Friday, July 1, 2011

It’s a new economy… again!

Remember the High Tech Boom and the talk about the 'new economy'? Well pretty soon thereafter we learned that stock valuations are driven by earnings and the craze came to a screeching halt. But that does not mean that the economy did not change or that the world did not change. They did, just like the world changed and investment changed after 9/11 or after the Enron debacle. China and India are certainly changing but all within the principles and laws of economics, of society and of the physical world. We just should admit that we may not know all those principles and laws yet and we certainly don't know their impact. We don't think very well in a non-linear fashion trying to estimate the combined effects of all those interacting laws and principals (That is David Dreman speaking – see earlier posts on stock valuation and maybe a bit of Ken Fisher as well – where is a black swan when you need one).

We are now at a new stage in our social and economic evolution, and yes, history repeats – to some degree. These new changes will affect our life in a more fundamental way than anything we have ever experienced before. We have reached or are close to peak oil production. Not only peak oil, but also peak copper and peak-whatever-other-commodity we have taken for granted in the past. The world population continues to grow but in many countries this growth has already slowed or is even stagnant. Demographics and their economic consequences are about to change dramatically as well. First world population may peak in the second half of this century (at 9 billion people or so) and then it may even start to decline. This combined with us living longer probably will lead to a much older world population – think health care but also think stable or declining growth.

Yes a lot of the world lives still in poverty in conditions we consider of the 18th century. But they will catch up. So even if population growth comes to a halt, the momentum as reflected in GDP growth may still go on for some years; just like a massive tanker that keeps moving forward for some time after it ran out of fuel. However, there will come a time that we reach our peak in material possession – when everyone has a dishwasher, an electric car, a computer and food. So what more do we want? Of course, there is the little problem of peak resources and added to the effects of a stagnant world population our economy may slow down much earlier than just based on demographics alone.

So what about tomorrow rather than the day after tomorrow? Well, whether we want to or not, we will live in another 'new economy'. We have observed the consequences of this new reality now a number of times and the picture is becoming clearer. We are coming out of a period of financial collapse, but was this collapse caused by overheated real estate, cheap credit and an overconfident financial establishment that invented ever more obscure and intricate financial derivatives, or was it caused by the rising price of energy, in particular oil? This is still a topic of controversy amongst economists; although – just like with the climate change debate- some may claim the delusion of scientific consensus – yeah right!

Deleveraging ourselves out of the financial ruins of the latest subprime mortgage and the real estate debacle will restrict economic growth. Heck, if we have to reduce our debt burden we can't spend as drunken sailors like when we could max out our credit cards and live of the smoke-and-mirror appreciation of our residences. So we consume less and then… wonder of wonders, retail sales go down and bank profits decrease because we don't pay that much interest any more, and factories will produce less… and the economy does not grow as fast as after past recessions caused by other matters than financial collapse. We have seen this before and overtime our growth will resume its more normal pace.

Simultaneously, all this economic growth and consumption led to the record oil prices of 2008. Cheap energy which had fuelled the booming economies of the 1990s became too expensive; we went into recession. Subsequently, energy demand in the developed world declined so much that despite continued economic growth in emerging economies, energy and commodity prices fell in early 2009. When at the start of this year, oil prices shot up again the economy responded with a minor slow down and this summer's stock market correction. Record economic stimulation by the world's central banks (except in the BRIC countries) using QE3, and historical low interest rates did not matter that much. Then this month, oil prices contracted again somewhat while the European debt crises has survived another fever attack; the economy is picking up its feet and stock markets are coming out of their latest correction.

It starts to look like our economic growth is no longer governed by central bank interest rates but more by commodity prices – in particular by oil prices but also by metals and, of course food prices. When speaking of food, in fact we're talking energy all over again. Oil production is peaking and soon, as Jeff Rubin has noted, demand will outstrip supplies. So, along with deleveraging, peak oil will set or cap the economic growth rate for some time to come. We may all dream of alternative forms of cheap energy but Japan's earthquake has reminded us that despite all its shortcomings, we are going to depend for a long time to come on those much hated fossil fuels. Environmental activists that now so vigorously oppose projects like the oil sands, Keystone and the new pipelines into BC are nothing more than the same reactionaries that fought the advance of the steam engine! In their hippie youth these activist groups earned kudos, but now rather than adding a constructive voice, their only goal seems to stop our evolution and trying to turn back our progress.

There is no doubt in my mind that working towards a sustainable economy where, just like boy scouts, we are 'wise in the use of our resources' is the way to go. We see numerous experiments aimed at achieving such goals, but stopping pipeline construction and oil sands projects while forgetting about the oil we're importing from Middle Eastern or African dictatorships makes not much sense. Yes, someone needs to ensure that our energy industries do the best they can regarding safety, environment and all stakeholders and in that today's environmental activists help us to stay on track. But their arguments are shrill, often sensationalized and hysterical. Their ideals and motives are as suspicious as those they accuse the industry and governments to have.

As investors should we expect a world of slower economic growth and does that mean lower profits? Are stock market returns diminished forever or will we return to the historical norm? Working towards a sustainable world with less material demands may result in higher efficiencies that offset the demands for resources. In the end, we will achieve even greater profits while working to a more sustainable world of robotic vacuum cleaners and clean transportation; a world of continuous sustainable improvement. When I look at today's advances in construction – the increasing number of LEED buildings - I think our economy and prosperity will continue to grow while we are adjusting to the new realities. The stock market will probably stick to its historic returns like it did over the last 200 years or even before we applied modern econometric tools consistently as we try do today. The more things change, the more they stay the same. We evolve; we learn and adjust to yet another 'new economy'.

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