The Bear and The Dragon
By Donald Coxe

Last week a reader sent me a very interesting essay by Donald Coxe, the Global Portfolio Strategist, BMO Financial Group. He is also the Chairman and Chief Strategist of Harris Investment Management in Chicago, and Chairman of Jones Heward Investments in Toronto.

He looks at the global oil situation from a different view, one truly “Outside the Box.” There is more to oil prices than Saudi production. “We’ll miss the days,” he writes, “when the G-7 and OPEC managed matters so that we had free time and money to blow on Nasdaq stocks, in the solipsistic confidence that we knew it all and had it all.”

Today’s letter is excerpted from the August 27, 2004: “Basic Points: The Bear and The Dragon” by Donald Coxe, Global Portfolio Strategist, BMO Financial Group.

Text excerpted from: “Basic Points: The Bear and The Dragon”

By Donald Coxe

Requiem for the Elites

Forecasting was so much easier when the global economy was ruled by the Democratic White Men’s Club of the G-7 and the Swiss, plus the generally complaisant Japanese. Yes, there was OPEC, but after the unpleasantnesses of the 1980s, OPEC seemed, under Saudi leadership, to be willing to keep the Club fueled with cheap oil, so the global VIPs didn’t have to spend much of their discussion time (or much of their nation’s money) on OPEC and its quota problems. The Saudis might, from time to time, have to intervene to prevent oil prices from collapsing, but that was their worry. Those global recessions caused by OPEC-spawned oil price leaps were simply distasteful contretemps of history.

Besides, as the new millennium dawned, few, if any of the Widely Respected among the intellectual, political and financial elites were seriously interested in oil or in commodities generally. Agriculture was an ongoing concern, but only because the European Union devoted more than half its budget to cosseting its farmers and France made sure that nothing on the WTO agenda was going to interfere with that arrangement.

Then came a series of shocks to the Club’s complacency:

1. George Bush, who had owned a baseball team, was elected President, although he had, from the Club’s perspective, three strikes against him: he was openly religious, he had a quasi-cowboy background in the Texas oil industry, and he ran against the sophisticated self proclaimed inventor of the Internet.

2. Nasdaq’s fall turned out to be something much worse than the “correction” the elites were so unanimously eager to call it.

3. The US and the world slipped into a recession, the consequence of the Triple Waterfall collapse of technology stocks and technology companies.

4. Al Qaeda suddenly became the most influential global multinational company of the new millennium. It showed its ability to use free TV slots as its key marketing tool. It displayed sophistication in financing and recruiting internationally, building its brand into a global force, franchising that brand successfully, and disrupting established trading channels–even to the extent of shutting down the NYSE.

5. Bush’s response to Al Qaeda’s most audacious venture was to declare a “War on Terror.” Not only did this mean driving the US defense budget back up to levels that were somewhat reminiscent of the Reagan era, but it meant open war in Afghanistan and Iraq–two countries that European elites had long been handling in what they called “constructive engagement.”

6. The Club’s favorite currency was the dollar. Its 45% appreciation against European currencies during the late 1990s had caused some embarrassment to the Euroelites, but they understood that it kept the US consumer available for high-cost European producers. That comfortable relationship was put at risk when the dollar began to look like the currency equivalent of a technology stock.

7. China had concerned the industrial world mostly because of its ability to set global prices at levels Club members couldn’t match for a continuously-increasing range of manufactured goods. By 2002 it was becoming a new kind of problem: by its fearsome purchasing power, it was becoming the price-setter for an increasing range of raw materials, initially metals, but then–ominously–oil.

8. OPEC responded to the novelty of a global shortage of oil by raising its quotas, then producing flat out–yet global oil inventories failed to rise. “Don’t worry,” said the elites, “There’s lots of oil in the world! Look at those huge production increases in Russia, and the big inflow of capital to develop the enormous reserves there. The Saudis can turn on the taps any time. Oil is headed back into the low twenties–maybe even the teens.”

9. Meanwhile, back in the Kremlin, the reconstituted KGB elites looked at the runaway profits and rising power of the oil oligarchs and decided to show who was boss. Yukos’s flamboyant Mikhail Khodorkovsky got slapped into a jail cell, along with two ordinary criminals, where showers are provided weekly; he was charged with almost everything except supporting the Chechnyan terrorists. Capital inflows collapsed, along with prices of Russian oil companies’ bonds and stocks. Forecasters had been relying on Yukos to continue boosting its production. Instead, its daily oil output fell by 4.5% to 1.72 million barrels a day.

10. In January 2004, Club members were fretting that soaring oil and commodity prices, and a strong global economy could re-ignite inflation. Some central bankers were already tightening. Global bond markets were sliding. Then China announced it was going to rein in its spectacular growth.Within weeks, the Middle Kingdom’s economy had turned on a yuan. Next, as if some miasma had mystically spread across the world, economic numbers almost everywhere turned from strong to moderate to weak. Leading Economic Indicators worldwide turned down, with the US indicator falling in both June and July, a trend shift of possibly momentous proportions.

11. By July, global stock markets had shed the last soup