No Bad Call Goes Unrewarded

Dave Gonigam – May 24, 2012

  • “No good deed goes unpunished,” the saying goes. At the Fed, no bad call goes unrewarded…
  • Oil hovers near $90: Byron King with a compelling chart that reveals why it can’t go much lower (not for long, anyway)
  • From China… to the United States… to Albania: Niall Ferguson’s shocking perspective on the state of U.S. education
  • Ritholtz on why J.P. Morgan’s bad trade is like a cockroach… a reason to be thankful for zero-tolerance school principals… your last chance for discounted early-bird Vancouver registration… and more!

   It’s an ironclad law of government: The bigger you screw up, the bigger budget you get.

The agencies that failed to “connect the dots” before Sept. 11 were rewarded with more manpower, more resources, more authority. Heck, entire new agencies were created. There’s even an “Office of the Director of National Intelligence” to hypothetically oversee the other 16 intelligence agencies.

We see this morning that what holds for government also holds true for that peculiar public-private mongrel known as central banking.

   The Federal Reserve has issued its 2012 budget. At $4.7 billion, it is 50% larger than it was in 2005.

That was the year Ben Bernanke told us with such confidence that “We’ve never had a decline in housing prices on a nationwide basis.”

Such a colossal miscalculation… and all the assorted fallout in the credit markets and the economy… turns out to merit a 50% budget increase in the ensuing years.

Worse, the Fed’s income from assorted fees — check processing and the like — hasn’t kept pace with expenses. So the net cost of running the Fed has more than doubled.

By year’s end, the Fed’s Board of Governors alone will have grown its head count by 25% since the start of the crisis, to more than 2,400.

True, the Fed’s budget doesn’t come from federal tax revenue. Well, not directly. Its operations are funded by the interest it earns on its portfolio of Treasuries, mortgage securities, etc. — plus any capital gains from the sale of those instruments.

But what’s a U.S. Treasury, other than a claim on the confiscated future production of U.S. income earners?

If they don’t get you one way, they get you another…

   Major U.S. stock indexes are fluctuating today after a rally late yesterday that managed to reverse hefty losses. Thus the S&P is holding the line on 1,300 with a comfortable margin.

Among the worldwide data in traders’ sights today…

  • Chinese manufacturing: “Flash PMI” — a preliminary reading for May — turned a seventh straight monthly number showing contraction
  • German and French manufacturing: Both sank deeper into contraction territory
  • U.S. first-time unemployment claims: Nearly flat at 370,000 last week — around where it’s been all month
  • U.S. durable goods orders: Up 0.2% in April. But if you back out transportation, it fell 0.6%.

Most worrisome about the “durables” report: Business orders for computers, machinery and other capital goods shrank for a second straight month.

   Eurozone leaders have held a summit amid a raging credit crisis… and put off making any decisions till next month.

There were the expected noises about wanting Greece to stay in the eurozone, but only if the government “lives up to its obligations” — that is keeps up its payments to the French and German banks that foolishly bought Greek bonds. But that was it.

[Ed. Note: It is our strict policy at The 5 to avoid using the trendy and hideous neologism “Grexit” to describe a potential Greek departure from the eurozone. You’re welcome.]

   “What should happen,” says the Gloom Boom & Doom Report’s Marc Faber, “is that Greece exit the eurozone right away and default on all its obligations to foreigners.”

“If they have obligations to foreigners,” he adds, “it’s the mistake of bureaucrats in Brussels.”

Greece, he suggests, is only further along the path that all European governments are:
“I have to laugh each time people talk about austerity. The fact is from 2000 up to 2011, government spending in the eurozone has risen by 76%. Where’s the austerity?”

“Government spending as a percentage of the economy has grown from 44% to 49%. There has been no austerity.”

   Precious metals are slowly climbing back from their most recent beat-down. Gold is at $1,556. An ounce of silver fetches $28.24.

   “The lesson we learn about cockroaches is that there’s never just one,” says Barry Ritholtz — applying this wisdom to J.P. Morgan Chase.

In theory, JPM lost $2 billion from its bad derivatives bet run from London. “The question is, ‘Is this $2 billion loss going to be $3 billion, $4 billion or $5 billion?’ I don’t know,” he tells Yahoo Finance.

Thus has Mr. Ritholtz’s firm cut its JPM exposure; he loaded up early this year because it was the “best house in a not great neighborhood,” and indeed he was able to book a profit even after the sell-off.

“The reason to own banks is that they used to be a safe, money making machine,” he adds. “The old joke was ‘Borrow at 3%, lend at 6%, be on the golf course at 4 o’clock.’ That’s how bankers lived. It was a boring, highly profitable business. And now these banks seem to think they’re hedge funds.”

   Oil is stabilizing after falling below $90 yesterday. At last check, a barrel of West Texas Intermediate fetches $90.64.

Brent crude — a better reflection of what most of the world pays — is at $106.50.

   “Never say never, but in my view, the oil price shouldn’t go down much from here,” ventures Byron King.

The reason: Oil producers can’t afford to let it fall much further. To illustrate, here’s a chart prepared by the chief economist at the French oil giant Total:

“Basically,” Byron explains, “the chart describes the oil price level that a series of major producers require in order to balance their national budgets.”

“The red-shaded region at the bottom is the ‘break-even cost’ for producers (as estimated by Total). That is, the red shading reflects how much it costs to lift barrels of crude oil out of the ground.”

“As you can see from the chart, many producers lift oil at an overall cost of $10-20 per barrel. Even the major international players (the blue shading on the right) are in the $40 per barrel average for production.

“But take a look at that ‘budget break-even’ line — the yellow shading. That’s the price at which a list of petro players has to sell oil in order to fund their national spending. Keep in mind that all of the countries on the list — from Qatar to Venezuela — rely on oil sales for the vast majority of their national income.

“Without a strong oil price,” Byron concludes, “these countries will have bread lines and riots.” And they account for 40% of total world crude output.

“WTI at $90 and Brent hovering over $100 is the threshold of financial pain for the world’s largest oil-producing nations.”

   “I can’t think of a single bigger thing for us to worry about,” says Harvard historian Niall Ferguson, with an eye toward the biggest of big pictures.

Western nations have lost their edge when it comes to education, he says. Education is one of the six “killer apps” Ferguson believes lay behind the West’s ascendance — a theme he explores in depth in Civilization — his current PBS documentary series and its accompanying book.

“The U.S. has a disadvantage,” he said at a recent conference, “in that a substantial number of our potentially talented young people who had the misfortune to live in poor ZIP codes are not being educated to nearly a high enough standard in basic math and science.”

Result? Mainland China ranks No. 1 in math and science, judging by standardized tests on students up to age 15. The gap between China and the United States is as wide as that between the United States and Albania.

Professor Ferguson will explore some unexpected investment implications during what’s sure to be a rousing session at the Agora Financial Investment Symposium, which starts only two months from today — July 24-27.

The aforementioned Dr. Faber will be there. So will Barry Ritholtz. Along with Byron King and the rest of the Agora Financial editors.

We’ll have return engagements with the colorful oil field geologist Marcio Mello and the always-provocative venture capitalist Juan Enriquez. Small-cap resource guru Rick Rule will lead his enlightening and entertaining breakfast sessions. By the time you leave, you’ll have no shortage of ideas to consider and act on.

[Ed. Note: We’re still offering an early-bird registration discount… but not for long. The fee goes up as of 5:00 p.m. tomorrow.

At last check, fewer than 300 seats remain. For each of the last three years, we’ve had to turn people away from this event. We’d hate to see that happen to you.

In addition, our block of rooms at the host hotel, the Fairmont Hotel Vancouver, is filling up quickly. Here again, time is of the essence.

We look forward to seeing you in Vancouver, July 24-27. For a full speaker lineup and registration details, please review your invitation here.]

   “You need to thank Principal Katie Pennington,” writes a reader who caught our item about the 64 high-school seniors suspended on their last day for riding bicycles to class.

“Do you really think that anything more than a handful of these kids who went through Principal Pennington’s P.C. bicycle shenanigans will end up being nanny-state types as adults after experiencing this?”

“If so, maybe you should go ask that 10-year-old girl in the yellow dress who is currently doing 10-20 breaking rocks in Leavenworth for selling lemonade.”

   “The North Dakota oil field known as the Bakken had a trade show in Bismarck Tuesday and Wednesday for oil field vendors,” a reader writes with an on-site report.

“Being a curious person, I thought to take a couple of hours to walk through. Imagine my surprise when told I needed to be registered — and my greater surprise to know that registration was $700 per person — $600 if preregistered.”

“A minimum of 4,000 registered — gives new meaning to Bakken Gold.’ Ah, then it gets better, as about 300 vendors paid $3,500 for their 10’x10’ space. Looks like $3.5 million for a two-day show — much better than drilling for oil!”

The 5: Amen… but that too illustrates Byron King’s bigger point about the new fortunes being created in the Bakken, the Eagle Ford and other shale plays. They’re feeding all manner of add-on industries in formerly down-and-out communities.

Whether it’s new restaurants, new housing or a $3.5 million trade show, it’s creating new streams of money. And it’s not too late to claim some of it for yourself.

   “Read your comments from the reader regarding the Drudge Report and was a bit stunned,” says yet another reader rising to The 5’s defense.

“As a fairly conservative individual and probably more of a libertarian than anything, the views of The 5 are fairly close to my own, but not always.

“That is part of why I value it. You do throw me come curveballs and I have to think them through. It causes me to constantly see a different view of the road and hopefully navigate it better. Keep up the good work!”

   “I have been reading The 5 for several years and it hadn’t dawned on me why I liked it so much until lately when I’ve been reading the latest comments about no spin, no bias and open reporting…quite refreshing!!”

   “I’m an 85-year-old veteran of World War II, and I served in the military for many years. We had two sayings that were relevant then as well as now.”

“They are: ‘If in danger, if in doubt, run in circles, leap and shout.’ The other: ‘Hands on ears please, now pull your head out of your ass.’”

“I am daily reader of The 5 and appreciate and thank you for the truths you report, no matter your sources.”

   “What, you [also] quote left-wing media?” writes a reader with tongue firmly in cheek. “I am appalled! How can you quote this brainwashing propaganda nonsense?”

“Are you working for Soros? You just can’t rely on anyone these days.”

The 5: The only thing that would have made this email funnier is if the guy who got this discussion going in the first place would write back… to accuse us of being in the pay of the Koch brothers!


Dave Gonigam
The 5 Min. Forecast

P.S. “Spread over 2,700 acres of rolling farmland, beach and forest, Rancho Santana is a collection of more than 50 homes and 25 villas,” says an article in The Nicaragua Dispatch, the country’s English-language daily.

“It has as a mini-grocery market, a fully functioning clubhouse, the best restaurant in Tola (and one of the best in Nicaragua) and the first modern conference center on the Pacific coast.”

“Rancho Santana,” says guest services manager Matt Prezzano, “is very unique in that it was one of the first significant tourism-investment projects made by foreigners in the Republic of Nicaragua. They helped put Nicaragua tourism on the map through various press publications and have been marketing Nicaragua tourism for over 12 years.”

We’re still in the planning stages for the second iteration of the Rancho Santana Sessions, coming up Dec. 5-9, 2012. As we line up topics and speakers, we’ll keep you posted…


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