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Oil and credit woes fuel long summer of discontent

Times Online
July 13, 2008

Oil and credit woes fuel long summer of discontent

American Account

This is the summer of our discontent. Only 14% of Americans are satisfied with the way things are going in the United States, the lowest figure recorded by Gallup’s pollsters since they began asking that question almost 15 years ago. Consumer confidence is at its lowest level in 28 years, according to the respected Reuters/ University of Michigan survey. And not many Americans are expecting things to improve soon. “Consumers’ economic outlook is so bleak that the Expectations Index has reached a new all-time low,” reports the Conference Board. In part this pervasive gloom is due to petrol prices that have passed the $4-per-gallon (about 53p a litre) level. In part it is the result of the squeeze soaring food prices are putting on consumers’ wallets.

No good to try to escape the gloom by taking a quick break. Hop in your car, and soon you are pumping $4-plus petrol into the tank of a vehicle designed more for safety and comfort than for fuel efficiency. Try to get on a plane, and you find most flights are full, fares are up, and your Airmiles are virtually useless as the number of seats allocated to freebies shrinks. Which might explain why sales of flat-screen television sets at Wal-Mart increased by double digits in June: staying home is an increasingly attractive alternative.

This only applies, however, if you live in a neighbourhood where for-sale signs aren’t festooning the lawns. Not only are home sales and house prices down and still declining, and inventories of unsold houses and mortgage foreclosures up, but the few families willing to buy houses are finding that their once-friendly lender is not delighted to see them.

The proud new owners of those flat-screen TVs will have to stay away from the 24-hour financial-news channels if they are to find solace in their new acquisition. Share prices are falling, earnings expectations are being lowered, financial-sector firms continue to scramble for new capital to offset write-downs of loans gone sour, and the job market continues to deteriorate.

Continuing claims for unemployment compensation — those lasting more than one week — hit a four-and-a-half- year high early this month, and the number of people unemployed for at least 26 weeks is up 37% this year.

In this atmosphere it is difficult for the shreds of good news to penetrate the gloom. The International Council of Shopping Centers reported that sales at stores open at least a year (“same-store sales” in the jargon of the trade) rose by 4.3% last month, with Wal-Mart recording a 5.8% jump, its largest in four years. Since June is the second- most-important month for retailers — summer stock is cleared to make room for back-to-school items — this should be unalloyed good news.

It isn’t. Pessimists argue that the sales increase results from a combination of the $86 billion tax-rebate cheques from a programme due to end this week, higher prices of food and petrol, discounts on clothing and electronic goods, and that old favourite of retail analysts, the weather — warmer than usual and therefore good for getting summer clothes off the racks and into consumers’ closets. Besides, much of the stuff that consumers buy in the flourishing discount stores comes from overseas, and so directly provides no jobs for American workers.

The two most powerful forces underlying almost all the economy’s problems are the price of oil and the condition of the financial sector. Bring oil prices down, and share prices will rise; revive the financial sector so that credit is again available to businesses and homebuyers, and the economy will revive. Unfortunately, it is not easy to forecast either of those important drivers of the economy.

The best we can say about the outlook for the price of oil is that in the short run it will continue to be affected by geopolitical events. An Israeli decision not to live under the threat of a nuclear attack by Iran, or President Mahmoud Ahmadinejad’s test-firing of a few Iranian missiles, can cause a temporary spurt in prices. In the longer run we are reduced to guessing about the balance of supply and demand. In a free market, higher prices would cause an increase in exploration and, eventually, available supply, while “demand destruction” — as high prices induce Americans and others to drive less, heat less and cool less — will ease demand. But the Opec cartel is capable of curtailing the amount of crude it allows on the market, which might offset the beneficent effect of increased non-Opec supplies and an easing of demand in developed countries.

The eventual outlook for the financial- services sector is somewhat easier to predict. Two of the biggest players, mortgage lenders Fannie Mae and Freddie Mac, have been under severe pressure, their shares down over 80% from last year and a government takeover being mooted. Investors worry that these government-chartered, shareholder-owned entities will be hit harder by defaults and that they will be forced to raise new capital on unfavourable terms. Even if those worries are realised, Treasury secretary Hank Paulson has made it clear that Fannie and Freddie “are working through this challenging period . . . [and] are adequately capitalised”.

Meanwhile, banks need to deleverage — raise more equity capital relative to their debt — to make up for write-offs of bad debts. Paulson said: “Much has been accomplished. Our financial institutions are repricing risk, deleveraging, recognising losses, raising capital and improving their financial position.” But he won’t attempt to guess when the recovery will be completed, and the credit spigots turned on.

Market analysts are guessing that share prices of banks will fall further, before an eventual recovery at the end of 2009.

That makes it unlikely that at this time next year we will be experiencing the “glorious summer” celebrated by Richard III, with all the gloom- producing clouds by then “in the deep bosom of the ocean buried”. But we might just have a merry Christmas. Or at least a less gloomy one.

Irwin Stelzer is a business adviser and director of economic policy studies at the Hudson Institute

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