Get Ready For Biflation And The Era of Wrestling With China For Oil

Finance at First Light
Good morning! Here’s what you need to know:
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OVERVIEW

  1. Volcker “Not Worried About Deflation” — Or Inflation | Maybe we’re in for a “biflation” of rising global commodity prices and falling domestic prices.
  2. US Loses Another 12,000 Jobs | Initial jobless claims for the week ending Sept. 18 rose to 465,000.
  3. GOP Issues “Pledge to America” | The plan calls for reinvigorating the economy, reducing government spending, and repealing Obamacare.
  4. Rail Traffic Rising | That, along with growing temp staff numbers, bodes well for GDP growth in the near term.
  5. Something Seismic This Way Comes | Todd Harrison feels something funky in the air, and he fears geopolitical conflict. China v. Japan/USA?
  6. China And Japan Share Economic Interests | But that doesn’t mean cooperation, it means more competition for scarce resources.

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BRIEFING

1. Volcker “Not Worried About Deflation” — Or Inflation

Former Federal Reserve Chairman Paul Volcker, an adviser to the Obama administration and ideological opponent of the outgoing Larry Summers, told reporters at a banking conference in Chicago yesterday, “I’m not worried about deflation. I do not think we should be worried about and consumed by the problem of a potential deflation that doesn’t exist.”

So, then, is inflation the beast to fear? No. He said, “We’re in a situation right now where we’ve got a sluggish economy, a lot of excess resources, a lot of unemployment. This is not an atmosphere that’s inclined to produce inflation. I think we ought to be sure that we don’t take actions that down the road might lead to an inflationary situation.”

Maybe we’re in for “biflation,” defined last month by Nick Summers at Newsweek as “inflation and deflation occurring simultaneously in different parts of the economy — specifically, rising prices for commodities that trade in global markets and falling prices for things bought with credit domestically, like homes and automobiles.”

That’s possible with Chindia demanding commodities as US unemployment lingers and banks keep dumping shadow inventory on the housing market. Most importantly, however, Starbucks customers are already suffering from inflation.

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2. US Loses Another 12,000 Jobs

According to the Labor Department, initial jobless claims for the week ending Sept. 18 rose to 465,000.

Economic strategist Dan Greenhaus of Miller Tabak & Co. told MarketWatch, “The labor market remains weak and while any number of people continues to suggest … that robust hiring is just around the corner, such job growth simply isn’t materializing. We remain of the belief that it will not for several more quarters.”

Vicki Needham wrote on The Hill’s Finance & Economy blog that “the unemployment rate is too high and for the recovery to root, employers need to hire. The economy needs jobless claims to drop into the low 400,000s or high 300,000s to reflect stronger job growth in the private sector and propel the recovery.”

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3. GOP Issues “Pledge to America”

The “Contract with America” is so last decade. Yesterday the GOP issued its “Pledge to America,” a list of policy beliefs and legislative goals that the party intends to pursue if it wins a majority in the House this November. Written by California Congressman Kevin McCarthy, the 48-page document is introduced with ideas like these:

An unchecked executive, a compliant legislature, and an overreaching judiciary have combined to thwart the will of the people and overturn their votes and their values, striking down longstanding laws and institutions and scorning the deepest beliefs of the American people.

An arrogant and out-of-touch government of self-appointed elites makes decisions, issues mandates, and enacts laws without accepting or requesting the input of the many.

Rising joblessness, crushing debt, and a polarizing political environment are fraying the bonds among our people and blurring our sense of national purpose.

Among other goals, the document offers plans to reinvigorate the economy, reduce government spending, and repeal and replace “the government takeover of health care.” On the latter, the document begins: “The American people wanted one thing out of health care reform: lower costs, which President Obama and Democrats in Washington promised, but did not deliver. Instead of expanding the size and scope of government with more debt, higher taxes, and burdensome mandates, Americans are calling for reforms that lower costs for families and small businesses, increase access to affordable, high-quality care and strengthen the doctor-patient relationship. We have a plan to do just that.”

Eugene Robinson at the Washington Post wrote the “problem with the pledge is that the numbers don’t remotely add up. The document is such a jumble of contradictions that it’s hard to imagine how it could possibly pass muster with anyone who survived eighth-grade arithmetic … Republicans propose a hiring freeze for federal employees — exempting the defense and security sectors. Since the private sector isn’t hiring, a public-sector job freeze would only ensure that unemployment remains higher than it otherwise would have been.”

Ezra Klein, also at the Washington Post, finds that “when you get past the adjectives and soaring language, the talk of inalienable rights and constitutional guarantees, you’re left with a set of hard promises that will increase the deficit by trillions of dollars, take health-care insurance away from tens of millions of people, create a level of policy uncertainty businesses have never previously known, and suck demand out of an economy that’s already got too little of it.”

Erick Erickson, editor of RedState.com, is disappointed that it’s “a series of compromises and milquetoast rhetorical flourishes in search of unanimity among House Republicans because the House GOP does not have the fortitude to lead boldly in opposition to Barack Obama. … Yes, yes, it is full of mom tested, kid approved pablum that will make certain hearts on the right sing in solidarity. But like a diet full of sugar, it will actually do nothing but keep making Washington fatter before we crash from the sugar high.”

David Frum “had a good chuckle at Erick Erickson’s enraged piece” and wonders what Erickson and other Tea Party activists expected. He wrote that the pledge rejects the Tea Party notion that “a potential voting majority for radically more limited government” exists. The pledge declares, “Sorry, we don’t believe that. … Too risky. We don’t think the voters want that -– not the smaller, older, richer, whiter electorate that votes in non-presidential years, much less the bigger, younger, poorer, less white electorate of presidential years. And even that smaller, older, richer, whiter electorate is highly wary of cuts to programs that benefit them, Medicare above all.”

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4. Rail Traffic Rising

Todd Sullivan reported at Value Plays that North American “rail traffic surged from the traditional Labor Day week pause level of 624k to 691k last week. This number resumes rail traffic at the highest levels of the year. Both Canadian and Mexican held steady meaning the overwhelming majority of the gains were in the US. Historically, when you combine increasing rail traffic and increasing ASA Temp Staffing numbers you get positive GDP.”

The Association of American Railroads wrote in a press release yesterday: “Combined North American rail volume for the first 37 weeks of 2010 on 13 reporting US, Canadian and Mexican railroads totaled 13,717,171 carloads, up 9.8 percent from last year, and 9,921,406 trailers and containers, up 15.1 percent from last year.”

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5. Something Seismic This Way Comes

I’ve warned readers for a while now that economic trouble as bad as we’re in brings a high chance of war — real war, not the police actions we’ve grown used to. My best guess is that war breaks out over natural resources, specifically dwindling oil.

Todd Harrison at Minyanville is worried about the possibility of war, too, and what it’ll mean to the market. He wrote:

With the bears scared, growing uniformity of a rally into quarter-end, and wars of words erupting between the US and Iran and China and Japan; something funky is in the air. I don’t know how social mood is around you but I can tell you it’s been particularly prickly on my particular path (not just NYC, but the West Coast, Florida, and other cities I’ve recently traveled through). …

Social mood and risk appetites shape financial markets and while I view The Great Depression as a framework for optimism, we would be wise to remember that it was an era rather than an event. It took years, not months, before ultimately manifesting through geopolitical conflict.

Does it look like coincidence that China’s recent territorial chest-thumping has centered on oil reserve areas? Not to Japan, and not to its ally, America. As China mulls a boycott of Japanese goods to punish Japan for enforcing its territorial claim on the Senkaku islands, saying that Japan can no longer “intimidate or antagonize China without serious consequences,” Michael Richardson wrote in the Japan Times yesterday:

Indeed, one of the striking similarities between China and Japan is that each is acutely short of domestic oil and natural gas to power their economies. Yet this appears to be stimulating conflict, not encouraging cooperation.

China is already the second-largest oil user in the world after the United States [and imports half of what it needs]. … [Japan] has virtually no domestic oil or gas reserves and is even more heavily dependent on imports than China. …

China estimates that there may be 70 to 160 billion barrels of oil in the East China Sea. Non-Chinese estimates come closer to the middle of that range, at around 100 billion barrels. … both sides want to maximize ownership rights and this is contributing to assertive policies. …

Japan suspects that China is now preparing to start drilling at a disputed gas field in the East China Sea. In response, Tokyo is considering whether to conduct its own test drilling in the sea near the site of the Chinese offshore platform. If naval or paramilitary vessels were sent to guard these activities, it would raise the risk of skirmishing that could lead to an exchange of fire. …

On a visit to Tokyo last week, Richard Armitage, former US deputy secretary of state in the Bush administration, said the 1960 Japan-US security pact covers the Senkaku Islands and the US would be obliged to defend Japan if Chinese actions were to escalate.

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6. China And Japan Share Economic Interests

The reason behind China’s increasing bumptiousness is its desire to secure more oil supplies. It does that locally by taking possession of nearby reserves, and globally by asserting itself on the world stage. That’s why analysis focusing on anything else in the current spat between it and Japan — fishing rights, anger over Japan’s invasion of China in 1937, China becoming Japan’s biggest trading partner, et al. — are missing the point. Let’s have a look at the typical discussion.

Below is an interview with Haiyan Wang, a managing partner at the China India Institute, focused on the shared economic interests of China and Japan.

Have a great day!

These periodic “Finance at First Light” briefings present a glimpse into my research. If you would like to read actionable investment advice based on this and other information, please consider subscribing to The Kelly Letter.

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