What happens when the sun begins to wander?

Feb 13, 2015

- By Bill Bonner

Bill Bonner
Sao Paulo, Brazil

Dear Diary,

The Dow rose 110 points yesterday. It seems to be struggling with the 18,000 milestone, as if some inner voice were telling it to beware.

An inner voice is telling us to beware too. It's impossible to know what will happen next. All we can say with any confidence is that something will happen. Probably something alarming.

Everywhere we look we see rivets popping.

The Baltic Dry Index just has an all-time low. The index measures the cost of shipping goods. As world trade sinks, so does the index (all other things being equal...which they never are).

The Bank of America says world GDP may fall by $2.3 trillion this year. In the US sales are weak. New building permits are weak. Income growth is weak.

Greece is still considering its options. We rate a "Grexit" from the euro at about 50/50 in the short term...and more like 80/20 in the long term. What that will mean exactly nobody knows...but it's bound to mean something.

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Most likely, it will mean an even lower euro. And maybe a collapse of euro-denominated, sub-prime government debt. What are the bonds of Portugal, Spain and Italy worth after Greece defaults?

That market - European sovereign debt - is bigger than the US mortgage market. When it cracks, there are sure to be fireworks. Because there are some $26 trillion in derivatives tied to it.

The falling price of oil was first thought to be a good thing. Consumers could spend less on gasoline. But a 60% drop in the price of the world's most important commodity can't happen without major disruptions.

A lot of financial decisions had been based on oil over $75 a barrel. Now that it's $50, there's $25 missing from every barrel sold. That's $25 that isn't used to drill new wells, hire new roughnecks, buy pick-up trucks or rent office space in Houston.

Speaking of which, a news item out this week tells us that as much as one-sixth of America's new office space is under construction in the Houston area...and prospective tenants are becoming hard to find.

They might even become scarcer if Citibank's new forecast for oil turns out to be correct. Citi's analysts see the price of oil falling as low as $20 a barrel this year:
    The oil market should bottom sometime between the end of Q1 and beginning of Q2 at a significantly lower price level in the $40 range - after which markets should start to balance, first with an end to inventory builds and later on with a period of sustained inventory draws. It's impossible to call a bottom point, which could, as a result of oversupply and the economics of storage, fall well below $40 a barrel for WTI, perhaps as low as the $20 range for a while.
What would happen if oil fell to $20? We don't know. But already 90 rigs are closing every month. There are bound to be consequences, seen and unseen, of a further drop in the oil price. And they're not all going to be good.

Over-building is a minor problem in the US. In China, it is huge. It is Houston times 100. China has the biggest stash of dollars in the world. It got the money by printing local currency and buying it. Most of that new money went into real estate. And when prices fall, trillions in mortgage-secured debt will fall too.

Another big seam is coming loose in the currency markets. At the end of last year, the US passed the baton of money-printing to the Japanese, Chinese, and Europeans. Since then, the hot money has rushed to the US for safety and profit. This pushed up the dollar to levels that are causing stress and strain on the whole system. .

Here again, the first reports of a rising dollar were greeted with good cheer, at least in the US. Americans thought they had won the World Cup.

But wait. There's someone on the other side of every transaction. For most of the world, a higher dollar acts like an income tax increase. For Americans it is like an export tax increase. As the dollar rises it pinches off America's industrial renaissance. That, along with the decline in shale oil investment, will mean fewer jobs in the US, less revenue to US companies, and darkening skies over the Northern Hemisphere.

Most of the world's commerce is done in dollars. The greenback is the world's reserve currency, the sun around which other currencies are supposed to orbit. It is the fixed point that that determines night from day, winter from summer, profit from loss, solvent from broke. What happens when the sun begins to wander? Well, that's what we're beginning to find out.

Expect volatility.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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