Occupy K Street not Wall Street

There is a lot of talk about contrarian thinking and contrarian investing, but there are very few people who actually practice it.  It has long been true in money management that it is better for career management to be invested roughly in the same way as the rest of the crowd even if you lose money than to be out on a limb and be right and make a killing.  This is sad, but true.  Although this is no way to please your clients or to become John Paulson rich, it is certainly the best way to cover your ass and save your job.  It provides the “everyone else was doing it so how could I know” defense.  Indeed, when the financial system is at risk of collapse (e.g. Long Term Capital Management and its aftermath, Lehman Brothers and its aftermath, etc.), a practitioner of this method is unlikely to be one the unlucky few to be made an example of and so will generally be exonerated and not end up in jail or even pay the price of losing his or her job for terrible decision making.  There is also virtually no accountability for poor oversight and bad management these days.  How else can one explain why many of the individual managers at Wall Street firms have generally not suffered at all and losses continue to mount at firms such as UBS that somehow managed to blow through over $2 billion in 2011as its managers remain immune to consequences?  

Thus, it is understandable why there is public anger directed toward managers who work on Wall Street.  But although there are a host of problems with Wall Street and much could be resolved with better (not necessarily more) regulation (i.e. get rid of Sarbanes Oxley and bring back the Uptick Rule and much of The Glass Steagall Act), bankers are not a cause of one of biggest problems that the US faces; they are merely one of many agents acting in their own self-interests.  Bankers are perhaps more high profile recently than many other groups, but we could lump pharmaceutical industry executives, oil and gas industry executives and a host of others into the same categories.  One of the biggest problems we face as a nation is that our government is no longer regularly responsive to its own citizens.  It responds to K Street and not to Main Street.  Instead of occupying Wall Street, I suggest the citizens in Zuccotti Park and elsewhere should occupy K Street.

I think this is unfortunately not very likely to happen, however.  The Occupy Wall Street crew in Zuccotti Park in NYC is not a particularly articulate, organized or terribly intellectual bunch.    And today, the real bang for the corporate investment buck is entirely in lobbying and this is a great tragedy. Where else in this market can one get a 6X return on investment?    There is practically no better return on a corporate investment dollar than on K street and it does not matter whether a Democrat or Republic is in control of the White House or Congress.  This is an incredibly sad state of affairs and if we want to take back our country, it is where we should focus our reform efforts. 

Unfortunately, the Occupy Wall Street battle is probably merely a prelude to an even greater battle that we are only beginning to touch upon in the US.  Many sympathizers with the Occupy Wall Street movement skew young and I believe that there is an undercurrent of the coming demographic war that we are facing in the US.  As the young graduate with overpriced, unsustainable university debts (and are often poorly trained) and face a job market that does not provide them with sufficient economic opportunities to service those debts, they begin to question the transfer of wealth from the working populations to the retirees of this country who receive these unprecedented transfers because they now have net worths far greater than younger households than ever before.  Indeed, households headed by a person 65 or older have a median net worth 47 times greater than households headed by a person under 35, according to a new analysis from the nonpartisan Pew Research Center.  In dollars, that gap amounts to a median net worth of $170,494 for older households, compared to $3,662 for those under 35.

Government policies make this situation possible and it is not sustainable for the long term.  Wall Street certainly has its own problems, but K Street is causing Main Street real angina.  I suggest the protesters Occupy K Street instead.

The Price of Oil is Still a Tax on the US Economy, but it's improving....

Oil recently broke below $80 per barrel and it caused me to reflect on its continuing importance to the US economy even though there is so much brouhaha over the price of gold.  So much has changed and yet so little has changed since 1973 regarding oil.  The US remains heavily dependent on foreign oil and Americans have learned relatively little from the lessons of the 1970s.  Technological advances frequently require more energy – not less – even as individually powered devices become relatively more energy efficient than their predecessors.  Consumers and producers today typically use more products and services and energy use continues its slow but inexorable climb.  Although the US consumes somewhat less oil than it did a few years ago due to recent weakness in its economy, the country still consumes more petroleum than it did in the 1970s. 


And oil is by far and away the largest energy source for Americans.  So when the price of oil goes up, Americans across all industries feel a real and substantial pinch.  So what exactly is the point of the Consumer Price Index (CPI) less food and energy?  Who can survive without food and energy?  Yes, I know, this form of the CPI removes a lot of volatility, but energy has its footprint everywhere in a modern economy and has to be considered in any serious economic analysis or measure of inflation.  And the US is still heavily dependent upon oil as a source of energy.  When the price of oil goes up, it raises the costs to produce a vast array of goods and services in the US and, in effect, serves as a “tax” on the US economy on top of the federal and state taxes already imposed on oil and its derivatives including gasoline.

Since the depths of the collapse in stock market confidence in March 2009, the price of oil rose from the low $40s to the low $90s at thebeginning of this year.   Earlier in 2011, however, the price of west Texas intermediate surpassed $110 per barrel.  Recently, the price of oil per barrel has pulled back below $80.  Much of the price of oil is driven by classic economics of the underlying demand for its use versus the ability of the oil producers to supply oil to meet this demand.  But there is probably at least one additional factor in the price of this commodity that contributes to this painful oil tax on our economy we have to bear as Americans – i.e. the chance of crises, political unrest or wars in oil-producing countries or their neighboring countries that would materially disrupt the world’s oil supply.  This uncertainty adds a premium to the oil price that goes up or down depending on the perceived risks of the moment.  Recently, I believe this perceived risk and the view of future oil demand have come down and accordingly so have petroleum prices. 

Nevertheless, some types of bad news for oil are good news for much of the rest of the US economy.  The professional skinflints of America (better known as CFOs) are acutely aware of oil’s pernicious effects and are among the first to respond to the high costs of oil.  These CFOs are the vociferous critics of their suppliers who are trying to force price increases on them and are the first to come up with cost cutting measure of their own tomeet the challenges brought on by the oil tax on the US economy.  All too frequently and to the detriment of the overall economy, this has recently meant letting employees go. 

 

In corporate America, these CFOs will also be the first to notice now that oil prices are beginning to come down and ease the “oil tax burden” somewhat.  With any luck, these CFOs will inform their CEOs that they will soon have some flexibility to spend on projects near and dear to their CEO’s hearts.  If the US does not enter another recession, a sustained drop in the price of oil should enable them to invest and grow again.  If oil prices can hold in the $60 to $80 range for an extended period of time again, I believe the US will begin to build off its employment base (albeit slowly) and can create net new jobs – especially in industries such as construction, travel and transportation and agriculture/ag-bio where energy costs are high.  Watch the CFOs here.  And with oil in the $40 to $60 per barrel range, the US can witness real new job growth.  Below $40 per barrel and we are talking substantial job growth.  Unfortunately, prices below $40 per barrel would probably lead to long term problems once again.  There would probably be too little investment in future oil production and too little investment in alternative energy sources due to complacency and uncompetitive initial price points.  I guess that is too much of a good thing….

 

In sum, oil prices have an impact on the US economy that is almost the inverse of housing prices.  (See my previous blog on this topic.)  Higher housing prices and new construction can drive the economy out of its doldrums.  Conversely, lower oil prices put more money in consumers’ pockets and give corporate CFOs and CEOs the confidence to begin spending again as long as we don’t experience another banking crisis at the same time.  Such confidence can rescue the US economy as well.   With oil at over $80 per barrel, however, I think it is difficult to convince consumers to dig deep and spend while they are paying down debt or to get CEOs and CFOs to hire new people for growth instead of investing in energy efficient lighting and teleconferencing systems to avoid the high cost of travel.  It will be hard for the US economy to get going again until the price of oil falls.  When the price of oil falls and it holds, that is a positive sign for the future.

Time to Pay the Piper

I posed myself the question: have the Greenspan and Bernanke puts since the 1980s combined with fiscal stimulus to avoid the pain of serious recessions caused the economic problems of today?  If so, is there a way out of our current economic quagmire of high unemployment and low growth without simply working off all of our excess debt accumulated over that time?  Or can there again be economic gain without terrible pain?  Is it as simple as true fiscal stimulus as opposed to some of the measures that have been offered recently?  Or are we headed to another downturn in a couple of years followed by the inevitable pain of war or some type of military spending that is the only way out of this mess?

To answer these questions let’s compare today’s situation to two other nasty economic periods in modern American history – the 1970s and the 1930s.

The 1970s:                                            America lost much of its opportunity for growth in the years 1973 – 1976 + 1979 – 1982.

                                                            Stagflation reigned brought on by a commodity bubble due to an oil price shock.

The 1930s:                                            America lost much of its opportunity for growth in the years 1929 – 1933 + 1937 – 1939.

                                                            Deflation reigned brought on by debt fueled financial asset bubbles and  monetary tightening.

Today:                                                  America lost the opportunity for growth in the years 2007/8  – 2010.  The US experienced an Internet/technology bubble and bust due to 9/11 followed by an even bigger real estate bubble and bust.  If we expect something similar to either of these prior eras, when is the next downturn going to begin?  2013?  2014?  If history is a guide, it is probably not going to occur as early as in 2011, but anything is possible.

                                                            Are we experiencing a combination of Disinflation then Stagflation or a taste of the 1930s followed by a meal from the 1970s?  I think we may very well be in for such an experience brought on by debt fueled real estate and commodity bubbles.  Look at the prices of many commodities and gold today.  The interesting distinction about real estate is that it is both a financial asset (the 1930s part of the equation) and a non-financial asset for homeowners.  Homeowners use their homes as a personal investment vehicle – as a financial asset – and borrow against it and use it to save and help fund their retirements.  Yet they also live in their homes and receive imputed rent benefits from owner occupied facilities.  Moreover, real estate is responsible for a good deal of the use and consumption of commodities (along with the real estate and industrial booms in emerging markets, real estate in the US is the 1970s part of the equation) – e.g. copper, steel, wood, concrete, etc.  It is real estate’s dual nature that may help explain the period of disinflation that appears to be followed by stagflation today.

Although America has not yet exhausted its borrowing capacity, bills for the US appear to have come due.  Since the oil crisis of the 1970s, the US began borrowing heavily from the Middle East and Japan adding to pre-existing European and domestic borrowing.  Since that time, the US has augmented its spendthrift ways by adding borrowing from China into the mix in its efforts to maintain an economy fueled by consumer spending and lessen the impact of “normal” business cycles.  The right hand of loose monetary policy from the Federal Reserve has enabled the left hand of fiscal policy to continue its profligate ways and allowed consumers to stretch beyond their means and enjoy a lifestyle that they cannot maintain across business cycles whose troughs are too shallow.  No one is willing to bear any pain.  We can no longer manufacture booms without any gloom.  It doesn’t work over the long term.

In the 1970s, it took painful, rising interest rates combined with increased government defense spending on the cold war in order to pull the US out of its stagflation mess.  In the 1930s/1940s, the US economy was slowly moving back to health, but it took holding interest rates around the 2 to 3 percent range and a truly massive federal spending effort on WWII to lift the US (and the world) fully out of the Great Depression.

What will it take this time for the US economy to reach escape velocity and avoid the fate of Japan of the 1990s and today?  Low interest rates and large amounts of public spending have not worked for Japan.  The correct monetary policy will depend on where inflation is.   If the US avoids another near term economic downturn, it may only take time to get the economy going again if there is a long term, credible plan for fiscal rectitude along the lines proposed by the bi-partisan commission.  That may be sufficient to restore confidence and the animal spirits necessary to reignite private investment.  Without such a plan, fiscal stimulus is wasted.  And it may indeed take some real fiscal stimulus along the lines of major infrastructure projects (upgrade of US electrical grid, US interstate highway system, universal broadband wireless) to get the private sector moving again.  If history is our guide, however, and if US GDP declines in the next couple of years, it is a dire situation and even most fiscal stimulus will not work.  In that scenario, it is likely to take substantial defense spending in anticipation of a war to get the US back on track as horrifying as that prospect may be.  Perhaps the war against Islamic fundamentalists is closer than we think?