November 19, 2004
Donald R. Byrne, Ph.D.
Edward T. Derbin, MA, MBA
Note: To print a hard copy of this newsletter, click on the following link for a PDF download…
The First Year Revisited
Please accept my apology for the several-month lapse since the last issue. I had to undergo a knee replacement surgery. It was very successful but required several months of rehabilitation. That rehab period is nearly finished and now it is on to the newsletter. With this issue, the eighth over all (Volume 2004, Issue 3), we will review and update the previous seven issues and introduce a series on the energy challenge, hoping to complete it in the next issue or two (since it is a highly complex topic). We at The New Economic Paradigm Associates, plan to return to our pattern of approximately 10 issues per year. We thank the many readers of this Newsletter for the encouragement to keep on going.
- Don Byrne, Editor
UPDATES ON PREVIOUS ISSUES…the first newsletter
(What Recession? Welcome to the World of the New Economic Paradigm)
When the first issue was published, the economy was in the seventh quarter of the recovery/expansion from the recession of 2001. Yet voices were bellowing at us from the media that the recession was still going on. Now we find out that by the traditional definition of a recession, two consecutive quarters of a negative real growth rate, the recession never occurred. Recent revisions show the second quarter grew in excess of one percent, positively. The original data showed that the same outcome was revised downward resulting in three consecutive quarters of negative real growth. Now, that revision is reversed...
By the traditional definition, no recession occurred in 2001! As we showed in the first issue of this newsletter, the downturn began in 2000. After an annualized growth of 7.3 percent in the fourth quarter 1999, the decline began, bottoming out at a -0.5 percent in the third quarter of 2000. It rebounded a bit in the fourth quarter of 2000 but turned negative in the first quarter of 2001 before rebounding yet again in the second quarter of 2001. After a -1.4 showing in the third quarter 2001 (9/11), GDP has shown positive growth for the last twelve quarters.
As we argued in the first issue, the downturn began in 2000 due primarily to two factors, with a third factor contributing to the loss of a 7.8 percent rate of growth (7.3% in 4th Quarter 1999 to -0.5% in the 3rd Quarter 2000).
The first of the two major factors was the continuous rise in federal income taxes from 1992 until 2000 - taxes rose much faster than government spending, with a general account surplus in the federal budget emerging in 1998. Remember that no matter the economic model employed, taxes depress and government spending stimulates; both by impacting aggregate demand, but in opposite directions.
A second major factor for the 2000 downturn as pointed out in the first issue of this newsletter was the rapidly growing trade deficits for roughly the same eight years. Imports depress by reducing domestic aggregate demand and exports stimulate by increasing aggregate demand. Thus, trade deficits depress by lowering aggregate demand on a net basis. Again, this is true no matter your economic model.
In the third case, the Federal Reserve applied the coup de grace by tightening in 1999, erroneously as this newsletter has argued. The downturn was already cast in stone from the rising burdens of the federal budget and the growing trade deficit.
We are now in the 12th consecutive quarter since the recession that never was in 2001! At times, notably the third quarter of 2003, the quarterly positive growth rates have reached those of 1999... [7.4 real growth in the 3rd Quarter, 2003 (see the following from the U.S. Bureau of Economic Analysis – BEA)
In Issue 2 of this newsletter, the question of deflation was discussed at length.
(Deflation --- not necessarily a bad thing…restructuring)
According to the New Paradigm, because of the significant and widespread growth of competition in many markets, the episodes of recession and inflation are becoming less frequent…when they do occur; they are less severe in terms of duration and depth. In fact, this newsletter pointed out that when deflation comes from cost reductions such as is happening in industries that are restructuring (in order to cope with growing competition), occasional episodes of deflation will occur. This is not the same great depression induced deflation of the 1930’s! Rather it is due to the increasing strength of competition wrenching the market power from firms and unions that formerly were able to expropriate the consumer surplus and convert most of it into surplus wages and profits. Competition, by eliminating market power, both eliminates surplus rewards and increases the consumer surplus.
Downward price rigidity, emanating from price power of firms and unions in the absence of significant competition in markets, is slowly but inexorably being eliminated as increasing competition is entering more markets. Downward price flexibility is eliminating those downward price rigidities and their resulting twin-biases toward recession and inflation that for many years were characteristics of the U.S. economy.
In at least three of the last 13 months or so, the Bureau of Labor Statistics announced that real labor compensation had risen and was partly due to deflation. In two months, deflation contributed to nearly 40 percent of the rise and in one month about 14 percent of the rise. In fact, according to the BLS, we have experienced nine months of deflation in the last forty. http://data.bls.gov/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=CUSR0000SA0&output_view=pct_1mth. Get used to some deflation; but fear ye not! It is a result of the widespread restructuring going on as the brave new world of competition in markets takes hold. It is not due to a collapse in demand as in the 1930’s (where firms reduced output, shuttering operations) but rather falling costs due to downward pressure on prices as increasing competition occurs. Remember, it is not your income that is critical but rather it is what your income can buy. To paraphrase some theoretic terms, the current trend toward bouts of deflation is due to “cost push” and not “demand push”.
In Issue 3 of this newsletter, we discussed the trade deficit and its implications.
(Trade Deficits – How dirty is your float?)
As noted in the third issue of this newsletter, the trade deficit continues at record levels. Trade deficits depress the economy. Remember, imports depress by increasing aggregate supply and exports stimulate by increasing aggregate demand. When imports of merchandise and services exceed exports of merchandise and services, a trade deficit occurs thus depressing the American economy. As we argued back in late last year, the causality probably ran from net capital inflows or a combined capital account surplus to the trade deficit and not the other way around! The reason for our line of argument was that a net inflow of capital from the rest of the world caused the dollar to appreciate against foreign currencies. This is the case since the demand for dollars by foreign investors exceeded the supply of dollars by Americans wanting to invest abroad. At an even more basic level, foreign capital has found the real risk adjusted interest rates on American assets to their liking compared to their own nation’s similar interest rates. American investors can be satisfied in staying at home for the same reason.
In the last FOMC meetings, the Fed saw fit to influence short-term interest rates upward. Fortunately, longer-term interest rates in the U.S. have not followed suit; rather they have fallen. If the Fed persists and attempts to go farther out in terms of maturity (and succeeds in influencing longer-term interest rates), it could increase the trade deficit. Another reason for the worsening trade deficit has been very high oil prices. Since this increases the dollar value of oil imports, it adds to the trade deficit.
As pointed out in the original issue of the trade deficit, some nations such as mainland China have deliberately intervened in the foreign exchange markets, pegging the U.S. Dollar at levels where the Yuan is probably around one fourth of its equilibrium price in the absence of China’s intervention. We kid you not, refer to the graph showing the last time there was a “balance” in the Trade Balance with China!
In Issue 4 of this newsletter, we discussed the federal deficit and its implications.
(National Debt and Federal Deficits…leveraging current assets for tomorrow’s growth)
follow-up on the first newsletter (see above), we discussed the three causes of
the downturn beginning in 2000. At present, in 2004 two of those factors
are in place: the huge trade deficit and the Federal Reserve’s continued
quixotic obsession with inflation (the Fed has pursued policies resulting in a
cumulative increase in the federal funds rate of 100 basis points (1%) since
The federal budget is currently trending in the opposite direction of what it was in 2000: in 2000, it showed a surplus of $159 billion; in 2003, it was in deficit to the tune of $506 billion. The federal budget continues to be in deficit in the range of between $400 billion and 500 billion, depending upon whom you ask…
From the Congressional Budget Office
From the Bureau of Economic Affairs
The negative affects of the trade deficit are virtually offset by the federal government budget deficit. This has the just the opposite affect of that which was occurring in 2000. In 2000, the growing federal government surplus (depressing in and of itself) added to the depressing affect of the huge trade deficit. If it were not for this reversal concerning the federal budget, the current expansion would have been much weaker (if occurring at all).
For those sensitive to federal government deficits, recall the concept of the fiscal drag discussed in previous issues of the newsletter. While tax cuts tend to have the immediate affect of reducing tax revenues, those same tax cuts, tend to stimulate the growth of the tax base through economic expansion. This then enables the “growing out of the deficit,” as taxes rise faster than spending. Such a pattern can be seen more than once since the end of the Second World War (See Kennedy tax cut proposal, April 1961 http://www.nationalcenter.org/JFKTaxes1961.html).
In Issue 5 of this newsletter, we discussed the Federal Reserve System and its role in the economy
(The Federal Reserve System: Sausage making and its relation to monetary policy)
Our opinion on the wisdom and efficacy of the Fed’s monetary policy continues to be highly skeptical. Our problem with the Fed lies in two areas: first is the Fed’s obsession with inflation; and the second is the inability of Fed policies to influence long-term interest rates.
Despite the huge run-up in oil prices and other commodities, significant inflation has not broken out and the economy continues to expand. Yet, the Fed, once again, continues to sound the alarm that serious inflation is just around the corner and that action must be taken to avoid it. The lesson of the increasingly relevant New Paradigm in Economics is that the strongest barrier to inflation is growing and pervasive competition throughout the markets.
The Fed’s obsession with inflation continues unabated despite extensive changes in the increasingly competitive nature of markets in the U.S.… http://story.news.yahoo.com/news?tmpl=story&cid=1471&ncid=1203&e=10&u=/ibd/20041111/bs_ibd_ibd/20041110feature
In addition to their preoccupation with the lack of evidence pointing to significant and persistent inflation, we also express concern over the effectiveness of the Fed’s policies in influencing the entire term structure of interest rates (yield curve). The Fed’s ability to influence longer term rates, such as the U.S. Government Bond Rate (at present the 10-year bond is more than 50 points below where it was when the Fed began its tightening four meetings ago in June 2004), seems ineffectual.
In terms of the Expectations Theory of the Term Structure of Interest Rates, the market is of the belief that short-term interest rates are going to fall in the future. Recall that in the Expectations Theory, actual long-term rates are the geometric average of the expected short-term rates for that time period.
It is clear that the Fed does not control expectations of future short-term interest rates. Some possibilities are that the Fed has set off fears of a softening economy, or that the public believes that any remaining inflation may be eliminated, if not outright deflation occurring. An alternative to the Fed’s fear of inflation could be that they want short-term rates higher in order to give them some room to maneuver should the economy actually soften (providing them an opportunity to lower interest rates should the need arise).
In Issue 1, Volume 2004, of this newsletter, we discussed various schools of thought influencing policymakers
(Economic schools of thought…of long dead economists and other items of interest)
There seem to be continued, but veiled references by Fed officials and prominent lawmakers that an inflationary gap is imminent and that federal government deficits portend future economic chaos. While one could argue that in the past, the economy was subject to a strong inflationary bias, those of us who support the New Economic Paradigm argument point out that the increasing pervasiveness of competition in our markets has led to the decline in price power in both product and resource markets. Again, in the past, it was the downward price rigidity that led to the inflationary bias – since prices would rise and rarely fall. Increasing competition has been an important factor in eliminating this bias.
Fed officials have and continue to chant the monetarist theme that the major cause of inflation is the excessive growth of money. Very recently, the president of the Federal Reserve Bank of Minneapolis joined this choir. What is surprising about this is that his district and the University of Minnesota nurtured the school of thought called Rational Expectations. This was the concept for which Professor Lucas was awarded a Nobel Prize. He, along with Thomas Sargent, brought to the forefront this concept, which says that periods of inflation affect only nominal, and not the real metrics of interest rates and labor compensation. A number of monetarists believe there was an inconsistency between Monetarism and Rational Expectations. Hence, the surprise from the recent statements by the president of the Federal Reserve Bank of Minneapolis.
In Issue 2, Volume 2004, of this newsletter, we discussed the two surveys used by the BLS to measure the employment situation
(On Unemployment and Debt…not as dreary as first thought or continues to be reported)
Contrary to reports showing a fall in jobs of 874,000 in the current expansion, the much more reliable population or household survey shows an increase of 1,848,000 over that period. The seventh and previous newsletter went into this dichotomy of the two surveys in great length.
Also, see the more current updated material…
ENERGY CHALLENGE: 2004
Economic development, a rising standard of living, the better life: all of these depend upon the increasing production and use of energy.
There are costs in producing energy in whatever form. Some of the costs occur in extracting sources of energy such as coal and oil for direct combustion or the production of electricity. These fuels also involve the cost of pollution, its prevention or cleanup – referred to as externalities in economic terms.
Other energy sources involve their own particular costs. Nuclear power involves significant upfront capital costs, including preparing the materials, the cost of the facilities (replete with redundant safety systems) and the finally the long-term storage systems for the waste products.
Renewable resources such as hydroelectric, wind and solar power involve environmental costs that range from the significant impact on ecosystems and reconfiguration of landscapes to the effrontery of people’s aesthetic values.
While we will leave the economic analysis to the next few issues of this newsletter, we would like to present some data that might be startling to some. We also encourage you click on the associated hyperlinks for more detail.
From Energy Information Administration, U.S. Department of Energy
United States Oil Picture
· Proven Oil Reserves (1/1/04E): 22.7 billion barrels
· Oil Production (2003E): 7.9 million barrels per day (bbl/d), of which 5.7 million bbl/d is crude oil (NOTE: Including "refinery gain," US oil production in 2003 is estimated at 8.8 million bbl/d)
· Oil Consumption (2003E): 20.0 million bbl/d
· Net Oil Imports (2003E): 11.2 million bbl/d (56.0% of total consumption)
· Gross Oil Imports (2003E): 12.2 million bbl/d (of which, 9.6 million bbl/d was crude oil and 2.6 million bbl/d were petroleum products)
· Crude Oil Imports from the Persian Gulf (2003E): 2.4 million bbl/d (around 25% of gross U.S. crude oil imports)
· Top Sources of U.S. Crude Oil Imports (2003E): Saudi Arabia (1.72 million bbl/d); Mexico (1.59 million bbl/d); Canada (1.55 million bbl/d); Venezuela (1.19 million bbl/d)
· Value of Gross Oil Imports (2003E): $132.5 billion (up from $102.7 billion in 2002)
· Crude Oil Refining Capacity (1/1/04E): 16.7 million bbl/d (132 refineries)
ANWR (Alaskan National Wildlife Reserve)
Projected output of 1.4 million barrels/day
Potential for 16 billion total barrels (30 plus years output)
Must read from U.S. House of Representatives…much more to follow
The United States – An Oil Thirsty Nation
The U.S. is the second largest producer of oil…
In 2001, the U.S. was the largest user of energy, consuming 24% of the world total, but also contributed 29% to the world’s GDP growth.
Nuclear Proliferation / Illumination
Energy consumption around the globe…
Fuel Share of Energy Consumption (2002E): Coal (46.6%), Oil (32.9%), Natural Gas (17.0%)
Electric Generation Capacity (2002E): 45.3 million kilowatts (84% thermal, 14% hydroelectric)
Fuel Share of Energy Consumption (2002E): Oil (51%), Hydro (33.2%), Natural Gas (5.7%), Coal (5.2%), Other Renewables (1.7%), Nuclear (1.7%)
Electric Generation Capacity (2002E): 76.2 gigawatts (83% hydroelectric, thermal 10%, renewables 4% and nuclear 3%)
Fuel Share of Energy Consumption (2001): Oil (30.3%), Hydro (27.3%), Natural Gas (23.6%), Coal (13.5%), Nuclear (6.6%)
Electricity Generation (2001E): 566.3 billion kilowatthours (Bkwh) (56% hydro, 28.3% thermal, 13% nuclear, 1.3% geothermal and other)
Fuel Share of Energy Consumption (2002E): Oil (24.5%), Natural Gas (3.1%), Coal (64.5%)
Electricity Generation (2002E): 1,575 billion kilowatthours (79% conventional thermal; 20% hydro; 1% nuclear)
Fuel Share of Energy Consumption (2001E): Oil (40%), Natural Gas (15.3%), Coal (4.6%)
Electricity Generation (2002E): 528.6 billion kilowatthours (Bkwh), nuclear (78.5%), hydro (11.5%), thermal (9.3%), other renewables (0.8%)
Fuel Share of Energy Consumption (2002E): Oil (40%), Coal (23%), Natural Gas (22%), Nuclear (11%), Hydro (2%), Other Renewables (2%)
Fuel Share of Energy Consumption (2002E): Coal (54.5%), Oil (34.7%), Natural Gas (6.5%)
Electricity Generation (2002E): 547 billion kilowatthours (84% conventional thermal; 12% hydro; 3% nuclear)
Fuel Share of Energy Consumption (2001E): Oil (47.8%), Natural Gas (31.7%), Coal (6.2%), Hydro (6.1%), and other Renewables (1.6%)
Fuel Share of Energy Consumption (2002E): Oil (49.7%), Coal (18.9%), Natural Gas (12.7%)
Fuel Share of Energy Consumption (2001E): Oil (55.1%), Coal (21.1%), Natural Gas (10.3%)
Fuel Share of Energy Consumption (2001E): Oil (62.8%), Natural Gas (24.2%), Hydro (4.9%), Coal (4.5%), Other (2.0%), Nuclear (1.4%)
Net Electricity Generation (2002E): 198.6 billion kilowatthours (Bkwh); 81% thermal, 12% hydro, 4.5% nuclear, 2.5% other
Fuel Share of Energy Consumption (2001E): Natural Gas (52%), Coal (18%), Oil (19%)
Fuel Share of Energy Consumption (2001E): Oil (54.9%), Natural Gas (12.7%), Coal (11.9%), Nuclear (10.9%)
Fuel Share of Energy Consumption (2001E): Oil (35.2%), Natural Gas (35.3%), Coal (16.6%), Nuclear (10.9%), Hydro (0.34%), Other Renewables (0.60%)
Fuel Share of Energy Consumption (2003E): Oil (40%), Coal (23%), Natural Gas (23%), Nuclear (8%), Hydroelectricity (3%), Other "renewables" (3%)
Electric Net Summer Installed Capacity (2002E): 905 gigawatts (76% thermal-fired, 11% nuclear; 11% hydroelectric, and 2% "renewables")
Energy Information Administration, U.S. Department of Energy
http://www.eia.doe.gov/emeu/cabs/usa.html you can use this link to check out all the preceding country’s as well.
…and let’s not forget coal
…Australia is feeding Asia appetite for energy
(Opinions expressed on this web page are those of a faculty member or employee and do not necessarily reflect the position of University of Detroit Mercy)