Another Perfect Storm

The fall of 1991 saw the confluence of two massive storm systems off the NE coast: a classic nor’easter and Hurricane Grace arriving from the south. It created what meteorologists called “The Perfect Storm”. Sebastian Younger wrote a book in 1997 using that title and in 2000 a very successful movie of the same name was released. It seems to me that another “perfect storm” is developing on the economic front that could be every bit as devastating and affect more than the east coast of North America.

The first of these “storms” is the so-called “sub-prime” problem. Loose credit and easy mortgages fueled a massive expansion in the US housing market. Some Wall Street wizard figured out that these shaky mortgages could be repackaged as bonds and sold Worldwide to banks eager for high yield. Like the dot COM bubble of recent memory and the tulip mania of the 17th century, the sub prime market unraveled like a poorly knit sweater. Banks lost billions and the Fed responded by throwing money into the system and dropping interest rates as a recession loomed.

At the same time another storm arrived on the scene in the form of rapidly increasing oil prices. With expanding demand in the fast growing economies of China, India and other emerging economies and questionable supplies, prices have skyrocketed. Exacerbating this problem was the dramatic decline of the US dollar and the concurrent speculation in oil futures. (Countless billions have flowed into oil futures with supplies tight and political unrest in many oil-producing countries.)

The confluence of these two storms is likely to give us the ugly twins reminiscent of the Carter Administration: recession and inflation. Those of you old enough to remember those days of 12.4% inflation and 21.5% interest rates may also recall that in that miserable period we also had an oil shortage and gas lines around the block.

Let’s look at these two storms and see what is likely to evolve as a result of the actions of our politicians in this election year. As they say, “Opinions are like assholes: Everybody has one.” Here’s mine.

Storm #1, the sub-prime thing: With actions by the Fed to infuse massive amounts into the system and bailouts, including capital from offshore, this storm would blow itself out. Sure, there would be misery along the way and were it not for Storm #2, would not plague us overmuch.

Storm #2, the oil crisis: This is basically an issue of supply and demand with speculation adding fuel (no pun) to the fire. I agree with Charles Krauthammer that a psychological tipping point for Americans was reached when gasoline prices reached $4.00 per gallon. At the tipping point people start to change their behavior. The evidence coming in suggests people are driving less, using mass transport more and buying fuel-efficient cars. While this is a good trend, it’s not enough to seriously impact demand. Many people remain stuck with long commutes and no mass transit alternative and the Suburban or Escalade in the driveway is now worth less in trade-in than the payments due.

What do the political wizards have in mind in response to the crisis? And, it is a crisis. The cost of oil threatens airlines and trucking companies with ruin and the inflationary pressure will ripple through the economy forcing the Fed to increase interest rates just as we teeter on recession. Well, first you send George Bush off to Saudi Arabia hat in hand to beg them to pump more oil. They must have laughed in his face. They know the US sits on more oil than the Saudis could ever hope for. (They have about 55 billion barrels). The Democrats in Congress have just refused to allow anyone to drill for it for the last 30 years. ANWR is estimated at 10.4 billion barrels. The 85% of restricted continental shelf guess is 87 bb and the 97% of restricted Federal lands? Who knows? Although they do estimate the oil shales of Utah, Colorado and Wyoming hold about 1 trillion barrels of recoverable oil. This, of course, does not include the zillions of cubic feet of natural gas. We don’t have a supply problem. We have a political problem. The Democrats are afraid of the environmentalists and to be fair, some Republicans too. That means drilling is off the table for the near term. Since McCain is against drilling too, a Republican revolt remains unlikely.

Two years ago Congress decided they would get a “twofer” by mandating the use of ethanol. They could please the environmentalists and the farmers at the same time. The law of unintended consequences reared its ugly head and we saw the price of gas go up along with skyrocketing food prices worldwide.

Recently Congress decided that in the midst of the oil crisis it would be an excellent time to introduce a global warming bill called the Warner-Libermann cap and trade program. This 3.2 trillion dollar behemoth was estimated to raise gas prices to $6 to $8 per gallon and represent the largest tax increase in history. Fortunately, cooler heads prevailed and it got trashed… this time. Expect this turkey to be resurrected in the coming veto proof Democrat Congress. This sop to the global warming zealots comes despite recent reports that global temperatures have not increased since 1998, and 2007 recorded a 1.4-degree decline. Go figure.

In another typical move by Congress they herded the heads of the US oil companies to Washington and grilled them about their “excess profits”. For the record, oil companies average 8.3% profit compared with tobacco and beverage companies’ 19.1%, pharmaceutical and media at 18.4% and technology companies at maybe 40%. Of course, untroubled by facts, the Democrats immediately proposed a windfall tax on these profits. They are seemingly ignorant of history. This was tried during the aforementioned Carter Administration. The result? Domestic production fell some 5% and imports increased by 10%. Gas prices went up by 60% and overall inflation hit 12.4%. This too fell to the threat of a Bush veto, but next time around…?

Still more recently 97 Senators voted to stop putting oil in the Strategic Petroleum Reserve, so they know it’s a supply problem. Strangely, 71 voted shortly thereafter not to approve drilling in ANWR. (I still think some Republican Congressman should introduce a bill to rename the place the “National Artic Wasteland”. I like the acronym too… NAW.)

With Congress likely to seed the clouds of this two headed storm and make it worse, it seems the US is determined to select as the Captain of the ship someone as oblivious to the fury of Mother Nature as George Clooney’s character in the movie. Mr. Obama has promised to raise numerous taxes, the equivalent of steering the ship into the heart of the storm. Just increasing the capital gains and dividend taxes as he has promised will shed another 2000 points off the Dow according to John Rutledge, a wise economist. Americans–especially middle class Americans–have already seen their wealth greatly diminished by the deflation of the US dollar (down 33% against the Euro), the decline in the value of their IRAs and 401Ks due to the drop in the stock market of nearly 2000 points and the loss in equity in their homes and SUVs. Obama’s supposed concern for the middle class is a sad joke. His other promises add up to damaging domestic corporations and driving them off shore with a concurrent loss of jobs. So much for punishing the wealthy and helping the middle class.

OK. I’m pessimistic, but if I were holding a ticket for this cruise I would strap on a life jacket and cinch up my jock. It’s going to be a rough voyage.


Filed under Economy, Oil

2 Responses to Another Perfect Storm

  1. Anonymous

    Yea, our politicians are re-aranging the deck chairs as the ship is sinking. This could be the “Cruse From Hell” Man The Lifeboats!
    Thanks again Butch for some good reading. Cousin Ken

  2. Anonymous

    Good thoughts and well written, Dick. Rod Freed pointed me to your blogspot and I will certainly be checking it periodically in the future.
    John Seelinger

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