wins
• Why investors should get out of stocks and commodities
• Why we have been oversold on shale gas and renewable energy
• Why oil prices will likely fall in the short-term
• Why the Eurozone is doomed
• Why there may soon be an oil war with China
• How government interference is ruining the renewable energy sector
• Why we need to get rid of fractional reserve lending
Oilprice.com: With oil prices now in the high 80's
and news out of Europe getting worse every day, do you expect prices to
stay in this range, or do you see them dropping in the short term?
Mish:
There are two conflicting forces here. One of them is oil prices over
the long-term and the other is oil prices over the short-term.
Even
in the short-term you will find there are conflicting forces at play.
For example, stress in the Middle-East puts an upward pressure on oil
prices. However, economic problems in Europe, a slow-down in Asia and a
slow-down in the United States put downward pressure on oil prices. New
orders are falling at a staggering rate across the board in Asia, China,
Japan, Europe, and the United States which also puts further downward
pressure on oil prices.
Long-term, forces such as peak oil and population growth in China are putting pressures to the upside.
One
needs to balance all of those factors out when they are about ready to
give a prediction on oil prices. My opinion is that over the short to
mid-term, oil prices will go down. Long-term, energy is a good place to
invest.
Oilprice.com: If your prediction is
correct and oil prices do go down – what sort of impact do you see this
having on the U.S. economy, if any?
Mish: That's an interesting question. However, the question puts the cart before the horse.
Looking
at prices in a vacuum is a mistake. One also has to look at why prices
are doing what they're doing. For example, falling oil prices that
happen when supply shocks are alleviated are a positive thing. Falling
oil prices because of falling demand is another. You seldom see this
kind of distinction in mainstream media.
Right now, oil prices
are primarily falling because of falling demand, and that is in spite of
geopolitical tensions. That is not a healthy sign for the economy.
Oilprice.com: As we have seen with the recent oil workers
strike in Norway
and subsequent rise in oil prices. Geopolitical risks always remain to
keep the markets off balance. Apart from Iran are there any other
geopolitical risks you think people should be aware of?
Mish:
A key geopolitical risk in the long-term is that China cannot continue
at its expected rate of growth. For years, the mantra has been "China,
China, China," and many thought China could maintain its 8% to 10% per
year growth going forward. That's not going to happen.
I agree
with Michael Pettis at China Financial Markets, that China is more
likely to see 2% growth than 8% or even 6% growth over the next decade.
2%
growth is a shocking reduction, even from the lowered expectations that
we've seen regarding China. The implication is commodity prices,
especially base metals, are going to be under extreme pressure because
of China stockpiles. For further discussion please see
"China Rebalancing Has Begun"; What are the Global Implications?
Oilprice.com: What are your longer term projections for oil prices – say 3-5 years out?
Mish:
I think it's a fool’s game to make such projections. Most of the
projections on the price of gold, silver and oil are ridiculous. They
are designed to sell newsletters. The bigger the hype, the greater the
sales. On occasion, I will make a call. For example, when crude hit
$140+ in the summer of 2008, and others called for $200, I said oil
prices would drop to the $45.00 - $50.00 range or so. Oil went to $35.
Moreover,
those predicting $200.00 never bothered to think what that would do to
the global economy. We saw the same thing in natural gas. People were
predicting $25. Look at prices now, at roughly $3.00 NG fell all the way
to $2.20, lower than even this staunch deflationist thought.
I'm
not willing to go out on the same limb and predict energy prices three
years in advance. The reason is we really don't know for sure how
central bankers are going to respond. China is particularly important.
If there's universal printing of money everywhere, I would expect a lot
of that to flow back into prices of gold, perhaps of silver, and perhaps
energy, but we really don't know what they're going to do. We don't
know when or how the Euro Zone is going to break up. I think it will,
but how is as important as when.
In the US, we don't know the
results of tax hikes following the 2012 election. Heck, we don't even
know who the next president in the United States is going to be. Will it
be Republican? Will it be Democrat? Numerous political and economic
forces are pulling and tugging in different ways.
I don't believe
there's anyone out there that can predict, with any kind of accuracy,
what oil prices are going to do. Which is why I believe trying to
predict oil prices in the midst of all of these possibilities is a
fool's game.
Oilprice.com: What are your views on inflation and hyperinflation.
Mish:
Hyperinflation is a complete collapse in currency. It is a political
event that kicks off hyperinflation, not a monetary one. Hyperinflation
talk hit an extreme when oil prices hit $140. Such talk was silly then,
and it is still silly now.
Hyperinflationists in general fail to
understand the role of collapsing demand for credit. The total credit
market is over $54 trillion. Base money supply is $2.6 trillion and
excess reserves are about $1.5 trillion. Seems to me we had huge
expansion in credit and Bernanke is struggling to reignite demand. I
suggest he will not succeed.
The
idea the US$ will suddenly go to zero is ridiculous. The US is the
world’s largest holder of gold reserves, and that alone would stop it.
Also note that Bernanke, as misguided as his policies are, is still
beholden to the banking system. As such he has no desire for it to
collapse.
As far as inflation goes, I am still widely
misunderstood. I view inflation as an increase in money supply and
credit, with credit marked to market. Deflation is the opposite. If one
insists that inflation is about prices, then we are in a state of
inflation with 10-year treasury rates below 1.5%.
For those who
woodenly view inflation in terms of prices, well, prices may or may not
rise. Price have generally risen, but credit is the key behind housing
prices, family formation, hiring, and in fact everything driving the
economy. So, where is credit going? Demographics and student debt
suggests nowhere. Indeed, credit has gone nowhere in spite of heroic
efforts by Bernanke.
Oilprice.com: You just
mentioned that we don’t know who the next president is going to be and
sticking to this topic how big an impact do you see energy prices having
on this year's presidential elections?
Mish: I
don’t think energy prices are what's on people's minds. What's on
people's minds right now are jobs. Oil prices have kind of stabilized
and in the very short-term they are likely to stay stable unless there
are some dramatic results in the Mid-East or a dramatic slowdown in the
US economy. Both are possible, but a major US slowdown is arguably more
likely. Regardless, I think energy prices are going to be a minor
election issue.
Oilprice.com: The message on
peak oil seems to be confused. Many are adamant that peak oil is the
largest threat to ever face humanity, whilst others believe that with
new technologies and new fields being found, peak oil is a myth and we
are actually swimming in oil. What are your thoughts?
Mish:
The idea that we're swimming in oil is preposterous. Moreover, abiotic
oil is a ridiculous pipe-dream. That said, the idea that the global
economy is going to come grinding to a halt in the next year or two
because of oil is also preposterous (discounting a geopolitical Mid-East
shutdown). In general, I would side with the peak oil folks, noting
that a global recession will likely pressure prices more than anyone
thinks, barring a breakout of war or supply disruptions in the
Mid-East.
Long-term, 8% growth in China is mathematically not
going to happen. People really need to get a grip on exponential math
and the implications thereof. If China does attempt to grow at 8-10% as
some people have predicted, there's going to be an oil war of some kind
between the United States and China because there's simply not enough
oil.
For a good discussion on the limits of exponential growth, please see
Calpers Pension Plan Reports 1% Return; Stunning "What If" Charts at Various Compound Annualized Rates-of-Return Going Forward
Oilprice.com: Shale gas has been generating a great deal of headlines recently. Do you believe it could be the
solution to America’s energy challenges? We are also seeing developments in oil & gas extraction technologies. Have we been oversold on such possibilities?
Mish:
I think we're oversold on everything. We're oversold on the idea of
cheap energy, of free energy, of green energy, of clean energy. We're
oversold on the stock market. We're oversold on what Obama can deliver.
We're oversold on what Mitt Romney can deliver. We're oversold in so
many areas, I can't even mention them.
In regards to new
technologies, how much water will it take to extract these reserves in
the midst of these droughts? What are we going to do with the
contamination, how do we get rid of the waste byproducts? These kinds of
projects look good on paper, but are they truly scalable in practice?
I hope I am wrong.
Oilprice.com: What is the role of government in alternative energy sources?
Mish:
The role of government should be to get the hell out of the way and let
the free market work. If peak oil really is a problem (and I think it
is), the free market will come up with a solution if left alone.
Instead,
the government is trying to pick winners. Look at the results.
President Obama backed solar panel manufacturer Solyndra and the DOE
loan guarantee scheme blew sky high.
Our ethanol program is a
total disaster. By government mandate, corn has been diverted to ethanol
production smack in the midst of a drought. Corn is not an efficient
way to produce ethanol, even if there was not a drought.
Governments
seldom back winners. Instead, government bureaucrats back companies
that contribute to their campaigns. This is worse than it looks because
such activities deprives companies with real solutions a chance at
funding.
We need to get government out of the energy business completely and let the free market work.
Oilprice.com:
Sticking with the renewable energy theme, do you see them making a
meaningful contribution to global energy production over the next 10
years?
Mish: Adding to my previous answer,
government subsidies of unviable products and unviable ideas gets in the
way of the free market actually producing viable products and viable
ideas. Simply put, the more government interferes, the less likely we
are going to see advances in the actual direction of a true solution.
Oilprice.com:
In regards to presidential elections, how do you think energy will fare
under Obama and under Romney? Which sectors will benefit, and which
will suffer?
Mish: Mitt Romney has declared that
if he’s elected he is going to label China a currency manipulator and
increase tariffs on China across the board. That's something that I
believe he might be able to do by mandate. If he's elected and he does
follow through, I think the
result will be a global trade war
the likes of which we have not seen since the infamous Smoot-Hawley
Tariff Act compounded problems during the Great Depression. Simply put, I
think that global trade will collapse if Romney wins and he follows
through on his campaign promises.
Unfortunately, campaign
rhetoric now is heating up to the point where President Obama and Mitt
Romney are trying to outdo each other on who's going to do more to
China. Thus, we may very well see a global trade war regardless of who
wins.
As an aside, Mitt Romney is pledging to increase military
spending. Given Romney’s statements on Iran, it's more likely he would
start a war with Iran than Obama. Note that the U.S. military is one of
the biggest users of petroleum worldwide and oil price shocks could be
devastating.
None of this is any good for the world economy at
all. I believe that Romney will do what he says. I believe he's more
likely to start wars than Obama, but that doesn't make Obama any good.
This is the worst slate of candidates in U.S. history running for
president, and I'm writing in Ron Paul.
Oilprice.com: As the global economy slows, where do you see the best investment opportunities available to investors?
Mish:
At this point, the best thing to do is wait for better opportunities. I
am talking my book, but something like 70-80% cash (or hedged equities)
and 20-30% gold seems reasonable. I'm telling people, "Get out of the
stock market. Get out of commodities except gold and perhaps a bit of
silver."
A global slowdown is underway. Actually, I made a
Case for US and Global Recession Right Here, Right Now.
Although
nothing is certain, central bankers worldwide are highly likely to pump
up money supply hoping to counteract the slowdown. If so, I think gold
is going to be one of big beneficiaries. Silver may be a huge
beneficiary, and I like it here. However, silver is also an industrial
commodity, so gold is safer.
Bear in mind, I may seem like a
broken record on this thesis given cash and gold has been my call for
the last year and a half or so.
In spite of calling the global
economy exceptionally well, I've simply been wrong about U.S. equities.
They have risen far more than I thought, but I still caution that risk
is high.
I'm going to repeat my general message here, that
another slow-down, and another big downturn in the stock market is
highly likely. Equities are quite overvalued at this point, cash is not
trash, and staying liquid now, with a percentage in gold, is a good
idea.
Oilprice.com: I was hoping you could tell
us your thoughts on the Euro. You mentioned previously, that you think
the E.U. will split in the future, why do you think this will occur, and
what will the economic and political implications be?
Mish: I
think it's pretty clear that the euro's going to split because no
currency union in history has ever survived without there being a
corresponding fiscal union in place. Right now we're in a situation
where Germany’s Chancellor Angela Merkel says that
"There should be
no fiscal union until there's a political union." Francois Hollande
said, "There should be no political union until there's a banking
union," and the German Supreme Court will not allow a political union or
a fiscal union, nor a banking union without a German referendum.”
I did a post on this, and it's called, "
It's Just Impossible."
If
politicians could not get agreements when times were good, how are they
going to get these agreements now, when they're bickering over every
little thing, including the amount of the ESM, whether or not the
bailout of Spain should be via the ESM or the EFSF, and whether or not
the Spanish government should be backstopping this loan.
They
can't get an agreement on anything, and the German Constitutional Court
is hanging like a Sword of Damocles over the entire thing.
For
these reasons, the Euro is going to bust up. What happens to the price
of the Euro depends on how it busts up. If the breakup is piecemeal and
disorderly, it means one thing. If it's orderly and prepared in advance
with Germany leaving and the northern states leaving, it's a completely
different scenario. Any point along that line is possible, but piecemeal
seems more likely. How disorderly remains to be seen.
For
example, if Germany exits the Euro and goes on the deutschmark, the
value of the deutschmark will soar, whilst the value of the Euro will
decline.
Instead, if we see a break-up by Spain leaving, by
Greece leaving, by Italy leaving, and the bulk of what's left is Germany
and the northern States, then the value of the Euro can soar. Those are
the two conflicting possibilities here. The market has not decided
which one of those is more likely.
Meanwhile, the Euro is in a
low 1.20 range to the U.S. dollar. A breakout or a breakdown might be a
signal that the market is expecting one of those possibilities over the
other.
We are in uncharted territory and everyone is guessing.
Short-term
I am neutral on the US dollar at this level because the euro is a bit
oversold, the idea of a Greek exit is no longer unfathomable, and the
Fed is likely to initiate QE3 at some point. This is a change from my
previous US dollar bullish stance.
Oilprice.com: We mentioned China earlier, and I was wondering what you think the future holds for China, both politically and economically.
Mish:
A regime change in China is coming up. The current regime has been
focused on growth. However, I think the next Chinese government already
understands that the growth at any cost of the current regime is not
sustainable. If so, we're going to see a major shift away from an
export-driven production model dependent on investment on roads, on
bridges, and more production, to a consumption-driven model. That shift
will be one of the major forces in the global economy.
If I'm
correct on this, then it's going to be a painful adjustment, regardless
of what China does. For example, a Chinese slow-down towards consumption
would increase the value of the renminbi, would decrease their exports,
would help the balance of trade between China and the United States and
Europe, and would put intense pressure on commodity prices. In turn,
asset prices and currencies of the commodity producing countries, like
Australia, Brazil, and Canada will come under heavy pressure.
Oilprice.com: Mark Faber is not a fan of the Federal Reserve, blaming them for the current US economic situation. He said,
“Usually
under a gold standard you have a bubble under one sector of the economy
but you don’t have it across the board globally and that’s really what
the Federal Reserve has done over the last couple of years.” Do you agree? Is the Fed to blame? And what can be done to avoid this in the future?
Mish:
I agree with part of it, if not most of it. However, the idea that the
gold standard itself causes bubbles is fallacious. The gold standard
does not cause huge bubbles. The real culprit is fractional reserve
lending. Historically, problems happened when banks lent out more money
than there was gold backing it up.
The gold standard did one
thing for sure. It limited trade imbalances. Once Nixon took the United
States off the gold standard, the U.S. trade deficit soared (along with
the exportation of manufacturing jobs).
To fix the problems of
the U.S. losing jobs to China, to South Korea, to India, and other
places, we need to put a gold standard back in place, not enact tariffs.
Oilprice.com: Mish, thank you for your time this has been a very enjoyable and enlightening conversation for us.
Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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