Reynolds - High Oil Prices Caused Worldwide Recession

Alan Reynolds is one of my most favorite economists. He has written another very good and very important article, It Didn't Start Here, which was published in the New York Post on 9 April 2009.

The recent G-20 meeting in London produced a consensus: The United States started and caused the worldwide recession. The United States should be humbled. Obama agreed. The Finance Minister of Germany, Peer Steinbrueck, said the Anglo-Saxon attitude in America and Great Britain had encouraged risky lending and investment practices due to "an exaggerated fixation on returns."

Reynolds says, "Hey, wait a minute folks, let's look at the data." Examine when industrial production first started declining in some countries. It began to decline in Canada in July 2007, in Italy in August 2007, in France in October 2007, and the Euro area as a whole in November 2007. Japan's production reached a peak in October 2007, though it had a one-month uptick in February 2008. The decline in the U.S. was in February 2008.

In January 2008, the OECD leading indicators were down from a year before by 4.1 points in Ireland, 2.8 points in Japan, 2.6 points in Korea, 2.3 points in Sweden, but only 0.8 points in the U.S. Stock prices are another leading indicator. Stock prices peaked in Japan and in the Euro area four months before they peaked in the U.S. and the U.K. in October 2007!

In the 4th quarter of 2008, real GDP was lower around the world than it had been 1 year before, but it had dropped by much less in the U.S. than almost anywhere else. The list is:

Taiwan, -8.4%
Turkey, -6.2%
Sweden, -4.9%
Japan, -4.3%
Singapore, -4.2%
Denmark, -3.7%
South Korea, -3.4%
Italy, -2.9%
Hong Kong, -2.5%
Great Britain, -2.0%
Germany, -1.7%
Mexico, -1.6%
France, -1.1%
U.S., -0.8%
Canada, -0.7%

So, how did the the failures of U.S. and British banks and financial institutions in September and October of 2008 cause the recession which had started in Japan and in Europe in January 2008?

The housing price boom and the low cost of borrowing in the U.S. and in Britain were problems, but they were also problems in a number of other countries. These problems developed later and many countries which went early into recession, such as Japan, Sweden, and Canada had had no housing booms. Reynolds points out that James Hamilton of the University of California at San Diego showed in 1983 that "all but one of the US recessions since World War Two have been preceded, typically with a lag of around three-fourths of a year, by a dramatic increase in the price of crude petroleum." Reynolds says the years 1946 to 2007 saw 10 dramatic spikes in the price of oil -- each soon followed by a recession. He also notes that in January 2008, he wrote that the US economy was likely to slip into recession due to the high energy costs no matter what the Federal Reserve did with respect to monetary policy.

The logical conclusion from this is that the U.S. was probably doing a whale of a job in diminishing the worldwide recession. Indeed, the dollar value of US imports did not start to fall until August 2008 and our purchases of consumer goods did not fall until September 2008. Strange that so many in the rest of the world are so eager to blame the US for this recession, including the very anti-American Barack Obama! It would be more logical to see the U.S. as the hero in these trying times.

Reynolds points out that Jagadeesh Gokhale, his colleague at the Cato Institute, noted that "the prolonged decline in exurban housing construction that began in early 2006 was a logical response to rising prices of oil and gasoline at that time. So was the equally prolonged decline in sales of gas-guzzling vehicles. And the US/UK financial crises in the fall of 2008 were likewise as much a consequence of recession as the cause: Recessions turn good loans into bad."

So, it would appear that part of the reason that existing home prices were shooting up was because new home building was becoming more expensive and few homes were being built, due to the energy crisis. The energy crisis certainly weakened the U.S. auto industry, which was making all of its profits and most of its income from SUVs, trucks, and large cars. When people were paying more than twice what they had been paying to fill their gas tanks, they became less likely to be able to pay more for home mortgages or to make payments on such new cars as they did buy. The banks came under increased pressure and the many high-risk loans that government had pushed them into became a real liability, albeit one exaggerated by the Sarbanes-Oxley mark-to-market asset evaluation requirement. Another gift from government.

So, what would a rational response be to minimizing such a future spike in energy costs, given that such spikes are the chief cause of recessions? For the U.S., it would be to allow oil and gas drilling in the Eastern Gulf of Mexico, as was approved by George Bush, but then immediately killed by Obama. It would be to open ANWR to drilling. A non-starter with our very foolish Obama. A rational response would be to sell off much of the excessive federal holdings of land in the western US and encourage companies to drill for oil and gas using modern good practices. When OPEC, which did cause the present worldwide recession, spikes prices upward, the US production facilities could run production at full output and hold down the price increases a bit in the U.S. This would help to moderate our future recessions.

What very irrational, shall we say, even insane policy are we following? First, the media and the government are blaming American banks and financial institutions for this recession, while claiming that this means they need to be be managed by our ever-perspicuous government. Second, they are using this to broadly blame Capitalism. Note that OPEC is a cabal of nationalized oil companies, which have nothing to do with Capitalism. Furthermore, Obama and his cut-throat gang are using this crisis as a means to cripple the fossil fuel energy industries in the U.S. One of the reasons the U.S. weathers the oil price spike caused recessions better than many other countries is because we have the world's greatest reserve of coal. We still use it to produce half of our electricity. Without it, we will be even more subject to the whims of OPEC and to the subsequent OPEC-caused recessions.

Do you suppose it is possible that the same impulse that causes Obama to bow to the King of Saudi Arabia, who is an important Islamic leader, is also causing him to make the U.S. itself more subservient to the Islamic Middle East for its energy supplies? Do not argue that Obama is going to replace our fossil fuel use with alternative energy sources. First, if it is done, it will be done by the free market far more than by government or any amount of community organizing and rabble rousing. Second, he is keen on destroying the American fossil fuel industries to the point that he is already doing this with no viable alternative energy replacements in sight. This man is a destroyer, not a creator.

Instead of characterizing this crisis as a financial crisis, let us remember to call it the oil crisis. We must also recognize that while OPEC has been primarily responsible for our post-WWII recessions, we can easily be the cause of future recessions by following policies designed to increase the cost of energy!

U.S. is to Food as OPEC is to Oil

The United States is in many respects to food production similar to OPEC with respect to oil production. The U.S. has a huge impact on the world price of food and affects prices in good part with Federal government mandates and price controls largely dictated by the huge Farm Bill passed recently and its predecessors. As a result, the U.S. government and many state governments also act in constraint of trade in food in many profound ways. When we pass a NOPEC bill in Congress which allows lawsuits against OPEC for their acts in constraint of oil trade and for conspiring to affect the cost of oil in the U.S., we are acting rather hypocritically. The OPEC nations might say that if we want to play that game, they can play it also. A lawsuit now has been initiated against OPEC in response to their constraint of the oil trade. Might OPEC nations respond with laws against the restraint of trade in food and follow-up with lawsuits of their own?

I am not suggesting that what OPEC is doing in the oil markets is wise or that it is moral. But, their restrictions on oil production are not different than our own refusal to explore and develop many of our suspected oil resources. As we will discuss here, we also have a huge impact on world food prices and we clearly manipulate those in many ways which also have nothing to do with the free market. As we complain about the sharp price increases in oil, much of the rest of the world is complaining about the great cost increases in food. We should allow the free market to develop our oil resources and we should allow it to control food production also.

Thomas Barnett wrote an interesting commentary published on 11 June 2008 in the Washington Times, entitled "U.S. edge in global food trade." On the Scripps Howard News Service it is entitled "U.S. sits pretty in global food trade network." Barnett only mentions concerns with the hypocrisy of our food manipulation policies in passing. The point of this article is that he is proud that we are as dominant as we are in the food production business. I am also proud of that and we should have enough self-confidence to allow the free market to prevail. Barnett says, "When the professional fearmongers try to scare you with America's 'oil addiction,' remember this: If the world's got us over the barrel on energy, we've got the world over a bread basket." Here are some of the interesting facts that Barnett notes:

• North America exports 105 million metric tons, the former Soviet Union nations export 21 million, South America 18 million, and Australia/New Zealand 9 million metric tons. Of this the North American share is 68%.
  
• The net importing regions are: North Africa and the Middle East import 58 million metric tons, Asia imports 47 million, sub-Saharan Africa 17 million, and Europe 12 million metric tons.
• North America imports half its oil, while the Middle East imports three-quarters of its food.

Barnett also discusses how global warming will help North America produce more food and cause people to use less energy, which will hurt OPEC. Since I do not think the global warming scare will last as people become more aware of how flimsy the arguments for it are and because a productive world will continue to have a great deal of use for oil, I am not too interested in Barnett's arguments here. But, it is clear that the demand for food is such that more farmland is being put back into production. He notes that Dakota farmers are presently tilling fields that have laid fallow for decades and that land speculators are counting on increased production in Russia, Ukraine, and Kazakhstan. He also notes that the Chinese are running around the world buying up arable land in other countries.

He notes that food is about 0.1 to 0.2 of a household's spending in industrialized nations, but is as much as 0.8 of household spending in developing nations. Today, only 7% of rice is traded globally and 12% of corn is traded. He believes these percentages will increase and that the global food trade network will become as important as the global energy trade network. Rather than moan so much about the cost of oil, we should produce more food for export. Of course, we should also produce more oil and gas as well.

An Abundant Future Energy Source?

For some time I have been meaning to write about an interesting article by B. B. Rath of the Naval Research Laboratory (NRL) from the April 2008 issue of the MRS Bulletin, a publication of the Materials Research Society. In the 1800s, French researchers reported the formation of hydrates of methane, ethane, and propane. In the mid-1930s, Germans discovered that gas pipelines incurred blockages at temperatures above 0 degrees Centigrade due to the formation of solid gas hydrates. Then in the mid-1960s it was realized that there are vast quantities of gas hydrates, primarily methane hydrates, deposited in the ocean sediments on the continental shelves and in the permafrost regions on land. These deposits are produced by microbial decomposition of organic matter or by geothermal heating wherever the temperature and pressure are conducive to the formation of gas hydrates. The amount of gas hydrates is estimated to be approximately twice that of all oil, natural gas, and coal deposits combined.

The Naval Research Laboratory has played a leading role in starting to map out where methane hydrates are to be found in sediment rich areas of the ocean floors and in the tundra regions. The ocean continential shelves all around the world appear to have deposits and to have the lion's share of the total reserves. At a depth of about 500 meters, the solid methane hydrates form due the combination of cold and pressure. In Arctic waters, since the water is colder, the solid gas hydrates are found at depths of about 300 meters. Alaska is believed to be completely surrounded by deposits in the Beaufort Sea Play to the north and in the Bering Sea Play elsewhere. The Northern Pacific Play lays off California, Oregon, and Washington. Then there is the Gulf of Mexico Play from the western coast of Florida to Texas and the Southeastern Atlantic Ocean Play from the middle Florida eastern coast up to Maine.

As a direct fuel source, methane produces energy efficiently on a per weight basis. It also is easy to burn it more cleanly than oil or coal. But, while this energy source may guarantee that mankind will not soon run out of energy, the means to deliver it up for commercial and competitive use does not now exist. Some programs are underway to learn how best to do this. Japan is leading an effort to study the potential of gas hydrates in the Nankai trough, an area that NRL earlier identified as promising. An international consortium is active in the Canadian Arctic area in a program. The United States Geological Survey (USGS), the Department of Energy, and NRL are working to identify methane hydrate fields and gas cavities in the US continental shelves. The USGS is working with India to map fields in its continental shelf. NRL has worked with Chile and New Zealand to learn more about their deposits of methane hydrates. There is some indication China is mapping its deposits.

World demand for energy is expanding rapidly, but the OPEC nations have proven unwilling to expand their production of oil. The Democrats in Congress, with some foolish Republicans, have prevented the drilling for more oil in Alaska, off the Pacific coast, off the Atlantic coast, and off the western Florida coast. The use of nuclear and coal energy sources is discouraged throughout the U.S. Wind farms and solar panel use are prevented by some government entities throughout the U.S. We have made it easy for Arab sheiks and Iranian mullahs with their Holocaust-denying puppets to extract dhimmitude tributes from us, rather as the pirates of the North African coast in Morocco, Tripoli, and Tunis prayed upon American and European trade vessels in the Mediterranean Sea in the 1700s and the early 1800s. Then there is the South American pirate Chavez extorting private companies of their oil fields and using his riches to foment socialist revolutions throughout South America. Even the Russians are becoming more belligerent now that oil is bringing them wealth again. These methane hydrate fields in U. S. waters and throughout the world may well help us limit the ultimate price of a barrel of oil and the time during which we are highly vulnerable to their control of energy.

Of course, we can and should place many other limits on their ability to drive up the price of oil and gas by developing more of our own oil and gas fields. We should produce more jobs and wealth in Iraq by working very hard to get their oil production into high gear. We should get busy building nuclear power plants again. We also have huge deposits of coal to use and have developed excellent scrubbers to remove pollutants. We have tar sands and shale oil to develop, which the Canadians are doing successfully now. One of our biggest problems is that the Federal government holds most of the land with these deposits on it. This is generally not beautiful park land. It is largely land that previously did not have enough economic value that private citizens were induced to put enough pressure on the government to allow them to settle it and develop it. It was wasteland, but modern conservationist nonsense makes it difficult for the Federal government to divest itself of the land.

Unfortunately, the die was cast by decisions made by American governments over the past 30 years that put us into the dire energy cost straits we are in now. If we were to adopt good energy development policies now, we would enjoy a great deal of relief in 10 years. Since the Democrats look to continue to control Congress for the next several years, this crisis will not have a 10 year time limit. The situation may well get worse before it gets better. The only hope is that some OPEC members, Russia, and Mexico will want to take advantage of the huge increase in the price of oil to produce more of it. Most of them have very inefficient national oil companies who have difficulty keeping up oil production, let alone expanding it. The longer it has been since they nationalized their fields, the more inefficient they have tended to become. Unfortunately, if some do increase production, many of those nations will use much of their higher income to cause still greater mischief in the world.