"Kee" Points with Jim Kee, Ph.D.

This Week it’s about Greece

There are a lot of events unfolding this week that will keep markets on edge. These include concerns over Greece possibly defaulting on its debt payments, the outcome of this week’s long-awaited June Federal Reserve (FOMC) meeting, and the fact that economic data globally remains soft. Among these, Greece is the most important issue right now. The on going inability of Greek ministers to reach an agreement with creditors (mainly the International Monetary Fund and the European Central Bank) is raising concerns of a Greek debt default. The European Central Bank has pointed out that the region is better able to deal with a disorderly Greek outcome than it was previously (Business Day), but “spillover effects” or contagion to other banks and bond markets cannot be known with certainty. Interestingly, none of the valid global risk measures are signaling a coming financial panic. Indicators like the Treasury-Eurodollar (TED) spread, the Libor-IOS spread, and the St. Louis Financial Stress Index (which combines the prior indicators as well as several others) have all been pretty well behaved, moving up lately but within a normal range. I don’t know if that reflects overall confidence in the ECB (and other organizations) to provide liquidity to the banking sector (as opposed to the Greek government sector) in the face of default, or if it reflects a confidence that Greece, in the end, will make some compromises.

 

Happy anniversary?


This from Christian Ledoux, CFA®, STMM’s Director of Equity Research & Senior Portfolio Manager:

 

“Yesterday marked the 1-yr anniversary of the energy downturn. A year ago, WTI oil prices peaked around $106; today it’s a little under $60. There has been a meaningful bounce off the bottom ($43.50) after news that production in the US is finally peaking.

 

The data still shows a big 2 million barrel per day excess supply of oil globally. Demand has not responded much from the lower price of oil, as many bulls had been forecasting, and supply remains stubbornly high. About a week and a half ago, OPEC had one of its increasingly infrequent meetings and decided to hold its targeted output steady (despite the fact that the OPEC members have been overproducing this target by about 5%). Let’s not forget that there is supply not even counted in the totals. For example, ‘fracklog’ wells (drilled but uncompleted wells), which is essentially oil in the ground just waiting for the right time to be released to market, are not included. This fracklog consists of many thousands of wells in the US. The incremental cost to release this oil is very low; all it will take is the right price (or financial desperation) to trigger this supply. We’ve have seen some bankruptcies, and will likely see many more, but assets with any value will simply transfer to new owners and oil will continue to flow. Essentially no one is ‘packing it in’ at these prices – all parties are suffering, but not enough to stop producing or building inventory.

 

The reaction to the downturn has been rational. Producers have cut spending on exploration and are demanding, and getting, discounts from their service companies. While this helps them manage the downturn better, it will also have the effect of lowering the ceiling (i.e. maximum) for oil prices in the future.”

 

Trade


Another big issue last week was the ongoing rift between many Republicans and Democrats regarding a bill that would provide the President with “fast track” negotiating authority over trade negotiations with other countries, particularly the Trans-Pacific Partnership, which involves Japan and 10 other countries. Trade bills tend to get bogged down in everything from human rights issues to pollution issues to currency manipulation issues. Lately economics itself has become a victim, as I have frequently heard it erroneously stated, “Economists used to favor free trade because it benefits all parties, but now that thinking is being questioned.” Actually, when it comes to trade, economists and basic textbook theory have always asserted, “Trade has both winners and losers, but in general the winners win more than the losers lose.” For example, a trade restriction that bans steel imports into the US would save US steel worker jobs. But people in the US would have to pay more for steel, and that value – the increase in the total dollar amount of money paid for more expensive steel – is usually much more than the value (dollar amount) of the jobs saved. Of course, if you’re a displaced steel worker, that doesn’t help you much. Nor does the junior economist’s statement that you are now “freed up” to produce other goods and services! (i.e., who gets a pink slip at work and is happy to be freed up?) That’s why labor unions tend to oppose trade measures, and why the main (but not the only) opposition to the current bill is coming from Democrats. Things like pollution and human rights violations, though hard to value, do raise the costs of trade relative to the expected benefits. But that is not a change in economic theory, it is an application of economic theory, i.e., “international trade with externalities”.