Ariba Asset Management Inc.

3rd Quarter Economic Commentary:

Fun With Numbers

by Roger Marshall, Fixed Income Managing Director

Someone said a picture is worth a thousand words, so I would like to say that a graph is worth a thousand numbers. And the graph below shows a lot. In 1992 the federal government was running a deficit of more than $250 billion. That was considered huge. By 2000/2001 that deficit was converted into a surplus. Since then, the deficit has ballooned to levels nobody would have considered possible.

First Quarter 2010—the federal deficit is running at a $1.347 trillion dollar rate!

How are we going to finance this gap? Well, let’s look at the next graph, Federal Debt Held by Foreign and International Investors.

As this graph illustrates, the amount of U.S. debt held by foreigners rose steadily through 2000, and then with the U.S. running budget surpluses for about two years, the foreign holdings actually declined. However, that respite was short lived. Since 2002 the foreign holdings of U.S. debt has soared. We are all aware now of just how important these buyers of U.S. debt are. Could we run such huge deficits if they were not willing to buy our debt? Hmm.

The next graph is probably worth more than a thousand numbers. It shows the U.S. money supply growth, or lack thereof. I say lack thereof because I find it amazing that in these hard times the money supply in the U.S. is actually falling.

Since most people would be expecting monetary policy to be somewhat easy in tandem with fiscal policy and reflecting the high level of unemployment, finding out that our money supply is actually contracting should be surprising to just about everyone.

So, why isn’t the Federal Reserve Board letting the money supply grow? Is the economy overheating? Is it growing too fast?

The GDP graph below certainly does not support the thesis that growth is too robust.

Maybe unemployment isn’t too high?  The graph below clearly suggests otherwise.

So, maybe despite a lack of growth, and despite high unemployment, the inflation rate is too high?

The graph of CPI shown below does not support that conclusion either.

In fact, inflation is at the lowest levels we have seen since before the 1970’s.

Conclusion

The U.S. economy is growing slowly. This growth is primarily due to the federal government running huge deficits, which are being funded to a large degree by foreign investors.

Despite slow growth, low inflation, and high unemployment, the U.S. money supply is actually shrinking rather than growing.

We need money supply growth. We need monetary stimulus. We need meaningful growth in the money supply.

When money supply starts growing meaningfully and income levels start to rise then we will know that our economy is on the right track.

Until then, we wait and we watch.

NEWS YOU CAN USE FROM ARIBA RESEARCH – 6/21/10

118 BILLION BARRELS OF OIL EQUIVALENT IN THE LOWER 48 STATES READILY AVAILABLE IN SHALE GAS DEPOSITS

In April 2009, the U.S. Department of Energy estimated that the total amount of recoverable shale gas in the United States at 649.2 trillion cubic feet.  That is the energy equivalent of 118 billion barrels of oil – or about four times America’s proved oil reserves.  The development of horizontal drilling in 1997 has led to large scale gas drilling and production today and a huge increase in estimated reserves.  Some have estimated the domestic supply at 50 to 100 years.

The hydraulic fracturing (fracking) technology has now been successfully employed in shale oil with promising results and several major companies are in production.

MAJOR U.S.SHALE GAS BASINS

By way of comparison, the biggest conventional  oil discovery in the past decade is Tupi located off the coast of Brazil in7,000 feet of water and 17,000 feet under the ocean floor.  Tupi is believed to hold about 8 billion barrels of oil.  The Marcellus shale basin alone, in the Western Pennsylvania area, holds an estimated 45.6 billion barrels of oil equivalent in the form of natural gas – nearly 6 times as much as Tupi.  And the Marcellus basin is near major markets and existing infrastructure for delivery and storage.

SHALE OIL DEPOSITS

There are large shale oil deposits in the lower 48 states that are now in production through the use of newly developed fracking technology.

MANY ARE ASKING WHY THERE IS NO FEDERAL ENERGY PLAN TO UTILIZE THE VAST SUPPLY OF DOMESTIC NATURAL GAS AND WHY WE ARE DRILLING IN SUCH DIFFICULT AREAS AS THE DEEP WATER GULF. 

Trends in Shale Gas Production (MMcf / Day)

 Horizontal and Vertical Well Completions