Battleship



As JP Morgan famously remarked, markets fluctuate; its impossible at any particular moment to pick trends out of the background noise. Nobody can say for sure whether tops or bottoms are in. Trends only reveal themselves in the rear-view mirror, even as they are obscured by non-stop advertising campaigns and PR. By the time a trend is clear it is usually too late for investors — otherwise known as ‘fools in the market’ — to do anything about it, the free lunch is already eaten and the punch bowl taken away …

Triangle of Doom 042916

Figure 1: Is the bottom in? Chart by TFC Charts (click for big). Oil prices have been fluctuating higher in futures’ markets but nobody can be sure whether prices will rise from here or head back for the cellar.

With current prices at- or below the cost of extraction, drillers look to survive by reaching for the plastic, offering themselves and their properties as collateral. This is a medium-sized problem for drillers: along with all the other industries they have been borrowing from the beginning of time. In the good ol’ days they borrowed less, now they borrow more while praying for the trend change that brings that punch bowl back.

Ordinarily, the oil drillers’ customers step forward with their own borrowed funds to retire the drillers’ loans. Customers don’t simply sign over the money to the drillers, they over-pay for drillers’ products. This is what the term, ‘sustainable business model’ actually means; customers pay higher prices for successive rounds of cheaper-to-produce goods; the margin is used by firms for debt service and the retirement of maturing loans. Naturally, as each round of financing is rolled over the firms borrow more. Some of this money flows to executives, by way of this process CEOs become tycoons. Economists gain as well because every increase in borrowing represents GDP growth they can take credit for.

Fast-forward to the present: goods are unaffordably expensive to produce, emptied-out customers are no longer able to over-pay. They have nothing to offer as collateral for loans but their (near worthless) labor and frantic urge to Waste as seen on TV. Because the customers are unable to borrow, they cannot benefit the drillers, the drillers must borrow for themselves and pray …

Because the ‘waste as collateral’ concept is absurd/ridiculous, both the customers’ AND the drillers’ loans are effectively unsecured. This leaves a maturity mismatch between drillers and their customers. Firms are borrowing tens- of billions of dollars even as their customers are standing in line at the food bank. Customers cannot borrow => they cannot overpay => prices crash as drillers have no place to put unsold crude => whatever collateral the driller offers becomes worthless. The customers stiff their lenders => there is nothing for lenders to seize. At the end of the day, drillers, customers and lenders are all ruined … this dynamic is playing out in real time, right this minute, under everyone’s nose, all over our Great Round World.

This is perfect if unremarkable sense; conditions within oil industry finance must reflect resource depletion and it is clear that they do. The non-stop PR campaigns touting driller technology, efficiency and innovation are irrelevant, none of these things touch the customer. Losses cannot be made up with volume. Real returns, solvency and cash flows matter; when customers cannot gain the means to buy fuel industry products there is ultimately no more fuel industry. Redistribution, or giving customers the means to buy fuel is an immediate-term (non)solution. Some expensive time is borrowed until the customers’ financing is exhausted. Because resource waste offers no tangible returns to the waster; his credit will eventually run out, he will waste no more.

Meanwhile, the drillers must borrow or go out of business while lenders hold their noses and lend! The alternative is an output crash; we are caught between a looming crash and conditions that are pregnant with crash possibilities. Credit access becomes a matter of desperate necessity with every borrowed dollar lodged against the lenders’ deteriorating balance sheets. At the twilight of the petroleum age, drillers survive by cannibalizing their bankers who in turn are becoming the global economic link under the greatest strain.

Giant finance firms preserve the illusion of system sufficiency by lending to each other. Self-pleasure here is deadly; the lenders have become zombies rotten with non-performing loans. Growth is stagnating, economies are falling into deflation, turning Japanese. The zombification of the banks becomes both the reason for- and the consequence of extraordinary monetary quackery: the intent is to goad finance into squeezing out every possible loan, to kick that can one more day while hoping for a miracle. For business as usual, there is no alternative: interest rates fall to zero- then negative, currencies depreciate, pensions are looted and depositors bailed in … we must endure these abuses or else! Everywhere in the Westernized world useless industries and sectors are propped up regardless of consequences. Deflation results from the longer-term inability of billions of end-users to gain purchasing power or returns on capital from a mechanized regime that is designed from the ground up to annihilate capital.

No capital, no purchasing power, no problem; we’ve got iPhones, instead!

Blows are starting to rain down on the technology sector. Instead of saving our bacon as its promoters endlessly insist, the industry is having problems saving itself:

AAPL

Figure 2: It isn’t just the energy sector: looking at this pretty chart (Yahoo Finance, click for big): Apple’s decline looks to be part of a longer-running trend rather than a fluctuation. The firm reported earnings, which were terrible; the company is being punished for its customers’ misbehavior.

Rotten Apple: Stock plunges 8% on earnings, revenue miss

Everett Rosenfeld

Apple reported quarterly earnings and revenue that missed analysts’ estimates on Tuesday, and its guidance for the current quarter also fell shy of expectations.

The tech giant said it saw fiscal second-quarter earnings of $1.90 per diluted share on $50.56 billion in revenue. Wall Street expected Apple to report earnings of about $2 a share on $51.97 billion in revenue, according to a consensus estimate from Thomson Reuters.

That revenue figure was a roughly 13 percent decline against $58.01 billion in the comparable year-ago period — representing the first year-over-year quarterly sales drop since 2003.

Shares in the company fell more than 8 percent in after-hours trading, erasing more than $46 billion in market cap. That after-hours loss is greater than the market cap of 391 of the S&P 500 companies.

AAPL is not some disposable startup at the end of a cul-de-sac somewhere in suburbia, it is (or was) the world’s largest company by capitalization. It is the technology sector’s tech company. When people hear the word ‘progress’, chances are they think robots and iPhones. Yet, markets are becoming unfriendly for the behemoth: its shares presently lurk at a support level, that if breached, would indicate a decline to $55 or so … from $125 per share a little over a year ago. In other words, a slump that mimics the fuel price crash.

This is very serious business. Stockholders are a who’s who of finance: pension funds, sovereign wealth funds, central banks, private equity and hedge funds. Shares are collateral for billions in debt that has been used for stock buy-backs and mergers. The entire tech investment ecology is at risk. Damage from a sixty-percent-ish price decline would be severe. Leverage against the shares applied backward compounds the damage just as it expands returns on rising prices; this puts more pressure on the hapless lenders reeling from their debacle in the oil patch. It isn’t just the money: against a backdrop of hand-wringing and denial, the science fiction narrative of a future running on innovation (and sharp business practices) is falling apart.

Ironically, Apple is constrained by a cleverness shortage: successive iterations of iWhatevers have become predictable variations on now-familiar themes. Offering customers novelty in modest increments at stratospheric prices has consequences; buyers are skipping over the brand and buying cheaper look-alikes. Commodity ‘clone’ products represent the race to the price basement, they can’t generate the marginal returns or snazzy narratives that support inflated share prices. In this sense, Apple is a victim of its own success, it must either compete going forward with its imitators on price or invent the next great must-have-at-all-cost consumer product that will re-establish its position of leadership in the technology firmament.

This is what AAPL has come up with …

bmwi3-800x448

So much for redemptive innovation and technology … Apple aims to reinvent the Dodge Caravan. It turns out all roads lead to more and more roads. Why not battleships, instead?

Battleship1

HMS Dreadnought, a brilliant technological achievement in 1906, it was rendered obsolete before its keel was laid by the airplane.

Apple cannot be serious! In choosing the car, AAPL lurches in the direction of the hapless Japanese, who make brilliant cars (made brilliant battleships) but cannot return value to the cars’ users (neither do battleships). The auto (battleship) industry is a subsidy hog, it twists in the wind even as it is on life support. By way of its actions, APPL admits its customers can no longer subsidize the company and its lenders, it looks instead toward the government (just like battleship manufacturers), to gorge at the public trough.

ATSLA1

Figure 3: TSLA, another investors’ darling, (click for big). Strapped customers can afford the cars by bellying up to their friendly sub-prime auto lender for eight-year loans. Even this absurd financing is inadequate without billions in additional subsidies. These in turn can only come from finance, the same industry under so much solvency pressure from resource depletion … resulting from over-reliance on cars (battleships).

And all for what end? Nobody connects the big picture dots behind the empty gestures; battleships, Teslas and iPhones are status symbols, worth little- or nothing outside their self-generating, hubristic narratives. “In the long run,” said Keynes, “we are all dead”, it seems certain that we have to humiliate ourselves first.

25 thoughts on “Battleship

  1. Ken Barrows

    If a lender holds its nose before lending, I am assuming it anticipates the transaction will be unprofitable. So why lend other than the expectation that the Federal Reserve will make the transaction profitable? When will the lender stop holding its nose and just not lend?

    1. steve from virginia Post author

      No loans and the entire industrial regime falls apart. There are no organic returns (except to agriculture) so choosing to lend or not is simply not an option.

      This became clear after 2009 when the US govt refused to prosecute lenders and their clients. Their argument at the time was the lenders were ‘too big to jail’. It was rather the lenders are ‘too critical to the functioning of the status quo to jail’. Even a marginal reduction in lending capacity would be fatal.

      That’s why lenders who got burned w/ subprime house loans are making car- and student loans to subprime borrowers.

      1. steve from virginia Post author

        I saw that I had to laugh out loud.

        When western North Dakota becomes a waterfront resort it will be a great place to live!

  2. Tagio

    Thanks, Steve, another great article.

    “It turns out all roads lead to more and more roads.” What a gerat literal truth and metaphor.
    It does indeed seem that we have reached the end of the road regarding new life-transforming discoveries and inventions. Most if not all new “stuff” seems directed to supplanting and pillaging existing systems, like Uber (supplanting the taxicab industry by sidestepping all the regulation and capital costs), or AirBnB (supplanting the hotel / motel industry, sidestepping all the regulation and capital costs), etc.
    Satyajit Das, “Innovative destruction, not disruption” https://www.youtube.com/watch?v=D-ysUu-sT1Q

  3. dirtfarm

    Sadly Apple has little debt. Why such poor results? Why do corporations carry so much debt? Most small businesses I know have little to no debt and do quite well.

    1. steve from virginia Post author

      Corps borrow to buy their own shares or other companies. In both cases, this has tended to result in higher share prices and larger executive pay packages.

      Debt is a response to Steve’s First Law of Economics: ‘The costs of managing any surplus increase along with it until at some point costs exceed what the surplus is worth.’ As firms grow and accumulate large surpluses a mechanism is required to shift the growing costs to 3d parties and to counteract them at the same time. That mechanism is debt: a company like Apple borrows indirectly; that is, its customers borrow in Apple’s place, and take on repayment obligations at the same time.

      Larger the firm = larger the firm’s surplus related costs = larger loans needed to offset those costs. As surpluses increase so do related costs. As credit surplus increases, costs (interest rate) decline. A $100 loan might cost 400% interest. A $10,000 loan might cost 20%. A $100 million business loan might cost 3%. A loan to Japanese govt for $100 billion … well, you have to pay in order to lend. Of course, interest costs are not the only costs related to lending, many are indirect, biggest is finding 3d parties to retire the large loans.

  4. Jb

    Steve,

    I’m hoping you can shed some light on the opinion that ‘peak demand’ is ‘dead as disco’ according to Sam Ori / Chris Nelder on Twitter the other day. Vehicle miles driven is increasing in urban areas and declining in rural areas. According to an 2012 AARP survey I found online, 64% of people use credit cards to buy gasoline.

    Is it simply that we can (and probably will) continue to increase our driving because we still have access to credit? Once the price of gasoline is higher than our ability to borrow (defaults looming) the miles driven stat will come down or at least flatten out like it did in ’08?

    Thanks as always.

    1. steve from virginia Post author

      ‘Myth Number One’ is the way we live now is both set in stone and also certain to ‘improve’ (more stuff) at the same time. According to this myth, economic growth isn’t the outcome of specific policies (such as moral hazard) but rather a natural phenomenon like sunrise that unfolds all by itself. We humans (liberals) are constantly screwing up and constraining the growth phenomenon … by making policy blunders such as over regulating, weakening/strengthening the currency, encouraging/restricting immigration, raising taxes on businesses (and business tycoons), raising real wages, considering the environment, etc.

      In real world, growth is entirely credit dependent, on increasing sophistication of credit infrastructure and on ability of firms and individuals to borrow. As one deteriorates so does the other. As available resources shrink as they must, credit — which is a claim against resources — must shrink as well. What everyone is getting right now is a lesson in purchasing power; the numbers change on the loans but what the loans buy is diminishing.

  5. Laserninja

    Where I live (Portland) there are huge number of new apartments being built because the millennials streaming in to town ( not sure what they do for jobs) can’t finance homes or condos. I figure this growth in apartments instead of houses is not only a matter of cost, but also because the rental income stream is being financialized by some part of the banking system which has better access to shrinking credit ( closer to the fed) than the millenials with low incomes and high student loans. Just a way to shift around credit growth to keep the machine going.

  6. Laserninja

    Steve,
    Have you refined your thinking on what happens when the defaults in the Tight Oil ( or higher cost oil) run their course and the oil availible is far below what we currently think we want? I think at one time you beleived that shortages and rationing were the logical outcome because their would be no credit availible to bid up prices. Is that still your thinking on what will happen on the street when this plays out?

  7. ellenanderson

    The media cartels are a big part of the tech producers problem right now. I can no longer afford to pay Verizon for a land line plus ATT for a mobile line plus Hughes for a satellite connection. Next month I am cancelling the mobile service and dropping back to the cheapest land line (where the next town is viewed as a long distance call.) Will keep the satellite service for the moment and tell people the only reliable way to reach me is by email. That will save me close to $200/month.
    A lot of people are talking about doing the same thing. They can’t afford the huge monthly bills from ATT and Verizon. People with TVs also have to deal with ComCast. So I would guess that most people find themselves paying as much for their media on a monthly basis as they do for their carz. Guess which they will choose if they must choose? Maybe that is why Apple is making carz – because as you say, all roads lead to roads.
    I used to be such a mac enthusiast thinking maybe Steve Jobs would make an IBike. Well that was silly of me and reveals my cluelessness back then. But I can tell you that he would never have made a mini-van!

    1. steve from virginia Post author

      I believed at the time that Apple Inc. was a short-sale candidate after Jobs died. Jobs really put his stamp on the smartphone business by emphasizing excellent design and highest level of craftsmanship without skimping on ‘features’. Newer smartphones are derivative of original iPhone models and cheap, with the plastic-y feel and useless bells and whistles (that run up the monthly bill). Apple has become another ordinary consumer electronics manufacturer like Samsung, with little imagination.

      The iPhone 4 was really the last of the Jobs’ smartphones, it’s really quite elegant: Iphone 4

      The follow-on phones = generic.

      BTW, there are different cell-phone plans that don’t carry the tariffs of the Big Four: http://www.pcmag.com/article2/0,2817,2375644,00.asp

      1. Mister Roboto

        I don’t do a whole lot of talking on the phone, so I have an old-fashioned “dumb phone” (which is actually a pretty amazing device by the standards of fifteen years ago) that I bought at Walmart for $20 that has pre-paid minutes. I have to make sure my phone is sufficiently filled with “minutes” the way an automobile-driver has to make sure they have fuel! (I take the bus to get around the major Midwestern city in which I live, BTW.) So…I guess I’m just trying to say I’m not like most people in this country and I don’t really want to be, which is probably why the only friends I have are online.

  8. Oilcrashing

    Hello everyone,

    Steve, it seems that USD has been experiencing some weakness during the last few months, compared with its prior super-strong performance. It is widely assumed these days that there is a strong correlation between Oil/Commodities and the USD, however a strong USD is also affecting US exporting capacity.

    Consequently, USD has failed to retain its value as the FED delays and slows the rate hike pattern, and the US economy is starting to show some signs of stagnation: http://www.reuters.com/article/us-usa-economy-idUSKCN0XP0BQ . As a result of it, both EUR and YEN have experienced a surge in their value, despite the fact of the continuous expansionary policies implemented by ECB and BOJ.

    Considering these facts, the following article states that both Europe and Japan’s economies stand to lose heavily if the USD continues to show weakness: http://www.zerohedge.com/news/2016-05-03/currency-war-europe-and-japan-cant-afford-lose , so my questions are: Will another Oil/commodities downturn make the USD stronger, or is the USD destined to be traded at a lower value since the US economy cannot sustain such a strong currency? Which one of the abovementioned factors is going to weigh more? What currency is going to win this race to the bottom?

    On the other hand, I presume that a strong EUR/YEN will also affect negatively Europe and Japan, so the USD will gain value again. I will appreciate if you can shed some light to this situation…

    Best Regards,

    1. steve from virginia Post author

      There is a ‘dialog’ between ordinary consumers vs. their bosses, rather, a struggle for the outcome.

      Who controls the fuel supply marketplace (and the money supply that is part of it)? Since the overall outcome is set in stone we have to work backward to see how we most efficiently get to that outcome.

      – The overall outcome is resource (capital) exhaustion, not necessarily in the absolute sense. Capital will remain in the ground but will be unavailable due to cost. There is no way to escape capital exhaustion, it is a consequence not an scenario. The only issue is ‘when’ does exhaustion manifest itself? Sooner (my observation) or later (everyone else’s fervent hope).

      – The marketplace dynamic that causes/allows for rapid decline in fuel availability is a deflationary scenario whereby credit evaporates and non-credit activity (human labor) is responsible for accessing fuel.

      – The struggle between control over the market is certain to be won by the customers as all fuel products must be sold to an end user and consumed (destroyed). Finance ‘ownership’ of fuel supply = excess fuel in storage = ‘glut’.

      – While the fuel- and currency markets will fluctuate, market participants cannot retrieve lost capital, nor can they offer means to access remaining capital that costs less means made use of in the past. A ‘strong’ currency is conventionally measured by comparing it to other currencies in currency trade. In reality, a strong currency offers the best (most certain) ‘deal’ for petroleum products at any given time … for end users. This does not mean the dollar trade in currency markets is non-relevant. However, the crude-for-dollar trade along with the dollar for ‘Brand X’ currency trade together … gives the dollar an advantage overall that other currencies cannot match. The biggest reason is the long-running goods/credit trade with all these other countries.

      One of the caveats over here is that it is hard to tell whether a market move at any particular point represents a trend change or simply traders making markets (and making money). There is a lot of noise (manipulation) in different markets but one thing is pretty clear … customers around the world are not getting richer and their resource waste is not making any aspect of their economies’ ‘better’.

      thanks!

  9. Eeyores enigma

    I am currently of the mind that as far as the general public will know collapse, that is resource depletion and biosphere degradation, will just be an economic issue.

    Most will feel collapse as an economic issue and will be told that recovery is just around the corner.

    This allows collapse to be managed to some degree and allows the wealthy elite to continue to live somewhat as they always have.

  10. Creedon

    http://peakoil.com/business/russia-nears-launch-of-ruble-priced-oil-trading-platform Steve, I know that you say that the dollar equals oil, but I wonder if at some point in this end game, and I think we are getting close to the end game, oil producing countries like Russia will be able to sell some oil in their own currency and that this will have a detrimental effect on our currency. If you were an buyer of oil on the world stage, would you want to buy oil in Rubles. I don’t think that at this point we will invade Russia to stop them, although I am sure we will try anything else.

    1. steve from virginia Post author

      Briefly (this is a large and complicated subject): Russia sells oil now in roubles but only in Russia and in countries that trade with Russia and have access to roubles.

      Russia would certainly like to lend the roubles but what would the advantage be to the borrower? Would oil be cheaper than it is in dollars and by how much? How risky would it be to borrow in roubles?

      Roubles do not trade in Forex markets (neither do yuan for that matter); this makes getting them difficult. Borrowing from Russia is risky because they are not trustworthy partners; Russia is a dictatorship with no rule of law. Government in Russia can be anti-business and capricious. Its economy is a shambles. It is risky to trade with an insolvent, anything can go wrong and often does. Dollars are in wide overseas circulation, they are traded in vast amounts on Forex markets, analogous derivatives such as currency swaps makes dollars almost as easy to get as any other currency including roubles, ringgits, pesos, etc.

      Russia’s problem is that it is not a credit provider, that is, it cannot lend ‘out of thin air’ except to itself. What backs the dollar is American creditworthiness. What backs the rouble is its foreign exchange reserves (same is true with China). Without the reserves, Russia’s credit is worthless, even though the has large remaining resources; they cannot be readily pledged as collateral; they aren’t portable (oil reserves cannot be removed out of Russia), at the same time they are ‘used up’ and cannot be recovered by a lender. The infrastructure used to exploit its resources is collateral => industrial infrastructure priced in dollars => these are gained by the Russians in exchange for their resources.

      Follow this logic = dollars are seen to be worth more than resources … which is deflationary. Russia is attempting this trade because they fear difficulties in gaining dollars, euros or yen and do not want to accept lesser currencies from countries that are — like themselves — not credit providers.

      Because of the dollar float (amounts in circulation) along with what they can be used to buy (quality of money), dollars enjoy a historical advantage over other, ‘Brand X’ currencies. Yuan, for instance, can only be used to purchase Chinese goods … (roubles = Russian goods) the dollar can buy American goods, but also also Chinese (and Russian) goods as well! The dollar float and near-zero interest rate also offers a price advantage relative to the yuan or another currency such as the rouble in external markets.

      Theoretically, if the rouble offered a price advantage and traded freely in Forex markets dollar traders could buy up the roubles in circulation and gain that advantage in Russia by way of 3d parties.

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