What Bailout?

Bail in or bail out?

There is an old expression: 'God helps those who help themselves'. In the current subprime banking Fannie/Freddie lending imbroglio I am left totally confused about who is the good guy and who is the bad one. There are so many making curmudgeonly noises as though these government assistance plans are from the devil himself, it is downright confusing. But is it true?

Rules for systems
We do have a system of private enterprise and one principle of it is that those who made mistakes should suffer the consequences and it is that knowledge that leads transactors to make good decisions. Still, mistakes happen. And when they do remedies are not always easy to find.

Limits to rules
While it is sensible to worry about 'moral hazard' when authorities step into a system of private enterprise to intervene, you don't let the Titanic sink with all hands on board to teach the captain or architect of the ship a lesson if you can help it. And that is the right context for considering the current so-called bail out plans.

Systemic considerations are important but so are people. And it is not just the individuals embroiled in this mess that are germane but the whole of the economy and what might happen to it if authorities were to turn a blind eye to its needs.

Not part of the plan...
In this episode, there are no plans to bail out banks in order to save shareholders. There are plans to assist markets and to support Fannie Mae and Freddie Mac so that they can support banks and mortgage markets in general. Without fixing the ability to finance housing we will not be able to fix the slump in housing and it will become an even deeper disaster that will weigh on the economy and spread across other sectors.

Culpability
In the end I do not like monies to go and help with foreclosed property. That is water under the bridge of sorts. A foreclosure is the result of a concerted act taken by a bank in reaction to a 'troubled' loan. Since banks can choose to foreclose or not, or to work out or not, aiding foreclosures does not seem wise to me. Banks did make loans in which they only wanted to take the house as collateral if anything went wrong. They eschewed the time tested income requirement and down payment amount to let buyers into the market that in the past would not have been let in. Bankers got what they wanted - the house as collateral. For them help is not advisable. But for homeowners who have been caught in this mess and caught by the drop in house prices there is more of a reason to provide support.

Bankers as real estate companies
One thing this lending episode should help to clarify is what a foreclosures is. We have seen banks foreclose on homes then try to unwind the transaction after the house value has fallen. Vacant homes lose value fast. Bankers need to adopt a better strategy to deal with payments arrears other than just foreclosures and that is one of the main reasons I am against sending monies to them to help with already foreclosed properties. Had bankers instead worked out deals with existing buyers, that house might have remained occupied and while it's mortgage payment may not have been made in full, the house would have been cared for. Bankers need to sort out where their interests lie in cases such as this. They have been too quick to say that they are not in the real estate business when in fact they are. The minute they decided that the only bank-stop they wanted on a home loan was to seized the property what else were they, other than a real estate company?

My sympathies lie much more with the homeowners who could not have understood as easily what was happening to the sector as clearly as bankers and Wall-Streeters should have.

The bailout principle to should be to assist entities when the risk of their failure endangers the system or risks setting off an adverse chain of events. Help to the aggrieved should be saved for those parties who can be the most construed as victims. Assistance to the participating institutions who got it wrong and caused grief for everyone else should be withheld. But that is not always the way it has gone.

One especially bitter pill is for those who did not participate in this house buying spree because they saw 'all this coming' and now are seeing actions taken to support prices that otherwise would have fallen possibly making them buyers at lower more sensible prices that they could afford. That is the cruelest aspect of the bail out.

Supporting the economy instead of stepping back and letting "God sort it out,' the way that a 'Hell's Angels central banker' might, seems the right thing to do. This is no time to get ideological at the cost of the economy.

Have we lost our minds or just our money?

Bull move in bear market?
Fannie and Freddie stocks are see-sawing, but they have recovered somewhat. The overall market is having its weekly rebound. We warned of the possibility of a rebound this week based on the fact that stocks were so oversold - down for four to six weeks in a row depending on the index. We previously highlighted that immediately after a BEAR market signal, markets tend to show some resilience...for a while. We also point out that there are few (very few) episodes of markets falling by 20% then rebounding very quickly thereafter. So while this rebound does not surprise us we don't think it signals anything in particular either. So don't get carried away with optimism. It's just a normal stock thing; stock fling.

A rationalized view of market behavior?
Markets appear to be still chaotic. Today markets are acting like the housing starts rebound is for real. We know that some technical rule changes in NY spurred building in one of the the few existing hot spots in the nation's real estate market. It's not real and definitely not nationwide...Stocks also are up strongly on Thursday on some mixed bank earnings but is that really news you can depend on? Bond yields are moving higher. But oil prices are falling. It is too soon to call the drop in oil prices 'stimulative' but oil is now making a significant drop from it's recent high. Any respite is helpful to consumers strapped for funds. But stocks and bonds are still trying to sort out the investment environment and its risks. For the moment it still looks more like chaos than like some new strategy.

Politicos are on the fence
Politicians are worried about putting taxpayer money into Fannie or Freddie or even making backstops for them that may not be needed. But without backing they will not be there to help housing recover and without that assistance, a housing recovery is a matter of fiction. So it's not a case of playing a game called 'Congress Mae I?' The 'nays' for the 'Maes' cannot carry the day. Like it or not assistance will have to be supported. It's time to put past problems with the GSE's behind us for a while and get the new management on board with the new plan.

Bank is still a four-letter word
Its nice to see that some banks can report better than expected earnings. But let's not get carried way. Regional banks in particular are chock full of mortgage loans and the housing market is still getting worse. It is far too soon to look for good news from banks. They are tightening up lending standards, something that will limit them making more bad loans but it also will limit revenues from new loans. That leaves them in a tough spot.

IMF says risks remain-
While the future for the economy is still unclear and politicians are talking about yet ANOTHER stimulus package. The IMF remains worried about the second half particularly about US growth in Q4 when the current stimulus package has run off, when housing may still sliding, and when foreign growth may be weaker impacting US exports. So don't kid yourself. We are not out of the woods. And there is still more money to be lost - or made. Don't go bottom-fishing prematurely not even for Fannie.

Saving Fannie or Gulf of Tonkin?

The plan
In his plan to save the GSE's Treasury Secretary Paulson proposed a blank check, an undefined amount of money that the government would have access to in order to assist the GSEs should assistance be needed.

Risk of the blank check
As Secretary Paulson presented this proposal to the Senate banking committee, many members were reluctant to sign on for a blank check. Senator Jim Bunning from Kentucky was one of the most outraged Senators. He promised to fight the whole thing. Perhaps some remember the Gulf of Tonkin Resolution in which the US military was given a 'blank check' in terms of endorsing a policy response to retaliate against an attack on a US ship in the Gulf of Tonkin. That check wound up jump-starting the Vietnam war. Blank checks have a checkered past.

Risk/reward
We do not suppose any such risk exists with this literal blank check, but there are other risks to be sure. Still there is merit in Paulson's suggestion that an unlimited backing would be the most effective. Underwriting a dollar amount runs the risk that it will be too little. Paulson further argued that the check might never need be written, it may only need to be ready.

Dodd wants action
Admitting the danger of this proposal Senator Chris Dodd endorsed a plan of action, saying inaction is not an option. He hoped to get something agreed upon by the end of the week. He did not yet endorse this particular plan.

Market see, market do
As for the poor market reaction that Sen. Bunning was too quick to hoist up as a sign that the plan was bad, he is likely wrong. True, the GSE stocks did not fare well on the day as this assistance talk swirled around. Fannie's stock fell by 37%. Freddie Mac's stock fell by about the same amount. Why is this reaction not a black mark against the Treasury Secretary's plan? Mainly because the plan has not been geared to help shareholders in the first place. The plan is geared to help Fannie and Freddie conduct business not to boost the value of the stock. In the Senate meeting Paulson was asked to be sure that if any public monies went into the GSE's that the taxpayer would be protected. The Senators do not want the taxpayer to be protecting the interests of the shareholders.

Shareholders look after shareholder interests -- Shareholders may feel rightly that they are still at risk even if the assistance plan has merit. The market is not judging the efficacy of the plan. Shareholders are assessing their own risks and financial exposures. However stocks has been down severely all day and whil they did trim some losses before the close they has a relapse the Dow closed off by 92 points. The S&P was off by more in percentage terms while the NASDAQ closed higher. There doesn't seem to be much of a vote for growth there.

General Motors opts for corporal punishment

GM plans for survival:
GM is opting to raise another $15bln in cash to prepare itself for harsh market conditions. But its plan seems to save about $8bln out of operating reductions $4 bln from asset sales and $3bln possibly in new secured market borrowing against over $20bln in unencumbered assets.

Vision? SURVIVAL, not success!
None of this is about what its vision is for the future except that it is planning to cut four truck assembly plants. So in some sense this plan is about survival and what GM plans not to be.

Where the monies come from:
In terms of operating savings, the $8bln list looks like this:

$2.5bln in structural costs cots and plant closings
$1.5bln in white collar layoffs and cost cutting
$1.5bln in reduced capital spending
$1.7bln by withholding a payment to its health fund taken over by the UAW
$0.8bln due to dividend suspension though 2009.

GM shares did rise but only slightly on the day. GM credit default swaps remained expensive. One potential problem is that analysts are not fully convinced that GM can raise this amount of money. For one, when you cut staff it saves money but usually has some large upfront costs.Shutting plants also has attendant expenses.

On balance GM is trying to dispel the talk of bankruptcy by becoming very liquid. But it still does not have a plan for success. Some doubt the extent of its plan for survival. The markets today gave GM a feeble vote of approval

Feds new lending rules should make bankers blush

The Fed lists four new protections for higher priced mortgage loans secured by a borrowers principal dwelling. The list is an enumeration of the most basic common sense principals.

• Prohibit a lender from making a loan without regard to borrowers' ability to repay the loan from income and assets other than the home's value. A lender complies, in part, by assessing repayment ability based on the highest scheduled payment in the first seven years of the loan. To show that a lender violated this prohibition, a borrower does not need to demonstrate that it is part of a "pattern or practice".

• Require creditors to verify the income and assets they rely upon to determine repayment ability.

• Ban any prepayment penalty if the payment can change in the initial four years. For other higher-priced loans, a prepayment penalty period cannot last for more than two years. This rule is substantially more restrictive than originally proposed.

• Require creditors to establish escrow accounts for property taxes and homeowner's insurance for all first-lien mortgage loans

Applied to education this would be like having the government decree you could not graduate with a BA from college unless you can read. Bankers should be mortified to have the Fed have to tell them how to make loans.

Moreover, these rules will straightjacket lending and make it impossible for banks to show flexibility here and there where it might make sense. The rules are set to avoid non compliance that is why 'rule one' says that a borrower does not have show that a lender has violated the rules as part of a practice or pattern.

Forcing banks to verify income is another 'novel' idea, though for small business owners this could become a problem where greater flexibility might have been preferable.

By and large these rules will force payment schedules to reflect a full cost of homeownership including taxes through the use of escrow accounts. Hard income will have to be identified to make payments. Rolling up a new loan for a refi ( the perpetual refi option) will not be part of plan 'A' to purchase a home any more. And borrowers will not be qualified on 'teaser' rates, but rather on the highest of formula rates.

Was all this a long time coming or what?

Unfortunately there may be times when banks would want to or would be willing to relax any one of these restrictions. But thanks to Greenspan's refusal to go after mortgage fraud during his tenure when he was Chairman things have gotten so bad that now a plain vanilla standard has been set for every one. Just like Henry Ford said when he built his Model T: "You can have any color you want, as long as it's black."

Fannie Freddie and Feddie

The three legged stool for the GSEs -- The Treasury's three prong attack to stabilized Fannie and Freddie seems to be a hit - a it would a big surprise if it weren't. Saying that it could buy equity helps to underpin the stock and give promise of more funding that could come were it to be needed. Planning to expand the Treasury credit line does much the same thing, even though no amounts have been mentioned. Getting the Fed to offer discount window services under certain conditions is the final and more immediate aspect of this three legged stool arrangement.

It's vague but that its strength -- While you can argue that the plans are all vague, that is partly what makes it effective. Paulson has said he sees keeping the GSEs operating in the manner they have been. The GSEs are part of the rescue plan so they have to be kept healthy. Understand that you understand all you really need to know about them. The treasury will fill in the blanks for amounts as needed.

Yes, but...When the crisis in housing passes there will be plenty of long knives out after Fannie in particular. But for now they are on our OUR side, helping to stem the decline in housing..

Worried? Petrified about risng import prices? Don't bother

When it hits the fan you cannot escape it...
Oh yeah…export and import prices are really surging now, and you just can’t subtract enough high-rising components out to be left with anything that is tranquil.

The subtractive approach to stable prices does not work (let’s see if you subtract oil and food and… from import prices inflation is stable after all but that's because there is nothing LEFT!!).

Export price trends are weak however...
And US export prices despite a weak dollar that should allow exporters to HIKE dollar prices while they lower foreign currency prices, export prices are even MORE CONTAINED than are import prices for core items… that suggests it is still a hostile environment for trade…

Even so despite these price trends, one thing stands as a sea of tranquility apart from the storm of inflation pressures and that is…

All hail the Core CPI!
The DOMESTIC core CPI. The goods core CPI which can be compared to consumer goods ex food is still quite stable. Even the domestic core PPI (all goods) is up sharply.

Two mints in one? Two oil price effects at once?
The start of the story of core is a story of OIL. It is like those fabled mints that are two , two, two mints in one. One is a deflation mint the other is an inflation mint. Put them in your mouth at the same time and its like mixing matter with anti matter…well ok not exactly…but it doe get messy.

Policymakers, nonetheless, can suck on that one for a while and decide what to do as it melts in their mouths.

Dueling oil price effects-
The income that oil and food prices are directing away from the consumer is having a BIG impact on non food and non oil prices (core prices). That’s how monetary policy works and why economists warn not to confuse a shift in relative prices with inflation. Now if price of A is rising and price of B is not but if the price index is the price of (A+B) then inflation (headline inflation) will be rising but if most of the economy is made up of 'good B', is that inflation? Even if good A’s price goes up by a lot, is it?

Question: if a consumer’s discretionary income falls in the forest and no one can hear him scream, does it still affect his spending habits? (answer: yes).

Money - the root of all evil and inflation to boot
You are reminded that money growth in the US is NOT accommodating any inflation. M2 and MZM aggregates are lower ('LOWER,' 'down.' 'DECLINING', NEGATIVE GROWTH RATES, etc. – unlike the explosive and barely slowing Euro-liquidity growth rates…just a reminder) over four weeks as well as over three months and weak or falling over six months. It’s no wonder that inflation is finding it hard to get started.

Yes we have no inflation: or why corn does not grow in the desert
Yes there is plenty of seed (rising import prices oil etc) but no fertile ground to plant it in (weak income and wage growth) and no liquidity at all to help it grow or nourish it. You can thank bank lending standards for part of that dry gulch stuff and the Fed for the rest.

Inflation? BAH HUMBUG!

I guess it’s not as bad as it seems

I’m not WORRIED after all.

Never mind…

Central Banks: Shooting at or hitting targets?

After today’s comments looks like the IMF and Trichet are getting apoplectic over inflation.


Who to blame?
It’s a bit of a quandary isn’t it? They want to reassure or to assure us that they are in control. Yet, when inflation seems to have gone adrift they need to sound a note of resolve. But isn’t inflation’s result the outcome of their previous action (along with market forces oil etc)? So if it is unacceptable are they taking the blame by being critical? If they are what is the remedy – I refer to a remedy that is different from the policies that got ‘us’ ‘here’? Or would CB’s do it the same all over again- if given the chance? Do they defend what they have done or not? I find the posturing by Trichet/the ECB curious.

Is it excessive money growth?
ECB/Italy’s Draghi blames excessive money growth for oil’s price...but isn’t oil priced in dollars –or am I confused about this?


Why it's not money...
If someone else prints too much money (non US country) shouldn’t their currency fall without direct impact on oil? Ironically the dollar has been falling but the US has some of the weakest money supply growth and trends of the G-7! (guess that’s e-Zone and Japan). M2 and MZM in the US are negative over 3months and four weeks. M2 is negative over six months as well. What excess is there to ‘fuel’ higher oil prices? So much for the notion that money supply begets oil prices…

It’s the ECB that has accommodated continuing strong money and credit growth and IT pretends to care about money and credit growth…

Back to inflation…

Headline inflation targeting SIMPLY DOES NOT WORK!!!
My own view is that a central bank cannot target headline inflation in the short or even medium term especially amid an ongoing oil prices shock (or shocks). Even for the single-mandated ECB the implied pain on the economy to hit that target (stay under the ceiling) is just too great. Simple arithmetic says you would have to squeeze NonOil prices lower fast enough to compensate for the weighted rise in oil prices. {EG if gas prices rose 20% and if gas were 5% of the CPI non-gas prices as a group would have to fall by 1% (20% rise times 5% weight) to hold the price level in place}. With repeated shocks this would have to happen again and again. Can you imagine how hard it is to force nonoil prices to fall in such an environment? Negative 5% GDP growth might be required- or worse with repeated shocks. This is why CBs are missing their own headline inflation targets. They are missing them ON PURPOSE.

A 'good' policy choice wreaks credibility -
This admission/belief implies that ECB policy TARGET is wrongly focused. With repeated ‘oil shocks’ headline inflation is constantly shocked above the core rate. In time it destroys credibility –unless a central bank adopts a core target like the Fed. That sort or target can be more effectively managed by the BANK and it can be explained – although the Fed has NOT done that well. .

Once a CB has let these repeated shocks blow out headline inflation –and it really has little choice in the matter- getting credibility back is a bit like reclaiming your virginity. It’s easier to pretend that ‘last night did not happen’ than to convince people that the last several years of inflation overshoot did not happen (or maybe Dr Who could help with a time machine approach).


Contrast ECB to FED
So the ECB has a problem of its own making. What’s wrong is an issue of choosing the wrong policy target. The ECB and FED face very similar inflation results (headline; core) but the Fed is controlling its measure relative to ‘target’ (…actually it’s not a real target but the Fed speaks of comfort zones and inflation is inside the Fed’s Zone on some measures). The ECB is simply NOT hitting its target and NOT dealing with that very well.


Find ANALOGY with money supply targeting:
I compare all this to the ‘good old days’ of money supply targeting. We used say that weekly money numbers are money ‘demand’ since the Fed did not control weekly money. But over time the Fed would adjust ‘monetary policy’ to bring the growth rate of its chosen aggregate back into target. In the current scheme, headline inflation is playing the role of weekly money supply and core inflation is more the role of longer term money growth. But central banks DO NOT articulate their policy this way. Not even the BOE is very clear about what is the acceptable divergence from it’s ceiling but it is clearer in speaking of the problems than either the ECB or Fed.


Despite transparency: "Mums the word"
Basically CBs are reluctant to say what we know. A long as oil SHOCKS continue they (central banks) cannot hit any headline target! It’s just that simple. But when the shocks stop core and headline inflation will merge and CB’s want to make sure they merge at the core pace and at a moderate core pace.


CBs walk the walk but don't talk the talk
All of this gets to MY ongoing concerns that central bankers know how to make policy better than communicate it. I think the Fed and ECB are each doing about the right thing. But that is not the perception. It isn’t even the ECB’s implicit assessment of itself! To be tough on yourself can be good- but too tough and you suffer a nervous breakdown. Let’s hope that the ECB knows when to stop its self inflicted public flagellation.

The Fed and Lessons of History

Gerard Baker in a Timesonline article wrote an interesting piece on the Fed and its critics linking them to a dispute over their views of the proper historic precedent for policy.

You can find the article by cutting and pasting this address to your browser:
http://business.timesonline.co.uk/tol/business/columnists/article4289018.ece

While Bernanke may be swayed by his knowledge of the Great Depression, there is no evidence that has has not learned the lesson of the last oil shock in the early 1970s.

The Fed is monotone on the issue of anchoring inflation expectations I don't see how anyone can think the Fed is unaware of the inflation risk from oil.

Maybe the real history lesson here is not about which lesson to learn- but who learned it.

The other statement about history is that it is a recollection written by the winners. In the case of inflation, history is written by the survivors. One point is that those who have seen this sort of inflation before know how dangerous it is.
Survivors remember the Fed's obfuscatory rhetoric from last time. So once again the Fed is at it and not singularly focused on inflation due to the banking sector turmoil.

But does that make the Fed an inflationist? I don't think so.

Rising oil prices make oil consumers poorer. They drain spending power and this happening to all countries around the world. Monies are being transferred to oil producer nations who generally have a higher propensity to save. So high oil prices are a growth-reducing event.. With the US economy already beset with financial turmoil, falling house prices and contracting lending the Fed wants to be wary of yet another contractionary event.

But the Fed has cut rates and inflation is rising so inflation survivors are wary- they have seen 'this' before. Or have they?

They have not. Money growth is weak. M2 and MZM money growth rates are negative over 4-weeks and mild to negative over three months. The Fed is not fertilizing inflation. Moreover the headline rise in inflation is unavoidable. To hold the headline rate 'in target' at all times would imply pushing other prices down as oil prices rose -a very painful approach and one THIS economy surely could not stand and continue to grow.

So for a while the headline inflation will continue to be excessive. That is no black mark on th central bank. As long as oil shocks continue to boost oil prices to higher and higher levels this configuration will continue: headline inflation will exceed core inflation. Once oil reaches a plateau or backs off then we will see core and headline inflation come together again. If the central bank has done its job they will converge at a still moderate level. That is why the Fed is working to contain CORE INFLATION and that is the point of it.


The Fed is doing nothing to moderate the rise in relative oil prices as the money growth figures show us. The Fed is guarding against inflation transmission by forcing the high oil price to push other prices down. By the way, while US interest rates are lower than the ECB's US money and credit growth still are much slower in the US than in Europe. Even more than the ECB, the Fed is not printing extra month to 'inflate' away 'the problem' as Aurthur F Burns did in the early 1970s.

So why aren't core prices falling if the Fed is not accomodating the oil price spurt? It's because the Fed's powers work over time. In the short run people do things to maintain spending (dis-save or sell assets etc) and that delays at the impact on nonoil prices. But as long as the Fed does not accommodate inflation, the rise in oil prices will not be inflationary but instead will become a hike in the relative price of oil and that will force great and painful change on the economy. The inflationist central banks try, in folly, to spare that pain. The Fed is not on that path.

But this Fed's head is Ben Bernanke and he knows the risks. He read the history - all of history. He even wrote some it... He is no Arthur F Burns. At some point even inflation survivors will have to give him his due.

Why did the chicken cross the road?

Who'd a thunk it?

Coffee and gas are complements. When the price of gas goes up people buy less gas and less coffee. Now Starbucks has launched a widespread store closing campaign. Instead of Starbucks on every corner there will be relief and some possibility for the small independent coffee shop at last - maybe.

The real story is how people have turned to coffee to save money on gas. I know a number of commuter folk who have vowed to give up their Starbucks to help lighten the burden on the their budget from gas prices.

500 more stores to close and 7% (12,000 jobs) of their workers to hit the pavement. I suppose an unemployed Barista could pump gas, but it wouldn't taste as good.

Starbucks reports that its research said some people were not willing to cross the street to buy a cup of coffee. No wonder they willingly have given it up as gas prices rose. These people are not really coffee lovers. Starbuks had a buisness bult on what? Apathetic consumers?

So why did the chicken cross the road? Maybe to get gas for his car but not for a cup of Starbucks java.

Here we go again?

Let's see...stocks, CDOs, oil?
Once upon a time...a long long time ago...Investors piled into tech stocks in the belief that it was a new economy with a new all-star sector. That conviction prompted relentless buying of 'New Economy' stocks and propelled a bevy of overpriced start-ups.

It proved to be more of a house of cards than one of chips and the tech bubble did burst.

The best of the best of the best of the best - Now we wear black
Next, it was a dark and stormy night...our best and brightest decided that they could turn uncertainty into risk by using some complex statistical process, credit enhancement, some bat wings, an eye of newt and such. But packaging straw and spinning it into gold has failed in the past. As it turns out, the only spinning was the yarn that told this story. Packaged CDO's were as big a bust as any ancient alchemist's promise. Our best and brightest failed us again. They called it gold, and priced it accordingly, but it rightly belonged in our septic tanks.

So what is that they are at again?


Oil prices... justifying ever higher oil prices.

Just trust me...one more time
Tech stocks spun estimates of market value and future sales that were wild. They became the basis for buying. CDOS promised to transform risk with sophisticated models mangers could not understand so they assumed the models had to be right - wrong again! The bill for those CDOs came COD, and hey I think that is the deliveryman at the door right now. With oil experiencing gains based on forecasts about things we cannot possibly know- they truly are at it again.

T-bone has his stake
Oil prices are crazy. They are extremely high. They continue to move up in spurts bolstered repeatedly by the same news -- again and again. The increase in REAL oil prices has surpassed the hike from 1973-1979. The main cheerleader for higher oil prices are not oil companies or producers but speculators and hedge funds. Yet we continue hear that speculative money is not behind this move. Right.

...and I do not know what I do not know
But we do not know about oil supply and demand that exists today, let alone what it will become five years from now. Because of steep-sloping short run supply and demand schedules the market clearing price can be quite volatile in the short run. Still, history tells us that the more that oil prices rise the more that we will get conservation and a supply response over the following period. Yet forecasts continue to find tighter and more squeezed oil market conditions in the future, as supply responses are ignored conservation is factored out and new demand from China and India are factored in.

Science in action or science inaction?
The relentless rise in oil prices because of China's and India's demand growing is not really scientific. It may not even happen. If high oil prices sent the global economy into recession China's and India's plans to develop could slow. China is creating pollution hand over fist... Is the world going to simply allow that to continue as the polar ice melts? China has pegged its exchange rate to take advantage of US China trade. Will that continue to drive China's growth as US consumers become bogged down in debt? There are an armload of issues that could slow China rapidly.

What goes straight up, must come down - As you look ahead and 'make up forecasts' about an unknown future, realize that the world can change in many ways. So cranking up oil prices for reasons that seem to have some validity today could prove another fatal error. One of the lessons in markets is that when prices go straight up, that price rarely sticks. I don't see why oil should be an exception to that. The faster and farther that a price rises, the less we know about how the economy- demand and supply as well as competition - will react to it. Remember that in economics it is the price mechanism that makes things work. A high price is supposed to be remedial.

The invisible hand at work or just a finger?
On balance oil is another of those famous bubbles. The higher the price goes the less likely that it will be sustained either because it will crash the economy and bring world demand down or because it makes substitutes viable- oil shales, tar sands, and other fuels. Let me go on record to say that these high oil prices are dumb. Its way too much way too fast.

Growth: Is it back on track?

The ISM surprised us in June by rising. The rise was not much. Just a gain to 50.2 from 49.6. But in moving up above 50 The ISM is in a cohort, or range, from which the ISM is rarely dips into recession.

Recession Probability &
The ISM PMI Values
	Probability
ISM Value	Of Recession
40 and lower	87.5%
35-40	74.2%
45-40	59.2%
50-45	15.4%
55-50	3.7%
60-55	1.7%
Current value:	50.20

Recession seems improbable

The ISM table above shows that in the range of 50-55, recession occurs less than 4% of the time. In the range 45-50, recession occurs about 15% of the time. But slip below 45 and the recession probability surges to 59%.

But is it?
Still, the ISM component readings registered weaker in their ranges constructed by ordering instead of by value. If we order the ISM and its component values by a simple queuing process from low to high the June component rankings would reside lower in the queue's percentage position than they would rank as a percentage of their cardinal position in a range of highs and lows.

This suggests that the current readings are not as strong as their range percentiles say.

Adjusting the PMI
To flesh this out, look at the PMI reading itself. At 50.2 it stands in the 43rd percentile of its range, below the range midpoint. Yet, by simple ranking (ordinal not cardinal) the PMI also stands in the lower 23nd percentile- much weaker. That means only 23 percent of the PMI observations stand below it, whatever their values. If the PMI were to slip to register the raw reading that produces the raw reading as a percentile that matches its ordinal percentage reading, it would have to drop to a raw reading of 44.9. And at 44.9 the probability of recession is much higher.

How solid is the PMI?
What these numbers suggest is that the PMI does not rank as solidly as the PMI value's percentile standing suggests. Its precise level is not yet as low as it gets to be in recession, true. Yet in terms of the number of weaker readings that lie below it, there are not so many of them. This raises the possibility that the ISM could turn weaker quicker than we expect. It is a finding in line with what we are seeing in the economy at large.

Reconciling the ISM's standing with reality
Weak economic readings persist but they are not of the magnitude of weakness that recessions generate. Still, they seem low by our own experience, and they are. They are weaker than their current level seems (at least for the ISM ) since only 23 percent of the time are they worse. It is not recession yet. But it might not take that much to tip us there. The BIS (Bank for International Settlements) already has warned that oil prices put us closer to the tipping point.

So, is growth more assured with the ISM's recent move up over 50? I don't think so.