Leaking Economy in Need of Fix

While I was in London, toward the latter half of this week I did hear and read that crude oil hit $120 dollars a barrel. (Ok, you caught me, I am catching up on what I missed.) The shame is, much to my great dismay, this commodity rise isn't letting up. I was one of those overly optimistic prognosticators who predicted that oil at year's end would be lower then where we started on the year and that the U.S. dollar would be higher. I'm not looking very smart on my top ten predictions for 2008 !

What concerns me is not the one-off situations in Nigeria or the UK, but the flight to commodities (like oil as an investment vehicle), a U.S. dollar hedge and good old fundamentals! What are those good old fundamentals? Demand, population growth, China and India.

Think about China... crude demand is expanding at 11% per annum. China will soon be the biggest oil importer, surpassing the U.S. What about India? Brazil? Mexico? As these emerging economies get richer and if the middle class across the world grows at the record pace most economists have predicted, demand will not soften -- it will only get stronger.

Take this statistic reported in The Sunday Telegraph. "The number of cars in the world, now around 625m, is set to double in less than 20 years. Think of the impact of that on global oil demand-seeing as around 70 per cent of current crude output is used to fuel cars." The Telegraph goes on to talk about the rise in oil prices from $10 dollars to $60 dollars from 1999 to 2006 and the doubling in the past year. Think about it: oil prices are up almost 90% in one year.

Who can afford this? One of the things that I said to Ashley Webster, our London correspondent, this past weekend while visiting London was how booming and busy the city was despite all the talk of inflation, declining home values and increased job losses. Home prices in London are off the charts. I was shocked! I asked Ashley exactly who was buying these $25 million dollar brownstones; he said it is the Russians. They've made a lot of money on oil and many bought companies for pennies on the dollar during the fall of communism. Here in the U.S., sovereign wealth funds, many of which are domiciled in the Middle East, are investing in American companies and real estate at breakneck paces, taking advantage of their riches in oil and the weak U.S. dollar. All of which could be viewed as a great development for both the U.S. and UK. After all, just this week Steve Schwarzman of Blackstone, a global private equity behemoth, announced that the company was raising a European property fund to begin nibbling on attractive real estate plays as property values were declining in the UK and Europe.

So what's my point? What do oil at $120 dollars a barrel and overseas investment in dilapidated U.S. and UK real estate and corporations have to do with one another? A lot! With the U.S. dollar at historically low levels, the sterling is touching another record low against the euro, now at nearly 79p. Even The Sunday Telegraph is recommending to the Brits where to go on holiday (as they call it) for the best exchange rates. Recommending Bulgaria and Turkey given the weakness in the pound against the Euro. I'm not a protectionist. If anything, I believe in free trade. The more, the better. I like cross-border activity, but I don't like paying almost $10 for a box of cheerios. While our currency is getting cheaper and our buying power weakening, we need overseas investment to keep many of our industries afloat but is it helping us cut prices and inflation?

The Federal Open Market Committee meets this week and most anticipate rates will be cut by 25 basis points or a quarter of a point down to 2%. The Fed has cut rates 3 full percentage points since last October all in an effort to avert a recession, recapitalize the financial markets and make lending more affordable so that Americans and overseas investors would buy our real estate. So, what has happened? Many argue, me included, that the reliquifying of the markets occurred because the Fed opened the discount window and pumped money into the credit markets by expanded Term Auction Facilities. Lending is still impossibly difficult and rates have hardly fallen for a 30 year mortgage. Demand for homes has not ripened and doesn't show signs of improving in the short-term and inflation keeps getting worse.

I am not a bear. In fact, if you listened to me over the past month, you'd know that I am very bullish. Perhaps too bullish! I am and have been in the camp that this is a slow growth, small recession at best. I realize that jobs will be lost and hear from many of my closest and most powerful friends in the financial community that as many as 30% of Wall Street jobs will be cut a year from now. JPMorgan will keep 7,000 of the 14,000 employees from Bear Stearns. Citi will layoff 9,000 this quarter and will continue to adjust to that 10% mark, maybe even 15 or 20% -- which at a minimum is 37,000 jobs lost and a maximum of 64,000. This will not be easy. This will be one of the biggest losses in Wall Street history.

What I don't understand is what the Fed can do about inflation and job losses. The Fed, in my mind, cannot and should not continue to cut rates after this week. Economists say it takes 6 months to a year to feel the affects of a Federal Reserve Banks' cut in rates. I don't see the effects just yet, and it has been over six months since the Fed started cutting rates. This week, stimulus checks will go out and, for a moment, we will all breath a sigh of relief. That moment won't last until we figure out one problem... INFLATION. We need an answer!