Daily Sources 10/31

1. The AP reports that the US Commerce Department announced today that consumer spending dropped by 0.3% in September from August. Paul Krugman has an opinion piece in the New York Times analyzing the consequences of the fall in consumer spending (which was at an annual rate of 3.4% in the third quarter. In sum, the citizen can no longer count on growing equity via his home or his stock portfolio, and so has begun to squirrel money away. This comes at a bad time because as less people spend money, the economy will shrink and so too, eventually, will the peoples' incomes. If their incomes fall faster than their savings, you have a scenario known as "the paradox of thrift." The Fed would usually stimulate the economy by cutting interest rates, but there isn't much left of the federal funds rate to go. Therefore, the only way to keep the economy from shrinking given a reduction in consumer spending and no room for further interest rate stimulae is government spending. Worth reading in its entirety.

And it turns out that folks in Congress are getting upset that the bailout funds extended to the banking system aren't being used to make loans, and thus grease the wheels of the economy, but to finance the purchases of other banks. Jessica Holzer at Real Time Economics reports that Rep. Barney Frank (D-MA) and Sen. Christopher Dodd (D-CT), are arguing that funds used by the banks for purposes other than lending are in violation of the terms of the act.

Joellen Perry and Luca Di Leo at Real Time Economics report that Mario Draghi, European Bank board member and head of the Financial Stability Forum--one of the entities asked to play a part in the November 15 financial summit--urged governments to provide further economic stimulus by cutting taxes and/or increasing spending.

"'Given the minimum level reached by America’s official interest rates and the ample liquidity put in circulation by central banks, the room for monetary policy maneuver is reduced,' Mr. Draghi told a meeting of Italy’s top bankers in Rome, noting that EU rules allow for increased spending during tough times. 'To sustain demand on a global level, the anti-cyclical action of budget policy may be required.'"

It sounds as if central bankers are more worried about the prospects of deflation now than they are for inflation. In Forbes, Nouriel Roubini argues that this will be their main preoccupation in the next six months as "a sharp slack in goods, labor and commodity markets will lead to global deflationary trends over the next year." His piece is well-worth reading in its entirety. If his thesis is true, the fall in supply and investment in new supply should not be able to do much to stop the fall of oil prices. That said, they rose considerably today.

2. Barbara Kiviat at the Curious Capital reports that First American CoreLogic released data today showing that in the US 18.3% of homeowners now have mortgages more expensive than the market value of their homes--are "underwater"--and an additional 5% are on the cusp. CoreLogic put out a state-by-state breakdown--the states worst hit are Nevada (47.8%), Michigan (38.6%), Arizona (29.2%), Florida (29.2%), California (27.4%), Georgia (23.2%), Ohio (22.0%).

What's in a way scarier, though, is that First American is also seeing a third group of states emerging—those where a lot of new people moved in and bought houses and simply didn't have much time to build equity before prices started falling. That partly accounts for why Georgia is so high up on the list, as well as growing problems in Texas (16.5%), Arkansas (16.3%) and Tennessee (15.0%)

3. Martin Fackler at the New York Times reports that the Bank of Japan cut its benchmark interest rate 0.2% to 0.3%. This is the first time the BoJ has cut rates in seven years as it also reduced its forecast for growth this year to 0%, "citing higher energy prices and weakening export demand. ... The eight members of the policy board were evenly divided on the cut; the bank governor, Masaaki Shirakawa, cast the deciding vote in favor, the bank said." Most analysts thought the rate cut more of a sign of Tokyo's willingness to coordinate with fiscal authorities internationally than fiscal stimulus given the initial low rate.

4. Eurointelligence has the story that Denmark may decide to join the euro after all as a result of the financial crisis. This is because Denmark has been forced to raise benchmark interbank lending rates in defense of the krone, to 5.5%, which is 1.75% above the rate for the European Central Bank. (Denmark has opted out of the euro, but has pegged the krone to the euro.) The Danish people dislike the notion of being left out of the economic stimulus--and paying more for money than their neighbors--in order to maintain a national currency. There is some hope for the Europeanists in Copenhagen that a referendum to annul the opt out provisions might pass now as early as 2011.

Generally speaking, however, it seems as if the crisis will delay the accession of many of the Eastern European nations to the euro as it will be harder to meet the economic prerequisites to joining the currency. (For example, Hungary is not likely to meet the current account requirement any time soon.) On the other hand, Sweden may find it convenient to join. However, now might be a good time to relax some of the prerequisites to joining the euro given that being part of the eurozone will generally seem more appealing as the financial crisis wears on.

The same issue of Eurointelligence reports that German representatives in Brussels are blocking efforts by the European Commission to raise the maximum insurance for deposits to €100,000 (now about US$130,500 )from €20,000 (~ $26,100). Germany does not want to raise the limit of its own deposit guarantee.

5. Andrew E. Kramer at the New York Times reported yesterday that Russia's bailout plan favored Russia's richest businessmen. Putting aside that our bailout plan surely favored the rich and connected, it might be important to realize that what is meant here is major holders of corporations deemed strategic by the Kremlin. For the most part the folks known as the oligarchs were replaced with Kremlin (perhaps better put as FSB)-friendly personnel. Of the original oligarchs the ones who remain are the ones who have made plain to the Kremlin that they will stay out of politics. It may not ultimately make much of a difference in direction, but today Bloomberg reported that shares in the Russian bourse soared Thursday. Perhaps that is because the taxpayer funds are being used as intended?

Snarkiness aside, and I admit that the jingoistic approach to Russia so favored by the press and pols is a pet peeve of mine, Brad Setser points out that money is leaving the economy faster that it entered it--Russia's reserves fell by $30 billion in the third week of October. $15 billion of that reflects efforts by the Russian central bank to shore up the ruble and to provide credit to companies seeking to service foreign currency denominated debt.

"$15 billion is a result of the drop in value of the ruble versus the euro and dollar. $15 billion is as much as the IMF committed to lend Russia back in 1998. And the IMF actually only disbursed a third of that total.

The most the IMF ever actually lent out to a single country in the past was roughly $30 billion (to Brazil, in 2002-03). At the current rate, Russia will run through that much in two weeks."

Setser suggests that though Russia has its own specific financial weaknesses, their situation is probably similar to what is being seen in the rest of the emerging economies.

6. Insofar as likely action taken by the Chinese with their currency reserves, Vandana Hari at Platts reports that Sinopec has launched a $1.7 billion takeover bid for Canada's Tanganyika Oil, a producer of heavy oil in Syria. Given that there is a fairly large consensus that the world economy will start to percolate in the second half of 2009 and that oil prices will surely follow, it seems at this stage that China is likely to pursue the conservative policy of continuing to purchase a production sharing contracts overseas. Net production from the fields in the first half of 2008 averaged about 6 kb/d. Further news in that vein--Eric Watkins at the Oil & Gas Journal report that Indonesia and China will renegotiate the price of Tangguh LNG to CNOOC's terminal in Fujian. This is after the renegotiation of 2006, where the price was raised to $3.80/MMBtu for 2.6 million tonnes/year on a ceiling price of $38/b (of oil).

"Following this week's agreement in Beijing, [Indonesian President Susilo Bambang] Yudhoyono and [Chinese Premier] Hu [Jintao] said the concessionary loan program China had initiated for Indonesia would continue despite the current global financial crisis.

Yudhoyono wants cooperation with China stepped up in the field of energy, especially in the construction of power plants under China's concessionary loan program"

Jakarta's government is under pressure to use its natural gas production for domestic power plants and for re-injection into oil fields in order to boost production of the more lucrative export. Energy planners in Japan have been especially anxious at language suggesting that contracts will not be renewed once they expire.

7. Julia Werdigier at the New York Times reports that Barclays will seek $11.8 billion from Qatar and Dubai instead of from the UK stabilization program. This comes in the middle of UK Prime Minister Gordon Brown's visit to the Gulf nations in an effort to secure substantial support for expanded IMF loan programs.

8. Al Jazeera reported yesterday that the UN General Assembly on Wednesday approved 185-3 a non-binding resolution calling upon the United States to lift the embargo on Cuba. The US, Israel and Palau voted against. Micronesia and the Marshall Islands abstained. "New" Europe voted for. Noticeably, so did Iraq. From a legalistic perspective, the United States either must strike a security agreement with al-Maliki's government or convince the UN to extend the mandate to operate in Iraq past December 31 of this year or the United States forces will have no more legal standing to be there. Matthew Lee at the Associated Press reports that the Bush Administration is beginning to think that a deal will not be struck with Baghdad. Votes like these make me think it might be difficult to secure an extension to the UN mandate, especially since the US negotiating team would be of a lame duck Administration which is of a party that as of now appears unlikely to win any of the elected branches of government. Failure to do so, however, would put our troops in a difficult position.

Meanwhile, the Oil & Gas Journal reports that Petrobras--Brazil's national oil company--announced today details of its plans to explore block 37 off northwest Cuba.

9. Vandana Hari at Platts reports that Indian Oil Minister Murli Deora met with the Minister of Finance, P. Chidambaram, to seek an increase in the amount of oil bonds the government will issue to compensate the refiners for selling oil products at below-market prices. The refiners' losses due to astronomical oil prices in the third quarter was exacerbated by a rapidly depreciating rupee, as the companies had to purchase dollars on the markets in order to buy the crude. Furthermore, the volatility of the foreign exchange markets and high cost of money has made the refiners especially leery of taking on foreign currency debt.

10. Amanda Rayborn and Nadia Rodova report that Kazakhstan has reached a new agreement with the seven corporations operating the Kashagan field--the largest single oil concession in decades. The agreement doubled the government owned company's stake and stressed that if the companies do not begin producing oil by year end 2013, they will not be allowed to recoup their investments in the project.

"Commercial production at Kashagan will start at 75,000 b/d in December 2012 and gradually to rise to 370,000 b/d, KazMunaiGaz executive director Aman Maksimov was quoted by Russia's Prime-Tass as saying in Astana after the project partners signed the new agreements.

'The third stage -- in two-three years -- [will see output] at 450,000 b/d,' Maksimov said.
...
In early October, company officials told Platts the revamped development plan for Kashagan aims for commercial production to begin in the fourth quarter of 2013 with a rapid ramp-up to an initial maximum production capacity of 370,000 b/d within a year. By late 2016, the consortium plans to take production to 730,000 b/d."

11. Sam Fletcher at the Oil & Gas Journal provides further evidence that the drop in oil prices has put the kibosh on new Canadian oil sands production.

"Some analysts are anticipating a 10-15% drop in capital spending in western Canada next year as producers try to remain within their cash-flow expectations. To many observers, this is a sign that low oil prices are starting to discourage new investment. Projects that were feasible a year ago no longer seem economic in the current environment. Other companies, including the Nexen Inc.-OPTI Canada partnership and privately held BA Energy Inc., announced delays at smaller projects in recent weeks."