Out of control consumer debt could sink the recovery

The latest statistics show that the total amount of consumer debt outstanding in 2010 in the United States is nearly $2.4 trillion.  Based on the 2010 Census statistics, that works out to be nearly $7,800 in debt for every man, woman and child that lives here in the U.S.  This, of course, does not include mortgages and other types of debt.  About one-third of this consumer debt, or about $800 billion, is revolving debt-mostly credit card debt.  The other two-thirds is comprised of car loans, student loans, and other non-revolving types of debt.

With such extreme levels of consumer debt, and the additional debt burden on the country from mortgage, commercial, and government debt, the U.S. economy will certainly struggle for many, many years to overcome the negative impact this debt will have on our economic future.  Lenders will need to rethink how the evaluate the creditworthiness of borrowers, especially in light of the huge number od defaults we are experiencing on every type of debt.

Banks traditionally look at many factors when considering making loans, but one of the key statistics they use to determine whether or not to lend to an individual is the FICO score.  An individual's FICO score is derived through a complex and proprietary formula, but the just of it depends on prompt, on-time payment of outstanding debts and the ratio of that outstanding debt to available credit.  Late payments and defaults on debts reduces the FICO score dramatically, which can mean no loan.  FICO scores typically below about 680, especially in today's tight lending environment will typically spell doom for a would-be home or car buyer.  

Credit card companies offer revolving, unsecured loans to consumers.  Because these loans are unsecured, credit card companies can justify charging much higher rates of interest, as compared to loans with collateral, like a mortgage or car loan.  However, these days credit card companies are selling debts in default to third-party collection agencies that are increasingly using the court system to basically turn unsecured credit card debts into secured debts.  Once the collection agency sues the consumer and wins a judgment, they can garnish wages, attach assets, put liens on property, such as cars and houses, etc.  

Many of these unscrupulous collection agencies will basically lie and state (to the courts) that they have served the consumer with papers on a lawsuit, when if fact they have never done so.  The court date comes and goes without the consumer ever knowing about it, and the collection agency then secures a default judgment against the consumer for the full amount of whatever they have claimed the consumer owed, plus interest and court costs in some cases.  Once the default judgment has been obtained, it is open season on the consumer and there is little that the consumer can do, other than pay the collection agency in full.  

There are many so-called debt consolidation and debt clean-up companies, that claim they can help consumers deal with credit card companies and collection agencies, once debts have gone into default.  Most of these are either complete scams, or at best are ineffective.

What is the consumer with debt problems to do?  Most credit card companies, if the debt has not already been sold to a collection agency, will negotiate with a consumer, to either reduce monthly payments, or to settle a debt in full for less (sometimes 50% less or more) than what is owed.  When credit card companies sell debts to collection agencies, they typically only get 5% to 20% maximum on the debt owed, so they will gladly take the 50% from the consumer.  This does not mean, however, that the consumer's credit report will be undamaged.  A settlement will show-up on credit reports, and will negatively affect the FICO score, etc.  Most collection agencies, once the debt has been sold by the credit card company, will negotiate a settlement as well, usually for some reasonable percentage of the total debt.  

Consumers entering into negotiations either with the credit card company, and especially with the collection agencies, should be sure to get all terms in writing, and should ensure that the agreement states clearly that the debt will be shown to be settled in full, and that any remaining amount will never be sold to another collection agency, and no additional attempts will be made to collect any remaining balance, etc.

The process of dealing with debts in default, or a full blown bankruptcy, can be complicated, and there are specialist attorneys out there that can help.  Consumers can do a lot of the necessary work themselves, however, if they take their time, research the issue, and work the problem through to conclusion.  Doing nothing is the worst thing one can do in this situation, so if you find yourself in default, take action, be proactive, and do your homework.  There is life after credit card debt, it just takes a long time and a lot of work to discover that life!

Fed Stands Firm - U.S. Economy is more like the Titanic than a speedboat

Bernanke, in his first ever press conference for the Fed, basically stated that the Fed still feels that maintaining rates at their current levels (basically zero), is still the best course of action.  The Fed statement, which is all we typically have to go on since they haven't changed rates in so long, maintained the same language about keeping rates low for an extended period of time.

The Fed did raise their inflation forecast (CPI) from 1.3% to 1.7% to 2.1% to 2.8%, and cut its GDP forecast to 3.1% to 3.3% from 3.4% to 3.9% (I think we will come in around 2% to 2.5%), for 2011.  They do see improvement in the unemployment rate from previous forecasts, to a range of 8.4% to 8.7% (it was 8.8% to 9% previously).  

For 2012, core inflation (ex food and energy) is now seen running at 1.3% to 1.8%, from the previous estimate of 1% to 1.5%, and U.S. (GDP) growth is now seen at 3.5% and 4.2% in 2012, and 3.5% to 4.3% in 2013.

I feel that the Fed is entirely too optimistic (about everything), and believe that they will be forced to start raising rates aggressively, very shortly.  The U.S. economy, I always say, is like the Titanic, not so much in that is is going to sink (although that is certainly a real possibility), but in that it is a huge ship with a small rudder - changes in rates, even dramatic changes, do not impact the economy for at least two quarters.  If the Fed waits too long to start raising rates, they may be too late to stem the tsunami of inflation.  Also, if they wait too long, they will be forced to raise rates at a much faster pace - so fast that it may stifle the economy.  A slower, more reasonable, moderate pace could be sustained without killing the economy, but they need to start right away (probably should have started about 6 months ago).  

Other countries, like Australia, China, and the ECB (European Central Bank), have already begun raising rates.  This has put even more pressure on the dollar.  A weak dollar can be good for our economy in the short-run because it makes our goods less expensive for foreign buyers.  But, in the long-run, a weak dollar will result in higher inflation, and will demand more drastic rate increases to defend our currency.

Commodity prices would begin to adjust back down, if we were to start raising rates.  We will have to raise rates anyway; it's just a question of when and not if.  Since we know this to be true, it would make more sense for the Fed to start raising rates sooner rather than later (right now), and to do so at a moderate pace that reduces inflation, including commodity price inflation, and still is slow enough to support continuing economic growth.  I fear they will wait too long (it may be too late already), and by the time they realize their error, they will be forced to drop the hammer on rates, which will feel like we are all getting hit over the head with a giant sledge.  

Is the U.S. a bad risk?

The recent change from S&P on their outlook for the U.S. as a AAA credit begs the question: Is the U.S. a bad credit risk?  Although this is an interesting question, and the answer is probably no, like a lot of things in life, the reality is that country risk is not absolute, it is relative - relative to other countries.

Despite the fact that our national debt and budget deficits are enormous, and skyrocketing, we have to compare ourselves to other countries, to evaluate the changing perceptions of U.S. credit risk.  In the developed world, basically every country, with the exception of Germany, made the same mistakes we made, that put us into this pickle.  Excesses in real estate and the credit markets in general, drove the worldwide economic collapse that resulted in the accumulation of not only huge national deficits, but also personal debt as well.

Even if we break the current debt ceiling, which is a virtual certainty, and even with the very real possibility (probability) that the U.S. credit rating will fall below AAA in the next year or two, the U.S. is still today, and will remain, the strongest economy on the planet, and therefore, to most, the safest place to put money.

While the fact that we will likely remain at the top of the heap economically is somewhat comforting, it does not mean that we will not feel some pain.  The reality is that financial markets trade on risk and reward perceptions.  If the risk of the U.S. is perceived to increase, as will be the case if and when our credit rating is lowered, the cost to service our debt or take on more debt, will increase.  In practical terms, the rates we will need to pay on new bonds issued will have to go up to compensate investors for that perceived increased risk.  If we couple this with a rising interest rate environment, which I believe we will be entering shortly, we could have a slingshot effect on the rising cost to maintain our debt and finance future budget deficits.

This scenario is very real, and has lead to the devaluation of many currencies around the globe.  We need to watch the value of the dollar closely, since rising inflation will be the trigger that forces the Fed to start the interest rate raising cycle.  The more the threat of inflation, the more aggressive the Fed will need to be with rates, and the greater the impact will be on the cost of servicing our debt (and the more negative will be the impact on economic growth as well).

Stocks getting spanked

The Dow is off almost 250 points and is falling fast after S&P changed their outlook on the U.S. debt situation to negative.  They maintained their AAA rating on the U.S., but made it clear that things are deteriorating.

The reaction in the stock market to this news underscores two key truths:

1.) Valuations are obviously very rich, otherwise negative news would not elicit such a negative response in prices;

2.) The serious debt issues facing countries across the globe is not going away, even though investors seem to ignore the obvious.

I remain cautious; looking for opportunities to re-enter at lower valuations/lower levels on the S&P.  Watch for the S&P 500 to challenge the 1,250 level shortly.  If it hold, I will likely put a little cash back to work.  If it cracks 1,250, I will look for lower levels before I risk my cash.

Google disappoints after the bell

Google reported after the market close today (Thursday, April 14th) that its first-quarter net income rose to $2.3 billion, or $7.04 a share, from $1.96 billion, or $6.06 a share in the same period a year earlier. Net revenue for the period ended March 31st rose to $6.5 billion. Excluding one-time items, Google said earnings for the period were $8.08 a share. Analysts polled by FactSet Research had expected Google to report first-quarter earnings excluding items of $8.11 a share, and $6.3 billion in net revenue.  

This was a disappointing report, and Google's share price is suffering in after-hours trading, with the stock down about $32 per share, or about 5.5%.  Tomorrow should be very interesting!  It's Friday, and with Google trading lower we could and should see a big sell-off in tech, and perhaps in the entire market.

Don't forget to check out my column in tomorrow's Santa Barbara News Press on the April 18th Tech Brew at Fess Parker Double Tree Resort!

Watch for commodity, stock and real estate prices to fade

Interest rates will inevitably rise.  Other countries, including China and some in Europe, and even the ECB (European Central Bank) have already started raising rates, weakening the dollar and putting further pressure on the Fed to raise rates here at home.  Inflation in commodities is rampant, and sooner or later (probably very soon) the Fed will be forced to raise rates.  A sharply rising interest rate environment is death for commodities, and with the current very high price structure for commodities across the board, we should see a significant sell-off for commodities in the near future.

Stocks don't do all that well in a rising rate environment either, and real estate usually performs even worse.  High interest rates is the other shoe to drop for real estate.  We have been lucky thus far not to have high rates, even though real estate prices have fallen more than 40% from the October 2007 peak here locally in Santa Barbara (and in most markets across the country by substantial percentages from their peaks).  If (when) rates begin to rise, real estate prices and sales activity will no doubt be negatively impacted.  It is already next to impossible for people to get loans, even if they have stellar credit, 20% or more to put down, and plenty of free cash flow to service the loan.  As rates rise, the monthly cash outflow, for a given loan amount, will increase dramatically.  Banks are already reticent to loan, so with rates rising, they will be that much more reluctant to provide financing.  Add all this up and it makes for a very tough real estate market for the foreseeable future.

Weather can be a significant factor for businesses - Published in the Santa Barbara News Press in February of 2011

Living in Santa Barbara, and Southern California in general, we tend to take the weather for granted.  I moved to California from Texas specifically because of the bad weather in Texas and for the good weather here.  For businesses, the weather can actually be a serious consideration, and a factor that can make or break others.

Over the past several weeks, the U.S. has experienced several powerful winter storms that have dropped huge amounts of snow, and iced streets.  The two days after Christmas were so bad in some areas that after-Christmas sales were affected so significantly that some retailers missed their earnings projections for the fourth quarter.  This week’s storm that hit Chicago buried cars and trucks on freeways, and was the third heaviest day for snow on record for the city, in more than 126 years.

When the employment numbers were released for December, we were informed that unemployment claims were down significantly from estimates, not because more people found jobs, but because the weather in December was so bad in several states that unemployment offices had to operate for fewer hours on several days.

The development of the Internet and e-commerce is still in its infancy, but it is clear that online commerce is here to stay.  In fact, Christmas sales saw a 12%+ increase in online sales, versus less than 1% for brick and mortar only operations.  

Many retailers including Target Corp., Costco Wholesale Corp. and Macy's Inc. reported sales gains below Wall Street expectations for the third quarter, and especially for December. Bon-Ton Stores Inc.'s sales were virtually flat and company officials blamed the severe snowstorms., and The Gap suffered a surprise 3 percent drop in December. (Analysts had expected a 2.6 percent increase.)

The overall holiday retail sales season was actually the strongest since 2006, but sales really fell off in December, in large part due to the poor weather around the country.  Early holiday discounts, which started in late October, drove big sales early in the season but also had consumers completing their shopping before December even began. A lull early in December and the blizzard of December 26^th in the Northeast also took a heavy toll on sales.

From October 31^st through January 1^st, revenue at stores open at least a year rose 3.8 percent over last year, according to an index compiled by the International Council of Shopping Centers. That's the biggest increase since 2006, when the measurement rose 4.4 percent.  However, the index slid to a 3.1 percent increase in December after a 5.4 percent rise in November, highlighting the drop off in December activity.  More expensive retailers saw better-than-expected sales. Abercrombie & Fitch Co., which saw robust gains that beat Wall Street estimates, though it had to discount to lure shoppers in.  Luxury stores, including Saks Inc. and Nordstrom Inc., also reported big increases as the rallying stock market kept affluent customers spending.

"The overall season was good, but the strength came from the beginning of the season," said Michael P. Niemira, chief economist at International Council of Shopping Centers.

December's gains came on top of a 3.6 percent gain in December 2009, while November's impressive increase compares with a 0.2 percent decline in November of 2009.  These numbers are based on “same-store-sales,” or sales from stores open at least one year (excluding sales from stores open less than one year).

However, changes in shopping habits and other factors have led the figure to lose some of its luster as a yardstick. Some stores exclude online revenue, which soared 12 percent overall and accounts for 8 to 10 percent of total holiday spending. Online spending spiked 17 percent the week after Christmas, according to comScore, possibly getting a boost from shoppers cooped up by snow.

In addition, many retailers have stopped reporting monthly figures, including some of the biggest chains: Wal-Mart Stores, Best Buy Co. and Sears Holdings Corp. Only about 30 merchants report now, down from about 60 at the end of 2005.

Analysts say that the holiday 2010 season also marked the time that spending in many categories returned to pre-recession levels. Online spending, as well as spending on groceries, auto parts and clothing, are now above the pre-recession peak, according to MasterCard Advisors' SpendingPulse, which tracks all transactions including cash.

Despite spending increases overall for the holiday season, many retailers are planning to raise prices in the Spring to counter skyrocketing commodity prices.  Brooks Brothers Inc. is raising prices on all cotton items by an average of 10 percent, for example.  It is not clear whether price increases will result in higher profit margins, or lower revenues and therefore lower profits. 

One thing appears certain – weather-related disruptions, which have always been a problem for retailers, will continue to impact sales.  More importantly, with the increase in online sales volumes, and the increasing level of comfort consumers have with online purchasing, brick and mortar retailers will be fighting an uphill battle. 

The growth in online sales of better than 12 percent during the holidays, dwarfing the 3.6% increase in overall sales, underscores the growing importance of online sales for retailers, and also the risk to those not offering an online shopping option. 

My feeling is that, each time a consumer attempts to shop at a brick and mortar store, only to be thwarted, due to weather, traffic, time-constraints, or because the store simply does not stock the item of interest, the retailer is vulnerable to losing that consumer permanently to the e-commerce world.  Human beings are creatures of habit, and behaviors are difficult to change, whether it is overeating, watching too much television or spending too much time at the mall.  But, once that behavior is changed, especially when a consumer becomes an online shopper, there is a high likelihood (and a high risk to the brick and mortar retailer) that the consumer will be an online shopper for good.

To me, this is a significant trend that will only expand as time passes.  We see its impact all around us, with stores closing, such as Borders and Barnes & Nobel, and others, such as Blockbuster, barely clinging to life as they navigate bankruptcy court.  More and more, online retailers are gaining market-share at the expense of the traditional, brick and mortar businesses. 

Local businesses can benefit in at least two ways from the trend towards online commerce and poor weather in many parts of the country.  First, the Internet is not going away, and e-commerce will continue to outpace overall sales, and sales growth at brick and mortar stores.  Local businesses should take this to heart, and wherever possible, offer their wares online.  Second, to the extent possible, Santa Barbara businesses should try to draw consumers here during those months when the weather is usually poor elsewhere.  A more concerted, focused effort on the part of local businesses to attract consumers to town during the winter months to shop could result in meaningful sales increases.

Many businesses have waited and watched as e-commerce sites have exploded, not wanting to embrace new technologies, or to spend the extra money to develop e-commerce sites for their businesses.  They have stood by and watched other lesser companies in many cases, take their customers away, and have watched their profits dwindle.  Local businesses should embrace these trends and aggressive pursue strategies to appeal to the growing number of online shoppers, who are here to stay.

“Real” inflation rising dramatically, despite official measures - Published in the Santa Barbara News Press in February of 2011

Although the Consumer Price Index (CPI) and Producer Price Index (PPI) both have shown tame inflation at most, “real” inflation - the cost of the things the average American ( you and me) – buys every day, continues to rise significantly.

The prices of food and energy, two things we all must have to get through each day, have risen steadily over the past few years, despite the recession and lack of demand.  Corn, for example, has risen from about $3.75 per bushel, to almost $7 per bushel, over just the past six months.  Corn is very important because it not only is a key ingredient in many food products such as cereals and as a sweetener – corn syrup, which goes into all kinds of foods, including candy - but it is also used to produce ethanol.  Ethanol is being added to gasoline more and more, since oil and gasoline prices are so high, and because we want to reduce our demand for foreign oil.

Food prices in general have risen steadily and dramatically around the world.  The United Nations Food and Agri­cultural Organization (FAO) food price index hit an all-time high in December of 2010. This sparked concern that high prices just prior to the global recession could reflect longer-term structural changes in supply and demand that will imperil the poor's ability to eat. 

Gallup surveys from 2009, (before this latest spike in food prices), indicated that about 1 billion people worldwide struggle to afford food.  We can expect the higher cost of food to dramatically add to the world's hungry. But it's clear that all around the world, where food is growing more expensive due to weather shocks, export bans, inflation, high oil prices and biofuels, speculation, and slowing growth in farm yields, many people are forced to get by with less food.  This situation is especially hard on the world’s children living below the poverty line.

In China, eggs have nearly doubled in price in just the past few months.  Overall, prices over the past three months or so have risen about 35%.  Prices for fresh foods, such as fruit and produce have increased much more.  Only 10 percent of China’s population went hungry in 2007, down from 18 percent in the early 1990s, according to the FAO.  However, many Chinese have seen incomes rise, offsetting higher food bills to some degree.

In 2008, a year with high food prices before the global economic crisis, the Gallup percentages of Chinese, Indians, Vietnamese, and Indonesians who said they had trouble affording food went down, not up, according to an economist with the International Food Policy Research Institute.  Now, however, these same countries are experiencing rapid food inflation.

Mexico's National Policy and Social Development Evaluation Council (Coneval) estimates that the percentage of their population that cannot afford basic food rose by roughly 20 percent between 2008 and 2010. Experts say this has more to do with the global economic crisis than food prices, but it is a sobering reminder that this food cost increase comes on the heels of an economic downturn.

In Egypt last year, vegetables rose 45 percent, fruit by 26 percent, sugar by 23 percent, and dairy products by 8.5 percent.  Egypt spends billions of dollars annually on food subsidies, and in 2008, due to soaring food prices, it expanded its subsidy program by 15 million people, bringing the number of beneficiaries to fully 80 percent of the population.  About 5 million to 6 million Egyptians in 2008 were considered food insecure.  Now, with Mubarak cutting back on a lot of the basic services that the vast majority of Egyptians have come to depend on, and removing many of their civil liberties as well, citizens are rioting and demanding his resignation.  In addition to the political risks associated with its woes, Egypt controls the Suez Canal, a key transportation rout for oil coming out of the Middle East.  If the Suez Canal were to be shut down (they’ve done it before), oil prices will spike.

Supply and demand are also key factors that help determine the prices of commodities, including energy and food.  Corn, as an example, is in short supply, partly due to its use in ethanol, but also due to weather factors, demand, and so forth.  Lower supply drives prices higher, just like we learned in economics 101.  Demand for other commodities, such as copper, which is at a 30-year high price at the moment, is coming primarily from developing countries like India and especially China. 

China will continue to increase its demand for just about everything, as their economy industrializes, and as their per capita income increases.  The Chinese have suffered for generations under communist rule, and are hungry for all things from the west, and especially from the U.S.  China’s need for energy is important for us, and is of great concern, because they, like us, do not produce nearly enough domestically to meet their needs.  As they industrialize, they will need more and more energy, and will continue to compete with us for external sources, such as the Middle East.  This increased demand will likely mean higher prices for you and me at the pump.

Keep in mind also that plastics, synthetic fibers, and thousands of other things that each of us have in our homes and buy on a regular basis, come from oil.  As the Chinese increase their earnings power, they will have more disposable income, and therefore will demand more consumer items, many of which will be produced from oil.  This means even higher demand for oil, and very likely, even higher prices for you and me on gasoline, and on all of the consumer items made from oil.

Gasoline futures prices are based on Brent crude oil prices, which have spiked dramatically due to the unrest in Europe and in Egypt and other Middle Eastern countries.  Gasoline futures are up 4% just in the past week, despite the fact that gasoline inventories are at their highest levels in more than 20 years.  Brent crude oil prices are significantly higher than West Texas Intermediate crude oil prices, although all oil prices are elevated at present.

The world population is expected to grow by 50 percent by 2050.  Food production will need to rise by 50 percent by 2030 to meet growing demand.  All of this growth in demand will mean food shortages and therefore higher prices for you and me. 

One positive from a purely economic standpoint is that we grow a lot of food in California, and in our surrounding counties.  To the extent that price increases can be passed on from farmers to food buyers, and that higher prices drive higher profits for farming operations, we could see a boost in local economic activity over time.  Unfortunately, some of the same commodity pricing pressures that cause price inflation for you and me also affect farmers. 

Energy, for example, is a key cost for farmers.  They need fuel for their tractors, fertilizer for their crops, (which in many cases comes from nitrogen, which in turn is typically made from natural gas), and they have to send their crops to market.  As energy prices rise, farmers’ costs also rise.  Farmers normally use hedging to reduce price risk, but if their hedges are unsuccessful, or if there are sustained price increases for the inputs into their farming process over a long period of time, farmers will not be able to offset cost increases fully.  If they can, they pass cost increases on to the buyer of their products.  Otherwise, their profits dwindle.

At the end of the day, despite the fact that CPI and PPI appear to show that inflation is under control, real inflation for the things we all have to buy to get through our daily lives continues to increase.  Sooner or later (and I expect it to be very soon), we will see real inflation showing up in the official calculations for CPI and PPI (and everything else).  When this happens, interest rates will rise, and the Fed will be forced to increase short-term rates to cool inflation, which can have a devastating impact on the economy.  On a personal level, we should all assume that the cost of living will continue to rise, and we should plan accordingly.

Gasoline prices are sure to rise significantly by summer - Published in the Santa Barbara News Press in February of 2011

The recent unrest in Egypt and Libya has underscored a serious issue facing every American as we drive (no pun intended) ever closer to the summer driving season.  Despite the fact that crude oil and gasoline inventories are at record levels in the United States; well above the five-year average and at the top end of the five-year range of inventories for this time of year, we are seeing prices spike.  Given the political and economic unrest, the improving U.S. economy, and the sustained, high price of oil, we can be certain that gasoline prices will continue to move higher – significantly higher – as we approach mid-year.

Demand growth for gasoline has been modest. For example, a gauge of gasoline demand - miles traveled by vehicles in the United States - is rising only slowly on a year-over-year basis, according to the U.S. Department of Transportation.  Supply has been strong with oil imports from Canada having been up along with higher U.S. oil production (despite the decline in Gulf of Mexico production).

The U.S. average retail price of regular gasoline marked its largest weekly increase of 2011, increasing by five cents to $3.19 per gallon, $0.53 per gallon higher than last year at this time. Prices on the West Coast gained ten cents, the biggest increase in the country. Gasoline on the West Coast is also the most expensive in the country at $3.48 per gallon.

One of the quirky things about gasoline futures is that they trade, based on Brent, North Sea crude futures, and not on West Texas Intermediate (WTI) futures prices.  This may seem like a completely esoteric fact, and it is, but unfortunately it matters (a lot).  Normally, anytime WTI futures prices and Brent futures prices diverge, creating a wider gap that is the historical norm, traders will take advantage of the arbitrage opportunity this divergence presents, and through their buying and selling, prices will converge – come back into historical alignment.  

Due to a variety of (again) really esoteric reasons, WTI and Brent prices have diverged and have maintained and even expanded their gap, which is now about $15 to $20 per barrel.  This week, WTI futures (for April delivery) spiked above $100 per barrel on the tensions in the Middle East and other factors.  At the same time, Brent futures traded above $119 per barrel.  This is the first time WTI has traded above $100 per barrel in 2 years. 

Recall that in mid-2008, when oil spiked to almost $150 per barrel, gasoline prices shot up above $5 per gallon here in town.  We were lucky at that time, in a sense, for several reasons:

·         

Oil prices spiked, but immediately began trading back down, and by December, were below $30 per barrel

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Because oil prices has traded up so rapidly, the hedging operations that refiners use were in place, and basically locked the refiners’ costs so that they did not experience major price increases for their crude oil needs, and therefore were not forced to pass those higher costs onto the consumer at the pump

·        

The economy was already feeling the effects of the coming recession, so demand for gasoline was relatively low

This time, unfortunately, it’s different.  Oil prices have been elevated for months and months, so any hedging that gasoline refiners have been using cannot protect them (and us) forever.  As the futures contracts they use to hedge expire, they are forced to replace them with more expensive contracts, or allow their costs to rise with rising crude oil prices.  Either way, they have higher costs and in most cases will pass most, if not all of those higher costs, on to the consumer at the pump.

If we couple the higher cost issue with the divergence of Brent crude futures, the result is even more upward pressure on gasoline prices.  Since, as stated above, gasoline futures trade on Brent crude futures, and Brent has spiked far more than WTI, there is added upward pressure on gasoline prices, which will ultimately make its way to the pump. 

Again, there are many reasons that have to do with traders, pipeline flows, production changes in the Gulf of Mexico and Canada, storage availability and composition, and a host of other issues that are weighing on Brent prices, but the bottom line is that the gap we see today has been developing for some time, and it does not appear that traders will be able to realign WTI and Brent futures prices anytime soon. 

On the positive side, we are only in February, so there is still time for things to settle down a bit before summer.  In fact, the Saudis just this week announced a new $36 billion package for new programs to pacify citizens, which was taken as a sign that tensions in the Middle East could diminish.  Some of the Saudi aid package, which included interest-free home loans and a pay raise for state employees, was seen as an direct effort to quell potential unrest in the kingdom.

Algeria also officially lifted a 19-year-old state of emergency, according to media reports Thursday that cited the country’s press service. That action lifts restrictions on freedom of speech and assembly that were imposed in 1992, during the country’s civil war.

Moammar Gadhafi’s grip on power in Libya appears to be weakening as rebel forces fought government loyalists near Tripoli this week. Parts of eastern Libya, including the country’s second-largest city, are believed to be in the hands of the opposition, according to media reports.  The situation in Libya could be seen as improving, if Gadhafi is ousted, or it could signal more uncertainty and strife, if no one comes forward who can quell the unrest and take power peacefully, quickly, and (hopefully) democratically.

Concerns have been growing not only that Libya, one of Africa’s top oil producers with its largest proven oil reserves, might spiral out of control, and that neighboring countries, on the heels of Tunisian, Egyptian and other turmoil, could be similarly gripped by mass unrest. 

The International Energy Agency earlier Thursday said between 500,000 and 750,000 barrels of oil a day have been removed from the world market due to the Libyan situation. That represents less than 1% of global consumption, the IEA noted.  The agency added it is in close contact with the Organization of Petroleum Exporting Countries, and IEA’s member countries have 145 days’ worth of emergency oil stocks at their disposal.

News that Saudi Arabia and other OPEC member countries were willing to put more oil into the market pushed crude prices down somewhat from their highs this week.  However, it will not take much to push them to even higher levels, especially if the unrest in other countries, such as Bahrain continues to escalate.  Some reports indicated this week that as much as half of Libya’s total oil production was taken off-line as the turmoil mounted. 

Libya supplies about 1.55 million barrels-per-day of crude, primarily to Europe. These disruptions in their supply do not affect us directly in the U.S., but the uncertainty, tensions, and political implications are certainly impacting us indirectly, through the spike in oil prices we are experiencing.

Ultimately we have about three months before summer, so we have time for these problems in the Middle East, and potentially the spike in oil prices and the gap between WTI and Brent crude to correct.  Unfortunately, I feel that oil prices have been elevated for so long that, even if prices come down quite a bit, and if the tensions in the Middle East subside, we will still experience very high gasoline prices this summer – possibly as high as $5.50 per gallon.  I feel confident in saying that $5 per gallon is a probability and not a possibility. 

If the mid-2008 oil price spike and the subsequent spike in gasoline prices taught us anything it was that many Americans living paycheck to paycheck cannot afford $5 per gallon gasoline.  We saw the evidence of this fact on the nation’s freeways, as people were running out of gas between paychecks, and leaving their cars abandoned on the roads.  The economy is improving, but most of us are not earning any more today than we were two years ago, and many are still out of work.  We should all plan for high gasoline prices this summer, and do our best to reduce our driving, where possible.

All Businesses Should Take Social Media Seriously - Published in the Santa Barbara News Press in February of 2011

According to Shawn Mulchay, President of Socialmash Media (805.312.0375); “the world is changing and more people are navigating their lives online in one fashion or another - to communicate with friends, research something, find deals & coupons, get their news, purchase goods or for just for entertainment.”  We are in the midst of a technology revolution.  Though the implications of this are broad-based and somewhat difficult to fully grasp, one thing is certain, businesses that do not embrace change will be swept aside.

Recently, I decided to start writing a blog again.  I had been writing a blog for an industry website for financial professionals a few years ago, but this site failed and I lost all of my content, which was extensive.  Since that time, I have focused on building my business through traditional methods - primarily word-of-mouth.  While I have found some success, the reality is that people are increasingly looking to the Internet for content, information, entertainment, and solutions to their problems.  There is no longer any stigma attached to shopping online.  In fact, shoppers are probably just as likely to have their credit card information stolen getting gasoline (which happened to me twice last year) as they are to have it stolen online.

The problem with traditional advertising, according to Mulchay, is that; “As consumers we've become immune to traditional advertising. We turn the commercial off as soon as we recognize it as such. What's the greatest benefit to DVRs and Tivo?  The fact that we can fast forward through commercials.  The biggest problem with traditional ads is that they are usually intrusive, disruptive, unwanted and irrelevant. They carry little value or relevance in the eye of the consumer and they push a monolog message (one way).”

Businesses have increasingly turned to technology, and specifically to the Internet and social media, for new, more effective and efficient methods of advertising their products and services.  Mulchay states that; “The largest advantage to social media marketing is that it isn't about pushing out a distinct message, but rather engaging a community in a dialog as it revolves around your industry, product, or business.”   

Social media is the use of web-based and mobile technologies to turn communication into interactive dialogue.  By using sites such as Facebook, LinkedIn, MySpace, Twitter, and others, advertisers can customize their message to a specific demographic group, and thereby focus their efforts and their dollars on those individuals that most closely meet their ideal customer characteristics.

Mulchay relates that social media is the most affordable form of marketing there is.  He prefers not to call it marketing because he feels it is something greater than that; “It is building human connections, communities, relationships, and friendships.” 

Many business owners, like me, are inexperienced at best, when it comes to using the Internet and social media to attract customers and clients.  After establishing my new blog, I looked for ways to attract followers to it.  My thought process is that I can provide research, commentary, and other information of interest to potential clients, who will (hopefully) like what they see on the blog and my website, and will think of me when they need the services I provide.  The problem is that, although I have a blog, and I am adding content to it daily, I don’t know how to attract followers to it. 

I also have an ulterior motive – I am writing a novel, and I want to get it published and distributed.  In speaking with some friends who are writers, I have been told that the publishing business has changed dramatically over the past few years, specifically due to the influence the Internet has had on the book industry.  What I have been told is that many agents are now social media/Internet marketing experts, and that, to sell books these days, authors are using social media to attract interest in their works.  I hope to use social media to generate interest in my novel (if I ever finish it). 

Social media is not free, even though it is often thought to be. It is free to set-up, but it takes time, thought, creativity, and determination to make it effective.  According to Mulshay, there are some very important rules that come with building a social community around your brand:

·         Listen to followers. They can determine your success or become the root of your failure.

·         Treat followers as friends and don't ever sell them out or blatantly sell to them. 

·         Be respectful of their time and interests. Post no more than 1 time per day. 

“The best way to sell through social networks is to not sell at all,” says Mulchay.  “Treat it like you’re hanging out with friends at a party. Be cool, be natural, and above all else, be human.  If you approach social media in the same fashion as traditional media you will lose, and will waste your money in the process.   Befriend people, entertain them, reward them and deliver them unique content that is relevant to your trade or business.  Ask them questions and encourage their feedback. Actually listen to what they say.  Use humor. Only be serious in situations where it is appropriate. Be considerate of people, be humble, and be down to earth in your interaction.  Respond to everyone and make them feel unique and special. Reply several times throughout the day. “

I met Mulchay through Jonathan Siegel and Brendan Searls.  Brendan is one of the owners of Dargan’s and Jonathan and Brendan are partners in the new Brendan’s, and just opened their first Brendan’s location in Camarillo at 1755 East Daily Drive.  I wrote the business plan for Brendan’s, and Shawn Mulchay handles the social media activities for Brendan’s leading up to their grand opening.  

Mulchay says that; “Brendan's Irish Pub’s Facebook page got as popular as it did because people could depend on it as a resource for their questions, input, or general feelings. They knew that if they posted they would get a specific and unique response back, usually within 30 minutes to one hour.  We work hard to create unique and ‘behind the scenes’ content for our community. We only post once a day, but respond to comments throughout the day.” 

Brendan’s developed a very active following in only a few months, leading up to their grand opening, drawing over 3,000 followers in that short period of time.  Mulchay advises; “Think of social media like opt-in marketing. You only have your audience’s attention for as long as they permit you. If you're not posting relevant content, or if you become a nuisance, followers will choose to opt-out.” 

Mulchay states that the “Best Practices” in building a social community include:  

• Post no more than 1 time per day 
• Be relevant, fun, and have a sense of humor. (It's OK to poke fun at yourself)
•  Be humble. Don't take it for granted. Be respectful and say your "Thank Yous."
• Post at high volume times of the day: 11AM, 3PM, and 8PM.
• Use rich media (photos/videos) where possible.
•  Have contests and give away free stuff/prizes -- make it fun!
•  Ask questions of your followers. Let them make decisions for you and your business.
• Use Facebook ads from the start. You may have to spend a few hundred dollars to jump start your social community.  Try holding a contest to attract people.
• Respond to negative comments. Don't simply censor everything that isn't to your liking. Use censoring sparingly (only for slurs, racial matters, provocative words or accusations.)  If it's a legitimate complaint then address it, don't erase it.
• Create a landing page that instructs visitors to “Like” your page, or to take a specific action.
• Take it offline with a city-wide scavenger hunt or another event or activity
• Facebook is the 800-pound guerrilla in the virtual room, so, for small businesses, it is best to place your emphasis on Facebook.  Twitter is secondary and location services are less important.

I know that many business owners have ignored, avoided, or just plain turned their backs on the Internet.  Social media seemed to be such a complicated concept to me that I just didn’t want to invest the time and effort into understanding it, much less using it to expand my business.  However, the fact is that in today’s highly competitive, technology driven, Internet-centric business environment, every business owner needs to embrace social media and Internet marketing, if they wish to prosper.

Oil tops $111 per barrel: watch out for $5 per gallon gas!

With oil prices continuing to skyrocket, as we move ever closer to the summer driving season, consumers should expect to see gas prices at the pump exceed $5 per gallon very shortly.  I filled-up last Sunday for $4.12 per gallon, so we are well on our way to that $5 per gallon handle already.  At this point, even if oil prices were to pull back significantly, say if, for example, Gaddafi were to leave Libya, it is too late.  Refineries have already committed to pricing for their supplies and whatever they have been able to do with regard to hedging has already been done.  Oil prices, in fact, has been elevated for such as extended time-period that, at this point, any possible benefit from hedging that the refiners could have gained will have long ago evaporated with the expiration of future contracts.

Even if refiners were able to successfully hedge away the dramatic price increases we have seen up to this point, they would still raise prices because they have no guarantee that they can continue to hedge away their increasing costs for crude.  Add it all up and you have the makings of a very expensive summer driving season.  So what does this mean for consumers and for the economy?

For drivers, we already know what the impact will be because we saw it in mid-2008 when oil prices spiked to almost $150 per barrel - cars were abandoned in large numbers across the country and especially in places like LA, when gas prices surpassed $5 per gallon, as commuters were unable to afford to purchase enough gasoline to get to work from paycheck to paycheck.  We will see this same impact unfold as gas prices once again soar.

For local economies that depend on tourism, for places like Las Vegas and to a larger extent smaller communities like Santa Barbara that depend more heavily on vehicular traffic rather than air travel, higher gasoline prices will have a significant, negative impact on economic activity.  We will not see as much travel this summer, as families find alternative ways to recreate that do not involve burning fuel.

Watch for fuel surcharges on deliveries, air travel, and even traffic tickets issued by police agencies, as fuel prices rise once again above $5.  Fuel costs permeate our economy, which was built on the interstate highway system, which accelerated our expansion west.  The U.S. is a very large country geographically speaking, and commerce depends on moving goods across large distances.  As fuel prices rise, economic activity in general will be constricted.

Unlike the 2008 oil spike, we have had sustained, high oil prices and I believe they will stay elevated for quite some time to come.  This will very likely mean that, unlike the mid-2008 spike in gas prices, the current pricing structure for fuel will remain in place at extremely high levels for much, much longer than in 2008.  The implications of this are significant, for consumers and the economy.

Interest rates will likely have to push higher in the near-term, which will have a somewhat positive impact on commodity prices, pushing them down.  However, higher rates will also negatively impact stocks and the economy, making it more expensive for companies and consumers to borrow money.

I remain cautious on the financial markets as a result, and have doubts as to the U.S. economic growth forecasts currently showing 3%+ projections for 2011.