Posted in Economics, General Musings at 10:22 am

WTI oil futures are trading at over $106 today.  This poses significant risks to the economy.  The fact that a number of “experts” in the media are going out of their way to tell us that it does not pose a threat should drive the point home.

In “Crude Realities”, Jeremy Siegel tells us not to worry:

“The U.S. consumes about 19 million barrels of oil a day and produces about 9 million b/d, meaning we import about 10 million b/d. Each $10 rise in the price of a barrel of oil increases our import bill by about $100 million a day or about $36 billion a year. In our $15 trillion economy, this increase costs us about 2 tenths of one percent of GDP. If crude rises $20 barrel, as it has from the beginning of the year, this increase will shave about 4 tenths of one percent from GDP. This is hardly debilitating to an economy that is expected to grow between 3% to 4% this year. If the price increase is much larger, say to $200 a barrel, this is more serious and could shave two percentage points from our projected growth. That outcome is likely only if there is a major disruption to the flow of Saudi Arabian oil.”


Seriously?  A couple of tenths of a percent off GDP?  Has he never heard of the effect of expectations?  Has he never heard of the concept of a consumption multiplier?  The accelerator effect on investment?

This is the same sort of simple-minded analysis (multiply the percentage of production costs attributed to oil by the price increase and subtract the result from GDP) that led him to declare a few years back that the subprime mortgage problem was “contained” (because subprime was just a small percentage of all mortgages and only a small percentage of subprimes were in default).  You’d think he’d have learned his lesson.  Apparently not.

The Economist does a little better in declaring that oil prices are “more of a threat than investors seem to think.”  Nevertheless, even they go on to underestimate the problem:

“Dearer oil still implies a transfer from oil consumers to oil producers, and since the latter tend to save more it spells a drop in global demand. A rule of thumb is that a 10% increase in the price of oil will cut a quarter of a percentage point off global growth. With the world economy currently growing at 4.5%, that suggests the oil price would need to leap, probably above its 2008 peak of almost $150 a barrel, to fell the recovery. But even a smaller increase would sap growth and raise inflation.”


There seems to be this idea that while the oil price spike of 2008 contributed to the economic downturn, we need not really worry unless the July 2008 peak of $147.50 is breached.

Let’s not forget that the peak number quoted was a one day event, even though the price spike was not.

To put things in context:

  • We entered 2008 with oil a little over $95/bbl and exited 2008 with oil just under $45/bbl.
  • Oil was only over $100/bbl from late February through late September.
  • Oil was only over $120/bbl from mid May through early August.
  • Oil was only over $140/bbl for a few days spread out over 3 weeks in late June and early July.

When you think of the oil price spike of 2008, don’t think of $147 oil.  Think of oil trading between $100-$125 for six months or so.  We’re already in the early stages of the 2011 repeat.

WTI Spot prices from:


FCIC Report

Posted in General Musings at 5:10 pm

I picked up a copy at the local B&N last night.  Stay tuned.  There has been quite a bit of commentary on it over the last week or so, but I’d prefer to actually read the whole thing before commenting.


And Spain?

Posted in Economics, General Musings, Politics and Policy at 7:12 pm

Assume you are a neutral observer, behind a sort of Rawlsian Veil of Ignorance, tasked with examining an unknown country’s economic situation and making policy recommendations.

The facts are: 20% unemployment rate, 0% GDP growth, inflation at just over 2%, and a budget deficit of 2.96% of GDP and down significantly from a year ago.

Would anyone in their right mind recommend further austerity, e.g., spending cuts and tax increases, given this set of facts?

Ireland, then and now

Posted in Economics, Financial Markets, General Musings, Politics and Policy at 6:17 pm

In 2007, Ireland ran a budget surplus of 0.051% of GDP.  That was the 5th straight annual budget surplus for Ireland.  In fact, from 1997-2007, Ireland ran an average 1.6% annual budget surplus.  Likewise, in 2007, Ireland’s total government debt was 25% of GDP.  This was not a country on the brink of a fiscal crisis.

Fast forward to the present.

Ireland is now running an annual budget deficit of around 32% of GDP and the national debt is 65.6% of GDP.

What happened?  Obviously the financial crisis led to a large falloff in tax revenue, along with an increase in countercyclical spending.  That’s not the main story, however.  What really happened is that Ireland experienced a banking crisis and the Irish government guaranteed its banks.  That is the prime driver behind the numbers and is the motivating factor behind the ongoing bailout talks.

Ireland is about to inflict an unconscionable amount of pain on its citizens through a combination of austerity programs while saddling them with an enormous amount of new debt in the form of the EU/IMF bailout.  Is this necessary?  This amounts to a naked transfer of wealth from ordinary Irish citizens to a handful of German, British, and French banks who are creditors of the failed Irish banks.  There’s no making the losses disappear, the only question is who realizes them.  It has been determined that the Irish government, and by extension, the citizens of Ireland, will realize the loss.  Why?  Why not the bondholders?


Thoughts on the “deficit crisis”

Posted in Economics, General Musings, Politics and Policy at 11:15 am

Post-WWII (1946-2009) Average Federal Gov’t Spending and Receipts as a % of GDP:

Receipts: 17.8%
Spending: 19.6%

2007 Numbers:

Receipts: 18.5%
Spending: 19.6%

2009 Numbers:

Receipts: 14.8%
Spending: 24.7%

There were no significant tax policy changes between 2007 and 2009.  Nor were there any major spending policy changes apart from those incurred due to the financial and economic crisis.

The long-term historical budget gap has averaged around 1.8-1.9% of GDP.  Immediately prior to the crisis, it was right around, if not slightly below, the long term average.

The current budget gap of around 10% of GDP is due almost entirely to the financial crisis which caused a falloff in GDP (and thus, tax receipts) and the need for temporary emergency spending.  Eventually, receipts will rise and spending will fall as a result of pickup in GDP and the winding down of temporary emergency programs even if we take no deliberate action.  Adopting austerity measures to try and prematurely bring down spending and increase receipts will likely have the opposite effect.

There has been no significant increase in the “structural deficit” over the past 3 years.  While the Bush tax cuts and the 2 wars we’re fighting have obviously played some role in our budgetary position, they’re not the major drivers.  Democrats who say otherwise are lying.  Likewise, Obama hasn’t done anything to increase the structural deficit either.  Republicans who say otherwise are lying.  The entire “deficit crisis” meme is nonsense.  Long term, we do need to get Medicare costs (and healthcare costs in general) under control; short term, the focus needs to be 100% on economic growth and jobs, even if that means bigger deficits.


Benoit Mandelbrot

Posted in General Musings at 8:00 pm

Benoit Mandelbrot died at the age of 85 today.  Mandelbrot was the mathematician best known as the founder of fractal geometry.  He was also a lifelong student of financial markets.  His book, The (Mis)Behavior of Markets, was a classic that argued against the financial orthodoxy of building models based upon probabilistic risk assessments, and instead argued in favor of markets as being dominated by uncertainty (in a Knightian sense), turbulence, and non-linearities and being far more risky than standard models suggest.  He will be missed.


Apologies for the infrequent posting

Posted in General Musings at 8:36 pm

The last couple of months have been busy, between working full time, raising a family, and pursuing an MS in Finance part time.  Although I’m not really sure that anyone actually reads what I post here anyway.


Income Distribution Changes

Posted in General Musings at 9:48 pm

Interesting stats on income distribution changes in the US:


See Table 5.

In 1980, the Top 50% earned 82.32% of all income compared to the Bottom 50%’s 17.68. By 2007, that was skewed to 87.74% and 12.26.

No surprise there, it’s well known that most of the income gains in the US over that period went to higher earners.

What is surprising is how small a sliver of the population actually saw an increase in income share.

Those in the “Between 26% and 50%” category went DOWN from 25.62% to 19.04%. So that huge gain made by the Top 50% must have come from the top 25%, since the other half of the top 50% actually lost out.

Top 25%
1980 – 56.70%
2007 – 68.71%

But wait, the “Between 11% and 25%” category ALSO went DOWN from 24.57% to 20.66%.

So ALL of the gains must have come only from the top 10%.

But wait, the “Between 6% and 10%” category ALSO went DOWN from 11.12% to 10.61%.

Thus, the ENTIRE gain made by the top 50% in reality came from the top 5%.

Let’s break that down further.

The “Between 2% and 5%” category went from 12.55% to 14.61%. That’s a gain, but just barely.

Almost the entire gain made by the top 50% in reality came from the top 1%.

The top 1% went from 8.46% to 22.83% of all income. Wow.

Let’s break that down further. Unfortunately, we only have data on the top 0.1% of income earners going back to 2001. But for that subset of the data, we can see that those in the “Between .1% and 1%” category went from 9.43% to 10.9%, which isn’t much. Extrapolating back to 1980, it looks like the top 0.1% went from around 3% of all income to around 12% in 2007.

In other words, almost all of the difference in income distribution can be accounted for by those in the top 0.1% of income earners.

For the record:

Top 5% = >$160k
Top 1% = >$410k
Top 0.1% = >$2.2 million

In summary, from 1980 to 2007 the share of income earned by the various percentiles changed as follows:

  • For the lowest 95% of the population (<$160k in income), meaning almost everyone, it went down.
  • For the next 4.9% of the population ($160k-$410k), it went up slightly.
  • For the top 0.1% of the population (>$2.2 million) it went way up.

On a related note, MarketWatch had a related release the other day:


Inflation adjusted median wages for both high school graduates and college graduates have fallen over the past 10 years.

Median weekly wages, when adjusted for inflation, fell slightly for both high school and college graduates from 2000 to 2009, according to a recent analysis by the Economic Policy Institute, a Washington think tank.

“The story is often told that college graduates have done well and everyone else has not. But that’s not true,” said Josh Bivens, an economist at EPI.

For high school graduates, median inflation-adjusted wages were $626 per week in 2009, compared with $629 in 2000, according to EPI. If you assume a worker gets paid for a full year, that adds up to $32,552 in 2009, down from $32,708 in 2000.

For college graduates, weekly wages were $1,025 in 2009, compared with $1,030 in 2000, according to EPI. Over one year, that works out to $53,300 last year, down from $53,560 in 2000.

A decade of stagnant median wages across the board, with virtually all gains in national income going to the top 1%.


Disinformation and Financial Reform

Posted in General Musings, Politics and Policy at 5:05 pm

The Heritage Foundation released an extremely disingenuous piece on the Dodd-Frank bill yesterday:


First of all, let me state that they do raise some valid concerns, ones that I raised in my analysis as well – mostly centered on the potential for conflict across regulators and an over-reliance on regulators’ discretion.

They also raise the same old tired groans about stifling innovation and making financial services more expensive for consumers. Completely baseless.

Here, however, I want to focus on one very specific claim they make, and one that has been making the rounds in Republican circles for months. It is the claim that the legislation would establish permanent bailouts. Originally, this criticism was aimed at the proposal to “pre-fund” the resolution authority. That proposal has since been removed. Now the criticism is aimed at the resolution authority in general:

Permanent Bailout Authority: The Dodd-Frank bill creates an “orderly liquidation” process by which regulators are empowered to seize financial institutions that they believe are in danger of failing and liquidate them. While the lack of a broadly accepted process for closing down large financial institutions helped lead to the massive bailouts of 2008 and 2009, this liquidation process is problematic. Federal regulators are granted broad powers to seize private firms they feel are in danger of default, and these powers are subject to insufficient judicial review. Such governmental discretion to seize private property is constitutionally troubling.

This position is extremely disingenuous. Does Heritage also oppose the existing resolution authority the FDIC has over commercial banks? Would they rather these banks just fail outright with depositors either losing their deposits or having the taxpayers directly pay for them? Does Heritage support ending the existing Discount Window, through which troubled banks borrow directly from the Fed? My hunch is that the answer to all three questions is “no”.

What does Heritage propose instead of a resolution authority? Nothing. Some Republicans have suggested simply creating a new chapter of the bankruptcy code, specifically for large financial firms. For the reasons I explained in my entry on Shadow Banking, this would not work. These firms are extremely dependent on short term (sometimes overnight) funding to run their operations. If they cannot roll over funding for a few days, they implode, at great cost to creditors. Bankruptcy courts can’t possibly move fast enough to liquidate these firms in an orderly manner. There was a reason for those all weekend long marathon sessions by the Fed and Treasury in 2008 to resolve failing institutions before the markets opened on Monday morning.

However, there is a much broader issue here. The whole “just let them fail and allow the free market to work” worldview is a canard. Banks are not furniture stores, where a disorderly failure has a limited scope of collateral damage. There are significant, far-reaching negative externalities involved when a large bank fails. Many innocent non-financial businesses will be bankrupted. Individuals with no connection to the bank will be harmed economically. A more apropos comparison is with that of a nuclear power plant. Imagine such a powerplant has experienced a catastrophic failure and is about to have a meltdown. The Heritage argument is akin to “just let them fail, even if it means everyone living within two hundred miles dies and the land in that area all becomes uninhabitable for a few thousand years, so be it, the government must not intervene in private business affairs”. That is an absurd position, yet it is essentially the one they are taking here.

A related argument is that the bill must somehow absolutely prevent another financial crisis to be worthwhile. Unfortunately, this argument is furthered by the bill’s sponsors, who have insinuated that it will do exactly that. It won’t. It is impossible to prevent financial crises. We can, however, take steps to make them less frequent and less severe and provide the regulators with the tools to better fight them when they occur. No reasonable person would argue against having fire safety regulations in building codes on the grounds that they cannot absolutely with 100% certainty prevent fires. Nor would they argue that having fire departments ensures that we will have fires, and so they should be disbanded.

There are many improvements that could be made to the bill. They should absolutely be considered. There are also legitimate concerns about unintended consequences. They should be addressed. Fear-mongering and the spread of disinformation does nothing to further that end, and does a tremendous disservice to the public.


Moving on up…..

Posted in General Musings at 3:55 pm

Disequilibria (my post on shadow banking) was referenced on Naked Capitalism today: