Bad Money

That’s the new book by Kevin Phillips.  He concludes:

The thirty- to forty-year tumble from national preeminence that made life more glum for most folk in seventeenth-century Spain, and eighteenth-century Holland, and the Britain from the 1910s to the 1950s may be somewhat moderated for the United States because of a position as a North American continental economic power with a large resource and population base…

Boo hoo, I say; I’ll be crying all the way to Rio.  Overall this book is a catalog of the usual arguments about the financial problems of the United States, peak oil, the potential weakness of the dollar, and related worries.  Phillips doesn’t seem to think that finance is much of a productive economic sector.  He is keen on the "inflation is larger than we realize" line, citing high growth rates for M3 (he doesn’t realize how much the different aggregates can move around and differ from each other) and then the Fed’s discontinuation of that statistic.  But who has been tricked?  Either the current market estimate of inflation is the best estimate available, or you know that it is wrong and you will be a very rich man.  I find the former scenario more plausible.

If there’s anything wrong with gdp statistics, it’s either environmental problems or that we don’t have good measures of the productivity of government itself.  Those problems are built into how the number is calculated and there is no conspiracy to make America look much richer than it really is.

There is remarkably little on future expected productivity growth or whether America will solve the problem of educating its non-upwardly-mobile, which are both (the?) major issues for our economic future.  The author should spend a week locked in a room with the Solow model.  There is also precious little recognition that America in twenty years’ time will almost certainly be a good bit wealthier than today.  Given that no other country is about to take us over, does relative international status really matter so much for the happiness of Americans?  I don’t think so.  The richer the Chinese get, the more I feel good about living in the world’s first country to be a true product of The Enlightenment.  If only Phillips could feel the same way.


Haven't read the book so far...still
-the Solow defense?
-retrain the laggards initiative?
-the happy Americans defense?

Maybe this is Kudlowism [bullish on America etc etc etc] dressed up in academic arcana.

Tyler - your readers, including this one, want more...

Kevin Phillips really rubs me the wrong way. He make all these negative claims that seem just wrong.

I think something funny is going on. There is a lot of money washing around in the investment (rich man's) world, but at the same time the middle (and lower) classes are being squeezed.

What's more ;-), I believe the above is a statement of fact, and that I haven't got to politics or prescriptions yet ... and I may not.

Where I'm going is to a question ... if seas of investment monies flow, even as "inflation" rises ... how exactly can investors demand the kind of premium you are asking for?

How do I, as an investor, demand it at this point?

I think one thing going on, Person, is that people are changing their expenditure basket. It is being called a slowdown in consumer spending in face of both higher prices and lower confidence ... but it doesn't seem to be producing the price moderation predicted.

It's not a happy situation, even if average growth over then next 20-30 years proves strong.

(Talk to many poor people Tyler?)

Is it safe to assume we can just ignore these types of books? How many times do we need to vacillate between "Dow 36000" and "Bad Money" before we stop reading? It might be instructive, Tyler, to post a chart of log GDP per capita over the past, say, 100 years; I'm looking at that chart right now, and aside from the Great Depression, the business cycle is essentially invisible.

Recessions do not mean America is doomed, and booms do not mean America is destined for eternal prosperity. We're only six years away from $.85=1 Euro and "The Era of $10/barrel oil", which was only 10 years away from "the giant sucking sound" that would destroy American wealth, which was...

If people should be upset about anything, they should be upset about the enormous relative decline of our infrastructure and education level.

the usual arguments about....peak oil
As a layperson, I have always been confused by the dismissal of system limits in economic discussions, and peak oil is as baffling as the rest.
Let's say that the average person is able to apply every calorie they consume every day to productive work. Further, let's say that the average person is a Tour de France competitor, putting away as much as 10,000 calories/day.
A single gallon of gasoline contains roughly 300,000 calories. Put another way, having a gallon of gasoline is the same as having 300 people work for you for a day. Hence, slaves in America prior to the industrial revolution.
When we reach peak oil, what will replace it? Natural gas is already in decline in the US; using coal in your car via Fischer-Tropsch is inefficient (and we'd need a long lead time to build plants, anyway); nuclear power also had lead time problems and would require electric cars, which we don't exactly have ready at hand, and it's not clear that .
The geologists generally agree that we have burned though very close to half of what is profitably extractable, and have no replacements close at hand -- and this doesn't even address non-fuel uses of oil (agriculture, plastics, pharmaceuticals, etc.)
So why the dismissive attitude about peak oil? It seems a huge economic event to me.

"Either the current market estimate of inflation is the best estimate available, or you know that it is wrong and you will be a very rich man. I find the former scenario more plausible."

Because the market is *always* right, innit? Ergo these persistent bubbles in which the market is dead wrong to such a large extent and for long enough periods that our economy swings precariously in the balance. Precarious enough to warrant government bailouts of private corporations, for example.

But nothing to worry about really.

"The spread between nominal Trasury and TIPS yields is a speculation on how the CPI will print not how actual inflation will run."

I probably missed some point ... but I don't believe "spreads" even if they chronicle Delphic prediction in general, are likely to do do so at this particular point in time.

We are in the midst of a strange credit crunch, with a lot of money fleeing to "safety" even at uncertain "costs."

When buyers are arguably betting on the "smaller loss" of available choices, spreads are pretty meaningless.

Doug Blair: Peak Oil would not mean the end of oil supply. It only would mean decades of rising prices, during which substitutes become both more technologically possible and more price competitive. 300 slaves cannot convey me from LA to Chicago in 24 hours, even if they are Lance Armstrong.

System limits are dismissed because they usually assume no reaction to changing costs and dismiss the value of human innovation.

Ian: Psychology may explain why people take a dismal view of the world. Economics explains why, despite their bad attitudes, people aren't starving to death. Eventually the facts of wealth overcome the angst. Sadly, it seems that people use their increasing free time to find shinier and more grand ideas over which to despair.

Hi Foxmarks.
Thanks for the response. Two quick thoughts:
Doesn't it make as much sense to disregard human innovation as it does system limits? I think we have to consider both if we're to be realistic.
Note that relatively mild disruptions of oil supply in 1973-74 and again in 1979 had significant impacts on our economy. I imagine that a global version of these same disruptions would have much more significant impact, no?

Re. energy - the market will produce new energy sources OR new efficiencies OR (failing those two) reduced productivity.

I personally think new efficiencies will pan out better than new sources (as they have done over the last say 20 years).

Note that relatively mild disruptions of oil supply in 1973-74 and again in 1979 had significant impacts on our economy.

Those impacts on the economy were caused far more by government reaction to the OPEC embargoes than by the embargoes themselves. The proper government reaction is to do nothing, allow prices to rise, permit the landing of windfall profits, and watch the domestic supply increase along with the global market of sellers and resellers. In 1973 and 1979, government responded with price controls, rationing, and taxes on producers -- a practical recipe for shortages and economic disruption.

So, yes, if governments behave like economically illiterate idiots -- see, for example, Kevin Phillips and the panoply of Peak Oil doomsayers -- then peak oil could prove a problem. But it should not pose more than a recession-inducing bump to a free economy.

I'm not sure that saying that limits on natural resources should be considered as serious as human ingenuity constitutes "hysteria," but anyway....
I agree with you that the various capabilities of oil are advantages which we have enjoyed immensely. I'm saying the absence of the advantage is likely to cause some sort of economic difficulty -- or "change", if you prefer. For a gross non-1970's USA example, consider WWII. This was largely fought over access to oil; Japan lost almost entirely due its inability to maintain certain levels of access to oil, and Germany lost for mostly this reason. (The eastern front being opened as Hitler needed the Baku fields to fuel his war machine). The Germans did the rational thing at the time: made gasoline from coal. it wasn't competitive, as the "marketplace" of the European theater showed.
What reason do we have to think that there will be no economic repercussions to peak oil, as the original post seemed to imply?

Actually Mike, what we've been seeing is that the theoretical break-even point for some alternative fuels rise along with traditional fossil fuels. Why? Easy, they have (hidden or obvious) fossil fuel inputs to their own production.

As an example, tar sands consume massive quantities of natural gas, a clean burning fuel we'd like to use directly.

Much as I'm a fan of Tyler, his pronouncements about the economy are remarkably bold considering the universally poor record of mainstream economists at predicting economic aggregates, whether for next quarter or for next decade.

The arguments about 'the financial problems of the United States, peak oil, the potential weakness of the dollar' may be ones that we are tired of hearing. But the reality is that per serious commentators (start with Volcker) we remain in a very serious financial crisis, the dollar has depreciated by 40% in the last 6 years and crude is up more than 3x. When the Federal Reserve publishes a paper exploring whether the US govt might be bankrupt (the Koltlikoff), perhaps one should take some of these scenarios seriously.

"Either the current market estimate of inflation is the best estimate available, or you know that it is wrong and you will be a very rich man."
I can assure you that many very rich men have through appreciation of this simple insight become very very rich men. Some of us speculators of more modest means have done okay too. Many of those commentators concerned today about the possibility of financial ruin for the US have been warning since 2002/03 of the coming commodity/precious metals bull market and the risk of runaway inflation in the US.

It's incredibly nihilistic to suggest that analysis suggesting a potentially profitable opportunity must be missing something otherwise the author would take a position himself and keep quiet.

M2, M3 and broad credit (including asset-backed issuance) tell the same story over a longer horizon. So his point stands, regardless of whether you think focusing on a single aggregate might be giving you a distorted picture.

> Phillips doesn't seem to think that finance is much of a productive economic sector.
How much economic value was really added by that part of the economy (from the money market funds, to the investment banks, to the mortgage brokers) devoted to allocating credit to people who had no potential ability to repay it? Versus the value allocated to that sector's activities in the national accounts...

>If there's anything wrong with gdp statistics, it's either environmental problems or that we don't have good
> measures of the productivity of government itself. Those problems are built into how the number is
> calculated and there is no conspiracy to make America look much richer than it really is.
Were the conclusions of the Boskin commission exactly right? Shouldn't we go back and revise pre-Boskin GDP numbers to reflect our much superior methodology?

> There is remarkably little on future expected productivity growth or whether America will solve the problem
> of educating its non-upwardly-mobile, which are both (the?) major issues for our economic future. The
> author should spend a week locked in a room with the Solow model. There is also precious little recognition
> that America in twenty years' time will almost certainly be a good bit wealthier than today.

Forecasts of productivity growth appear to have been worse than useless in the past (remember how bright things looked at the peak of the tech bubble), and we can't even rely upon the statistics for the past few years given the possibility of substantial revisions. Is there some reason that our forecasts should start to suddenly turn useful today?

I suspect the reason that he doesn't deal with the Solow model is that it's not very helpful in exploring the issues he raises in his book.

I accept your comments, but they don't address my core question: We have lots of history that says the availability of natural resources has a profound effect on economic development (or the lack thereof). Why, then, is the topic of peak oil waved away as being unimportant to economic discussion?

Sorry; I guess you did address my point. But let me try again, because I think the point I made wasn't what I meant to make.... :-)
wrt peak oil, I think the degree of concern/interest in economic circles is much lower than the evidence suggests it should be, to the point where people who even mention the two words together are often called "hysteric" by economists. OTOH, the Department of Energy has said that we need 20 years lead time to build new infrastructure to allow new energy sources (if/when/as discovered/developed) to pick up from oil/other fossil fuels smoothly. I believe their exact phrasing (I can't find the cite at the moment) is that we can expect "severe economic consequences" if we don't allow this time for adjustment. Only the most optimistic estimates of oil reserves suggest that we have 20 years left of production at this level; some argue that we have already passed peak. In the meantime, our incentives arguably keep the price of oil artificially low in the market (taxes for roads and military protection of petroleum supplies, to name two major subsidies). In Europe, in contrast, incentives are set to inflate the price of oil, and thus encourage (rather than discourage) the development and deployment of alternatives that we know we need.
Here's my question: Why does this seemingly-serious situation elicit such dismissive rhetoric from economists?

Odograph, the perfect hedge is probably not possible, but you can get pretty close.

Energy ETFs are easy to buy with low fees.
As are Agriculture ETFs.
Same for metals.
Obvioulsly it is easy to own a home or to buy a real estate investment trust.

So right there you have covered

energy: for heating, driving and electricity (since Natural gas is a major fuel for power) and as an input to many goods

food: since corn, soybeans and wheat are the major feedstocks for almost everything we eat today. Plus you can find indexes that include stuff like milk and meat if necessary (buy I think corn, soybeans, wheat and rice do the trick)

housing: Owning your own home is obviously an inflation hedge.

Stocks also tend to be a good bet on inflation. Stcck prices inflate right along with other assets.

extraordinary claims require extraordinary proof
But some of the peak oil crowd (not of of whom are calling for armageddon tomorrow) would say the same thing about economist's position. Fossil fuels are, for all intents and purposes, a one-time resource; their replenishment will take millions of years. Before the Industrial Revolution the planet supported roughly a billion people on a purely solar energy budget. We don't know what steady state we can maintain with renewables but we do know it will take decades to build infrastructure to use them. We also know that we're, at best, right up against the lead time we need for a smooth transition. This is all well-known and not at all controversial. The idea that this would not be hugely disruptive would seem to be the more extraordinary claim.
Put another way, why aren't you concerned (at least) about existing distortions in the market that delay our investigation/deployment of alternatives?
And thanks for keeping this civil. Not all of these conversations go this way. :-)

A lot of the Phillips book is simply economically illiterate.

Food riots are presently engulfing the nations of Haiti, Egypt, Bangladesh, the Philippines, etc. There are reports out this past week detailing how even the Japanese might become susceptible to the food crisis.

And yet, during all the past several years of rah-rah-ing from market fundamentalists about how wonderful the emerging economies of India and China will be for everyone concerned, there were very few, if any, predictions of the massive food-price inflation now gripping the globe. The increasing appetites of hundreds of millions of newly-middle-class Indians and Chinese never seemed to figure into the equations of the free market-eers.

Economic experts, economic rubes -- who's to say?

"That has little bearing on why a decrease in oil production will disrupt the economy so much that it will preclude normal market responses and lead to irreversible global depression."

LOL. I like the word "irreversible" in there. Sort of sets the standard for concern, eh?

OK, sorry. I think I did try to stake out my moderate position above. If it is just an argument (in the PO lingo) between cornucopians and doomers, that's not really interesting (or useful) to me.

The really interesting problems, choices, decisions, are around boring little things like fleet mileage and whether CAFE mileage requirements amount to a hill of beans (etc.)

Your use of the word "smooth" is telling: There is no evidence for the presence of discontinuities in either supply or demand.
The price of a barrel of oil has doubled in the last year; it's now more than six times the price it was ten years ago. This isn't a discontinuity?

That has little bearing on why a decrease in oil production will disrupt the economy so much that it will preclude normal market responses and lead to irreversible global depression.
"Little bearing"? If the incentives in the economy prevent the market from responding in a way that would help us prepare, they would seem to be important.

I made clear what I was arguing against and what I wasn't.
I believe this started with me asking why economists generally discount the importance of limitations in natural systems. I would argue that natural resources tend towards discontinuous pricing behaviors (exponentially rising) as they near depletion. For example, the cost of a breeding pair of passenger pigeons was very low in 1895 but went to infinity in 1914. While we are nowhere near full depletion of petroleum, we're seeing pricing behavior that matches the "undulating plateau" predicted by the peak oil community, which, according to theory, will resolve towards exponential price rises as the peak becomes clear. This is a position I believe to be generally disregarded by economists, but, at the same time, geologists and those who refer to and draw conclusions from geologic data are to trust in "human innovation."

doug_Blair: I don't think you're getting very responsive responses here. I think a better discussion of your concerns from an economist would be this link, in which James_Hamilton (who seems to pay more attention to Peak Oilers) discusses what most economists have a hard time believing, and what you would need to convince them of.

the rate of oil price rises far outpaces the development and deployment of alternative infrastructure to serve the same needs?

But my point is that alternatives at higher prices do not need to serve the same needs. Some of those "needs" are "wants". Some are even "superfluous consumption", such as taking an afternoon drive in the mountains. Every use of oil has a value to the consumer. When the price of oil exceeds that value, that use ends. Not only does this remove that particular demand at that price: It leaves more oil around for the remaining demands.

That doesn't mean that there won't be a problem. It means that the problem won't be catastrophic and hit everybody simultaneously and equally. It hits people at the margins. It will be dealt with at the margins.

Since current policy artificially depresses the cost of oil in the US marketplace, I would further argue that it is a destructive policy.

I can agree that government policies that bias the supply, demand, or price of oil should be terminated. I also think that no new government policies that bias the supply, demand, or price of alternatives to oil should be initiated.

It's not clear how much of the world food shortage is due to land being taken out of food production and put into biofuels production.

Well, food-based biofuel development is pretty dumb. It's also uneconomical at present prices, save for government subsidies of alternatives to oil.

OK, but what if the market's signals arrive too late for us to build alternative infrastructure?

I have no compunctions about taking advantage of innovations discovered in nations whose governments may in the future prove to have had more foresight than markets did.

In terms of the discussion of peak oil:

I think you are all overlooking the elephant in the room.

The war in Iraq is about oil. This war is the market's and the US government's way to resolve the supply issues. You want a discontinuity; well you've got it right in front of your eyes.

It doesn't matter if there is enough oil in the ground to last another thousand thousand years. Markets may very well solve the energy dilemma, but there is no reason to think that the solution will be without great pain or without a lot more Iraqi-like wars.

All this talk of letting the markets solve the problem is very nice until you realize that one of the mechanisms markets may use is war and embargoes, and long lines, and shortages and a lot of suffering until some kind of balance is restored.

Tyler -

I think the best explanation of today's situation is economic and political decline, masked by extreme technological growth.

Productivity in a number of sectors has shown amazing increases. Our gadgetry is wonderous.

But if due purely to regulations and taxes, 15% of our GDP gets locked up in the healthcare industry, we'll have a wide disparity between GDP growth and actual standard of living.

We've become far more productive, but at the same time, more people end up in the government or in the highly regulated sectors, which makes us poorer. The Solow model does not address the systematic misallocation of resources due to regulation, and I believe that is what we are seeing today.

"If you think the commodity ETFs are bubbled you could easily short them, but you don't really think that, do you?"

What are you, a day trader?

Get over that thinking before you bankrupt yourself.

As John Maynard Keynes succinctly commented, "Markets can remain irrational longer than you can remain solvent."

But Odograph you cannot both believe that Energy ETFs are bubbled and that peak oil is around the corner and that energy price inflation will continue to erode your purchasing power. It is either one or the other.

Either the fed is right and core inflation (leaving out bubble prone energy and ag) is a better measure of long term inflation.

Or energy and ag refelect the true inflation and due to resource contstraints and printing money that inflation will continue and the indexes will be a good hedge.

It can't be both.

Here is the point.

Right now commodites prices are high. And consequently inflation is high in products of commodities. This phenomenon will either stay the same (no inflation in these areas) continue (more inflation in these areas) or reverse (less inflation in these areas).

If it is a bubble then you and I should expect inflation not to continue because the bubble will eventually reverse and the prices of these commodities will come down. Markets are over estimating inflation.

If they are correctly priced then we have seen inflation but should not expect more.

If they are under priced then the market is underestimating inflation/resource constraints and we should expect inflation to in those areas to go up and buying those funds wlll be a good hedge against that eventuality.

You can't believe both that you will experience a lot of inflation from rising fuel prices from this day forward and that the etfs are overpriced because they reflect today's market and cash prices are very close to the front month futures.

You can believe that we will never return to $20-$40 oil but that prices are going to fall from today's prices, but that would still entail disinflation from today's prices. That would mean a reversal of recent inflation trends.

"You seem to be combining an Efficient Market Hypothesis with a belief in bubbles."

I know that is kind of a joke, but I don't think my argument has anything to do with efficient markets.

I am stating a near mathmatical certainty.

ETF Payout= Pfuture-Ptoday
(ETFs typially hold the front month oil contract which is HIGHLY correlated to cash oil for a number of reasons principle amont these is storage/delivery arbitrage).

Energy prices in the future can only do 1 of 3 things

go up, go down, stay the same.

if they go up, energy inflation goes up and you make money on your etf

If they stay the same there is no inflation from energy prices and you don't make money on the etf.

If they go down there is energy disinflation and you loose money on your etf.

None of this requires that markets are efficient just that the etf tracks the front month contract and that the front month contract is well correlated with cash prices. Markets could be wildly irrational but chickens always come home to roost in the cash market do to the ability to deliver actual oil against a futures contract.

(Actually I was thinking you were trying to get me to bet on my bubble call. I may think the bubble will pop before fundamentals reassert themselves, but I'm not crazy enough to gamble on calling those turns in the market.)

;-). More fun tomorrow maybe ... busy today. Good luck with that hedge.

eccdogg: what does oil have to do with inflation? Inflation is purely a monetary phenomenon. Oil price increases can drive up prices all across the economy, but that doesn't make it inflation. You need to read your Friedman and von Mises.

"Bad review" is more like it.

September 2008 has shown us that Tyler Cowen, pseudointellectual extraordinaire, had it wrong, and I bet even Mr. Cowen feels pretty glum.

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