It’s A Wonderful Theory

Scott Sumner:

It makes no difference who gets the extra money from the Fed, because the recipient is no wealthier than before (money is swapped for bonds) and hence they have no incentive to spend any more.  Rather the impact occurs in the AGGREGATE.  Total holdings of the base now exceed total base demand at the current price level, and hence aggregate nominal spending rises (if the injection is permanent.) [Emphasis added.]

So, Sumner is essentially asserting that the people who sell bonds to the government for cash are essentially kind-hearted souls who are doing the economy a big ol’ favor by spending a ton of time and energy in an unprofitable activity to help plain ol’ average Americans avoid a liquidity trap.  And who are these blessed, selfless individuals?  Why, these oh-so-helpful people who are engaging in unprofitable activities for the sake of all Americans are none other than bankers!
It is truly amazing how some economists can get so wrapped up in their abstract theories that they cling to the point of absurdity.  Seriously, Sumner’s model is essentially predicated on an implicit assumption that those who engage in trading bonds for cash from The Fed only do so out of the goodness of their hearts.  It ignores the actual motivations of the economic actors involved, and somehow ignores that most people engage in what they determine to be profitable activities (in whatever way they subjectively value profit).  And if Sumner’s theory is predicated on the assumption that bankers do not, when messing around with hundreds of billions of dollars, seek to make a profit, then his theory is probably not all that realistic.
It makes considerably more sense to assume that bankers will swap out their bonds for cash from the central bank because doing so is quite profitable.  The central bank will take the hit because, like all good political agencies, it is corrupt and inefficient, and exists to channel wealth from the middle and lower class into the hands of the wealthy.  Of course, Sumner can’t admit this because committing heresy against the church of the central bank and its high priest Ben Bernanke would miraculously cause Sumner’s head to explode.  And so, he assumes that bankers (again, bankers) engage in economically unprofitable activity because…bankers are nice people, I guess.
And so, you can see that Sumner’s assertion is probably false because there is quite a mismatch between incentives and behaviors.  At least it’s a wonderful theory.

The Case of the Missing 200 Million Barrels of Oil: Marshall Adkins

Marshall J. Adkins Supply threats in the Middle East have governments around the world hoarding oil, largely in secret. But it didn’t get past Raymond James Director for Energy Research Marshall Adkins, who noticed the 200 million-barrel discrepancy between what was pumped and reported global oil reserves. Where did the missing oil go, and why don’t prices reflect this substantial surplus? More importantly, what happens once the reality of an oversupply sets in?—A tough six months, Adkins expects. Read on to find out where you can hide when prices plummet.

The Energy Report: You’ve written a provocative research report titled “Hello, We’d Like to Report a Missing 200 Million Barrels of Crude.” It argues that the global oil inventory should have grown by over 200 million barrels (200 MMbbl) during the first six months of 2012. Where did this oil go? And a better question is, why hasn’t this surplus shown up in pricing?

Marshall Adkins: When the U.S., the European Union and the United Nations imposed sanctions against Iran, the world responded by putting oil into storage. China rapidly began filling its strategic petroleum reserves. Saudi Arabia topped off its surface reserves. Iran put oil in the floating tankers.

TER: Why isn’t this storage being reported? Is it normal for this oil to not go into the regular reporting channels?

MA: Yes. Unfortunately, it takes three or four months, and often six months, to get good data from the Organization for Economic Cooperation and Development (OECD). It’s a lag, but at least you usually get the data. We estimate that OECD data accounts for about two-thirds of global oil inventory capacity. The other third, which is just an estimate, is off the radar. Few sources really track this non-OECD data. The International Energy Agency (IEA) does not track it either, because there’s simply no reliable way of getting the information. China is probably the best example of that. It just does not tell us exactly how much it has.

TER: Could this result in dumping at some time in the future, potentially after the November election in the U.S.?

MA: It could. But even if they don’t dump it, we think there is an even bigger structural problem. We are running out of places to put the growing supply of oil. Based on our supply-demand numbers, the world is poised to build significant inventories in early 2013. There is a very real possibility that if Saudi Arabia does not initiate production cuts sometime in early 2013, we will run out of places to put this oil around the world.

TER: Your particular specialty area is oilfield services. You maintain a U.S. rig-count table, which showed a 6% drop year-to-date as of August 31, 2012. Does this indicate that it’s getting easier to get oil horizontally than it is to drill straight down?

MA: There is no question that the application of horizontal oil technology has completely changed the game for both oil and natural gas here in the U.S. Yes, it’s just a much more efficient way of extracting oil and gas, particularly from formations that are very tight. This is a trend that’s going to be here for a long time. It has led to an incredible increase in production per well.

TER: I noted dry gas rigs in your table are down 57% during that same one-year period. Even wet gas rigs are down 40%. How long can this go on before gas prices turn around?

MA: The decline in the overall rig count this year is mainly a function of the falling natural gas rig count, both wet and dry gas rigs. Early on, oil rig growth offset a lot of that gas decline, but the growth rate in oil has stagnated. So, low prices for natural gas are causing a meaningful decrease in gas drilling, but we think there will continue to be reasonable growth in gas supply from the oil wells in operation. That said, gas prices should gradually rebound as we build out infrastructure and consumers start to take greater advantage of extremely low gas prices in the U.S. Next year, we think the overall U.S. rig count will continue to deteriorate with lower oil prices. As that happens, overall gas production growth should flatten. That allows growing gas demand to offset stagnating supply growth. That should eventually drive U.S. natural gas prices higher. It will take a while, but we expect gas prices to improve steadily over the next several years.

TER: Natural gas prices were up about 35–40% before summer. Was this just a bounce, or could this be the beginning of a bull market in natural gas?

MA: I wouldn’t call it a bull market in gas. Gas prices have certainly improved, but I think most people who are out there drilling for gas would say that $3 per thousand cubic feet ($3/Mcf) isn’t exactly a bull market. They simply aren’t making a whole lot of money at that price. That said, today’s prices are much better than six months ago and things are looking better. We think natural gas prices will average closer to $3.25/mcf next year and $4/Mcf the year after. Yes, we think the gas price bottom that we saw earlier this year, $2/Mcf, is well behind us. Directionally, things should continue to improve.

TER: Should investors be bullish on any segment in energy right now? If so, which ones?

MA: In light of our relatively bearish overall stance on crude, we don’t have any Strong Buy recommendations in our oil services universe. We’re not recommending a whole lot of exploration and production (E&P) names at this stage either. The ones that we think do perform here are refiners that benefit from the price differential between West Texas Intermediate (WTI) and Brent crude. In addition, infrastructure companies such as master limited partnerships (MLPs) and companies that service either pipelines, refineries or other new infrastructure should outperform over the next several years.

TER: Any final thoughts?

MA: The bottom line is that we have a tough six months ahead of us for crude oil prices as inventories continue to build in Q1/13. Sometime in early 2013, oil prices should deteriorate as much as 30% from where we are today and hit bottom in mid-2013. At that point, we’ll probably get a lot more constructive on oil services and E&P names.

TER: Thank you very much.

MA: Thank you for having me.

Marshall Adkins focuses on oilfield services and products, in addition to leading the Raymond James energy research team. He and his group have won a number of honors for stock-picking abilities over the past 15 years. Additionally, his group is well known for its deep insight into oil and gas fundamentals. Prior to joining Raymond James in 1995, Adkins spent 10 years in the oilfield services industry as a project manager, corporate financial analyst, sales manager, and engineer. He holds a Bachelor of Science degree in petroleum engineering and a Master of Business Administration from the University of Texas at Austin.

Don’t Trust Mainstream Economics

Here’s why:

It was almost exactly 20 years that statistics prepared by Paul Krugman about the extent of rising income inequality began to show up in the New York Times on page 1. Back then we–or at least I–thought that this would quickly reverse itself: I remember one dinner at which Claudia Goldin challenged Paul, asking him to agree that rising inequality had made going to college such a no-brainer that we would soon see a flood of increasing investment in education that would bring income distribution back into balance. She was wrong. I was wrong. The American income distribution righted itself, at least for white guys, after the Gilded Age. It did so with mass education and the rise of the social democratic welfare state. What is different this time?

This paragraph belies some astonishing ignorance, held by one of the better-known mainstream economists.
In the first place, DeLong assumes that the laws of supply and demand do not apply to college graduates. How else to explain his assumption that continuing to increase the supply of college-educated labor would either a) drive up the price of marginal college-educated labor or b) drive down the price of fundamental college-educated labor? That there was such a high degree of price inequality in the college-educated labor market should have suggested that market was near saturation (side note: this is perfectly exemplified in the current labor market for lawyers, in that wages are generally low, but there is a high degree of inequality among income-earners).
In the second place, DeLong assumes that there is a natural balance of income distribution. There is not, because humans are not equal to one another in terms of drive, ability, temperament, sociability, intelligence, and other factors that are tied together in determining one’s income. As such, it is unreasonable to assume a trend towards income equality in general. However, the presence of extreme inequality should at least be checked out, if for no other reason than to ensure that politicians aren’t enriching themselves or their cronies by defrauding the populace. But it shouldn’t be assumed that high degrees of inequality are themselves bad. Basically, inequality should be viewed as a consequence, not a cause.
Thus, DeLong is unable to understand why the policies that appeared to work the first time around don’t work the second time around. Here’s a hint: the market for educated workers has obviously reached its saturation point. Also, people aren’t equal. Expecting more equality and more education to fix the problem is therefore stupid, and DeLong is stupid for not seeing why. The sad thing is that he is not alone; there are many experts asking the same question, unable to provide the answer. They are not to be trusted; in fact, they should be ignored.

The Denial on Housing in Spain

I am sure many of my readers will have caught this Bloomberg piece earlier this week, but if you haven’t it is a brilliant piece of journalism by Bloomberg reporters Sharon Smyth, Neil Callanan and Dara Doyle. The story takes us to Spain and Ireland and the former’s denial with regards its housing market.

Quote Bloomberg

In the stages of death of a real estate boom, Spain is still in denial. In Ireland, they’re moving toward acceptance. The first auction of one of 2,000 unfinished housing estates takes place tomorrow at the Shelbourne Hotel in central Dublin, with sales expected to fetch cents on the euro, showing the Irish may be closer to the end than the beginning.

“Ireland faced up to its problems faster than others and we expect growth there rather soon,” said Cinzia Alcidi, an analyst at the Centre for European Policy Studies in Brussels. “In Spain, there was kind of a denial of the scale of the problem and it may be faced with many years of significant challenges before full recovery takes place.”

Spain, Europe’s fifth-largest economy, is the current focus of attempts to contain the region’s sovereign debt crisis, as Prime Minister Mariano Rajoy struggles to quell speculation it will need a bailout. Developers are showing similar optimism. They continue to build even with 2 million homes vacant around the country, new airports that never saw a single flight being mothballed, and property appraisers and banks reporting values have fallen only about 22 percent, said Encinar, who estimates the real decline is probably at least twice that.

Another passage that was staggering to my mind was the comments by Miguel Angel Garcia Nieto, mayor of Avila (a town showcased in the article) that this is just an interim soft spot as a result of the crisis and that oversupply and overcapacity will eventually be absorbed.

Quote Bloomberg

“When we approved the first urban plan back in 1998 there was an unprecedented demand for homes,” Nieto said in a telephone interview on April 19. “Yes, there is oversupply at the moment because of the financial crisis and everyone’s gone back home to live with their parents, but it’s not because there is lack of demand. When the economy gets back on track I am confident the supply will be absorbed.”

Hope as they say, spring eternal.

Consumer Demand is Not the Whole Picture

See if you can spot what’s missing:

Businesses aren’t investing in the United States because of a lack of consumer demand, International Paper CEO John Faraci said Friday.

“I think this was all about consumer spending and demand. You know, the problem we have is there’s inadequate demand to create jobs. We know how to respond when there is demand,” he said on CNBC’s “The Kudlow Report.”

The U.S. Commerce Department estimated that gross domestic product expanded at a 2.2 percent annual rate in the first quarter, falling short of analysts’ expectations it would grow 2.5 percent and slowing down from the fourth quarter’s 3-percent rate.

The more correct way of saying this is that there is a lack of consumer demand for products at profitable prices. There is plenty of demand for cheap goods (for example, imagine what would happen to iPad sales if the price dropped to $150 each). The problem is that cheap goods often have very thin profit margins.

Also overlooked in this admittedly shallow Keynesian market analysis is that purchasing power has declined. It’s not that demand has disappeared or necessarily reduced (who doesn’t want stuff?); it’s that people don’t have the ability to act on their demand. Put plainly, people don’t have money, regardless of whether we’re talking cash or credit.

Thus, saying that demand has declined is a rather shallow way of addressing the problem and thus begs a shallow solution (quantitative easing, e.g.). The deeper issue is that people’s real income has declined, alongside their ability or willingness to use credit to purchase things. Therefore, the proper solution is not a short-term stimulation of demand, but rather an attempt to fix the structural flaws that have caused a decline in real income. The causes for such a decline are various: free labor, inflation, free trade, and so on. Fixing these things won’t be easy—in fact, they’ll be quite painful in the short-term—but they will lead to a long-term fix. Unlike a stimulus.

Student of the physical market - demand doesn't drive the gold price

Eric Sprott and David Baker has a new article out discussing central bank buying of gold and particularly China. I agree with his conclusion that this is an important demand side shift in the market but then Sprott plays it up way too much with statements like:

“… there isn’t a physical market on earth that can withstand that type of demand increase without higher prices over the long-run, and the gold market is no different. There are no sellers of physical gold that we know of who can satiate that scale of new demand …”

“Who is going to give up their gold purchases to make room for this scale of new demand? Where is the gold going to come from? We ask because we don’t actually know.”

“We have written at length about the disconnect between the paper gold price and the physical gold market. If the demand changes stated above applied to any other market, the investing public would lose their minds.”

“The paper market for gold can continue its charade, but demand in the physical market will soon overpower it through sheer momentum – there’s only so much physical to go around, and it appears that there are some very large buyers that are eager to take it.”

If Sprott and Baker “are students first and foremost of the physical market” then they surely are aware that the one thing which makes gold different from all the other physical markets on earth is its huge above ground stocks relative to new mine supply – 170,000 tonnes versus 2800 tonnes.

This, I suggest, is a quite material fact and one which may be where “the gold is going to come from”. Unlike “any other market”, to which conventional supply/demand analysis can be applied, one cannot understand the gold market by just looking at annual supply/demand numbers when there is such a large overhang of stock.

What drives the gold price I would therefore argue, is not so much demand, but to what extent existing holders of the 170,000t will withhold it from the market. It is actually supply – the withholding of supply – that matters most. If even a small fraction of these holders decide to sell, then that supply “will soon overpower” the physical market, China or no China. This is not a negative statement. The decade long gold bull market is a message that the existing holders are requiring higher and higher gold prices to let go of their gold and that the new holders are more likely to withhold it.

The reason you don’t see this approach to analysing the gold market is because there are only sketchy numbers on the flow of gold from existing holders to new holders – say ETF volumes, futures warehouses and scrap – and therefore its difficult if not impossible to get any handle on total real supply so analysts just avoid it. It doesn’t mean you should.

This unique feature of the gold market, which we can describe as “a stock overhang so large relative to new supply that in any other market would push the price to zero, but for some reason for gold it doesn’t”, is often referred to as monetary demand or gold as a monetary metal. When you see someone refer to gold as a commodity, it tells you they don’t really understand the gold market and you need to exercise some caution with their statements.

Gold is monetary in nature, with only a small commodity component. Further proof of this is the fact that central banks hold it as they generally hold only money as reserves. A lot more can be said on this but it is 8:30 on Sunday night.

The other thing I find interesting about the Sprott piece, and what I react to negatively, is the use of emotive phrases like “on earth”, “lose their minds”, “charade” etc. Never a good thing when we are talking about investing and its a point Kid Dynamite has made, that Screwtape dissects, and which Erik Townsend makes quite forcefully in the Martenson/Harvey interview discussion.

Speaking of that discussion and Sprott, for those interested in Sprott’s silver delivery problem, Jeff Christian has weighed in with some interesting comments at the Martenson/Harvey interview. Warren James has updated Screwtape’s post on the issue with the relevant material and it is a good summary and discussion of the “problem” for those new to it (or who want a refresher).

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CBO Nonsense

From the CBO Director’s blog:

Many factors are responsible for the rise in unemployment in general and in long-term unemployment:

-Weak demand for goods and services, as a result of the recession and its aftermath, which results in weak demand for workers;

The better question is: what is causing weak demand? Could it be that people are realizing that it’s fiscally unhealthy to spend lots of many that they don’t technically have? Could it be that the extend-and-pretend games of the last thirty years are starting to catch up to us? Could it be that, having pulled demand forward for so long, the future is now finally catching up to us?

-Mismatches between would-be employers’ needs and the skills or location of the unemployed;

This is actually a valid point, although it’s probably helpful to look at a couple of points that contribute to this situation. The declining value of an American education certainly contributes to mismatched needs and abilities. Interestingly, the sheer vapidity of modern American education is mostly due to Boomer tinkering. Also interesting is that Boomers are now in charge of major businesses, just in time to find out how terribly awry their experiments in education have gone. Furthermore, their arrogance and blind trust in their educational model prevented them from doing the one thing that would currently save their companies: hiring bright kids out of high school and training them on the job instead of waiting for them to get a college diploma. (Of course, it probably didn’t help that Boomers made employment testing illegal.)

Regarding location, I think there are three reasons people refuse to move for work. First, government benefits currently make staying in the same place to wait for a new job feasible. Second, I would theorize that most of the once-employed are intelligent to suspect that government benefits may not be around forever, and therefore it is best to stay where one is, since one will have more social capital at one’s current location than at a new location. Finally, the increasingly transient nature of jobs discourages employees from traveling, particularly in light of government benefits. Why endure moving a thousand miles away only to lose your job after a year? Especially when, after moving costs and loss of social capital are accounted for, you’re fiscally worse off than if you’d been on government benefits?

-Incentives for people to stay in the labor force and continue searching for work that result from extensions of unemployment insurance benefits; and

This is more of a technical point, as unemployment statistics are calculated by dividing the number of unemployed workers by the total labor force. The issue is defining the labor force (if memory serves me correctly, the government has six or seven definitions). Some metrics only consider adults that are currently looking for work as part of the labor force, and so the claim being made by the CBO is that rates are artificially (or, more accurately, tautologically) high because there are some who are looking for work instead of just giving up.

-The erosion of unemployed workers’ skills and the belief of some employers that people who have been unemployed for a long time would be low-quality workers (a phenomenon sometimes called stigma).

This is pretty much the same as above. As the social stigma that comes with long-term unemployment wears off, more of those workers who were at one time out of the labor force will come back into the labor force (by seeking jobs) and tautologically drive up the unemployment rate.

In all, the CBO is blaming increased unemployment rates on the fact that Americans are finally realizing that man cannot live by debt alone and on an increasing number of people who have the gall to seek employment again. In essence, the CBO would prefer that people continue to spend money they do not have and just go back to being lazy and unproductive. And that’s how the government plans on reducing unemployment.

I’m Right (Again)

But, in the first study of its kind, the MAC – set up by the last Labour government, and independent of Whitehall – said large-scale immigration was having a significant impact on the job prospects of the ‘native’ population.

The report, which follows years of controversy over whether immigration leads to fewer jobs for British workers, showed that every increase of 100 foreign-born working-age migrants in the UK was linked to a reduction of 23 Britons in employment between 1995 and 2010.

Between 2005 and 2010 alone, the number of working-age migrants in employment rose by 700,000 and displaced 160,000 British-born workers, it said.

As can generally be expected, increasing the supply of something—in this case labor—without a similar increase in demand for that thing will generally lead to lower prices. When there is a price floor of sorts (minimum wage, workers’ rights, etc.), the better labor will win out at the margins, which is what appears to have happened here. Since those who decide to emigrate usually tend to be of a rather hardy stock, it should come as no surprise that they are often viewed as marginally better labor, and, as such, get hired more often. And it should also come as no surprise that the marginally superior laborers (immigrants) are offered jobs that would otherwise be offered to natives.
But more than that, it is philosophically consistent to support both free trade and free labor, as the arguments or them are rather similar. The problem, though, with both free trade and free labor is that domestic regulation of both tends to discourage domestic production/producers. As such, both free trade and free labor operate essentially as foreign subsidies. However, free labor is the more pernicious of the two seeing as how it not only undermines domestic production, but also domestic culture, what with the sudden influx of people from other cultures. Ad while people from another culture may enjoy the consequences of living in another culture, this is no guarantee that they will ever do anything but support and further their original culture.
The lesson to be learned from this is that free labor—or even limited regulation—is not particularly beneficial for the native population, economically. As such, it can reasonably be said that any politician who advocates an increase in immigration, tolerance for illegal aliens, or otherwise promotes the migration of foreign workers of any sort is one who is ignorant, hates his country, or is simply stupid.

The Rationalizing Creature

It turns out that humans aren’t so rational after all:

For centuries thinkers have assumed that the uniquely human capacity for reasoning has existed to let people reach beyond mere perception and reflex in the search for truth. Rationality allowed a solitary thinker to blaze a path to philosophical, moral and scientific enlightenment.

Now some researchers are suggesting that reason evolved for a completely different purpose: to win arguments. Rationality, by this yardstick (and irrationality too, but we’ll get to that) is nothing more or less than a servant of the hard-wired compulsion to triumph in the debating arena. According to this view, bias, lack of logic and other supposed flaws that pollute the stream of reason are instead social adaptations that enable one group to persuade (and defeat) another. Certitude works, however sharply it may depart from the truth.

Basically, humans have a tendency to make a variety of decisions and take sundry ideological stances before thinking them through. Most of us do this unconsciously on a daily basis (think of driving a car, for example). However, we don’t generally think of a reason why we do what we do, and when confronted with the why of our behavior and opinions, we craft an ex post rationale for it.
Often, our rationales are deceptive and self-serving. The 2008 bailouts, for example, were touted as a way to save the economy. Perhaps many of those who proposed the bailouts really believed that the bailouts were good for the economy. What’s interesting is how some who supported the bailouts and benefited directly from them argued for them in selfless terms. What’s even more interesting is how all humans do this, albeit in regards to different things.
Anyhow, the point made in all this is that we are not as rational as we would like to suppose. We often do many things out of subconscious habit, laziness, greed, and self-promotion. Sometimes we don’t even know why we do something; we simply “feel” something and act accordingly. And only when we’re confronted with the “why” of our behavior do we even think to provide a reason for doing what we did.
Thus, the lesson to take away from this is that those who assume humans are rational (most notably economists) are completely bonkers, and any behavioral model predicated on the assumption of human rationality is most likely completely wrong. Humans are finite beings with near-infinite desires. Being rational is not optimal in this event, for a careful consideration of every potential decision will inevitably lead to having fewer enjoyable experiences and goods by mere virtue of the fact that time spent contemplating decisions reduces the number of decisions that will eventually get made. Therefore, the rationalizing tendency among humans in light of their finiteness is perhaps the most rational thing they do. And those who ignore this fundamental rationality are fools.

Spot The Fallacy (Labor Edition)

From ASI:

Economist Diane Coyle has noted that migrant workers in the UK tend to be either very highly skilled or low skilled, which suggests that they are filling gaps in specific areas of the labour market, not taking jobs from the native or resident population. And Bryan Caplan explains that by doing low-skilled work migrants enable more productivity in the native labour force. [Caplan’s post can be found here. –ed.]

Caplan argues that the native workers don’t have to spend time doing daily, menial chores and are free to focus on improving their skills, and working harder. And this increases wages.

For a fun little experiment, I propose that Britain deport 50% of its migrant workers and see what happens to unemployment. If Alabama is any indication, unemployment rates will decline.

Why? Because wages, aka prices, are determined by two things, and two things only: supply and demand. Increase the former without increasing the latter and wages decline. Decrease the former without decreasing the latter and wages increase. And so on.

Caplan’s fallacy, and by extension ASI’s, is that there is an ever-increasing demand for highly productive labor. This may or may not be the case, and I suspect that it’s the former. Labor laws make it difficult to determine how much demand exists for highly productive labor. Not only that, economists seem to forget that some employers are rather satisficing in their approach to hiring. Furthermore, many jobs are part of a sufficiently complex process that attempting to maximize labor productivity in one specific role is likely an exercise in futility. In essence, Caplan’s theoretical model bears little resemblance to the real world, which is why it is wrong.