Thursday, August 18, 2005

Flirting with Stagflation?

Irwin Stelzer takes a crack at assessing the meaning of current oil prices in his latest piece. On the one hand, supply is tight and the developing world (China especially) displays voracious demand. On the other hand, demand might be slowing, and supply has always seemed to satisfy demand in the past, leading to lower prices. How's that for a hedge? Now you know why it's so hard to make money placing "macroeconomic" bets or trading commodities -- unless you're Hillary Clinton apparently.

There's "expert" opinion on both sides, with the CEO of Chevron (CVX), David O'Reilly, paying up (over $18 billion) for Unocal and the CEO of ExxonMobil (XOM), Lee Raymond, exhibiting optimism about future supply. But supply interruptions are precisely what is adding the huge "risk premium" that Stelzer sees baked into the price currently. For example, the debate is not whether the medieval Saudi regime (sitting on the world's largest reserves) will be able to hang on to power, but how much time it has left. Less than a decade seems to be the educated opinion on the question.

Additionally, Venezuela's virulent anti-Americanism and inefficiency combined with Russia's outright hostility to the private capital investment required for pulling crude out of the ground are making things worse. Possible sanctions against Iran and the difficulty of protecting Iraqi pipelines complete an unattractive picture for the supply side of the equation.

The demand side hardly looks better. The recent passage of the energy bill demonstrates an "unwillingness to develop policies to reduce the nation's massive dependence on imported oil, preferring instead to pass an energy bill that is long on gifts to a variety of special interests, but short on any measures that will reduce gasoline consumption," according to Stelzer.

This is the scene that Alan Greenspan confronts. Additionally, he faces a host of other conflicting economic indicators. Consumers continue to spend, despite higher oil prices. Business spending also appears to be picking up, indicating a strengthening economy. In fact, things are picking up so much that he seems to be concerned with inflation. On the other hand, he also faces a yield curve resistant to his recent ministrations, flattening and threatening to go negative. (This is the counter-intuitive situation of lower interest rates on longer-term debt than on short-term debt, indicating the capital markets anticipating a recession and the need for a dramatic reduction in rates.)

Greenspan continues to raise rates, believing that inflation more than recession is at hand. (So much for his libertarian belief in the infallibility of markets -- in this case the capital markets that continue to bid up bond prices and keep yields down.) Nevertheless, as Stelzer argues, high oil prices make it hard to know what to do, because they can somewhat paradoxically be both a drag on the economy and a source of inflation. That's the definition of "stagflation".

Big politico-economic questions aside, check out the latest holdings of your mutual funds to see their oil or energy exposure. A big position will tell you if your manager is a swashbuckler (or, perhaps a fad-follower). Also, if your fund has never had much exposure but has a bit now, that could also tell you if your manager is a lemming who doesn't really believe in energy, but is afraid to be without it and not look like his peers. The energy component of the S&P 500 Index is roughly 8% now, compared to more than double that in the late '70s.


Post a Comment

<< Home