Spending is easy, cutbacks are hard. True for Joe Sixpack, true for the U.S. government. Well, maybe it’s a little harder for Uncle Sam.
The latest evidence comes from yesterday’s news that the deliberative body known as the Senate rejected $14 billion in Medicaid cuts recommended by the Bush administration. “The 52-48 vote was a setback for the Bush administration and Republican congressional leaders, who had identified Medicaid cutbacks as a key element in a plan to shrink the federal budget deficit,” reports New York Newsday.
In fact, canceling the budget cuts in Medicaid required the support of a few Republicans—seven, to be exact, who joined forces with the full lineup of Senate Democrats. Republican or Democrat, it seems, doesn’t lend much help in overcoming the spending inclination that sooner or later finds every pol and corners him or her in the dead-end of budgetary profligacy. Yes, there are always a few exceptions, keeping hope alive that self-corrective financing will emerge triumphant in the U.S. Congress. But for the moment, the empirical record suggests otherwise.
Paring the nation’s budget deficit, in short, isn’t going to be easy if one draws the pessimistic interpretation from yesterday’s Senate action. But just when you thought you had it all figured out, the dollar opted for rosy perspective. Indeed, forex traders have been chasing the greenback of late, helping the U.S. Dollar Index reach its highest point at one point today since March 8. A catalyst for the jump came from yesterday’s release of the Conference Board’s leading indicator for February. It was the fourth rise in four months and the biggest monthly gain since November.
The primary contributor to the increase in the leading index, which is designed to predict future economic activity, were falling unemployment claims. The implication: the economy is poised to continue expanding through the spring. “The leading indicator, and others, suggests trend-like real [economic] growth of around 3.5 percent after more than 4 percent this quarter,” Steven Einhorn of investment advisory firm Omega Advisors tells Bloomberg News.
With the import-hungry American economy bubbling, is it any wonder that import prices are up? The obvious answer is “no” in the wake of this morning’s release of import prices for February, which posted a stronger-than-expected rise of 0.8%, reports the Labor Department.
In sharp contrast, export prices were unchanged in February. One could argue that the U.S. is importing inflation and exporting deflation, or at least a milder form of inflation. Indeed, the thesis holds up when looking at the 12-month numbers. For the year through last month, import prices rise by 6.1% while export prices advanced by only 3.4%. Deflation proper seems to be alive and kicking when it comes to agricultural export prices, which declined by more than 8% in the 12 months through February 2005.
But all commodities aren’t created alike when it comes to pricing, as the continuing rise of oil prices reveals. And as the U.S. imports more oil, the higher prices for the commodity are feeding into rising import prices.
The buzz on the Street in the wake of the import price report is that the Fed will be that much more inclined to raise interest rates at the next Federal Open Market Committee meeting on March 22. And beyond. Some say that the current 50-basis-pont gap between Fed funds and the equivalent at the European Central Bank is set to widen further. “If the Fed continues to raise rates by 25 basis points every meeting then we will get a 2 percent gap with Europe and that will be significant,” Momtchil Pojarliev, senior currency manager in London at Invesco Asset Management, opines to Bloomberg News. “I am more bullish on the dollar.”
But isn’t the U.S., overtly or otherwise, engaged in a scheme to lessen the dollar and thereby boost exports to lessen the trade deficit? Or was that last week?

When one quota doesn’t do the job, maybe another one will.
Therein lies Opec’s rapidly evolving strategy when it comes to its ongoing struggle to convince oil traders that the cartel’s in charge of crude’s price destiny. Kuwait’s oil minister and Opec’s president, Sheikh Ahmad al-Fahad al-Sabah, detailed the new-new philosophy on Thursday, explaining, “We believe that if prices stay as they are in the next seven to 10 days, we will start contacting minister colleagues to discuss the other 500,000 (barrels a day) that the president has the authority (to decide on) after consultations,” reports AP via ABC News. Hey, at this rate, maybe they’ll be a new meeting about having a meeting about talking about even future potential production hikes…maybe.
But talk (and talk of talk) continues to decline in value, suggests a fellow Kuwaiti who happens to be an oil analyst. “Opec is no longer the same influential power that controls oil prices as it did in the past,” Kamel al-Harami told AFP, reports Channel NewsAsia. “Today, they have a small output capacity and they cannot control increase in demand.”
Or so the theory goes. Opec, for the moment, says otherwise. Whether they can do otherwise keeps the world economy on pins and needles.
Meanwhile, it was no accident that Opec’s public rethinking of its Wednesday announcement of a production hike, which was greeted early today with another sharp jump in oil prices in New York to yet another new high. At one point on Thursday, the near-term futures contract on oil threatened the $58-a-barrel range before pulling back under $57 by the close.
The situation is precarious in the short run if only because the world economy remains increasingly dependent on the likes of Nigeria, Iraq, Venezuela, Russia and Iran for crude. Stability and political calm don’t necessarily come to mind when such names pass one’s lips. That’s old news, of course, but the dependence on those countries takes on a new twist as the world’s spare oil production capacity recedes to nail-biting levels. Opec’s spare capacity, most of which resides in Saudi Arabia, has dropped to an optimistic estimate of 1.6 million barrels a day, according to the Energy Information Administration. That’s cutting it close, considering that global oil consumption was recently running at 83 million barrels a day, by one estimate. That puts Opec’s spare capacity at under 2%.
There are two threats that make 2% something to worry about. As always, it comes down to demand and supply. Demand is rising rapidly, courtesy of China, India and other emerging markets. Supply, meanwhile, isn’t keeping pace, or so we’re told. But the more immediate concern is that Iran, Iraq, and so on may be vulnerable to a variety of unnatural and ultimately self-inflicted export disruptions.
But all’s not lost, at least in the matter of hope. There are still some who take an optimistic view of the markets. Neil McMahon, oil analyst with Sanford Bernstein & Co., writes today in a letter to client, “With crude reaching new record highs, it is clear that pricing levels continue to discount the fact that the market is currently well supplied as evidenced by rising inventory levels.” Accordingly, he predicts a correction looming that will bring crude back to the $40 to $50 range.
Meanwhile, it’s not clear how much more “discounting” the global economy can take, although we may soon find out. In any case, there’s more than one way to spin crude inventories. James Williams of energy consultancy WTRG Economics writes in a missive to clients today that U.S. crude oil stocks are in the upper half of the normal range. “However, when the additional demand over the last five years is factored in total crude oil and petroleum inventories remain near historic lows.” Williams goes on to observe,

For the last two years the number of days of inventory has averaged 46.3 days compared to the current 45.3 days. The last two years have had the lowest sustained level of days coverage in over 25 years.
Not surprisingly this two-year period coincided with a sustained increase in petroleum prices.

Williams is wrong about one thing: some of us (you know who you are) were surprised.