What's the Problem With The Economy, Part 1: No Organic Demand

Sorry it's been so long since I posted last, I actually wrote this last week, but then I lost it before I was able to post it to the blog.

Everybody in the media (except for Phil Gramm) appears to be on board at this point that the economy is in the crapper. However, most people really don't understand why. There are several big factors that are affecting the economy right now and a lack of organic demand is the one I want to talk about today.

What is organic demand? Simply put, organic demand happens when someone decides to replace a product they own or they decide to purchase said product for the first time.

Think about cars. Every year you have a whole new group of people that are ready to buy their first car (mostly teenagers and young adults). Likewise, there's also the large group of people that own cars but they need to replace it for whatever reason (cars break down, leases run out, etc.). This is a built in customer base for the auto industry and every month of every year these two groups of people provide a revenue stream for the auto makers. That is organic demand.

Now I want to go back to a dark day in our history. The terrorist attacks of September 11th, 2001. I don't know if you remember, but in the days following those attacks the economy almost completely stopped. General Motors decided to roll out a very bold advertising campaign in order to spur sales for the company.

The campaign was called "Keep America Rolling" and it appeared to be a great success. GM, for the first time, introduced 0% financing for up to 60 months on all new GM cars.

They thought they were spurring new sales, however all they actually were doing was bringing demand forward. People that were thinking about buying a new vehicle in the next 6 months decided to buy now. All GM was doing was stealing from the future.

Then the campaign ended and GMs sales fell through the floor. In order to bolster their sales they had to bring back the 0% financing and then start adding cash back incentives to spur sales. More people came in and bought cars, but again all they were doing was stealing from future sales.

The next step for GM was to start lowering their credit standards. Now marginal buyers, people who were "upside down" (meaning they owed more than their trade in was worth), or people that needed to finance a car for 6 or 7 years in order to afford the payment bought cars. In many cases people were getting greater than 100% financing to drive away in a new car.

Eventually what happens it that you hit a wall. You've pushed forward demand as far as you can go. Your pool of potential buyers has shrunk down to almost nothing because everybody that needed or wanted to buy your product for the next few years already did.

Then you throw in $4/gallon gas and you are ready for a catastrophie. GM sales are down 25% as compared to last year (and last year wasn't that great, either). There is no market for the big SUVs and trucks (GM's bread and butter) because of gas prices.

And it's not just GM. Ford, Nissan, Hyundai, even Toyota are getting hit hard with plunging sales. In June, only Honda was able to eek out a 1% gain in sales, and that's because they specialize in smaller vehicles. Every other manufacturer saw sales crash 20% or more. Only small, fuel efficient cars are selling well right now.

What can be done about this? Right now, nothing. You have to naturally allow that organic demand to form again. With high gas prices and a slowing economy, people are holding onto their cars longer. You have to let that demand build back up. Sadly, this could take several years and I'm not sure GM and Ford can wait that long for the economy to turn around.

It is the exact same problem for housing. Basically, everybody that wanted to buy a house did over the past 4 years. It didn't matter whether or not you could afford the house, or had a down payment, or even a job. The organic demand for housing is almost non-existant right now.

On top of that, you have a massive housing glut from all the overbuilding of the past few years (and they're still adding about 1 million housing units a year to our housing stock!). Right now the only real demand for housing is from people like me who are waiting for prices to come back down to a reasonable level. It will be years (maybe 2012 at the earliest) before organic demand comes back into the real estate market.

How Safe Is Your Bank?

With the recent Federal siezure of IndyMac bank and many banks and financial institutions getting a beatdown on Wall Street, it's important to check and see if your bank is okay.

First of all, here are the rules for FDIC insurance:

http://www.fdic.gov/deposit/deposits/index.html

The insurance is for up to $100,000 per depositer per insured bank. IRAs are insured up to $250,000 if the money is deposited in a FDIC insured bank account.

However, don't wait for the bank to be taken over by the FDIC (there were lines of people outside the IndyMac bank waiting to get their money today). Once the bank is taken over, your ability to access your money will be severely limited. If your bank is in trouble, go there tomorrow and take all your money out and put it in a better institution (again, do your research).

FDIC only has about $50 billion in capital available to insure every bank account in America. They estimate IndyMac is going to cost them about $10 billion. If one failure will suck up 20% of their capital, how much is the next one going to cost, and what's going to happen when they run out of money?

You can check the rating on your bank at bauerfinancial.com. They rate it on a 5 star scale (my bank still has a 4 star rating) and you can purchase a report on your bank if you're interested.

However, there is no guarantee. Apparently FDIC keeps a list of troubled banks (not disclosed to the public). There are about 90 banks on this list right now. The shocking news is the IndyMac WAS NOT ON THAT LIST WHEN IT FAILED!

Also, try to keep an eye on your bank appearing in the news. Have they had to do any emergency capital raising? Is the bank based out of California or Florida (ground zero for the housing bubble)? Has their stock price recently plunged? Is Senator Chuck Schumer talking about your bank? All of these can be signs that there are problems.

At this juncture, it might make sense to keep a little cash around the house just in case. Am I being paranoid? Probably, but better safe than sorry.

Be proactive! Don't be a victim! This is going to get worse before it gets better.

The Pickens Plan

I was at the gym last night doing my cardio and watching Lou Dobbs. Then during a commerical break (where I normally tune out), I happened to catch an ad for "The Pickens Plan". Here's the website:

http://www.pickensplan.com/

The man in charge of this is T. Boone Pickens, the billionare oil man. I have been following him for a while and this guy is very, very smart!

Several years ago, when talking about oil prices, Pickens said in a interview that the world will never see much more than 85 million barrels a day in output no matter what we do. Why is this? Because any gains we get from new fields (like ANWAR or offshore drilling) will be completely offset by declines in existing, aged fields (like Cantarell in Mexico).

This is important. The era is cheap oil is over. From here on out oil is going to be expensive and difficult to get. Likewise, we import nearly 70% of our oil from foreign countries, meaning we spend $700 billion a YEAR on oil imports (that's 4x what we are spending in Iraq). We have to spend our wealth in order to get this oil, so every year our country becomes poorer while totalitarian countries like Saudi Arabia, Venezuela and Iran become richer.

Not only is this a bad idea, it's not sustainable and we need alternatives.

This is a viable solution and it makes a lot of sense. His proposal is to start a massive investment in wind power across the great plains of this country (which he identifies as one of the windiest areas in the world) and use that capacity to replace the electricity that is currently generated by natural gas power plants. We can then redirect the natural gas they were burning to our transportation network and he estimates that would reduce our oil imports by 38% in 10 years!

Natural gas should be thought of as an equivalent to oil. It is highly portable, can be transported through pipes, and has a high energy content per unit - all of these are the same as oil.

Oil is what powers our transportation because of it's portability and high energy content. That's the reason why you don't see any coal powered cars on the streets. Coal has to be mined (which is more difficult and expensive that drilling), it has to be transported by rail, and the energy content is much less than oil or natural gas (you get more BTUs out of a pound of oil than you do out of a pound of coal).

Right now about 20% of our electricity is powered by Natural Gas plants. Using Natural Gas to generate electricity is wasting a valuable resource. Natural Gas should be diverted to our transportation needs just like oil (we already do have natural gas vehicles in this country but they are not widespread).

Other benefits include helping revive many of these small towns in middle America that have been in economic decline for decades. This will also spur investment in cars that can run on natural gas and expanding the infrastructure to distribute natural gas (Now I'm thinking since most homes already have natural gas service, why not just add a pump at your house? You can fill up at home and pay for it when you pay your utility bill.- Business opportunity!!!!)

Does this solve the energy problems we have? Absolutely not, but I think it's a step in the right direction and will help reduce the price of oil (because demand will fall), increase the wealth of this country and help the environment (natural gas burns clean and wind power has no emissions).

I encourage you to talk to your friends and representatives in government about supporting the Pickens Plan.

Day of Defiance

Happy 4th of July, everyone!

I hope you get your fill of hotdogs, beer and fireworks today, I'm sure I will. And it is a day to celebrate the fact that we are Americans and we are lucky to live in a country with the freedoms we have.

However, when you think about the term "Independence Day" and what it represents, this is a day that we should celebrate our defiance of authority.

Our brave forefathers rose up and defeated a world power to finally achieve their freedom. Think about the brass balls that were required to do that! Britain had colonies all over the world and we were one of their crown jewels. They had a fearsome army and a formidable navy that could outmatch anything our "rebels" could muster.

Have you actually ever read the Declaration of Independence? If you haven't read it in a while, you really need to read it again. Here's a link:

http://www.ushistory.org/Declaration/document/index.htm

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. — That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, — That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness.

BRASS FUCKING BALLS! Imagine sending that letter to King Fucking George. I would be shitting my pants delivering such a message! (Pardon my French, I just got a little worked up.)

Here' another thought, George Washington was a terrorist according to the British Empire! He was the most dangerous person in the world in 1776!

We were the rebels! We were the insurgents! We were the terrorists! Just because we didn't want to be ruled under the iron fist of a foreign power.

That is what independence day should be all about. It should be a clear and consistant message to our government that they need to "keep on the straight and narrow, or else!"

We should have rallies in front of the capital buildings of all 50 states and in front of the White House and Congress as well on Independence Day. Not about any particular issue or anything. Just to remind them that WE THE PEOPLE are the boss and THEY are the servant.

You look at all the shiftless corruption, bribery and scandal among those 535 congressmen and the president and it makes me sick! It's time to remind them exactly who they are, what their function is and that their job is to serve us!

The 1,000 Yard Stare

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What is the 1,000 yard stare?

I first learned about the 1,000 yard stare when talking about soldiers returning home from Veitnam. The stare was them constantly scanning the horizon for any trouble, even if there was absolutely no danger where they were at. In this case it was trauma, but the idea of a 1,000 yard stare intrigued me.

In my case, it is the long term view that I consider when looking at economic and financial issues.





Whenever I see a new trend developing, I always ask myself what are the long term consequences if this continues? Regardless of whether the trend is positive or negative, I move my investments to areas that will be positively impacted by that trend.





Using this technique, I was very skeptical of technology stocks as early as 1997. The housing bubble popped up on my radar in 2002. These things were easy for me to see because I knew that the long term fundamentals were out of whack.





I am firmly convinced that most people, not just in America but around the world, are severely nearsighted when it comes to financial matters. I often have told my friends and colleagues that most people are absolutely unable to see things more than 30 days out from today. Why 30 days? Because that's when the next bill is due.





One of my favorite blogs is the Irving Housing Blog. One post that always makes me crazy are the refi and Home Equity Line of Credit (HELOC) abusers that he talks about. Most of the comments are from exasperated readers wondering how someone could refinance their house 5+ times this decade, taking out hundreds of thousands of dollars in additional debt under increasingly onerous terms (the borrowers always move from a fixed mortgage to an ARM to an Option ARM before the house ends up in foreclosure) only to lose everything to a foreclosure.





In my view this was a completely logical choice for them. They were so busy with their distractions: work and family, buying expensive toys, taking exotic trips, plastic surgery, home renovations, etc., etc., that they couldn't see the impossible levels of debt that were building up. As soon as they got in any financial trouble, the easy answer was to refi or open a HELOC and the problem went away for a while. Rinse and repeat until the home is taken away from them.





Lets look at the recent runup in commodity prices, especially oil. When did this start? Oil prices have been steadily rising since 2000, but all of a sudden last September they moved from about $70/barrel to now at $142/barrel. A 100% gain in 9 short months.





What happened? Is this the fault of speculators, as the commentators on MSNBC or politicians are saying? In fact it is not. This was the easiest thing in the world to see, I saw it coming from a mile away. Last August/September Ben Bernake, the Chairman of the Federal Reserve decided to start cutting interest rates in response to the subprime crisis on Wall Street.





Why is that significant? Last year it was very easy to earn 4-5% in cash on your accounts. So if you had $100,000 sitting in a money market you could pocket about $4,000 - $5,000 in interest essentially risk free. Now, after multiple cuts, most money market funds are paying between 1% and 2% (treasury funds are paying even less). So your cash is earning significantly less than it was last year.





On top of that, inflation has picked up. Even the government statistics (which I feel are massively understated) show inflation is running at about 4% right now. So the return on money is lower than inflation. If you keep your money in cash you are losing purchasing power!





So, what is the logical response of people who have their money in cash? The response is that they move their money into riskier investments (also called engaging in speculation) in order to try to earn a rate of return greater than inflation. This is the same thing happened when the Fed lowered rates to 1% in 2003 - 2004, all the cash flowed into real estate causing the housing bubble. This time the money has flowed into commodities causing tremendous hardship because of high energy and food prices.





This will not change until the Fed starts raising rates again. Once the interest rates on cash start going up, people will be less inclinded to put their money in risky commodities. The Fed knows this but won't do it because raising interest rates would kill the housing market and tank the economy.





Unfortunately, the housing market and the economy are not going to be saved by low interest rates. Both are still going into the toilet, all we're doing is prolonging the pain.





I've already given several predictions and we'll see what happens with them. Right now it appears I'm on the right track on all of them, plus I was right on with the gas price call back in February.





One big trend I'm looking at now is a possible crash in oil prices. As I said earlier, prices have doubled in 9 months. We're at $4/gallon gas. The economy is slowing and you can see demand destruction everywhere. Just this week I read an article about how teenagers aren't cruising nearly as much as they used to and Indian truckers are on strike because of high fuel prices.





This indicates to me there will soon be a glut of oil on the market soon. I've been debating whether or not I should be shorting oil at this time. I think it's a solid play, but I'm not sure how much farther oil has on the upside. Everything I'm seeing now suggests to me that we've got a blow off top on oil (think Nasdaq in January - March of 2000 when it moved up 20% in less than 90 days right before it crashed). On the other hand, it looks like oil could push as high as $200/barrel before it pulls back (and Iran is a big question mark, too).





Of course, I'm not giving investment advice and you need to do your own research.