USA TODAY US Edition
A bleak picture of global economy
It’s bad and going to get worse, analyst says
The Federal Reserve could raise interest rates for the first time since 2006 at this week’s meeting Wednesday and Thursday. A debate is raging whether this would be the right time to do it. Economic growth has been slow, and jobs growth has lagged. Leaders from The World Bank to the International Monetary Fund to former Treasury secretary Larry Summers have publicly asked the Fed to hold off on the first rate hike in the face of a sluggish global economy and plummeting commodities prices. Of course, traditional thinking is that lower oil and gasoline prices will ultimately help consumers and encourage them to spend more money, which will lead to economic growth. But we have yet to see that happen. So I turned to one of my favorite independent research analysts: Stephen Schork, who writes The Schork Report, and got a dreadful picture of the global economy. He says the drop in commodities is critical because it is a sure sign of a recession on the way. Our interview follows, edited for length and clarity.
Q What are the implications of lower oil? How concerned are you about the sell-off in commodities?
A: Extremely concerned. Commodity prices, be it oil, lumber, steel, iron ore, are essentially the canary in a coal mine. The pullback in prices is a telltale sign that poor economic times are headed there. The best way to say it is that commodity prices don’t create economic growth. Pundits constantly tell you that the drop in gasoline prices is good because it gives the consumer more money to spend. But what it’s actually doing is moving the deck chairs around on the Titanic. We’re just shifting money around. The velocity of money has not increased. Sure, if I’m saving $100 a month at the gasoline pump, that
gives me $100 to spend elsewhere. That’s not an additional $100. I think it’s the biggest misnomer out there that somehow this is a good thing. Some 72,000 people in the U.S. energy industry have been laid off through August. The average weekly paycheck for somebody in the energy industry is upwards of $1,500 a week. It’s more than twice the average of the total private sector. So not only are we bleeding massive amounts of jobs in this industry, but it’s the highest-paid industry. When you have plunging commodity prices, and we’ve seen this across the board in oil and in the industrial metals, this is simply telling us that we’re not seeing economic growth. Or at best, it’s stagnating. At worst, it’s contracting.
Q China is among the biggest consumers of things like oil, iron and copper. If there’s a slowdown in China, that means they’ll be buying less of all of that, right?
A: Absolutely. China is the largest consumer. If we look at the industrial sector of the majority of the emerging economies, they all have one thing in common: They are energy-centered economies. And it’s the emerging markets that are getting beaten up. Here at home in the U.S. we look at U.S. factory orders, which dropped for a ninth-straight month. The fall in these prices is telling us something is wrong and all contend that the U.S. smokestack economy is in recession. So once again, it is China. When you look at our own numbers (such as durable goods orders and the PMI), they are screaming at us that something is wrong on the industrial side of this economy. And when you look at the spike in the dollar over the past year, it’s one of the largest catalysts for the sell-off in commodity prices. So the U.S.’ industrial side is challenged. How are we going to export our way out of these doldrums with a massive rise in the dollar? This is why China devalued the yuan a few weeks ago. The Chinese are having problems with their exports as is the U.S. — as is everybody because of these doldrums.
Q So do you think that the U.S. is in recession right now?
A: I don’t think we’re in a recession, but we’re certainly seeing a lot of telltale signs that we’re on the cusp. And if you look around the globe, we know there’s a problem in China. Japan has been in and out of recession four times over the past seven years. Brazil is in recession. Canada just went into recession. Europe is weak. Economic activity is absolutely slowing, hence commodities prices are selling off. And then we have to ask how long can the U.S. go it alone if every one of our trading partners is challenged right now?
Q What are the implications to the leveraged players out there? Some shale oil companies, for example, are highly in debt. How do you see that playing out if oil goes lower?
A: As we look ahead to the fourth quarter, we’re about to start to see a massive rush of blood coming down the streets. It’s been bad up into this point as we said, with 72,000 layoffs in the industry, and it’s only going to get worse. The expectations for oil prices in 2016, 2017 and 2018 are still upwards of $65, $70 a barrel. The thought was that even a highly levered, inefficient producer can still make money at those levels. But back in the spring when the banks went ahead and did the reformation on credit facilities for the exploration and production (E&P) companies, they looked at high prices out into the future and the ability to hedge. And hedge is nothing but collateral. The bank liked that collateral, sent out a lot of E&P companies to kick the can down the road further, and feast off of more of the Fed’s easy money.
Not only are prices crashing again back $15 to $20 lower than where we were in the second quarter, but more importantly, the back end of the curve has also crashed. So many E&P companies are going to be challenged. With that kind of price decline, the hedging is not as robust. Therefore, the collateral is not going to be there. So when the banks come and do their fall termination on the credit facilities, there’s going to be a massive dryup in credit liquidity for the E&P companies. And that’s the concern right now. Production has pulled back. But capital spending is about to be pulled back even further without these credit lines. It is going to create a significant scenario where the strong, larger guys with cash on the books are going to be able to go onto a buying spree. It’s bad, and it’s about to get worse.
Q The picture you’re painting is pretty negative. Is this 2008 all over again?
A: Not necessarily on the level of 2008. But just anecdotely, I haven’t seen anything akin to this. There’s certainly a tremendous amount of uncertainty out there, and with that uncertainty you’ll start to see people pullback, hold their cards close to their chest and be afraid to make decisions.
Q What do you say to people who feel a drop in gas is only a positive because it’s going to help so many sectors of the economy, like transportation and industrial, because their costs are going down?
A: Let’s take a perfect example: FedEx and UPS. These are companies that should intuitively benefit from lowered diesel, jetfuel prices, gasoline prices. And they have been. But these are also very large international companies. So where they’re saving money on their transportation costs, they’re getting hurt on (the strong) dollar, on bringing those dollars back home at these prices. So for some of these companies where you have that boost, it’s a hamster wheel because one reason earnings are lower is because of the strength of the U.S. dollar. If we look at the consumer level, we have to also bear in mind the rebound in the job market — it’s been more of a rebound of lowerpaid jobs. So the incomes aren’t necessarily rising with the decrease in unemployment. If I save $100 a month at the gas pump but my affordable care for my family premium went up $160 a month this past year, I’m saving $100 but I’ve already spent that $100 on my family’s health care, and I have to dig deeper for another $60 a month. So that savings is not a savings.
Q Is this behind the wild swings in the stock market as well?
A: The financial markets are in a very scary time right now. I would expect an extreme amount of volatility and trepidation. For the past year, China has had five rate cuts. They devalued the currency. The People’s Bank of China has instituted itself as the world’s largest specialist firm, adding liquidity and ordering liquidity to its markets, and it’s still not enough. And then when you look at the unemployment situation in the U.S., and factor in the amount of people who want a job but they’re not in the workforce for various reasons, we’re still looking at the real unemployment rate well into the double digits.
Q Can the Fed raise rates in the face of all of this?
A: The Fed has painted itself into a corner. The biggest takeaway here is that commodities don’t lead economies. Economies lead commodities. And falling commodity prices are a big telltale for us all.