Straw on the Camel’s Back
Here’s an understatement: the news in the oil markets has been troublesome lately. Although the relatively peaceful transition to sovereignty in Iraq is a bright spot, there are many darker ones. Some of these have been with us for years; others are more recent in vintage.
For months, I’ve watched the news coming out of Iran with concern. Iraq, of course, remains vulnerable to car bombs, sabotage, and other foul play from insurgents and terrorists. These situations have grabbed headlines and caused the price of oil to jump, although they are unlikely to significantly disrupt oil supplies.
Adding further fuel to the fire, crude oil demand is on an upswing spurred by economic growth. With resurgence in business activity in many countries—the US, Germany, Japan, and others—comes an increased need for oil. In China, manufacturing sector growth and a virtual explosion in the number of cars and trucks on the road have boosted demand by some 20% over last year. There’s not a lot of excess capacity at the moment in several links in the oil production and supply chain to deal with this jump in oil requirements. Many producers are pumping all they can, refineries are at 97% capacity, and demand just keeps growing.
And now the latest news, a rumored, forced shutdown of Russia’s largest oil company, Yukos, sent oil futures to a 21-year high. Yukos accounts for some 2% of oil production, and is a monstrous company by any standard. When a huge overdue back taxes bill led to a threat by Russian authorities to stop most of its production, it was like the proverbial straw on the camel’s back. Markets went wild, up to levels not seen since 1983.
What are the chances of gloom and doom continuing on all of these fronts? Virtually nil. We’re in a strange period of time now, with many causes for uncertainty, but it’s not likely to last. Russia can ill afford to shut down one of the country’s largest sources of economic activity, and the powers that be know that. The stability of the entire nation would be jeopardized if a prolonged closure led to an economic crisis. There are also investors waiting in the wings with funds ready to bail out the struggling Yukos. Even if the company did cease production for a period of time, there are other producers who could take up some of the slack.
Crude inventories are up about 23 million barrels over a year ago, and the current threats to supplies are not as real as they have been at points in the past. When Iraq invaded Kuwait in 1990, prices jumped (though not this high) in response to the very possible idea that Saddam Hussein could disrupt supplies in Iraq, Kuwait, Saudi Arabia, and beyond. For the market to react with such fervor to the very low probability that Russian authorities will actually shut down Yukos for an extended period of time would only happen when things are already skittish. Otherwise it is simply not rational.
Projects are underway around the globe which will augment the capacity to supply oil. Construction in Mexico is nearing completion on projects which could raise production levels by up to 4%. Several other oil-rich nations (Venezuela, Saudi Arabia, Nigeria, and elsewhere) have intentions of increasing supplies, but face political, workforce, or other problems that are constraining their ability to expand immediately.
The oil market is likely to be under pressure for months to come. Rising demand and supply issues will leave the market vulnerable to unanticipated shocks. An early cold snap could see prices spiking, for example. Even so, the US economy is far more able to deal with higher oil prices than in the past. Expensive oil is certainly not good for economic growth (unless you live where it is extracted), but it’s not likely to derail the ongoing recovery.
posted @ 10:18 AM CST [link]
Friday, July 23, 2004
Stalling the Engine of Growth in a Global Economy
US-VISIT (United States Visitor and Immigrant Status Indicator Technology) is a program intended to improve the information collected on foreign nationals traveling to and from the United States. It is an outgrowth of enhanced concerns over security issues before and especially after the tragic events of September 11, 2001 and is currently being implemented at air and sea ports of entry. Its implementation at land ports along the US-Canada and US-Mexico borders is scheduled to occur in the near future, despite significant shortcomings in personnel, infrastructure, and technology (particularly at ports of entry for Mexico).
While one of the stated goals of the program, improving US homeland security, is clearly a worthy aim, it is not at all apparent that US-VISIT is the optimal (or even a viable) method for achieving this objective. In fact, the US-VISIT program has been called into question by the US General Accounting Office (GAO), which in a recently released report described it as a high-risk endeavor.
US-Mexico trade represents a crucial source of business activity for virtually all regions of the US. The flow of goods and people across the US-Mexico border is vital to the ongoing economic health of families, corporations, cities, regions, and states. The land port segment of the US-VISIT program involves tremendous harm to the national, state, and regional economies. Even under conservative assumptions regarding the increase in time required for crossing the US-Mexico border, hundreds of thousands of jobs will be lost. If delays prove to be more disruptive (up 75%), the job losses could top 1,400,000 in the US and 800,000 in Texas. These effects are concentrated in the manufacturing sector and other key drivers of the domestic economy.
The program is likely to prove particularly damaging to the economy of the border region, which is home to concentrations of manufacturing concerns relying on cross-border trade, retail stores where Mexicans tend to shop, and real estate developments with historically high rates of ownership by Mexican nationals. Many of the advantages of the North American Free Trade Agreement (NAFTA) will essentially be reversed if US-VISIT is implemented as currently proposed. In essence, US-VISIT will impair the competitiveness of goods crossing the border in much the same way as a tariff.
In particular, the manufacturing sector would lose more than 465,800 jobs in the 75% scenario. Given that manufacturing sector performance is a critical component of ongoing American prosperity and the current concern over “offshoring” of domestic production jobs, it is imperative that actions such as US-VISIT receive extremely careful scrutiny as they have the potential to do substantial damage to the US economy.
Because much of the lost trade represents integrated production activity, the ramifications extend to US competitiveness on a global scale. Manufacturers on both sides of the border utilize “just-in-time” (JIT) inventory management techniques. Delays caused by US-VISIT will reduce the ability of firms depending on border crossings for deliveries to utilize JIT techniques, thus hampering their performance and that of the border, state, and national economies.
US manufacturing concerns will also generally become less competitive as a result of US-VISIT. In effect, constraining the free flow of goods across the border raises the costs to US manufacturers. As they are less able to compete in the global economy, they face reduced demand for their products and shrinking profits. In particular, the US and Mexico stand to lose ground relative to every Asian competitor.
There is a substantial component of retail trade, particularly in US border areas, that will be affected by US-VISIT regulations. Mexican shoppers form an important market for stores in the US, and delays in border crossings could significantly reduce this activity. Banking relationships are also likely to be affected, with border financial institutions potentially seeing a reduction of more than $2 billion in deposits. Healthcare providers in Texas stand to lose more than $3 billion in yearly revenue. Housing values in the border region would decline by 2.8%-10.6% depending on the severity of the delays, thus causing a substantial loss of household wealth.
The Department of Homeland Security’s goals for US-VISIT include facilitating legitimate travel and trade, enhancing national security, and adhering to US privacy laws and policies. The desirability of achieving these goals is beyond question.
However, it is unclear that the program is capable of achieving these objectives given the current state of technology and other issues. At the same time, implementing US-VISIT along the US-Mexico border could prove to be devastating to certain types of business activity and the economies of specific geographic areas. Implementation of the US-VISIT program as currently proposed would result in needless economic disruption, a loss in competitiveness of US manufacturing concerns, and myriad other problems.
posted @ 08:20 AM CST [link]
Friday, July 16, 2004
Go to School
Summer is flying by. It seems that the older (and busier) I get, the faster it goes. I recall, when I was a kid, the long, hot East Texas days seemed to stretch into eons during the time from June through August. Now, I can wear myself out just trying to keep up with the comings and goings of my brood. The ringing of the school bells in the fall brings a certain level of stability (though not too much).
For those of you who are contemplating with some trepidation the approaching September return to academic environs, take heart. You’re doing the right thing. I’ve written in this space multiple times about the financial benefits of education. A high school diploma is worth an additional 29% in lifetime earnings, and an associate’s degree adds 20-25% more. Go for the bachelor’s and gain 75% over the course of your working life. It goes up from there.
There are two factors at work in these enormous differentials. Clearly, there’s a direct correlation between an educational level and the ability to hold certain types of jobs. No high school dropout is going to become a highly compensated physician, for example, and many of the greatest earning power occupations are those requiring advanced degrees. The second factor, though, deals with the probability of employment. The more educated a person is, the less likely they are to be unemployed. Therefore, when the lifetime average earnings are calculated, they’re not only picking up on the fact that high-paying jobs often require intense training, they’re also reflecting the relatively lower chance of lingering unemployment. To put it the other way, people with less education are more likely to end up in low-paying positions, and often have greater difficulty in finding and keeping them.
This is not a trick of the numbers, it’s a very real phenomenon. If you look at the directions the economy is going, you can see that the importance of education is only going to intensify. The Bureau of Labor Statistics of the US Department of Labor recently released a listing of what they expect to be the fastest-growing occupations from 2002 to 2012. Of the 30 with the highest percentage change in the number of jobs, 18 require a postsecondary degree (a bachelor’s or better for 12). Looking down the list reveals a number of medical fields (medical assistants, physician assistants, home health aides, medical records technicians, dental hygienists, occupational therapists, and more. There are also a number of computer-related fields (software engineers, systems analysts, and database administrators). Education is a big one, with huge percentage growth in the numbers of postsecondary and preschool teachers.
If you look at the occupations with the largest numbers of new jobs (as opposed to the fastest growth in percentage terms), nine require at least an associate’s degree. Number one on the list is registered nurses, with 623,000 new positions. Second is postsecondary teachers, with some 603,000 new jobs expected (and a doctoral degree required). While it is true that many of the occupations growing by hundreds of thousands only require on-the-job training (retail salespersons, cashiers, receptionists, food preparation workers, and so on), it is also true that these positions generally tend to be at the low end of the pay scale, and suffer substantial turnover rates. In fact, many companies now systematically plan significant attrition as a means to keep wages low to maintain competitiveness.
Those attempting to decide whether to go back to school this fall should pay close attention to the trends at work in the economy. As technology is incorporated into the workplace and the level of training required to perform many jobs rises, higher premiums are placed on the skills gained in an academic setting. As cutting-edge industries continue to flourish in the US, those with the right mix of knowledge will be in demand. As the US population ages and medical treatment options become ever more complex, the need for higher-level training in those fields will only escalate.
One of the most pivotal decisions an individual can make is to elect to pursue further education, particularly if it’s part of a strategy to achieve life goals. As a society, one of the most pressing problems we face is the lack of preparedness among many of our populace to fill the jobs of the future. On the fence about what to do in September? I have some advice: GO TO SCHOOL!!!
posted @ 07:58 AM CST [link]
Friday, July 9, 2004
Value
As many of you are aware, I have spent a great deal of time and effort over the past few years in modeling and quantifying the value of arts and cultural activities to the overall economy. When fully considered, this creative process is responsible for about 15% of global business activity. Its role literally cannot be overemphasized.
The value of culture recently came into focus in a starkly different manner when Pablo Picasso’s Boy with a Pipe sold at auction for more than $104 million. This price shattered the record obtained by an 1890 portrait by Vincent Van Gogh that sold for more than $80 million more than a decade ago. What makes a painting by a 24-year old artist whose best days are yet to come so valuable?
There are some aesthetics that account for this price. The painting is a rare major work from Picasso’s “Rose Period,” a reference to the color that dominated his work for a short span of time. The date of the painting is also significant. It was completed in 1905, which is only a few months before he began to develop (along with Georges Braque) Cubism and other more abstract forms. This transformation, as well as the Abstract Expressionist movement which occurred almost simultaneously, emerged shortly after Albert Einstein introduced the concept of special relativity. Free form literary movements also surfaced at about the same time. I suppose the world had to abandon Newton’s determinism for Einstein’s warping before we could embrace similar paradigms in other fields.
In any case, Picasso lived a long and very productive life, was a pioneer in several movements, and was without question the most important artist of the 20th Century. In some respects, his accomplishments and influence later in his career added to the mystique of and interest in his earlier works. For some, but certainly not all observers, the fact that it is “pretty” rather than abstract actually adds to its appeal.
None of that, however, answers the question of what makes a single painting sell for over $100 million while a medicine with the power of life and death may be available for a few dollars (or even pennies in some cases)? A similar question is what causes a Michael Jordan, Tiger Woods, or Tom Hanks to earn many times as much as a school teacher who arguably contributes more to social welfare and progress?
The answer is very old, but often forgotten—scarcity!! In a market based economy, the value of anything is what someone will pay for it. Adam Smith wrote about it in 1776 as he laid out the foundations of markets in a formal setting (that had been around in one guise or another for millennia). He referred to it as the “diamonds and water” paradox. Diamonds, which served few useful purposes (and even fewer back then) were quite expensive, yet something as essential as water was either free or very near so (that was a year or two before they started putting it in small bottles with designer labels). The point was simply scarcity relative to demand creates value. It was the case then, and it still is today. Michael, Tiger, and Tom do things we like and are willing to pay for, and not many (if any) others can do the same things as well; it’s as simple as that.
Now, back to our Boy with a Pipe. Though a grueling process, critics, connoisseurs, and the public at large have determined that—of all those who have attempted to draw, paint, or sculpt in the annals of history—Picasso is one of the elite. He became so prolific in his later years that scarcity became less of an issue, thus causing some of his other (arguably superior) works to command much lower prices (the very best ones have not come on the market and are unlikely to do so in the foreseeable future, as they are safely ensconced in major museums with sizable endowments). A major early Picasso has the essential advantage of scarcity. It also has the necessary characteristic of being in high demand. Works of this magnitude are almost never available, thus creating a great deal of “buzz.” Fortunately, we have determined as a global community that great art is to be treasured and pursued.
Boy with a Pipe sold for $104 million because it is scarce and because it is in demand. There is no more to it than that.
posted @ 08:07 AM CST [link]
Friday, July 2, 2004
Let Freedom Reign
Less than a week before we in America celebrate 228 years of independence, another sovereign nation was born halfway around the globe. Power was handed over on June 28, 2004 to an interim government in Iraq, two days before the officially announced target date. While the war has been fraught with controversy, both here and abroad, this peaceful transfer of power is without a doubt a good thing. The trouble in Iraq is not over, but we can hope that stability will come all the sooner.
Aside from any political perspectives, the changeover was clearly viewed as a step in the right direction by the markets. In passing this milestone, the US continues to move in the direction of exiting Iraq at some point in the future. The uncertainty associated with the war is thus reduced, a good thing for equity markets.
On the news, oil prices dropped sharply , with crude futures down about $1.30. Gasoline prices are also falling. Iraqi terminals are moving millions of barrels of crude each day, and repairs from attacks continue. These price declines are a clear sign that oil traders and others moving that market are feeling more confident about the future of Iraq’s oil industry. While it’s too early to gauge the ultimate effect on prices, the immediate reaction is indicative of a perception among market watchers that the migration of power to the Iraqis is a good thing.
There are difficulties to be overcome in the days ahead. Martial law has been mentioned as a possible last resort mechanism to keep the peace in the short term. At the other extreme, many express the firm belief that insurgence will wind down now that there’s no real reason (such as an American in a position of power) to stop the country from being rebuilt. Depending on the speed with which such challenges are dealt with, the economic revival in Iraq will build momentum.
The country represents a burgeoning market for the provision of goods and services ranging from infrastructure to consumer goods. Schools have reopened, electricity access has improved, and reconstruction is progressing nicely. Consumer goods such as cell phones and televisions are selling rapidly. The needs (and wants) of the Iraqi people form a long list, and a lucrative market for purveyors of the desired items. Companies from around the world stand to gain by providing the things the Iraqi people need and want and have long been denied.
Although some naysayers view the lack of celebration among the Iraqi people as a sign that the fledgling government lacks support or credibility, others are far more optimistic. Conditions for many have improved radically since the end of Saddam Hussein’s regime, and others are likely to see significant advances in the weeks to come. According to one poll, some 75% of Americans approve of the transfer of authority; the positive signals sent by both oil and equity markets also indicate a “thumbs up.” Only time will tell whether the route to freedom is a smooth one for Iraq, but even if it’s a rocky path, at least it’s in the right direction.
posted @ 08:19 AM CST [link]