Kevin Drum - August 2011

Our Oil-Constrained Future

| Fri Aug. 26, 2011 2:55 AM PDT

I've talked a few times (first here, most recently here) about the possibility that world growth is now constrained by oil production. The basic story is simple: As long as there's spare oil-production capacity, increasing demand caused by economic growth produces only a steady, manageable increase in oil prices. But oil production is now close to its maximum and can't be easily or quickly expanded. When the global economy grows enough that demand starts to bump up against this ceiling, oil prices don't rise slowly and steadily; rather, they spike suddenly, causing a recession, which in turn reduces oil demand and drives down prices. When the economy recovers, the cycle starts all over. Because of this dynamic, the production ceiling for oil produces a corresponding ceiling for world economic growth.

Stuart Staniford puts some numbers to this for our most recent recession. What would it have taken for growth to continue at its 2000-08 rate over the past few years?

In the counterfactual world, 2009 gross world product would have been 6.4 percent larger than in the actual world. We can estimate the implications for oil supply because we know that the global income elasticity of oil demand is about 2/3. Thus the counterfactual world would have required an additional 4.5 percent more oil than the real world.

…2009 oil production was around 85 [million barrels per day] (depending on what source you like) so in the counterfactual world we would have needed it to be around 88-89mbd. Now, in 2008, oil production got up to around 86mbd (on an average basis) but doing so triggered (or required) an oil shock in which prices briefly reached $135/barrel on a monthly basis and almost $150 on a daily basis. What would the likely price path have been had the world then needed an additional 2-3mbd the following year?

To give an indication of the scale of 2-3mbd, note that the loss of 1.6mbd of oil this year (Libya) triggered something like a $30 increase in the price of oil (before it became clear that the global economy was slowing again causing prices to fall). That, along with other commodity price increases, was enough to cause a little bump in inflation that significantly reduced the Federal Reserve's latitude for action.

OPEC countries routinely claim that they can increase pumping capacity to meet world demand. "Our customers aren't asking for more supplies," is the usual phrasing. But that's not true. The world plainly wants more oil that OPEC can't provide. After all, if OPEC had plentiful supplies, we wouldn't see huge price spikes whenever demand gets near the neighborhood of 90 mbd. But we do.

Now, there are some caveats here. For one thing, no one can say for sure precisely what OPEC's pumping capacity is (Middle East regimes are very secretive on this score), and Iraq, in particular, can certainly increase its production capacity if it ever gets its infrastructure rebuilt. But in a way, that's small beer. Global production capacity right now seems to be a little under 90 mbd, and even if this increases to 95 mbd or 100 mbd a few years down the road, we're going to be continually bumping up against this ceiling along the way as the global economy grows. That's going to cause sporadic but frequent price spikes.

The effect this has on the economy is probably greater than even most pessimists realize. James Hamilton, a University of California-San Diego economics professor who's studied the economics of oil demand deeply, points out that 10 of the 11 recessions in the United States since World War II have been preceded by an increase in oil prices—and even small increases in oil prices can have a surprisingly big impact on economic growth. In a recent update of a model he originally published in 2003, he estimates that an oil price spike of 10 percent over its previous high produces a GDP decline of 1.4 percentage points one year later. To put this into real-world terms, his model suggests that the huge run-up in oil prices between 2007 and 2008, when prices nearly doubled, explains most of the Great Recession that followed. And he forecasts that the Libyan price spike early this year, which came on top of a 9 percent increase the previous quarter, will reduce GDP by an estimated 2.4 percentage points by the end of 2011. And the Libyan price spike was pretty modest.

The precise effect of oil prices on the economy depends on which model you prefer, and Hamilton says that a different model that uses a three-year window might be more accurate. That would be good news for the economy in 2011 (and 2012), but it doesn't matter much for the long run. Basically, we're stuck with two stubborn observations. First, world demand for oil is very near its production ceiling, which means that even small increases in demand (or small disruptions in supply) now result in large oil price spikes. And increases in demand are inevitable every time the economy starts growing even modestly. Second, even small increases in the price of oil cause large GDP losses. Price spikes of 20 to 30 percent are likely to be common in the future as we periodically bump up against production ceilings, and if Hamilton's model is correct, this will produce subsequent declines in GDP of 3 to 5 percentage points. That's huge. The effect on world GDP may be less pronounced, but it will still be significant.

If this model is accurate—and if the ceiling on global oil production really is around 90 mbd and can be expanded only slowly—it means that every time the global economy starts to reach even moderate growth rates, demand for oil will quickly bump up against supply constraints, prices will spike, and we'll be thrown back into recession. Rinse and repeat.

If you don't believe in global warming, that's one thing. But the evidence that the world is starting to reach growth constraints based on oil production is, if not a slam dunk case, still pretty compelling. So even if, as Rick Perry says, the world's climate scientists are just inventing global warming as a devious scheme to increase their funding, we still ought to be going balls to the wall to expand existing forms of alternative energy and fund research into new ones. Unless, of course, you really like the prospect of a future full of relentless and painful oil-induced recessions. It doesn't seem very agreeable to me.

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Fear and Loathing at the Federal Reserve

| Thu Aug. 25, 2011 9:47 PM PDT

Why is Ben Bernanke unlikely to announce any major action to help the economy in his Jackson Hole speech on Friday? Because of inflation hawks on the Fed board? Because of concerns that further monetary policy isn't effective when interest rates are already near zero? Because of a generalized fear of being on unfamiliar ground? Mark Thoma says it's all of the above:

But that is not quite enough. I think a majority on the FOMC would still push forward if it weren’t for the change in the political environment. When Bernanke wrote earlier in his career and criticized the Japanese central bank for not doing more, I don’t think he thought the consequences of being wrong about inflation were as severe as they are now. The Ron Pauls in Congress looking for a reason to attack and take away the Fed’s powers, the criticism from many on the left for all sorts of things, etc., etc., puts the Fed in a more precarious political position than they ever expected to be in, and the fear of making a mistake and losing independence is tying its hands. The Fed values independence first and foremost, and it is unwilling to put that in danger. Thus, the Fed is trading more unemployment now for less in the future, and it’s mainly the political environment rather than economics that is driving this decision.

Paul Krugman says much the same thing today. The political environment is so toxic right now that the Fed is afraid that helping the economy — and thereby "interfering" with next year's election — might produce a serious backlash in Congress.

But there's more to this. The Fed is secure from Republican backlash as long as (a) Obama remains president and (b) he refuses to go along with Republican mischief. So if fear of losing its independence is really what's holding back Bernanke and his allies at the Fed, it means they think there's a significant chance that either (a) or (b) or both won't be true over the long term. Fasten your seat belts.

The End of Refrigeration

| Thu Aug. 25, 2011 8:19 PM PDT

The last refrigerator we had lasted about 20 years. Sometime around year 15 it finally blew out a condenser or a coil or whatever it is that makes refrigerators produce coldness and we paid $400 to have it fixed. A few years later it broke again and we bought a new one.

This one broke after eight years. But not because of a condenser or a coil or something comprehensibly structural. The repair guy took about five seconds to diagnose the problem: it stopped working because the "main board" blew out. That's it on the right. Now, maybe I'm off base on this because it's been so long, but this looks like a butt simple design to me. One small custom chip, some relays, a transformer, a couple of heat sinks, and a bunch of passive parts. Maybe a build cost of $20-30 or so? But GE's price to me was $250, plus $150 for the 20 minutes it took to pull out the old one and swap in the new one.

Paying $400 for a big piece of physical gear plus a couple hours of labor didn't bother me. Paying $400 for a primitive circuit board and a few minutes to plug it in does. The repair guy laughed good-naturedly when I mentioned this. "All the computer guys say the same thing," he told me. He even knew what I was going to say about the board before I said it. Our neighborhood is lousy with electrical engineers and other high tech weenies.

Bottom line: $400 because a $2.02 Song Chuan 832 Series 30 A SPDT 12 VDC Through Hole General Purpose Heavy Duty Power Relay burned out. So here's your economics question for the day: Did I stimulate the economy today? Or this an example of the broken refrigerator fallacy? Or did most of my consumption spending leak out to China? Please phrase your answers in the form of a koan.

Quote of the Day: Flexible Mind, Flexible Body

| Thu Aug. 25, 2011 12:36 PM PDT

From yoga teacher Sarah Miller's piece in The Awl today, "Why Yoga Can Be So Irritating":

There are teachers and students who think flexibility is some kind of indication of how good a person you are. A teacher once said to me, "Your hamstrings are tight is because your mind is not flexible." I said, "Have you ever taken differential calculus?" She said, "What?" I said, "Have you ever taken differential calculus?" She had not. She said she was terrible at math. I said, "Well, I am very good at math." (This was not strictly true, but I was quite confident I was better at math than she was.) “Is there something wrong with your mind that you aren’t?”

This was obviously written for nerds everywhere. You shall know the differential calculus, and the differential calculus shall set you free.

Hearing From the Other Half

| Thu Aug. 25, 2011 11:34 AM PDT

CJR's Erika Fry tallies up the op-ed contributions to the New York Times last month:

From my analysis of the past month’s bylines, New York Times readers were treated to the views of:

  • forty-one academics (ten at Ivy League institutions)
  • forty writers and journalists
  • nine presidents and one vice president of an organization or think tank
  • four current and former political office holders.

While the contributions opined on a wide variety of topics—“Why do Russians hate ice?” to “Drones Alone are not the Answer”—and reflected geographic diversity, they originated from a rather narrow class of well-educated and successful individuals. When contributions did occasionally focus on working class issues—“Isolated, Vulnerable and Broke” told of the fast decreasing fortunes of Hispanic families in America—they were expressed in the voice of an Ivy League academic.

Part of the problem may be a lack of submissions, and perhaps these op-ed pages are as representative as the submissions they receive. But if that’s the case, it surely wouldn’t be difficult for papers to find individuals from the “other half” with worthy (and fresh) things to say. Perhaps editors could take a more active role in soliciting contributions; certainly the Internet has proven that there are lots of articulate people out there who want to speak their minds. For editors, it could be as easy as looking for blogs and combing comments.

I'm not sure what to think of this. On the one hand: yes, it would be nice to hear from actual people with actual lives a little more often. On the other hand: I have to admit that I'm skeptical that the blogs of America are full of working class diamonds in the rough who would expand our visions if only we had a chance to read them. These folks get interviewed on the local news with some frequency, and most of the time they're not especially enlightening. The truth is that writing even minimally interesting op-eds is harder than it sounds.  

But yes, I'm elitist scum. And technocratic elitist scum at that, more interested in bloodless charts and statistics than I am in actual human blood, sweat, and toil. Anyone who reads this blog knows I'm not joking, either: I really am more interested in what the big-picture evidence says than I am in eavesdropping on the kitchen table conversation of middle-class families.

Still, it would be an interesting experiment. Every day for a month, let's insist that Andy Rosenthal dig up and run a submission from someone who's literally a working stiff and has absolutely no other credentials. Let 'em tell us what's bugging them, whether it's the owner of a dry cleaning shop complaining about onerous regulations, a truck driver tired of long hours, or a waitress who wishes her customers weren't such assholes. Whatever. I'd have pretty low expectations for this experiment, which means it wouldn't be hard to impress me. So come on, Rosenthal, give it a try.

The Economy and the Auto Industry

| Thu Aug. 25, 2011 10:09 AM PDT

In the LA Times today, Jerry Hirsch digs into the Commerce Department's report that orders for autos and auto parts rose 11.5% in July, the most in eight years:

After a massive restructuring and several high-profile bankruptcies, a leaner, more aggressive auto industry is making a comeback, hiring workers and ramping up manufacturing plants. From a trough two years ago, Ford Motor Co., General Motors Co., Chrysler Group and other auto companies have added almost 90,000 manufacturing jobs, a 14% increase, according to federal employment data.

....Dealers are having a banner year, making more money per sale than they have in years and hiring back some workers shed during the recession. "I have been adding dozens of employees for sales and sales support," said Mike Bowsher, who owns Chevrolet and Buick dealerships in Atlanta; Nashville, Tenn.; and Orlando, Fla. "The economy is crazy, but our retail business is still growing and getting better."

....Auto sales peaked at about 17 million in 2000 and held near that level until 2007 before crashing to just 10.4 million two years later. They were heading back into the 13-million range — helped by a wave of new models, low interest rates and improving consumer confidence — only to be upended by the Japanese earthquake in March...."If you see a 13-million-unit sales rate in the fourth quarter, that would help a lot," said Shulman, senior economist at the UCLA Anderson Forecast. "It would be very hard to see how the U.S. would go into recession with cars selling at that rate."

Some of the immediate rebound is due to pent-up demand following the Japanese tsunami, but in general it seems like a fairly durable response to an aging auto fleet. And it's benefiting American employment due in large part to the Obama administration's surprisingly agile rescue of GM and Chrysler. Taken as a whole, it probably saved upwards of a million jobs economy-wide. You can throw this into the mix with Medicare cost control and higher CAFE standards for cars and light trucks as things that Obama doesn't get enough credit for.

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Peak Earnings

| Thu Aug. 25, 2011 8:54 AM PDT

Stuart Staniford directed me today to a report from the Georgetown University Center on Education and the Workforce about the distribution of earnings throughout the workforce (here). It's got lots of interesting stuff, including basic data about the value of education. On average, workers with a college degree earn 74% more over their lifetimes than workers with only a high school diploma. And workers with a high school diploma earn 34% more than high school dropouts.

But for some reason, the chart below drew my eye. It shows the trajectory of earnings from age 25 through 65, and most people hit their peak earning power around age 45. But there are two big outliers at the very top and very bottom. The earnings of those with professional degrees rise very steeply and max out at age 37, after which they go nowhere. Conversely, although high school dropouts don't make much, their earnings rise steadily for quite a long time, not peaking until about age 53. Also: people with Associate's degrees have an oddly delayed peak until about age 50.

This is, needless to say, one of the least important pieces of information in the report, but it seemed sort of interesting to me. Discussion?

Public Debt and the Great Meltdown

| Thu Aug. 25, 2011 7:23 AM PDT

According to Paul Krugman, Germany's finance minister, Wolfgang Schäuble, gave a speech today in which he said:

It’s actually undisputed among economists worldwide that one of the main causes – if not the main cause – of the turbulence – not just now, but already in 2008 – was excessive public debt everywhere in the world.

Say what? Krugman points out that he and Brad DeLong and Christina Romer, among others, dispute this, but I'd go much, much further. Two years ago I jotted down a list of all the common explanations for the financial meltdown that were then making the rounds, and out of 18 items there wasn't a single one related to public debt. That doesn't mean that literally no one was talking about this, but it does mean that it was uncommon enough that I hadn't heard it. That makes it pretty uncommon.

Now, since then, there's no question that Ken Rogoff and Carmen Reinhart have popularized the notion that public debt is bad news for economic recovery. But as far as I know, even they don't suggest that it was the cause of the 2008 collapse. So what is Schäuble talking about? Well, Ambrose Evans-Pritchard reports on things that a few other Germans are saying today:

German President Christian Wulff has accused the European Central Bank of violating its treaty mandate with the mass purchase of southern European bonds. In a cannon shot across Europe’s bows, he warned that Germany is reaching bailout exhaustion and cannot allow its own democracy to be undermined by EU mayhem.

....The blistering attack follows equally harsh words by the Bundesbank in its monthly report. The bank slammed the ECB’s bond purchases and also warned that the EU’s broader bail-out machinery violates EU treaties and lacks “democratic legitimacy”.

....Chancellor Angela Merkel has struggled all this week to placate angry critics of her bailout policies within the Christian Democrat (CDU) party. Labour minister Ursula von der Leyen said countries that need rescues should be forced to put up their “gold reserves and industrial assets” as collateral, a sign that rising figures within the CDU are staking out eurosceptic positions as popular fury mounts.

....Mr Wulff said Germany’s public debt has reached 83pc of GDP and asked who will “rescue the rescuers?” as the dominoes keep falling. “We Germans mustn’t allow an inflated sense of the strength of the rescuers to take hold,” he said.

So: Germany is (understandably) unhappy about having to bail out the PIIGS and equally unhappy that this rescue will probably require them to substantially increase their own public debt. Politically, this means they need to badmouth public debt, so that's what they're doing. Schäuble is just taking a bit more dramatic license about it than the others. That will probably earn him points both at home and with the GOP's deficit hawks here in America, but it doesn't make him right. Debt was indeed a major cause of the 2008 financial collapse, but not the public variety. The private financial sector managed it all on its own.

Shooting Yourself in the Foot as Political Strategy

| Thu Aug. 25, 2011 6:23 AM PDT

Starbucks CEO Howard Schultz has gotten a lot of press for his campaign to get CEOs to halt all political contributions until politicians in Washington, DC, stop their insane bickering. Except it's not really bickering that he and his fellow corporate titans are upset about:

More than 100 business leaders have signed onto Starbucks CEO Howard Schultz’s pledge to stop making donations to incumbents until Washington gridlock eases, sending a message to lawmakers that they must make real progress in reining in deficit spending.

…In all, more than 100 business leaders have agreed to the pledge, which not only has leaders agreeing to stop campaign contributions until lawmakers “strike a bipartisan, balanced long-term debt deal that addresses both entitlements and revenues,” but also has the leaders agree to find ways to accelerate job growth in their companies and the economy as a whole.

I'm not sure that spending their personal fortunes on mansion upgrades instead of political contributions is quite the cri de coeur these guys seem to think it is, but whatever. As a PR device—and what is politics besides PR?—it seems to be getting some attention. So more power to them.

As usual, though, I'm sort of flummoxed by the substantive thinking on display here. I mean, I assume these guys are all bright and politically aware. Which means they must know perfectly well that one party in Washington is already willing, however grudgingly, to cut a debt deal that addresses both entitlements and revenues. In fact, the leader of this party has spent the last several months leading his own PR campaign to sell precisely this "balanced approach."

And then there's the other political party in Washington. This one relentlessly mocks the "balanced approach" as yet another big government giveaway. Its presidential candidates unanimously agree that they'd oppose a deal that includes $10 in real spending cuts for every $1 in increased revenue. Its leader in the House walked away from several opportunities to strike an ambitious deal based on an 85-15 split of cuts vs. revenue increases. Its leader in the Senate declared himself delighted with the debt ceiling debacle, saying his party learned it's "a hostage that's worth ransoming." And the rest of its congressional leaders have all sworn blood oaths not to compromise on their pledge to never ever raise taxes under any circumstances.

This description of recent events isn't really controversial or especially inflected by partisan hackery on my part. Everyone knows this is how the deal went down earlier this month. Republicans are pretty proud of it, in fact. So in exactly what way are Schultz and his fellow boycotters seeking a "bipartisan" agreement? They aren't. What they really want, if their own words are to be taken seriously, is for the Republican Party to agree to tax hikes as part of any future debt deal.

And for some reason they've decided that Republicans will cave in on this if they announce their intention to withhold all political contributions to both parties this year. Seriously? My guess is that the GOP leadership is laughing its ass off over this. If this kind of strategic thinking is typical of these rock-jawed titans of American industry, it's no wonder our country is in such trouble.

Steve Jobs

| Wed Aug. 24, 2011 9:48 PM PDT

I've never been susceptible to the Steve Jobs reality distortion field. The only time I ever used an Apple product was in the late 80s, when my company bought a bunch of Mac SEs. I hated mine and was delighted when we finally gave up on them.

So my admiration for the guy is completely dispassionate. But genuine nonetheless. He was largely responsible for the Apple II, the Macintosh, the iPod, the iPhone, and the iPad. That's five dazzling, smash hit products in four completely different product areas. Toss in Pixar and it's six huge successes in five areas. I'm honestly not sure that any other businessman/inventor/product designer in the past century has a record quite that brilliant. We're not likely to see his equal anytime soon.