The Cultural Economist

Winning Means Losing

2011-12-10T09:31:00.001-08:00

The economy sucks. Unemployment is ~ 8.6%. Underemployment is > 22% (Note 1). America is living the debilitating misery of chronic recession. The stock market trembles with every European rumor. Fear of economic depression hangs in the air. Washington appears determined to make matters worse. Americans are agitated.

And that sets the stage for the 2012 elections.

Both political parties are slinging mud just as fast as they can. Caustic lies and nasty matter pollute the air. (More global warming?) Republicans are flustered. Democrats are frustrated. For both parties, venomous rhetoric is more important than substance. But while our politicians are preoccupied with smut, many of America’s potential challenges are not even on the election issue radar. Some subjects are avoided because any mention of them would be condemned as politically incorrect. Some of America’s challenges are evaded because meaningful debate would be politically inexpedient. And some are left out of the election deliberations because few politicians understand the subject.

Does that shake voter confidence?

For republicans or democrats, the downside penalty of winning in 2012 is far greater than any upside reward. For the winner there will be continuing frustration and anger. No matter who wins, Washington will still have to deal with chronic recession, a deteriorating situation in the Middle East, determined terrorist activity, incessant civil war in multiple nations, an embarrassingly ineffective and corrupt United Nations, a nasty collection of anti-American politicians, chaos in Mexico, China’s ascendancy as a self-centered political and economic power, a destabilized European Union, government corruption, domestic terror attacks, and escalating domestic anarchy.

Oh. And higher oil prices. And the threat of ruinous inflation.

Does that shake voter confidence?

Obama is pulling American troops out of Iraq. The resulting power vacuum will lead to increased political turbulence throughout the Middle East. Iran is uniting the Shia Muslim population against Sunni Muslims, forming anti-western, anti-Jewish, anti-American alliances, and funding an army of terrorists. Democracy will not survive in Iraq because this region has neither the culture nor the economic basis to support a democracy. Afghanistan and Pakistan will become armed Islamist camps. Islamist influence already dominates Egypt and multiple African nations. Regional war is inevitable. World war is possible.

Does that shake voter confidence?

All the Congressional failures of the last 25 years will come home to roost. The promise of democracy has been debased by ceaseless bickering and a cascade of outright lies. Socialist ideology has weakened America’s financial strength, desecrated the legitimacy of American media, and trashed the financial viability of America’s health care system. Free market enterprise has been debauched by crony capitalism. Bureaucratic oppression routinely sabotages entrepreneurial activity. Legislative confrontation has replaced meaningful compromise. Stalemate prevails over common sense.

Does that shake voter confidence?

In many respects, this is a very strange election cycle. The next five years could be apocalyptic. Although most Americans can not verbalize the challenges that lie ahead, they definitely know something is wrong. Voters feel helpless. Threatened. Uneasy. Congressional approval is a wretched ~ 19%. Obama’s credibility is sinking.

For republicans or democrats, winning in 2012 means losing. There are no uncomplicated answers to the challenges that lie ahead. Potential solutions will be smothered by the appalling ignorance of ideology. That will force a dramatic shift in political power. The opposition will win in 2016.

Assuming the political establishment allows free elections.

TCE

1. By my calculation methodology, underemployment must include: 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 (Table U6 published by the DOL), and an estimate of those who the DOL would count as employed, but are unable to work full time. Just because someone is working does not mean they are making enough money to pay their bills!

A Monetary Crisis = National Debt Defaults

2011-11-27T09:08:00.000-08:00

Here is a partial list of nations that will find it more difficult to roll over their national debt in a monetary crisis.

Australia

Austria

Belgium

Canada

Denmark

Finland

France

Germany

Greece

Hong Kong

Hungry

Ireland

Israel

Italy

Japan

Norway

Portugal

Singapore

Spain

Sweden

Switzerland

United Kingdom

United States

The Netherlands

In order to create a list like this, we need to review each nation’s current public debt, future debt obligations, and future tax revenue streams:

· Current public debt is a simply tally of debt obligations already on the books for payment over the next 12 months. Regional and State debt obligations need to be included in this computation because in a monetary crisis, national governments will be pressed to provide aid to defaulted regional and State governments. Think California, New York, and so on.

· Future debt obligations are those expenses that exceed annual tax revenues. The only recourse for any national government is to either borrow the money or cut the expense. Since expense reduction implies cultural change (or shock), we need to estimate to what extent strikes and riots will act as a counter to austerity measures. And then we need to estimate if the national government will be able to increase its debt obligations enough to cover any increased expense.

· Future tax revenues include a projection of current tax policy, the fiscal effect of possible future tax policy (change), and an analysis of future national economic wealth (often counted as Gross Domestic Product). We need to know how a monetary crisis will affect annual economic activity and the concurrent generation of tax revenues.

This is a job for the Cultural Economist. And this is what I did in order to develop the above list of nations. Of course we can only make estimates. How does one, for example, quantify the fiscal impact of a riot? A revolution?

In a monetary crisis, all of these nations have incurred (and can be expected to encounter) more expense than they can easily finance. Although nations such as Austria, Finland, France, Germany and The Netherlands currently have excellent credit ratings, internal cultural change and economic recession will force future credit challenges as they try to finance growing welfare commitments. We will probably muddle through for awhile. But there is a distinct possibility any national monetary crisis will spread like a contagion throughout the world economy.

Let's all hope I'm wrong. What do you think?

TCE

Did the “Stimulus” Help Our Economy?

2011-11-22T18:24:00.001-08:00

According to Congressional Budget Office (CBO) estimates, the Stimulus package put together by Barak Obama and a panicked Congress will have “a net negative effect on the growth of GDP over (the next) 10 years." In addition the cost of carrying the debt will “represent a drag on the level of GDP beyond that, if no other actions were taken."

For politicians in Washington who apparently don’t understand what GDP means, you people have guaranteed higher rates of unemployment, and negative to inadequate real income prospects, for most American workers over (at least) the next 10 years.

And you do not have a credible economic plan. In fact, you don’t have any economic plan. The so called “Jobs Bill” is just another collection of transfer payment goodies for your political supporters. It does virtually nothing to create private jobs because it does little or nothing to address waste, corruption, excessive regulation, oppressive bureaucracy, crony capitalism, and a bunch of other issues you people are too disorganized and too faint-hearted to tackle. As a result, your “plan” is to further decimate America’s middle class and create an even greater divide between high and low income earners.

Thank you Congress. Thank you BO. Thank you and your cronies on Wall Street.

TCE

Social Security: False Alarm Or False Hope?

2011-11-15T19:23:00.000-08:00

This essay was originally published in April of 2008. Here are excerpts.

A Wall Street Journal MarketWatch column (4/17/2008) by Dr. Irwin Kellner entitled “False Alarm”, concludes Social Security is not likely to run out of money any time soon.

Kellner’s conclusion contradicts the findings of the fund’s Trustees in their 2008 report “Status of the Social Security and Medicare Programs”. As described in their summary: “The financial condition of .. Social Security …. remains problematic. Projected long run program costs are not sustainable under current financing arrangements. Social Security's current annual surpluses of tax income over expenditures will begin to decline in 2011 and then turn into rapidly growing deficits as the baby boom generation retires. …. Growing annual deficits are projected to exhaust …. Social Security reserves in 2041.”

Furthermore, Kellner’s conclusion also disagrees with the findings of the Congressional Budget Office which estimates Social Security insolvency will occur in 2052. Kellner points out the Fund’s Trustees assume an average annual growth rate of 2.3% per year in making their intermediate projections of American economic growth. He compares this rate of growth with the 3.4% per year America experienced from 1960 through 2005, and concludes the lower figure must be labeled as “conservative”. Furthermore, Kellner believes the Fund’s low cost projection, which assumes an average annual GDP growth rate of 2.9%, is more realistic because (we presume) it is closer to his historical benchmark of 3.4%. With this growth rate assumption, Kellner believes Social Security will never run out of money. There will always be sufficient funds to keep the fund solvent.

I disagree. Predicting Social Security solvency is not an easy task, and it is not simply a mathematical exercise. We must consider both the economic and the cultural environment within which these estimates are made. By way of illustration, let’s look at two problems – one economic and one cultural.

First. Conventional economists frequently fall into a credibility pothole because they project the future based on the past. With a little tweaking here and there, they believe the mathematical extrapolation of dead data can be used to predict future economic performance.

But this assumption is absurd. Life is not a catatonic repetition of events and circumstances. Cultures evolve. Lifestyles change. Immigration shifts the balance of political power and changes the economic landscape. Technology creates new products. Technological change destroys old markets. Once powerful institutions stumble and fade away. Life is a dynamic process. Credible economic analysis must be equally dynamic.

For example, conventional economics does not handle resource depletion very well. Economic theory assumes increased demand will bring about higher prices; higher prices will stimulate additional production; and when production exceeds demand, competition will force prices down. That works just fine if we are forecasting the market for door knobs. It doesn’t work very well if there are serious limits to the addition of new production.

It should not come as a surprise if the average annual increase in GDP, adjusted for inflation, is less than 1% from 2006 through 2030. If this happens, Social Security will be in trouble long before 2041. (From 2006 – 2010 chained GDP averaged .8%)

Second. Conventional economics ignores people. It assumes human behavior will not change much in the future, or at least not enough to alter the results of an mathematical extrapolation based on dead data.

This assumption is also false. If the average annual Social Security payout is $12,000, then a couple can expect to have approximately $24,000 a year to spend (less Medicare). If the median income for an American couple is $48,500, and if we assume they need at least 70% of that amount to maintain their current lifestyle, then they need an annual income of $34,000 upon retirement. To this amount, one must add annual increases to cover the cost of inflation. That means, on average, American couples must fund $10,000 a year, plus additional sums to cover the cost of inflation, from other sources. Since the basis of projected Social Security benefits is projected to decline, and Medicare premiums are projected to increase, the spread between your Social Security benefits and the cost of living will increase over the years. Because the Federal Government underestimates the rate of inflation, no sane person should anticipate annual increases in Social Security benefits will actually keep up with the rate of inflation.

Unfortunately, less than 50% of married couples (or domestic partners) will have additional income from pensions or annuities. More than 40% of all retirees will see their annual income decline by more than 30%. Really dumb agricultural policy is currently focused on increasing the price of food, and gasoline ain’t going to be cheap.

Baby Boomers (all born between 1946 and 1964) are not going to be happy when they retire and the reality of their desperate financial situation finally sinks in. These people are going to be really, really depressed when they have to sell their comfortable 2400 square foot middle class suburban home in order to scrape together enough money to rent a 420 square foot mobile home, endure unbearable cold in the winter because they can’t afford the cost of fuel, and eat dog food for meat. No. Baby Boomers will do what they have always done.

Protest.

And politicians, ever mindful of the next election, will increase Social Security payments to help them out. That means current estimates of Social Security fund solvency are inherently bogus because they fail to consider the possibility of some unknown, but definitely probable, increase in benefits.

Conventional economic research frequently yields inadequate conclusions based on irrelevant or obsolete data that has been interpreted using algorithms of questionable relevance. In other words - we play with the numbers. It's a great academic exercise. Cultural Economists, on the other hand, must have a strong sense of the cultural matrix within which economic phenomena occur. Culture, in this sense, includes everything we are: our political systems, economic psychology, mores, traditions, sciences, and education. These all play a role in how we make purchase and investment decisions.

As for the Social Security “Trust” Fund, it’s in more trouble than anyone can guess.

TCE

Postscript: Some people mocked me when I published this essay. No more.

How To Fix America’s Housing Mess and Create Thousands Of Jobs

2011-10-06T10:12:00.000-07:00

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     I first published this idea in March of 2008. It’s too bad Congress is ruled by people who have absolutely no business acumen. If Congress had acted in 2008, our housing crisis would be (mostly) over. America’s economy would be moving in the right direction.

     The fundamental concept is still valid. Will a Republican Congress do any better?

     Probably not... But one can hope for a miracle.

     Thanks to Investment Bank amorality and Congressional regulatory failure, our banking system is still saddled with a ton of residential foreclosures and disastrous commercial property loans. Small business activity has been strangled by a dysfunctional banking system. We are headed for another financial crisis.

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

     Fix America’s Banking System
     You may remember the Office of Thrift Supervision set up the Resolution Trust Corporation in the 1980s to deal with hundreds of insolvent thrifts. Given its relative independence and management skills, the RTC was able to move quickly to dispose of rotten assets. We can do that again. Allow desperate 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 helps to clean 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 two unique rental contracts as an option.
     1. The renter signs a long term agreement. A portion of each months rent is allocated 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.
     2. A new homeowner could sign an agreement wherein the RMC receives a percentage of any gain received when the home is sold. This increases the probability the RMC can recover at least some of the cost basis of its investment in the property, and adds to the flow of funds to repay the RMC’s debt obligations.

     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 an 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.

     Put Thousands Of Americans Back To Work
     This proposal creates thousands of new jobs. Increased loan activity means more jobs in the Finance Industry. Increased real estate activity will provide jobs for thousands of real estate property management employees, and put thousands of real estate agents, appraisers, and loan brokers to work. Property renovation and maintenance will provide jobs for thousands of plumbers, carpenters, electricians, contractors, and maintenance workers. There will be an increased demand for truck drivers and equipment operators. Increased real estate market activity increases the tempo of employment activity at hardware, lumber, equipment, and other supplier companies. Retail sales pick up. Even local coffee shops benefit!

     Message to Congress. We need to bite the bullet. Get our economy back on track!

     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. Think stock market crash. Higher rates of unemployment. Destitution. Poverty far worse than the 1930s.

     Is that what we want?

     Let’s all pray for a miracle. Congress actually fixes the problem. Before it’s too late.


     Ron

     Reference 1: How To Save America’s Banking System, TCE, March 2008

     .

The Price Of Oil: How Much Will It Hurt?

2011-09-28T12:29:00.000-07:00

Significant Cultural Change Lies Ahead

Disclaimer - Putting together the research for this essay has not been an easy task. One can not take published data at face value. Some critical data is unavailable. Much of it is untrustworthy. I was thus forced to make many estimates and assumptions. Because of these challenges, the content of this essay can only be taken as indicative of broad trends. The content, charts, tables, statements, comments, conclusions, and forecasts found in this essay are presented without any warranty.

Introduction

My wife and I were shopping for groceries at our local supermarket. We overheard a woman tell her little boy: “Now that’s all we have to spend here. We still need to buy gas to get home.”

I wonder how many time a day this same scenario plays out. Food or gas. Food or rent. Perhaps if our people in Washington spent more time at the checkout counter, they would have a gut level sensitivity to the inflationary spiral currently driving food and fuel prices.

The Issue

We hear consumers have less money to spend on food, clothing, housing, and discretionary items because the price of oil has risen to ~ $99 per barrel on world markets. That translates into higher prices for gasoline, diesel, kerosene, propane, and heating oil fuels as well as thousands of other products that are either made from oil, or consume oil in the production and distribution of finished goods. Of particular concern is the impact of higher oil prices on the cost of food. The USDA tells us that in 2009, about 14.7% of American households had either low food security (need financial help to cope with food prices) or very low food security (one or more members of the household occasionally do not get enough to eat).

The Law of Unequal Distribution states there will be an unequal distribution of economic change among the economy's participants. Although there are several different ways to classify people in order to make comparisons, the most common measure of economic change is money. Oil prices are a particularly good illustration of this law because higher oil prices have a serious impact on lower income households. They will pay a higher percentage of their income to purchase products made from oil. But will they really be hurt? Can the effect be quantified? And what is the potential social outcome?

Intrepid analyst that I am, I plunged into this project with a grim determination. I fired up my trusty spread sheet and diligently searched the WEB for answers. We want to know:

How will rising oil prices impact the lifestyle of American households?

After days of research and several hundred calculations, I pulled together the following observations.

Motor Fuels

We start with a determination of how much these households are likely to spend on gasoline or diesel motor fuel, assuming they drive an average of 11,000 miles per year.

There are approximately 116,500,000 households in the United States. (Note 1) Of these, approximately 79.5 million are family households, and 37 million are classified as “non-family” households. About 92 % of all households (107,180,000 units) have at least one vehicle. Research into the average number of vehicles per household, the average miles traveled for each vehicle, and the probable average fuel economy per vehicle, yields the conclusion that Americans will use an average of 838 gallons of motor fuel worth $3,160 per household in 2011. (Note 2)

Estimated annual motor fuel costs, versus percentage of household income, are shown for 2011 in the following graph. Households with an annual disposable income of $25,000 have an average of 1.05 vehicles per household, and consume an estimated 385 gallons of motor fuel worth $1,451 per household. That’s just under 6% of household income. Households with an annual income of $50,000 have an average of 1.49 vehicles per household, and consume an estimated 636 gallons of motor fuel worth $2,397 per household. That’s almost 5% of household income. By contrast, households with an income of $275,000 or more have an average of 3.21 vehicles per household, and consume an estimated 1,468 gallons of motor fuel worth $5,535 per household. That is, however, just 2% of household income.

Higher oil prices translate into an increase in motor fuel costs. After estimating the average number of vehicles per household by income, and the number of miles traveled per vehicle per household, we can plot this increase. In comparison with 2009 (when motor fuels averaged ~ $2.41 per gallon), these costs will be $524 higher in 2011 (assuming an average of $3.77 per gallon) for our theoretical household that has 1.05 light vehicles and an income of $25,000. They increase by an average of $865 for households with 1.49 vehicles per household and an income of $50,000, $1,501 for households with 2.29 vehicles per household and an income of $100,000, $1,857 for households with 2.68 vehicles per household and an income of $200,000, and $1,997 for households with 3.21 vehicles per household and an income of $275,000. (Note 3)

Of course, if a household with an income of $25,000 insists on driving a vehicle that gets 16 MPG, then its annual motor fuel costs will be a painful 10.4% of disposable income. For households that make $50,000, their vehicle fuel costs would jump to over 7.6% of their annual income. And here is a key point. Households with an income of $50,000 or less account for 49 percent of American households that own at least one vehicle. Obviously, as the price of oil increases, available discretionary spending for other items decreases.

The Hypothetical Family

Let’s compare how the price of oil affects a family of four that has a disposable income of $25,000 per year, one older vehicle that gets 32 Mpg, and uses either propane or heating oil for household heat. In doing this analysis, we recognize the costs for individual line items can vary widely by household. Taken as a whole, however, these estimated average costs appear to be reasonable for all households in this income bracket.

Column 1 in the following Table lists the individual line items. Motor fuel includes diesel or gasoline products. Heat costs are an average of propane or heating oil costs for this type of household. Column 2 shows household costs incurred in 2009. Column 3 shows estimated comparable line item costs for 2011, assuming the price of oil averages $99 per barrel. Column 4 shows the incremental costs for each line item for 2011 versus 2009, and Column 5 shows the percentage increase over this two year period.

Using data from the Bureau of Labor Statistics Consumer Price Index - All Urban Consumers (CPI-U) and other sources, it would appear the two year rate of inflation from 2009 through 2011 for our hypothetical family will be ~ 7.6%. Sharp increases in the price of fuels and other products made from oil (up about 56%) will be accompanied by higher prices for food (up ~8.8%) and health care (up ~15%). For more on inflation, see Does The Price Of Oil Drive The Rate Of Inflation? on my Blog “The Cultural Economist”.

Our family will spend $2,062 in 2011 on indirect oil costs. These costs are hidden from the consumer because they are included in the price of the product. Examples can be found in products made from refined oil, processed using refined oil, or transported by fuels made from oil. The largest factor is the role oil products play in the cultivation, production, processing, packaging and distribution of food. Indirect oil costs (IOC) for our hypothetical family will increase by an estimated $216 from 2009 through 2011.
Direct oil costs for heat and vehicle fuels (HFI) consumed by our hypothetical family, will increase by an estimated $1,113 from 2009 through 2011. Indirect oil costs, plus oil fuel costs, increase by a total of $1,330. Inflation has increased our hypothetical family’s cost of living by a total of $1,900 (7.6%) from 2009 through 2011. It should be noted that the price of oil has indirectly or directly accounted for 70% of this increase in the cost of living. The following graph shows the impact of food and fuel prices on our hypothetical lower income family.

So. If our hypothetical family of 4 with a disposable income of $25,000 uses either propane or heating oil for household heat, and has one vehicle, and if oil is $99 per barrel, they will spend over $5,150 (~19%) of their income on oil. They spend their money on oil when they purchase products made from oil (directly), or when they purchase products and services that have been produced, processed or transported with oil (indirectly).

If oil increases to a consistent price of $124 per barrel, then they will spend over $6,400 (24%) of their disposable income on oil products in order to maintain their mobile lifestyle. But is this really realistic? At what point does the cost of owning a vehicle become prohibitive? When does money for food, housing, clothing and other necessities preclude a continuation of personal mobility?

It should also be noted that the federal government’s poverty threshold in 2011 is officially $22,350. Based on this analysis of the cost-of-living, if oil consistently sells for $99 per barrel, then the poverty threshold is realistically $24,250. That’s ~$1,900 more than the official peg.

And what about households that use electricity, natural gas, wood, or coal for household heat? As we shall see later on in this essay, they are in better shape financially.... but not by much.

Who Gets Hurt?

But wait. Aside from lower income working families, students, and welfare recipients, do we know anyone else who is trying to get by on $25,000 or less per year? How about people on Social Security? There is nothing hypothetical about these households. This is reality. Over 10 million Social Security and railroad retirement recipient households have incomes of $25,000 or less. Individuals and couples. Living on retirement benefits and whatever else they may be able to scrape together for income.

Here is the official story. In 2009, the Obama Social Security Administration told all Social Security recipients: “”When there is a period of no inflation, the law does not permit an increase in benefits. Based on the Consumer Price Index (CPI) published by the Department of Labor, there was no rise in the cost of living during the past year, so your benefit will remain the same in 2010.” Then in 2010, the Obama Social Security Administration told all Social Security recipients: “The government measures changes in the cost of living through the Department of Labor’s Consumer Price Index (CPI). The CPI has not risen since the last cost-of-living adjustment was determined in 2008. As a result, your benefits will not increase in 2011”.

Here is the truth. Increases in Social Security benefits always come after increases in the cost of living. Furthermore, the Department of Labor (DOL) typically underestimates the rate of inflation. The official CPI-U NSA increased by 2.6% in 2009, and 1.4% in 2010. In 2011 it is likely to increase by 3.6% (or more). That’s a 7.6% increase in the rate of inflation. If Social Security recipients needed $25,000 to survive in 2009, then their cost of living will increase between $1,700 and $2,000 in 2011. Over 10 million retirement households are struggling with declining real income.

Total Oil Related Expense Per Household

Vehicle fuels are only part of the oil price inflation story. America’s 116,500,000 households heat their homes with natural gas (50.1%), electricity (33.5%), heating oil (6.5%), propane (5.6%), and other fuels such as wood, coal, and kerosene (3.4%). Approximately .9% of these households do not have a primary source of heat.

Assuming the average world price for a barrel of oil is $99 in 2011, we can calculate the national average annual oil consumption cost per household by type of heating. In the following Table, Column 1 lists the type of fuel used for household heat. Column 2 shows the percentage of households that use each type of heat (or do not have any heat). Column 3 lists the number of households by type of heat. Column 4 shows the average annual cost per household, and Column 5 calculates the average cost by type of heat for all households with heat. The average annual cost of fuels used for household heat is $1,217. Total heat, motor fuel and other oil products and services cost – on average - $6,006 per household. But households using propane or heating oil (~ 12.1% of all households) will spend far more than the average – about $7,325. Households with electric or natural gas heat, (~ 83.6% of all households) will spend less – about $5,699. Households that use wood, coal, or other fuels (about 3.4% of all households) will spend about $6,700. About .9% of all households either have no heat or only use supplemental heat (an electric room space heater, for example). Space heating costs for electric households are less because electricity delivers a lower average cost per BTU of useful heat, and because these households tend to be located in warmer regions of the United States. Recent domestic drilling activity has reduced the potential cost of natural gas.

The average annual cost of vehicle fuels, heating fuels, and other oil products per household can be graphed by income. At a price of $99 per barrel, households with a disposable income of $25,000 that depend on heating oil or propane for household heat will spend over 21% of their income on oil products. Households in this income bracket that use lower cost heating systems such as natural gas or electricity, will spend over 15% of their income on products made from oil.

We need to remember, electricity is not really a "fuel". It is a means of moving energy from one place to another. Electricity is primarily produced by consuming coal, natural gas, and nuclear fuels. Hydroelectric and renewable energy resources provide the remainder of America’s electric generation capability.

Oil Expense as a Percentage of Income

But at what point are households forced to alter their lifestyle because they can no longer afford the price of oil products they purchase? In the following charts, we use household incomes of $25,000, $37,500, $50,000 and $100,000 for this analysis. Most blue collar workers, students, welfare recipients, and Social Security beneficiaries fall within the two lower income levels. According to census data, approximately 49% of American households (~57,000 units) have incomes of $50,000 or less. (Note 2)

In this analysis, we calculate the average number of vehicles per household, the typical miles per gallon each vehicle gets, the number of gallons of gasoline or diesel motor fuel each household consumes, the cost to heat the household, and the cost of other oil products and services the household consumes. In addition to heat and vehicle fuels, households will directly purchase high oil content products (motor oil, plastics, lubricants, fertilizers, chemicals, etc.), and indirectly purchase low oil content products and services (where oil products are used in a manufacturing process, agriculture, or the provision of a service).

Our conclusion? It would appear that if a household is forced to spend more than 20% to 25% of its disposable income on oil products, then it will eventually be forced to alter its lifestyle. It is highly likely oil product consumption will decline if income divided by the household’s cost of living is less than 1 for an extended period of time. As we have seen in our budget analysis, households have to set aside a substantial portion of their income for housing, food, clothing, and other necessities.

Households that consume Propane or Heating Oil for household heat.

In 2009, when oil averaged $62 a barrel, there was a moderate pressure on households with $25,000 of disposable income to alter their lifestyle. At $99 per barrel, however, households that use propane or heating oil for space heating and hot water will have entered the “red zone”. They will purchase an average of 1,475 gallons of oil products worth approximately $5,315. Direct and indirect oil costs devour ~21% of household income. At $124 a barrel, the price of oil will force households with a disposable income of $37,500 into the red zone, followed by households with $50,000 of disposable income if oil reaches a consistent $149 dollars per barrel, and households with $100,000 of disposable income if oil is a consistent $174 per barrel. Vehicle ownership will decline, especially among households that have less than $50,000 of disposable income, because that’s the most obvious oil related expense to cut. They drive fewer miles per year, purchase fuel efficient vehicles, and drive their vehicles until they literally “fall apart”. In order to reduce their oil costs, many of these households will also be forced to skimp on heat and hot water.

Households that consume Natural Gas, Electricity or Other Fuels for heat

The projected pressure on household finances is somewhat less if a household uses natural gas, electricity, wood, coal, or other (non-oil) forms of heat. Households with disposable incomes of $25,000 will have entered the “red zone” by the time oil reaches $124 per barrel. Households with an annual disposable income of $37,500 will have entered the red zone by the time oil reaches $149 per barrel, followed by households with a disposable income of $50,000 at $174 per barrel, and households with a disposable income of $100,000 at $199 per barrel.

Add it all up. On average, American consumers who heat their homes with propane or heating oil will either directly or indirectly purchase approximately 2,000 gallons of oil with a finished product value of over $7,300 in 2011. Consumers who use natural gas, electricity or other fuels for heat will consume ~1,270 gallons of oil with a finished product value of just under $4,800.

Vehicle Ownership

Let’s see if we can quantify how the price of oil affects the size and characteristics of the American motor vehicle market. Using the basic data described above, we can develop a profile of probable light vehicle ownership at different oil price points. For this analysis we add together the average the cost of household heat, motor fuels, direct oil product consumption, and indirect oil product consumption, across all households for each income level, and plot vehicle ownership by the price of oil per barrel in $25.00 increments starting at $74 per barrel. As the price of oil increases, families and individuals are forced to spend a greater percentage of their income on oil products. This decreases available funds to purchase and operate a motor vehicle. As the price for a barrel of oil increases from $99 to $199, projected vehicle ownership among lower income groups declines rather quickly. Although the decline in vehicle ownership does not occur immediately, it would appear lower income consumers will eventually be forced out of the light vehicle market. In the following graph, we show this trend for households that have an annual income of $25,000 $37,500, and $50,000.

At $74 per barrel, American light vehicle ownership appears to have been 636 vehicles per 1,000 people (assuming a population of 310,000,000 persons), or ~ 197,234,500 units. At a price per barrel of $199, vehicle ownership among the three lower income groups described above will have declined by ~ 56%. Vehicle ownership among higher income groups will decline ~ 2%. In this scenario (which ignores population growth, and the effect of inflation on other household costs), total vehicle ownership declines by ~ 22% to a total of ~ 153 million vehicles if the price of oil reaches $199 per barrel. American motor fuel prices will then exceed $7.50 per gallon. At this price, it would appear Americans will be forced to reduce the number of light vehicles used for personal transportation to about ~ 495 vehicles per 1,000 persons.

This projected change in total vehicle ownership by income group is shown in the following graph.

The following graph shows the associated shift in light motor vehicle ownership as a percentage of the total market. Households with annual disposable incomes of up to $50,000 currently own about 37% of these vehicles. At $199 per barrel, high oil prices will eliminate about 41 million vehicles as lower income households are forced out of the light vehicle market. Their share of the light vehicle market declines to ~ 21%. Households with incomes of between $51,000 and $100,000 currently own ~ 31% of all light vehicles. This increases to ~38% of the market at an oil price of $199 per barrel. The percentage of vehicles owned by households with an income of $101,000 to $200,000 increases from 22% to 28%, and the percentage of households with an income of over $200,000 increases from ~ 9% to 12%.

Implications Of Higher Oil Prices

The availability and price of oil has serious cultural and economic implications. At $99 per barrel, at least 25% of American households will be forced to alter their lifestyle. At $199 per barrel, this percentage increases to at least 67% of households.

Cultural

In Winter, lower income households are forced to choose. Fuel for heat and hot water, or fuel for the car? Food for the table or fuel for the furnace? As oil prices increase, these choices will become more difficult – and depressing. There isn’t enough money. It becomes a challenge to find enough cash to pay for household heat. In some communities, public and private groups help households that consume oil products for heat by contributing to the purchase of heating oil, propane or kerosene. A few precious gallons at a time. Although households that use natural gas, electricity or other fuels for heat, are currently under less financial pressure, they will also be forced to alter their lifestyle as oil prices increase.

The freedom of personal transportation has long been a fixture of American life. For lower income households, however, this freedom is being curtailed. As the price of oil increases beyond $99 per barrel, the stress of this change will become ever more evident. Vehicle operating costs – including fuel, purchase costs, maintenance costs, insurance and fees - become prohibitive. Oil costs also push up the purchase price of other goods and services. Vehicle ownership will decline. Vehicle miles traveled will decline. Households become more dependent on the local community. It will take longer and be more difficult to commute to work. Declining mobility forces workers to move closer to the place of their employment, even if it means moving into a less desirable neighborhood. Many households living on Social Security can not function without local a public transportation option. Lower income households will need locally available shopping, medical, dental, banking and other services. Local and State governments will have to rethink the placement and staffing of schools, clinics, and public safety facilities.

Retailers will reorganize the distribution of food and other goods. Think about it. If most of your customers must struggle, or are unable, to come to your place of business, what do you do?

Personal mobility creates the perception of social equality. The decline of personal mobility will be psychologically painful and socially demoralizing. How many Americans live in substandard housing, but are proud owners of a vehicle? Without a personal vehicle, one feels trapped.... helpless. Expect increasing social discontent and anger as higher oil prices exacerbate the financial divide between upper and lower income groups.

Economic

It should not be a surprise that most of the economic impact relates to the means of transportation. Moving people and goods. Distribution of products and services. Economies of scale will become far more important. Railroads or highways? Airplane or train? Trucks or containers? Cost per mile of travel. Weight per dollar per mile of travel. Fuel efficiency. Buses and share ride vans are a growth industry. Assume an increased demand for shopping services that bring groceries and other products from the store to your home.

Aside from occasionally begging a ride with someone else, higher oil prices will force a segment of lower income groups into public transportation. It’s either that or don’t go. Sure. We are experiencing an intermediate period where lower income people keep their old vehicle until it dies, or make the stretch to purchase an inexpensive (probably used) vehicle that gets great gas mileage. That trend is already in place. But as we have shown in the text and graphs above, the American vehicle market will gradually favor cars, trucks, SUVs, and vans that appeal to the more affluent because these are the only households that can afford the cost of fuels.

In a nation without enough cheap energy, GDP has to deteriorate. Without assertive and competent government planning, unemployment will increase. Limited mobility makes the daily commute to work an arduous task. Higher energy costs limit business activity. Higher oil prices also translate into higher rates of inflation, especially for the current consumption of food, fuels, clothing, and so on. Despite gradual gains afforded by increases in energy efficiency and “green” energy, America’s economic fortunes are inexorably tied to the availability and price of cheap oil, natural gas, coal, and nuclear power. The disappearance of low cost energy will definitely damage America’s economy.

Government

Unfortunately, America does not have a credible energy policy. It does not have a proactive energy exploration, production, and distribution strategy. Government is not focused on the need for cheap energy. Instead, America has a patchwork of politically correct, Federal and State energy measures, that guarantee Americans will pay higher prices for gasoline, diesel, propane, kerosene, heating oil, and jet fuel. Public policy also favors higher prices for electricity, thus increasing the cost of electric heat and making electric vehicles less attractive as a transportation option. Federal and State regulation continues to increase the cost of operating of natural gas, nuclear, coal and hydroelectric generation facilities, thus making electric heat more expensive. It would appear our political system is determined to place limits on the supply of affordable energy. For the American consumer, the cost of current consumption (including food and fuels) will go up. That’s called inflation.

America does not have a credible public transportation policy. Although politicians routinely give this subject the appropriate amount of lip service, the United States does not have a comprehensive strategy for the funding, construction, maintenance, and operation of public transit lines and terminals. Railroad infrastructure and operation has been largely ignored. The integration of public and private systems needs far more proactive attention.

The United States will have an energy crisis because there is no plan to satisfy America’s need for lower cost fuels. America’s politicians don’t even have the will power to address the issue. Furthermore, if there is an acceleration of oil prices, then welfare and entitlement costs, along with a decline of GDP, will devastate Federal and State budgets. It does not matter. Republican, democrat, socialist or conservative. There will not be enough money to fund the promises of America’s political establishment.

The Bottom Line

As I have pointed out in other essays, oil product consumption is relatively inelastic. Increases in price do not have a direct correlation to consumption. At $74 per barrel, the price of oil has a marginal effect on demand. Most lower income Americans can still afford a mobile lifestyle.

Oil at a sustained price of $99 per barrel (in 2010 dollars), however, appears to be a pivotal point in the balance of demand versus price. And as the price of oil rises through $149 per barrel (again- in 2010 dollars), a growing segment of the consumer population will not have enough money to pay for all the gasoline, diesel, propane, kerosene, heating oil and other oil products they would like to consume. Further, the use of oil based products for agriculture, manufacturing, and transportation gradually becomes prohibitive. Crop yields per acre will decline, goods will become more expensive, and transportation costs will soar (especially for airline travel).

Think higher rates of inflation.

As the price of motor fuels and household heat go up, expect a growing dissatisfaction, frustration and anger with Federal and State politicians who have failed to develop an adequate response to the fuels and mobility needs of lower income households. And the old political solutions may not work. America can not afford the cost of a meaningful personal transportation subsidy, nor can it pay enough welfare to compensate for the dramatic effect of higher oil prices.

The Law of Unequal Distribution shows us that households with a disposable income of less than $50,000 (~ 49% of American households) will be forced to make serious adjustments to their spending on personal transportation and household heat in order to balance the budget.

But there is a thin line between having enough cash to buy fuel, and not having enough money to survive from one paycheck to the next. The official rate of inflation masks the real world costs of current consumption because for the last three years they have been lumped with declining asset values to calculate the total rate of inflation. It gets worse. Since existing government policy favors increasing the cost of coal, oil, natural gas, nuclear energy, hydropower, and green energy, there is no upper limit to the inflationary impact of these policies.

How soon will fuel prices become a serious political issue? When does constant exposure to frigid temperatures lead to illness? Frustration? Anger? Where is the breakpoint of rebellion? Which political theology will be the most appealing? Which political system is most likely to provide a practical solution?

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 Wal-Mart or pay the rent? It's going to be rough.

The folks are not happy.

Ronald R. Cooke

The Cultural Economist

Notes

Note 1: Identifying the number of households is a bit tricky. U. S. Census American Fact Finder data 2005 – 2009 enumerates 112,611,029 households, but indicates the actual number of households can be found in the population survey. The U. S. Census 2009 population data estimates there are almost 130 million housing units, but not all units are occupied. The USDA estimates over 118 million households. I calculated my estimate of 116,500,000 by analyzing the contraction of households caused by unemployment and underemployment. The kids are moving back in with Mom and Dad. Multiple persons are sharing a single household.

Note 2: Please note. We are only counting households that have at least one vehicle for personal use, or personal and commercial use (as one would expect of real estate agents, trades people, and so on). In addition, we need to remember most households currently have more than one vehicle.

Note 3: For this analysis, light vehicles are defined as household passenger cars, SUVs, passenger vans, and pickup trucks with 2 axels and 4 tires that can be used for passenger transportation. Excludes commercial vehicles. Many vehicle estimates are poorly defined and may include motor cycles, motor homes and/or freight trucks. As a result, one can find higher numbers of vehicles in other estimates.

Oil Price Inflation: The Data Problem

Analyzing consumer spending on oil based energy products (as distinguished from common household energy products such as electricity, natural gas, coal and wood) has been a challenge. For example: most homes use more than one fuel for cooking, laundry, heat and hot water. Although surveys have been taken in an attempt to separate fuel use by volume, they tend to limited in scope, and are more likely to reflect the consumer’s opinion than actual fact. There is a conspicuous inconsistency of data definitions among the surveys and tabulations of consumer data. What, for example, is a light vehicle? Does that include motorcycles and Scooters? Golf carts? And how does one differentiate between personal versus commercial vehicles? And how do we count personal vehicles that are also used for commercial purposes?

Increased oil prices will have 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 (excluding military and transportation services), and utility enterprises will experience modest 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.

Based on these challenges, it has been necessary to estimate certain data points. Although they appear to be reasonable, there can be no assurance as to their accuracy. All dollar estimates are in 2011 dollars, and exclude the effect of other forms of inflation.

Oil Price Inflation: Sources

The data for this essay has been researched from the U.S. Department of Labor, Bureau of Labor Statistics; U. S. Department of Commerce, Census Bureau, U. S. Department of Transportation, Federal Highway Administration; U. S. Library of Congress; U. S. Department of Agriculture; and various private institutions.

Who Do We Blame for America’s Financial Mess?

2011-09-24T20:36:00.000-07:00

First published 10/26/10
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 a two Administrations and a negligent Congress, complicit Banks ignored their responsibility to monitor the credit worthiness of mortgage applicants. Wall Street then sliced and diced these 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 has been promoted as “investment”. Our banking system, which only works if there is an environment of trust and institutional integrity, must now deal with consumers who have an overwhelming 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.

A Massive Failure Of Federal Governance.

The Bush Administration
At first blush, it would appear the Bush Administration was locked in a state of bureaucratic stupor. This situation had 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 just what were America’s Federal agencies supposed to be doing?   Well.   Here is what they claim they should be doing….

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.”

Now then. Let us review the above statements of responsibility. Did these agencies do their job?   Can we trust their judgment going forward?

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.”

Let us review the above statements of responsibility. Do you believe Congress did 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? Or do you chose to believe certain members of Congress were instrumental in the creation of the housing bubble, the collapse of the financial markets, and the mortgage mess that led America into this recession?

The Real Story

Blame
The Democrats will obviously blame the Bush administration for everything that has gone wrong. They conveniently ignore the fact that Liberal Democrats were in charge of Congress while this mess was collecting in America’s financial toilet. The Republicans, bless their hearts, 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 continue to increase 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 this what we want?

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 too confused to be an effective legislative counterparty. House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid continue to be models of vitriolic ideology. Don’t expect them to pursue a course of constructive leadership. And what about Senate Banking Committee Chairman Chris Dodd (D-CT)? Or Chairman of the House Financial Services Committee, Barney Frank (D-MA)? Did they play a key role in creating this mess in the first place? Nancy Pelosi claims "we haven't really gotten the credit for what we have done.” She’s right. These people have demolished America’s economy. We should give them full credit for America’s financial mess.

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. Blame Barney Frank. Blame Chris Dodd. Blame Nancy Pelosi. Blame Barack Obama. Blame the vapid Republican response. But when you go to the polls, remember who is at fault.

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.

Ronald R. Cooke
The Cultural Economist

.

Barney Frank has a plan.

2011-09-23T10:48:00.001-07:00

Barney Frank wants to insert absolute political control over the Federal Reserve by cutting out its regional presidents and replacing their votes with political appointees. With this change in place, politicians can manipulate America’s Federal Reserve whenever it is politically expedient to do so. The temptation will be to devalue the dollar to increase inflation, reduce the value of America’s debt, and temporarily pump up the economy. This tactic will be especially useful to the party in power whenever they want to look good just before election day.

Our political establishment could care less what impact this would have on the American people or the world economy. Anything goes, it seems, to get re-elected.

TCE

About Water and Food

2011-08-29T10:09:00.000-07:00

Read the following two short essays. Then ask yourself two questions.

What impact does this reality have on the Cultural Ecosystem of our planet’s human population?
What should we do?

Water
According to the United Nations, the quality of our global fresh water is declining. A serious gap is beginning to appear between the water demands of a growing population and available supplies. The two regions that are already experiencing the most serious absolute and seasonal water shortages are – unfortunately – two of the geographic areas where population is growing much too fast.

The population of Africa (excluding North Africa) is growing at an average of 2.2 percent per year. A University of Cape Town study predicted decreased rainfall will lead to reduced river flow and lower lake levels. Serious water shortages will occur before 2100. That means trouble for a growing population.

In the Middle East and North Africa (MENA), population growth currently exceeds 3 percent per year. Home to approximately 6.4 percent of the world’s population, MENA has less than 1.5 percent of the world’s fresh water. More cultural trouble.

     Population Action International (PAI) makes projections of national per capita water availability, and forecasts water shortages by 2025. By then, more than 2.8 billion people will live in 48 countries facing water stress or water scarcity. Of these countries, 40 are in the Near East, North Africa or sub-Saharan Africa.

     Problems of water quality and availability are evident all over our planet. About 70 percent of our planet’s fresh water supplies are used for irrigation. Depletion means less food. Over 20 cities in India are currently experiencing chronic water shortages and water quality is a national problem. China, which has 22% of the world's population but only 7% of all freshwater, is drawing down on its available water resources faster than they can be re-supplied by nature. Ground water depletion is a problem in Europe and the United States where over-use and contamination has reduced the geographic area of arable land, and threatens the quality of drinking water supplies. Both the South Eastern and South Western states of America are experiencing sporadic drought conditions. We are using the water from our aquifers faster than they are being re-supplied by rainfall. A large area from Iran to Kazakhstan, the North Eastern portions of South America, and the entire continent of Australia (despite excessive regional rainfall in 2010) are vulnerable to severe drought.

     If the IPCC is right, we will be challenged by worldwide water problems. By mid-century, annual average river runoff and water availability are projected to increase by 10-40% at high latitudes and in some wet tropical areas, and to decrease by 10-30% over some dry regions at mid-latitudes and in the dry tropics. Some of these areas are already stressed for lack of water. Up to 40 percent of the world’s population relies on snow melt for fresh water and agricultural irrigation. The availability and reliability of these snow falls is questionable. There will be increased algal blooms in both fresh water and sea water resources. Look for a continuing contamination of our water supplies from the use of chemicals, poor control of human waste, and the salinization of irrigation water, estuaries and freshwater systems. Higher sea levels will lead to salt water intrusion that decreases our fresh water resources and reduces the essential elements of our sea life food chain. The existing competition for over-allocated water resources will intensify and lead to regional conflict.

     Should we add water resource depletion to our list of challenges that promise to pressure our cultural and economic future? How will desertification and rising levels of salt compounds affect our production of food? What is the potential threat from waste and chemical contaminants to our drinking water supplies?

     Chronic shortages of fresh water increase the risk of disease, reduce food production, stifle economic development, and create the basis for ugly regional conflict.

Food
     Future food production will be constrained by global climate change, as well as the loss of arable land, declining water quality, and fossil fuel resource depletion.

     One of the most immediate results is an increase in malnutrition and hunger. Famines occurred throughout the 20th century: The Allied blockade of Germany from 1915 – 1918; Armenia 1915 – 1917; The Soviet Famine of 1932 – 1934; Poland 1940 – 1942; Leningrad 1941 to 1944; India 1943 – 1944; China 1928, 1942, 1958 - 1962; Biafra in the late 1960s; Cambodia in the 1970s; and more recently the famines in North Korea, Sub-Saharan Africa, South Asia and parts of Latin America. Pockets of starvation and malnutrition happened all over the globe. Two thirds of the nations in Africa face chronic malnutrition (less than 2300 calories per day), and at least 40 percent will experience increasing shortages of food. (UNDP).

     We can blame these problems on crop failure, drought, and pestilence. But many were either created or exacerbated by man. Hatred, war, genocide, lousy economic policy. Hunger has been politicized and globalized. Famine is invariably attended by disease, malnutrition, poverty, inflated food prices, declining education, disrupted medical systems, social disintegration, and – bloody senseless conflict. Most of the dead are little children and old people. More men than women. Millions suffer from severe malnutrition – the bride of crippling disease. And things are getting worse. We humans are destroying our arable land. By the end of the 2oth century, the basic infrastructure of food production was breaking down in many parts of the world. In Brazil, for example, the replacement of small farms with vast seas of industrialized sugarcane monoculture has led to a decrease in biodiversity, the conversion of more forests to farmland, increased food prices, and rising social problems from vandalism, unemployment, political unrest and violence. Food production has declined at many subsistence farms in Africa, Asia, Mexico, and elsewhere. Although the demand for corn promises to increase the income of poor farmers in Mexico, they will have to chose between planting crops for food to feed their family, or crops for fuel that bring in cash.

     A study of third world cultural economics suggests millions of Third world farmers face increased deprivation. If impoverished farmers are forced to raise fuel crops because they increase the wealth of those in power, the farmers will starve because they did not grow enough food. Sadly. The prerequisite pattern of oppression has already been established in Third World countries. Farmers are finding they can not afford the cost of inorganic fertilizers, herbicides and pesticides which are manufactured from increasingly expensive oil and natural gas. So they plant the land without them until it is exhausted.   Useless.

     From the 1960s through 2007, food production actually increased faster than population. Optimists believe this increase can go on forever. What they forget, however, is that past rates of food production (the Green Revolution) have been achieved by applying ever larger increments of fertilizers, herbicides, insecticides and irrigation to impoverished farm land. Year after year. But chemical soil amendments are made from fossil fuel resources – natural gas, oil, and coal. As the availability and cost of these resources became more restrictive, agricultural use declined. Oil depletion will also increase the cost of food production, processing, and distribution because gasoline and diesel fuel are made from increasingly expensive oil. And finally, thanks to thoughtless agricultural land destruction and global warming, over a billion people will be living in areas where there is a critical insufficiency of cultivated land by 2040. (IPCC)

     “Just when we need more soil to feed the 10 billion people of the future, we’ll actually have less—only a quarter of an acre of cropland per person in 2050, versus the half-acre we use today on the most efficient farms.” David Montgomery, author of the 2007 book Dirt: The Erosion of Civilizations

     These facts must lead us to the conclusion that food will become less available and more expensive as we move though the 21st century. Increased yields in higher latitudes will be offset by decreased yields in warmer regions because of drought. Increased temperatures have already encouraged expanded migration and rising numbers of plant pests. Look for increased plant disease, and the loss of arable land from soil erosion, salinization, and desertification. And finally, as frequently reported in the media, most of the world’s fisheries are already either fully exploited or are in decline.

      Global fossil fuel resource depletion, climate change, urbanization, desertification, and limits to irrigation place an upside limit on food production, creating lifestyle challenges for people in every nation.

The Answers
     And so. What are the answers to the two questions posed at the beginning of this essay?

What impact does this reality have on the Cultural Ecosystem of our planet’s human population? Will we humans consume our planet’s resources until they are either (for all practical purposes) depleted, unusable, or unaffordable? As accessible resources decline, so will our human population.
What should we do? We could try population management. Reducing our human population would create a more sustainable EchoSystem. But we all know that will not happen.

So this is our fate. Archeologists tell us there have been many civilizations that have flourished and then disappeared. It is a natural process.

      TCE

     Definition: “Accessible” resources are those reserves of minerals, water and land that can actually be found, produced, transported, refined, distributed and used without material disruption at a price the consumer can afford to pay.
   UNDP United Nations Development Program

What is Cultural Economics?

2011-08-27T19:50:00.000-07:00

It Is ...

The study of how human culture interacts with economic events and conditions. Culture, in this sense, includes everything we are: our political systems, religious beliefs, ethnic character, mores, traditions, history, customs, arts, sciences, and education. These all play a role in how we chose to organize the production of goods and services, the values we place on labor and opportunity, how we make purchase and investment decisions, and how we utilize the resources of this earth. The term "Economics" refers to the extent and process of how we employ capital, labor and materials. In the aggregate, these drive the data that is used to measure how our economy is behaving - markets, raw materials, production, finished goods, revenues, costs, profits, inventory, employment, housing, income, savings, stocks, bonds - and so on.

Why is Cultural Economics Important?

Cultural Economists must have a strong sense of the cultural matrix within which economic phenomena occur. However irrational they may appear, values and traditions are non-the-less relevant to economic analysis. Political and religious allegiance influence purchase decisions. Fear and greed are economic motivators. Attitudes about education, individual rights, the accumulation of wealth and the importance of private property drive the adoption of economic systems and political institutions. Collectivist, dictatorial and democratic solutions compete for political power that will determine how labor, capital and material resources are allocated and managed. Culture defines the collective manifestations of who and what we are, including our religious beliefs, political systems, customs, values, intellectual acumen and creative endeavors.

It should be obvious. If we want to make long range economic forecasts, we must understand how culture and cultural change will shape future economic choice.

What sets Cultural Economics apart
from other methodologies of economic analysis?

Economic research frequently yields inadequate conclusions based on irrelevant or obsolete data that has been interpreted using algorithms of questionable relevance. In other words - we play with the numbers. It's a great academic exercise. Then we project our conclusions into the future on the basic assumption that future reality will be an extension of past reality.

Sometimes it actually works. We can usually make reasonable estimates of near term demand and consumption, Gross Domestic Product (GDP), inflation, employment and so on. We have a reasonable probability of success if we are making a specific forecast for event driven data that will occur within the next three to six months. It helps our accuracy if future events within the forecast period are well understood and relatively static. In other words – our economic environment will not be altered by any surprises such as weather disasters or unanticipated political events.

Unfortunately, the longer the forecast period, the higher the margin of error. Cultural change is a given. Our economic environment is always evolving in reaction to current events. If we only use historical data as the basis of our economic analysis, then forecasts that extend out beyond a year or two will be something of a crap shoot.

Why? Because the future is NEVER an exact duplicate of the past. The technology boom of the 1990s was a one time series of specific events that will never be repeated. It is therefore useless to extrapolate the economic data of that period in making forecasts of future events. When the boom went bust, all of our economic data got reshuffled. Sure. We will have other periods of boom - and bust - but they will be propelled by a different set of circumstances. Data from periods like the Great Depression and the 1990s can be used as a point of comparison, an illustration of what might happen, but not a blueprint of future events.

For example. Various economists have made estimates of how the price of oil impacts GDP, inflation and employment. These forecasts have usually been based on an analysis of historical data and events. They generally conclude that oil consumption only constitutes about four percent of domestic consumption and therefore even radical changes to the price of oil will only have a marginal impact on the economy. The numbers are correct.

But the forecast is not.

Why? Three reasons.

Past oil demand occurred in a world where there was excess capacity. Although temporary supply restrictions drove up the price of oil in the early 1970s and 1980s, the supply of oil eventually recovered to a point where there was more than enough oil to satisfy consumer demand. The price of oil then declined. Our cumulative thirst for oil continued to increase. As we look ahead, however, the combined impact of cultural change and declining oil reserves will bring about a continuing decrease in available supply versus a continuing increase in demand. Islamic Jihad, for example, promises to have a negative impact on oil exploration, production and transportation. On the other hand, China and India are scrambling to secure as much oil as they can to satisfy the needs of their growing economies. Since actual consumption will be restricted by available supply, the economic disruption will far exceed a mere change in price. At first, supply disruptions will cause intense shifts in the world’s economy. Oil shortages will drive recession and inflation. Subsequent reductions in economic activity will reduce the demand for oil. When demand falls below available production, excess capacity becomes available and oil is no longer a barrier to economic growth. As economic activity recovers, the demand for oil will again increase until consumption equals production. The cycle will then be repeated. Good times beget bad times beget a resumption of good times. However, as described in “The Report on Oil Depletion”, the cumulative impact of declining reserves and escalating cultural conflict will push the world’s economy into a long term decline.
Generally speaking, relatively short term oil shortages and price increases do not have much of an impact on long term consumer behavior. Despite what happened in the 1970s and 1980s, we Americans continue to favor energy intensive life styles and emerging industrialized powers such as China need a lot more oil in order to continue their economic growth. These life style and economic choices are structural in nature. That means they are embedded in the economic outlook of our respective cultures. The net result? Even though higher prices and widespread oil shortages will unquestionably force a transformation of national cultures, cultural change usually takes a long time to evolve. During the interim, oil depletion will have a long term inflationary impact on the price of oil and a recessionary impact on the world’s economy.
The third reason has to do with the uneven impact of price on individual consumers. In 2002, the national average price per gallon for refined oil consumed was just over $1.50 per gallon. By 2008, it appears the average price for the refined oil we consume may exceed $3.00 per gallon. Since fuel shortages can be expected to increase the cost of transportation, warehousing and distribution, net discretionary income will decrease from 2002 to 2008. The greater percentage of this decrease will fall upon lower income groups. Given the patterns of oil product consumption by income group, and factoring in a three percent per annum increase in wages, if you made $25,000 in 2002, refined oil products absorbed over 8 percent of your income. By the end of 2008, refined oil products will cost you over 13 percent of your income. For someone making $100,000 a year, however, the direct and indirect cost of oil increases from a more affordable 2.35% of income in 2002 to 3.94% of annual income in 2008. There will be substantial shifts in the economy as consumers, particularly in lower income groups, scramble to reduce the cost of transportation. Consumers will demand vehicles that can deliver greater fuel efficiency, there will be political pressure to improve the public transportation infrastructure, and we will be forced to adopt less energy intensive life styles. Economic stress will drive a cultural transformation which – in turn – will drive additional economic change.

We must conclude that if we hope to forecast future reality with any accuracy, we must find a way to factor cultural change into our economic analysis. To meet the demands of this challenge, we need the disciplines of Cultural Economics.

What are the Disciplines of Cultural Economics?

Cultural Economics is not some dreary cross between tedious accounting and data necrophilia. It is a science that quantifies the past, present and future of human behavior. If human existence is dynamic, then economics – as a field of study – must be able to characterize the interaction of culture and economics in contemporaneous terms.

We start with an understanding of human nature and its expression through the institutions and corporations that characterize our existence on this planet. Every organization has a unique personality. The contemporary economic environment influences organizational behavior. Political and social constraints impact business decisions. And finally, we need to understand research, development, production, marketing, distribution and finance as a series of interrelated business processes.
To this we add the sociology and psychology of consumer behavior and the projected evolution of established religious and political institutions. Both will respond to economic, demographic and social trends.
We then add information resources that quantify and describe our economic environment - population, employment, inflation, GDP, production, consumption, finance, commodities, trade, property, geography, and so on.

Research is a process of discovery. Raw information is accumulated and assembled into a series of related data structures that describe economic events, trends and environments. We are not looking for random pieces of information. Every piece of data that we chose to save must relate to the essential issues and questions of our inquiry. Research provides information. Analysis is a process of creation. Starting with validated data structures, we assemble a hypothesis of future reality. Our hypothesis can then tested for logical consistency and intellectual credibility. Analysis yields understanding.

In order to make sense of our economic environment and to forecast future reality, we need to know how to focus our attention on a specific issue. For example, the key issue in our study of oil production and consumption was not - How much oil is left? Or when will we run out of oil? It soon became apparent that the real issue was - How much oil can we (humans) produce? That shifts the burden of research from geology to questions that describe how we find, produce, transport, refine and distribute the products derived from oil. Along the way we need to consider where the remaining oil is located. That leads to questions like: Who actually owns the oil that is left? Under what conditions will they be willing to let us find, extract and transport the remaining oil? Can we find oil elsewhere? What are the production constraints of alternative energy resources? And so on.

All of our questions should be relevant to the key issues we have identified. In doing the research for “The Report on Oil Depletion”, it was unnecessary (however interesting the topic) to become an expert on Islam. It was enough to establish if Islamic Jihad has the resources, intensity, and endurance to disrupt oil production. The next step was to establish a probable timetable and a realistic disruption scenario.

Our Cultural Economics Forecast starts with an examination of industry trends. We must understand existing and projected oil exploration and production by geographic region; the application of technology to enhance the discovery, extraction, refining and distribution of petroleum resources; competition and accommodation among the national governments that actually own most of the oil on this planet; how standards and bureaucratic duplicity impact the veracity of industry data; the role of cultural conflict as a barrier to exploration and production; and how political agendas, government regulation, and environmental challenges impact world oil supplies.

We then build a profile of current and projected consumer demand by examining petroleum market trends, consumer wants and needs, historical and projected demand data, consumer demographics, and purchase criteria. This profile of consumer demand is matched by a corresponding synopsis of suppliers that includes a characterization of their exploration and production capability, market presence, financial strength, strategy, use of technology and business practices.

Assuming we have done a good job of identifying the key issues and developing a relevant set of questions, we can now plunge into a period of intensive primary and secondary research. We methodically collect the data and collateral information needed to answer our questions. Along the way, we will undoubtedly develop additional questions that scream for an answer because they are critical to our analysis and forecast.

After we collect, organize, calibrate, qualify, verify and synthesize a mountain of data that will (hopefully) permit us to accurately describe the contemporary economic environment and to lay down a credible forecast of future trends, we can proceed with our analysis and interpretation. Our oil production and consumption forecast, and the data upon which it is based, can then be substantiated by treating it as a hypothesis. In order for the hypothesis to be true, it must have intellectual consistency and the individual data elements should be verifiable through further research. If our hypothesis survives this rigorous examination, we have a credible forecast of future reality.

Our final step is to document our conclusions and forecasts in a comprehensive report that not only profiles the impact of resource depletion on oil production and consumption, it can also be used as a basis for projecting the effect of depletion on our economy.

So there you have it.

The market or industry research used in Cultural Economics is a process that involves a number of interrelated steps. Research reports are based on facts and opinions which have been compiled, organized, analyzed and interpreted by someone who understands the research process. Cultural Economics is not about static absolutes. It’s about people. Events. Products. Issues. Questions. Change. And their interrelationship.

Why is Economics called "The Dismal Science"?

Economics has been called "The Dismal Science". That phrase was coined in 1849 by Thomas Carlyle in an essay "An Occasional discourse on the Negro Question.". The essay attacked John Stuart Mill for supporting the emancipation of slaves. Mill, along with many other Economists of that era, assumed that people were basically all the same, and thus all entitled to liberty. The paragraph reads: " Truly, my philanthropic friends, Exeter Hall Philanthropy is wonderful; and the Social Science—not a "gay science," but a rueful—which finds the secret of this universe in "supply-and-demand," and reduces the duty of human governors to that of letting men alone, is also wonderful. Not a "gay science," I should say, like some we have heard of; no, a dreary, desolate, and indeed quite abject and distressing one; what we might call, by way of eminence, the dismal science." There are those who believe that Carlyle's label was also, in part, motivated by Mill's support of T. R. Malthus's gloomy prediction that population would always grow faster than food, dooming mankind to unending poverty and hardship.

If my work had been confined to the mind numbing analysis of extinct events described by copious quantities of dubious numerical data; if economics were merely an exercise in abstract analysis based entirely on theory; then my interest would have withered long ago. But I quickly learned that neither number crunching nor theory can predict real world events with consistent accuracy. Because it is people – in their infinite diversity - who interact with economic events and conditions. That undeniable truth makes Cultural Economics a challenging, interesting, and provocative field of study.

Does The Price Of Oil Drive The Rate Of Inflation?

2011-06-03T08:31:00.000-07:00

A dramatic increase in the price of oil can lead to higher rates of inflation, as it did in the periods 1973/74 and 1979/80 (both due to conflict in the Middle East). It would appear, however, that a comparison of the annual rate of inflation (a percentage) with the annual rate of change in the world price of oil (also a percentage) produces a more reliable correlation. The rate at which the price of oil changes apparently has a greater effect on short term inflation than the absolute price of oil. Research suggests it takes several months for higher oil prices to translate into a long term increase in consumer prices.

If we generate a chart that shows the annual percentage rate of change for the price of oil, versus the annual rate of inflation for the period 1970 through 2011, we can see – by inspection – there is a reasonably strong correlation between changes in the price of oil and concurrent or subsequent rates of inflation. We have to remember, however, the rate of inflation has been influenced by many other economic factors: the level of current economic activity, the virtual collapse of the mortgage backed security market in 2008, the subsequent sharp deflation of home values, speculation in the commodity markets, interest rates, changes in productivity, and so on. None-the-less, history suggests a correlation exists between a rapid change in the price of oil and the rate of inflation.

In doing the research for my book on oil depletion "Oil, Jihad and Destiny", 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 optimistic assumptions about the rate at which we increase the efficiency of oil consumption, the average price for products made from oil, or used in the production of an oil dependent product or service, are trending upward.

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 its policy of easy money has sown the seeds of increased inflation. In addition, there is the acknowledged challenge of America's overwhelming burden of public and private debt, as well as the cost of sustaining a presence in the Middle East, Social security, and Medicare. The Fed is very much aware 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.

Based on an average annual price of $99 per barrel( Note 1), my model projects that the year-over-year change in the consumer price index (CPI-U) for 2011 will be a modest 3.7% because deflationary pressures are also working their way through our economy. Low interest rates, high rates of underemployment, abysmal economic growth, and America's 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 $99 per barrel, however, the rate of inflation will be higher and the Fed will be forced to accelerate its pace of interest rate increases.

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.

Ronald R. Cooke

The Cultural Economist

Note 1: Futures prices Cushing Oklahoma; in dollars per barrel.

How are American workers supposed to compete?

2011-05-26T10:56:00.000-07:00

America has been decimating its manufacturing base since the 1970s by shipping a steady stream of jobs to foreign nations. In the 1990s, America began to ship its corporate support, marketing, engineering and software jobs to foreign nations in volume. Neither Congress nor any Administration has ever made any genuine attempt to deal with these trends.

The resulting effect has included a sharp reduction in the availability of corporate middle class jobs. Without a robust middle class, America has come dangerously close to losing its ability to create new physical product wealth. This kind of wealth creation is being done in other nations, by foreign multinational corporations, who will eventually decide they do not need American partners. They only need American subsidiaries that employ low wage workers.

And then there is Barack Obama. He promised “Change”.

But thus far, America is not seeing the economic policy “change” it really needs to restore a robust economy. We are, in fact, moving in the opposite direction at a terrifying speed. And if one complains about the loss of jobs, there is an instant cry of protest. No politically correct politician will utter these words: “American jobs are for Americans”.

American middle income labor will not be competitive with foreign labor until after the decimation of America’s economy, the collapse of its welfare system, high rates of unemployment and underemployment have forced desperate workers to take any job that will feed them, and there is an ascendency of a more affluent middle class in competitive foreign nations.

By default, failure is the economic policy of the American political establishment. The first three items in the preceding paragraph are in place... they are happening. The development of a higher paid foreign middle class, if it happens in sufficient strength to balance international middle income labor costs, may take awhile - or it may never happen.

America is competing with foreign nations that have robust mercantile economic policies. Neither our Administration, nor Congress, has evidenced any substantial interest in creating off-setting policies to defend America’s economic interests. Without them, there is no hope for America’s middle class.

If you are not an American, and this short essay disturbs you, I should point out that North America (the USA and Canada) is the largest cohesive and relatively open marketing opportunity available to any non-American corporation. But. America will only be an attractive marketing opportunity so long as Americans and Canadians have sufficient income to purchase goods manufactured elsewhere.

Just remember: A prosperous America is an attractive trading partner.

Inflation: A Parade of Zombies

2011-05-15T20:08:00.000-07:00

Let’s see if I get this straight. The United States Federal Reserve tells us that the rate of inflation is too low. The “Core” CPI (which excludes food and fuel) is up only 1.3% over the last year. The BLS tells us food and fuel only make up about 20% of consumer expenditures, and it is routinely claimed they are too volatile to use as a “reliable” measure of inflation. Consequently, food and fuel are excluded from calculating the “Core” CPI.

Media zombies parrot whatever the Fed tell us. Over and over again. It gets repeated so often, it becomes fact. Even Fox News tells us there is no inflation.

Well .... what they say is true. Food and fuel are not all that important an indicator of inflation .... if you are lucky enough to be making over $100 grand a year.

The rest of us are screwed.

If there is no inflation, then can anyone please explain to us why the price of gasoline has gone up 30% in one year, and 42% over the last 5 years? Can anyone explain to us... if there is no inflation, then why has the price of food gone up 9% in one year, and 28% over the last 5 years? (Note 1) And lets see. The price of gasoline has gone up 30% in one year, and the price of food has gone up 9% in one year. BUT... per capita personal income has declined .1% over the last year. (Note 2)

So tell us again: why isn’t eating and gasoline and staying warm important?

I’ve graphed this data so we can see it in living color. See those two little bars on the right? That’s how much American personal income changed. The bars to the left show how much the price of gasoline and food went up. Over the last 12 months, income went down, prices went up – big time. Over the last five years, gasoline went up over 11 times faster than per capita personal income, and food went up over 7 times faster than per capita personal income.

Things were relatively OK from 1990 through 2004. Then inflationary trends began to ramp up. As shown in the following graph, the US Federal Reserve Broad Dollar Index began to decline. We paid more dollars for almost everything we purchased. American food prices began to accelerate. World oil prices also went up, mostly due to speculation. But there is another factor in higher oil prices. Nations that sell oil try to maintain the monetary value of a barrel of oil. So. If the value of the dollar goes down, they want more dollars per barrel.

And they can get it.

Higher oil prices also help to increase the price of food. It costs farmers more to plow, plant, cultivate, harvest, store, and transport the food they grow. Crop care and treatment costs go up. Soil amendment costs go up. Food processing and retail distribution costs go up. Food costs also went up because some sugar crops (up 73% over 5 years) and certain cereal grains (up 92% over 5 years) were diverted to make ethanol. That means not only do we pay more for gasoline laced with ethanol, we also pay far more for the sugars and grains that are consumed to make ethanol. These costs increase the price of food.

According to the United Nations Food and Agriculture Organization, world food harvests have been inadequate. Food stocks are marginal. We are one bad harvest from real trouble. If that happens, food prices will escalate further. More inflation. In some nations, nutrition is down: famine is up. Low income people can not afford to eat. Famine often breeds bloody conflict.

What happens next?

Of course the rate of inflation is volatile, and it will decline for a period of time. But if we make an honest assessment of projected food and oil production, versus projected demand, prices are headed higher. The gap between personal income and the price we pay for almost everything we buy will increase.

Count on it.

For now, Obama isn’t worried about inflation. Congress isn’t overly worried about inflation. The Federal bureaucracy doesn’t care about the rate of inflation (not their job). And the Federal Reserve actually thinks the rate of inflation is too low.

So.... Fix your eyes straight ahead, stare vacantly at the wall... and repeat after me....

There isn’t any inflation.

TCE

Note 1: Data from the Bureau of Labor Statistics, Department of Labor; The Bureau Of Economic Analysis, US Department of Commerce; the US Federal Reserve Price-adjusted Broad Dollar Index; and the United Nations Food and Agriculture Organization.

Note 2: Per capita personal income calculated from BEA data. Inflation calculated from BLS data. It could be argued that the gain in average personal income – adjusted for inflation, underemployment, and declining employment opportunities – is actually negative over the last 5 years.

I received this E-Mail today.

2011-05-05T09:21:00.000-07:00

The author wrote:

It's practically miraculous that the 435 members of the House and the 100 members of the Senate along with whatever President we have at the time agree on any alternative for the federal government to do anything different tomorrow than the way it's done today.

I responded:

America needs good management and effective leadership, backed by the authority to act, a strong sense of responsibility, and a passionate belief in the mission.

If Washington can’t get the job done, then it’s over. Just a matter of time.

The Energy Policy Act of 2005

2011-04-21T19:38:00.000-07:00

Legislative Achievement or Management Fiasco?

Author’s note: I wrote this essay after publication of the Energy Policy Act of 2005. Please read the entire essay, and then ask yourself --- what progress have we made? Are we any closer to solving our energy challenges?

The Passionate E-Mail.

I received an impassioned E-Mail chain letter last week. The author asked everyone on the list to boycott ExxonMobil because the price of gasoline is too high. My response? The price of oil is set by a complex interaction between producer nations and the commodity markets. The current price increases have been caused by the very thin margin between world supply and demand, and a lack of refining capacity – particularly in the United States. Since gasoline, diesel, propane, and heating oil fuels are all made from oil, consumers can expect more price shocks in the future. The supply of oil and refining capacity will continue to be inadequate until new production comes on-line, or demand decreases. Although future oil prices promise to be very volatile, resource depletion guarantees the long term price trend is UP. As for "Big Oil", I agree these imperious corporations need to stop hiding behind the walls of their PR fortresses and "come clean" about profits and prices. But most troubling of all, they should tell us why (most of them) aren't finding enough oil to increase their reserves. They appear to be using higher and higher levels of technical sophistication to find smaller and smaller puddles of oil.

Although the boycott idea is naive, it reflects a genuine distrust of "Big Oil" and an unfortunate lack of knowledge about resource depletion. But the letter got me to thinking. It added "fuel" to my concern that the recently passed energy bill will fail to resolve America's energy challenges.

We need a better plan.

Program Management Vs. Political Power

Read the poorly written conference summary of the Energy Bill. Just passed by Congress and signed by a grateful President Bush, the Energy Policy Act of 2005 is a collection of fashionable technology decisions driven by political expediency, rather than the practical disciplines of sound program management. In more than 1700 pages of disjointed and profligate spending, Congress has found a politically beneficial way to funnel $14.5 billion to farmers, energy companies, and an assortment of pop-culture ideas.

The Energy Policy Act of 2005 is too fragmented to be useful. Lest someone be offended, all solutions have been considered equal. This legislation virtually guarantees that competing groups of energy solution advocates will continue to position themselves for additional taxpayer largess. There is no practical mechanism to focus our resources on the best technology. It would appear Congress has even discouraged objective scientific inquiry by hand picking the winners.

How was this achieved?

Although Congress has neither the qualifications nor requisite self discipline, it has put itself into the position of making program management decisions. As a result, preordained solutions have been selected without adequate critical evaluation or technological development. Many simply pander to pop culture idealism (the hydrogen car), entrenched special interests (ethanol from corn), corporate influence (shale oil development), or down home pork (coal). The ensuing energy programs will be dominated by entrenched special interests with big wallets or pop culture appeal.

Dare we ask? Is Congressional duplicity built into the energy bill?

This patchwork of legislative micromanagement and vague directives throws taxpayer money at multiple projects. Tax credits, loan guarantees, accelerated depreciation, and/or direct financing have been specified for multiple research projects including; ethanol, nuclear power, methane hydrates, clean coal and coal gasification projects, oil from oil shale, hydrogen production, fuel cell development, solid-state lighting devices, bioenergy from cellulose feedstocks, solar power, ocean energy, a zero-energy house, energy efficiency, and cogeneration of hydrogen and electricity from renewable sources. Worthwhile research has been intermixed with legislative pork in a tome of bewildering complexity.

Congressional hearings and political opportunism have thus produced a long list of energy projects and policy. Everyone is positive the results will be good. We have lots of promises.

But no credible management plan.

Despite lengthy hearings, years of bureaucratic confusion, and indeterminable political vacillation, Congress has failed to launch a disciplined and well organized program of energy research and development. For example, the energy bill establishes a program to encourage the purchase of stationary and vehicular hydrogen fuel cell systems, even though the technology is not ready for prime time. This timetable, which is good politics (but lousy science), ignores the realities of fuel cell development and hydrogen production, storage, distribution and consumption. Nevertheless, it sets a goal of enabling the private sector to make a fuel cell vehicle commercialization decision by 2015, and encourages the purchase hydrogen fuel cell products before then – perhaps on the assumption - technology will solve all problems.

Somehow. Maybe.

The Energy Policy Act of 2005 lacks focus. The lines of authority and responsibility are too fragmented. Turf wars are inevitable. Solutions will be selected on the basis of political power and expediency, rather than the prudent management of technology. The bill failed to establish a comprehensive energy strategy, ignored the basic marketing questions, selected technology without regard to reality, glossed over the manufacturing challenges, ignored the related energy consumption issues, and simply assumed there are no distribution problems. But worst of all, the energy bill did not establish a cohesive management mechanism for cooperative energy research and development, production, distribution, and consumption.

Why not? Why didn't the Energy Policy Act of 2005 include a credible program management structure with the authority and funding needed to achieve the goals so important to our nation's economic health??

Can We Come Together On A Common Sense Plan?

The first step in addressing any problem is to understand it. We need a really good definition of the challenges that lie ahead – technical, social and economic. Thus we start with a thorough review of the energy market. We need a realistic forecast of America's energy requirements by fuel type by year for the next 20 years. Fuel types fall into two basic categories: fuels for mobile applications (cars, trucks, railroad engines, airplanes, etc.), and fuels for stationary applications (power plants, furnaces, generators, pumps, industrial motors, etc.). Then we need a forecast of fuel resources by type by year for the same 20 year period. The supply forecast must include a conservative estimate of resource depletion, potential political challenges, and international competition for available fuels. Our market plan should also examine future cost/price trends and their potential impact on our economy.

Where shortages appear in our forecast – and they will – we need to review alternative solutions. Again, there are two categories: energy efficiency and new resource development. Since energy efficiency improvements provide us with the quickest and cheapest solution, all avenues of improved energy efficiency must be defined and quantified. The remaining energy shortfall defines the annual fuel volume requirements of our resource development objectives.

Changes in energy consumption, no matter how they occur, will have an impact on our culture. It's inevitable. Employees will either have to live closer to where they work or telecommute. For many families, one stall of the suburban two car garage will be empty. Private vehicles will gradually be replaced by pubic transportation. Neighborhood relocalization will displace distant shopping malls for daily needs. Municipalities will have to encourage higher density zoning. These multiple changes all need to be explored before we can develop our strategic plan because they define the parameters of distribution and consumption.

Our energy solutions will come from existing and proposed technologies. Each one deserves careful consideration and evaluation. We need to understand the source, use and application of each technology, its ultimate development, manufacturing and distribution cost, the method of consumption, and its environmental impacts. Tradeoffs need to be made between competing and complimentary technologies. Selected technologies will be matched against a set of specific performance objectives, given adequate funding, and developed according to a timeline with managed milestones.

Energy is not just "Big Oil". In point of fact, most of our energy challenge lies with foreign governments, cultural conflict, multiple companies working the supply chain, technology, increased demand, insufficient attention to fuel efficiency, environmental constraints, NIMBY activism, weather, and geography. The point is, before we invest our money in the development of energy solutions, we need to understand the energy industry as a whole, including exploration, production, transportation, refining, distribution and consumption. Against this knowledge, we can select options that make common sense because they fall within existing industry attributes and the evolution of consumer demand.

If we do a good job, we now have a clear definition of the problem. We have characterized our challenge by fuel type, by application, and by development objectives. Available technologies have been identified. Government, corporate and academic resources have been evaluated. We have factored cultural change and economic impact into our strategy. We have given due consideration to ecology and energy efficiency. This report would then be communicated to the public in multiple media formats and forums. Public education is a vital component of our program.

By the way. Did Congress take these steps? No.

Why not?

The next step is to create a business plan to address the problem. Yes Virginia. If we are to make any sense of this highly complex effort, we need a real business plan with a statement of goals and objectives, a comprehensive strategy, and an organization.

The statement of goals and objectives establishes what we need to accomplish and a timeline for the completion of our strategy. It is highly likely that an honest job of market research will reveal we Americans must moderate our energy intensive lifestyle. We have to move from a carbon-based energy cycle to an energy resource that does less environmental damage. Energy moderation will mean cultural change on a scale we have never experienced. So although our goal will be to gradually reduce per capita petroleum consumption, it will have to be done in a way that sustains our economy and the transformation of our culture. The objectives we then postulate will address the means to achieve these basic goals.

It appears our strategy falls (roughly) into three phases: those changes and developments that can be done within 5 years (improved energy efficiency, introduction of hybrid vehicles, etc.), those changes and developments that can be done in 5 to 15 years (development and distribution of alternative fuels, diesel fuel from coal, the nuclear option, enhancements to public transportation, etc.) and those changes and developments that will take longer than 15 years (introduction of a new fuels technology, lifestyle changes, etc.).

A task of this magnitude requires the resources of a large organization. It must have the funding, structure, responsibility, and authority to carry out its mission. This organization must provide, or identify and contract, the technical, manufacturing, and distribution resources needed to ensure the success of America's energy program. It should make periodic reports to Congress on its progress.

There you are. Three key components of a successful business plan.

By the way. Again. Did Congress put these three elements into place? No.

We the people should ask. Why not?

It's Time to Re-mission NASA

We need a large organization that is familiar with the challenges of technology development to manage our energy program. Look around. Where can we get an established technology management resource that is large enough to handle this program? An outfit like Battelle Science and Technology International? Sure. The DOE (Department of Energy). Of course. The people at DOE certainly understand the challenge and management disciplines.

But this effort is far larger and more important than anything we have ever attempted. We need a dedicated technology development center. Management skills. Technological competence. A sense of mission. A sense of urgency. A program that is both comprehensive and cohesive. And we need a management team that can (hopefully) make science based choices. Minimize the politics or risk failure.

Here are a few of the program challenges this organization must manage:

Create an energy R&D program that recruits the best talent we have from academia and industry.
Establish and fund cooperative projects.
Establish an international research program to share development costs and technical knowledge.
Define planned products and their purpose by application, volume/time, and cost/price targets.
Select the best technologies against established criteria (such as Energy Returned On Energy Invested - EROEI).
Manage the resources needed to bring selected energy solutions to market, including research, development, manufacturing, and distribution.
Establish objectives and milestones for each project.
Establish and conduct phase reviews.
Manage project financing, including the source and use of funds.
Explore alternative project funding mechanisms such as R&D partnerships, cooperative ventures with industry, and cost sharing programs with other national governments.
Propose and initiate the necessary regulatory changes, including safeguards for intellectual property, methods of fuel distribution and handling, and environmental mitigation.
Foster communication, rather than competition, among alternative energy solutions.
Work with industry to be sure selected energy resources can be manufactured (or produced), distributed and consumed within an evolving supply chain.
Identify the required feedstock resources for manufactured products.
Provide quarterly reports to the American people on program progress.

Give our organization a name that articulates energy, a positive definition of program responsibility, and the authority to carry out its mission. We can make this work if we are united by our concern for the potential cultural, economic and ecological impacts of petroleum depletion. Prudent energy resource management must include conservation, improved efficiency, ecologically responsible energy production and consumption, and the development of alternative energy resources under the direction of a qualified product management team.

And by the way, America's energy program must be an international program.

Since no nation will be able to resolve its energy challenges without due consideration for the energy needs of other nations, we must encourage international cooperation in the development and production of our planet's energy resources.

In addition, we need to resolve both the technical and the political issues of sharing our planet's dwindling energy resources. Equitable sharing will be a long term challenge. But we have a choice - share or compete. From the perspective of cultural economics, a well crafted sharing arrangement will have the least recessive impact on international GDP, and consequently offers the best way to mitigate the inevitable cultural impact of energy resource depletion.

And finally. Petroleum depletion will inevitably force extensive cultural change. Of particular interest is the development of a constructive response within our state, municipal and county infrastructure, the implementation of a pragmatic federal agenda, and the formation of productive partnerships between private and public organizations.

Now where can we find an existing organization that has the skills to manage complex technology programs?

NASA

Think about this.

What is more important. Heat for your home? Or a mission to Mars?

Fuel for your car? Or counting the pixie dust floating around some planet?

There are some very bright people at NASA. Forget outer space. Think of our kids. Think of humanity. Re-mission NASA. Put these people to work on a comprehensive energy program. We need their intellectual energy. We need their program management skills. NASA can provide the focus we need for a successful energy program.

Sure. I know this idea is not politically expedient. Congress has a hard time setting priorities. And we sure as hell can not expect Congress to do something perfectly logical and fiscally responsible. But nevertheless, I firmly believe we should take the best minds we have in America (and on our planet) and put them to work on a REAL challenge with REAL benefits for all of us.

I mean – like – why not?

If we have to blow tax payer money on this organization,

shouldn't they be working on a challenge that benefits humanity?

Does this proposal make sense?

Dare we ask? Why didn't Congress create a credible program management organization? Is Congress incapable of restructuring the Federal bureaucracy? Are these agencies supposed to be managed as a public trust for the benefit of the American taxpayer? And where is the Bush administration? Out to lunch?

Conclusion.

The Energy Policy Act of 2005 is not about success. It's about failure. It's unlikely the new energy law will stabilize or lower fuel prices, give America any real energy security, provide an effective framework for energy independence, result in the use of cleaner energy resources, or create a net increase in American jobs. Unless we get really, really lucky, it will not solve the energy challenges facing America (and the rest of the world). In fact, the energy bill's greatest impact - in all probability - will be to exacerbate the economic and cultural chaos that threatens to turn our whole existence upside down.

We are a long way from having all of the answers to our energy challenges. There will be many ideas. Some good. Some not practical. But we must test them all against economic and technical criteria. We must select and implement the best available technology based on the adroit use of scientific investigation under the direction of competent program management.

But it will not happen. Congress has failed us - again. When they passed this bill, were our politicians concerned about protecting their own selfish-best-interests?

Although refinery capacity is a key downstream bottleneck to the production of gasoline, diesel fuel, propane and heating oil, Congress apparently believes it will not be politically expedient to take meaningful action until after fuel shortages occur.

Even though conservation and improved energy efficiency should have been a centerpiece of America's energy policy, Congress has sidestepped politically dangerous measures like vehicle fuel economy and energy prudent development.

Congress continues to make technology decisions based on political expediency rather than science based inquiry. One would think they should have learned their lesson after they used the Police Power of the State to force the use of MTBE as a gasoline additive – and poisoned our drinking water in the process.

Worst of all, Congress has failed to communicate the need for a comprehensive energy policy to the American people. The realities of resource depletion have been largely ignored. One can only wonder, is this because Congress doesn't understand the problem? Or because it wants to avoid the subject?

Only two champions of truth stand out in my research of the Congressional Record. Joseph P. Riva, Jr., a Specialist in Earth Sciences for the Library of Congress, did an excellent report on oil depletion "World Oil Production After Year 2000: Business As Usual or Crises?" in 1995. (For the numerically challenged, that's ten years ago). The other voice is Congressman Roscoe Bartlett, R- Maryland, who was allowed to speak before the House of Representatives on Peak Oil for one hour at 10 PM on March 14, 2005, and again for 10 minutes at 11:40 PM on April 20, 2005. (Late night presentations are allowed for subjects that Congress doesn't want to think about).

It is most regrettable. Sad. Congress could have done a better job. America is the one nation on this planet with the financial and technical resources to launch an international program of science based cooperative energy research, development, production, and distribution. We could have made substantial improvements to energy efficiency and conservation, cooperative petroleum sharing agreements among nations, and long term international supplier/consumer agreements. Everyone on our planet would be a beneficiary. Creative cooperation is far more likely to be productive than political confrontation. The challenge is to get the players to focus their collective power on solving the problem, - rather than fighting with each other.

What we got from Congress was political expediency, evasion, pandering and conflict.

What a shame.

Am I right? You decide. Take the challenge. Do your own homework. Then answer the following four questions:

Has Congress shown it comprehends the potential economic, lifestyle, and environmental chaos of the energy challenges that lie ahead?
Has Congress done an effective job of communicating our emerging energy challenges to the people of this country?
Did The Energy Policy Act of 2005 establish a credible foundation for managing the business of energy research, development, production, distribution, and consumption?
Has Congress demonstrated that science based program management is more important than political expediency?

And one more:

Do you believe the Energy Policy Act of 2005 will solve our energy problem?

Ronald R. Cooke

The Cultural Economist

The Perils of Forecasting

2011-04-14T10:49:00.000-07:00

I just came across an old energy market analysis by the U. S. Department of Energy, Energy Information Administration (EIA). Their Annual Energy Outlook published in 2003 projected that by 2010, the average annual price of oil would be $23.99 in 2010.

Wow! The actual number was closer to $80.00 per barrel.

This not only shows the pitfalls of forecasting the future, it also demonstrates the problems associated with simply predicting future values based on an extrapolation of past data. To its credit, the EIA has since broadened its forecasting methodology.

I gave up making specific predictions of oil prices, consumption and production in 2004. There are just to many variables, and much of the background data is either wrong or unavailable. Instead, we try to put together credible scenarios that make sense. Given the underlying assumptions, these provide a reasonably reliable indication of future trends.

Ron

Oil Depletion Economics 101

2011-01-14T19:58:00.003-08:00

The following article, first published in 2006, looks at the basic economic considerations that must be resolved when we try to analyze oil production, consumption and pricing, or the impact these factors will have on the economy.

Consumption and GDP
When we buy goods and services, we are engaged in an act that will lead to their consumption. We may use (consume) them immediately (as with goods such as gasoline or services such as haircuts, etc.), sometime in the future (as we typically do with canned food, clothing, etc.), or over a long period of time (refrigerators, automobiles, etc.). We use Gross Domestic Product (GDP) as a way of measuring the dollar value of everything an individual nation, a geographic region, or the world is able to produce within a given time frame (a month, a quarter or a year).

As one may suspect, there is a relationship between consumption and GDP. As consumption rises, there is an attendant increase in the demand for goods and services that results in greater production (and hence GDP). Conversely, when consumption declines, so does GDP.

Historically, there has also been a relationship between oil consumption and GDP. In the past, the increase or decrease in GDP (which measures the production of goods and services), tended to drive the demand and consumption of oil. The more goods and services we produced, the more oil we needed in order to produce our goods and services. We used more gasoline to move things and people, we used more oil for the generation of electricity, and we used more oil as a feedstock for the production of goods (plastics, chemicals, cosmetics, drugs, and so on). If on the other hand, the consumption of goods and services declined, then GDP and oil consumption also declined.

In developing an economic impact analysis for oil crisis scenarios, estimates of GDP are tied to estimated oil consumption and estimated oil pricing. In so doing, our formulae must account for the fact that the quantity of oil used per unit of GDP has been changing. While the mature economies of the world – like the United States - are becoming more efficient in their use of oil (using less per unit of GDP), emerging economies (such as China) have tended to use more oil per unit of GDP. We also need to include in our formulae the concept that sharp increases in the price of oil will force people to consume less oil (almost immediately because we cannot afford to pay a higher price) and sharp decreases in the price of oil will stimulate greater consumption (although this takes a longer time because lower consumption has usually been associated with recessive economic conditions that take time to improve).

There is another problem. In the past, GDP and oil consumption have tended to move in tandem (more or less - oil consumption tends to be more volatile than GDP). Changes in GDP drove changes in oil consumption. But as we move from a world economy that has enough oil to meet demand, to an economy that must deal with periodic oil shortages, then the reverse will be true.

Oil shortages (or availability), along with the price of oil,
will tend to drive the growth or decline of GDP.

In addition, the price of oil will rise until there is a balance between supply and demand. But this relationship will also be more complicated than it has been in the past. There is a high probability that future oil markets will be characterized by arbitrary oil prices (including the volatile effect of speculation). It will take longer for the supply versus demand mechanism to resolve any imbalances. In addition, oil consumption for transportation will evolve from an emphasis on individual vehicles (my car) to mass transportation (including ride sharing), moderating the normal impact that the supply versus demand mechanism would have on pricing.

In determining how changes in oil production (availability) will impact the price of oil, we must also consider whether or not changes in the price of oil are based on a willing buyer and a willing seller in a market that is free to move according to negotiated supply and demand pricing; we must factor in the impact of other inflationary forces; we must include the length of time that these changes take to occur; and we must determine the status of the economy at the time these price changes occur. And finally, the price of oil and GDP tend to have an inverse relationship.

Confused? Just remember.

We are moving from a world economy that enjoyed excess oil capacity
to a world economy dominated by chronic shortages.
The GDP of all nations will have a volatile response to these shortages.

Rate of Inflation
It's safe to say that increased oil prices will drive up the Rate of Inflation. Although the price of oil tends to be more volatile than the Rate of Inflation, there is a correlation. Rates will be highly volatile as periods of oil shortage alternate with months of surplus. If the price of oil were the only driver of inflation, then inflation would skyrocket. But there are other factors that must enter into our calculation of inflation. The combination of higher prices and sporadic shortages will drive an increase in unemployment, restrict consumption and disrupt both the production and distribution of goods and services. Productivity will decrease. Lower interest rates will only marginally help the economy because oil shortages will disrupt the flow and use of money in the economy. These impacts are all deflationary. Thus in our formulae for calculating Inflation, we must offset the inflationary impact of higher oil prices with the recessive impact that oil prices and shortages will have on the economy.

We also have to include the deflationary impact of unemployment on regional demand and GDP. Over the last two decades, over 60 percent of displaced white collar workers found new jobs that paid less than they were making before becoming unemployed1. For white or blue collar workers living in the highly developed economies of the industrialized world, a political or production crisis will exacerbate this problem. Lower pay means lower oil consumption and a declining GDP.

The Rate of Inflation is tied to the rate of change in the world price for oil as well as a calculation of unsatisfied oil demand. It works this way. The demand for a scarce commodity will drive up its price. As the price of oil goes up, changes in consumer spending choices gradually reduce real demand. This in turn reduces the upward price pressure on the commodity. As long as real demand (how much oil we would consume if it were readily available) exceeds actual consumption, the difference is called unsatisfied demand. All oil depletion scenarios reflect greater volatility in the Rate of Inflation because we are moving from a world economy that (usually) enjoyed excess oil capacity to a world economy dominated by chronic shortages. Once this trend has been established, unsatisfied demand and inflation will increase as consumers adjust to shortages by bidding up the price of oil based products.

Unemployment
Any oil crisis will drive up the rate of unemployment. Primary factors include: a decrease in consumption of goods and services, the disruption of transportation, and a fear driven decrease in capital spending (as we witnessed in the housing bust of 2007). In the Best Case scenario, oil shortages create a mildly recessive condition in the economy. A more likely production crisis drives us into a long period of chronic recession that alternates with intervals of mild economic recovery. A political crisis, such as war in the Middle East, threatens to plunge the world economy into a depression.

Future estimates of unemployment must include a consideration for persistent oil shortages and the resulting volatility of oil prices. The annual change in oil consumption is therefore a better guide to estimated unemployment than the price of oil. We can assume that in periods of restricted supply, nations will consume all the oil they can get up to the point where there is sufficient oil to sustain current economic activity. The level of economic activity will be directly proportional to available oil supplies. Oil consumption and unemployment, however, have an inverse relationship. As oil consumption increases, unemployment will decrease - and vice versa.

For example, if a nation has sufficient free cash flow, consumer demand, and non-oil resources to increase its GDP by 1.3 percent for a given year, then its oil consumption also needs to increase by 1.3 percent (ignoring the impact of changes in energy efficiency). If there is a surplus of available oil, then a growth rate of 1.3 percent is achievable. However, if there isn't enough available oil to permit the potential increase in consumption, then economic activity must grow at a slower rate. If the shortage is severe enough, economic activity will be forced to decrease.

I relied on an inspection of how unemployment has acted in previous recessions (and the depression of 1929) in order to make an educated guess of the projected rate of unemployment that will occur in an oil crisis.

Global Impact
Although my scenario models only deal with the economic impact of oil availability and price on the United States, these calculations could be duplicated for every nation on this planet.

Any oil crisis will have a global reach,
sparing no nation from its pain and hardship.
The industrial nations of North America, Europe and the Pacific Rim
will be hit the hardest
because they have the most energy intensive economies.

In making assessments of global oil consumption, we have to factor in the rapid economic growth of nations such as China and India, increasing demand in third world countries, recognize the interaction of regional economies (consumption in America creates jobs in China, and so on), and make some assumptions about the development of alternative forms of energy that will eventually reduce the demand for oil.

There is one other factor that we must consider when we make an estimate of how an oil crisis will impact global production and consumption.

People.
In making production assumptions, it can be assumed that as the price of oil increases, limited additional production will come on-line to satisfy demand. Thus, if Middle Eastern producers restrict production, the resulting shortages will drive up the price of oil and this in turn will stimulate additional production in the Pacific Rim, North America, EurAsia, Africa and South America. Although substantial increases in the flow of oil are unlikely because it takes 3 to 7 years to develop a new field, this has been the traditional economic response to shortages.

But we must modify our production assumptions based on social responses as well as the limitations of elasticity discussed above. People have political power. Environmental concerns will act as a drag on new production, exacerbating oil shortages and prolonging the recessive impact of an oil crisis. Islamist influence will have a negative impact on production and transportation in the Caspian, North African, West African, and Pacific Rim oil fields. The transition to alternative fuels is both a technical and a politically charged challenge.

The most significant reason why supply will fail to keep up with demand, however, has little to do with exploration, reserves or production capacity. National political leaders control most of the world’s available oil and they have made it very clear: we will produce our oil on our schedule. We have no intention of producing oil based on consumer demand – unless it is in our selfish best interest to do so. Many oil producing natuions rely on oil revenues to fund government programs. The first priority is to find enough money to support political promises. This takes money away from oil field exploration and maintenance activity. It deteriorates.

Thus we can expect national leaders to determine the levels and timing of production investment. And when shortages do occur, they will be looking for higher prices. It is unlikely they will be motivated to honor existing production contracts. Consuming nations will be forced to pay higher taxes, fees, and royalties.

1929
The last comparable economic shock to the world economy occurred in 1929. Severe deflation dropped the American Consumer Price Index (CPI) by over 23 percent to a low of 13 in 1933. The years 1934 through 1940 were characterized by modest changes to the CPI. Unemployment increased by 728 percent, from 1.55 million in 1929 to 12.83 million in 1933. America did not reach a full employment economy until 1942 - 13 years after the collapse of the economy in 1929. American Gross National Product (GNP) plummeted 9.4 percent in 1930, 8.5 percent in 1931, 13.4 percent in 1932, and 2.1 percent in 1933. It bounced back from 1934 through 1937, was negative again in 1938, and then increased through the years of WW2.

By 1932, industrial stocks had lost 80 percent of their value, 40 percent of the banks had failed, and international trade had fallen by more than 60 percent.

If a political crisis occurs, the world will suffer the same kind of devastating economic volatility that it did in 1929. If oil production simply fails to meet consumer demand over a long period of time (there is no political crisis), then a production crisis scenario becomes more likely. In both cases, however, the economic trends will be irreversible unless we humans develop a suitable alternative energy system.

Interest Rates
In the above discussion, I stated that lower interest rates will only marginally help the economy because oil shortages will disrupt the flow and use of money in the economy. The reverse is also true. Although the American Federal Reserve (or its international counterparts) can try to contain inflation by raising interest rates, the availability and price of oil have a structural impact on the world economy. Higher prices will tend to exacerbate inflation (primarily for current expense consumption), irrespective of the Federal interest rate policy. History shows that lower oil prices ease the upward pressure on inflation.

A gradual decline in the availability of oil will tend to be less inflationary because consumers have time to adjust their spending habits as they encounter higher fuel and product prices. However, a sudden – and very large – decline in oil shipments could cause a short period of intense inflation (as consumers scramble to buy available oil based products), followed by a longer interval of deflation (as economic activity rapidly declines). It would appear that under depressive economic conditions, Federal interest rate policy will only have a modest impact on the outcome.

Conclusion
We do not have reliable oil reserve and production data. Availability and price depend on several variables that are impossible to predict. We are wise, therefore, to use the scenario approach to our analysis of future oil market trends. Scenarios are not predictions. Rather, they permit us to make, and then test, a hypothesis. We will then be able to challenge the assumptions, encourage debate about the model, and profile the probable result of our analysis. Scenarios are tools that give our evaluations focus, permit us to deal with the unexpected, and characterize the results of dynamic circumstances.

Based on its own alternative set of internally compatible assumptions, each scenario can be constructed with due attention to the associated economic and cultural constraints. These assumptions drive the values shown for each data series. We can then assign a probability value to each scenario we construct. High probability scenarios give us a clue to the future of the oil market.

After constructing several alternative scenarios, it became abundantly clear they all produced results that were strikingly similar. Every scenario produced higher rates of inflation and unemployment with declining GDP. The only real difference was in the timing and degree of severity.

Ron

1 McKinsey Global Institute, reported in Business Week, December 8, 2003, pp. 71.

About Global Warming

2010-12-25T14:22:00.000-08:00

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   The IPCC Report
     A summary of the Intergovernmental Panel on Climate Change (IPCC), Fourth Assessment Report "Climate Change 2007" was released in early 2007. The IPCC was established by the United Nations Environment Program (UNEP), and the World Meteorological Organization (WMO) to undertake periodic assessments of the physical science of climate change. The IPCC Summary For Policymakers concluded the Earth is warming and human activities have very likely caused most of the warming of the last 50 years.

     America’s contribution included multiple scientists, software developers, and technicians, as well as facilities, mainframe computers, and millions of taxpayer dollars. The U.S. effort included climate scientists from the National Aeronautics and Space Administration (NASA), and the Department of Commerce's National Oceanic and Atmospheric Administration (NOAA). Twenty of the computer model runs were done by the NOAA Geophysical Fluid Dynamics Laboratory in Princeton, N.J.

     Unfortunately, the IPCC report remains a controversial document. There are those who believe the IPCC Fourth Assessment Report has many deficiencies. Errors of methodology. Questionable conclusions. But one failure stands out. Of the original published, Special Report on Emissions Scenarios (SRES), none are valid. For one very simple reason. They all ignore fossil fuel resource depletion. All of the published SRES scenarios assume there are no resource constraints on the consumption of coal, oil and natural gas.

     That is most unfortunate. And just plain wrong.

     Why has the IPCC failed to include this critical data in their calculations? If, as the IPCC claims, human fossil fuel consumption drives global warming, then the depletion of oil, natural gas and coal resources will automatically force a decrease in the production of CO2 and other Green House Gases (GHG). Current projections indicate total fossil fuel consumption will peak around 2040. After that, we humans will have less to burn each year. If that’s the case, then there is no problem. Right? By 2100 GHG production will be down to 2000 levels (or less) because we will have less fossil fuel to burn. There is no need to take any draconian measures to curb global warming.

     Sorry. It’s not that simple.

     From the IPCC report: “Climate carbon cycle coupling is expected to add carbon dioxide to the atmosphere as the climate system warms, but the magnitude of this feedback is uncertain. This increases the uncertainty in the trajectory of carbon dioxide emissions required to achieve a particular stabilization level of atmospheric carbon dioxide concentration. Based on current understanding of climate carbon cycle feedback, model studies suggest that to stabilize at 450 ppm carbon dioxide, could require that cumulative emissions over the 21st century be reduced from an average of approximately 670 [630 to 710] GtC (2460 [2310 to 2600] GtCO2) to approximately 490 [375 to 600] GtC…”

     It would appear total carbon from the consumption of oil and natural gas during the remainder of the 21st century is well below this number (490 GtC). It is the rapid increase in the consumption of coal within the Asia Pacific region that puts us over the IPCC’s objective, most notably China and India. Inadequate environmental controls, along with high rates of economic growth, promise to bring about a sharp increase in CO2 emissions from the region until coal production “peaks” sometime later in this century.

     By contrast North American, European and EurAsian CO2 production has declined slightly since 2007, in part because the recession has decreased the demand for fossil fuels. Technology, fuel and demographic trends already in place within the nations of western Europe and North America will limit near term increases in CO2 emissions. Longer term, however, coal will become an attractive alternative to increasingly expensive propane and heating oil for domestic heating.

     Although CO2 emissions within African, Central American and South American nations are expected to increase substantially over the next 20 years, they will be well below the volumes produced elsewhere on our planet.

     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 global warming in the 21st century, followed by a decrease in global temperatures after 2075.

     Or maybe not.

     We need to consider global warming within the context of fossil fuel depletion. And vice versa. Otherwise our calculations of global warming are – by characterization – deficient.

   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 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) versus a prescribed baseline. If we go back 600 million years, temperature variations are even larger. In fact, according to available scientific information, average temperatures have been significantly higher (over 18 degrees C) than today (about 14 degrees C) for much of the earth’s history. No one knows if our current warm period will include temperatures as high as 18 degrees C., or if the recorded temperature volatility of this natural cycle means we are about to enter a period of global cooling. Scientists disagree.

     We can associate warm periods with lush plant life, dinosaurs, swamps, expanding deserts, overflowing oceans, and high concentrations of carbon dioxide. Our treasure trove of coal, oil and natural gas (all are forms of carbon) was created during these warm cycles. Low temperature cycles, on the other hand, have been associated with expanding glaciers, ice ages, struggling animal populations, limited vegetation, and low concentrations of carbon dioxide.

     Current temperature events are not all that different from those experienced in the Medieval Warm Period (MWP) ~900 – 1250 AD. Evidence of global warming can be found in studies from Australia, Europe and America, as well as bore holes from all over the world (“Late Quaternary Temperature Changes Seen in Worldwide Continental Heat Flow Measurements. Huang, Shaopeng, Henry N. Pollack and Po Yu Shen, 1997.) It was warm enough to permit the Vikings to colonize Greenland where they found grass and trees. Higher tree lines and droughts are an indication of higher temperatures for an extended period. The MWP was accompanied by intense weather events, retreating glaciers, decreasing ice packs, rising oceans, long growing seasons, and very warm summers. Just like today. There is, of course, an active debate about just how warm it became during the Medieval Warm Period, and whether or not its effects may have been more regional than universal. But however one debates that point, the MWP did enable a relatively rapid expansion of the human population.

     The Medieval Warm Period was followed by an abrupt decrease in temperatures to the Little Ice Age (LIA) ~ 1250 – ~ 1860. These frigid temperature events have been recorded in contemporaneous literature and ship log data. The Little Ice Age was accompanied by frequent and intense weather events, glacial expansion, ice pack advances, heavy snowfall, bitter cold, floods, crop failures (because the growing season was wet, cool and short), bread riots, famine, and death. Frigid weather forced the Vikings to leave Greenland (some perished there). Millions died from exposure and frigid temperatures. Millions more died from disease because famine weakened their natural defenses against infection. There are those who believe the Black Death, for example, (which wiped out approximately one third of Europe’s population), can be linked to malnutrition brought on by LIA privation and famine. Although there were intervals of modest global warming during the LIA, these alternated with periods of extreme cold beginning in ~1650, ~1770 and ~1850. During winter, most of the upper Northern Hemisphere rivers were all or partially frozen. In 1780, for example, people walked across the ice from Manhattan to Staten Island. There was an annual ice carnival on Great Britain’s Thames River 1608 - 1814. Napoleon’s disastrous losses in Russia were primarily due to bitter winter weather in 1812. Although the connection is still the subject of debate among scientists, some of these coldest periods were associated with decreased sun spot activity. Volcanic activity – which fills the atmosphere with ash that reflects the sun’s rays – was probably responsible for New England’s year without a summer in 1816. It was so cold, it snowed in July.

     We also have reasonably reliable worldwide temperature records going back to 1880. As our planet emerged from the LIA, temperatures began to ratchet upward, stalling briefly in their upward climb from ~ 1929 to 1978, and then resuming their upward drift. No one knows how high these averages will go before our planet enters a prolonged period of global cooling.

     The following graph tracks actual world temperature data against the consumption of primary fuels (oil, coal and natural gas) from 1880 through 2009. Assuming global warming advocates are right, and assuming a continuing growth in the demand for fossil fuels, it would appear these two data sets will continue to track through 2030. By 2040, however, production restrictions will force us to decrease our consumption of primary fuels. This presents us with a conundrum. If global warming advocates are right (increased fossil fuel consumption is responsible for a continuing increase in global temperatures), then a decrease in global consumption should bring about a corresponding decrease in world temperatures by 2050. If, on the other hand, global warming skeptics are right (there is little or no relationship between human fossil fuel consumption and global temperatures), then global warming could come to an end at any time.

     Based on my research, it would appear that a shift from warming to cooling will occur during this century. In any event, global temperature change will definitely create lifestyle challenges for people in every nation.

To Summarize.
Global warming and cooling are natural events. It would be incredibly naive to believe our global ecosphere has always had a benevolent environment. That is simply not true. In addition, many scientists believe our prolific generation of green house gases adds to our planet’s global warming trend. Whether we agree with this conclusion or not, it is clear that both global warming and global cooling are real events that will happen in this century. Our weather and environmental conditions currently mimic the MWP. Will a new version of the LIA come next?

Key Point
     Legislative action for hydrocarbon resource depletion and global warming must be done as a package.

     Else.   We will make foolish mistakes.

     Those who are concerned about global warming and those of us who are worried about hydrocarbon depletion have much in common. We all want to reduce the consumption of hydrocarbon resources. For global warming, that means a reduction of greenhouse gases. For depletion, it means transforming ourselves to an energy detensive lifestyle. The devil is in the details. For example, the use of natural gas for power generation may yield a temporary reduction in greenhouse gases, but on a long term basis the depletion of natural gas means consumers will be forced to burn coal and wood for heating and cooking.

     That would be an ecological disaster.

Ron
.

The Ten States Most Likely To Default

2010-07-23T08:56:00.000-07:00

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     Business Insider lists ten states likely to default, based on the proprietary Fitch CDS-IR model. All have unfunded pension liabilities, excessive welfare expenditures, and high labor costs.

     State Rankings in Descending Order – Number 1 is most likely to default

     Rank                   State                   CPD

     1                           Illinois                 41.2%
     2                         California            39.3%
     3                          New York           35.3%
     4                          New Jersey         34.7%
     5                          Michigan             33.8%
     6                          Nevada                 32.0%
     7                          Massachusetts      22.0%
     8                         Ohio                        20.9%
     9                          Texas                      15.0%
     10                       Virginia                  12.3%

     CPD = Cumulative Probability of Default

Ronald R. Cooke
The Cultural Economist
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Who Is Big Oil?

2010-07-05T07:59:00.000-07:00

When Americans talk about “Big Oil”, they are usually referring to the independent oil companies – ExxonMobil, Shell, BP, ConocoPhillips, Chevron, and so on. Politicians are fond of trashing “Big Oil” because these companies make an easy target. Consumer groups like to throw stones at “Big Oil” because they want lower prices. Environmentalists hate Big Oil because they don’t like the pollution from oil production and consumption. Everyone, it seems, has a reason to distrust these big companies.

But who is “Big Oil”? The really, really big oil companies?

Back in the 1950s, independent western oil companies produced 45 percent of all foreign oil. Because they had the expertise and money, they could make lucrative deals almost anywhere. But all that has changed. By 2006, seventy eight percent of the world’s oil and natural gas was produced by companies that are owned by a national government, and 98 percent of the world’s oil reserves belong to national governments. National governments like Saudi Arabia, Iran, Venezuela and Iraq dominate the oil industry.

So... Who is Big Oil?

Here is a list of the 10 largest oil and natural gas companies based on annual production in 2004:

Saudi Aramco   (Saudi Arabia) 28%
National Iranian Oil Co.   (Iran) 12%
Petroleos Mexicanos   (Mexico) 11%,
Petroleos de Venezuela   (Venezuela) 8%
Exxon Mobil   (U.S. IOC) 8%,
Royal Dutch Shell   (U.K./Netherlands IOC) 7%,
Kuwait Petroleum Co.   (Kuwait) 7%
BP    (U.K. IOC) 7%
Iraq National Oil Co.   (Iraq) 6%
Petro China   (China) 6%

And here is a list of the 10 largest oil and natural gas companies based on claimed reserve holdings:

Saudi Aramco   (Saudi Arabia) 32%
National Iranian Oil Co.   (Iran) 16%
Iraq National Oil Co.   (Iraq) 14%
Kuwait Petroleum Co.   (Kuwait) 11%
Petroleos de Venezuela    (Venezuela) 10%
Abu Dhabi National Oil Co.   (U.A.E.) 6%
Libya NOC   (Libya) 4%
Nigerian National Petroleum Co.   (Nigeria) 3%
Petroleos de Mexico    (Mexico) 2%,
Lukoil   (Russia) 2%

Source: GAO, analysis of data from Petroleum Intelligence Weekly (Dec. 12, 2005). IOC: Independent Oil Company. All other companies are controlled by their respective national governments.

The point, of course, is that most of these companies are controlled by the state and are subject to the political policies of the nation within which they reside. For many of these nations, local welfare programs and political initiatives are far more important than satisfying the world’s demand for oil. For some, oil is also a potential weapon of war.

So now you know. You know where most of the gasoline, diesel, propane, and heating oil fuels you buy come from. You know who has increasing control over the price and availability of oil. You know what the term “Big Oil” really means.

In the oil business, companies like ExxonMobil, Shell, BP, ConocoPhillips, and Chevron are small potatoes. And they are destined to become less relevant.

Ronald R. Cooke
The Cultural Economist

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The Great Recession: 34 Million Workers Struggle To Survive

2009-11-11T09:37:00.000-08:00

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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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The Evil Twins

2009-07-26T10:59:00.000-07:00

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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 man made 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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The Sherman Antitrust Law Is Obsolete

2009-06-20T09:24:00.000-07:00

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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), and emerging economies?
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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Home Prices: Where Is The Bottom?

2009-01-28T09:02:00.000-08:00

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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

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.
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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NBER: It’s A Recession

2008-12-19T09:29:00.000-08:00

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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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Greenspan: You Blew It

2008-10-31T11:25:00.000-07:00

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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?

2008-10-16T08:22:00.000-07:00

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. But it is impossible to determine "when". In any event, 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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Three Points On ANWR

2008-06-30T09:31:00.000-07:00

'
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

2008-05-22T08:10:00.000-07:00

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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?

2008-05-15T11:00:00.000-07:00

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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.

2008-05-05T14:24:00.000-07:00

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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?

2008-04-15T08:05:00.000-07:00

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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.

TCE

Barack Obama's Middle East Dilemma

2008-03-30T07:55:00.000-07:00

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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.

TCE

PS: What would I do? My recommendations are outlined in “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

2008-03-28T08:08:00.000-07:00

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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.

TCE

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How To Save America’s Banking System

2008-03-25T11:28:00.000-07:00

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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.

TCE
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Banks: Bleeding Value And Hiding Desperation

2008-03-23T17:03:00.000-07:00

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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 strategy.

But. I could be wrong. You decide.

TCE

A Few Words On The Economy

2008-03-09T08:56:00.000-07:00

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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 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, 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.

TCE
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Credit Crunch: It Ain't Over Yet

2007-11-15T16:39:00.000-08:00

Introduction

In March of 2007, I published an essay entitled “Warning: Recession Ahead”. 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 two concerns: debt and real estate. 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 trade-able 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 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.

TCE

Warning: Recession Ahead

2007-03-29T16:18:00.000-07:00

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 two 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 Government Sponsored Enterprise (GSE) 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 plow 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 derivative 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 6 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.

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 2009.

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 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 huge national debt obligations, works against the economic health of the world economy.

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. 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 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.

TCE

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.