The World According to Opa

With two economic experts, the former and current chiefs of the Federal Reserve Bank of the United States, giving mixed signals, something’s gotta be wrong.  Right?  Or could it be that nobody really knows for sure where our country’s economy is headed?

Earlier this year, Alan Greenspan, former Fed Chief serving nearly five successive four-year terms since 1987, warned that the U.S. economy could stumble into a recession by year’s end.  Markets dipped in response.  Then, two days later, they rebounded on soothing words spoken by Greenspan’s successor, Ben Bernanke.  Mr. Bernanke, the former chief economic advisor to President Bush, was nominated last year and confirmed by the Senate while it was still controlled by members of the president’s own party.

Hmmm… in light of what has recently taken place, even though the Fed is, by charter, suppose to function completely independent of the executive branch, maybe we’re putting too much stock in what the current administration’s choice for our nation’s head banker is saying.

So, what has taken place recently?  You should know by now that the DJIA has tumbled after briefly reaching an all-time high of 14000 earlier this week.  The tumble was nothing like the one-day drop that happened on Black Tuesday, October 29, 1929 starting a decline that lasted until 1954.  But the loss was enough to send shock waves through Asian Markets on Thursday.   According to Market Watch, the Dow industrials closed with a 311.5 point loss and there were big sell-offs for the Nasdaq and the S&P 500 as well.  On Friday, the Dow was down another 208.10 points, ending the week down a total of 4.2 percent!

Experts have said that recent postponements of loan deals, weak U.S. housing data, and poor results from home builders are the reason.  But I fear the problem could be bigger, maybe much bigger.  The good news is that I’m not a real economic expert, so nobody needs to worry too much about what I think.

I expressed concern about the housing market last week while attending a summer institute for teachers of economics.  I said I was worried about the effect that it and foreclosures on mortgage loans of sub-prime or second-chance borrowers might have on the broader market.  Now we learn that many homebuyers with good credit are defaulting as well.  Some of the other teachers seemed to agree that this is a bad sign, while most withheld comment.  Others, one in particular who dabbles in real estate, argued that it isn’t that big of a deal.  Then I pointed out, with a copy of the morning’s Wall Street Journal in-hand, that despite a sizable gain by the Dow the previous day, most mutual funds showed losses.

Our current Fed chief, Ben Bernanke, has told Congress that we can look forward to continued modest growth for the rest of the year.  So, we shouldn’t worry, right?  Well, while you consider this, you might enjoy watching a humorous YouTube video submitted by Dean Hubbard, activist and author of articles on economic human rights, and Vice-President of the World Organization for the Right of the People to Health Care.

Click the run button twice, once to load, the second time to start.

Could Mr. Bernanke have been wrong in his forecast of future economic growth in his semiannual report to the Congress?  Of course he could.  Economics is not a “hard” science, it’s a “soft” science — black art may be a more appropriate term for it.  You see, unlike real scientists who have laboratories in which conditions can be controlled for experiments, economists have to work in the real world, a world where conditions are constantly changing.  And real science, as opposed to “pseudo” science, is devoid of any biases such as political influence.  Markets respond to what Fed chairmen say about the economy, not so much because they believe what they say as much as they’re trying to anticipate what monetary policies the Fed may adopt based on what the their analysts think the economy needs.

The Fed Chairman based much of his report to the Congress on something called the Real Gross Domestic Product (GDPr), which is the value of all domestic goods and services produced over a certain timeframe, corrected for inflation.  The formula for this, using the “Expenditures Approach,” is GDP=C+Ig+G+Xn, where C is consumption (what people are spending their hard earned money on), Ig is gross private investment (business purchases of equipment, tools, construction and changes to inventories), G is government spending, and Xn is net exports (the difference between exports and imports).

Mr. Bernake, in his report to Congress, was talking mostly about the GDPr for the second quarter of 2006.  This is because it takes time for the government to collect all the data it needs to calculate this important economic indicator.  So his report spoke to what was, not what is.

In addition to the hindsight vs. foresight problem that economists have to deal with when projecting where our economy might be headed (we’re always kind of walking backward — you see), there’s an issue in my mind having to do with data quality (garbage-in/garbage-out)… not that anyone would purposely want to make Americans think that things are better than they really are.  But let’s just take a moment to do a little analysis of our own, beginning at the end of the GDP formula and working our way to the front.  You can check all of what follows yourself by accessing data at the Bureau of Economic Analysis website.

We all know that the U.S. has a trade deficit.  We have had for years.  In 2006, according to the BEA, it was a negative $176.8 billion, with an increase in deficit over 2005 being 2.4 percent.  The biggest part of this increase is in our ever increasing thirst for foreign oil.  So, Xn is a negative factor.

Government spending, despite the Bush-Chaney tax cuts of 2004, was up in 2006 contributing on the positive side to the GDP calculation.  It increased 8.5 percent over 2005 spending, which had an increase of 4.6 percent over 2004 spending, which was up 10.9 over 2003 spending.  But most of these increases have gone to defense and the War on Terror, with much of it going to Iraq in wasteful efforts to rebuild their infrastructure.  Investment in human capital and infrastructure here at home was down.  This is in keeping with the current administration’s economic/political philosophy of reducing the size of government.  So any growth in the economy based on government’s contribution to it is illusionary.

Growth in Ig (gross private domestic investment) was down for 2006, the increase was 2.7 percent over 2005 spending.  Spending for 2005 showed an increase of 5.6 percent over 2004’s spending, which was a 9.7 percent increase over 2003.  So, while industry continues to invest in our future, they’re doing so at an increas- ingly diminished rate.  So much for the trickle-down theory.  This helps to explain why some corporate profits have been in record territory recently with COEs making mega-bucks.  Ig, while still in the black mid-way through 2006, is well on it’s way to becoming a negative factor.

Growth in C (consumer consumption) was also down.  For 2006 the increase over 2005 was 3.1 percent.  The increase for 2005 over 2004 spending was 3.2 percent.  The increase for 2004 was 3.6 percent over 2003.  So, growth in consumer spending has been declining over the past four years, even though personal income was up 9.1 percent.  Keep in mind, the personal income figure is an average.  The top 2 percent of Americans could be making half again as much as they did before the Bush-Cheney tax cuts went into effect, while the rest of us are making increasingly less, layoffs, out sourcing, and corporate restructuring all taken into account.  According to the Bureau of Labor Statistics (BLS), real wages (the source of most Americans’ income) have not kept pace with the Consumer Price Index (CPI).  Here in Texas, the average increase in real wages last month was 0.1 percent, while the CPI grew 0.4 percent.  The real wages number is adjusted for inflation while the CPI is inflation.  So, while most of us are spending all we make and much that we can borrow, the spending can’t be helping the economy grow.  C, while still in the black ink, could really be a negative factor because much of the spending by Americans is with borrowed money.

The new Fed chief also used the current unemployment figure in his projection of continued growth.  At 4.5 percent, economists consider this to be “full” employment, a rate at which the economy should be going strong, inflation being our only real concern.  But the unemployment number only considers those adults who are able and willing to work.  It does not take into account the number of persons recently laid-off who have not been able to find work at a commensurate wage or salary.  Many have given up the search and opting instead for early retirement and dropping off the radar screen.  Some, in order to keep the wolf from the door, have taken part time jobs, and part time workers are considered by the BLS to be employed.  In fact, the lay-off rate has become such an embarrassment to the administration that the BLS no longer publishes percentages of change over previous periods as they do with other data.  Layoffs now are reported only in gross numbers by region. 

Again I say, I’m no expert on this stuff, but I don’t see anything in these numbers to suggest that the nation’s economy is strong, nor that we can expect “continued” growth for the rest of the year.  But then, maybe I’m not holding my mouth exactly right.  If Greenspan was right (I hope he’s not, for the country’s sake, despite my back-of-the-envelope analysis) and Bernanke chooses the wrong monetary policy, we could be in for worse than recession.  After seven years of bushenomics, stagflation could now be on our nation’s doorstep.

Maybe Greenspan carefully chose his words when he said that the economy could “stumble” into a recession.  Maybe he knew we were already in one, but also knew what a panic it would cause for him to say so.  After nineteen years as our nation’s top banker, surely he knows the power of his words.  Golly, you don’t suppose this is why he retired from the head banker’s job before com- pleting his fifth term?  So, anyway, you do whatever you’re comfortable with, my friends, but my retirement portfolio, since last week when the stock market was at it zenith, is considerably less aggressive now.

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There has been much talk in Congress and from the White House lately about our overdependence on foreign oil.  The President himself has said that we are addicted to it.  Well, in the upcoming general elections, I hope that my readers, and all American voters, will consider candidates of both parties as well as Independents who plan to do more than just talk about it.  Thus, the topic of this posting — recognizing the problem for what it really is, greed, and resolving to do something about it.

Sometimes people choose to respond to my blog postings off-line, and that’s alright. I understand how some might not want to go world-wide with their views.  I had several contrary responses to my recent article on Big Oil, how I believe that they are an oligopoly in the U.S.  Great!  That’s what The World According to Opa is for — the free excange of ideas, call it part of the great market place of ideas.  But all of the contrarian comments I’ve receive have been private.  Interesting — I must be doing something wrong.

What follows, fully protecting the confidence of a fellow thinker, is based on my private response to his off-line comments.

In a private email, my fellow thinker said that he thought the Federal Government is the true monopoly, not Big Oil… hmmm. This probably means that he’s a Republican.  Not that there’s anything wrong with that, most of my friends here in Texas are — Republicans that is — used to be one myself.

Texas, you know, actually collects more than the Federal government does in gasoline taxes:  20 cents per gallon, whereas the federal government takes 18.4 cents.  Notice that these are a flat rates, not percentages.  They are rates that haven’t changed for years (1997 for the federal tax) despite the recent increase in prices.  Further, the oil companies don’t pay these taxes, consumers do.  Since the demand of gasoline and other fuels is very inelastic, the effect of  taxes on these products minimally effect how much we buy of them.

Sort term supply in response to a new or increased tax will shift leftward, but it usually doesn’t take long for supply to recover so as to meet demand at a new equalibrium price.  Also, governments don’t profit from the taxes, which we more liberal thinkers consider to be user fees rather than true taxes.  This is because much of this money is hypothecated (dedicated) to transportation.  All but one cent per gallon of federal gas tax is dedicated to highways and mass transit, infrastructure without which there would be little market for oil companies’ products.  Neither are gas taxes a factor in figuring corporate profits, as my fellow thinker suggested in his comment.  This is because they really aren’t part of their costs of doing business.

My fellow thinker said that he didn’t begrudge Exxon Mobil from making a profit, and I responded that I don’t either.  I don’t begrudge any business from making a profit; that’s what we do in a free market economy.  And Exxon Mobil’s reported profit of 10.6 percent for 2006 is low compared to other large corportations like Microsoft, WalMart and Starbucks.  But, I said, remember that profit is the difference between accounting cost and total revenue, so it’s whatever a company says it is.  Lots of things can be counted as accounting costs.  Factor-in how much Exxon Mobil paid out to shareholders last year, to foreign governments for exploration and drilling rights, to corporate executives and to political action groups, and I would have to conclude that their accountants do a better job than most in “cooking the books.”  Less civic-minded corporations, I learned obtaining my MBA, sometimes do this so as to minimize corporate taxes.

My fellow thinker pointed out that there have been no new refineries built in years, and he was quite right.  But, as I pointed out, if they are to be built, oil companies will have to have an economic incentive to do so.  I agreed with my fellow thinker that there is plenty of oil, but only in the near term “pipeline”.  I’m not comfortable with projections made by some that there’s not a problem with future supplies.  True, we have not yet found all of Mother Nature’s oil, but no new discoveries are easy-to-get-at oil.  Which means that the cost of future discovery and recovery can only go up, and all these costs will be passed on to consumers. 

Petroleum reserves are limited. Petroleum is not a renewable resource and production cannot continue to increase indefinitely. A day of reckoning will come sometime in the future. When?  Ah, that’s the question.  But the point at which production can no longer keep up with an increasing demand will mean a radical and painful readjustment globally.

According to a U.S. Geological Survey Report, as of 1996, OPEC’s proven and undiscovered reserves amounted to about 853 billion barrels, while similar non-OPEC reserves were 769 billion barrels. I doubt that this ratio has changed much since then. So, based on actual production patterns in many non-OPEC oil producing countries, output can increase until there remains between 10 and 20 years of proven plus undiscovered reserves.  At this point, depending on the reserve growth that is actually available, a production plateau or decline will set in.  Now, given that non-OPEC production rates are nearly twice as great as OPEC rates, and assuming stable prices and a modest 2 percent per year market growth, non-OPEC production has been projected to reach a maximum sometime between 2010 and 2018 based on resource limitations alone (assuming complete cooperation of producers and that all undiscovered oil is actually found and produced as rapidly as needed). Once this happens, OPEC will control the market completely, and it is unlikely that production will increase much after that to meet the growing demand which, as my fellow thinker pointed out, includes the counties of India, China, and Russia.

My fellow thinker suggested the following Free Market remedies:

• Buiding new refinineries in the US and refining permian sweet crude rather than Saudia sour crude.
• Going to one formulation. 
• Expanding exploration off shore and in Alaska. 
• Keeping on the offensive in the war on terror so as to prevent others’ control of the world market.
• Expanding alternative fuel research.

I agree with all of these ideas.  However, only the last, expanding alternative fuel research, has great potential in the long term.  But this is something Exxon Mobil and the other majors have declined to get invloved in.  So, who do we suppose is going to do it, three or four smart guys in a backyard garage workshop?  Maybe so.  But if and when they do, lets hope that Big Oil doesn’t “make ’em an offer they can’t refuse” before they get their ideas to market — as in the mythical 150-mile-per-gallon carbeurator.

CLICK THE CARTOON ABOVE TO SEE SOME GREAT ENERGY INNOVATION IDEAS, then please hit your browser’s return arrow to finish reading this article.

Since industry is disinclined to develop any serious alternatives for their products, which are currently very profitable, I modestly suggest that government is going to have to play a much bigger role, and pretty darned quick.  Alhough my fellow thinker will vehemently disagree, as well as my Libertarian son who thinks I’m nuts, perhaps raising taxes should be considered as a way to reduce consumption and help pay for the needed research on alternatives. 

Actually, I consider myself to more moderate politically than this idea suggests.  But these are critical and dangerours times for America — indeed, for mankind.  We must not be limited in our response by ideology, not if we are to survive.

I’ll be interested in reading your comments on this.

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