Economy feeling pre-QE2 déjà vu

May 4, 2011 07:00 PM

Oh no! It's pre-QE2 all over again!

Is the US economy going back into a pre-QE2 malaise? We are starting to see the first real signs that high energy prices are beginning to hurt. As if we needed more evidence. Yesterday's big drop in the ISM non-manufacturing number and the weak ADP jobs report seems to suggest that high energy prices are starting to really take a toll. We are seeing a situation where businesses may hold back on hiring as they are stunned by the spiraling cost of oil, gas and diesel that continue to rise to a shocking level.

Once again the euro is rising as we await the ECB rate decision that will of course be followed with a statement that will signal rate increases in the future.

While demand driven commodity inflation rages across the developing world, it seems that in the US demand is weakening. That has been evident in weakening gasoline demand that cannot now be attributed all to lousy weather. It looks as if the US is headed into another summer of subpar growth, similar to the type of summer we had when Fed Chairman Ben Bernanke announced QE2. In other words, if growth continues to falter, we could see QE3 and it is possible that gasoline prices that are hitting record highs in Chicago and Indiana could be the catalyst.

Another factor in high gas prices is the high cost of ethanol. Sugar, corn and ethanol are becoming the story as the food vs. fuel debate rages and have been another factor in our rising gasoline prices. Sugar reversed course after Brazil hinted that because of the high cost of food, it might be lowering its use of ethanol. On top of that, the sugar harvest has brought sugar to the lowest level since last November.

The Wall Street Journal says, "A shortage of the sugar cane-based biofuel during the inter-harvest season caused a price spike in ethanol, which is mixed 25% with gasoline at the pump and heavily used as an alternative fuel in Brazil's massive flex-fuel car fleet. As ethanol prices soared, motorists opted for cheaper gasoline and forced state-run energy company Petroleo Brasileiro SA (PBR, PETR4.BR), or Petrobras, to import gasoline for the second time in two years. Government officials have hinted at a temporary reduction in the percentage of ethanol mixed with gasoline at the pump, although so far no changes have been made. In 2010, a similar inter-harvest shortage forced Brazil to reduce the amount of ethanol mixed with gasoline to 20% for a brief period. President Dilma Rousseff also recently signed a decree to expand the range of the ethanol-gasoline mixture at the pump to between 18% and 25%, greater than the previous range of 20% to 25%."

Brazil of course has been the model for activists calling for promotion and government subsidies. In the US, it is estimated that we will use 45% of our corn crop for fuel or close to a whopping 5 billion bushels! Tim Hannagan, PFGBest grain analyst, says that to understand the gravity of that, compare it to 2001 when only 600 million bushels went to fuel. This increase is a major reason why the world may run out of corn. So what better time for the US Senate to introduce a bill to end ethanol subsidies and import tariffs?

Bloomberg News reported that U.S. senators introduced a bill to repeal a $6-billion-a-year tax break that helps the corn ethanol industry. It was bipartisan as Bloomberg reported, "Senators Dianne Feinstein, a California Democrat, and Tom Coburn, an Oklahoma Republican, said the 45-cent credit, which is given to oil refiners for each gallon of ethanol they blend with gasoline, was unjustified given the U.S. deficit. The break is set to expire this year. Repealing it by July1 would save about $3 billion, the senators said. The legislation also would repeal a 54-cent tariff on ethanol imports. ‘It's time we end subsidies that we cannot afford and tariffs that increase gas prices,’ Feinstein said in a statement. Matt Hartwig, a spokesman for the Renewable Fuels Association, a trade group for ethanol producers in Washington, said in an e-mail that the bill would increase gas prices and oil imports. Democratic Senators Ben Cardin of Maryland and James Webb of Virginia and Republicans Richard Burr of North Carolina, Susan Collins of Maine and James Risch of Idaho also support the bill, according to the statement from Feinstein. Coburn has also introduced the bill as an amendment to small-business legislation the Senate is now debating, according to John Hart, a spokesman for Coburn."

Look for corn to sell off big time if this credit is taken off.

Phil Flynn is senior energy analyst for PFGBest Research and a Fox Business Network contributor. He can be reached at (800) 935-6487 or at

About the Author

Phil Flynn is a senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. Phil is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets.