If it looks too good to be true…

While gross domestic product in Newfoundland and Labrador is now forecast by the provincial finance department to shrink by 8.5%, finance minister Tom Marshall today forecast he expected to receive $520 million more than budgeted last year in oil royalties.

That’s pretty much typical of the incongruity between what the  “mid-year” financial update said about the economy and Marshall’s prediction of higher than expected revenues.

Here’s a summary of the 2009 economic performance to date in Newfoundland and Labrador, as presented by the finance department:

• Real gross domestic product is now expected to decline by 8.5% compared to 2008.  That’s worse than the 7.7% drop forecast last spring.
• Oil production in the first nine months of calendar 2009 is down 20.6% compared to the same period in 2008.
• Despite that, the revised budget projection is for an increase in oil production to 101 million barrels by the end of March 2010 compared to the spring projection of 98 million barrels.
• The value of oil production is expected to decline by 45% compared to last year.  That’s on a calendar basis. 
• Government oil royalties on an accrual basis is expected to be $1.813 billion, an increase of $520 million over the forecast in Budget 2009.
• The value of mineral shipments is expected to be down by 56% compared to 2008.
• Mining employment down by 9% compared to 2008.
• Paper production is expected to be about 47% lower than in 2008.
• Retail sales and personal income are up slightly compared to 2008.

Some quickie observations:

Apples and oranges comparisons: Most of the economic information presented in the update compares performance over a calendar year while the budget works on a fiscal year. 

To illustrate how this can have a distorting effect, consider that oil production in the first three months of calendar 2009 remained at 2008 levels of 10 and 11 million barrels per month.  However, during fiscal 2009 thus far (starting in April) , monthly production has averaged about 30% below that.  The first three months artificially inflate the average for the calendar year compared to the fiscal year.

Triple the year-to-date oil revenues and then some:  As BP reported earlier, oil royalties in the first half of fiscal 2009 (Apr to Sep) totalled about $488 million.  September’s royalties were 60% below the monthly average needed to hit the spring budget projection of $1.3 billion on an accrual basis.  Overall, royalties are running about 15% below forecast.

The fall update now projects oil royalties at $520 million higher than forecast. That’s 40% higher than forecast, despite the prediction that the value of oil production will be down by  45% and that production will be down by at least 20%.

Oil royalties are function of price and production.  Even if the royalty rate is higher in 2009 than 2008, lower production and lower average prices should produce lower royalties. 

As it is, the revised oil royalty is only 8% below 2008’s figure despite a projected 45% drop in value and a 20% drop in production.

A missing chunk:  On page nine of the budget speech from last spring, then finance minister Jerome Kennedy blamed the deficit on two things:  the impact of the stock market on pension investments (about $380 million) and lost Equalization revenue owing to changes in the formula for 2009.  That part was supposed to account for about $414 million.

There isn’t a single word about the pension plan investments and their current valuation in the update.

Hmmm.

Read the fine print:  While things might just turn out to be as rosy and wonderful as the budget forecast, it might be useful to bear these words in mind.  They come from page five of the budget update document itself:

However, at this time, there are four months remaining in the fiscal year, and there are many factors and uncertainties which may impact year end results.

Uh oh.

This wouldn’t be the first government that blew smoke to try and keep consumer wallets open through a rough patch.  There are plenty of things in this budget update that don’t add up.  Maybe they aren’t supposed to unless you realise that this update was less about the facts and more about the torque.

Whatever happens, we’ll know for sure in the spring.

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The first forecast for negative economic growth in 2010

According to the Conference Board of Canada’s latest economic projections for the provinces,  province’s that are down this year are going up next year.

All except one.

Newfoundland and Labrador’s economy is forecast to shrink 3.6% this year but the Board has now said that the local economy will also contract another half percent in 2010.  The Board doesn’t anticipate a return to growth in Newfoundland and Labrador until 2011.

It put Newfoundland and Labrador in a category of its own. That province is expected to post the biggest GDP decline this year at 3.6% and is the only provincial economy forecast by the Conference Board to contract (by 0.5%) in 2010. The board said the province was hurt by declines in forestry, mining and manufacturing this year, and offshore oil drilling is expected to remain at depressed levels next year.

Incidentally, VOCM missed the importance of that entirely.

The forecast contraction for Newfoundland and Labrador this year is the largest in the country for 2009, incidentally.

Now all of that make as a complete mockery of the line coming from local politicians.  After the collapse last year, the Premier talked about the province being protected by an economic bubble last year.  That turned out to be a version of the St. John’s Harbour bubble apparently.

And just within the past couple of weeks, environment minister Charlene Johnson was out telling a local Rotary Club audience about how the province was well positioned to weather the economic storm due to the wonderful things done by the crowd she’s a part of.

Well that’s another issue.

There’s no question however, the economic bubble was entirely fictitious.

The Conference Board projection is in line with the actual oil revenue data for the first half of 2009 that Bond Papers brought you exclusively earlier this week. it shows royalties are down 57% for the same period in 2008 and that they are 15% below the government’s own forecast thus far.

Oil production is also down.  In the first six months of fiscal 2009, production is  running about 29% below the same period in 2008.

Add to that personal income tax. Last year, personal income tax (PIT) generated $899,460, 000 in government revenue.  That works out to $4, 037 for each of the 220, 300 people working in the province, full-time and part-time.  You can find those figures using information in the provincial government’s own financial documents tabled with the budget last spring.

Government lowballed the number for its 2009 budget, projecting PIT at $786 million.  That’s despite expected growth in income  - yes, they forecast more income going around - and a decline in employment of only 2,000.  That $786 million is about $100 million below what the government’s own numbers would work out to be, incidentally.  That’s why the ones actually published in the Estimates are said to be low-balled.

Job losses are currently running higher than forecast.  In October it was 5,400 for the same month in 2008.  Now word publicly on wages but working with the provincial government’s figures and the actual performance you would bring personal income tax in at around $870 million.  (4037 X 215,000)  Now that’s a rough estimate.

Even if PIT went to the same number as last year by some quirk, it still wouldn’t offset the forecast decline in oil revenues and the drop that came in mining and the forestry sector.

The government is on track to get the budget they forecast.  There won’t be any surprises, like discovering that despite all the posturing and puffing about being a have province, the government actually opted to switch formulas and collect Equalization in 2008.  They did that, incidentally, five months after Danny Williams made his great “have province” speech at the November Tory fundraiser. It was a spectacular poll goose but it was also a fraud since the provincial government knew the numbers and cabinet knew that it would not make its Equalization election until the following March.  There is more to being a have province than a political speech, a poll goose and a rip-off video.

But that, too is another issue.

There are serious issues to be faced in the months ahead.  The people of Newfoundland and Labrador are only just now starting to see the signs.

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And now from the “No D’uh” economics desk…

1.  OPEC is warning that sustained high oil prices coupled with a weakened economy – like say in the Untied States? – could push demand for crude oil downward. Oil demand may not reach the pre-crisis level in the near to medium term.

2.  World Bank head Robert Zoellick is concerned about the persistently high jobless numbers in the United States and the impact that could have on economic recovery globally. The unofficial jobless rate could be as high as 20%, according to former labour secretary Bob Reich.  Officially it is only half that.

3.  TD Economics forecasts that Canada will experience “tepid” growth over the next decade. 

"It is critical to recognize that things will not simply return to how they were," TD economist Grant Bishop says in the report published Tuesday.

Yes, Grant, we are all glad the gang at TD Economics figured out – finally – that the crisis meant change.  When things change they aren’t the same afterward as they were before the crisis. It just takes some people a while to figure that out, apparently.

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Another tumble coming

People may be cheering the rising loonie.

Some people may be rubbing their hands with glee at the current and forecast prices for crude.

Gold is wonderful, if you own it already.

But, note the references in those articles to “weak fundamentals” and the fact there haven’t been many “signs of a pickup in the underlying oil demand in industrialized countries”.

The same sort of underlying weakness  - particularly in the American economy  - is what fuelled the surges in oil prices before the peak in mid-2008.

Remember what happened after that, right?

Well, get ready again.

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Another drop on the way?

Could be, at least if David Rosenberg is right.

Rosenberg, chief analyst at Glusken Sheff and Associates, thinks the current pricing in the markets is based on the false assumption that corporate profits and gross domestic product have already rebounded.

He basis his opinion, in part, on an analysis of the price to earnings ratio for stocks.

Furthermore, the stock rally is pricing in an employment rebound of 2.1 million and a rise in bank lending of 16.5% on average. But both employment and bank lending continue to decline.

At its current valuation, Mr. Rosenberg said the S&P 500 is priced for US$83 in operating earnings per share, which is nearly double from the most recent fourth quarter trend.

Meanwhile, consensus bottom-up estimates are predicting US$73 in operating earnings per share in 2010, with US$83 not likely until 2012.

Rosenberg’s analysis puts stocks overvalued by 20%.

In a similar way, oil has been over-valued considering the huge drop in American demand and corresponding high inventories. Prices have been dropping both for crude and refined products. NYMEX gasoline fell six cents per gallon and ICE Brent crude fell three dollars a barrel in the past 24 hours.

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RBC on NL economy: strong headwinds

RBC Economics has revised downward its 2009 forecast for the Newfoundland and Labrador with the economy expected to shrink by 3.5%.

That’s the largest forecast drop in GDP in the country and compares to the 1.9% shrinkage forecast in March 2009.

RBC also forecasts the province will have one of the  top economies in the country in 2010.

However, if you look at the chart, virtually all provinces will experience growth of nearly 3.0% in 2010 as the effects of all that government stimulus spending takes hold.

That wouldn’t be entirely surprising since Newfoundland and Labrador is also spending among the largest amounts in the country on stimulus as a percentage of gross domestic product.

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More to follow update:

From another RBC Economics report released on June 5:

• Employment in the province is expected to be down by almost 7%.  that's the biggest drop of any province.
• While our housing prices and starts are tops in the country, the resale price is expected to drop about 15%.  That's right in the middle of the pile. 
• Manufacturing sales are expected to be down about 26%.  That's the biggest drop in the country.
• Retail sales are forecast to be up by the highest amount in the country.  Most places are dropping.
  

RBC expects 2010 to be relatively good again based on increases in mineral production, the expanded White Rose project and government infrastructure spending. Here's how they view the current situation:

On the resources side, softer demand and the resulting nose-dive in the prices for commodities following last summer’s peaks have negatively affected energy and metals production in the province. Iron ore mining operations cut output by nearly 19% in the first quarter compared to a year ago and rapidly rising stocks would indicate that they will further slash it in the near term. Market-related downtime is also affecting nickel production. In the case of crude oil, rapid maturation of the province’s existing offshore oil fields will keep output on an accelerated downward track until late this year or early next when the White Rose project expansion enters into operation. Crude oil production in Newfoundland and Labrador fell by more than 4% year-over-year during the first quarter.

There are two things that should be noted.

First of all, next year's return to growth in GDP is driven by government spending.  While it's great that government had the cash to throw into a stimulus package, the amount of cash on hand is finite and will likely be consumed over the next two years.

If the economy doesn't rebound as expected, then 2011 and beyond may be different especially since the provincial government won't have the ready piles of cash to toss around.

At the same time, demand for increases in other sectors will start biting into the government treasury.  That twin challenge - increased demand and decreased resources to meet the demand - could become even more pronounced if the drop in oil production that will take place is coupled with soft energy markets and lower than forecast resource prices.

Second of all, and following out of the prospects of recovery, it must be borne in mind that the provincial economy is tied directly and indirectly to the American one. The prospects for a major turn around locally are very much tied to recovery south of the border.  Concerns about that prospect continue. RBC is forecasting a turnaround in the US economy in 2010.

The second most dismal science

If economics is the dismal science, then reporting on economic issues is in contention for the title of second most dismal science.

Take, for instance, stories about oil prices and where they might go.

There’s one from The Star and a new one this sunny Wednesday from cbc.ca.  Both take quotes from different people all of whom suggest oil prices will zoom back up to 2008 levels and beyond in very short order.

You get this kind of stuff from the Star’s reporter, for example:

All of this means that when global demand comes roaring back – as it will in China, India and other emerging economies –and returns to its pre-recession levels in mature economies in North America and Europe, the needed additional supply won't be there to satisfy the resurgent demand except at exorbitant prices.

Lack of exploration will supposedly mean tight supplies at a time of supposedly high demand on top of that and all that will mean stratospherically high prices.  The cbc.ca story is in a similar vein and both take as part of their story the recent jump in oil prices into the US$60 a barrel range for West Texas Intermediate.

But hang on a second.

The most recent spike has been caused by declines in the value of the American dollar which are themselves tied to uncertainty about the future of North American car manufacturers.

Beyond that, it’s a little bit much to take the word of the Saudi oil minister or a guy – T.Boone Pickens – both of whom, it should have been noted,  have a vested interested in seeing oil prices shoot up to $200 a barrel.

The major problem with these two stories is that they disconnect the connected and then reconnect them in a way which is dubious, at best.

Take The Star for example, which blames the drop in exploration on falling oil prices and then adds that “[t]he worldwide credit scarcity didn't help.”

These two things aren’t unrelated. 

Oil prices dropped as the credit market crashed which itself took all the energy out of what was driving heightened American demand.  All of that economic boom stuff business writers were drooling over right up to mid-2008 was fuelled by an artificially inflated supply of  easy credit.  When the cash left, so did all the growth.  Not surprisingly, we’ve seen almost unprecedented drops across the board in the economy around the world.

Demand is not going to come “zooming back”, as The Star claims, when the American economy is still struggling and cash is tight.  If oil does shoot up in price for understandable reasons – security concerns, refining issues etc – then that will only prolong the recession. 

People with only so much cash to spend will be re-thinking their plans if the cost of transportation shoots up again.  It doesn’t matter if the people we are talking about are individuals or companies. Demand isn’t inelastic, as cbc.ca suggests, for plant expansions or cross-country road trips.  That’s pretty much optional, especially if you don’t have the cash.  

The other thing they miss-connect is price and exploration.

The local oil patch is a good indicator of how some of this works.  Exploring offshore Newfoundland and Labrador is costly.  We saw a growth in exploration here in years when oil prices were well below US$60 a barrel and no one in their right mind was forecasting $100 a barrel let alone $150 by 2008 and $200 by 2010-2012.

The Hebron project  - already discovered but very costly to develop - suddenly found life when oil was around US$25 a barrel and, as we’ve noted before, only people about to be pumped full of Thorazine (r)were screaming about paying 10 times that for oil within five or 10 years.

When it comes to exploration, we can take Chevron’s 2009 capital plan as a good indicator as well of how the major oil companies tie this stuff together.  Chevron’s 2009 expenditures announced in January were the same as 2008. 

They aren’t lower.  They are the same. 

In fact, the major oil companies have announced plans to continue their capex programs. The ones slashing are smaller, for the most part.  In the case of the oil sands, companies are lopping off spending on very costly projects which have a consistently low rate of return.  In other words, the projects that cost the most to produce and return relatively less profit are going into mothballs at a time when the cash needed to build the things is tightening.

Makes perfect sense.

And, at the same time, oil companies are continuing to bring new production on stream and are exploring for new conventional oil supplies because they know they can make money at it even at US$50 a barrel or less.

Deep water offshore oil might be a technological stretch today but in a couple of years time, technology will allow that to be produced far more efficiently than oil sands.  After all, what’s down there a few miles below the sea floor is basically the same oil that comes out of wells much closer to the surface.  You just need more pipes to reach the reservoir.

Part of what we are seeing in these reports is an echo of the basic problem we noted some time ago.  Forecasts tend to  travel in packs and those packs tend to carry around the same set of assumptions.  When oil was US$35 a barrel, everyone forecast oil at those prices into the future.  As oil prices went up and didn’t come back down, the new forecast norm kept getting reset higher and higher.

All you can really see in The Star and cbc.ca is just a confirmation there are still people out there who – for one reason or another -  are still using the first half of 2008 as their frame of reference without allowing that the arse fell out of it all in the second half of the year. 

Put another way, the “fundamentals” all these people like to talk about were the old fundamentals.  They just haven’t figured out what the new fundamentals are. They have to reset their assumptions for the mid- to long-term.

And when it comes to peak oil and the end of cheap oil and all that stuff, people just have to recall the same sort of thinking from the mid-1970s.  Lots of people forecast the end of the world and super-high oil prices back then and those predictions didn’t come true. 

That’s basically because the world hit the end of $5 oil but the doom-sayers never noticed all the stuff out there that was viable at $10 and $20 or even $50.  In the current context there’s still lots of oil out there viable at those prices. 

We don’t have to go to $100 a barrel simply because the supply is there.  And over on the demand side of the equation?  Well,  let’s just say that the things which drove demand before June 2008 just aren’t there any more.

The global economy still hasn’t found its new “fundamentals” yet, but one thing is a good bet:  they won’t be the same ones we had before the Great Crash of 2008.

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NL exports down 50% in ‘09 according to EDC

Export Development Canada is predicting Newfoundland and Labrador exports will drop by half in 2009 and rebound only 7% in 2010.

“Newfoundland and Labrador will have a tough go in 2009 as massive commodity price declines and production cutbacks lead to high double digit drops for energy, industrial goods, and forestry exports,” said Peter Hall, Chief Economist of EDC.

“In 2010, gains in prices for key commodities like crude oil and iron ore will lift the value of the province’s exports, but volumes will likely weaken again as crude production continues to fall. Ongoing mega construction projects mean the long-term outlook is bright, but the export benefits of these projects lie largely beyond 2010.”

While oil prices started the year well above the EDC forecast of USD 47 per barrel, they may be right about production declines over the course of the year. Other economic forecasts have shown a forecasted 15% drop largely due to downtime at the three production platforms for regular maintenance. 

No one appears to have forecast the effect a drop in demand would also have on production levels.  According to figures from the offshore regulatory board, cumulative production in the first three months of calendar 2009 is down about 5% from the same period in 2007 and 2008.

The fishery is also expected to take a hit:

The agrifood sector accounts for 6 per cent of the province’s total export picture. While commercial fishermen have seen the combined pressures of high oil prices and a high CAD disappear since last year, faltering demand in the wake of the global recession has now set in. This will drive agrifood exports down 4 per cent in 2009 before a modest price increase adds to the underlying strength in the emerging aquaculture sector.

Exports of farmed salmon and steelhead trout could see tremendous upside as a result of the province’s significant coastline and ongoing investments. EDC does not anticipate any major quota adjustments for key species such as crab or shrimp through 2010, but there is some upside for landings of lesser valued ground fish.

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Bursting bubbles everywhere

last year the provincial government budget for 2008 forecast the provincial economy would shrink by 2.2%. Even with the economic down-turn, the economy seems poised to grow by that much.

But that was last year.

And the provincial government number was a forecast.

In 2009, the economy in Newfoundland and Labrador will shrink.  There are no bubbles to protect any economy from the recession.

The Conference Board of Canada puts the drop at 2.6% and for good reason:

Despite a positive outlook for consumer spending and construction, Newfoundland and Labrador’s economy will decline in 2009 by 2.6 per cent, the worst performance of all the provinces. Oil production continues to fall off at mature sites and the closure of the newsprint mill in Grand Falls will hurt manufacturing output.

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Norsk Hydro planning for two more years of downturn

Like the groundhog seeing his shadow, Norsk Hydro is preparing for a economic downturn that will last at least another two years.

The company said it was in the process of raising new funds, which it would be able to borrow, and did not rule out further production cuts as the global economic slump ate further into demand for raw materials.

Hydro has already announced cutbacks of 22 percent compared to last year, including at its Karmoy and Soeral smelters in Norway and Neuss in Germany.

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The fault, dear Wade…

Wade Locke doesn’t like a story in the Thursday Telegram. He dislikes it so much he called a local radio talk show to set the record straight.

Locke didn’t accuse the reporter of misquoting him in exactly those words, but he did end the conversation with the radio host by suggesting that maybe his comments were deliberately misrepresented.

Locke said something along the lines that he couldn’t imagine anyone reading the comments and coming to the conclusion he was suggesting the economy might be headed for disaster.

Locke went out of his way in the Open Line call to repeat phrases along the lines of “the future is bright” and “the future is rosy.”

The root of the issue is in comments Locke made for a news release from the Atlantic Provinces Economic Council. The headline on the story by Peter Walsh reads “N.L. economy facing disaster: experts”. The rest of the story summaries the comments from Locke and fellow economist Scott Lynch.

Here’s exactly what APEC attributed to Locke before getting into the specific suggestions Locke and Lynch had for the federal government’s budget:

Depressed commodity prices continuing throughout the year and longer would have a disastrous impact for Newfoundland and Labrador from a fiscal perspective and for the continuation and expansion of major resource projects within the province. A continuation of the existing tight credit market conditions will adversely impact small export firms and fishing enterprises and will be felt disproportionately in rural parts of the province.

If the U.S. economy continues to lose jobs as it did last quarter, then real GDP would decrease by 5% on an annual basis, which would produce a significant deep and prolonged recession. Forecasts of U.S. growth at -2.5 to -3% with recovery in late 2009 assumes that the Obama stimulus package removes deflationary expectations and returns the economy to its trend growth rate. For this optimistic scenario (successful stimulus and late 2009 recovery) Canada could experience a 1 to 2.5% decrease in real GDP, with the earliest recovery in September/October.

However, should the U.S. recession reflect the 5% decline in real GDP then Canada, as a small open economy, will follow the U.S. and be faced with a significant period of rising unemployment and declining economic activity, with recovery occurring in 2010. If, on the other hand, the recession in the U.S. is closer to the pessimistic scenario, then this may produce a decoupling of the Canadian/U.S. trade relationship and in that case, predicting possible outcomes becomes very murky.

It’s hard to imagine anyone reading that and not coming to the conclusion the boys were suggesting there could be disaster out there.

In fact, that’s exactly what Locke said in the very first sentence:

Depressed commodity prices continuing throughout the year and longer would have a disastrous impact for Newfoundland and Labrador from a fiscal perspective and for the continuation and expansion of major resource projects within the province.

Locke’s problem likely isn’t with the Telegram, Peter Walsh – who wrote the story – or indeed with APEC.

Rather his problem is that his APEC stuff wasn’t on the same page as the line being pumped by Locke and the provincial government before Christmas. The government crew have been in lock-step with one of their favourite outside consultants on this economic bubble thingy since the get go.

They were matching up word-for-word before Christmas and Locke this morning and the APEC suggestions sounded almost like a replay of what the Premier delivered to the feds last week. [edited to clean up the sentence jumble; link added to Premier's comments.]

Number One thingy: reform employment insurance to give people more money for longer.

Number Two thingy: Build ships and dole out the money so Newfoundland shipyards can get the work.

Number Three thingy: Lower Churchill. Never mind that the thing is shaky, let’s get people out there cutting brush and doing stuff of some possible, theoretical kind.

The odd thing is that Locke’s APEC assessment is actually closer to the truth than anything else. If commodity prices stay down for the rest of this year, into next year and maybe a few years after that, then there will be disaster.

But it won’t be a disaster necessarily for Newfoundland and Labrador, as in the province. It will be a disaster for Newfoundland and Labrador, the provincial government.

There’s a difference even if some people tend to forget that in these “l’etat c’est moi” days. That’s not to say there won’t be problems in some sectors of the local economy. Tight credit is going to force the fishing industry to sort itself out once and for all. Lower prices for minerals will mean that mines will shut down for periods and lay people off.

And let’s not forget that a slow down in Alberta will mean that remittance workers will either roost here and agitate for government help or leave altogether, permanently.

But still, there are mines that will be working away. There’s a new project coming for Long Harbour and the oil industry will continue to do very well, despite lower prices and reduced production. After 2009, production will pick up again. If we look farther out, then Hebron will come along.

The disaster Locke noted in his very first sentence for APEC (unless APEC misquoted him terribly) is really one for the provincial government’s treasury. Their disaster is entirely self-made. They boosted spending based solely on highly unreliable commodity prices and foolish predictions of ever higher or constantly high prices. They did very little to pay down public debt (accumulated borrowings) or sock away money in a rainy day fund. The provincial government also committed to a raft of borrowing to support the oil plays.

That put the provincial finance minister looking at 2009 with a shortfall of over a billion dollars in cash and demands for higher spending. Downturns in the market put extra costs in there to cover pension shortfalls. The 21% wage increase promise looked great politically but it was way beyond the rate of inflation even in the headiest of commodity price days over the past couple of years.

That sounds pretty much like a disaster to anyone who cares to take a look at it either from an economic or public policy standpoint.

It’s hard to imagine anyone could look at that and not see the disaster waiting to happen. Now the disaster doesn’t have to happen if the government shifts its policy direction in a number of significant ways.

That would require people in power to look at the world as it is and take appropriate action. But if think we live in a bubble, you’d be almost guaranteed to head down the wrong track.

You’d keep smiling all the way to disaster.

And it would be your own fault.

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Local math prof stirs international economics controversy

Odds are no one heard of Antal Fekete.

The Hungarian-born emeritus professor of mathematics at Memorial University in St. John's isn't someone local media  look to for commentary on economic issues.

But through a series of articles published on his website - professorfekete.com - he's earned some measure of international notariety for his arguments about backwardation of gold, the problems of unsupported debt and the global economic crisis.

Backwardation is the phenomenon of spot gold prices being higher than futures prices.  That situation happens frequently in other commodities but seldom in gold.  The difference is that gold, once used as the ultimate support  for paper currency, is a monetary commodity.

It's also a clue that the commodity is, or is perceived as being, or will be in short supply.  Logically, no one would buy gold today at a price higher than it could be purchased in as little as two weeks time.  The only reason to do that would be in a case where there was some doubt about delivery in the future.

Here's the way Professor Fekete describes the situation in his most recent article:

We are facing a pathology of the international monetary system based, as it is, on irredeemable promises to pay. People are enjoined through 'legal tender' legislation to use these irredeemable promises as if they were the ultimate means of payment, even though they are not, and the world would rather use gold and silver as the natural and ultimate extinguisher of debt. But gold and silver have been coercively eliminated from monetary circulation for the competition they offered to synthetic debt-liquidating devices.

Mainstream economics pretends that the issue has been settled for once and all. It asserts that liquidation of debt through the coercively maintained payments system has no threat to the national and world economy. Yet what is happening is that the government keeps kicking the toxic garbage upstairs which keeps accumulating unobtrusively in the attic, only to come crashing down in its own good time to cause untold amount of social damage.

In the real world it is natural law, rather than man-made coercive laws, that prevail. The pathology of the regime of irredeemable currency has not been attended to, and day of reckoning has dawned. Our pathological monetary system has allowed the burgeoning of debt beyond all rhyme and reason. It has no mechanism to extinguish debt. It pretends that transferring debt to the banks, and ultimately to the government, is tantamount to extinguishing it. However, the truth of the matter is that only gold circulation is able to extinguish debt. When it is stopped in its tracks, as it is under conditions of backwardation, debt explodes. [Italics in original]

Fekete's theories have attracted global attention since gold started backwardising in early December.  That's the first time such a situation has occurred since the early 1930s by some accounts, let alone lasted for more than 24 hours.  As The Australian columnist Robin Bromby put it:

It wasn't just the internet sites. London's Daily Telegraph was reporting the gold markets being in turmoil, with traders saying it was extremely hard to buy physical metal in the form of coins or bars, a problem the paper attributed to the emergence of backwardation.

Fekete said the development showed a drastic drop in the velocity of gold circulation and was a repeat of the situation in 1931 when, in the face of serial devaluations started by the British, gold circulation seized up. And we all know what happened after 1931 -- 1932, the worst year of the Great Depression.

It's not like Fekete hasn't been predicting this for a while.  In June - before the peak crude price and long before the credit meltdown - Fekete forecast gold backwardation.

There are plenty of people around who will tell you what everyone else says.  Sometimes it's the ones who go against the grain who are worthy of more attention than they get.  Sometimes they are a bit more clued in that people forecasting more of the same. 

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The economics of Snuffleupagus

Funny thing how people miss stuff.

Like a Bank of Montreal economist who offered this view of the provincial financial state:

"The commodity boom has lined the province's coffers," he said. "Meantime, a reversal in migration flows has sprung population growth back into positive territory after three years of outright declines - an important development given that a lack of skilled labour could be a constraint on the province as offshore development picks up speed and major construction projects come online."

If "lining the coffers" means supported spending way beyond what is sustainable then he's right, but look at that migration comment.

You'll see similar views coming from the provincial government, not surprisingly.  There's lots of talk about the growing population as another sign that the fiscal messiahs are now in charge and that their "plan" is working.

That would be the plan, by the way, that Barack Obama is following.  No, gentle reader, that isn't some effort at humour.  It's a real quote and yes, he believes every word of it.  That's just how brilliant this crowd are.  This plan  - which consists of nothing more grand than spending everything that comes in through the door - must come from all those books, well not books really but articles and magazines the Premier reads 24/7 on a go forward basis to try and keep track of what's going on out there.  

But we digress.

This migration thing.

Three years, eh.

Only goes to show how much these bank economists don't know.

The outmigration problem - and net population decline - goes back to the cod moratorium of the early 1990s. 

It hit some new records in the best years of Danny Williams economic miracle.  That's right.  At a time when the economic miracle was taking hold people were flooding out of the Happy Province in near record numbers. The chart at left gives an idea of how big the problem has been.

There are parts of the province that are almost entirely dependent on migrant labour and remittance workers.

In others - like Stephenville - the economic disaster of losing a pulp and paper mill on the Premier's watch didn't materialize solely because the workers there could find jobs in Alberta.

But yes, you say, there has been more people coming back to the province since 2007, you say.

And yes, that's true, but it isn't because of great economic opportunities in this province.  Look around, especially outside the overpass.  All those enormous, job-creating projects that were supposedly luring people back don't actually exist.

Even though he mentioned them in his financial statement, finance minister Jerome Kennedy told CBC Radio this morning that - in fact - the big projects that supposedly exist to keep the fire going in the economy, stuff like the Lower Churchill, don't actually exist right at the moment.  These are projects Kennedy and his boss are "trying to get money for", according to his own words.

People started coming back to Newfoundland and Labrador, just as they have done previously, in advance of a major downturn in Ontario and Alberta.  Only the stupid came back for jobs that - as Jerome Kennedy knows - don't exist.  The housing boom in St. John's is driven largely by the movement of people within the province toward St. John's where there is at least the chance of decent work. The open taps on those public coffers don't hurt either. You'll find detailed discussions of the whole population thing over at labradore.

It really is funny how people miss stuff. Really obvious stuff that is readily available in the public domain.  People who - presumably - actually keep track of these things like bird-watchers scanning the trees for this winged thing or that.

Evidently not.

Evidently, great big yellow birds get missed a lot.

Aloysius Snuffleupagus would understand.

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Rio Tinto to release results of OPEX/CAPEX review earlier than planned

In the wake of the end of talks by BHP to take over Rio Tinto, the latter is reviewing the books to reassure the marketplace despite the company's $42 billion debt load.

The capital expenditure (capex) and operating expenditure (opex) reviews were slated for release in February 2009, but it now appears Rio will release the results earlier.

In the wake of the BHP pull-out, BHP's stock has risen while Rio has dropped about 34% in value.

Rio Tinto owns a 59% interest in the Ironore Company of Canada (IOCC).

Now word thus far on what if any impact the Rio capex review will have on IOCC's planned three phase expansion at its western Labrador operations.

The expansion was recently cited by Memorial University economist Wade Locke as evidence supporting his projection that markets will recover relatively quickly and return to pre-collapse conditions based on "the fundamentals":

In historical terms, commodity prices are still strong, he explained, and there are positive signs everywhere. He singled out the confidence shown by the Iron Ore Company of Canada in Labrador West, where a major expansion is planned.

"That should tell you everything you need to know. That company believes the future is bright for them and they're increasing their capacity now to take advantage of an improving situation in the future," he said.

Locke made his comments last weekend. News of Rio's capex review came in mid October.  BHP withdrew its offer before Locke's comments appeared in The Telegram.

In early November, Locke hinted at an unidentified major development coming in Labrador.

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Reality, what a concept: the global economic crisis version.

Only a few short weeks ago, some were wringing their hands over the imminent peril of the perils of inflation.  This was despite the obvious signs of a looming market "correction".

How long before they notice the scope of the problem and the current deflationary pressures?

Meanwhile the state-approved economist had another go at prognosticating in the Telegram on Saturday.  Sadly, the story isn't on line. [Afternoon update:  Courtesy of The Western Star.]

On top of his prediction last month that the the provincial government surplus will be as large or larger this year and originally forecast (and that prediction after the global meltdown started mind you) he is now saying that the economy will recover from the current crisis.

Well, of course it will. A penetrating insight into the obvious is that.

Outside of a few anarchists, everyone knows it will. Even in the 1930s after the Great Depression, the economy rebounded, eventually.

The question is not whether it will turn around but what will it look like when it does recover.

Pretty much like it did before - think 2006 with oil running at 80 or 90 bucks a barrel - apparently, since all the "fundamentals" that led to high oil prices are still there we are told in the Telegram story.

Really?

Well, at least, according to the state's favourite economist.

Like the ridiculous credit situation in the United States that fueled demand to heights never seen before. 

Yep.

That will exist after the current mess is over. 

After all, it is one of the fundamental causes of the demand spiral.

Now one of the things to bear in mind through all this is that in 2004 or 2005 you wouldn't have found an economist on the planet seriously suggesting oil at US$90 a barrel let alone US$150.  Those predictions didn't emerge until oil hit close to 150 and even then Goldman was thought a bit loopy to be tossing around 200 bucks by the end of 2008.  These days not too many are willing to buy into the current Goldman idea of oil being over $100 again next year.

That's because economic forecasts have a distressing tendency to rethink the future in terms of the here and now. As oil prices climbed above first 40 and then 50 and then 70 dollars, you started to see more and more revised forecasts for oil staying that those prices into the future.  A few months or years earlier and none of them seriously projected 50 let alone the heights it reached.

Apparently, it is taking some people a while to realise the scope of the current problem.  It isn't limited to the financial services sector and the automobile sector in North America, as if it was merely a couple of companies.  There is a broadly-based - fundamental - problem and as such it will have an impact both in time and across all sectors of the economy.  [Aside:  some analysts provide a refreshingly sober view of things, as in this video from CBC Here and Now.] 

You'd be silly to think we don't have a problem right now, but you'd be equally silly to think that a correction of this magnitude isn't going to alter some of the conditions that existed beforehand and which led to the current mess.  Fundamentally altering the fundamentals will likely produces a very different situation, and that likely doesn't mean one that will see oil shooting up to US$100 a barrel any time soon.  To be sure, let's make it plain that it isn't likely to occur again for a couple decades, much like the last time this sort of pattern  - high climb and then sudden price collapse - emerged.

Some companies will continue expansion plans.  This will especially apply to companies that are well managed or that secured their funding for expansion before the string of bank crashes.  Think IOCC in western Labrador.

That's proof of a well managed company, not any sign that the company believes in historically high prices for iron ore on into the future.  Rather the company management likely knows that by lowering costs whenever it can, the company is more likely to thrive even in lean times. That's how oil companies do it.

Smart business managers don't budget on the basis of historically  - and in some instances absurdly - high prices continuing forever just because they happened a couple of times.

Governments shouldn't do it either.

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NL crude hits $51

Brent crude for January delivery hit US$51.84 in trading on London's commodity exchange Tuesday, the lowest settlement since January 2007.

Brent is the benchmark price for Newfoundland and Labrador light sweet crude.  Such a low close for January crude, and even allowing for a 20% currency premium - virtually guarantees that crude prices in the second half of the current fiscal year will average well below the government's assumed average of US$87 a barrel for the entire year.

In Alberta, the provincial treasurer today announced his province would lose $6.5 billion in revenue this year due to the economic downturn and lower oil and gas prices.  The 2008 Alberta budget assumed an average price for crude of $78 per barrel.

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The burst bubble

Only a few short weeks ago, Premier Danny Williams was claiming that Newfoundland and Labrador would be largely immune from the global economic crisis because it was protected by some sort of magical fiscal bubble.

On Thursday, Williams acknowledged that the bubble burst:

"But going out next year [2009] and the years forward … once you get into the $60 range, then you are starting to look at deficit situations."

Of course to anyone paying attention, Williams' magical bubble claim was preposterous:

1. The provincial government knew for some time  - pre-dating the October 2003 general election - that oil production would decline this year and every year from here onward.
2. The Auditor General, among others, has warned as recently as this past spring that massive increases in public spending since 2005 built on highly volatile  - and hence unreliable - commodity prices were unsustainable in the long run.
3. In October, Dominion Bond Rating Service changed the trending on the provincial government's finances from positive to stable with a cautionary note in its detailed analysis about the heavy dependence on volatile commodity prices.
4. Historic trending, coupled with an analysis of the causes of high oil prices in recent years, strongly suggested a correction would occur.  it was only a question of when the correction would occur.

New wells at White Rose and Hibernia will not restore oil output to the peak level, no matter what the price.  Rather it merely slows the rate of decline.

Hebron is not around the corner.  Even if it is sanctioned within the next twelve months, Hebron will not come on stream until sometime after 2018.  At that point, it will merely replace White Rose, Terra Nova and Hibernia which by that time will have ceased production or be on the verge of being tapped out.  One field cannot replace three.

Of course, we are already looking at deficits on a cash basis.  Bond Papers readers have known that for months.  There have been a series of posts highlighting economic forecasts of extremely poor growth in gross domestic product, forecasts that have only forecast even further shrinkage in the economy. 

On top of that, however, several specific posts addressed in detail the factors contributing to the current and future economic problems to be faced:

• On 27 October, a post described exactly the scenario the Premier confirmed on Thursday. In fact, that post underestimated the scope of the problem by assuming a much higher premium for oil sold in American dollars and then converted to Canadian dollars on a 30% premium.  The Canadian dollar has been trading at a 20% and Brent crude is trading - as of this writing - at around US$51 to $52.  That would translate to about $700 million less in oil revenue next year than this year.  This year's budget already projected a cash deficit of $414 million on current and capital account.
• A 12 March post titled "We live in a fiscal house of cards" describes the massive spending increases over the past four.
• A 21 March post titled "What goes up must come down" described the shaky foundation on which the spending was built.
• A 25 March post titled "Hebron and old people" highlighted two fiscal challenges well known to the provincial government that would boost spending at the very time that - even without a massive economic downturn - would strain the treasury.  One - the impact of demographics - has been known for decades and is unavoidable.  The other - debt for oil projects - was discretionary.

That last one is only one major item which will add to the provincial government's financial burden.  The money needed for the 5% shares of Hebron and White Rose, and possibly for a 10% share of Hibernia South will have to be borrowed, either from lenders or from the other partners.  That debt is not optional any more and in the case of Hebron, there will be no revenue for at least a decade from that project which would make the debt self-sustaining.

Any cuts to government spending in the coming months and years will further tighten the local economy and consumer spending.  The St. John's housing market, for example, is enjoying a boom built almost entirely on public spending.  Some have credited projects like Hebron but since that project doesn't exist yet, it's hard for it to generate anything but marginal economic activity. 

Nor has the St. John's market, for example, been buoyed by remittance workers.  Some of the boom can be traced to that source but the major beneficiaries of migrant labour revenue have been in areas like Stephenville or the Great Northern Peninsula.  St. John's remains a company town and the company is the provincial government.  Hack its spending, either in salaries, programs or capital works and you hack into the local service and retail sectors. Hack into those sectors and consumer spending, another staple of government revenue, will decline as well.

Nor can the provincial government look to other construction projects to boost the economy.  NLRC's refinery is dead.  The gas facility is rumoured to be still on track but until sod is broken, it remains nothing more than speculation.  Harvest Energy's expansion at Come by Chance has been shelved. The Lower Churchill project is also more talk than reality.

More than anything, the looming provincial government financial mess should put paid to the fairy tale that the current administration practices anything looking like prudent fiscal management.  To the contrary, it has shown repeatedly that there is little if any strategic planning to its spending beyond the need to present the best face to the polls or to have spending match income.

The current administration ignored any criticisms of its approach and specifically.  It emphatically rejected constructive alternatives to its spend-happy approach such as creating an investment fund from some non-renewable resource revenues. 

A former finance minister once forecast annual deficits of a half billion dollars a year. His successor borrowed $1.0 billion to fund public sector pensions.  The Premier himself committed to meet any future deficits with increased public debt.

By all appearances, he will get his wish.

The people of Newfoundland and Labrador will get the bill.

It didn't have to be this way.

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Friday Math

1.  Brent crude is trading at $58.67 per barrel.

2.  The Canadian dollar is worth $1.18 against the American dollar.

It's easier to plan a party and pump out happy face uncommunication than provide an update on the provincial government's finances.

Polling season is just a bonus excuse.

Obviously.

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APEC catches up

Gross Domestic Product in Newfoundland and Labrador will grow just 0.2% in 2008, according to the Atlantic Provinces Economic Council.

Oil production will drop 15% this year.  That's pretty much as expected.

In fact, it's all pretty much as expected, if you've been following Bond Papers and the whistling post.

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Inflation menace? Not so much.

Yes, with the world economy in a bit of a crisis and central banks and political in the West worried about recession, the inflation hysteria has subsided in most places.

Like Australia:

"The clear deceleration in annual inflation since June signals quite starkly the speed at which the inflation problem of the last few years is unwinding,'' said Joshua Williamson,  a senior strategist at TD Securities in Sydney.

"The depressed domestic economy, especially for consumer demand, together with the sharp fall in commodity prices, suggests we could be in the early stages of a substantial deceleration in price pressure,'' he added.

The biggest decrease in the index came from falling prices for fruit and vegetables, holiday travel and accommodation, and household services, today's report showed. Those declines were partially offset by higher costs for financial services, books and newspapers.

Or Europe:

European inflation edged down in October, data released Friday showed, as a result helping to pave the way for the European Central Bank to deliver another hefty rate cut next week.

Or even the United States:

As dozens of countries slip deeper into financial distress, a new threat may be gathering force within the American economy — the prospect that goods will pile up waiting for buyers and prices will fall, suffocating fresh investment and worsening joblessness for months or even years.

The word for this is deflation, or declining prices, a term that gives economists chills.

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