15 December 2014

American Oil in 2015: Less Production, More Dependence, Higher Gas prices

Memo:   To all those who claim shale oil has the potential to eliminate America’s dependence on foreign oil. Don’t forget reality.

Read the USGS Report
The physical laws of shale oil exploration and production have not been repealed. We need to understand what the USGS has been telling us. (The italics are mine.)

“The assessment of the Bakken Formation indi­cates that most of the undiscovered oil resides within a continuous composite reservoir that is distributed across the entire area of the oil generation window.”

“The forma­tion consists of three members: (1) lower shale member, (2) middle sandstone member, and (3) upper shale member. Each succeed­ing member is of greater geographic extent than the underlying member. Both the upper and lower shale members are organic-rich marine shale of fairly consistent lithology; they are the petroleum source rocks and part of the continuous reservoir for hydrocarbons produced from the Bakken Formation. The middle sandstone member varies in thickness, lithology, and petrophysical properties, and local development of matrix porosity enhances oil production in both continuous and conventional Bakken reservoirs.”

“There is no certain method to determine the exact volume of oil that is contained in the Bakken Formation or any formation. The Bakken Formation oil resource is much different than the oil resources of Saudi Arabia. The Bakken oil resource is what we refer to as a "continuous" or unconventional resource; whereas the oil resources being produced in Saudi Arabia and other Middle Eastern countries are conventional resources. Continuous or unconventional resources require more technical drilling and recovery methods that are much more costly and the oil recoveries per well are commonly much lower than in a conventional resource accumulation.”

“Oil is produced from the Bakken Formation shale in a manner that is a refinement of traditional oil field practice. Traditional oil fields produce from rocks with relatively high porosity and permeability, so oil flows out fairly easily. In contrast, the Bakken Formation is a relatively tight formation consisting of low porosity and permeability rock, from which oil flows only with difficulty. To overcome this problem, wells are drilled horizontally, at depth, into the Bakken and then water and other materials (like sand) are pumped downhole at high pressure (called hydro fracturing) to create open fractures, creating artificial permeability in these tight rocks. The oil can then flow more easily out of these fractures and tight pores.”

The USGS reassessed the Bakken formation in 2013. It concluded the combined mean total oil resource of the Bakken and Three Forks formations is 7.38 billion Bbl of oil, with 3.65 billion Bbl of oil attributed to the Bakken formation and 3.73 billion Bbl of oil attributed to the Three Forks formation. The Eagle Ford Shale and Austin Chalk in the Western Gulf basin included approximately 1.7 Bbl of oil. According to BP data, shale structures have thus far added approximately 14 Bbl of oil to America’s potential oil resource base.

This does NOT tell us how much of the estimated oil will be found.
This does NOT mean all of the found oil is economically recoverable.
It does NOT mean there will be a net yield of energy (EROEI) from all possible wells.
And finally, these numbers do NOT tell us how much of this oil is accessible oil. (Note 1)

The conventional oil component of this assessment is a negligible ~ 1 percent of the estimated technically recoverable oil resource base. That means oil companies had to develop (and continue to develop) increasingly sophisticated methods of exploration, assessment, and production.

As an economist, I am interested in oil that can be found, produced, transported, refined, and distributed at a price the consumer can afford to pay. In my opinion, a high percentage of this potential oil resource, perhaps 25 to 35 percent, may be technically recoverable, but is not economically viable. Shale resource development, like almost all oil exploration and production, involves substantial financial risks. Of lesser concern, but also important, is the EROEI of found oil which must be greater than 1. (Note 2)

Another issue which has been obfuscated by the media is whether or not shale oil production will enable America to eliminate its dependence on foreign oil. That is highly unlikely. Although American oil consumption has recently declined, and American oil production has increased, both conditions are temporary. Lower gasoline prices will encourage greater consumption, and existing oil company debt loads will limit new exploration and production until the price of the WTI oil index exceeds $90 - $100 per barrel.

America currently consumes ~19 million barrels of oil a day (over 6.9 Bbl per year). Absent an economic recession, consumption should hold at 19 – 20 million barrels a day into 2015. In my opinion, production is likely to decline to less than 9 million barrels a day (3.3 Bbl per year) in 2015, forcing America to import over 10 million barrels a day (3.6 Bbl per year). If OPEC continues to provide oil to world markets at less than $80 a barrel through mid-2015, than the spread between production and consumption will be higher.

On the other hand, I fully expect the American economy to decline in 2015. If this does occur, American oil demand will decrease. But world oil prices could still rebound. Although this may appear to be counter-intuitive, it is highly likely we shall see a sharp increase in world oil prices by the second half of 2015 or early 2016 if world oil production continues to decline as suppliers decrease capital investments and withhold product from the market.  

The economic laws of supply and demand have not been repealed.

But I could be wrong.  Do your own homework and then judge for yourself. As usual, any text published on my blog is subject to the Legal Information found here here.


Note 1: Accessible reserves. It is important to understand the definition of “accessible” reserves: "Accessible reserves are those reserves of oil, coal or natural gas that can actually be found, produced, transported, refined, and distributed without disruption at a price the consumer can afford to pay." Our fossil fuel resources are useful only if they can be produced and consumed, without disruption, at a price the consumer can afford to pay.

Note 2: EROEI. Energy Returned On Energy Invested means that the energy derived from exploration, production, refining, and transportation exceeds the energy consumed for these activities. We tend to forget. If the EROEI of any energy resource is 1 or less, then doing that activity no longer provides a net addition to our stockpile of energy.

The average EROEI of world oil production has been declining. I read somewhere that before 1950 the EROEI for oil was more than 100:1. By the 1970s it had dropped to 30:1, and by 2005 the average EROEI on new production had fallen to 10:1. As we go for oil in increasingly difficult environments (deep under the ocean, open pit mining, fracking, etc.) the EROEI will decline further. We have to face the facts. Just because there is oil in the ground does not mean it is practical to extract. Every well has its cost in money AND energy. At some point the EROEI for every well will fall to less than 1, making oil from that well an impractical resource for energy.

10 November 2014

A No Spin Look At American Unemployment


There has been a lot of political spin on American unemployment. Democrats want us to believe the rate of unemployment is going down. Republicans point to a continuing high rate of “unofficial” unemployment. So what is the truth? Without any election campaign bias to obscure the facts, here is what you can find in the unemployment data provided by the U. S. Department of Labor for October 2014. (Note 1)

“Total non-farm payroll employment rose by 214,000 in October, and the unemployment rate edged down to 5.8 percent. The unemployment rate for whites declined to 4.8 percent in October. The rates for adult men (5.1 percent), adult women (5.4 percent), teenagers (18.6 percent), blacks (10.9 percent), and Hispanics (6.8 percent) changed little over the month. The jobless rate for Asians was 5.0 percent (not seasonally adjusted), little changed from a year earlier.

In October, job growth occurred in food services and drinking places (42,000), retail trade (27,000), health care (25,000), and manufacturing (15,000). Over the year, manufacturing has added 170,000 jobs, largely in durable goods.”

Civilian Employment (all workers age 16 or more) rose from an average of roughly 137 million in the period 2000 through 2004, to a high of 146 million in November of 2007. Full time employment then fell to a recession low of 138 million in December of 2009. By October of 2014, civilian employment had more than recovered. The DOL reports 147 million workers were employed in full time jobs. Absent contradictory data, this would suggest American employment has recovered from the Great Recession and it would appear the trend of full time jobs will continue to increase.

During the period 2000 through 2007, unemployment increased from a low of 5.5 million in 2000 to 9.3 million workers in 2003. Unemployment then declined to a low of 6.7 million in March of 2007. The Great Recession pushed unemployment up to a high of 15.4 million workers in October of 2009, an increase of 130 percent. Since then, the official rate of unemployment has dropped to ~ 9 million in October of 2014. Unemployment appears to be on a downward trend.

The Great Recession increased the “Official” rate of unemployment for those who were actively looking for a job to 10 percent in October of 2009. The Labor Department’s alternative measure of unemployment reached 17.2 Percent. The alternative measure counts total unemployed persons, plus all marginally attached workers, and total persons employed part time for economic reasons, as a percent of the civilian labor force. Both measures of unemployment appear to be declining. The Alternate rate of unemployment declined to 11.5 percent in October, and the “official” rate of unemployment was down to 5.8 percent.

The DOL does not count unemployed workers who are not actively looking for work, but who claim they wanted a job now. The DOL’s definition: “These individuals were not in the labor force, 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 preceding the survey.” As shown in the following chart, the number of potential workers who fall into this classification remains stubbornly high.

The terrible experience of being unemployed for a long time has also declined. The number of workers who were unemployed for 27 weeks or more reached 6.7 million persons in March of 2010. By October of 2014, it had declined ~57 percent to 2.9 million. It would appear, however, long term unemployment will not decline to acceptable levels until 2016. Long term unemployment is a major drag on worker income, family spending, and consumer psychology.

Extended periods of unemployment produce an increase in the number of workers who get discouraged because they believe no jobs (for which they are qualified) are available. Although the numbers are improving, over 750,000 Americans still fall into this category and it would not appear the job situation will reach the levels of 2000 – 2008 until 2016 or later.

In a desperate attempt to find any employment that provides income, an estimated 9 million Americans were forced to take part time jobs working 1 to 34 hours per week at the height of the Great Recession. Although this number declined to ~ 7 million workers in October of 2014, we are a long way from the part time statistics of 2000 – 2008. At current rates of decline, it will be 2018 before the part time employment picture materially improves.

So here is what’s wrong with our economy. There are more workers living on a reduced income now than when Barack Obama took office in January of 2009. Although the number of workers classified as unemployed or part time has decreased, the number of potential workers who have dropped out of the workforce and the number of self-employed individuals who have a reduced income has increased. The total number of workers (or potential workers) living on a reduced income (including welfare) has increased 15 percent, from 29.6 million in 2009 to 33.9 million in 2014. From an economic perspective, these are all underemployed individuals. If we add short term unemployed workers who want a job, then underemployment as a percentage of the American workforce has risen from 23 percent in January of 2009 to 25.7 percent in October of 2014. Total underemployment has risen 12.8 percent to ~ 40,000 million American workers.

Now here is a question the democrats never ask: How many Americans are directly affected by underemployment? Is it 80 to 120 million people? What about the immediate family members? Or are all these underemployed workers single and living alone?  

And as we should expect, there has been little or no economic improvement for those workers (or potential workers) who have simply dropped out of the workforce. In a healthy full employment economy, civilian labor force participation should run around 66 – 67 percent. It has now fallen below 63 percent. That means approximately 9.7 million potential workers have simply dropped out of the work force. This extremely negative trend suggests millions of Americans have adopted a permanent welfare lifestyle. As of the October 2014 DOL employment report, there is no sign of recovery.

What can we conclude? Unemployment appears to be declining. But much of that decrease is an illusion. If the 9.7 million Americans who left the workforce all decided they want jobs, the unemployment rate would be ~ 12 percent. Furthermore, if we divide the total number of underemployed persons by the total population, the underemployment rate is 13.6 percent (versus 12.6 percent when Obama took office), and 25.7 percent of the American workforce (versus 23 percent in January of 2009).

This is unacceptable. America’s sluggish income and employment numbers, when coupled with existing economic and regulatory policies, suggest America will not return to a full employment economy until 2018, or later.

So there you have it: an unbiased, by the numbers, straight up, look at America’s unemployment data.


Note 1: Labor Force Statistics from the Current Population Survey
Note 2: Just a reminder. Public sector jobs do not create national wealth. They are funded by transfer payments from the private sector (or debt financing which has to be funded by private sector income). A relatively stable employment scenario can only be achieved by focusing our attention on permanent private sector employment.

07 November 2014

The Fifth Wave

History will characterize the first four waves of computing as the Age of Experimentation and Discovery. The dimensions of these four waves are: mainframes, minicomputers (servers), personal computers, and the Internet. As an industry, the objectives were:

·       Develop technology to meet identified consumer needs.

·       Develop technology because there will be a market.

·       Develop technology because it's creative fun and we think there is a market.

·       Develop technology because it can be used to control market share.

·       Develop technology because it can be done.

The Age of Experimentation and Discovery has now transitioned into the Age of Institutionalization. Hardware companies are institutions. Software companies are institutions. Internet service and retail companies are institutions. Government agencies are institutions. The objectives in this brave new age are:

·       Protect, preserve, and increase the political authority of the institution.

·       Protect, preserve and increase the economic power of the institution.

·       Develop technology to enable the mechanisms of political control.

·       Develop technology to support the economic objectives of the institution.

·       Develop technology to neutralize competitors and antagonists.

·       Develop technology to control the user’s consumption of goods, services and ideas.

Tell consumers what they need.  And can have. The economic and political strength of the incumbents has institutionalized the development, distribution and use of technology.

Going forward, a dramatic contrast will emerge between the Fourth and Fifth Waves of computing. In the age of experimentation, we developed technology because there was at least a possibility that it could be used to solve a real problem. The "Market" would decide if we would be successful. Demand came from the buyer. In the age of institutionalization, we develop technology because we have a vision of how things should be. We create a model of consumer demand based on how we think the technology we are developing should be used. Consumer demand is guided by the revenue needs and technical capability of the institution. Hype sells product. The "Market" must be educated.

The Fifth Wave of computing - the era of pervasive computing - has already started. Credit and Debit cards trigger transactions that can be recorded and processed in every civilized country on this planet. Location and identity tags are already in use. GPS is already used to track vehicles and kids. Federally mandated location equipment is being used to locate the whereabouts of cell phone users.

The key to Fifth Wave computing is the integration of environmental, activity, location and identity sensors with communication links that are tied to application and data base servers in one big network with a huge database. Robotic computer software has been developed to process events (who we are, where we are, what we are doing, what we are thinking) using policies defined by an unseen institutional bureaucracy.  They will be reported.  There will be a response.

In the following table, we show some of the changes that have occurred as the Fourth wave morphs into the Fifth Wave.  Personal communication gives way to pervasive systems. Instead of bringing the computer to the individual, we will bring the individual to the computer.

Even if you do not wish to go.

During the Fifth Wave of computing the Personal Communication services of the Fourth Wave will be reversed. Instead of bringing the convenience of communication to the individual, the individual will be brought to the services of the network. We become mobile network nodes. We must be integrated into the social structure of the network.

And its rules.

Network centric living.  A new life style.

To network operators, we become a moving target that must be continually tracked in order to be connected and monitored. There is an institutionalized fusion of network resources that integrates the individual into the domain of the network. We enter a digital world. We become wired - not for our benefit - but rather for the benefit of the system.

Consumer profiling is already a defacto business practice over the Web, giving sponsors an uninvited glimpse of viewer lifestyles and habits. Targeted advertising constantly demands we buy something. Consumer behavior must be monitored. Interactive television is watching us. The continually expanding infrastructure of the Internet is being used for an unprecedented volume of data collection. 

You may choose to believe this stuff is fantasy.
It is not.
The institutions of government and commerce own the necessary infrastructure.
And we shall reap the inevitable results.
Good or Bad.

There will be a fusion of the individual with the information resources of the network. A flood of carefully prepackaged information will be fed to us - a sort of stream of consciousness - to maximize the content we absorb. We become targets that can either be connected to other targets (people we may or may not want to talk to) or the information resources of the network (to collect more data about us or to feed us more information). Targeted ads and infomercials are already being sent to cell phones carried by persons when they
 come near a retail store sensor. Cell phones have been designed to be electronic versions of the credit card. Make a purchase and the sensor knows whose account to debit.

Once we are targeted, the network can also monitor us for emergency service and public safety purposes. Parents will know where their children are and will be able to reach them as needed.

The government will protect us from ourselves.


You arrive home one evening to find a message on your personal server from the public safety service. "Your daughter", it says, "has just visited an unauthorized Internet site in France. May we remind you that certain sites have been declared "off limits" by the International Public Safety Commission. We have installed software on your daughter's personal server in order to prevent a reoccurrence".

You check with your daughter. She professes innocence. With frantic keystrokes you inform the computer that it wasn't your daughter who made the unauthorized access. Someone must have stolen her identity. 

“Again?” responds the computer.


News content is currently acquired, interpreted and presented as quickly as possible to the consumer. The interpretation reflects the political and social bias of the reporter and reporter's employer. We get sound and video bites. There is insufficient depth to support our critical evaluation. This vaporous treatment if current events will be become even more intense as the years pass. In the Fifth Wave, content will be prepackaged to mold our economic and political attitudes.  Everything is a sales job.  Even the news.

Our thought processes are being institutionalized.

So we must ask ourselves: 

And at what point does public safety become individual surveillance?

Sure, there will be a loss of freedom. The age of institutionalization makes it inevitable. But that fact forces us to make a decision.

How much independence are we willing to give up for the benefits of being connected? 

The Fifth Wave will have an incredible impact on the culture - social structure - of wired nations. Millions of numb network users look down on other millions of people who by choice, economic circumstances, education, religion, or distance from the network, remain unconnected. High tech wired life styles versus heritage life styles.  Social groups and regions share the same prepackaged beliefs cannot believe the “backward” intelligence of independent thinkers. Institutionalized life styles clash with individuals who simply do not want to be managed for the benefit of the "system".

Will our blind faith in the god of technology lead to political conflict?

What kind of culture do we want to build?
If we manage the introduction and use of technology, we have a choice.
We may be able to influence the industrial forces that will shape our destiny.
If we continue to uncritically believe that all technology is good.
We become victims.

Damn near everything has a computer: a connected computer. We become woven into the fabric of the network, a slave to its prepackaged ideas and demands.

Should we ask ourselves: “Where will this institutionalization lead?”


30 October 2014

What Are The Odds in 2015: Inflation or Deflation?

Like other Central Banks, the U. S. Federal Reserve has “printed” copious quantities of money. Despite better GDP numbers and positive media commentary, much of the American economy continues to be lethargic. The Euro zone appears increasingly vulnerable to recession. Financial and geopolitical risks could derail economic growth. What are the long term trends that will shape the outcome?

The Case for Inflation

As I have documented several times, the rate of inflation is sensitive to the price we pay for a barrel of oil. Political turmoil in Iraq, Iran and North Africa threatens to decrease potential production. New discoveries are not keeping up with consumption. However, a combination of sluggish world demand, increased American production, and Saudi production strategy, has temporarily depressed oil prices.

There is a fundamental economic problem with fracking. It is capital intensive per barrel of oil produced because even “good” wells deplete very quickly. Depletion rates can exceed 70% in the first year and economic well life can be less than 5 years. That means oil exploration and production companies must recover well capital costs over a relatively short period of time. After accounting for the costs of well production and company operations, it will be a struggle – at current oil prices – for many companies to generate enough cash flow from future production to pay off accumulated debt.

Lower oil prices have also savaged the profitability of oil sands production. According to the International Energy Agency, about 25 percent of the synthetic crude produced from the sands is no longer profitable at $80 per barrel.

It is difficult to understand how one can predict increased oil production from fracking or sands at current oil prices. This conflict of revenue versus cost is not sustainable. Unless there is an unlimited amount of junk bond debt available, aggregate production will decrease. Speculation will quickly drive up the price of Brent and WTI crude.

Conclusion: expect oil price inflation in 2015. Current expense items –such as food and fuel – are extremely vulnerable to the price of oil.

Public debt financing, along with entitlement and contract obligations, will force Federal and State government administrations to increase taxes. Look for increases in investment, estate, property, income, sales, and corporate taxes. The idea that only incomes over $200,000 ($250,000 for married couples) will be taxed is a politically expedient myth. Every worker will pay more personal income taxes. All consumers (including welfare recipients) will pay more direct and indirect taxes when they purchase goods and services. The cost of living goes up. That’s inflation.

Obamacare, Medicare, and Medicaid costs are out of control. Individual premiums will skyrocket in 2015. Medical care continues to be a critical driver of inflation.

Despite the growing availability of competitive on-line education, college, university, high school and grammar school costs will continue to escalate at rates that exceed the base rate of inflation.

State and Federal Environmental Protection Agency (EPA) rules will continue to increase the cost of doing business while decreasing economic growth. Proposed rules will raise the price of goods and services for all consumers and businesses.

State and Federal regulation of employment, welfare, business, banking, and consumer activity continues to increase the cost of doing business. Lawmakers typically ignore the economic damage. Businesses that manage to survive will have to raise the prices they charge for the goods and services they sell.

Conclusion: government bureaucracy and regulation will be a primary source of inflation in 2015.

Central Bank financial policy has not resulted in a sustained economic recovery, witness the declining fortunes of Western Europe and the declining financial condition of the American family (except for the very rich). Printing copious amounts of money (paper and electronic) has increased national debt burdens. It could be argued low interest rates are actually impeding economic activity because money is flowing into financial instruments (including rank speculation) rather than business building financing instruments. The health of the stock market is an illusion.

John Maynard Keynes, that icon of Central Banking and liberal intelligencia, believed government spending and regulation could modify economic cycles. Liberals have perverted his theories into a socialist political ideology that believes government should manage the economy. Liberals do not understand, or choose to ignore, a simple economic truth: the wealth of a nation is created by its people. Liberals ignore the “cultural” part of Cultural Economics. No government has ever been able to mechanically manipulate sustained economic activity with a politically motivated financial policy.  Monetary accommodation (lower interest rates and public spending) can stimulate aggregate final demand – BUT – only if these stimulus funds flow into private commercial activity, the consumer has manageable debt burdens, and families have (at least the hope of) increasing real income. There is no money multiplier if the consumer is broke, and small businesses are unable to secure loans. It is people, after all, who make investment decisions including personal time, personal risk and personal money. It is government bureaucrats, on the other hand, who always bury economic activity under the dung pile of excessive regulatory restrictions, and it is politicians who will make politically expedient spending decisions without regard for the eventual financial consequences. These are structural problems that will forever trash the Keynes monetary management thesis.

Which brings us to the value of money: the cocktail circuit likes to talk about dollar deflation, as though the declining value of the dollar is deflationary. For democrats and liberals, such talk may be politically correct and politically expedient, but it is based on a deliberate perversion (or outright ignorance) of economic reality. When the value of the dollar (or Yen, or Euro, or ...) goes down (deflates) the price of goods and services that can be purchased with that dollar goes up. We know national governments make a huge effort to obfuscate the rate of inflation (because inflation hurts the proletariat), but if the article I bought yesterday cost $1.00, and today it costs $1.10, that’s inflation. Anytime the dollar devalues, the price we pay for goods and services goes up. That’s inflation.

Some central banks are suggesting the devaluation of their national currency in order to compete with the (declining) value of other national currencies. The easiest way to accomplish their objective will be to print money. If a currency war breaks out, there is no upper limit to the rate of inflation.

Conclusion: Central banks, particularly in Europe and the United States, have created a dung pile of debt. The winds of economics will bring in higher interest rates and currency devaluation. It’s all inflationary.

The Case for Deflation

The public debt bubble will collapse. Chinese capital spending is not sustainable. According to the OECD, Japan’s “official” debt to GDP ratio is projected to be 232% in 2015, followed by Greece (188%), Italy (147%), Portugal (142%), Ireland (132%), France (116%), Spain (111%), the United States (107%), Belgium (105%), and the United Kingdom (103%). As shown in the following graph, the 15 country Euro area has a debt to GDP ratio of 107%, and the total average debt burden for all OECD nations is 111%. These “official” debt burden numbers do NOT include forward spending commitments for promised welfare payments, “off the books” public debt, or the effect of higher interest rates on public debt service. There is NO credible plan to pay off these debts. The bubble just keeps getting larger, and larger....

Should we be concerned when tepid economic growth and low inflation are accompanied by increasing public and private debt? Are we borrowing just to stay alive? National debt loads accelerated from 2008 through 2012, and then moderated into 2014. Although existing commitments for 2015 call for a moderation of debt spending, the weakness of the Euro area economy could easily derail these plans. The key point: national governments will increase national debt loads in order to stay in power. This means printing money and/or paying higher interest rates on newly issued or refinanced debt. The load of national debt will continue to increase until one or more nations default. Then the national debt bubble will burst. The ensuing financial panic will trash bond values. Derivative values will be worth pennies on the dollar. The net effect will most certainly be deflationary. We don’t know how long it will take for this scenario to play out.

If the world economy unravels, then unemployment, underemployment, and fear will combine to reduce consumption. Investment and GDP will decline. The economy will deflate. Just like the 1930s.

If the world economy deflates, fixed asset values will decline. Rental properties are especially vulnerable. Stagnant incomes, increasing unemployment, and credit card debt guarantee consumers will prioritize spending decisions based on urgent need: food, fuel, and then rent (or mortgage payments). In periods of declining economic activity, rental property owners (homes, apartment buildings, shopping malls and so on) face potential bankruptcy because of higher vacancy rates. It will also become increasingly difficult for rents to keep up with property, debt, tax, and maintenance costs.

Expect a flood of cheap imports into the OECD nations followed by ever increasing national protectionist trade policies. Asia will export deflation; and that will work until the protectionist trade barriers go up.

Despite current optimism, we know the stock market will collapse. Aggregate stock valuations and derivative values will decline. That’s deflation.  

Expect confidence in the financial viability of the public sector to erode. Because national central banks will continue to print money, public debt ratings will likely decline. Federal and state agencies will have to pay higher rates of interest in order to offset the perceived risk of buying public debt. It will become increasingly difficult and more expensive to sell new bonds, or to roll over maturing issues of existing public debt. But as public sector bond interest rates go up, bonds not held to maturity will decline in value.

Recession makes it increasingly more expensive to sell new bonds, or to roll over maturing issues of existing private sector debt. As interest rates go up, bonds not held to maturity will decline in value.

Bond devaluations and declining property rents jeopardize the asset base that supports existing pension plan and insurance annuity contract payments. Aggregate plan values decrease.

The International Monetary Fund (IMF) has recently forecasted World GDP to increase by 3.8 percent in2015. GDP is expected to increase by7.1 percent in China, 3.1 percent in the U.S., 2.7 percent in the U.K., 1.3 percent in the Euro area, and .8 percent in Japan.

But this scenario appears to be optimistic. In order to sustain a stable economy through 2015, we have to assume:

WTI oil prices below $105 for most of 2015,
No disruption of oil supplies,
No substantial increase in taxes,
Medical costs are brought under control,
Restrictions will be placed on Federal and State EPA regulatory authority,
Federal and State regulations will favor private business activity,
Central Banks will refrain from printing money,
Central Bank policy will compel the banking system to support private business activity,
Governments will not increase national debts,
Nations will not engage in deliberate currency devaluations,
The Stock Market will not collapse,
Vladimir Vladimirovich Putin will not try to annex more nations, and last – but not least -
Relative calm will prevail in the Middle East, Africa, and elsewhere. (Note 1)

Since liberal economic and social philosophy dominates OECD national political agendas, we can expect liberal financial solutions will be imposed to solve OECD financial problems. Liberal ideology is unlikely to support the creation of national wealth, very likely to increase government spending, and absolutely certain to increase the transfer of income and savings from “rich” to “poor”. Although it decreases national wealth, growth in public employment is seen as beneficial. Fiscal discipline is (deliberately) ignored. Liberal ideology will encourage (and demand) national central banks print copious amounts of money. The resulting currency devaluation is likely to increase the cost of living. It is possible the net effect will be to drive OECD nations into a long period of high inflation accompanied by declining business activity. Expect high rates of unemployment and underemployment. Poverty and liberal theology will drive widespread social unrest.

But, I could be wrong. Perhaps the collapse of the financial system will usher in a period of deflation like the 1930s. Perhaps currency devaluations will result in high rates of inflation. And maybe the IMF is right.

Do your own homework and then judge for yourself. As usual, any text published on this blog is subject to the Legal Information found in http://tceabout.blogspot.com/


Note 1: OK. I left out some problems. But you get the point.

Note 2: for more information about food and fuel inflation see: http://www.tceconomist.blogspot.com/2011/05/inflation-parade-of-zombies.html  

For an analysis of the relationship between the price of oil and the rate of inflation, see:  http://www.tceconomist.blogspot.com/2011/06/how-does-price-of-oil-change-rate-of.html

21 September 2014

Outlook for a Cold Winter

Much of Europe will be brutally cold this winter. Putin is watching the weather with one hand on the natural gas valve. He has a superbly effective negation tool – and he will use it. Bloody conflict in the Middle East, potential conflict in South East Asia, the mess in North Africa and the growing threat of an Islamist terrorist incident within several OECD nations all point to continuing political instability. Are we really dumb enough to think the world economy is somehow immune from the impact of political events?

International liberal money management ideology has created a huge, gigantic, large, humongous quantity of potentially worthless paper money and electronic currency claims all tied to an enormous pile of potentially worthless derivatives. Investors are so desperate for a safe place to park their money; they are even willing to take negative rates of return. The real return on consumer bank deposits is so negative the value of money trapped in the banking system is declining in value.

Institutions are willing to pay the government to hold our money until this scary financial catastrophe blows over. Banks are willing to pay other (preferred) banks to store their money rather than lend it to banks on the not preferred list. Smaller regional and local institutions are feeling the heat.

The financial world has turned upside down. Banks used to be in the business of making loans to businesses large and small based on an assessment of reasonable risk. But a financial crisis monster has frightened them into hording cash. Instead of loans, checking accounts, and financial transactions, they have focused their attention on the perceived safety and potential profitability of financial instruments. Thanks to the democrats, banks are no longer focused on supporting economic growth. And here is a question: do these financial institutions really trust each other?


Higher interest rates might work. Make it in the banking system’s selfish best interest to lend money. Give them back the historic spread between income (deposits) and outgo (loans). Let greed do its thing. But unfortunately that strategy creates another financial challenge. Most governments are up to their respective eyeballs in debt. Higher interest rates mean more government income has to go to service public debt. That in turn will bring on austerity measures, confiscatory taxation, and general public rebellion.

Not a very encouraging.

More quantitative easing will not solve the structural problems plaguing the world economy. Notational derivatives are higher than in 2007. Margin debt and leverage is excessive in the foreign exchange, commodity, stock and bond markets. Interest rates are already so low they are actually acting as a drag on the economy. Bringing them down another one tenth of a percent will be about as stimulating as cold soggy half eaten grilled cheese sandwich.

But that will be the liberal economic solution. They don’t know what else to do. Ideology trumps the common sense solutions of cultural economics.

Governments are rapidly losing their financial management credibility. Geopolitical chaos, stupid (but politically correct) government regulation, irrational (but politically expedient) welfare, lousy energy and industrial policy, insider crony capitalism, endemic corruption  – these are NOT money problems. These are structural economic and social problems crafted by liberal ignorance.

Over and over again we are being told the central banks can manage economic growth. Borrowers and investors perceive too big to fail institutions can depend on the central bank to bail them out if the monetary system collapses. But this assumes national central banks will never fail.

Bad assumption: most are technically bankrupt.

But then why not let the International Monetary Fund (IMF) print and issue its own currency to shore up failed national central banks? Nations could trade old debt for a new international currency. Unfortunately, that will put international monetary policy and the availability of credit into the hands of a few bankers and politicians who do not understand cultural economics, sneer at economic success, and favor worldwide income redistribution. Expect monetary decisions to be driven by politically correct ideology and politically expedient connections.

The potential for disharmony is mind boggling. And the creation of an international dollar will NOT solve either the debt, or the structural problems, that are certain to overwhelm the world economy.

The outlook for global economic growth has deteriorated. But stock market volatility has fallen sharply because investors have taken a “no fear” attitude toward the purchase of potentially risky assets. That scenario could turn upside down in the blink of an eye.

Even if a political event does not trigger a stock market sell-off, confidence in a “business as usual” investment climate is deteriorating. Consumers don’t have much cash left. Posts on e-bay suggest a massive liquidation of assets. If this proves to be the case, that trend could be globally deflationary and the cause of currency wars as nations rush to protect their manufacturing base.

Many of the big guy billionaires, liberal and conservative, seem to be preparing for stock market collapse – and the chaotic social results.

Sam Zell tells us that every company that has missed its numbers recently has missed on the revenue side, indicating companies are facing a weakening of demand.

When you got a demand issue it's hard to imagine the stock market at an all-time high.” – Sam Zell

It has been reported George Soros has increased his total SPY puts to $2.2 billion, a new record high. Now that is a real “put your money where your mouth is” bet the stock market is headed down – big time.

The masses are nervous in Brazil, Argentina, Europe, Japan, Canada, the United States and elsewhere. Islamist terrorist activity is certain to be disruptive. We are looking at the wrong end of a gun barrel. There are (at least) three key questions: at what point will the proletariat lose confidence in the banking system? Is the collapse of the international monetary system inevitable? Will that lead to bloody political, social and economic chaos on a global scale?

One can only speculate – with trepidation.

But I could be wrong. You decide.


16 January 2014

Does The Price Of Gasoline Affect The CPI?

Media pundits and some government officials like to tell us that the price of gasoline and food are not important indicators of inflation because they are “volatile”. To them I say: Your pronouncement is absurd, preposterous, ridiculous, ludicrous, misguided, illogical, and foolish. The price of gasoline (and diesel) affect our economy by raising (or lowering) the price of everything we buy and thus the Consumer Price Index (CPI).

Proof?  Let’s calculate 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 December of 2013.  Although the ratio of gasoline price change (in %) to monthly changes in the CPI are significant, there is a very high correlation.
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 percentage change in the price of gasoline as reported by The Department of Energy (DOE).

As shown by the following chart, there is also a strong correlation between the annual change in the CPI-U index and the annual percentage change in American gasoline prices.  

This is important stuff. The long term trend for the price of oil (and hence gasoline) is UP.  That means - on a long term basis - the rate of inflation will also increase. As shown by this chart, the price of oil has been (and will continue to be) volatile.  This chart also shows the predominate bias of oil price movements and the CPI are up (above 0%).  Since the price of oil is a very important component of what happens next to the world economy, the development of alternative (lower cost) production options such as fracking assume increasing importance.


04 April 2013

Will America Ever Pay Off Its Debt?

Assuming no unusual economic event occurs during the last 6 months of the federal fiscal year (ending September 30, 2013), American GDP for that period should be in the range of ~ 16.3 trillion. If so, then the United States will end its fiscal year with a debt to GDP (Gross Domestic Product) ratio of 106%. That means for every $1.00 of GDP, the Federal government owes someone one dollar and six cents. About 78% of this debt to GDP ratio will be in the form of public debt: money that has been borrowed from pension funds, foreign banks, insurance companies, individuals, and so on. Buyers receive notes, bonds and other financial instruments that promise to repay the face value of the paper they purchase plus interest. Interest on this paper is projected to have an average year-end rate of 2.36%. Gross interest costs are estimated to be ~ $293 billion. (Note 1)

Gross Federal Debt also includes interagency (intergovernmental) debt.  For the full fiscal year, another 31% of this debt to GDP ratio was in the form of money that has been borrowed from other federal agencies. These securities, issued by the Treasury, include paper issued to government trust funds, revolving funds, special funds, and the Federal Financing Bank. Social Security is the largest Trust fund and holds over 50% of the Treasury’s interagency paper. Other large creditors that own Federal Government debt include the Civil Service Retirement and Disability Fund, the Medicare Trust Fund, and the Military Retirement Trust Fund. Treasury gives these agencies an electronic IOU that acknowledges the existence of the debt. Booked (but not paid) interest costs for the 2013 fiscal year are estimated to be about $179.3 billion.

Public debt should end fiscal 2013 at ~ $12.4 trillion, interagency (intergovernmental) debt is estimated at ~ $4.9 trillion, and total debt is projected to be ~ $17.3 trillion. The 2013 fiscal year federal budget is $3.8 trillion. For fiscal 2013, total accrued or paid gross interest costs are estimated to be about 12.4% of the federal budget, and about 2.9% of GDP.
With the exception of maturing paper, and demands for funds received by Federal agencies, there is no provision in the 2013 budget to repay any prior debt. The total debt outstanding, including accumulated interest, just keeps growing larger each year.
Despite the common belief that China holds an enormous portion of U.S. debt, two-thirds of the treasury’s bankroll currently comes from the Social Security Trust Fund, pensions for public-sector workers, pensions for military personnel and other retirees, and American investors. China, with less than 8 percent of the U.S. government’s paper, is among several nations that invest in treasury securities. As of March 2013, the Federal Reserve was holding $1.79 trillion in U.S. Treasury securities. On a net basis, it increased its holdings of treasury securities by $58.9 billion in calendar 2012. The Federal Reserve is required to send its net profits to the treasury, and was able to pay $88.9 billion in profits to the treasury in 2012.

For the full fiscal year 2013 budget, gross treasury interest costs are projected to be $472 billion. These interest costs are paid in cash, IOUs, and electronic transfers to its creditors. But treasury does not have to raise $472 billion. This amount is offset by funds received from on and off budget funds, as well as other interest and income sources. Projected net debt interest costs, which are included in the federal government’s annual fiscal budget, will be approximately $247.7 billion.
But why, we ask, is all this accumulation of debt so important? To answer this question, let’s go out five years and construct a scenario for 2018. If GDP is $22.1 trillion, and accumulated debt has increased to $24.1 trillion (both reasonable expectations), then America will have a debt to GDP ratio of 109%. About 76% of this debt to GDP ratio will be in the form of public debt. The remaining 33% will be in the form of debt owed to agencies and Trust Funds. Normalized interest costs on America’s federal debt will have increased by 80% to $741.2 billion. If the federal budget is (as proposed) $4.7 trillion, then interest costs will increase to 15.8% of the annual budget. (Note 1)
For those of you who like their data in pictures, I have included a graph of America’s debt from 2000 – 2013. The data comes to us courtesy of the U. S. Bureau of the Public Debt.
It is also useful to visualize the annual gross cost of America’s federal debt for 2013 and 2018.
But there are two problems.
In my opinion, by 2018 Social Security and Medicare (and perhaps some other trust funds) will no longer be net buyers of treasury securities. They are going to want some portion of their money back in order to fund projected retirement benefits.  If so, the treasury interest income statement will look something like this.

According to this scenario, net treasury interest costs will have increased by 124% to $555.8 billion. These increased interest costs will have to be included in the projected federal budget of $4.7 trillion, forcing either a reduction of federal spending or an increase in the budget. America will either have to raise taxes or borrow more money just to pay the interest on the federal debt. Given the conservative estimate of interest costs in our scenario, interest on America’s debt will have almost doubled from 6.5% of the budget in 2013 to 11.8% of the budget in 2018. Without an increase in taxes, that’s $308 B that would have to be cut from federal programs. You should know, however, interest on the public debt could be substantially higher. Here is a graph of the estimates used in our scenario.
This brings us to the second problem. What if we want to pay down the federal debt?  Could we?  What happens if we just try to pay off the debt that will exist at the end of fiscal 2018 over a period of 20 years? Dividing $ 24.1 Trillion by 20 years means we would pay off $ 1.2 T of America’s debt each year.  The federal budget for 2018 would have to be increased by at least 25% to $5.9 trillion, and ~ 30% of the federal budget would be allocated to servicing America’s federal debt. (Note 1)

Could America pay off its debt?  A graph says it all.

It’s not hard to visualize the scope of America’s debt challenge. Unfortunately, the increased debt service, including the payment of principle and interest, would be a politically unacceptable burden on the budget. In addition, all too many people in Washington - for political reasons - do not believe any meaningful debt reduction is necessary. Consider the plausible solutions:

  1. Use austerity measures including a reduction of Social Security, Medicare, Medicaid and other health and retirement benefits to hold the line on further indebtedness.
  2. Use draconian austerity measures, including a wealth tax on bank accounts, to save the financial system.
  3. Increase sales and income taxes.
  4. Shift an increasing share of health care costs to the American worker.
  5. Shift more federal spending to State government budgets.
  6. Increase the rate of inflation by adjusting interest rates.
  7. Print money (also inflationary).
  8. Default on selected blocks of treasury debt
  9. Take a much longer time to pay off the debt
  10. Use trade and/or currency measures to enhance domestic economic growth.
  11. Increase tax revenues by encouraging the growth of the private sector.
  12. All or some of the above.

But most of these solutions are not politically expedient. America has accumulated an excessive load of debt, is stuck with costly interest payments, and has become vulnerable to the availability of capital (including money created by the Federal Reserve). It is also worth noting these debt estimates do not include a massive off balance sheet accumulation of unfunded obligations for which the America people are legally responsible. There is only one rational conclusion: America has been led into a debt trap from which there is no politically expedient escape. Given the size of the debt burden and Washington’s attitude, a full repayment of America’s existing debt obligations is highly unlikely.

America will never “pay off” its load of federal debt.

This raises an interesting question. If there is no attempt to control the amount of debt on America’s balance sheet, at what point does America become a bad credit risk? And what would happen next?

The election of 2016 should be lively. Someone will point out America’s political elite have buried our children in a mountain of unmanageable debt. Someone will point out Washington has demolished the economy. Someone will claim federal policies have made Wall Street rich. Someone will point out our political system isn’t working.

Someone will propose a radical solution.


Note 1: Data gleaned from Federal Reserve, Treasury, GAO and CBO sources. Estimates are based on a risk adjusted analysis of publically available federal data. The objective of this essay is to provide the reader with a simple and concise explanation of America’s budget debt challenges. The debt costs discussed in the essay do NOT include planned (or unplanned) additions to Federal debt obligations, nor do they include unfunded government obligations (health care, Social Security, welfare, pensions, etc.), or State and Local debt. 

Note 2: Other interest rate assumptions would give a range of interest costs from $650 - $900 billion. The Social Security Trust Fund assumes it will get a minimum of 3.5% interest per year on the treasury paper held by the fund. Other agencies have similar expectations. As a reference, here is the theoretical range of interest rates at various debt to GDP ratios.
Note 3: Trust Fund Management Program.
The Secretary of the U.S. Treasury is designated by law as the managing trustee for eighteen of the approximately two hundred thirty Federal Investment Funds. With over $2.5 Trillion in assets, the Treasury-managed Investment Funds are the majority of the largest Trust Funds in the Federal Government. They receive Social Security, Medicare, excise and employment taxes---all collected by Treasury---as well as premiums, fines, penalties and other designated monies collected by the agencies that administer the programs for which these Trust Funds exist. 

The Bureau of the Public Debt is delegated the responsibility for administering these eighteen Funds. For each of these Funds, Public Debt immediately invests all receipts credited to the Fund, and maintains the invested assets in the Trust Fund account until money is needed by the related Federal Program agency to fund program activity, such as Social Security and unemployment benefit payments, as well as highway funding.
When the program agencies determine that monies are needed, Public Debt redeems securities from the Funds' investment balances, and transfers the cash proceeds, including interest earned on the investments, to the program accounts for disbursement by the agency. The Bureau provides monthly and other periodic reporting to each Fund's program agency.

Data for Federal Debt Charts - Fiscal Year 2013 and 2018