$2 Billion Up in Flames

by Addison Wiggin – January 31, 2011

  • Poor return on investment: How $2 billion a year is literally going up in flames

  • Byron King with a chart that helps answer a burning question about Egypt: Why now?

  • China seeks more gold, cuts another U.S. energy deal

  • Rotten economy forces a merger of “till death do us part” with “rest in peace”

  • “Our very lifestyle makes us less competitive”… Readers sound off on U.S. labor costs

Here’s a helpful reminder as we begin the week: Out of every $100 Uncle Sam spends, 52 cents buys this:


Every year, Washington sends $2 billion in aid to the regime of Hosni Mubarak; $1.3 billion of that is for his military. Egypt is the No. 2 recipient of foreign aid, after Israel. Right now, the return on investment doesn’t look very good.

Rising food prices were the catalyst that set off long-simmering anger over repression and corruption. But what exactly set off the food prices?

“I believe this depicts a major aspect of Egypt’s problem,” says Byron King of the graph below:

“As of 2010, Egypt began consuming all the oil that it extracts. Egypt no longer exports oil. Interesting timing for social unrest, don’t you think?

“Here’s what the numbers show. Egypt’s net oil exports have been falling each year since the mid-1990s. So for the past 15 years or so, Egypt’s government has been raising less and less income with which to offer food and fuel subsidies to the teeming masses in the country’s expansive slums.”

Without those subsidies, huge numbers of people in Egypt — population 85 million — would not eat. As we mentioned last week, Egypt is the world’s biggest wheat importer.

“In the past few years,” Byron continues, “Egypt has imported about 40% of its food overall and 60% of its wheat. Egypt buys the food on world markets, paying world prices.

“In the past year or so, as net oil exports shifted down to zero, the food problem became even worse for Egypt. World wheat production is down, and global export markets are tightening.” You know the story: drought in Russia, floods in Australia and so on. And at the very moment Egypt has less oil revenue, it’s shelling out more for food. And the subsidies go only so far.

“The bottom line is that energy is a problem for Egypt, compounded by revenue shortfalls, compounded by large and growing population, compounded by the need for food imports.

“It’s an explosive mix, and now the fuse has burnt down. I don’t doubt that this all is why we’re seeing riots in the streets.”

[Ed. Note: Iran’s government is throwing its support behind the “revolution of the noble” in Egypt. “The start of this revolution has astonished the despotic regimes of the region,” says parliament speaker Ali Larijani. Will the support go beyond mere rhetoric? That’s a possibility Byron explores in his $220-a-barrel oil scenario.]

After a free fall Friday driven by events in Egypt, stocks are starting the new week mixed. As we write, the S&P 500 is up a point, to 1,277.

“I wouldn’t be surprised if stocks slid back to support at 1,275 this week,” says Jonas Elmerraji of our small-cap team. “If stocks sustain a break above 1,300, expect rally mode; if the S&P falls below 1,275, brace for selling.”

Having said that, “a bit of sideways consolidation would be ideal right now,” Jonas opines. “Even though the S&P isn’t as overbought as it was earlier this month, we need to remain wary of the market psychology exhibited by unsophisticated investors who are prone to pull their cash on a whim.”

With the book about to close on the first month of 2011, Jonas’ readers have laid on six plays that are now closed. The average gain is 9.5% after a holding time of just 25 days.

To learn about the strategies Jonas uses to “break all the rules,” check out this presentation.

Gold is giving up most of the gains it made on Friday… also fueled by trading jitters over Egypt. The spot price has retreated to $1,329. Silver, though, is holding its own at $28.09.

The dollar is proving to be anything but a safe haven amid the Egyptian turmoil. The dollar index is down nearly 1% this morning, to 77.7.

China plans to take our long-standing advice and buy gold on the dips… at least if an adviser to the central bank has any sway. Xia Bin tells the Economic Information Daily that China should build its gold and silver reserves at the “appropriate time.”

Xia was the guy who gave QE2 an acid reception back in November when he said, “As long as the world exercises no restraint in issuing global currencies such as the dollar — and this is not easy — then the occurrence of another crisis is inevitable.”

Then again, the Chinese don’t need Xia to tell them to load up on gold. Chinese gold imports grew fivefold in the first 10 months of 2010.

The Chinese are also adding to their overseas oil and gas holdings… by adding more U.S. properties. CNOOC just struck its second deal with Chesapeake Energy in four months.

This time, CNOOC will spend $1.3 billion for a 33% stake in Chesapeake’s shale properties in Wyoming and Colorado. That’s in addition to the $2.2 billion it’s spending for a similar stake in a Texas project.

Hmmm… that’s $3.5 billion CNOOC has put up so far. Its total bid for Unocal in 2005 — rejected by a xenophobic Congress — totaled $18.5 billion. What the Chinese can’t get in one fell swoop, they’ll be content to get piecemeal.

“In our community, two banquet halls closed because of the economy,” says James Olson of Sheboygan, Wis.… who’s graciously taking up the slack for people who need a place to hold a wedding.

Mr. Olson owns a funeral home.

“A lot of [traditional wedding facilities] are shutting down because of the economy,” says Mr. Olson, “while we aren’t going anywhere.”

Indeed, the National Funeral Directors Association found in a recent survey that 10% of its members now offer a “community” or “family” center.

“Over the past five-six years, more and more funeral homes are offering the use of their facilities to the greater community,” says the association’s Emilee High, “whether it’s hosting a full-blown wedding reception or offering meeting space to an organized community group.”

“A banquet hall is a banquet hall, and a chapel is a chapel,” says Sue Totterdale from the National Association of Wedding Professionals. “If you can get past the driveway and the cemetery, it’s going to be beautiful.”

Maybe… but we can’t get past the thought that the party favors might be stored next to the embalming fluid.

“It’s fine and well to talk about ‘incentivizing corporations and entrepreneurs to build “stuff,”‘“ writes a reader who hails from a commonwealth country somewhere, “but the real problem is that American workers will not work for $2 or $3 a day, compounded with the fact that Americans will buy products that have a labor cost of $2- 3 per day component.

“I think the component and labor cost of an iPhone are well documented. Build that iPhone in the U.S. with U.S.-made components and labor and then ask anybody on the street which one they would pay for, and the answer is the real problem.

“Patriotism stops at the wallet…everywhere.”

The 5: Indeed, there’s the rub.

“I think the problem is far deeper than just a matter of the ‘willingness’ of American workers to work or not work for lower wages,” writes another, willing to go a little further with the thought experiment, “The whole design of American life has so many built-in inefficiencies, right down to the individual and family level, that Americans simply need more to get by.

“One major factor (among many) is that we live so spread out spatially; most of us must rely upon individual vehicles to get to work, school, shopping, church, friends, etc. All of that cost has to be covered by our paychecks, and that means that American paychecks simply have to be that much higher than paychecks in countries where folks can walk, bike or bus to the places they have to go.

“In other words, our very lifestyle makes us less competitive. It’s a systemic structural problem, and fixing that is going to be a very tall order.”

The 5: Yeah, it’ll probably collapse before we get our act together.

But as our investment director Eric Fry suggested in our editorial meeting on Friday: Capitalism is a phoenix rising from the ashes of collapsed systems throughout the world and throughout history. The question for us is: where it will rise again…?

“100 years ago, the purpose of the patent system might have been to enable small businesses to protect their uniqueness in a competitive world,” writes a reader in reply to the small business owner who was bitching about the cost to maintain patents.

“Today, the purpose of the patent system is to lock small companies out of markets which big companies find very profitable. The system is doing what big-company lobbyists want it to do. Since most legislation is written, in effect, by lobbyists, there is no chance that this will change anytime soon.”

“As I read the comment about Social Security trust fund money being spent long ago, I thought of the movie Dumb and Dumber, in which the two guys spend all the cash in the suitcase they found and replace it with IOUs, but with good intentions.

“Didn’t someone say the road to hell is paved with good intentions?”

The 5: We said as much of Woodrow Wilson in Empire of Debt.

“Always hilarious,” writes our last correspondent, “and I usually get some practical info out of each 5, as well. Comic break, satire, parody, fear, sarcasm, ridicule: It’s all available in your 5. Y’all should give up your day jobs and go on the road!

“Please don’t ridicule me; it would crush me… and Byron has me looking so-o-o-o-o good to my wife! Oh yeah, and I’m a Reserve member — I think…”

The 5: You ‘think’ you are? If you want, you can make sure by calling John Wilkinson at (866) 361-7662.

Cheers,

Addison Wiggin

The 5 Min. Forecast

P.S.: “Ever wonder,” reads an email from Daily Reckoning managing editor Joel Bowman, “if you’re getting the most accurate insights about the turmoil in the Middle East from your regular media outlets?”

“Apparently, someone snapped the picture with their iPhone when it appeared on Fox News. Not sure if it’s authentic… but it wouldn’t surprise me. You’ll notice immediately that Egypt is apparently now where Iraq once was.”

Turns out the image is authentic… but not current. This egregious foul-up by the Fox News graphics department dates to July 2009… and appears to be going viral on the Net today.

P.P.S.: “This is becoming the region’s first telecommunications civil war,” reads a tweet from Cairo that managed to escape the Mubarak regime’s shutdown of Egyptian Internet traffic. “Our Internet and smartphones are weapons they won’t allow us to have.

“Mobile communications have the potential to be in our own times what Gutenberg’s printing press was in a previous era,” says Ray Blanco of our tech team. “It changed Western civilization forever.

“Our own revolution could not have occurred without the invention of the movable type press. What would 1776 have been like without Thomas Paine’s influential pamphlet Common Sense?

“The mobile revolution won’t be televised,” says Ray, spotting the potential investment angle, “but it will be streamed over a wireless broadband connection.

“With all those new connections, and with existing ones being upgraded to 4G, wireless service providers need to be able to manage their networks. They also, of course, need to monetize the growth in order to maintain profitability. My latest pick sits on the intersection of these trends. It will make a lot of money in the coming years.”

Ray’s latest recommendation comes later this week. To get on board — and secure access to all his current picks — look here.

rspertzel

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