Economic Mysteries

Ὁ βίος βραχὺς,

ἡ δὲ τέχνη μακρὴ,

ὁ δὲ καιρὸς ὀξὺς,

ἡ δὲ πεῖρα σφαλερὴ,

ἡ δὲ κρίσις χαλεπή.

Life is short,

the scope of our art is large,

opportunity fleeting,

experiment fallible,

judgment difficult.

 Hippocrates, Aphorisms, Sect. 1, No 1

A while back I had the audacity to write a piece about our debt to the Chinese central bank. It was called “Mutually Assured Economic Destruction,” and it was wrong. Not completely wrong, but significantly. In it, I compared the U.S. international debt situation to a bunch of guys in a closet, each with a grenade strapped to his chest, each with a finger hooked in the pin of the next guy’s grenade. Everybody wants out, but nobody makes a move for fear of a) not getting out in time, and b) getting his own pin pulled. The grenade, in this labored analogy, stands for the instant devaluation of the dollar if anybody stops buying our debt, and the resulting financial chaos. Nobody likes holding a shaky currency, but nobody wants to end up underneath the stampede away from it, either.

There are a few problems with this story. One is that China has its currency, the renminbi, pegged against the dollar. That means that a dollar is always worth a certain number of renminbi, that number being 6.8 for the past few years. Everyone outside China considers the renminbi undervalued because the exchange rate effectively discounts Chinese exports. The conflict with my previous thesis is the reality that China can’t stop buying U.S. debt unless it is willing to see the renminbi rise. The only way China can maintain the exchange rate is to offer to buy U.S. Treasury bonds, as many as are left on the market, at 6.8 renminbi to the dollar. If the renminbi rises, Chinese exports fall, and Chinese unemployment rises, along with social/political unrest. Catch-22 for Hu Jintao. The Chinese government, in response to widespread criticism, has made a vague statement about letting the renminbi float higher against the dollar. A number of observers have pointed out that they have promised exactly nothing, and that the renminbi has stayed within its previous trading band.

Another problem with the story is that now, in 2010, even the dollar is looking good compared to the Euro, compared to stocks, compared to commercial bonds, compared to just about anything. The interest rate on U.S. 10-year Treasury bonds is around 3.5%, which given long-term inflation is essentially bupkis. That means that people and institutions are willing to buy relative safety in an ugly financial world by sacrificing return.

The Euro is in trouble because of the old problem of responsibility without authority. Back when the Euro was introduced, the European Central Bank had all the Euro Zone countries cross their hearts and promise to keep their debt levels low and their finances transparent. Of course, these were a bunch of sovereign nations with varying degrees of prosperity and starkly different sets of internal political pressures. The ECB had no authority to proactively reach into any nation’s internal affairs and stop them from borrowing. Countries, both geographically and economically speaking, on the borders of Europe acted under the assumption that Dad would bail them out if they got in trouble. The PIIGS, (Portugal, Italy, Ireland, Greece, and Spain) are all deep in debt, with no apparent magic streams of income showing up to get them out. The usual options for countries in this predicament are 1) give the finger to your creditors and declare a sovereign bankruptcy, or 2) crank up the printing press and create enough paper money so that inflation makes your nominal debt smaller in real terms. Euro nations are denied both of these options. The whole wheezing, clanking, shuddering Euro mechanism perseveres or collapses together.

About 20 years ago my then-girlfriend and I saved up a few thousand dollars each and decided to blow it on a trans-European ramble. We hit the UK, France, Italy, Austria, and both West and East Berlin, changing currency all the while. I remember being in Berlin, contemplating some minor purchase, and racking my brain back through half a dozen exchange rates trying to figure out what the damn price was in dollars. The value of money suddenly seemed so airy and arbitrary. I do remember that the Italian lira was pathetic, at about 1500 to the dollar, compared to a handful for francs, marks, and schillings. All these values shifted against each other on a daily basis, according to the whims of…what?

After reading the contrary opinions of dozens of economists, one could be forgiven for believing in capricious and vengeful Money Gods. I mean gods in the old Greek style; proud, devious, horny, sentimental, and cruel. I can imagine ones that would dick with us just to while away eternity. Think of anthropomorphic figures in gold armor or robes, armed with an abacus or a ballpoint tipped spear, endlessly setting us up. Hubris, nemesis, hubris, nemesis – till in our madness humans come up with the mythology of free markets and trickle down economics, churning our portfolios according to the superstitions of priests in pinstripes.

Swinging with the Hellenic mythology for a moment, I just imagined Tony Hayward (CEO of BP) and Lloyd Blankfein (CEO of Goldman Sachs) chained side by side to a rock, like twins of Prometheus. An eagle comes every day to feast on their livers, which grow back every night, ready for the next morning’s payback brunch, forever. Hey, at least Prometheus brought us fire.

Economics a complex subject and half of it is mythology. It also suffers from the problem of too many hands on the steering wheel, all pulling in different directions at different times for different reasons. Our economy is one of hundreds of interlocking economies, markets, and sub-markets, with millions of participants, all with different sets of ideas and information. It adds up to alternating periods of weaving, stasis, and apparently decisive moves. Someone trying to call the next direction needs to integrate rational, semi-rational, and irrational actors, plus other rational, semi-rational, and irrational actors trying to predict the actions of the first set, and each other. Players who realize that most people are operating primarily from the lowest, reptilian third of the brain have a slight advantage.

The only relief from this hash of conflicts is to contemplate physical reality in the long term. The virtual world of electronic financial transactions rests on the foundation of a very real, hard world of physics, geology, and biology. This world resists manipulation and imposes its own thoughtless will in the end.

Making a living in the real world is difficult. People and businesses are limited by resources and physics. It takes effort to move things around and transform them. When the financial firms realized that they could make money, not by investing in real world processes, but by making bets on the real world, or bets on bets on the real world, they created a virtual gold mine. They could disconnect themselves from physics and make money in a world restricted only by regulations. Which, of course, they mostly dismantled. The amount of money flowing through these virtual channels still far exceeds the amount of money connected with real world activities. What killed the bubble was the physical world.

Our economy, as I noted above, is still founded on manipulating real world objects. Virtual money and software can’t feed us, clothe us, or shelter us. The real estate market collapsed when the speculative price of houses exceeded the real world ability of people to pay. Real estate was only the most recent physical asset to be used as a nominal poker chip by speculators. Remember tech companies? Telecom infrastructure? In the 1920s it was the entire stock market, in the 19^th century it was railroads and canals, and in the Netherlands a few centuries ago it was tulip bulbs. All the bubbles eventually returned to the practical value of the commodity.

As will this one. Expect real estate prices to return to their inflation adjusted levels of 1997, just before the bounce. Expect the Euro Zone economies to return to their pre-Euro levels of prosperity. Expect our long-term level of prosperity to be governed by the net amount of useful resources we can sustainably extract from the planet.

“But make no mistake: the weeds will win; nature bats last.” Robert M. Pyle

The Crushing Handshake

I just read a piece in the Rutland Herald about Joe Trippi coming to work for Doug Racine in his gubernatorial bid. Trippi gained fame as the new media genius behind Howard Dean’s insurgent run for the Democratic presidential nomination. Dean did better than expected, raising a lot of money outside the normal DNC channels.

Some have noted that Racine has a nice guy image and might lack the teeth for hardball campaigning. This has been a failing of most recent Democratic contenders for the Vermont governor’s office. In contrast, Peter Clavelle, former mayor of Burlington, came across as combative and sour. I watched Clavelle in a debate against Jim Douglas at the Renewable Energy Vermont conference. Clavelle scored all the points on a factual basis, but Douglas had on his usual Teflon suit and engaged in genially vague deflection. Talking with a few other renewable energy professionals afterward, we agreed that Clavelle would get our votes, but that the public in general would be turned off by him. Apparently they were.

The secret of success in Vermont politics is the crushing handshake. Metaphorically speaking, the two (or more) contenders walk up to each other, smile broadly, and shake hands. They hold the pose for the cameras. In reality, each is squeezing as hard as possible, attempting to reduce the other’s metacarpals to chalk dust. Neither is allowed to show the least hint of anger or pain. They just smile, a sheen of sweat on their brows, perhaps a bit of moisture in their eyes, squeezing with all their respective strength.

In practice, this means saying that your opponent is a lying ignoramus, and supports policies destined to bankrupt the state or reduce us to slavery, without seeming to be angry, accusatory, or unpleasant. Jim Douglas’ success can be attributed to just this skill. What I hear people say about him is that in person “..he’s a really nice guy!” No doubt.  His public persona is bland to the point of unflavored oatmeal, a kind of Rorschach blot in gray. I’ve never heard the man raise his voice. And yet, with this low-affect voice he has criticized his political opponents to great effect. I should say, because of this low-affect voice – it’s his secret weapon.

Which brings me back again to Trippi and Racine. As noted, Doug Racine already has a nice guy image. He needs to use it like a spiked club. An odd simile, but that’s Vermont politics. Trippi and Amy Schollenberger (Racine’s campaign manager) need to manage the content and imaging of Racine’s statements to bust Brian Dubie’s chops – in an easygoing manner. Douglas has managed to make right wing myth and the usual hortatory blather sound like common sense. Dubie will try to follow his lead. Racine should be able to start with rational policy and make it appealing. It’s all in the presentation.

It may all be useless at this point. I recently spoke with a Vermont Democratic Party insider who had serious doubts about the ability of any of the Democratic candidates to beat Dubie. In his opinion, any one of them could have beaten Dubie if there hadn’t been a primary. With a primary, however, all five have been busy jockeying with each other instead of focusing on the general election. The real money is tied up until after the primary, and meanwhile Dubie is organizing. Another factor he mentioned was that more and more people are voting early (if not often). Almost a quarter of voters are voting with absentee ballots, which can be sent in the day after the Democratic primary. A double digit percentage of the votes could be cast before the Democratic candidate could even put out a press release.

As far as the Minor Heretic is concerned, any of the five Democratic candidates would be far superior to Brian Dubie. Doug Racine, Deb Markowitz, Matt Dunne, or Peter Shumlin would be perfectly satisfactory. Susan Bartlett less so, but I wouldn’t whine. The question for me is which one has the greatest political grip strength. Who among them can latch on to Brian Dubie and make him lose his cool? The race is his to lose at this point, and we need a forced error.



Proper Prior Planning

…Prevents Poor Performance, as the hokey saying goes. I read and heard recently about BP’s latest failure to stop the oil gushing out of their offshore well. Their next attempt will be to cut off the bent pipe with robots and place a new valve on top. Apparently the preparation for this will take four days. This raises a question: If the top kill procedure that just failed was such a chancy maneuver, why didn’t BP have the next option already in place?

I was discussing this with an engineer friend the other night, and he asked why they hadn’t pursued six different possibilities, both long and short term, all at once. Perhaps the third option would have worked and the fourth through sixth would have been wasted money, but so what? Spending money on contingencies is the price of safety.

This raises the further question of what they had, or didn’t have in place when the well blew. As I mentioned in a previous essay, BP could have spent what now looks like chump change on an auxiliary, remotely operated emergency valve on the sea floor.

That containment dome that they hurriedly fabricated – why wasn’t it already made and waiting on a barge? My engineer friend proposed the plausible idea of a set of hydraulic rollers that could crush the leaking pipe and roll a section of it flat. Why not have something like that ready to go, plus half a dozen other devices for various situations?

The answer, as always, is that insurance costs money and requires a long term view. BP, like the rest of its corporate cohort, has an eye on the next quarter’s earnings report.

But wait, there’s more. According to an article in the Alaska Dispatch (hat tip to HuffPo), BP and other oil companies have known for years that their blowout preventers only work about half the time. The last ditch device on the blowout preventer is called a shear ram. It is a combination of a sliding door and a knife, powered by a large hydraulic ram, that can cut off the pipe and seal the top of the well. As far back as 2002, oil companies were reporting that existing designs of shear rams couldn’t cut the pipe in all situations. An independent study in 2004 confirmed this. If there was a drill down the pipe, or if a weld was in the way, the shear ram failed. The existing designs had trouble with stronger modern pipes as well. Chevron has a stronger shear ram under development, but the industry has been operating with a demonstrably defective technology for the past eight years.

The investigative journalist Greg Palast has written about the response, or non-response, to the 1989 Exxon Valdez oil spill. The government required BP to have oil spill response equipment and crews stationed around Prince William Sound. (What? BP, not Exxon? Yes, BP was in charge of spill response in the Sound.) At the beginning the company did just this. They trained local Inuit people to handle spills, stationed skimmer barges around the Sound, and hired teams to be on call like firemen. Then they abandoned it all. The response teams were laid off and the equipment left on shore. When the Exxon Valdez ran aground there was nothing in place to deal with the disaster. But BP’s and Exxon’s quarterlies looked just that little bit better. Exxon blamed their captain, who wasn’t at the wheel, instead of the broken and never fixed radar. Twenty years later there is still a layer of oil three inches under the beaches. Prince William Sound is dead. The surviving natives got paid off at ten cents on the dollar.

BP is heading down exactly the same path today, trying to save money while the oil kills the Gulf of Mexico. I’ll bet the rent that BP will try to place the blame on operator error rather than ongoing safety violations and cost cutting. Likewise, it will be cheaper for BP to pay lawyers to obfuscate and delay than to pay the price of cleanup. And you can be sure that a full PR blitz will ensue, with high profile, yet inexpensive acts of kindness towards the residents of the Gulf Coast.

As long as I am channeling Greg Palast, I should note his recent report that another BP facility, the Alaskan oil pipeline, leaked 100,000 gallons onto the tundra last week. BP explained that “procedures weren’t properly implemented.”

Can we still pursue offshore drilling? Perhaps. There would have to be backup valves on top of backup valves, with skimmers and domes, booms and crews standing by. There would have to be constant inspections and perp walks for violations. With flow rates from existing wells disappointing their owners, the cost of safe operation might not appeal to the major oil companies. It might just be that offshore drilling in the Gulf of Mexico is technically feasible but not ethically feasible. Of course, ethics gets in the back seat when America wants to hop in its 5,000 pound SUV and go get a bag of chips. We’re all guilty, to some extent.

There’s the hard part – it’s about lifestyle change. Not new car models, not biofuels, not windmills and solar panels, although these things are part of a long term solution. We could ban offshore drilling, and we should at least scale it back, slow it down, and tighten it up, but what follows that decision?

What follows is the necessity of preparing for expensive oil. It will take fifteen years to work through our present stock of cars, and a similar time scale to make a dent in our fossil fuel use through efficiency upgrades and renewable energy installation. In the meantime it’s a question of how we behave. Forty years ago we drove half as many miles per person annually. Extrapolate that to today and it would eliminate 10% of the world’s oil demand, about 8.5 million barrels a day. Right now, offshore oil platforms in the Gulf of Mexico produce about 1.5 million barrels per day. A nine or ten percent reduction in our annual mileage would offset that. We’re going to have to reduce our driving by that much at some point, and then more. Why not now, before the next blowout?



A Miscellany

First, something fun that caught my eye, so typical of Japan. You undoubtedly have heard of their high-speed rail service over there. Sleek, aerodynamic trains rocket down the tracks at upwards of 200 miles per hour. At the tip of each train is a sculpted aerodynamic nose made of thin aluminum plate. The odd thing is that it is literally sculpted. Elderly Japanese craftsmen hand hammer each nose cone individually. A 73-year-old metalworker named Kiyoto Yamashita hammered out the first one as a rush job for the train serving the 1964 Tokyo Olympics. Now his company makes them for all of Japan’s high speed trains. Nobody has come up with a cheaper or better method. As a former professional blacksmith I find it satisfying to know that my craft still surpasses high tech solutions somewhere in the modern world.

Continuing on the old vs. new theme, I’d like to recommend the Park-McCullough House in Bennington, Vermont, as an interesting place to visit. A lawyer and southern Vermont native, Trenor Park, made his fortune as a lawyer and land speculator in California during the gold rush. He returned home a millionaire and in 1865 he built a 42 room summer home in the grand French style. The Parks and McCulloughs lived there for the next 100 years. After the last family resident died it was turned into a museum. Trenor Park was deeply involved in the design, and his daughter renovated it for a presidential visit in 1891. The result is grand, yet human scaled, with rich detailing. Every room has custom carved woodwork and a marble fireplace. Apparently the occupants never threw anything away, because the place is stocked with furniture, paintings, carpets, clothing, and housewares, all beautiful. It’s a time capsule of Gilded Age life in the upper class. It has a carriage house that I’d be happy to live in, pleasant grounds, and even a children’s playhouse that is an exact miniature replica of the main house, complete with cupola and slate mansard roof.

On a more topical note, I have an idea for compensation for the BP/Deepwater Horizon spill. It’s called, “You blow it, we own it.” If an offshore well blows out and spills oil for more than a day, the U.S. government takes possession of the well and contracts its operation to another oil services company. In the case of the Deepwater Horizon we could be looking at a gross of about $500 million a year (at 10,000 barrels a day), with the development costs left on BP’s tab. That would tighten up deep water operations and oil executive sphincters.

There’s a trend on National Public Radio that is annoying me. Part of it is those Story Corps segments where family members interview each other. Part of it is disaster and tragedy coverage where they interview the family member about the victim. They refer to this kind of stuff as “driveway moments.” Supposedly we are listening to these stories on the drive home and, unable to tear ourselves away, we sit in the car listening after we are in our respective driveways. I call it lachrymography, the exploitation of tears.

I have to give them credit for knowing their medium. Radio is intimate. Scott Simon’s soft voice is right there in your ear as he sympathetically probes the wounds of some surviving spouse. I also credit them for being good at it. My breakfast has stuck in my throat more than once as some poor soul has shared a loss with millions of strangers. Afterwards, I feel manipulated. NPR is playing me for my dopamine and my donations. There is some kind of relationship between NPR and its faithful listeners that suspends cynicism, gets far enough into the listener’s ear that these exercises in controlled pathos strike home. I’m not saying that there is some evil genius at NPR headquarters cackling, “That should have them sobbing on their steering wheels!” It is something that has evolved, survived, and become more sophisticated, as editors drift towards stories that contain that donation-laden, quavering voice.

Here’s a note from the flash collapse and rebound of the New York Stock Exchange on May 6. As you may remember, the Dow Jones Average lost and regained a thousand points in the space of an hour and a half. There is an international consulting firm called Accenture that was trading for about $44 a share just before the plunge. It briefly reached a low of 4 cents before rebounding to $41. If someone had been able to jump in at the right moment and buy $5,000 worth of Accenture at the bottom, they would have walked away with $5 million an hour later. Of course, only some major firm with computer programs in place could have pulled off anything like this. These big traders with computerized high speed trading are generally considered the culprits behind the plunge. This thousand to one opportunity is another piece of evidence that the stock market has transformed from a place for investment to the world’s most complex casino.

Some startup drug company is selling for $12 a share. I buy a thousand shares. The next day they announce a successful trial of their new (insert name of common affliction) drug. Their stock jumps to $20. I sell, and pocket $8,000. A week later someone questions their study and the stock drops to $10. The people who bought at $20 grieve. What has been accomplished here? What net social benefit has come out of these transactions? I’m trying to see a substantive difference between this and pari-mutuel gambling on horse races. Yes, the drug company needs investors, but what benefit is there from this volatility?

I’m in favor of what is sometimes called a Tobin tax. It is a tenth of one percent levy on all stock exchange transactions. The NYSE, AMEX, and NASDAQ together are churning about $90 billion a day. A 0.1% Tobin tax would put $90 million per trading day into our coffers, or roughly $22 billion a year. It would also discourage high speed trading, reducing market volatility. There would be howls of outrage on Wall Street, but that is soft and gentle music to my ears.



The Important Bill

Occasionally I get the sense that someone in Washington D.C. is actually paying attention. For years I have been pounding a single note on the political keyboard, namely campaign finance reform. There is a bill in play right now that actually addresses the problem.

I have written about how people focus on political personalities while ignoring the system that promoted those personalities. Imagine you have a machine that makes coffee cups. You pull a lever and out comes a cup. You pour coffee in it and find that there is a hole in the bottom. Coffee leaks out on your lap. You discard that cup, pull the lever again, get another cup, pour more coffee, and get another cup in your lap. Repeat, repeat, repeat. You can discard cups forever, but until you fix the machine you are going to keep getting burned.

The most significant two numbers in U.S. politics are 2,400 and 30,400. These are the numbers of dollars that an individual can give to a federal candidate or a national party. The problem with these numbers is that very few people in this country can afford them. Perhaps one out of a thousand Americans can donate anything close to these amounts on a regular basis.

The Public Interest Research Group did an analysis of campaign finance over a number of election cycles and found that, on average:

• Whichever candidate in a congressional primary spent the most money won, 9 times out of 10.
• The high spender outspent the number two spender 3:1 – it generally wasn’t close.
• 75% of the money that these high spending winners raised came in big chunks - $500 up to the $2,400 limit.

 I like to say that the difference between elections in Iran and elections in the U.S. is that in Iran a small group of mullahs decides who gets to run for office and in the U.S. a small group of millionaires makes that decision.

The bill in question is the Fair Elections Now Act. It would beef up the public campaign funding available to candidates who are either unwilling or unable to schmooze millionaires. The vital number here is $100, the limit for contributions to candidates taking advantage of the public funding. Each candidate would have to raise thousands of sub-$100 donations in order to qualify for funding.

Qualified House candidates would get $900,000, split 40/60 between the primary and general elections. Senate candidates would get $1.25 million plus $250,000 per district in their state, again, split 40/60. This is real money for contesting an election.

Even better, if a publicly funded candidate faces a high spender, he or she can raise more $100 donations and have them matched 4:1. This provides the monetary parity that swings elections.

The cherry on top is mandated discounts on media buys and media vouchers of $100,000 per congressional district.

The question must pop into your mind: Where will all this money come from? Oh, it gets better. Government contractors (Halliburton, anyone?) will pay a percentage of their contracts into the campaign finance fund. The fund will also get the proceeds of sales of portions of the broadcast spectrum.

You can read about the legislation in detail at Public Campaign and Fix Congress First!. The Senate bill is S.752 and the House version is H.1826.

This is a complete game changer. Finally, candidates with opinions that might offend the mighty will have funding equal to their less discriminating opponents. This is the fix that the machine has been needing.

Thankfully, all my elected representatives are on board. Senators Leahy and Sanders will cosponsor, as will Representative Welch. There are over a hundred cosponsors in the house right now, but there are many yet unconverted.

I don’t ask for action from my readers very often, but I do now. Forward the news of this legislation to everyone you know. It isn’t a liberal/conservative issue, it’s a 99.9% of Americans who can’t fling $2,400 checks around issue. Ask people to contact their Senators and Representatives and firmly demand their support for this bill. Those legislators that are already supporters should get praise and thanks. Here’s a list of who’s who in terms of demands or thanks.

Examine any government policy that angers or mystifies you and you can almost always trace it back to the undue influence of big money in our electoral system. The big money rewards the spineless, the hacks, the flunkies, the ethically challenged, the shortsighted, and the just plain evil. The Fair Elections Now Act is the most important piece of legislation I have seen since I started paying attention to politics. Let’s get it passed.