The Great Recession: 34 Million Workers Struggle To Survive

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As I expected, this recession has now pushed unemployment in the United States to more than 10%. Mass layoffs continue. Unemployment has not been this bad since 1983. Although job loss may abate through the end of this year, do not be surprised if it accelerates again in early 2010. A record 5.6 million workers have been unemployed six or more months. In September 2009 there were – on average - a total of 6.3 unemployed persons per non-farm job opening.   In September of 2007, there were only 1.6 unemployed workers per opening. Not only has unemployment doubled since this recession began, available job opportunities have decreased by almost 50%. (Reference 1.)

But the official Department of Labor (DOL) unemployment data does not tell the whole story. Millions of Americans have dropped out of the labor force, or are counted as employed even though they have seen a reduction of income. We need a better measure of  income loss.

Let’s start with BLS statistics for October, 2009. You can find this data by reviewing the BLS tables shown in the parenthesis.

The Unemployment Rate
America has a Civilian noninstitutional population (A-1) of:        236,550,000
The participation rate (people who want to work) (A-1) is:        153,975,000
Workforce as a percentage of civilian population                               65.09%
The number of people who are actually employed (A-1) is:        138,275,000
The number of employed divided by the total population is:                58.45%
The number of people in the workforce who are unemployed (A-1) is:  15,700,000
And that yields an unemployment rate of:                     10.20%

Now let’s calculate the rate of Underemployment.  We want to include the people who have dropped out of the labor force, and thus have no income, as well as the people who are working, but have reduced income because they are working less than 35 hours per week.

Underemployment               
The number of people in the workforce who are unemployed (A-1) is:  15,700,000
The number of people who have dropped out of the labor force is:       2,373,000
Those who are now working less than 35 hours per week (A-5):       9,284,000
Total Underemployment is:                                                             27,357,000
As a percentage of the workforce                          17.77%

Unfortunately, we are not done. As we have seen, just because someone is working does not mean they are making enough money to pay their bills.  The largest single group of workers who have a diminished income during a recession are those of us who are self employed.

According to the U. S. Census Bureau, which bases its estimates on IRS tax return data, there are 21, 708, 021 nonemployers (government speak for self employed persons). Included are 19,089,091 Individual Proprietorships; 1,189,998  Partnerships; and 1,428,932  Corporations with no employees. It would appear this characterization is more accurate than the data used by the DOL. Reference 2.

Who are the self employed? We are private contractors, construction workers, skilled trades people, artists, consultants, doctors, lawyers, farmers, accountants and so on. Eighty percent of us need to work in order to support ourselves and our families. Reference 3.

According to Pew Research Center, 40% of self-employed workers say their family income either falls short of meeting their basic living expenses or are barely getting by. It is highly likely that percentage will increase as the Great Recession drags on. Reference 3.

This is an important number for those who want a true measure of worker income loss.  By my calculation, using Pew data and other research resources, and adjusting for self employed workers who are not a primary source of family income, it would appear 6,987,700 self employed workers (32.2%) are not making enough money to pay family expenses. If we add nonemployer firms with deficient incomes to our total underemployment calculation, then 34,344,700 workers have no income, or are struggling to survive on a reduced income. That’s 22.3% of the American workforce.

Why is this number important? Aside from its use as a measure of human misery, it also gives us an indication of how many consumers are being forced to curtail their spending.  Over 34 million workers, and their families, are living on a restricted budget. Looking ahead, it would appear the number of workers who will be forced to curtail their spending will increase. We are in danger of experiencing a situation where growing unemployment feeds on itself. As the number of workers who must restrict their spending increases, the funds available for discretionary spending stalls or decreases, reducing potential supplier revenues, encouraging suppliers to lay off more workers, which – increases the number of workers who must restrict their spending. Employers tend to schedule fewer hours of work, place additional workers on part time employment, and find ways to eliminate jobs. Self-employed persons find it increasingly difficult to find productive work. Earning power continues to erode.

Unlike prior recessions, Americans will have a tougher time financing any increase in spending by borrowing against their home equity or credit cards. We may have to wait for solid gains in the job market before prosperity returns to America. Bottom line: job growth must be the number one priority for Congress and the Obama Administration.

But it is not. Perhaps we should be asking these people in Washington:
“Why aren’t you focusing your attention on job growth?”


TCE


Reference 1: Data from the Bureau of Labor Statistics (BLS), of the United States Department of Labor (DOL).

Reference 2:  Report: Nonemployer Statistics, 2007  Total for all sectors, United States. Self employed and firms without any other employees.  Nonemployer Statistics originate from tax return information of the Internal Revenue Service. For nonemployers the Census counts each distinct business income tax return filed by a nonemployer business as a firm. A nonemployer business may operate from its owner’s home address or from a separate physical location.

Reference 3:  Source: Many thanks to Rich Morin, at the Pew Research Center, for his article “Take this Job and Love It, Job Satisfaction Highest Among the Self-Employed”, September 17, 2009.
http://pewsocialtrends.org/pubs/743/job-satisfaction-highest-among-self-employed

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Cuba: Discovering Personal Independence

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For an economist, Cuba has been a perfect laboratory experiment. Fidel Castro was a charismatic leader, Cuba enjoyed economic and political support from Russia, it had a closed economy, and the revolution gave the government absolute control over the people. The government confiscated millions of acres of land. Established collective farms. Centralized planning. It all came together to create the perfect experiment in socialism.

And for awhile, it seemed to work. American liberals gushed with euphoric descriptions of the people’s paradise. If anything went wrong, it was obviously America’s fault.

But something was missing. Personal independence and the economic opportunity that comes with the freedom to work for yourself. The chance to create personal wealth. The pride that comes with being able to own the results of your labor.

An article on the BBC WEB site by Michael Voss, BBC News, Camaguey Cuba, entitled “Seeds of change in Cuban farming” describes a new Cuban revolution. In a bid to boost food production and reduce costly imports, Communist Cuba is leasing state-owned farmland to individual farmers and co-ops. Approximately 4.2 million acres will eventually be available. So far about 86,000 applications for land have been approved, with tens of thousands more Cubans hoping to participate.

Socialist state-run collective farms have allowed as much as half of the land they manage to become overrun with weeds. Although these farms control roughly two-thirds of Cuba’s farm land, they produce only one third of the food. Collective farm productivity is so bad, Cuba has been forced to import over $2 billion a year in agricultural products. Much of that food could be grown locally.

Fidel Castro was devoted to socialist ideology. But socialism always fails to create economic wealth for a nation’s workers, and it severely limits the wealth of the middle class. Backed by the police power of the State, oppressive and inept bureaucracies force their will on the people. This leads to frustration with the “system” and indolent behavior. (See: Is This The End of Wealth Creation)

Fidel’s brother, Raul Castro, appears to be more pragmatic. As President, he has been willing to introduce reforms that give Cubans a chance to work for personal gain. Incentives, like the profit motive and productivity-related pay, are reappearing after half a century of an idealistic experiment in egalitarian socialism.

It is back-breaking work to make long neglected land productive. Much of the available land is covered in a thick, impenetrable, tall bramble called "marabu". It has to be hacked, burned, and uprooted before the fertile land can be used to grow fruits, vegetables, and cattle feed. Private farmers form co-ops to share capital intensive farm equipment. The Cuban government has decided it is now legal for them to hire farm workers, increasing the available pool of farm labor.

These farmers are a living experiment in free market capitalism. They earn more money because they sell more food. According to Voss, average earnings have risen to around $200 a month, roughly 10 times the national average.

If Cuba continues to introduce free market reforms, the door will be open for the Cuban people to achieve greater personal prosperity. If Raul wants an economic model to follow, he should spend some time with Luiz Inacio Lula da Silva, the President of Brazil. Lula, as he is known, is working to blend capitalism with populism in a regulated economy.

TCE
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The Evil Twins

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Introduction
In our zeal to do something about global warming, we need to avoid solutions based on false assumptions. Mistakes made now will be impossible to correct later. Of particular concern is our approach to balancing CO2 reduction versus the realities of fossil fuel depletion.

Media discussion of global warming seldom makes any connection between the ecology of temperature change and pending fuel shortages. Our political leaders appear reluctant to discuss fossil fuel depletion and global warming in the same conversation. Although both Democrats and Republicans know about the consequences of fossil fuel depletion, critical questions about depletion are – for the most part – taboo.

All this denial raises a critical question. How can we expect our political establishment to make intelligent decisions about the price, availability and use of our energy resources if they refuse to acknowledge half the data? For me, global warming and fossil fuel depletion are the evil twins. We must deal with both of them at the same time. Else we risk making tragic policy mistakes.


Is Global Warming Real?
Absolutely. There is plenty of real data and empirical evidence to support the contention our planet is going through one of its natural, normal, climate cycles. According to the National Oceanic and Atmospheric Administration (NOAA), over the last 420,000 years temperatures on our planet have ranged from plus 4 degrees C (five periods of very warm weather) to minus 10 degrees (four periods of very cold weather) when compared to a nominal baseline. If we go back 600 million years, temperature variations are even larger. In fact, average temperatures have been significantly higher (over 18 degrees C) than today (about 14 degrees C) for much of the earth’s history. We can associate warm periods with lush plant life, dinosaurs, swamps, deserts, and overflowing oceans. Our treasure trove of coal, oil and natural gas (all are forms of carbon) was created during these warm cycles. Low temperature cycles have been associated with expanding glaciers, ice ages, struggling animal populations, and limited vegetation.


Is Fossil Fuel Resource Depletion Real?
Absolutely. The depletion of our oil, natural gas and coal resources is not a phenomenon that will happen sometime in the distant future. It is happening now. It has already raised the price of energy, altered the objectives and alliances of international diplomacy, empowered the political aspirations of producer nations, restructured how world energy markets work, and changed the economics of fossil fuel exploration and production.

Depletion creates a critical problem. Here is why. Make a chart of world population growth. Add the data for fossil fuel consumption on an appropriate comparative scale. Population growth has obviously driven the consumption of energy. The more people on this planet, the more energy we consume. Within OECD nations, fossil fuel energy has provided the foundation for economic wealth and population growth. But this begs a question.

If we no longer have enough cheap and readily available energy to support our lifestyle, what happens next?


False Assumptions
Public policy has thus failed to make a meaningful connection between fossil fuel resource depletion and global warming. This has led to the implementation of politically expedient pop-culture energy solutions of dubious (and often negative) value. The underlying fossil fuel energy assumptions are frequently false:

* American energy policy currently assumes we will forever be able to consume unlimited quantities of cheap oil. This assumption is false. Reliable, available and affordable oil resource consumption will peak before 2020.

* American energy policy assumes unlimited quantities of low cost natural gas. This assumption is false. Although opinions differ, it appears that reliable, available and affordable natural gas consumption will peak before 2050.

* American energy policy assumes the continuing availability of unlimited quantities of low cost coal. This assumption is false. Although opinions differ, it appears that reliable, available and affordable coal consumption will peak before 2075.

* Many global warming advocates assume we will be able to minimize the consumption of coal in order to reduce CO2 production. This assumption is false. As propane, kerosene and fuel oil increase in price, and fuel shortages become a continuous problem, coal will become the fuel of choice for residential and commercial heat wherever it is available.

* Advocates tell us we can “grow” our way out of fuel shortages with biofuels. This assumption is complex. There is a Malthusian tradeoff between biofuels and hunger. The more arable land we use to grow biofuels, the less arable land there is to grow food. For this reason, it is unlikely food stock biofuels will never provide more than 5 – 7% of today’s fuel consumption. In addition, documented evidence shows that agricultural biofuel production seriously damages our EcoSystem. On the other hand, there is hope (with crossed fingers) that processed algae can be used to supplement oil fuels.

* Public policy has thus far assumed fossil fuel depletion will not impact on our (world) economy. This assumption is false. Historically, there has been a close correlation between fossil fuel consumption and economic growth. Thus far, no alternative energy solution appears to be robust enough to fill the gap left by declining fossil fuel consumption. Of particular concern are liquid fuels for mobile applications.

* American energy policy assumes the worst case IPCC CO2 scenario. This assumption is false. Fossil fuel depletion CO2 levels will begin to decline in the second half of this century – even if we do nothing. That makes it highly unlikely we humans will ever produce the amounts of CO2 envisioned by the IPCC worst case scenarios.

So. What does this all mean? It means that if we want to make good public policy decisions about global warming, we must include the effect of fossil fuel depletion in our calculations. These are the evil twins – global warming and fossil fuel depletion. We can not deal with them one at a time. Public policy must include both of them in the legislative deliberations that lie ahead.


NASA Has Looked At Depletion
Scientists at NASA’s Goddard Institute for Space Studies have in fact made an attempt to include a consideration of fossil fuel depletion in a set of CO2 production scenarios. You can find the PDF of this work: “How Will the End of Cheap Oil Affect Future Global Climate?”, on the Internet http://pubs.giss.nasa.gov. (Ref 1).

From the text:
“Peaking of global oil production may have a large effect on future atmospheric CO2 level and climate change, depending upon choices made for subsequent energy sources. …. . We suggest that it is also important to “stretch” conventional oil reserves via energy efficiency, thus avoiding the need to extract liquid fuels from coal or unconventional fossil fuels. …..”

In the following graphs, the Business As Usual (BAU) scenario shows total CO2 emissions will peak around 2075. American energy policy currently assumes this data is correct. However, if we incorporate the depletion of oil, natural gas, and coal, CO2 production peaks around 2050 and declines thereafter. It would appear the Peak Oil Plateau (e) best describes the CO2 emissions of oil depletion. Total CO2 emissions peak in 2025 and fall below 2000 levels by 2050. If these graphs are adjusted for unlimited coal consumption, CO2 emissions from fossil fuels would peak before 2075.

The Effect Of Oil Depletion On CO2
Congress has used IPCC data in order to determine the levels of CO2 that would be present in 2050 (the end date of H.R.2454 CO2 reduction goals), if America does nothing to “fight” global warming. In the following graph, the data used by The House of Representatives to justify H. R. 2454 is shown in the left column. It suggests there will be a 21.2% increase of atmospheric CO2 in 2050 versus 2005. This data ignores any consideration of fossil fuel depletion. The right hand bar, however, shows that if we do include the reality of oil depletion on CO2 emissions, then it can be determined CO2 levels will actually decline by 9.2% by 2050. This reduction will occur even if we do nothing to decrease the production of manmade CO2.


At first glance, the CO2 data used by Congress does not justify the terms of H. R. 2454. But the subject of green house gas production is far too complex to make this simple conclusion. Fossil fuel resource depletion and global warming are joined at the hip. Evil twins that threaten our human existence. Failure to consider them together could lead to even greater CO2 production over the next 50 years because coal will become the fuel of choice for populations trying to stay warm. Of particular concern is untreated fossil fuel combustion occurring within nations located on the western shores of the Pacific basin.


Conclusion
The availability, security and cost of energy, along with the impact of energy consumption on our EcoSystem, are subjects of the highest priority for our political establishment. They belong – together – center stage in America’s energy plan. We should demand our politicians engage in a frank and intellectually honest discussion of energy. Start with an assessment of what kinds of energy we will need, how much of each kind of energy it will take to sustain our economy, and an assessment of alternative energy choices. A relatively simple energy plan that includes fossil fuel conservation, improvements in the efficiency of energy consumption, and the development of lower carbon alternative fuels will decrease manmade emissions and help to ensure energy security. How we chose to utilize, stretch out, and allocate our remaining fossil fuel resources is a critical decision, one that will impact America’s future – and the welfare of all nations.


TCE


Reference 1: Kharecha, P.A., and J.E. Hansen, 2008: Implications of "peak oil" for atmospheric CO2 and climate. Global Biogeochem. Cycles, 22, GB3012, doi:10.1029/2007GB003142. See: http://www.giss.nasa.gov/research/briefs/kharecha_01/

OECD
Do you live in one of the Organization for Economic Co-Operation and Development (OECD) nations? You do if you live in Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Japan, S. Korea, the Netherlands, New Zealand, Norway, Poland, Portugal, Spain, Sweden, Switzerland, the United kingdom or the United States.

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Energy Bill Ignores Oil Depletion

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Although future fuel shortages and price increases are openly predicted by four Federal Government reports, several books, and multiple documents, Congress refuses to acknowledge oil, coal, or natural gas depletion. There is nothing in H.R. 2454 that even hints Congress understands the consequences. It’s as though energy resource depletion doesn’t exist.

Congressional failure to acknowledge the reality of depletion creates an interesting irony. Congress wants us to believe the American Clean Energy and Security Act of 2009 will create clean energy jobs, achieve energy independence, reduce global warming pollution and transition America to a clean energy economy. But this bill is based on a basic assumption we will always have unlimited quantities of cheap coal, oil and natural gas. The stated objectives of this bill are therefore rendered useless by the underlying assumptions.

There is nothing in this bill that addresses, or even acknowledges,
that oil resource depletion will reduce the production of greenhouse gases
between now and 2050.

Higher prices and limitations on availability will force a reduction of consumption and a decline of economic activity. By 2020 North American oil and other liquids consumption will have fallen below year 2000 levels. Additional reductions will occur through 2050 and beyond. Declining global oil consumption will bring down CO2 levels with greater efficiency than H.R. 2454, and at a much lower cost to the consumer.

Congress needs to include energy resource depletion in its legislative discussions. There can not be any doubt, depletion is a critical component of a credible energy plan.


TCE
www.tce.name

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The Sherman Antitrust Law Is Obsolete

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Introduction
Christine Varney, one of America's top antitrust officials, has announced the Obama Administration will be aggressive in the pursuit of antitrust violations. Although I support a more assertive and even handed administration of our government’s antitrust obligations, the Obama clan is overlooking one small detail -

The Sherman Antitrust Law Is Obsolete.

This raises two serious questions:

• Why has Congress has failed to overhaul the primary law that will be used for prosecution?
• Without adequate legislative policy, will the Obama Justice Department be tempted to pursue its antitrust agenda based on political expediency, political correctness and the ignorance of passionate ideology - rather than the considered application of law?

Here is an essay I wrote several years ago on this subject when Microsoft was the target of a lethargic and ultimately ineffective Federal antitrust action. With some minor updates, it is just as relevant today as it was then.


The Sherman Antitrust Act
As a piece of legislation, this law is obsolete. The Sherman Antitrust Act of 1890 was designed to deal with the political and monopoly power of (frequently interlocking) trusts. Specific companies had pricing, availability, distribution and product power over the consumer. Relief came in the form specific restrictions to business practices and monetary punishment.

That was circa 1890. Over 110 years later, the cultural and economic structure of our nation – and indeed the whole planet – has changed. Big time. We have created the telephone, radio, television, movie, airline, automobile, electronics, computer, software, pharmaceutical, and Internet industries (to name a few). Business is now done on an international scale by global companies. Huge corporate interests control the world’s financial markets and the flow of money.

But Congress does not appear to have noticed. For our people in Washington, it’s still 1890. Or maybe 1929. Instead of comprehensive reform we are burdened by a confusing patchwork of consumer protection laws and regulatory mandates.


Unanswered Questions
Dominant players set the rules of competition and corporate existence. All industries are vulnerable. Software, banking, insurance, manufacturing, retailing - it does not matter. The potential for domination - whether by marketing power, financial strength, or technology - exists.
And if 21st century industries tend to gravitate toward the business ground rules established by one or two dominant players, then we need to ask multiple questions:

• What is an open and competitive market?
• What is the basis for determining economic concentration?
• What is market domination?
• Should a company be allowed to use it's domination of one market to leverage its customer base into the domination of other markets?
• If the consumer is forced to purchase defective and/or dysfunctional products because there is no viable alternative, what is the dominant company's implied liability?
• What are consumer rights? (How can they be measured?)
• At what point does the power of the dominant player jeopardize consumer rights?
• What is a fair penalty for jeopardizing consumer rights?
• If a market is dominated by a single company, at what point does this imply that it must assume a fiduciary responsibility to act in the public interest? And what are the guidelines for corporate behavior? How will they be enforced?
• How much political and economic power do we want a single company to accumulate within a specific market?
• Since almost all very large Corporations are global companies, and because they may be headquartered anywhere on our planet, how should American antitrust law and public policy be coordinated with other members of the international Organization for Economic Cooperation and Development (OECD)?
• Should public policy take “after the fact” punitive action, or should antitrust law include pre-emptive guidelines for what is, and what is not, a monopoly or unacceptable concentration of economic power?
• What is the mechanism for restructuring competition? And what is the basis for deciding what is, and is not, in the public interest?
• And finally, existing antitrust law does not address the defacto standards issue. Over the last 85 years, the telephone, teletype, electric, water, radio, entertainment, and television industries have been characterized by the evolution of increased concentration based on a company dominated list of defacto standards. So. Congress needs to address at least two questions: what is the basis for determining if defacto standards are in the best interest of the consumer? And if it is established they are not, then what is the mechanism for leveling the playing field? (Note 1)
  

Obviously, there are many more questions that need to be resolved if antitrust policy is to be rendered relevant to the realities of the 21st Century Corporation. It must address existing global market structures, emerging technologies, defacto standards, economic liability, and the use of 21st century corporate power. To be both effective and fair, implementation America’s antitrust policy should be contemporaneous with the antitrust policy efforts of the other OECD nations.

We should be concerned about what will happen next. Since the Sherman Act currently provides inadequate guidelines for establishing what will be - essentially - public policy, then the court has two choices:

• Interpret the law within the narrow confines of legal precedent (which essentially will let favored Corporations off the hook while encouraging the venomous persecution of others); or
• Broaden the interpretation of the Sherman Act in order to protect the consumer from further harm that may occur in the future (which will require the Court to consider issues and questions not necessarily documented within the scope of each individual case, and empowers the court system to make law).

Either way, the lack of comprehensive antitrust legislation means that these issues will be addressed in an arbitrary fashion, one by one, without regard to the guidelines of legislative policy. The temptation will be to turn prosecution into politically expedient persecution.


Conclusion
Once again, Congress has failed to do its job. Our existing financial crisis has been caused, in part, by an unchallenged concentration of economic power. The Sherman Antitrust law should have been overhauled long ago.

And that’s my opinion.


TCE

Note 1: Within the public services industries, regulation has sometimes been used to ensure that these standards are beneficial to the public interest. That is why your land line telephone can call anyone on our planet. And there are additional examples of industrial standards that have been promoted for the benefit of all potential players. When RCA set the defacto standards for color television, for example, multiple industry participants were able to adopt them for their individual benefit. On the other hand, a good example of defacto standards that have proven to be a costly and irritating problem for the consumer (including corporate and government consumers) is Microsoft’s Internet browser and this company’s domination of the PC OS market.
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Is This The End Of Wealth Creation?

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The Roman Empire
The rise and fall of the Roman Empire is a classic example of Return On Investment (ROI). Rome essentially funded conquest through pillage, tribute and taxes, bringing rich treasures of gold and silver back to Rome. During the early years of the Empire, the ROI on conquest was very good and Rome prospered. It had plenty of coin to fund its Legions. As the years went by, however, it became more difficult to find lands worth conquering and the travel costs to send a Legion to remote lands increased. The ROI of conquest began to falter, and Roman Emperors finally concluded additional conquests were not worth the cost. Years of wealth creation came to an end. The Roman Empire shifted its attention to wealth preservation.

Whenever a nation slips from wealth creation
to wealth preservation,
it becomes increasingly difficult
to sustain the prior level of wealth.

As the cost of maintaining the Legions went up, the ROI on having them declined. In order to pay the cost of preservation, Rome debased its currency multiple times. Debasement is a way to pay today’s bills with tomorrows worthless coins. That led to incredibly high rates of inflation. Payment in kind often substituted for worthless currency. This debasement continued until mercenary legions refused to take Roman coins, sacked Rome, and established their own government. (Reference 1)


Sound Familiar?
There is a lesson here. If economic circumstances yield a positive ROI on labor, capital and material, then a nation is able to create wealth. When a nation lapses into wealth preservation, the ROI on invested capital declines. It becomes very difficult to sustain transfer payments because the creation of wealth declines to a point where there is no more wealth to transfer.

Wealth, in this sense, has little to do with how much money the rich can command. We are talking about the wealth of a nation’s workers, and more specifically the wealth of its middle class. Rome’s declining ability to maintain the wealth of its workers led to unsustainable welfare costs. The cohesive energy of Roman culture collapsed.

This is precisely the situation in America and the European Union. The 20th century was marked by multiple opportunities to create great wealth – radio, television, movies, telephone, automotive transportation, coal, oil, natural gas, electricity, railroads, airplanes, bio-sciences, communications, electronics, semiconductors, computers, PCs, the Internet and software. Economic circumstances created multiple opportunities to create wealth for the ordinary person from the mid 19th through the end of the 20th century. The collapse of the technology bubble from 2000 – 2003 was especially significant. Beginning in the late 1960s, computers, then PCs, then networking, and finally the Internet – along with all the software to make them work – offered the last significant wealth creation opportunities of the 20th century. When the technology bubble burst, the era of wealth creation ended. Subsequent development of cell phones, computer games, and other electronic devices are merely an extension of the technology era. Important as they are, they did little to increase the GDP of most nations.

Every OECD nation will be focused on wealth preservation.

Aside from nano-technology and energy, it would appear the 21st century will be characterized by an unsuccessful attempt to sustain prior wealth. There are few significant opportunities to generate new wealth on a scale of the innovations that underpinned wealth creation over the last 160 years. We will build new cars, interesting vehicles with new energy components, but we will not create the auto industry. We can now fly anywhere in the world, but our ability to manufacture economically viable airliners has peaked. The traditional media industry is now in contraction. We have already discovered, and consumed, most of the cheap oil. And so on.


The Deterioration Of GDP
The American economy has an embedded structural problem. Our economic focus has shifted to the preservation of wealth. This is not a prediction of the future. It is already happening. The following chart shows the annual change in Current Dollar Gross Domestic Product (GDP) from 1968 – 2008. Note that current dollar GDP seldom exceeds 2% after Q2 of 1984. For the last 20 years, the average has been just over 1.2%. The “Internet Boom” of the 1990’s actually did little to increase current dollar GDP. And despite a few quarters of spectacular growth as we claw our way out of this recession (no sure thing), it would appear average annual current dollar GDP growth will continue to deteriorate.


This is why I am furious at the intellectually challenged thinking that has gone into the proposed “stimulus” bill. It does much to transfer wealth. It does a woefully inadequate job of providing the opportunity to create substantial new wealth.

Our government is currently trying to artificially elevate American Real Estate values and sustain economic activity by spending several trillion $ of taxpayer money on “bail-outs” and “stimulus” packages. Although money flow will surge for a time, these efforts will ultimately fail because they do not address the fundamental underlying problem – we have slipped into preservation mode. If we want these programs to be successful, they have to either create wealth, or facilitate the creation of wealth. (Reference 2)


Looking Ahead
For the purposes of this article, there were four other reasons for the decline of the Roman Empire:

1. Product manufacturing drifted away from Rome to outlying regions. As Rome’s importance as a manufacturing resource declined, its ability to pay for food and goods from outlying lands also declined. “Why trade with Rome?”, went the argument. “They can’t pay you and if they do, it’s with worthless debased coin.”
2. In order to pay for its Legions and welfare recipients, Roman Emperors increased taxes to the point they were confiscatory. Farmers lost their lands because they could not pay the taxes, or because the tax burden made further farming uneconomical. Cultivation declined. Displaced, and often starving, thousands of farmers drifted into Rome or became bound to rich patrons (the start of serfdom).
3. Thousands of slaves, displaced farmers, former Legionnaires, and aliens flooded into Rome, swelling the welfare rolls and degrading Roman culture.
4. Rampant political corruption and moral decay demeaned the value and quality of life. Desperate for spiritual fulfillment, thousands abandoned pagan beliefs in favor of emerging Christian doctrine.

If we are willing to compare the decline of the Roman Empire with the current cultural and economic condition of the United States, Canada, and several nations in Europe, the parallels are too obvious to dismiss. Our manufacturing base is declining, and welfare transfer payments are increasing. There is a call for higher taxes. Aliens flood across porous borders. Corruption and moral decay is not merely the norm, it is defended with emotional fervor.

The era of wealth creation is over.


TCE
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Reference 1. With sincere apology to those who have invested hours of time in the study of the Roman Empire. This thumbnail description is all too brief and partly whimsical.
Reference 2. For more information on how we got here in the United States, please do browse through my blog www.tce.name

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How To Create 4 Million Jobs In 90 Days

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Lost Jobs
At least 23 million Americans are either unemployed (they do not have any job) or under-employed (they are being paid for less than 35 hours per week). America’s Work Shortage Index (WSI) of unemployment plus underemployment will increase from 15.2% at the end of 2008, to a Work Shortage Index of more than 21.9% by the end of 2009. Over 33.8 million Americans will be forced to sharply curtail their spending. Over 27% of all American households will be in financial trouble. (Reference 1)

Despite this shortage of work, however, the Obama Administration has thus far adopted the immigration and outsourcing policies of the prior G. W. Bush, W. J. Clinton, G. H. W. Bush, and R. Reagan Administrations. The result? Not only have American workers been losing good job opportunities for more than 20 years, existing Washington policy guarantees over 2.5 million more jobs will be lost in 2009!

Is this what we want?

America’s job losses include:

• Over 6 million production related jobs in development engineering, manufacturing engineering, manufacturing, distribution, and administration. Key losses have occurred in vehicle manufacturing, computers and computer accessories, telecommunications equipment, electronics, electric components and equipment, medical equipment, industrial machines, pharmaceutical preparations, consumer electronics, household goods, toys and sporting goods, shoes and clothing, food and beverages, oil and petroleum products, natural gas, and vehicles. Almost 2.5 million production related jobs evaporated during the 8 years of the recent Bush Administration. (Reference 2)
• Over 2.3 million off-shore, outsourced, jobs in back office accounting operations, reservations, customer support and service, software development, maintenance, and support, paralegal services, document management, financial services, human resources, records management, aviation maintenance, health care, financial transactions, marketing and sales, and research and development. That’s a payroll of over $27 billion in 2008.(Reference 3)
• Over 3.6 million non-immigrant jobs currently taken by legally authorized working age foreigners within the United States.
• Over 7 million jobs currently taken by illegal aliens.
  

The total? Federal industrial policy has cost American workers over 18 million jobs. At least 9 million of these jobs paid a decent wage. (Reference 4)

Not only are we exporting mundane repetitive jobs, we are deliberately exporting the ability to grow our economy. We are giving away intellectual property and critical job skills to foreign manufacturers. Just as fast as we can. And foreign governments are doing a far superior job of supporting their manufacturing base. The result? Thanks to Washington’s obtuse industrial policy, millions of Americans now face economic privation.

Why? Because Congress and four Administrations believed it was politically correct and politically expedient to do so. Democrats and Republicans. And despite rising unemployment and under-employment, existing Federal policies guarantee there will be a continuing drain of American jobs.

Why do we want this?


Time Out
OK. Before we launch into a discussion of a solution, Here are 3 points.

1. Few people believe it is possible, practical or even desirable to get all these jobs back. We do live in a global economy. Free trade does reduce the cost of goods and services. International trade is better than international conflict.
2. I strongly favor the free interchange of jobs among and between workers who live in one of the OECD nations. We can learn from each other. We can create lasting friendships.
3. I also strongly favor the creation of more international University level student exchange, education and work opportunities. Participation should be encouraged for every under-graduate, and a requirement for every Master’s Degree candidate.
   

In other words. I am not an isolationist for one very simple reason: the more we work together, the more we learn from each other, and the more likely we will come together. That’s good - if we think world peace is a virtue.


But
But – and there is always a “but” – the first duty of our Federal Government, indeed the first duty of any national government, is to protect the welfare of its citizens. It is OK to encourage foreign employment when times are good, but when the economy dumps into a recession, then all the rules change.

Given America’s current economic slump, and until American unemployment drops below 5 percent, our employment policy should be guided by one simple objective:

American Jobs Are For Americans

Period.

How many jobs do we need to create? If unemployment increases from 7.1% to 10.0%, and our goal is to reduce unemployment to 5% of the available workforce, then America needs to generate over 13 million new full time jobs by the end of 2010.

That’s unlikely to happen. We are being told the stimulus package before Congress will create or save from 3 to 4 million new jobs. That’s not enough. Not by a long shot. We need an alternative strategy. One with far less risk.

Fair warning to Congress and the Obama Administration.
You will not get a second chance.

The proposed stimulus package will drain the coffers and debase our currency. If it fails, America’s credit will be dead meat.


Action Proposal
So. What is the alternative? Here is a proposal.
Part 1. The foundation. America needs to develop a constructive, positive, and supportive industrial policy. One that creates good jobs for Americans. Permanent jobs we can do with pride.
Part 2. Make Tough Policy Decisions. Re-examine our offshore outsourcing and work visa programs to shift a higher percentage of employment to American workers.
Part 3. Economic stimulation. Based on the policies thus developed, we need a stimulate our moribund business community into action. We can do that with a package that focuses on long term economic growth. Key areas of attention include energy, bio-science, health care, electronics, software, communications, nano-technology, infrastructure, public transportation, and the manufacture of capital goods.


Stop The Bleeding
In the following text, we examine offshore outsourcing and work visa policy because it is the easiest and quickest way to generate American jobs. I propose 7 Steps.

Step 1. Pay a living wage for American jobs. Raise the minimum wage to $9.00 per hour. Create a substantial differential between unemployment benefits and the minimum wage by limiting unemployment benefits to the equivalent of $6.00 per hour.
Step 2. Prohibit the export of American jobs. Until the unemployment rate drops below 5%, employers may NOT transfer internal functions to off-shore locations, and they may NOT contract to have those functions done by a company that uses foreign workers in the United States. (Reference 5) Estimated jobs created or saved in 2009 and 2010: 1.0 million (includes the termination of existing contracts).
Step 3. Place a premium on work visas. Charge a flat fee of $12,000 for each work visa and limit the duration of all visas (including those which have already been issued) to 12 months. Charge an additional $12,000 for each work visa renewal. Estimated jobs created or saved in 2009 and 2010: 2.4 million (66% of work visas, includes termination of existing permits).
Step 4. Create a Guest Worker program by issuing 6 month temporary visas to alien workers who will earn no more than $6.00 per hour. Charge $200 for each guest worker visa issued. The combination of steps 1 and 4 should create an estimated 1.7 million jobs (20% of illegal alien workers).
Step 5. Establish a realistic, constructive and positive industrial policy. Encourage the restoration of America’s manufacturing base. Use import fees and appropriate regulation to level the playing field with subsidized foreign competition. Estimated jobs created over time: 3.0 million (50% of lost manufacturing jobs).
Step 6. Training and education. Use the fees thus collected in steps 2 – 5 to establish and support job training programs specifically aimed at the jobs thus created or saved. Establish both quantitative and qualitative job skill development objectives.
Step 7. Enforcement. Persons or corporations who violate these laws should be fined as appropriate, per violation. Require all employers with 15 or more employees to use the E-Verify program to confirm applicants are legally entitled to seek employment.

Let’s see. We just created at least 8.1 million American jobs in less than 90 days. And we didn’t have to spend a dime of taxpayer money.


Reality
Don’t like my numbers? Do your own homework. This first thing you’ll discover is that our politically correct and politically expedient people in Washington have never asked the DOL to even study this issue. For example: DOL/BLS Table A-8 “Unemployed Persons By Reason Of Unemployment”, does not tell us how many of these jobs were lost because they were (effectively) exported. Doesn’t that seem odd? Could it be our “political leaders” are more concerned about the rights of illegal aliens that the rights of the American worker? Have they found it “profitable” to ship American jobs to foreign nations? Why are they focused on bringing foreigners into the United States to take American jobs when we are headed for catastrophic unemployment?


About Inflation
Yes this policy change will contribute to a higher rate of inflation. That gives us a gruesome choice. Unemployed people with high rates of inflation, or employed people with high rates of inflation. Given Federal monetary policy, higher rates of inflation are a given. Creating a (temporarily) restrictive offshore outsourcing and work visa policy won’t make much difference to the cost of living.


Yes We Can
We can reduce our unemployment problem by making a few simple changes to our offshore outsourcing and work visa policies. And we don’t have to spend a dime of taxpayer money. We don’t have to bankrupt America with a pork laden stimulus bill. We don’t have to risk our economic future, the economic future of our children, and the economic future of our grandchildren. We don’t have to dump America into the abyss of depressing socialist economic policy.

Yes, I know. I’m proposing to upset the status quo. Giving American jobs to foreigners has become a BIG business. Few intellectual elitists will like my proposals. Special interest groups will go ballistic. Lobbyists will lie to confuse the issues. Democrats will fumble for politically correct words. Republican’s will sputter in confusion. Foreign governments will posture and complain.

Lots and lots of whining. But for me, our first priority is to provide job opportunities for American citizens. Let’s focus on putting Americans back to work.


Conclusion
One can argue with my numbers. One can whine about my proposed solutions. But the underlying thesis will remain. It does not change. The first obligation of our political establishment is to put Americans back to work. If we are willing to change our offshore outsourcing and immigration policies, we can create several million job opportunities and sharply reduce the size of the stimulus package now before Congress. This approach to our economic crisis poses significantly less risk for America’s financial health, and is far more likely to be successful.

So Mr. President. If I were running America, I would create 4 million jobs in 90 days. And not spend a dime of taxpayer money. All we need to do is conduct a serious review of our work visa and offshore outsourcing policies.

We can do it. Yes we can. All we need is the political will in Washington.


TCE
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Reference 1: Under-employment includes people, such as real estate agents, independent trades, and contract personnel, whose business has declined for economic reasons, along with hourly workers who are working part-time because they are unable to find a full time job. For more information on unemployment and under-employment, see “Unemployment: How Do We Measure A Shortage Of Work?” at www.tce.name .
Reference 2: Department of Labor, Bureau of Labor Statistics - LNU02032213. Assuming production job opportunities grew at the same pace as chained GDP.
Reference 3: Key employment losses include jobs in information technology (28%), human resources (16%), sales and marketing (15%), finance (11%), and administration (9%). Offshore outsourcing has become a $50 to $80 billion per year industry (I have seen both figures. Absent any relevant DOL/BLS data, we can only guess which number is right.) It was growing at more than 25% per year until the credit crunch hit. This puts the current American job loss somewhere between 2 and 3.2 million employees.
Reference 4: These figures exclude jobs for seasonal workers, artists, entertainers, athletes, and new working age permanent residents who have come into the United States. They include the loss of jobs associated with importing foreign goods and services, as well as foreign facilities operated by American companies.
Reference 5: A simple way to discourage offshore outsourcing is to charge a federal tax of $1.00 per minute for all telephone calls made to other nations (excluding NAFTA participants). That would substantially decrease the cost advantage of offshore outsourced labor.

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Home Prices: Where Is The Bottom?

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Little Good News
I pulled the following from a Reuters article, January 27, 2009:

• “Home prices plunged a record 18.2 percent in November from a year earlier as the country's housing market remains in the throes of a deep recession, according to the Standard & Poor's/Case-Shiller composite index.”
• “Since August 2006, the 10-city and 20-city composites have declined every month -- a total of 28 consecutive months”.
• “As of November, average home prices are at similar levels to what they were in the first quarter of 2004. From their peak in mid-2006, the 10-city index is down 26.6 percent and the 20-city Composite is down 25.1 percent.”

In many geographic areas, housing market values continue to deteriorate. Last year I projected that the national average price of a single family home would decline by more than 30% (see Banks: Bleeding Value And Hiding Desperation, March, 2008). In that essay, I posed the following question about California real estate: “why would I pay $268 per square foot for a purchase property when I can rent an equivalent house for $195 per square foot? ( For lower quality properties, and assuming a 7% gross ROI, this means the owner occupant who pays $1.81 per square foot per month can reduce cash outlays to $1.14 per square foot per month by renting an equivalent unit).”

It would appear American average single family home prices, already down by more than 25%, will indeed decline by more than 30% from their highs of July 2006 (using Case/Schiller Data). The “bottom” will not be reached until per square foot purchase prices are in the same range as the per square foot investment value of rental units. Unfortunately, escalating unemployment and under-employment, along with restricted credit availability and a continuation of mortgage defaults, have combined to put an almost chronic downward pressure on single family home values. This suggests we shall have to wait a bit longer to see a “bottom” in the single family real estate market.

When parity occurs, vacant homes will be purchased by investors as rental units, and they will also become an attractive option (versus renting) for consumers who would like to buy a home of their own. As the surplus of vacant units declines, owner in possession homes will again command a premium over rental properties.

Two Notes

1. Unfortunately many investors have already purchased single family homes with the intention of converting them into rental properties. They came into the market too soon. For some of these deals, annual mortgage, tax, rental, and maintenance costs will be less than rental income. Hopefully, these early investors have the capital to sustain their losses until the economy recovers and rental rates start to increase.
2. In some geographic real estate markets, single family rental versus purchase parity is already in place. Problem areas include California, Florida and Nevada, where the price increases and new construction were excessive.

Conclusion
Although we could see a sporadic increase in the national average of single family home values during 2009, buyers continue to be frightened by America’s economic malaise. Because I believe our economy will not begin to show significant upward movement until 2010 or later, home values will continue to be under pressure for the foreseeable future. Look for average national single family home prices to decline by more than 30% from their peak in 2006.

But, perhaps I am too pessimistic. Let’s all pray for a speedy economic recovery.


TCE
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Another Confirmation of Oil Depletion

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Of all the very large companies in the oil business, one has to particularly admire the business strategy of Schlumberger. This company is the world’s leading supplier of technology, integrated project management and information solutions to customers working in the oil and gas industry. Employing more than 87,000 people in approximately 80 countries, Schlumberger attempts to work with the national governments that actually own the world’s oil resources on a cooperative basis. This non-competitive, cooperative, strategy brought Schlumberger revenues of $27.16 billion in 2008.

Because of its stature, I listen when this company comments on industry trends. In the following excerpt from a January 23, 2009 press release, Schlumberger Chairman and CEO Andrew Gould talks about the availability and price of oil. I highlighted a few key points in italics:

“….. The sharp drop in oil and gas prices due to lower demand, higher inventories and the belief that demand will erode further in 2009 as a result of reduced economic activity, is leading to rapid and substantial reductions in exploration and production expenditure. At current prices most of the new categories of hydrocarbon resources are not economic to develop. It will take time for inflation to be removed from the system and to bring finding and development costs more in line with lower oil and gas prices.

We expect 2009 activity to weaken across the board with the most significant declines occurring in North American gas drilling, Russian oil production enhancement and in mature offshore basins. Exploration offshore will be somewhat curtailed but commitments already planned are likely to be honored. Seismic expenditures particularly for multiclient data are likely to decrease from last year. …

The key indicator of a future recovery in oilfield services activity will be a stabilization and recovery in the demand for oil. The recent years of increased exploration and production spending have not been sufficient to substantially improve the supply situation. The age of the production base, accelerating decline rates and the smaller size of recently developed fields will mean that any prolonged reduction in investment will sow the seeds of a strong rebound (in exploration activity). ….”

For those of us who have been concerned about oil depletion, this statement provides yet another confirmation of our analysis and conclusions. Most of the new categories of hydrocarbon resources (including “tar sands”) are not worth developing unless world prices are higher than the current $45 per barrel of oil equivalent. The decline of hydrocarbon resource development guarantees deficient supplies when the world economy recovers. Oil supplies will again be tight, leading to another round of upward price volatility.

TCE
www.tce.name
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NBER: It’s A Recession

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There is always a certain sense of satisfaction when economic scenarios play out as expected. In the spring of 2007, I predicted a recession would start before the end of the year (see: Warning: Recession Ahead). I identified the basic cause in March, 2008 (see: A Few Words on the Economy), and discussed the impact of the recession in May, 2008 (see: Yes Virginia, This Is A Recession). Then in early December, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) confirmed my start date. Recent events confirm the rest.

The NBER maintains a chronology of the beginning and ending dates (months and quarters) of U.S. recessions. The committee determined that a peak in economic activity occurred in the U.S. economy in December 2007. The peak marks the end of the expansion that began in November 2001. A recession, according to the NBER, is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough. Between trough and peak, the economy is in an expansion.

The NBER does not identify economic activity solely based on real GDP. It uses a range of indicators and places considerable emphasis on a monthly chronology that measures the depth of the decline in economic activity. A recession, in NBER terminology, is a period of diminishing activity rather than diminished activity. The Committee identifies a month when the economy reached a peak of activity and a later month when the economy reached a trough. The time in between is a recession, a period when economic activity is contracting. The following period is an expansion.

As I put the final draft together for my book “Oil, Jihad and Destiny” in the Spring of 2004, it became obvious that most probable economic scenarios would have to include a recession starting in the fall of 2007. Time has shown my projected start date was early by approximately 90 days.

For an economist, that amounts to a perfect score.

Ron

OK. To be perfectly honest, I overestimated the rate of inflation because - and this was a dumb mistake - I forgot that the rate of inflation is closely aligned with the price of oil based fuels (see the next essay). As we fell into a recession, the demand for fuels declined. When supply exceeds demand, commodity prices decline. Lower fuel prices equal lower rates of inflation. But a little caution. The reverse is also true. Any shortages of oil, real or merely perceived, will drive up the rate of inflation.
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Price Trends: Gasoline and CPI Are Twins

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Just for the fun of it, I calculated the month to month change in the price of American gasoline (all grades) versus the month to month change in the Consumer Price Index (CPI-U), from January 2004 through October, 2008. Although the correlation is not perfect, it does show how the rate of inflation tracks the price of gasoline (and the oil from which gasoline is made). The left scale of the following chart shows the month to month change in CPI-U as reported by the Department of Labor, Bureau of Labor Statistics (BLS). The right scale shows the month to month change in the price of gasoline as reported by The Department of Energy (DOE).This is important stuff. Although the annual change in the average price of gasoline versus the annual change in the CPI have a lower correlation, the long term trend for the price of oil (and hence gasoline) is UP. Unless we humans find an alternative source of low cost fuel to replace the portability and high energy content of oil, the long term outlook for inflation is also UP. As shown by this chart, the price of oil has been (and will continue to be) volatile. We can assume the rate of inflation will be equally volatile. Since the price of oil will become an increasingly important component of what happens next to the world economy, the development of alternative (lower cost) energy options assumes increasing importance.


TCE
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Oil Depletion: Obama Faces Hard Political Decisions

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Washington insiders are well aware of oil depletion. It has been the subject of at least four detailed reports funded by the United States Government, more than a dozen books, and multiple independent reports. Congress has taken testimony. Key figures in Washington have made speeches. Although there are some differences in the details, they are trivial in comparison with the broader perspective.

It is highly probable that oil demand will exceed oil supply within the next 8 years.

If you buy heating oil, propane, gasoline, or diesel fuel, you have already become a victim of oil depletion. The lethargic pace of production was almost overtaken by growing demand in 2008. Tight supplies led to higher prices. Greed driven speculation subsequently pushed oil prices over $140 a barrel. Then came the financial crisis. When speculators discovered recessionary forces were driving down the demand for oil, fear immediately replaced greed. The price of oil declined. Fast.

But do not be fooled by this temporary decline in the price you pay for fuels. OPEC will curtail production until demand picks up again. The fundamental trends have not changed. As our world economy gradually recovers, the supply of oil will not keep up with the demand for oil. Higher prices and shortages are in your future.

The Washington establishment’s past failure to acknowledge oil depletion was not one of ignorance. It was a matter of political expediency. Politicians prefer to avoid bad news. Depletion means higher prices and possible shortages. Depletion adds confusion to the problems of global warming. Depletion complicates American policy in Iraq and Iran. Oil depletion will force us to make substantial lifestyle changes. Dealing with the challenges of oil depletion have already created additional stress for our political system.

Yes. Oil depletion creates a real political dilemma for Barack Obama. He will be expected to do something about it. It will not be easy. Acknowledging oil depletion means finding more oil resources to keep our economy going. Shortages must be avoided. Put a lid on prices. Drill everywhere. No sacred environmental cows such as ANWR or the Santa Barbra channel. Make deals for oil with whomever is in charge of the big oil nations. Control the political outcome in the Middle East. Stay in Iraq to protect America’s interests. Tough choices. High political risk.

But if Barack ignores oil depletion, then what? He runs the risk of cataclysmic political failure. Because it is highly likely that sometime – during his administration - shortages and high prices will decimate America’s economy. That means high unemployment. Out of control inflation. Voters will be mad as hell. Why – they will ask – did you let this happen to us?

So. What to do? Barack faces hard political decisions. Oil depletion will force his hand. One way – or the other. In the spirit of being constructive, here are four suggestions:

1. Take an integrated approach to contemporary concerns about global warming and fossil fuel depletion. Global warming and fossil fuel depletion are in fact evil twins, and if we want to make intelligent choices, we need to deal with them as a package.
2. Persuade national leaders to form an oil and natural gas consumer’s union. Start with the United States, Canada, and the European Union. Invite China and India. This will give consuming nations the leverage needed to deal with supplier cartels, and – hopefully – lead to resource sharing agreements.
3. Find a way to deal with the Middle East. These nations have most of the world’s remaining deposits of cheap oil. For the sake of world peace, we must control the outcome.
4. Create a credible energy program. One with strong management, specific objectives, adequate funding, and a time line for accomplishment. Include public policy initiatives that promote conservation and the evolution of energy conscious life styles.

There is a very long list of potential initiatives Barack could implement. Sorting through them will test his wisdom and political courage. But try he must. Oil depletion is a challenge that will not go away.


TCE

For more on oil depletion and what we can do to help our nation, go to www.tce.name , check out the essays under the Energy Tab, and then read “The Report on Oil Deletion” .

Greenspan: You Blew It

Recently, Alan Greenspan appeared before the House Committee of Government Oversight and Reform. In a prepared statement, he said: “We are in the midst of a once-in-a century credit tsunami. …. This crisis, however, has turned out to be much broader than anything I could have imagined. It has morphed from one gripped by liquidity restraints to one in which fears of insolvency are now paramount. Given the financial damage to date, I cannot see how we can avoid a significant rise in layoffs and unemployment. …. those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity (myself especially) are in a state of shocked disbelief. ….. It was the failure to properly price … risky assets that precipitated the crisis.”

In other words, Alan, you admit the Federal Reserve failed to comprehend what was going on in the world’s financial system. I don’t know how to say this Alan, but – um – uh – Wasn’t that your job?

In the Board’s own words, here is a definition of what we the people thought the Federal reserve was doing:

“From: Board of Governors of the Federal Reserve System Washington, D.C.
April 2008
To: The Speaker of the House of Representatives:

As the nation's central bank, the Federal Reserve System has numerous, varied responsibilities:

• conducting the nation's monetary policy by influencing monetary and credit conditions in the economy
• supervising and regulating banking institutions, to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers
• maintaining the stability of the financial system and containing systemic risk that may arise in financial markets
• providing financial services to depository institutions, the U.S. government, and foreign official institutions”
  

This is very discouraging. As enumerated by the preceding paragraph, the Federal Reserve’s responsibilities are very clear. But Alan, you are telling us the global financial system was coming apart at the seams and – no one at the Fed even noticed!

Alan. Explain something to us. How is it, the Federal Reserve, which spends over $150 million a year collecting financial market data, can not seem to understand what the hell is going on? And how is it that I, by myself, with a tiny, tiny percentage of the Federal Reserve’s resources, can do a better job of forecasting? And, oh – why is it that I identified and wrote about the mortgage backed security mess a full five years before the Fed finally acknowledged sub-prime lending is a bad idea? And lastly, how come I correctly predicted a recession a full 14 months before the Fed finally conceded the economy was in real trouble?

The Fed – with all its resources - should be far better at economic forecasting than I am. But if the Fed is unable to create a realistic scenario of future economic activity, then why should we believe it can carry out its mission?

Again. From your testimony: “In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivatives markets.”

Wow! Big computers. Massive data bases. Complex algorithms. And - all that highly regarded intellectual firepower.

Ignored the obvious. .. Why?

My point, of course, is that the Federal Reserve would have done a far superior job of forecasting if it had used the tools of Cultural Economics rather than the obsolescent parochial analysis of conventional economics. In short. If it wants to restore its credibility, the Federal reserve needs to overhaul its approach to the collection and analysis of relevant cultural and economic data.

Assuming – of course – such a move would be considered politically expedient.

TCE
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Where The Heck Is The Bottom?

A Logical Conclusion

One can make a case that sometime in 2010 our stock markets will “bottom out”. In this scenario, the DOW will decline below 5700 and the NASDAQ will fall under 930, after 33 to 35 months of highly volatile trading.

How credible is this conclusion? Read on.

According to this morning’s stock market news on CNN, most economists believe this will be a relatively short and shallow recession. This conclusion is apparently based on an extrapolation of past economic performance in comparison with currently available data. To construct this scenario, one merely needs to look at the “usual” market direction indicators. Corporate profits, GNP, auto sales, the Purchasing Manager’s Index, payroll employment, personal income, public consumption, retail and durable goods sales, housing starts, and the value of the dollar are all negative. Unemployment is up, along with the rate of inflation. By themselves, the data underlying these factors would indicate a mild to moderate recession lasting into 2010.

If you watch to CNN or FOX, however, three factors could derail this conclusion. Economists appear to be unsure how to measure the impact of the mortgage crisis, the rash of financial institution failures, or the sudden decline of available credit. No one seems to know how to include these three “challenges” in the recession calculation.

No matter. If we ignore them – goes the thinking - perhaps these factors will not have a long term impact on the direction of the stock market.

But. I do protest this shallow and incomplete analysis. This stock market is unlike anything we have experienced in our lifetime. Extreme volatility has thus far been the norm. The markets have been in a virtual free-fall since mid- September. Last Friday the DOW closed below 8500 (down 40% in 12 months) and the NASDAQ came in under 1700 (down 42% in slightly less time). This week the DOW rocketed upward by 1300 points in less than 9 hours of trading, and then promptly lost almost 1200 points in the next 8 hours. Past performance has never been anything like this. Throw out the rule book. We are in new territory.

So. Where is the bottom?


Constructing An Alternative Scenario
I was watching Neil Cavuto on Fox News last weekend. Like many media personalities, he just doesn’t comprehend the gravity of our precarious economic environment. Media ignorance is irritating. For a business commentator, failure to understand the economic fundamentals is inexcusable. Let us see if we can help him out.

Neil: This isn’t your usual economic contraction. If we want to construct a high probability scenario, we must develop a way to include all the probable economic factors in our recession equation, and then characterize the interaction of these factors with our culture. How will people, including governments, react to this crisis? And how will this reaction shape the probable outcome?

Let’s summarize the “challenges” ahead ….

* Home loans. Additional Option ARMs and Interest Only loans are scheduled to reset through 2012. Almost a trillion dollars of debt to roll over, and most of the original loans are “under water”. Many home owners will chose to walk. It could be long into 2010 before we know the true value of our banking system’s housing portfolio.

* Housing. In some areas, it will take several years for the market to recover. Start with excess inventory, factor in higher unemployment, and we have a recipe for sluggish sales.

* Retail shops. Landlords are currently working with retail tenants to keep the doors open through Christmas. Both struggle to make a buck. But in January, many retailers will throw in the towel. Look for a sharp increase in retail store vacancy signs, accompanied by higher unemployment. Building owners take a revenue hit. More questionable bank loans.

* Office and Industrial space. Escalating unemployment means increased vacancies. Corporate contraction is inevitable. “Downsizing” becomes a verb. Building owners take a revenue hit. Bankers buy TUMS by the barrel.

* Commercial loans. This will be an all-to-typical situation. The money has been loaned, and the construction has been completed. But there aren’t enough tenants to carry the paper on a take out loan. Does that spell default? More bad debt on the books of our banking system?

* Small businesses. Typically undercapitalized, and unable to borrow enough money to meet payroll, small business failures will increase. More bad debt. Thousands of people out of work.

* Debt defaults. Look for a sharp increase in credit card and auto loan defaults through 2010. Not only will this add to the load of non-performing debt, it will change the economics of the Credit Card industry .

* Credit. We are in a cycle where a lack of credit triggers loan defaults, leading to even tighter credit markets. Without access to credit, businesses (large and small) are forced to curtail operations, leading to layoffs, expense reduction, and reduced capital investment.

* Derivatives. The $60 trillion Credit Default Swap mess is starting to unravel. The worst will hit in 2009. And we do not have adequate visibility as to how much other derivative junk will crash.

* Hedge funds. Redemptions are up, forcing asset sales. Unfortunately, many of these assets are worth less than their original book value. Paper losses will continue to increase into 2009.

* Government response. People are becoming really frustrated with the failure of our dysfunctional government institutions. There is a clash of political philosophies. Add in a tough job market and one has a recipe for political turmoil. Generally speaking, philosophical conflict is not good for the stock market.

* Globalization. This crisis is global in nature. If this were a sane world, the response would also be global in nature as governments worked together to resolve the crisis. Instead, look for self serving, politically expedient, and ultimately ineffective nationalistic responses.

I could add three more critical factors to this list. But I will not. They take a lot of explanation and I am running out of space. Suffice it to say, if I include all these factors in my analysis, they make an ugly contraction highly likely.

A Look At History
Do we have a historical model that gives us a clue as to what lies ahead? Yes. The panic of 1873. And I do mean panic. There was a v shaped stock market contraction. It took several years to reconstruct an over-extended banking system. Bankruptcies skyrocketed. Corporate profits were miserable. Real estate values fell. Credit dried up. Wages were cut. By 1876, unemployment had risen to 14%. Tens of thousands became homeless. There were bloody riots. Employment frustration and lousy policy led to labor conflict. Crime increased. The panic of 1873 was accompanied by industrial consolidation, politically motivated violence, and a call for institutional nationalization. Welfare systems were overwhelmed. Millions took solace in the practice of fundamental religious beliefs. In some nations, aliens and Jews became scapegoats for a failed economy. Political systems were destabilized.

Yes, Neil. This is what happens in a depression.

Conclusion
It is hard to construct an optimistic scenario. It is far more likely this crisis will not be resolved until 2012 – or later. Look for economic destitution accompanied by political conflict. Given the acceleration of this contraction, and the challenges listed above, a DOW under 5700 and a NASDAQ below 930 are feasible in 2010. Perhaps sooner. These economic events will exacerbate the already deep philosophical divide between “Red” and “Blue” Americans. Debilitating cultural turmoil and bitter political confrontation are in the wind. No matter who wins the American elections, the next four years are going to be brutal.

But don’t believe me. I could be wrong. Do your own homework.

And pray I am not being overly optimistic when I say – “We can get through this.”


TCE

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Who Do We Blame for America’s Financial Mess?

Time for a reality check

The traditional checks and balances of America’s financial system have been deliberately bypassed. The Real Estate industry encouraged the production of very high risk mortgage applications. With the full knowledge and support of Congress, most of the Banking System ignored its responsibility to monitor the credit worthiness of mortgage applicants. Wall Street then sliced and diced these worthless loans into $ billions of highly questionable securities called Collateralized Debt Obligations. In the process, everyone involved dipped their hands into the cookie jar. Millions and billions of dollars. Get rich selling worthless paper.

But our folly doesn’t end with mortgage market insanity. We have also created a colossal dog pile of derivative instruments tied to thin air, slopped at the trough of greasy debt, and turned Wall Street into a raucous gambling casino. Financial chicanery parading as “investment”. A system based on trust must now deal with the fear of deception. Dare I ask. Are the we victims of fraud and misrepresentation? Criminal conduct? Gonad driven hubris? Mindless greed? Or just outright stupidity?

In theory, this financial mess should never have happened. The Bush Administration should have provided the leadership and management necessary to ensure America’s federal agencies were doing their job. And under our “system” of checks and balances, if the cognizant federal agencies continued to screw up, then Congressional oversight should have kicked in to fix any problems.

But the system is broken. Financial ruin is the norm. The stinking sludge runs both wide and deep. Ordinary Americans are being savaged by economic privation.

What We Have Here,
Is A Massive Failure Of Federal Governance.

The Bush Administration
At first blush, it would appear the Bush Administration has been in a state of bureaucratic stupor. This situation has been developing for several years. One would think someone on the Federal payroll would notice the smell of rotting value. Now mind you, I’m just an old middle class American, but dare I ask – just what were our Federal agencies supposed to be doing? Well. Here is what they claim ….

The Securities and Exchange Commission
“The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”

The Federal Reserve
“The mission of the Federal Reserve is to provide the United States with a safe, flexible, and stable monetary and financial system.”

The Department of the Treasury
“Serve the American people and strengthen national security by managing the U.S. Government's finances effectively, promoting economic growth and stability, and ensuring the safety, soundness, and security of the U.S. and international financial systems.”

The Comptroller of the Currency, The Department of the Treasury
The Comptroller of the Currency is responsible for “ensuring a safe and sound national banking system for all Americans.”

Office of Thrift Supervision, The Department of the Treasury
“To supervise savings associations and their holding companies in order to maintain their safety and soundness and compliance with consumer laws, and to encourage a competitive industry that meets America's financial services needs. ….”
“The OTS examines each savings association every 12-to-18 months to assess the institution’s safety and soundness, and compliance with consumer protection laws and regulations. In addition, examiners monitor the condition of thrifts through off-site analysis of regularly submitted financial data and regular contact with thrift personnel. OTS examinations and its ongoing supervisory oversight are tailored to the risk profile of each institution.”

The Justice Department
“To enforce the law …… to provide federal leadership in preventing and controlling crime; to seek just punishment for those guilty of unlawful behavior; and to ensure fair and impartial administration of justice for all Americans.”

Have these agencies done their job? Can we trust their judgment?

You decide.

And what about Congress?
Who has ultimate oversight responsibility for America’s Federal Agencies? Who holds hearings on agency operations? Who has the responsibility to enact regulatory legislation? Who determines what these agencies are supposed to do and then monitors them to be sure they are meeting their legislative objectives?

Congress. Republicans and Democrats. There are two key committees. Let’s look at how they define their responsibility.

House (of Representatives) Financial Services Committee
“The Committee oversees all components of the nation's housing and financial services sectors including banking, insurance, real estate, public and assisted housing, and securities. The Committee continually reviews the laws and programs relating to the U.S. Department of Housing and Urban Development, the Federal Reserve Bank, the Federal Deposit Insurance Corporation, Fannie Mae and Freddie Mac, and international development and finance agencies such as the World Bank and the International Monetary Fund. The Committee also ensures enforcement of housing and consumer protection laws such as the U.S. Housing Act, the Truth In Lending Act, the Housing and Community Development Act, the Fair Credit Reporting Act, the Real Estate Settlement Procedures Act, the Community Reinvestment Act, and financial privacy laws.”

(The Senate) Committee on Banking, Housing and Urban Affairs
“(The) Committee on Banking, Housing and Urban Affairs, ….. (has responsibility for) all proposed legislation, messages, petitions, memorials and other matters relating to ….
• Banks, banking, and financial institutions.
• Control of prices of commodities, rents and services.
• Deposit insurance.
• Economic stabilization and defense production.
• Federal monetary policy, including the Federal Reserve System.
• Financial aid to commerce and industry.
• Issuance and redemption of notes.
• Money and credit, including currency and coinage.
• Public and private housing (including veterans housing).
Such Committee shall also study and review on a comprehensive basis, matters relating to international economic policy as it affects United States monetary affairs, credit, and financial institutions; economic growth, urban affairs, and credit, and report thereon from time to time.”

Now then. Do you believe Congress has done its job? Did these Congressional committees perform their duties in a responsible manner? Do you believe they should have been aware of the financial mess Wall Street was creating?


The Real Story

Blame
The Democrats will obviously blame the Bush administration for everything that has gone wrong. They conveniently forget that Liberal Democrats have been in charge of Congress while this mess was collecting in America’s financial toilet. The Republicans, bless their hearts, will continue to be totally confused by just about everything. Let’s face it. Neither the Democrats nor the Republicans have enough intellectual depth to even know what questions they should be asking. Even if they had the will. And do you really think anyone in the Washington establishment will take any responsibility for this massive failure of the Federal regulatory system?

Every American should demand an answer to this one question: Did the Federal bureaucracy fail because it did not have the authority (which infers Congressional legislative failure), or did it refuse to pursue its responsibility (which may infer massive corruption)? Either way, the Federal Government has effectively transformed $ trillions of dollars of stinking paper into what will become very suspect Treasury bonds. New mortgages purchased by Fannie and Freddie will add to this dog pile of debt. Add it all up. Current debt plus mortgage debt. America’s total Federal debt will exceed $12 trillion. That’s $39,400 per American. Then add unfunded Social Security and Medicare obligations. NO – we can not afford it. The only recourse will be a devaluation of the dollar – all accompanied by a sharp increase in inflation, higher unemployment, declining “real” GDP, and the worst personal economic misery our nation has ever seen.

Is it time for real change?

Change
We Americans know the “system” is not working. We know it is incredibly corrupt. Incompetent. And totally dysfunctional. The only question is: how long will this go on before we the people are so fed up our nation explodes with anger?

Obama will talk about change. All political vapor. He will carefully avoid mentioning our Democratic Congress had multiple opportunities to avoid this mess. McCain will talk about change. But the Republicans are far to confused to be an effective legislative counterparty. House Speaker Pelosi and Senate Majority Leader Reid continue to be models of vitriolic ideology. Don’t expect them to pursue a course of constructive leadership. And what about Senate Banking chair Dodd? Or House Financial Services chair Frank? Didn’t they play a key role in creating this mess in the first place?

Are you confident the Washington Establishment will do its job? Will these individuals put the welfare of the American people before their own personal selfish best interest?

Conclusion
There is absolutely no excuse for the financial carnage that has occurred. Members of the House Financial Services Committee and Senate Banking Committee either knew, or should have known, that America was headed for financial disaster. But instead, our Federal system has failed the American people. It is unlikely the Washington establishment will fix our financial system because politics and ideology will be more important than decisive action. That can only lead to ill conceived legislation. Followed by the misappropriation of funds. Decisions based on political expediency rather than virtue. And endless corruption.

It’s time for a radical change in the way we govern ourselves. If we want effective government, we must establish a better system of management with strong, positive, and constructive leadership.



TCE

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Three Points On ANWR

There has been much discussion - mostly acerbic, ignorant and deceptive - about drilling in the Arctic National Wildlife Refuge (ANWR). Without taking sides, I would like to point out three facts everyone is missing:

* In order to support America’s economy, we are going to need every barrel we can pump during our transition to other fuels (and life styles). The less oil we have, the higher the rate of inflation, the higher the rate of unemployment, and the worse our recession will be for all Americans. If you would like to understand why, then pick up a copy of my book “Oil, Jihad and Destiny”. It’s all there.
* Curtailing oil production will increase air pollution. America depends on oil to keep warm in winter. Heating oil, propane, and kerosene are cleaner burning than coal. If these fuels are unavailable, or unaffordable, then families are going to burn waste, wood and coal to stay warm – dirty or not. This – by the way – is already happening.
* Drilling in places like ANWR is just the tip of the iceberg (a pun). The USGS believes 25% of the world’s remaining oil is under Arctic ice (soon to be the Arctic sea). Russia and Canada are already sparring over rights to drill. If we are concerned about the environment, it should be understood the Russians have a miserable environmental record. If they drill, it will be disastrous for the environment because they are just not going to care. The point is, liberal environmentalists are NOT going to stop exploration for oil in the Arctic. It’s just a matter of who does the drilling. If America doesn’t, then some other nation will get the oil – dirty or not.


It’s nice to be concerned about the caribou and a polar bear. But don’t you believe it is also important to be concerned about human welfare? Is there a way to inject a dose of reality into the ANWR debate?


TCE
6/30/2008

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The Perfect (Economic) Storm

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Introduction

When two or more storm cells come together and then form a larger and more violent storm, the event is often called a “Perfect Storm”. The reference is to the increased ferocity of the combined cells as drenching rain, high winds and rolling gray clouds cover the landscape. It is an event fit for neither man nor beast.

That reference came to mind when I wrote the scenarios for Oil, Jihad and Destiny. “What is the worst case scenario?”, I wondered. “What is the probability it could happen?” Although the “Perfect Storm” scenario is discussed in my book, I did not publish the results of my analysis. I could not bring myself to believe an economic catastrophe of that magnitude was probable.

No more. All of the elements are in place. This storm has begun.


Storm Cell One: Higher Oil Prices

During a presentation on energy and economics last fall, someone asked me if we were headed for a recession. “Yes,” I replied, “we should be in a recession right now.”

My response, of course, was based on a previous analysis of the link between oil consumption and the price of oil, versus the occurrence of past recessions (see Reference 1 below). In theory, the American economy should have been reacting to higher oil prices the way it had in several past recessions. But according to the Bureau Of Economic Analysis in Washington, America’s economy was still growing – however poorly.

Puzzled by that discrepancy, I did the research and analysis for three other essays on Gross Domestic Product (GDP), the Consumer Price Index (CPI) and unemployment (see Reference 2 below). My conclusion is that the Federal Government’s methodology overstates GDP, understates the CPI, and takes a very “optimistic” view of unemployment.

Recent events suggest America is experiencing declining rates of GDP, higher rates of inflation and increased unemployment (see Reference 3 below). One of the key drivers is the price and availability of oil, not only because of oil’s value to American commerce, but also because of the accompanying impact oil has on the price and availability of all our energy resources. Sales of coal and natural gas increase because they are an alternative to expensive oil. Wind and solar power become competitive energy options. Given the long term volatility of production and pricing, these realities of the world oil market are unlikely to change - ever.

There is a relationship between oil consumption, expenditures and recessions. Significant increases in the amount of money America spends on oil (1973, 1979, 1990 and 2000) were followed by a recession. Yes. Other factors contributed to the decline in GDP that characterized these recessions. However, one can not escape a nagging fear that sharp increases in oil expenditures may cause a subsequent recession. World oil prices have increased by over 350% since 2002. If oil price and consumption history is any predictor of future events, our economy is in big trouble.

Oil prices for “sweet” crude have exceeded $100 a barrel. There are two possibilities. High oil prices could force an economic contraction, or they could trigger a credit crisis. It will be interesting to see how this all works out. Although the current speculation driven oil price frenzy is unsustainable, high oil prices will play a role in whatever happens next.


Storm Cell Two: A Decimated Financial System

Let’s not mince words. America’s financial system is a mess.

Private Debt. We have gorged ourselves on unlimited private and public credit. With the complicity of a dysfunctional Congress, and a deficient regulatory system, Wall Street has been able to create multiple financial instruments of dubious integrity. Billions and billions of dollars are now tied to devalued assets and financial documents that have the value of wet toilet paper. We have not experienced the full impact of this brutal devaluation. Last year I estimated international financial institution losses would exceed $700 billion. Current thinking exceeds $1 trillion. Fannie Mae and Freddie Mac teeter on the brink of disaster. The financial strength of many regional banks has been compromised.

Public Debt. The federal budget deficit is projected to more than double in size to $482 billion in the 2009 budget year (which ends on September 30, 2009). Add to this the cost of wars in Iraq and Afghanistan, the costs of the mortgage rescue measure, a likely restructuring of Fannie May and Freddie Mac, the escalating costs of Medicare, as well as under funded Social Security and Government pension obligations – and it should be obvious America is pushing its ability to fund federal operations. Although Congress has increased the national debt limit to $10.615 trillion, the ability of the United States to pay its debts will increase public debt loan costs and will eventually restrict the issue of additional public debt obligations. Now add these costs to the more than $2.2 trillion in State and Local debt the United States is carrying on its books, and one begins to wonder if public debt payer solvency will become an issue.

Business Credit. Thanks to America’s debt crisis, our banking system has been forced to restrict the availability of business credit. Hardest hit are the retail, travel, transportation, and automotive industries which are dealing with declining credit availability, higher costs, lower revenues and troublesome profit margins. Although some very big corporate names will take a hit, small and medium sized businesses will suffer the most damage. Without easy credit, they will be forced to restrict their activity. It is possible that over a million businesses and more than three million jobs will be lost before the end of 2009. By then, over 3.5 million of America’s self-employed individuals will also be unable to find adequate employment.

Household Credit. Household debt service payments exceed 14% of disposable personal income. Total debt, which includes $2.6 Trillion of consumer credit obligations, is approaching a total of $14 Trillion. Revolving credit appears to be increasing a rate of 7 percent per year. Because consumers have less (or negative) home equity to fund additional loan obligations, they have increased their credit card exposure to fund current purchases. Struggling to regain its health, our financial system has been forced to decrease the availability and size of revolving credit account balances. This will reduce potential consumer spending.

And of course, we live in a global economy. America’s financial crisis is the world’s financial mess. Few nations will be immune to the deterioration of the world’s financial markets. Change a few names and numbers, and one could write an essay like this for many of America’s trading partners.


Storm Cell Three: Conflict In The Middle East

Let’s add a little thunder and lightning. The Middle East. Endemic hatred, deadly civil confrontation, uncompromising theology, and the smoldering embers of war threaten to erupt into a devastating political crisis. Into this arena come the leaders of Iran. Shia Iran. And Sunni Taliban. These people have a definite agenda. Increased political and economic power. Sanctimonious beliefs justify aggression. They firmly believe they will win.

The opposition is uncertain. Poorly organized. And plenty worried. From weakness comes tragedy. Desperation makes poor decisions. The American elections add to the potential for disaster. Another struggle for political power. Domination. The imposition of self-righteous political theology. Here are a few thoughts. Will President Bush attack Iran before he leaves office? Do the leaders of Israel believe they must neutralize Iran’s nuclear threat before Bush leaves office? Will Iran move to block oil shipments through the straits of Hermuz?

However this all plays out, any prolonged disruption of oil shipments would have a devastating impact on the world’s economy. When Iran deposed the Shah in 1979, the resulting turmoil reduced Iranian oil production by almost 40%. The price of oil jumped by 125%. American inflation notched up to 11.26%. The subsequent 1980 – 1988 confrontation between Iran and Iraq devastated oil production in both nations. American inflation was 13.52% in 1980, 10.37% in 1981 and 6.13% in 1982. Our GDP, adjusted for inflation, was ? 4.72% in 1980, 1.83% in 1981 and ? 2.13% in 1982. During 1982, unemployment reached 9.7%.


Storm Cell Four: Political Theology

No storm would be complete without gale force winds. It’s election time and the Democrats are pandering to pop culture theology. “If we can’t drill our way out of oil shortages”, goes the mantra, “then let’s not drill at all”.
Few have asked a key question:
how does Congressional failure to develop a comprehensive energy plan
impact our economy?
If the Democrats continue to block oil exploration and the development of a comprehensive energy program, then this storm will last forever. Many reason that higher gasoline and diesel prices are good. It does not matter if fuel oil and propane become unaffordable. Why? Because higher prices force us to consume less oil, and that reduces the production of carbon dioxide.

Clean air. No matter what the human cost. How many families will not be able to afford heating oil or propane during the long cold winters that lie ahead? How many men and women will be thrown out of work by a very sick economy?


Ominous Clouds

So. What are the odds of a Perfect Economic Storm? In the Internet era, financial change can be as powerful as a hurricane and as spectacular as lightning. Just ask Bear Sterns.

Higher oil prices? Done deal.
Along with higher prices for gasoline, diesel, propane and heating oil fuels, as well as food, cosmetics, pharmaceuticals, and just about everything else you buy. These prices will not abate until the price of oil comes down.

Higher rates of current expense inflation? Under way.
The Consumer Price Index for All Urban Consumers (CPI-U) rose 1.1 percent in June, 2008. Although that’s a run rate of 13.2% per year, I expect the average rate of inflation for 2008 to be closer to 6%. If the credit markets collapse, look for a period of deflation.

Financial system contraction? Happening.
In order to get their balance sheets back into shape, banks are setting higher standards for loans, and scrambling for cash. These moves decrease the availability (and increase the cost) of commercial and personal credit.

Devaluation of fixed assets? In process.
It would appear my previous projection of a 30% residential housing devaluation is on track. Commercial real estate and business property are also taking a beating.

Credit market collapse? Current events.
As discussed in the above text, only Devine intervention will prevent a further deterioration of world credit markets. Somehow, I do not think that will happen. Volatility, disruptions, deteriorating credit performance, and bankruptcy lie ahead.

Consumer spending? Austerity is a virtue.
Although we can expect consumers to push the limits of their credit resources, a contraction is inevitable as they maximize their credit options.

Positive political leadership? Missing.
Will America ever have a constructive, positive and well managed energy policy? Does Congress have the will, organization, leadership and business competence needed to create one? Or will current proposals lead us to a politically correct document laced with theology, corruption, over-regulation, and confusion (see Reference 4)? You decide.

Stock Market? High downside risk.
The American stock markets have entered “Bear” territory with 52 week declines of 20% or more. If economic growth is down and inflation is up, profits will suffer at most companies for the next several quarters. Add in a dose of consumer “blahs” and it is hard to see how we will escape the downside risk.

Middle East Conflict. Open Question.
Only the addition of an Iranian confrontation remains uncertain. You tell me. What are the odds of adding war and oil shortages to our torrent of bad news?


A Perfect Storm Scenario

Can we project the outcome? To find out I fired up my trusty spread sheet, made several key assumptions about the factors described above, added a dose of historical data going back to 1929, and ran the numbers. If past economic performance in times of economic stress and higher oil prices is any indicator of future performance, then it is likely 2009 will not be a good year. Thanks to a decimated financial system, irresponsible political theology, and a lack of constructive leadership, our economic malaise could last for years. Depending on the data you chose to use, and the assumptions you make, the results of the Perfect Economic Storm scenario can be described in many ways.

Here are two graphs our political leaders should memorize
because they will come back to haunt them

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The following chart graphs the Rate Of Change calculation for North American oil consumption (includes Canada, the United States and Mexico), and American GDP adjusted for inflation. The chart shows actual historical data from 1970 through 2007, and then graphs my projections through 2030. Since 1970, the rate of change in oil consumption has closely matched the rate of change of adjusted U. S. GDP. The sharp decline in oil consumption and GDP shown for 1973/1974, 1979/1982 and 1991 were primarily due to the effect of oil production shortfalls in the Middle East. America was forced to use less oil. Less oil means less commerce. Less commerce means a lower GDP. These are the facts of economics.

As you view this graph, please note: I have assumed a gradual increase in the use of alternative mobile fuels, as well as electricity, as the automotive force for public and personal transportation. This assumption increases the gap between oil consumption and GDP by 2030. Also please note: the findings of this scenario are consistent with past economic events from 1970 through 2007. Given the assumptions used to construct this scenario, a deep recession is likely. The projected trends through 2030 are consistent with the projected production, consumption, availability and price of oil.

Unless we find salvation, net inflation adjusted GDP will continue to deteriorate though 2030. American GDP per capita will decline, placing additional stress on consumer spending. Low and middle income Americans will see a continuing decrease in their standard of living.

In the second chart, I have graphed actual inflation and unemployment data from 1970 through 2007, and then charted the results of my analysis from 2008 through 2030. Please note: given the economic circumstances described above, these projections are entirely consistent with prior history.

Inflation is a tough call. Fixed asset devaluation and unemployment act to push down the rate of inflation. Higher oil prices lead to higher product transportation costs. Fixed asset deflation versus current expense inflation. Although my model suggests higher inflation lies ahead, a rapid decline in fixed asset values is entirely possible. When the financial markets collapsed in 1929, the CPI fell by 26.3% from 1929 through 1933. On the other hand, the oil crisis of 1973 set off a wave of inflation that lasted until 1982. The worst period was 1979 through 1981, when the net increase in the CPI exceeded 35%. Either scenario is possible. Or maybe both.

In this scenario, unemployment could easily exceed 9% for the better part of four years, 2009 - 2012. Under-employment will increase to more than 16%. That means at least 25% or the American work force will be unhappy. Furthermore, average annual unemployment rates will be higher than we want through 2030.

A word to the wise. My estimates of bad news are typically understated. For example I thought last year that financial system losses from the global credit crisis would exceed $700B. Current estimates from other sources run from $1.5 to $2.0T. One could construct a perfectly logical scenario that shows far higher rates of unemployment and inflation.

But wait. Could things really be worse? Sure. This scenario assumes relative stability in the Middle East and elsewhere. If there is a prolonged disruption in the flow of oil, then the recession will be deeper and last longer. Remember. There are no quick fixes. It will take from 15 to 20 years to restructure America’s how America uses its energy resources. (see Reference 5). The longer Congress piddles around, the worse the lingering devastation of a perfect economic storm.

Of course we need to transition our nation to alternative forms of energy. And most Americans want to sustain the cleanest possible environment for human habitation. But as a cultural economist, my key issue is:

how do we get from here to there without totally screwing up our economy?

It is impossible to run a complex and sophisticated economy without adequate resources of energy. That enduring fact is true for all nations. But in the United States, current political theology ignores the human consequences of a dysfunctional energy policy. A recessive economy increases personal misery. It is that simple. Although we can (and must) increase the efficiency with which we consume energy, Congressional failure to enable greater access to all forms of energy is an act of criminal neglect. The result? Millions of Americans will endure the deprivation of a failed economy.

There are times I really hope I am wrong. This is one of them. Maybe we will continue to enjoy the benefits of cheap and readily available oil. Perhaps our economy will prove to be amazingly resilient. Maybe most of the credit crunch is behind us. It’s possible 2009 will be an “OK” year. The Federal Reserve Board’s Federal Open Market Committee, for example, believes inflation will moderate later this year. If so, unemployment should continue below 6.5% and “real” GDP should be slightly positive into 2009.

So. Who is right? You decide.


TCE


The following essays may be found on my WEB site www.tce.name. A detailed explanation of scenarios and how I use them may be found in my book “Oil, Jihad and Destiny”, at Amazon.


Reference 1: Look in TCE
Will High Oil Prices Fuel Inflation?
Warning: Recession Ahead

Reference 2: Look in TCE
Unemployment: What Is The Real Story?
CPI: Sophisticated Economic Theory, Terrible Ethics
American GDP: Can We Trust The BEA Data?

Reference 3: Look in TCE
Yes Virginia, This Is A Recession

Reference 4: Look in TCE/Energy
The Energy Policy Act of 2005, Legislative Achievement or Management Fiasco?
As a point of information, I am qualified by prior experience to develop the kind of energy program America needs.

Reference 5 may be found on the Internet:
Peaking of World Oil Production: Impacts, Mitigation, and Risk Management, published by the U.S. Department of Energy, National Energy Technology Laboratory, February 2005; Robert L. Hirsch, SAIC, Project Leader, Roger Bezdek, MISI, and Robert Wendling, MISI.

The executive summary of the report warns that "as peaking is approached, liquid fuel prices and price volatility will increase dramatically, and, without timely mitigation, the economic, social, and political costs will be unprecedented. Viable mitigation options exist on both the supply and demand sides, but to have substantial impact, they must be initiated more than a decade in advance of peaking."

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Unemployment: What Is The Real Story?

Introduction
If you have been reading my essays, you know I firmly believe the United States Department of Labor (DOL), Bureau Of Labor Statistics (BLS) understates the rate of inflation (see: CPI: Sophisticated Economic Theory, Terrible Ethics). You also know that a low Rate Of Inflation may be an indication that the Department of Commerce (DOC), Bureau Of Economic Analysis (BEA) has overstated “Real” Gross Domestic product (see: “American GDP: Can We Trust The BEA Data?” and: “Yes Virginia. This Is A Recession.”). In other words, both measures of our economy are in worse shape than the much quoted official data suggests.

This raises a question. If there are structural problems with the credibility of our government’s reports on the Consumer Price Index and Gross Domestic Product, can we trust the BLS report on Unemployment?

Yes and Maybe.


Statistics
The BLS reported on May 2, 2008: “Nonfarm payroll employment was little changed in April (-20,000), following job losses that totaled 240,000 in the first 3 months of the year, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. The unemployment rate, at 5.0 percent, also was little changed in April. Employment continued to decline in construction, manufacturing, and retail trade, while jobs were added in health care and in professional and technical services.”

Frankly, a 5% unemployment rate lacks statistical credibility and certainly fails to document the pain of America’s unemployed. Let’s take a closer look at the BLS data:

* Since its peak in September 2006, construction employment has fallen by 457,000.
* Over the past 12 months, manufacturing employment has declined by 326,000.
* Since its peak in March 2007, the retail trade industry has shed 137,000 jobs.
* The health care industry has added 365,000 jobs over the past 12 months.
* Professional and technical services employment rose by 27,000 in April after showing little change during the first quarter of 2008.
* Since October 2007, food services employment growth has declined to an average of 13,000 jobs per month; this compares to an average increase of 28,000 jobs per month for the preceding 12-month period.
* Total unemployment increased by 11.6% from 6,532,000 persons in April of 2007 to 7,287,000 persons in April of 2008.
* The number of people who lost their job, or were no longer holding a temporary job, increased by 21.0% from April 2007 to April 2008.
* The number of people who were told they had permanently lost their job increased by 30.1% during this same period.
* From Q1 2006 to Q1 2008, the number of Layoff events has increased by 45.3%. They increased by 20.6% from Q1 2007 to Q1 2008. There has been a continuing increase in the number of layoff events, and the number of Total Initial Claimants, since August of 2007.

Despite these data points from the BLS report, the BLS claims the Unemployment Rate has increased from only 4.30% in April 2007, to a negligible 4.76% in April of 2008. Does this create a credibility problem?

Let’s look at the BLS definition of “Employed” and ”Unemployed”:

“People are classified as employed if they did any work at all as paid employees during the reference week; worked in their own business, profession, or on their own farm; or worked without pay at least 15 hours in a family business or farm. People are also counted as employed if they were temporarily absent from their jobs because of illness, bad weather, vacation, labor-management disputes, or personal reasons.

People are classified as unemployed if they meet all of the following criteria: They had no employment during the reference week; they were available for work at that time; and they made specific efforts to find employment sometime during the 4-week period ending with the reference week. Persons laid off from a job and expecting recall need not be looking for work to be counted as unemployed. The unemployment data derived from the household survey in no way depend upon the eligibility for or receipt of unemployment insurance benefits.”

Statistically speaking, these are narrow definitions. And that is OK. But we must be aware they also create a structural downward bias in the reported Rate Of Unemployment. That means a low Rate Of Unemployment may not reflect what is happening in the “real” world.

So what else does the BLS data tell us about unemployment? If we examine Table A-12 “Alternative measures of labor underutilization”, we find this little jewel: “U-6 Total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all marginally attached workers (not seasonally adjusted) was 7.9% in April of 2007 and 8.9% in April of 2008. To quote the BLS: “Marginally attached workers are persons who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the recent past. Discouraged workers, a subset of the marginally attached, have given a job-market related reason for not looking currently for a job. Persons employed part time for economic reasons are those who want and are available for full-time work but have had to settle for a part-time schedule.”

And from the “Persons Not in the Labor Force” (Household Survey Data) page: “About 1.4 million persons (not seasonally adjusted) were marginally attached to the labor force in April. These individuals wanted and were available for work and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks pre-ceding the survey. Among the marginally attached, there were 412,000 discouraged workers in April, about the same as a year earlier. Discouraged workers were not currently looking for work specifically because they believed no jobs were available for them. The other 1.0 million persons classified as marginally attached to the labor force in April cited reasons such as school attendance or family responsibilities.” (Emphasis is mine. Ron)

So. If we examine the BLS data and add up the number of self employed persons who are not working, the number of persons who are working part time because they can not find a permanent full time job, and the number of persons the BLS classifies as unemployed, the total number of people who are either unemployed or underemployed equals 12,395,000 workers.

If we are willing to accept this broader definition of unemployment pain,
then the “real” rate of unemployment is 8.1%.

Conclusion
It would appear an 8.1% rate of unemployment (or underemployment) is far more consistent with the information we have heard or seen in the media, and certainly more sensitive to the economic pain of this recession. It should not be a surprise if this figure exceeds 12% before this business cycle is over. Not only will the ranks of the unemployed increase, but there will also be a sharp increase in the number of persons who are discouraged because they can not find work, or are working in part time jobs because they can not find permanent employment. All three conditions are detrimental to the economy, the community, the security of the family, and the self worth of the individual. They also promise to strain the viability of our political institutions.

And that’s the real story on unemployment.


TCE

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Yes Virginia. This Is A Recession.

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A preliminary report from the United States Department of Commerce, Bureau of Economic Analysis (BEA), claims American Current-dollar GDP -- the market value of the nation's output of goods and services – increased 3.15 percent or $111.0 billion in the first quarter of 2008 (versus the last quarter of 2007), to a level of $14,185.2 billion. That economic performance equates to an average annual year over year increase of 4.67% against Q1 2007.

The United States Labor Department, Bureau of Labor Statistics (BLS), reported an average annual increase in the rate of inflation (CPI-U) from Q1 2007 to Q1 2008 of 4.10%.

Real GDP growth from Q1 2007 to Q1 2008 was therefore (in the neighborhood) of .57%. Or to put it another way, although “Real” GDP growth in the first quarter of 2008 was very weak, the American economy is not in a recession.

Nonsense.

The declining value of the dollar increases the price of goods and services. It does not, however, increase the production of goods and services (which is what GDP is supposed to measure). Furthermore, a declining dollar inflates the price of goods and services purchased from foreign nations. In order to trust the BLS numbers, we have to believe they have not been inflated by the declining value of America’s currency.

Is that a good assumption?

Ok. For the sake of argument, let us assume the BEA made suitable adjustments for currency anomalies. Can we make the same concession for the inflation data published by the BLS?

No. People are not buying more. They are just paying more for what they buy. As I pointed out in my essay “CPI: Sophisticated Economic Theory, Terrible Ethics”, the BLS understates both the percentage of disposable income an “average” family spends on fuel and food, and the average prices for the fuel and food they buy. This has the effect of reducing the reported rate of inflation. Apparently the BLS believes high fuel and food prices are “temporary” and thus do not reflect the real world.

Tell that to a mother struggling to find enough money to buy food for her family and suddenly realizing she also has to buy gas with the little bit of cash that’s left in her purse.

Someone should tell the BLS. Farm prices are up. Higher consumer demand, coupled with decreased production due to crop failures and increasing production costs, have increased the competition for available food grains. Higher fertilizer, herbicide, insecticide and fuel costs will push up the price of commercial vegetables. Higher feed costs mean higher prices for meat animals, dairy products, poultry and eggs.

Preliminary April 2008 data shows a general easing of pricing pressures. Better weather and increased planting promises to increase the 2008 grain crop. But do not expect prices to come down to 2006 levels. World-wide competition for available agricultural products, coupled with higher production costs, means that people will have to allocate a larger share of the family budget for food. The UN’s Food and Agriculture price index is up over 150% from March of 2007 to March of 2008. Over a billion people are in danger of malnutrition or starvation. The competition for available food supplies will be intense for the foreseeable future.

And then there is the pain of rising fuel prices. American gasoline prices were up 32.5% in February 2008 versus February 2007. There is nothing going on in the international oil markets that would lead us to believe these prices will be coming down in 2008. Or 2009.

Except for one little glitch. If America slides further into recession, other nations will be drawn into America’s economic malaise. A world-wide recession will decrease the demand for oil, and weaken the pricing power of the producer nations. If the OPEC oil cartel fails to reduce available production, then oil prices will decline.

But not for long. The long term upward demand for oil assures there will be an increasing competition for a depleting commodity.

Higher food and fuel prices decrease the money families have available to spend on clothing, housing, recreation, and so on. Eventually, that shift of spending will mean declining employment and an even lower GDP.

In my essay “American GDP: Can We Trust The BEA Data?” (www.tce.name), I projected Q4 2007 inflation would exceed 5%, rendering a neutral or negative GDP. I am not aware of any data that would contradict that conclusion. After several hours of research, I have also concluded that Q1 2008 inflation was roughly 5.61%. If so, Q1 “Real” GDP was a minus .94%.

Yes Virginia. This is a recession.


TCE

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Will Higher Oil Prices Fuel Inflation?

The following essay was written in 2006.

It is still true and very relevant.

A news story that compares the rising price of oil to the rate of inflation made the rounds of American media last month. Reporters, pundits and some economists repeated the parable without giving it much thought. The essential claim is that in 2005, higher oil prices will not drive up the rate of inflation as much as they did in the 1970s because oil consumption, as a percentage of GDP, has decreased by half since then. We have become much more efficient in our use of oil, claim the analysts, and therefore higher oil prices will only have a modest upward impact on inflation.

Rubbish.

Although the statement is true, the concept masks a lot of dirty little problems.

Here is why.

Economics

The historical relationship between the price of oil and the rate of inflation gives us clues as to what we may expect in the future. In 1974, the price of oil on the world market increased by 252 percent, from an average of $3.29 per barrel in 1973 to $11.58 per barrel in 1974. Inflation (CPI-U) rose sharply, from an average of 6.23 percent in 1973 to 10.97 percent in 1974, and remained high at 9.14 percent in 1975. In 1979, oil again made a dramatic 121 percent jump in price as it moved from $13.60 in 1978 to $30.03 in 1979. It gained another 19 percent in 1980. Despite the fact that Americans had become more efficient in their use of oil since the price increase of 1974, inflation also increased, by a chaotic 11.26 percent in 1979, 13.52 percent in 1980, and 10.37 percent in 1981. One could argue that conservation had not done anything to slow down the inflationary spiral. By contrast, a 48 percent decrease in the price of oil in 1986 was accompanied by only a modest decrease in the rate of inflation from 3.57 percent in 1985 to of 1.92 percent in 1986. Given the percentage decrease we experienced in the price of oil in 1986, the rate of inflation remained stubbornly buoyant.

If we generate a chart that shows the average annual nominal price of oil versus the average annual rate of inflation for the period 1970 through 2002, we can see – by inspection – there is a modest correlation between changes in the price of oil and concurrent or subsequent rates of inflation. We have to remember, however, that the rate of inflation is influenced by many other economic factors: the level of current economic activity, speculation in the commodity markets, interest rates, changes in productivity, and so on. None-the-less, history suggests that if the price of oil effectively doubles, there has to be an increase in the rate of inflation.

In doing the research for "The Report on Oil Depletion" I developed a formula to replicate historical changes in the annual average price of oil versus corresponding changes in the rate of inflation from 1970 through 2002. I discovered that the formula's accuracy was greatly improved if it also included the annual increase in oil consumption efficiency. Unfortunately, the model can only project the rate of inflation based on changes in supply and consumption. It cannot account for futures speculation or changes in the value of the dollar. Never-the-less, if we use the formula to project future rates of inflation versus projected increases in the price of oil, we must conclude that even with liberal assumptions about the rate at which we increase the efficiency of oil consumption, the rate of inflation is going to accelerate.

When the Federal Reserve increased the fed funds rate to 2.75% on March 22, 2005, it noted that "pressures on inflation have picked up in recent months." With the computer modeling tools at its disposal, its extensive information resources, and its staff of very bright people, the Federal Reserve must certainly be aware of the relationship between the price of oil and its inflationary impact on economic activity. The Fed knows that its previous policy of easy money has sown the seeds of increased inflation. In addition, Federal Reserve Chairman Greenspan has already warned that America's heavy burden of public and private debt, as well as the cost of sustaining a presence in Iraq, homeland security, Social security, and Medicare are a troubling financial burden. The Fed is very much aware that these factors – taken in the aggregate - create an inflationary economic environment. Even with computer models and bright people, however, it is still difficult for the Fed to judge the timing of future inflation.

Unequal Distribution

There are gut wrenching reasons to fear the inflationary pressures of increased oil prices. Take the Law of Unequal Distribution. This law states there will be an unequal distribution of economic change among the economy's participants. We can classify these participants by various measures in order to make a comparison.

For example, increased oil prices will have only a marginal impact on organizations that use relatively little oil in the provision of goods and services. We can anticipate financial service, insurance, health care, education, government, and utility enterprises will experience little or no cost inflation as the price of oil increases. On the other hand – depending on their business model - transportation, retail, wholesale, agriculture, construction, and manufacturing enterprises may experience modest to sharply increased cost inflation. These costs, less gains in oil consumption efficiency and changes to the basic business model, will eventually have to be passed on to the ultimate consumer.

The Law of Unequal Distribution will be especially hard on consumers. I fired up my trusty spread sheet in order to determine how rising fuel costs would impact the finances of households making $25, $50, $100, $200, and $275 thousand dollars per year. Assuming one car per household that gets 18 MPG, and 10,000 miles of driving per year, each household consumes 555.6 gallons of fuel per year. Last year that fuel could be had for $1.44 per gallon. On average, households in this scenario would have spent .33 percent of their income on vehicle fuel. With gasoline prices moving up to $2.88 per gallon, the average household expenditure increases to .66 percent of income.

The trouble – as stated in the first paragraph of this article – is in the averages. The percentage change in vehicle fuel costs are relatively easy to absorb if your making $100, $200 or $275,000 per year. Households with $275,000 in annual income, for example, would only spend .58% of their income on vehicle fuel. However, lower income households take a terrific hit. Households with $25,000 in annual income would be forced to spend 6.4 % of that income on vehicle fuel. For households that make $50,000, their vehicle fuel costs would jump to 3.2% of their annual income. And it's important to note that these two groups, taken together, account for 56 percent of American households. Obviously, increases in the price of oil will have a serious impact on the available discretionary spending of the two lower income groups.

I then developed a second model, making suitable adjustments for the probable average mileage per vehicle (assuming wealthy households would retain their 15 and 18 MPG vehicles while lower income households migrated to vehicles getting 22, 27 and 33 MPG). If the price of vehicle fuel is $2.88 per gallon, the average percentage of household income spent on vehicle fuels would only be .42 percent of income. That's the kind of figure the media likes to quote in its "sound bite" news broadcasts. The average expenditure doesn't appear to be too bad. But unfortunately for a household having an annual income of $25,000, the cost of vehicle fuel actually increased from 1.75% of income in 2003 to 3.49 % of income in 2005. That's over $870 ! And households with an income of $50,000 will have to spend over $1,000 on vehicle fuel.

And how about the guy who wants to keep his beloved pickup truck that gets 15 MPG? If his household is in the $25,000 bracket, he'll have to pony up almost 8 percent of his household income for vehicle fuel.

Sorry.

But vehicle fuels are only part of the inflation story. These 112,000,000 households also heat their homes and buy other products made where oil is either consumed as a raw material or used in the production process. The big nut is heating oil and its natural gas equivalent, followed by oil intensive products (fertilizers, chemicals, lubricants, and so on) and products whose manufacture uses relatively small amounts of oil. Taken in the aggregate, America's economy consumes 3,450 gallons (or 82.1 barrels) of oil per year per household.

Non vehicle oil costs probably add over $1,000 (or 4 percent) per year to the budget of a household making $25,000 per year. They will add over $1,800 (but less than 1 percent) to the budget of a household making $275,000 per year. For households making $50, $100, and $200,000 per year, the percentages are 3, 1.5, and less than 1 percent, respectively.

The bottom line. If we add the annual cost of vehicle fuel oil consumption to the cost of non vehicle oil consumption, and if oil prices hold at the levels experienced during the first quarter of 2005, then American households – on average – will spend just over one percent of their income on oil. That's the figure we will see in the media. It's the same logic described in the first paragraph of this article. But for households making $25,000 per year, that number jumps to more than 8 percent of their annual income, and it's almost 6 percent for households in the $50,000 income bracket. The Law of Unequal Distribution shows us that at these prices, households in the lower two income groups (56% of American households) will be forced to make serious adjustments to their spending habits.

The Impact

Still think oil price increases aren't inflationary?

Well, here is another reality. Any claim that an increase in the price of oil will not drive up inflation is based on the implicit assumption there is no shortage of oil. Bad assumption. Shortages are coming. Competition for available fuel will drive up the price (as it has already done in 1974 and 1979). For manufacturers and retailers, supply chain and distribution costs will increase faster than other business costs. Transportation links will be less reliable and more expensive. Suppliers of both goods and services will be forced to develop business models that use less transportation. Logistics productivity will decrease.

It's all inflationary.

For a country like the United States, there will be an outsized impact. This economy, and the business models of its individual enterprises, has been built on the assumption of readily available and low cost fuel. Both assumptions are now false. Depletion induced oil shortages will occur. Higher fuel prices are inevitable. Decreasing transportation flexibility translates into higher production and distribution costs. Just-in-time delivery will gradually migrate to local warehousing operations. Production will move closer to the consumer. Inventory costs will increase. Retail consumer traffic patterns and buying habits will change. Food costs will go up. The list of probable change is very long. Oil dependent enterprises will be forced to make significant changes to their business model

– or perish.

But the real change will be at the consumer level in the chain of distribution.

Productivity will decline. That drives up inflation. In an effort to drive down their costs, suppliers will attempt to accelerate their use of computer based inventory management systems and the Internet for consumer distribution. On-line transactions can be tracked in order to tighten the distribution channel and reduce the need for excess inventory. Consumers will be encouraged to make their purchases from the suppliers WEB site, rather than drive to the store. Home delivery services will proliferate. Companies such as WalMart, Federal Express, Ford, and McDonalds will be forced to make a fundamental change to their business models.

Unfortunately, there is a limitation to the substitution of on-line transactions for in-person shopping and distribution. Because the Internet suffers from the embedded faults of an inadequate architecture, defective software, and a deficient network, America lacks the communications infrastructure to fully substitute on-line interaction for travel. Why? Congress has thus far failed to establish a credible communications policy. Our representatives refuse to recognize the realities of the economic and cultural challenges that face us.

Too bad. If Congress was on the ball, we could avoid a lot of headaches.

Based on an average annual price of $41 per barrel, my model projects that the year-over-year change in the consumer price index (CPI-U) for 2005 will be a modest 3.1% because deflationary pressures are also working their way through our economy. Higher interest rates, a decrease in the rate of economic growth, and our policy of exporting jobs in exchange for low cost goods and services all tend to retard inflation. If oil continues to sell for more than $50 per barrel, however, the projected rate of inflation will be higher.

Speculation and shortages will push up the price of oil. Speculation and surpluses will drive the price down. But the impact of oil depletion guarantees that the long term price trend is UP. Obviously something has to give. The consumer will have to make choices. Shoes for the kids or gasoline for the car? Meat on the table or fuel for heat? Make an impulse purchase at WalMart or pay the rent? It's going to be rough. Tight spending control for two thirds of American households.

Or go broke.

They aren't going to be happy.

And a final note. The model I developed for the American economy can be applied – with some revision of the assumptions – to the economy of any industrialized nation. Japan, France, Australia, South Korea – it doesn't matter.

Inflation knows no borders. It will be everywhere.

The Cultural Economist

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Here Is A Way To Reduce The Price Of Gasoline

We humans have done a really good job of reducing the amount of air pollution produced by the combustion of gasoline. Total hydrocarbon emissions have been reduced by ~98% since we started to clean up our act in the 1970s.

But now we are facing a tradeoff that no one wants to make. Do we go for lower gasoline prices? Or do we continue our quest for absolutely pristine air by invoking rules to decrease gasoline pollution by another 1 percent (or less).

I have long felt that if we are willing to stop chasing the elusive 1%, we can have cleaner air and lower gas prices. How? Instead of focusing our efforts on the reduction of tailpipe emissions, let’s focus on the reduction of gasoline consumption. It seems logical. The less gasoline we burn, the less air pollution we have to deal with at the tailpipe. The more complete the combustion process, the less hydrocarbon waste. Honda, for example, has repeatedly proven it can reduce tailpipe emissions by reducing gasoline consumption. It would appear that if we shifted from a fixation on air quality to a more balanced evaluation of gasoline manufacture and consumption, then we could reduce the price of gasoline and increase the miles per gallon we get from newer vehicles.

It’s your choice.

As I write this, oil has moved up to $112 per barrel. The average price for a gallon of regular gasoline is ~$3.36, and diesel fuel will set you back ~$4.05 for each and every gallon you feed into your vehicle. It is highly likely prices will go higher this summer (2008). And to put fuel prices in perspective, most of the nations that own the oil have made it very clear- they really don’t care how much we Americans (or Europeans, or Chinese, or Australians, etc.) have to spend on fuels. They plan to keep on raising prices until we can not afford to buy all the oil they can produce.

One of the reasons spring gasoline prices in America are higher is because supplies are interrupted by the switch from producing winter blends to the government mandated summer grades. Then we pay higher prices for summer gasoline blends because they are more expensive to make. Throw in a patchwork of State mandated blending rules which make it harder to match demand with supply, add the Federal government’s very expensive ethanol program, and you can see why the price of gasoline is higher than it needs to be. (For more on ethanol, see “What Is The Real Cost Of Corn Ethanol?” elsewhere on www.tce.name.)

So. Should we rethink our approach to the tradeoffs between clean air and the price of gasoline? Few people would advocate relaxing our hydrocarbon emissions vigilance. But perhaps it would be productive to rethink our objectives. If we focus on better gasoline mileage and the reduction of fuel production costs, we can reduce the amount of money you spend on gasoline.

Let’s ask our politicians to revisit these issues.


Ron
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Barack Obama's Middle East Dilemma

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He can not risk failure in Iraq. Or Iran.

Does Iraq have anything to do with the price of gasoline? Diesel fuel? Heating oil? Propane? Natural gas? What role will Iran and Russia play in the price and availability of Middle Eastern oil and natural gas?

Let’s start with a statistic. At least 42 percent of the accessible conventional oil we humans need is located in one relatively small region on our planet. The Middle East. And the people who run this region do not seem to be in any hurry to send it our way. Get used to it. These people will produce their oil on their schedule. They are not going to produce their oil on our schedule. Existing drilling programs guarantee demand will exceed supply. Sometime between 2010 and 2017.

Most of the nations that own the world’s remaining oil really don’t care what you think about the price of gasoline. Nor do they particularly care how you feel about the price of diesel, propane or heating oil fuels. They will just keep raising the price until you can’t afford to buy all they can produce.

Get the picture?

Let’s digress for a moment.
Natural gas. Heat in winter. Fertilizers to grow food. Electricity. Do you think heat and food and electricity are important?

Approximately 40 percent of the world’s known accessible natural gas is in the Middle East. The big players are Iran (38% of identified Middle Eastern natural gas) and Qatar (34% of identified Middle Eastern natural gas). The other big player in the world market is Russia with over 70 percent of the accessible EurAsian natural gas. In fact, between them, Russia and Iran control over 41% of the world’s known reserves of accessible natural gas. These people have made it very clear. They will produce their natural gas on their schedule. They are not going to produce their natural gas on our schedule. If we do not like the price we have to pay for natural gas – too bad!

Do you believe Putin really cares how cold it gets in European homes?

Reality check
Every nation needs a stable supply of oil and natural gas. Most nations want to increase their consumption of these fuels in order to grow their economies. Germany. France. England. America. Australia. Japan. China. India. We are competing for the same barrel of oil or cubic foot of natural gas. That is reality. As a result, we are in the midst of a brutal international competition for commodities that can not be easily replaced from available resources. That means higher prices for every fuel you purchase: gasoline, diesel, propane, kerosene, heating oil, propane, and natural gas. Ever higher prices will drive weaker buyers out of the market. Low income consumers will drive less or not at all. They will be cold in the winter. This is not some dreary prediction of the future. It is already happening!

Motivation.
Putin – the guy who runs Russia – wants to restore Russia’s position as a world military and economic power. He is using Russia’s oil and natural gas reserves as a tool to achieve his goals. He has already told the European Union – we have natural gas - and you don’t. So. If you want our natural gas, then support the Russian political agenda. That little reality is altering the international geopolitical balance of power. Putin is also courting Iran. Being very nice. Why? Because between them, Russia and Iran control a big chunk of the world’s oil and natural gas production.

Should we be concerned about Iran? Shia Iran. Muslim theology. The church is the state. And vice versa. Spiritual and political power are inseparable. Iran’s leaders have a vision. Shia Iraq marching in lockstep with Shia Iran. Backed by guns and money. Iran would like to control the Middle East. And its oil. And its natural gas.

China is being nice to Iran and Iraq. Why? China needs copious quantities of oil and natural gas to support its economic growth. China envisions itself as a world power. That adds to China’s thirst for fossil fuels. If China’s growth falters, there will be internal rebellion. So China is – and has to be - a very assertive consumer in world oil and natural gas markets. The Middle East is an obvious target for China’s aggressive diplomatic and military agenda. China has already signed agreements to acquire large quantities of Iranian oil. China is squabbling with Japan over access to Russian natural gas.

The European Union does not have enough oil or natural gas. It must acquire a growing percentage of its oil from the Middle East. Russia, Iran and Qatar are resources for natural gas. Iran, Iraq, Kuwait and Saudi Arabia are primary resources for oil. The EU can not survive unless it has strong consumer relationships with Russia and the nations of the Middle East. That reality is having a seminal impact on the EU’s diplomatic options.

The United States does not have enough oil or natural gas. Imports account for a growing percentage of the fuels we use each year. Although the United States has diversified its oil imports away from the Middle East, a growing percentage of future imports will have to come from this region. Like the European Union, the United States needs closer ties with Russia and the Middle East.

Consumer nations are in a precarious position. We are competing for the same reserves of oil and natural gas. Most of which is controlled by a small number of nations who really don't give a damn about your comfort or mobility.

Iraq
Now. What happens if the United States fails to control the outcome in Iraq? We seem all too anxious to ignore the consequences. When we invaded Iraq, we took on a moral obligation to keep the peace as best we can while the people of Iraq develop the institutions they needs for self-governance. The military personnel who went into Iraq from multiple nations recognized that challenge from the start. Fashioning a working government out of the ashes of a fallen dictatorship would take courage, willpower and patience.

Barack has suggested America walk away from Iraq. Bring the troops home. Give up. But - what happens next? Chaos. Civil war that leaves many thousands dead. As we have already witnessed, it will be Shia against Shia. Shia against Sunni. Shia Iran will link up with Iraq’s Shia population. Iran has enough military power to dominate Iraq and its vast reserves of conventional oil. It is only a matter of time before an Iran led coalition sweeps into the oil fields of Kuwait. Between them, Russia and Iran will then control over 41% of the world’s known accessible natural gas and over 29% of the world’s known accessible conventional oil. Can you guess what would happen to the price and availability of oil and natural gas? Would Iran be tempted to sweep on through the oil and natural gas fields of the Persian Gulf? The Russian Iranian coalition would then control 55% of our planet’s identified natural gas and 40% of its identified accessible conventional oil.

Brutal. Isn’t it. Reality.

Fuel shortages are highly likely if war disrupts Middle Eastern production. That means long lines at the gas pump. You can expect to pay a lot more for natural gas, gasoline, diesel, propane, kerosene and heating oil fuels. And you will pay more for electricity. Expect to be colder in the winter and hotter in the summer. The price of everything you buy will go up. And you may be unemployed.

Yes. I know. This is a terribly pessimistic scenario. And none of the alternatives are much good either. And we can whine forever about how we got into this mess. But here we are. What do we do next? We need truth. A reality check. A frank discussion of our situation.

And that brings us back to Barack Obama.
I challenge him to answer one critical question:
What are the consequences of getting out of Iraq?

Our intellectual leaders are terribly misguided, be they from Europe, Australia, New Zealand, the United States or elsewhere on our planet. Members of the international elitist political clique are especially clueless. They worship the theology of misguided beliefs. Truth does not matter. Facts do not matter. Rational thought is rejected. Smug insider conviction rules.

Get out of Iraq. Ignore the consequences. Blame the Bush Administration, Republicans, Conservatives, America, corporations, and the rich (which pretty much means anyone who actually works for a living). Ignore oil depletion. It does not exist. Stop building coal power plants (except in China). Our reserves of natural gas will last forever. Shortages are a greedy corporate conspiracy. Ignore the reality of a resurgent Russia and a bellicose Iran. Placate Islamic extremists. Ignore the cultural changes now happening within the Muslim world. The list of obtuse intellectual reasoning goes on and on.

If you have read this far, you are probably very upset. These are unpopular concepts. But our political leaders appear to be reluctant to even discuss the consequences of our actions in the Middle East. That failure is incredibly irresponsible. We must work together. We must control the outcome. Because if we fail, we risk economic destitution and human carnage on a scale greater than we humans have ever experienced.


Ron


PS: What would I do? My recommendations are outlined in two books – “Oil, Jihad and Destiny” which provides a detailed discussion of oil and energy, and “Detensive Nation”, a book that describes the kind of government we will need to deal with the challenges that lie ahead. Both books are available at Amazon. I place an emphasis on a realistic assessment of our options and a robust program of international cooperation.

Isn’t that better than killing each other to control our planet’s remaining oil and natural gas?

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Climate Change: Let's Not Forget Reality

If you have a copy of my book “Detensive Nation”, you know I am deeply concerned about the most endangered species on our planet – Homo Sapiens. Us. Humans. People. We are in the process of destroying our own environment and the sustenance it provides for our survival.

But why do we believe the weather on our planet has always been benignly supportive of human activity? Why do so many chose to ignore the reality of our planet’s weather history?

Competent scientists have been studying the history of weather on our planet for decades. Scientists with impeccable credentials in geology, archeology, paleoclimatology, and other fields have identified periods of change in temperature, rainfall, ocean currents, glacier formation and recession, and so on going back 600 million years. We have accumulated a lot of data on the changes that have occurred since the last ice age ~ 11,000 years ago.

What do these research projects show? Periods of global warming have alternated with periods of global cooling many, many times in the past. Big weather changes carry names like the Holocene Climate Optimum, the Roman Climate Optimum, the Medieval Warm Period and the Little Ice Age. Less extreme, and shorter, periods of cooling or warming modulate these larger trends, yielding cold years in warming trends and warmer years in cooling trends. History also shows that wild wicked weather has decimated life on earth multiple times in the past. Years of wet and flooding. Years of dry and desertification. Cold years. Hot years. It’s all part of our meteorological history.

The real thrust of human evolution began after the last great ice age. About 10,000 years ago. Since then there have been 6 primary periods of global warming and multiple periods of less extreme temperature change. During the Holocene Climate Optimum, average temperatures may have been significantly higher than they are now. Prior to ~ 8500 BCE, human settlements were confined to the rivers and lakes of Egypt and Sudan. Then a change in the pattern of monsoon activity nourished the grasses and trees necessary to make the Sahara more inhabitable. Lakes appeared. Human habitation spread across the region for the next 2000 years. About 6000 BCE, however, the pattern of monsoons again changed. The desert began to dry out, and eventually human habitation was again confined to the Nile, dessert oases, and the Sudan. Evolving weather patterns had changed the course of human history.

It was a pattern of moderate weather with plentiful rain that encouraged human migration northward around the eastern Mediterranean. A period of warmer weather permitted humans to move westward into what is now Europe.

But periods of global warming have always alternated with centuries of global cooling. There are multiple examples of weather related human migration. Over the last 4000 years, cold weather has forced northern tribes to move south in search of food during at least three extended periods of human history. As they moved south, these migrating hordes conquered and decimated the settlements they found in their path. For example, the rise of the Greek and Roman civilizations occurred during a period of global warming. Although the decline of Rome has many causes, one of them was the simple fact that the Goths (et al) were forced by increasingly cold weather to move south. Rome just happened to be in the way.

Human progress and population growth resumed during the Medieval Warm Period when grains were plentiful. Warmer weather permitted the Vikings to colonize Greenland. But this period of growth was interrupted by the Little Ice Age (~1300 – 1850). Cold and wet weather (including violent storms) decimated food crops. This led to widespread and repeated famines from ~1350 to 1800. The Vikings were forced to abandon Greenland. Weakened by starvation, the people of Europe were easy targets for the Black Death that killed 25 million people 1347 – 1351. Unusually strong North Atlantic storms, perhaps caused by the climate impact of huge accumulations of polar ice during the Little Ice Age, decimated the Spanish Armada as it tried to make its way back to Spain in 1588. Lousy weather, which led to grain crop failures and subsequent famine, was instrumental in triggering the French Revolution of 1789. Extremely cold and wet weather was a factor in the failure of Napoleon’s Russian campaign in 1812. He started out with an army of 691,000. Less than 130,000 got out alive. Cold and wet weather was a factor in the Irish potato famine of 1845 – 1851 that killed 1.5 million people. Washington’s victory in the Battle of Trenton in 1776 was more a victory over frigid cold weather than a defeat of enemy forces. The worst weather of the Little Ice Age occurred between ~1645 and 1715. Although it can be said that our planet had entered a new period of global warming by 1850, occasional winters of extreme cold and copious quantities of snow still occurred.

And so. What does this all mean? Periods of extreme weather have happened before. Global warming and global cooling have happened before. Oceans have risen and fallen before. We happen to be in a period of global warming. How much warmer will it get? Meteorological history suggests average temperatures in temperate zones could reach – or exceed – 16 degrees C. About 2 degrees warmer than it was in 2007.

Yes. It will get warmer, and then cooler. No matter what we humans do. To say we can prevent global warming is to display an ignorance of our planet’s weather history.

On the other hand, does this mean we are “off the hook”? Can we ignore our environmental responsibilities? Not by a long shot. Not if we want to insure the survival of the human species. We have to take a common sense approach to solving our environmental problems. Conclusions based on a thoughtful analysis of collected data. Our biggest challenges include the allocation of dwindling natural resources, the availability of fresh water, the preservation of agricultural land, and the management of population growth. Addressing these problems will take a new approach to how we govern ourselves.

And that is the subject of Detensive Nation.


Ron

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How To Save America’s Banking System

Thanks to Investment Bank amorality and Congressional indifference (ignorance, apathy, stupidity, pre-occupation with playing politics, failure to do its job, lack of management capability, confusion, institutional obsolescence, etc. – take your pick), our banking system is saddled with a ton of residential foreclosures. There is no profit in foreclosure. The Bank’s income stream dries up. That’s not good for the Bank, its depositors, its employees, or its investors. In the aggregate, it can be disastrous for America’s banking system. That will do bad things to your credit, credit cards, debit cards, savings accounts, CDs, checking accounts, employment, income, and a bunch of other things you think are important.

We need a fix. Here is an over-simplified explanation of my proposal.

Allow selected banks to sell their non-performing loans to a property management company at the lesser of book or market value. This sale could only occur once. The bank balance sheet would carry the sale as an “Deferred Asset”. The Bank would not receive any cash from the Property management Company. Instead, it receives a note for each transferred property and treats the value of the note as a capital investment. That cleans up the Bank’s balance sheet and reduces the need to bolster reserves. We presume the Bank could then focus its attention on being an active and constructive part of America’s financial system.

The Property Management Company (PMC) would treat the property as an asset and the loan as a debt. Additional Government loans would provide the capitalization needed for PMC operations until the PMC is profitable. The PMC’s objective is to maximize the return on invested capital by either selling or renting each acquired property. Income from sales or rentals would be used to pay off Bank and Government loans. The PMC takes a percentage fee from realized income to fund operations.

The PMC assumes responsibility for property maintenance and improvement, as well as rental and sales activity. This solves the problem voiced by several Cities that abandoned properties become liabilities to the community because they are targets for vandalism, illegal activity, and neighborhood deterioration. It also increases the availability of “affordable” housing.

We could offer a unique rental contract as an option. It allocates a portion of each months rent to a down payment option escrow account. The idea is that at any time, the rental tenant has an option to convert the rental contract into a sales agreement at a pre-determined price. The down payment would come from accumulated funds in the escrow account and whatever other financial resources that are available to the renter at the time. On the other hand, rental tenants who need to move elsewhere could simply give notice, and vacate the property. Funds accumulated in the escrow account would then be used by the PMC to help pay down the loan value.

Since every real estate market is a little different, we should probably look to the creation of regional and local PMCs, rather than one big PMC. These could, in turn, be under the supervision of HUD or some other appropriate federal government agency.
Non-performing assets can be converted into income producing properties. Additional affordable housing becomes available for low and middle income groups. The banking system can be saved.

Of course there will be opposition to my proposal from those who have a vested interest in the status quo, those fearful of the outcome, those whose vision is obscured by the fog of ideology, and those who have no clue as to what in hell is going on.

But try we must. And take the bitter medicine. Otherwise there is no limit to the downside risk.

And that could hurt you a lot more.

Ron

Banks: Bleeding Value And Hiding Desperation

The decline in fixed asset values continues. Homes. Shopping Centers. Commercial and industrial properties. Land. And the decline is not done. Not by a long shot.

Residential Housing

Let’s look at the decline in residential housing valuations.

According to National Association of Realtors data, average American home prices have declined by ~ 13% from their high in June 2007 to January 2008. Unit sales were down ~ 23% during this seven month period. Although unit sales are expected to increase this spring, property valuations are still under downward pressure.

Geography plays a big role in real estate valuations. Prices are either stable or increasing in many specific geographic markets. In bubble markets like California, however, current asking prices are out of sync with reality. Higher quality home sellers are asking – on average – for $270 - $340 per square foot. Lower quality and obsolescent properties have listing prices of $214 to $268 per square foot. The larger the lot (particularly for homes with acreage), the higher the asking price. On the other hand, actual sale prices are declining. According to the California Association of Realtors, the median price for a single family California home declined by 21.9 percent from January 2007 to January 2008. A review of foreclosure data shows that average Bank repossession sales are in the $178 to $260 per square foot range.

If we run the numbers, it is highly likely the final sales price of higher quality properties will come down another 15 – 20% from current asking prices. Lower quality and obsolescent property values will decline by another 8 – 12%. In this scenario, the net loss from the highest real estate valuation in 2006/2007 to the actual sales price in 2008/2009 for higher quality properties could exceed 35%. Lower quality and obsolescent home values loses could exceed 20%. In some California communities, over 30% of the “For Sale” listings are in foreclosure. It is highly likely Bank repossessions will frequently be sold at a discount to the original loan value.

The point about the sub-prime mess that everyone seems to be missing is this: a high percentage of mortgages in these “bubble” markets (including refinance and second loan deals) now exceed, or will soon exceed, the sales value of the underlying asset. That’s all mortgages. Prime or sub-prime. Furthermore, purchase home values will tend to decrease until there is some reasonable equilibrium between rental and purchase home values. Or to put it another way: why would I pay $268 per square foot for a purchase property when I can rent an equivalent house for $195 per square foot? ( For lower quality properties, and assuming a 7% gross ROI, this means the owner occupant who pays $1.81 per square foot per month can reduce cash outlays to $1.14 per square foot per month by renting an equivalent unit).

This is actually happening. As banks continue to unload Real Estate Owned (REO) properties (where the bank has foreclosed and taken possession of the property), and property owners find it is better to rent, rather than sell, their vacated property, the number of rental units will increase. For a buyer with cash, it’s a good investment so long as rental income exceeds property ownership costs. Does that mean our banking system will continue to suffer a decline in the value of its fixed asset portfolio?

Yes. Using Case-Schiller data, residential real estate prices will decline by more than 30%.

If consumers – on average – are strapped for cash to pay current expenses, they will max out their credit card debt (thus further increasing the risk of loan defaults), and cut back on discretionary purchases. Since they are unable to borrow against the value of their home, many consumers have no way to sustain their prior lifestyle. Let’s face it. For them, monthly income will be less than monthly expenses. There are only two ways out: bankruptcy and/or create a new downscale lifestyle. For some, that means spending less on shelter. The monthly cost of owning a home must be competitive with the monthly cost of renting a home.

In California the median down payment for property purchases in 2005, 2006 and early 2007 was less than 17%. Most of these loans are under water. With no equity left, buyers are now able to treat monthly home mortgage and tax costs as rent. Under pressure to cut their cost of living, and with the need to re-allocate monthly income from housing to food and fuel, consumers will be forced to consider less expensive shelter. This is both a direct and an indirect result of high oil and natural gas prices, increasing world demand for more and higher quality food, the inflationary impact of America’s ethanol program, and the shortfall of current agricultural production.

In effect, Banks have become property managers. They “rent” to the buyer. If the value of the house goes up, the buyer can cash out the additional equity by refinancing the mortgage or taking out a second loan. If the value of the property does not change or declines, the buyer may chose to walk away from the loan.

Bleeding

Under existing accounting rules, Banks can cook the books by claiming income long before actual cash comes in the door. Option loan income includes interest which has not been paid, but merely added to the balance of the loan. Earnings from mortgage backed securities can be booked as income long before they are earned. Banks have considerable flexibility when it comes to identifying the status of bad debt. Add these items up, and a bank may face asset losses that exceed reserve capital.

It would appear to be imprudent to claim this will be a short and mild recession. Conventional economics looks at dead data and assumes the numbers look good for a quick recovery. Cultural economists, like me, look at what is happening to consumer lifestyles. And that picture is not good. Higher food and fuel costs do force a reallocation of consumer financial resources. They will have to spend less on other non-discretionary purchases – like housing. They will have less free cash to spend for discretionary purchases. A return to more conservative financing rules, and relatively weak real estate values, have effectively eliminated the use of home equity financing as a sort of savings account that can be tapped at will for more cash.

No. The collapse of our financial markets is not over. The value of debt financed assets (fixed asset deflation) will continue to deteriorate until intrinsic value roughly equals the underlying debt. Look for further declines in the value of:

• residential real estate (single family homes in one to four unit structures),
  
• commercial real estate (shopping centers, apartment buildings, office buildings, industrial properties, and land),
  
• mortgage backed securities and collateralized debt obligations (CDOs), and
  
• leveraged debt (including derivatives).

What determines intrinsic value?

• For hard asset properties, two parameters. How much the buyer or renter can afford to pay per month, and the availability of lower cost alternative properties.
  
• For leveraged debt: there must be an identified asset with a stream of income sufficient to cover monthly debt payments. If one can not determine the underlying asset upon which the income stream is based, then the paper is worthless. And that – is one of the problems with CDOs.

I’ll stick with my prior estimate: loan losses from all financial instruments will exceed $700 B

With the full support of Congress, (including Senators Clinton, Obama and McCain) the Fed is giving copious quantities of cash to the big investment banks that got us into this mess. No one is being held accountable. These banks will spend the cash. But when its gone, the mortgage default problem will still be there. We are committed to printing an unlimited amount of money to keep a small number of insider institutions solvent.

This would appear to be a high risk and very inflationary strategy.

But. I could be wrong. You decide.

Ronald R. Cooke
The Cultural Economist
Author: Detensive Nation

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A Few Words On The Economy

In March of 2007, I predicted America would have a recession before the end of 2008. (see Warning: Recession Ahead. At that point in time, my thoughts were greeted with a certain amount of – shall we say – skepticism. Well. Here we are one year later. It would appear the number of skeptics has decreased.

So. What is happening to our economy?

It has been my contention the Bureau Of Labor Statistics (BLS) understates inflation when it reports the Consumer Price Index (CPI), and the Bureau of Economic Analysis (BEA) overstates “real” economic growth when it reports Gross Domestic Product (GDP). In other words, our economy is in worse shape than the federal government is willing to admit.

The BLS continues to underweight the percentage of aggregate household budgets spent on food and fuel. That decreases the CPI estimates of inflation. Since the BEA deducts inflation from current dollar GDP (and makes some other adjustments) to calculate “Real” GDP, the result is an overstatement of Real GDP. We can summarize the equation as follows: Current dollar GDP - the rate of inflation = Real GDP. The effect of the BLS understatement shows up in the reported data for Q3 and Q4 of 2007.

* The BLS reported a CPI –U increase of 2.36% for Q3 2007, and an increase of 3.97% for Q4 2007.

* The BEA reported a current dollar GDP of 5.14% for Q4 2007. After deducting the effect of inflation, the BEA reported a very anemic Real GDP of .6%.

By my calculations (see CPI: Sophisticated Economic Theory, Terrible Ethics) the rate of inflation for Q3 2007 was closer to 4.02%. It is my belief consumer living costs actually went up by 5.18% in Q4. In my essay on GDP (see American GDP: Can We Trust The BEA Data? ) I projected that Q4 2007 Net GDP would be neutral or negative. Based on reported data, Net GDP in Q4 – by my methodology – was a negative .04% (5.14% - 5.18% = -.o4%). Furthermore, I believe Net GDP for all of 2007 versus all of 2006 was a very sluggish .61%.

So what can we look for in Q1 and Q2 of 2008? Do not be surprised if inflation exceeds 4%, and economic growth is negative. And furthermore, when the books are closed on 2008, it would appear we could record an annual rate of inflation of more than 4.5%, a GDP of less than “zero”, and an unemployment rate of over 6.5%.

By contrast, the United States Federal Reserve has forecasted our economy will be just fine in 2008 with a GDP growth rate of 1.3 to 2 percent, an annual average unemployment rate of 5.2 to 5.3%, and an inflation rate of 2.1 to 2.4%.

Does it appear the Fed is overly optimistic?

There is more downside risk in 2008 and 2009. High fuel prices, Federal fuel policy, low interest rates, declining currency values, and the Federal Reserve’s easy money strategy are all inflationary. Why on earth would anyone believe the Federal Reserve’s inflation forecast? In truth, the Federal Reserve will be caught between a rock and a hard place. Do they raise interest rates to combat inflation? Or keep them low to float the economy?

If our over-extended credit markets and banking system come unglued (highly likely), we could be in for a period of severe fixed asset deflation, and much higher unemployment by mid-2009. Foreign creditors will be reluctant to fund more American debt. That will eventually drive international interest rates UP. And what about GDP? Pundits will be debating the terminology: is this a recession or a depression?

Am I being too pessimistic? You decide. I could be wrong.


Ronald R. Cooke
The Cultural Economist
Author: Detensive Nation
From Regulation to Leadership
Redefining The Role Of Government

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Credit Crunch: It Ain't Over Yet

Introduction

In March of 2007, I published an essay entitled “Warning: Recession Ahead”. You can find it on my WEB site. Many scoffed at the time. For most economists, there was no recession in sight.

But reasonable pundits mock no more.

My basic argument was grounded in three concerns: debt, real estate and oil. Here are two little jewels from that essay:

1. “It’s a wonder the financial markets have not become unglued. The size of the high yield corporate debt market has exploded to about $1 trillion. High yield? It’s high yield because the debtors are in trouble. Corporate bond defaults, now running at less than 1 percent, could easily top 8 percent if the economy goes into recession. Debt defaults are certain to increase. Private equity firms, hedge funds, and Government Sponsored Enterprises will all need help (along with some mutual funds, pension plans, banks and brokerage firms).

Thus far, struggling debtors have been buoyed up by a liquidity glut. But we must ask ourselves: how long will that generosity last?

Only until lenders perceive it is in their selfish-best-interest to bail out.”

2. “If my analysis is correct, one to four unit residential loan delinquency rates will exceed 4 percent for 33.3 million prime loans, and 18 percent for 10 million sub prime and government insured loans by the end of 2008 (versus 2006). Total non performing consumer loan obligations, including mortgage and consumer debt, could exceed $ 700 billion.”

Sound familiar? These excerpts could be from a current issue of the Wall Street Journal. We are sinking into a credit crisis of very large dimensions. Q4 of 2007 and Q1 of 2008 could be quite messy.

Home Mortgages

In the old days (before 2005), traditional mortgages were well documented, included a confirmation of the borrower’s credit risk (ability to pay), an appraisal of the property that justified the amount of the loan, and usually were made at 70 to 90 percent of the property value at the time of origination.

In the new financial era, mortgages were offered to any borrower with a “reasonable” credit rating. These instruments included interest only loans, Adjustable Rate Mortgages (ARMs), and loans with little or no documentation. Over the last 2 or 3 years, up to 50 percent of all mortgages have been funded with loans for which there was no down payment, loans for more than the current market value of the property, interest rate only deals, and ARMs with teaser rates. The result?

These loans sucked low and middle income buyers into deals they could not afford.

As one may guess, these loans carry a higher risk of default. Worse, during the mortgage bubble of 2005 and 2006, loan originators were able to pass these debt bombs through to banks, which passed them on to investment institutions, which then turned them into securities called CDOs (Collateralized Debt Obligations). As usual, the Federal Government was so entangled in political squabbling and officious posturing there was little or no effective imposition of Federal guidelines which should have put some sanity into home mortgage lending practices.

If we examine existing default rates, it would appear that total defaults are on track to exceed my original estimates by the end of Q3 2008. Once again, economic reality trumps financial greed. Investment institutions are stuck with borrowers who are unable to bring their mortgage payments up-to-date. Given the stricter lending standards banks are now imposing on loan applications, they are unlikely to be able to refinance their property. And because home prices are falling – they are unable to sell their house to repay their debt.

The decline of housing values has increased the debt to equity ratios of all mortgages. Loans that started with a high debt to equity ratio are in danger of acquiring a net negative value. These, along with outright defaulted loan obligations, than become unmarketable. Despite balance sheet manipulation, investment institutions will eventually be forced to classify them as a Level 3 asset.

More Asset Trouble

Borrowers were encouraged to go into excessive debt. This pushed up asset prices. Refinancing only works if asset prices keep going up. When the asset bubble popped, leveraged deals went into reverse. Speculators who were counting on increasing asset values in order to borrow more money or cash out got caught in a downward spiral of unserviceable debt.

• The financial risk of securitized credit card debt has been increasing as borrowers exhaust their credit. It has become more difficult, and frequently impossible, to borrow additional money against the value the consumer’s home. Consumer credit defaults, including failed auto loans, will have to become Level 3 assets.
  
• As asset values decline, the credit quality of leveraged buyout bridge loans is deteriorating. If cash flow fails to match debt payments, these will have to be written down.
  
• The risk of asset backed commercial paper is increasing. Some portion of this debt will become unmarketable.
  
• Multiple leveraged buyout deals are in trouble. Highly leveraged corporate debt helped to fuel stock market speculation. Let’s face it. Junk bonds are really junk!
  
• And finally, to these risks we must add derivative contracts, credit default swaps, and other financing misadventures.

Reckless lending practices were encouraged because the securitization of these loans allowed banks to pass the credit risk on to someone else. Loans were simply packaged into CDOs and sold to a buyer. Everyone in this chain of financial deceit made money from the generation of fee income: mortgage brokers, banks, investment banks, and credit rating agencies. Clueless buyers were all too willing to purchase these instruments based on the credit rating agency’s promise they were investment grade securities.

The chain of value has lost its transparency. Who knows the value of these exotic instruments? No wonder investors have finally panicked and become risk adverse. According to New York-based Fitch Ratings, up to 27 percent of this debt carries a high default risk. If all goes well, only 5 percent will actually become worthless.

The generous financial liquidity offered to corporations from hedge and private equity funds is declining. This, along with the asset crunch, will drive more corporations into Chapter 7 or 11 bankruptcy proceedings than we have seen since the last recession.

A Small Bit Of Relief

Starting November 15, 2007, accounting rule SFAS157 requires banks to divide their tradable assets into three “levels”. This requirement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. That means we should see greater debt transparency by Q2, 2008. To quote SFAS157:

“Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. A Level 1 input will be available for many financial assets and liabilities, some of which might be exchanged in multiple active markets (for example, on different exchanges).

Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly through corroboration with observable market data (market-corroborated inputs). If the asset or liability has specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability. An adjustment to a Level 2 input that is significant to the fair value measurement in its entirety might render the measurement a Level 3 measurement, depending on the level in the fair value hierarchy within which the inputs used to determine the adjustment fall.

Level 3 inputs are unobservable inputs for the asset or liability, that is, inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability (including assumptions about risk) developed based on the best information available in the circumstances. Assumptions about risk include the risk inherent in a particular valuation technique used to measure fair value (such as a pricing model) and/or the risk inherent in the inputs to the valuation technique.”

I think these rules mean that Level 3 assets can be valued at the owner’s discretion. Since the definition of what assets can be included in Level 2 versus Level 3 is apparently “fuzzy”, it is in the banks selfish-best-interest to classify as many assets in Level 2 as is possible. Even with this discretion, don’t be surprised if a few players write down more than 25 percent of their portfolio value. But this begs a question to which few investment institutions have an answer: does the fictitious value of Level 3 assets exceed the owner’s capitalization?

And that brings us to the consumer. You and me. Who bought this paper? Pension funds? Insurance companies? How good is the paper in your 401K? Your CD? Your money market fund?

Now About Oil

The only element of this three part thesis still unfulfilled is the contention that sharply rising oil prices have usually foreshadowed a decline in GDP. But that little “gotcha” is still laying in the economic weeds. Higher hydrocarbon prices are now reducing the bottom line of every business. Big losers include airlines, trucking companies, and the food chain (from planting through distribution).

It should not surprise us to discover a price inflation driven decrease in corporate profits and a loss of consumer confidence has rolled the economy over into a recession by spring. Certainly before the end of 2008.

Ronald R. Cooke
The Cultural Economist
Author: Detensive Nation

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Warning: Recession Ahead

Introduction

Although the world economy continues to grow, the economic health of the United States is at risk. There are several potential problems. In this essay we examine three of them, and conclude a recession is highly probable. If America does experience a recession, or even a period of declining GDP, the resulting economic malaise will spread to all of its trading partners.

That’s one of the “benefits” of globalization.

Is America’s Debt Profile Sustainable?

America has developed an irresistible affection for debt. According to the Federal Reserve, Total credit market debt, domestic and foreign has increased from 29.3 trillion in 2001 to over $44 trillion in 2006. That’s (roughly) a 50 percent increase in 5 years. Federal Agency and GSE-backed security debt increased by more than 31 percent from 4.9 Trillion to $6.5 trillion. Mortgage debt climbed from $7.4 trillion to over $ 13.0 trillion – up more than 74 percent. Corporate and foreign bond debt increased by 62 percent to $8.8 trillion. Treasury obligations now exceed $ 4.8 Trillion (up 43 percent), and municipal debt exceeds $2.3 trillion (up 46 percent). And finally, we doubled the debt load of asset backed securities to approximately $3.4 trillion, - mostly on the incredibly imprudent assumption that real estate investments would never depreciate.

Can you say “Debt Bubble”?

Intensive price competition from low wage nations has been, and will continue to be, a double edged sword. On the one hand, it is the basis for the reduced rates of inflation Americans have enjoyed since the 1980s. Foreign companies have flooded American markets with low priced goods. Everything from shirts and shoes to television sets and vehicles. Imports have climbed to 18 percent of GDP. But – although low priced foreign goods reduce the cost of living, they also take away American jobs and are the primary reason why American workers have experienced low rates of real wage growth for more than 20 years.

Even though America is a primary force in the global economy, it is now interdependent with most of its trading partners for roughly 33 percent of its domestic investment. Americans send money to foreign nations to purchase goods and commodities (such as oil). Thus far, these nations have been using a substantial portion of these proceeds to purchase American debt instruments, artificially driving down American interest rates. Because of this flow of funds, Federal Reserve interest rate increases have had little impact on the rate of interest Americans pay for mortgages and consumer debt, or the interest various agencies pay to fund Government operations.

Globalization means money flows freely through the world banking system, seeking either safety or profit. Leveraged buyout transactions have driven a huge increase in junk bond (rated CCC) debt. Financial institutions and funds continue to plough capital into extremely leveraged buyout debt on the promise of dramatic valuations, asset looting, cost cutting, and market prospects. Instigators plan to dump their risk by collateralizing the debt as securities and derivatives contracts.

But we must ask a simple question. What happens to inflation and interest rates if the flow of foreign funds into the United States decreases? The simple answer: inflation and interest rates go up. American consumers face a double setback. The cost of everything they buy goes up and - at the same time - the cost of financing restricts their purchasing power. Debt defaults increase. The cost of rolling over America’s massive trade deficit goes up. Government obligations become more difficult to finance (forcing up interest rates) just as tax revenues stagnate or decline. If history is any guide, the loss of junk bond principal could easily exceed 60 percent from par value.

It’s a wonder the financial markets have not become unglued. The size of the high yield corporate debt market has exploded to about $1 trillion. High yield? It’s high yield because the debtors are in trouble. Corporate bond defaults, now running at less than 1 percent, could easily top 8 percent if the economy goes into recession. Debt defaults are certain to increase. Private equity firms, hedge funds, and Government Sponsored Enterprises will all need help (along with some mutual funds, pension plans, banks and brokerage firms).

Thus far, struggling debtors have been buoyed up by a liquidity glut. But we must ask ourselves: how long will that generosity last?

Only until lenders perceive it is in their selfish-best-interest to bail out.

Real Estate Bust?

The Mortgage Bankers Association recently reported the delinquency rate for mortgage loans on one-to-four-unit residential properties stood at 4.95 percent of all loans outstanding in the fourth quarter of 2006 on a seasonally adjusted basis. The delinquency rate increased 13 basis points for prime loans (from 2.44 percent to 2.57 percent), 77 basis points for sub prime loans (from 12.56 percent to 13.33 percent), 66 basis points for FHA loans (from 12.80 percent to 13.46 percent), and 24 basis points for VA loans (from 6.58 percent to 6.82 percent). This quarter's NDS results cover over 43.3 million loans (33.3 million prime loans, 6 million sub prime loans and 4 million government loans).

Over $6.2 trillion of real estate debt is held by mortgage pools or trusts whose financial instruments depend on the asset value of the underlying properties. Much of this debt has been turned into Mortgage Backed Securities (MBS) for sale to banks, mutual funds, pension funds, insurance companies and the public. Unfortunately, these securities act like bonds. If interest rates go up, the value of the MBS goes down. The financial stress of a debt crisis could easily force interest rates up, thus decimating the balance sheets of dozens of financial institutions.

Obviously, the run-up in real estate values is unsustainable because these paper profits had to be supported by a corresponding increase in debt obligations. Loan originators created exotic products to make these purchases appear affordable. Common sense underwriting rules were broken with abandon. It should have come as no surprise that sub prime mortgages would take the first hit from delinquencies. Unfortunately, just as the originators were entering the financial market to refinance the mortgages they had to repurchase, regulators were encouraging lending institutions to tighten their lending standards. Since sub prime loan funds were no longer available, these originators quickly became financially unstable.

That means an unusually high percentage of existing home real estate loans are at risk. Since the majority of sub prime loans are packaged into mortgage-backed securities and sold to investors, the repercussions from a mortgage meltdown could impact sub prime lenders and their shareholders, consumer banks, investment banks, loan insurers, and the owners of mortgage backed securities. In addition, defaults will put additional homes on the market, depressing real estate values even further.

Companies that originate loan securities face uncertain times as average securitized mortgage collateral declines and the availability of new financing at attractive rates dries up. In addition, the mortgage industry continues to face rising early payment defaults, increasing repurchase activity, a compression of net margins, and a decrease in the fair market value of derivatives.

If my analysis is correct, one to four unit residential loan delinquency rates will exceed 4 percent for 33.3 million prime loans, and 18 percent for 10 million sub prime and government insured loans by the end of 2008 (versus 2006). Total non performing consumer loan obligations, including mortgage and consumer debt, could exceed $ 700 billion. In order to reduce the collateral damage from these non performing loans, lenders have been aggressively trying to renegotiate them with extended payment plans. Never-the-less, loan originators, along with the banks and institutions that funded them, are faced with a massive asset devaluation as home prices and mortgage backed security investments decline in value. Banks (such as Bank of America, Citigroup, and Washington Mutual), and financial institutions (such as Vanguard, Fidelity and Putnam) will be reporting the impact of these emerging devaluations on their balance sheets over the next 8 quarters.

Given the large inventory of unsold homes, new home housing starts should decline by more than 15 percent relative to 2006. Financing restrictions will reduce home remodeling activity. Both trends will increase unemployment in the construction industry.

It is likely real estate will be a drag on America’s economy through the end of 2008.

The Oil Factor

In 2006, the United States consumed an estimated 20,700,000 Bl of oil a day, or approximately 7,555,500,000 barrels of oil for the entire year. That’s the equivalent of 65.3 barrels of oil for each and every one of the 115,677,000 households in America. The bill for refined oil products, such as gasoline, diesel, and heating oil fuels, along with the consumption of refined oil as a material used in the manufacture of other products, now exceeds $ 860 billion per year (about 6.5 % of GDP).

In the following chart, the world price per barrel for oil has been plotted against America’s annual average oil consumption per household. Oil is purchased as a refined product by consumers (gasoline, diesel, propane and heating oil fuels, etc.), and by manufacturers who use it as a feedstock or in the processing of other products (plastics, pesticides, cosmetics, pharmaceuticals, etc.). This chart shows it took roughly four years for consumption to decline after the price shock of 1979. On the other hand, the price reduction of 1986 and the lower prices of 1986 through 1999 encouraged only a marginal increase in consumption. The price increases of 2000, 2004 and 2005 have yet to cause any significant change in oil consumption.

Thus, on a per capita and on a per household basis, oil consumption has been relatively inelastic since 1986. (For a discussion of elasticity see “The Elasticity of Oil Production and Consumption” at http://www.culturaleconomics.blogspot.com/). At this point in history, it will take a significant recession, an incredible shift of consumption to alternative fuels, or a deep transformation of lifestyle to bring down oil consumption.

The relationship between oil consumption, expenditures and recessions has been graphed in the chart below. Significant increases in the amount of money America spends on oil (1973, 1979, 1990 and 2000) were followed by a recession. Yes. Other factors contributed to the decline in GDP that characterized these recessions. However, one can not escape a nagging fear that sharp increases in oil expenditures may cause a subsequent recession. Do the huge increases that occurred in 2004 and 2005 suggest the possibility of a coming recession in the 2007/2008 timeframe?

Sharp, sudden, increases in foreign oil purchases are not only inflationary (because they contribute to the devaluation of the dollar), they often mirror subsequent decreases in GDP growth. In the following chart we adjust annual GDP growth for inflation and then compare GDP growth with U. S. foreign oil purchases per person and periods of recession. The key point of this chart is tied to the huge increase in foreign oil purchases that occurred in 2004 and 2005. Prior economic response patterns suggest a possible period of weak or negative GDP growth in the 2007 to 2008 timeframe.

Historically, there has been a good correlation between U. S. oil purchases per person and the rate of inflation. Although there was a lag to the increase leading up to the 1974 recession, spending more on oil has always meant higher inflation (see “Will Higher Oil Prices Fuel Inflation?” at http://www.culturaleconomics.blogspot.com for this discussion). The real puzzle? Why have we not seen a comparable – or even greater – increase in the rate of inflation during this cycle? This chart suggests a period of much higher inflation is just around the corner.

When constructing and analyzing charts like these, there is always the possibility of making a mistake in the process of data collection or analysis. But the odds of a recession induced by sharply higher oil prices (and possible shortages) is consistent with my world oil production and consumption model. Given the evidence, the odds of oil playing a role in either triggering or exacerbating a worldwide recession before the end of 2008 are very high.

Will Lower Interest Rates Help?

Pumping more monetary stimulus into the economy will not do much good because Americans will just send much of it to foreign nations for goods, commodities and debt payments. The value of the dollar (which is already moribund), would most certainly go into a precipitous decline. Because globalization moves money and the means of production around so easily, a surge in fiscal stimulus may not do much to create new jobs in America (or for that matter, in Western Europe or other OECD nations – they all have the same problem). Smaller Federal budget deficits become impossible. Raising taxes would only exacerbate the consumer’s financial quandary. Taxing the rich only serves to increase welfare spending and encourages high rollers to send their money elsewhere.

This scenario will play out – no matter which political party is in power. Liberal ideology hates globalization, but it is reality. Conservative ideology likes to think in terms of global markets, but there is no way to control the economic outcome.

So. We must confront THE essential question. What event, what trend, and/or what circumstance will prompt foreign nationals to decide they must - in their selfish-best-interest - dump American debt?

• It could be the stock market. As of the date of this essay, both the American and the international markets appear edgy. In my opinion, another leg down is certain. Decreasing stock values will rattle the currency markets and increase the fear factor among debt holders.

• It could be a growing fear of recession. In my opinion we are heading for a period of declining GDP. Weakness in the housing market, along with trends discussed elsewhere in this essay, work against the economic health of the world economy.

• It could (easily) be an event in the oil market. Iraq and Saudi Arabia remain vulnerable to disruptive attacks on their respective oil production and transportation infrastructures. American refining capacity is tight, particularly in California where increasing demand is on a course to collide with inadequate supply. Both Iran and Argentina would like to disrupt oil deliveries to the United States. (Although that remains a possibility, both nations need a flow of oil revenues to support their economic and social programs.) And there is always the panic of a disruptive weather event.

So. What is the risk? Will the fear of unknown probability cause more panic than the event itself? In the currency markets, perception is often more important than reality.

It should be obvious the interest rates on America’s debt, and the availability of additional credit, are far more likely to be influenced by decisions made in Beijing or the Middle East than in Washington, DC. Fear and greed drive the international currency markets. If it is perceived that America’s debt burden has become untenable, or if increasing international conflict appears to be inevitable, funds will flow to whatever safe heaven appears appropriate at the time.

Conclusion

Low and middle income consumers are caught in a bind. Do we buy food? Purchase gasoline? Or pay the mortgage? When Congress voted for the corn ethanol program, it basically mandated a permanent increase in the price of food. Competition for arable land insures eating will be more expensive. (see “What is the Real Cost of Corn Ethanol?” . Unless there is a recession, products made from oil – such as motor fuels – are vulnerable to further price increases. For many American homeowners, ARM interest rates are going higher, and it would appear that homeowners are not going to be able to pull much more cash from their real estate loans because housing values are decreasing. These simple facts will force a curtailment of consumer spending. Add growing unemployment, and one could project a devastating consumer financial crisis.

So here we have it. A rather bleak outlook for America. Food prices are headed UP. Energy prices are likely to remain high. It is becoming more difficult to make mortgage and consumer debt payments.

Something has to give.

It’s time to face reality. Based on available evidence, it would appear the United States could experience a recession (as officially defined by the Feds) before the end of 2008. It would appear the odds are better than 90 percent. But that’s not the whole story. It should not surprise us to see declining GDP before the end of 2007, leading to higher rates of unemployment and declining consumption.

If so, the trend to recession will feed on itself. The world economy is at risk for several quarters of sub-par performance.

Ronald R. Cooke
The Cultural Economist

Please note: This essay is presented without any warranty what-so-ever.

References: All data used in this essay may be found on the WEB sites of the United States Department of Commerce, Department of Labor, or Department of Energy.

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