Tuesday, September 23, 2008

Where's Mine?

Your Genteel Moderator feels that he should reward his loyal readers. Consequently, below you will find a document that should help all of you to claim a share of the proposed $700 billion “bail-out” plan proposed by the President last Friday and currently under debate in Congress. The Bloated Plutocrat and the Bleeding Heart are unfortunately unable to comment this week as they are busy working on their own plans…

Strategic Plan for MyCo Inclusion in Government Bail-Out of Financial Industry

Background:
On Friday, September 19, 2008, the President and Treasury Secretary Paulson announced that they would seek Congressional approval for a $700 billion + bail-out of troubled US financial institutions suffering from the home mortgage crisis and related financial woes. It is as yet unclear what criteria will be used to define “troubled financial institutions” eligible for bail-out.

Objective:
Ensure that MyCo benefits from the bail-out and receives substantial sums of cash from the federal government. The specific monetary objective is four times 2007 earnings.

Strategy:
1. Develop evidentiary support for claim that MyCo has been damaged by the credit crisis and is at risk of bankruptcy;
a. Exchange outstanding bad debt for defaulted mortgages to ensure consideration as bail-out candidate;
b. Hire large number of employees (target: 25,000) and back-date employment to 2007 to ensure their employment status factors into evaluation criteria;
c. Do not pay employees and claim this is because of credit crisis and not the company’s fault.
d. Indentify and fire middle management scapegoat for “mismanagement” of funds;
e. Use employee pension fund to buy stock in financial institutions likely to be bailed-out showing MyCo is clearly inter-linked to troubled financial institutions;

2. Seek opportunities on high profile media (ie CNN, CNBC, MSNBC etc.) for MyCo senior management to explain company’s plight and the importance of federal bail-out ;

3. Activate Harvard and Dartmouth Alumni Association contacts to lobby Paulson on MyCo’s behalf;

4. Provide form letters/e-mails to MyCo employees to contact relevant Congressional Representatives and Senators urging action on their behalf;

Issues for Consideration:
Although MyCo has no current exposure to defaulted mortgages or any of the major financial institutions filing for, or at risk of, bankruptcy, the actions listed under Step 1 above should ensure that MyCo is able to show need by the time any legislation is approved by Congress;

MyCo’s track-record of consistent profit over its lifespan was originally considered a possible hurdle to consideration for bail-out, but review of companies already named as likely bail-out candidates suggest that this is immaterial;

Senior management bonuses may be negatively affected by such a bail-out and the potential for increased government oversight in the future, therefore back-dating mid-year bonuses at a higher than average rate should be considered;

In relation to above, it is possible that MyCo senior executives may at some future date be required to explain what it is they do to merit such large salaries and bonuses. At this time, we have been unable to elicit any comprehensible responses from MyCo senior management.

Annex: Additional Background Information on Bail-Out Plan
http://www.msnbc.msn.com/id/26787984/
http://www.marketwatch.com/news/story/bernanke-urges-fast-action-congress/story.aspx?guid=%7BE1F27722-6231-4007-8F49-F33F2493C076%7D&dist=msr_1
http://www.treas.gov/press/releases/hp1153.htm
http://www.marketwatch.com/news/story/us-futures-drift-lower-before/story.aspx?guid=%7BDAA80FCF%2DADE2%2D45D2%2D9052%2D5677DC3EADA8%7D&dist=TNMostRead
http://firstread.msnbc.msn.com/archive/2008/09/23/1435286.aspx
http://www.ustreas.gov/organization/bios/paulson-e.html
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Thursday, August 28, 2008

Russia’s Georgian Adventure: Whither an Economic Cold War?


I remember the arcane science of ‘Kremlinology’; sifting through the tea leaves in an attempt to understand the USSR’s objectives and motivations. An East – West studies major at the end of the Cold War at Georgetown’s School of Foreign Service, we were still very much focused on such matters. Within a year of graduating, the paradigm had begun to drastically change with the break-up of the Soviet Union and Warsaw Pact. Within four years, Your Genteel Moderator was writing speeches for pro-market economy politicians in formerly Communist controlled countries and working to acquire privatized companies in Poland, Hungary, [then] Czechoslovakia, the Ukraine, and Russia. The latter was open for business and despite the enormous difficulties of doing business there, from legislative uncertainty to serious issues with currency, foreign direct investment was flooding in at the multi-billion dollar level. One theory, much touted by the Clinton Administration and one of my former professors of “Kremlinology”, Secretary of State Madeleine Albright, was that such investment would so entwine Russia in the global economy as to ensure its commitment to the principles of free-market democracy. I must say, I was dubious after spending time in Russia (including a forced stay in Moscow during the aborted Coup d’Etat in the summer of 1991) and dealing with the Russian government.


Fast forward through the chaos of the Yeltsin years when “bizness” generally meant the expropriation of any state assets one could lay hands on and the swelling of numerous Swiss bank accounts. Pass more slowly through the pendulum reaction of the Putin Presidency when the supremacy of the State, and the Head of State, were reestablished creating an “etatist” economy that closely entwined government, political cronies, and economic strategy, fueled (literally) by ever increasing oil and gas revenues. Arrive at the farce of “President” Dimitry Medvedev’s election and subsequent appointment of Vlaidmir Putin as “Prime Minister” with a substantially increased portfolio of overt powers to bolster his continued de facto control of the State. Russia is a powerful, re-armed, aggressive regional power with substantial wealth, and major leverage (in the form of natural gas sales) over Germany and other Western European nations. Rightly or wrongly perceiving NATO expansion into Central Europe and potentially further east (Georgia’s abortive candidacy was ill-advised to say the least), Russia is using US preoccupation with Iraq (and irony of ironies) Afghanistan to reassert its political and military hegemony over the former USSR states. It certainly doesn’t appear that investment by US and Western European companies has entangled Russia in the global economy to the extent necessary to force more responsible and less hostile activity. The question one has to ask is whether substantial investment in Russia and its littoral states has in fact diminished the US and Western European appetite for confronting such aggression and reverting to a traditional policy of containment?


Despite protestations from both Russia and the West that we are not seeing a return to the Cold War, it is very hard to view this in any other light. Reemerging from a period of military and political weakness Russia perceives the West (and particularly the US) pursuing a policy of encirclement. Its old nemesis NATO is on its western and southern borders with a vastly diminished ring of “buffer states”, the US military is conducting extensive operations along its soft southern underbelly, and a US anti-ballistic missile system threatens to neutralize its strategic nuclear threat. The West is no better. Viewing the inevitable return of authoritarian government in Russia (who could imagine anything else?) as necessarily a threat to security and stability in Europe and Central Asia (granted, with good reason), it has put the boot in with abandon wherever it could from the Ukraine, to former client states like Tajikistan, Turkmenistan, and Kazakhstan, and finally to its courtship of Georgia, all the while decrying the conduct of the Russian government domestically. For Russia, expansion and the creation of buffer states has been an historic imperative from a security standpoint. For the West, containing that expansion and mitigating Russia’s (in whatever guise) influence and power farther afield has been a basic policy since the mid 19th century. Re-emergent Russia means resuscitation of containment in one form or another.


There is however a major twist in this emerging Cold War: a global economy. In the old Cold War, the economic doctrines of Marxist/Leninist Communism in Russia meant that the USSR and its Warsaw Pact satellites were not integrated into an economy that had become increasingly global in scope in the forty some years after the close of WWII. While East – West Trade existed, it was almost always subservient to the political strategies and interests of either party. After 1990, the growth of trade, the substantial inflow of foreign direct investment to Russia, and the substantial capital flight from Russia to investment opportunities around the world contributed the rapid acceleration of Russia’s involvement and participation in the global marketplace. Rising fuel costs in the middle of this decade (driven in part by Russia’s partial success in developing its own economy and, to some extent, by the large expansion in disposable income for a segment of Russian society) have given the country economic muscle and the wherewithal to rebuild its military. Not only has Russia’s emergence as a player in the global economy been one of the forces driving current pressures on commodity and fuel prices, but its control over substantial volumes of commodities as well as its own oil and gas reserves have provided it with leverage over the likes of Germany that even batteries of medium range nuclear missiles couldn’t deliver in the 1980s.


What does this mean for “Western” companies with investments, affiliates, joint ventures, etc., in a Russia that appears set on a course for confrontation with the West? Risk. And risk management. The first thing that any high profile companies with transparent investments in Russia and listings on Wall Street needs to do is take stock of its political entanglements in Russia. Despite the Foreign Corrupt Practices Act (FCPA) and the best of intentions in adhering to it, nobody has been doing large-scale business successfully I Russia without some sort of political entanglement. If confrontation escalates or, perhaps, as conflict escalates between the West and Russia, those entanglements – silent partners, minority JV partners, counselors, “friends”, whatever one is calling them these days – will be the cause of pressure. Whether that pressure is from the West over revelations of such entanglements or through them from the Russian government, now is the time to be cutting them loose or distancing the company from that exposure. As time goes by, this will get harder and the cost of doing so will be higher.
Next, take the “New York Times test”. What will the nature of any transactions, investments, or entanglements look like printed on the front page of the New York Times or Wall Street Journal when the next act of Russian aggression or Western provocation results in something more serious than the annexation of unpronounceable territories at the back end of nowhere? Develop scenarios. Will there be a share-price impact? Will such revelations negatively impact business development efforts elsewhere? Finally, develop contingencies and exit strategies starting now – quietly. Better to run the risk of unnecessary planning now than face the Board’s question as to why you weren’t prepared for this later.


The Bleeding Heart does not share Your Genteel Moderator’s gloomy forecast. Over the phone from Denver, sounding like a teenager on ecstasy at a rave, he assured me that all would be well come November. “When Obama is elected, this gloom and doom atmosphere is going to rapidly change. There will be a new optimism in this country and a new respect for America abroad. He’s going to be able to work with the Russians and others because he believes that talking and negotiating are the way to get things done, not unilateralism and provocation. Investment in Russia has been a good thing and has helped to tame Putin’s more aggressive tendencies.” The Bloated Plutocrat was somewhat less optimistic. “The only thing worse than Godless Communism is Russian Capitalism. My family lost a lot when Russia went Red in 1917 and while I have made a good deal of money through investments and transactions in Russia over the last 15 years, I am divesting rapidly. Whether this President or the next does something stupid to set them off is irrelevant. The rules have never been fair and the market has never been free in Russia, but with the return of increasing political and security tension on the geo-political level as well as the significant economic risks, the costs of doing business there are simply going to be too great in the not so distant future”.


To be sure, in any time of political uncertainty there is money to be made. That will be true in Russia for the foreseeable future. What many need concern themselves with is that there is also a great deal to be lost, and it will be the re-emergence of the dialectic between Russia’s urge to expand and the West’s perceived need to contain, with a new global economic twist, that will govern the risk/return ratio in Russia and Central Asia for some time to come.
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Tuesday, August 12, 2008

Cheaper Invasions?

You are of course well aware of those “evil foreign dictators”, whose “monopoly” control over our oil imports threatens our national security. You must be aware of them, every member of Congress, the Presidential candidates, their operatives, the pundits, and the media meat puppets are constantly talking about them. Sen Chuck Schumer (NY) was going to sue them if his co-sponsored Consumer-First Energy Act was passed back in June. It certainly is an issue of concern: these undemocratic, foreign potentates in distant lands whose nefarious plans to exploit US energy needs threaten the future of the nation. You know: “them”.

“They” are also a threat to our national security not only because of their “near monopoly powers”, but because of their support for terrorist organizations and the unremitting oppression of their own people, which encourages further resentment and terrorist action against the US. Indeed, their profiteering and price gouging is a major cause of the current economic recession and constitutes a virtual act of war by other means against the country. In fact, as Paul Wolfowitz (subsequently US Deputy Secretary of Defense and a leading “Neo-Con”) noted in 1994, “The United States and the entire industrialized world have an enormous stake in the security of the Persian Gulf, not primarily in order to save a few dollars per gallon of gasoline but rather because a hostile regime in control of those resources could wreak untold damage on the world's economy, and could apply that wealth to purposes that would endanger peace globally.” As of May of this year, the United States had imported 398,714,000 barrels of oil. Indeed, with daily US oil production at just over 5 million barrels/day and it’s oil needs at just over 19 million barrels/day, imports will remain critical for the economy.

The situation is very clear. Foreign control of oil necessary for the economic well-being of the United States represents a clear and present danger to the national security of the country. The only possible response should be the invasion of those countries that pose such a grave threat to the US and the confiscation of their oil resources. But wait, Iraq is only contributing about 600,000 barrels/day of the nearly 14 million barrels/day in imports required by the US – at market prices. There has to be a better solution. From where does the US get most of its foreign oil? Well the top three despotic, monopoly suppliers of oil are: Canada, Saudi Arabia, and Mexico. Saudi Arabia has many of the same problems as Iraq. It’s far away, hot and dusty, and full of people that despise America and aren't opposed to a dynamite vest for the cause. Next on the list is Venezuela at roughly 1 million barrels/day of oil exports to the US. So, Canada, Mexico, and Venezuela combined make up about 3 million barrels/day of US energy needs. Hmmmm….

“Canada's trade surplus widened for a second straight month in June as exports of energy products such as crude petroleum and natural gas surged and car shipments rebounded.

The surplus widened to C$5.76 billion ($5.41 billion) from a revised C$5.22 billion in May, Statistics Canada said today in Ottawa. Exports and imports both rose to records in June, gaining 3.1 percent and 2 percent respectively, and the trade surplus with the U.S. was the widest since January 2006.”

Hold on. Canada has been a steadfast ally of the US ever since the last time the US tried to invade them in 1812. They are the US’ leading trading partner and a part of the North American Free Trade Agreement (NAFTA). And while they do tend to be a little goody-goody and socialist, ruthless oppressors and supporters of terrorism, they are not. There’s always Mexico. Almost every night, CNN anchor Lou Dobbs, that paragon of intellect, is on television urging that the US go to war with Mexico, right after the hundreds of millions of illegal Mexican immigrants (most of whom are saboteurs infiltrated by the Mexican government) are gathered up in concentration camps. Mexico is currently good for almost 1.5 million barrels/day and, under occupation, they could certainly be counted on for up to 5 million barrels/day without truly undue suffering by the civilian population. And there is a history of invasion and successful annexation of Mexican lands between the US. The problem is that not only is Mexico a member of NAFTA and, Lou Dobbs aside, a friend and ally, they are rather fond of their independence. And, as General Pershing noted following his 1915 invasion of Mexico, the Mexicans are rather good insurgency fighters.

Ah, Venezuela. In 2007 it averaged 2.4 million barrels/day production and should be relatively easy to bump up above the 3 million barrels/day mark. Lead by the loveable Hugo Chavez, the Neo-Communist and attempted dictator-for-life who aspires to Fidel Castro’s mantel, here is a country whose leadership does indeed oppress its people, that certainly supports organizations with a professed antipathy to the United States, and whose arms dealing with Iran might be stretched to support for terrorism. Certainly, with a little creative writing by the intelligence community, Chavez could be shown to be in search of WMD. Chavez’ relationship with Iranian President Mahmoud Ahmadinejad, himself involved in nuclear arms proliferation, would certainly lend credence to any such claims, while the fact of his conventional arms build-up, his aggression toward US ally Colombia, and his support for allegedly socialist but clearly anti-US political movements across Latin America and the Caribbean, all help make the case.

So, Venezuela it is! Or….perhaps there are some things that might be considered before such an invasion to alleviate the energy crisis and improve the US economy. Maybe some improved deficit management to strengthen the dollar? Maybe some diminished government expenditures? Maybe steps towards a realistic alternative energy policy based on rewards for sustainable energy alternatives to oil imports (as opposed to incentives to pursue energy objectives and strategies set by Congress). Food for thought?

The Bleeding Heart thinks so. “Hugo Chavez is the replacement for an ailing, and possibly already dead, Fidel Castro in the iconography of Neo-Con ‘boogey-men’ created by this administration. The real issue is not how to get cheap oil by invading yet another country, but how to reduce dependence on imported oil, whether imported from friend and ally or foreign despot. The market simply doesn’t work and Congress needs to be allowed to deveolop an effective energy policy that incentivizes sustainable types of energy production.”
The Bloated Plutocrat is less certain. “Congress is the last refuge of the scoundrel and the incompetent. Their idea of energy policy is to spin the ‘wheel of populist nonsense’ and see where the dart lands – that’s the new energy policy this week. The market does and will work. If Congress wants to break with tradition and do something useful, providing tax credits and other rewards for initiatives that provide measurable, sustainable offsets against oil imports may be helpful. Mostly, they can stop talking nonsense about the price of gasoline being the result of oil company speculation.”

Let us hope that further military adventure is not seen by this or coming administrations as a viable mechanism for alleviation of the so-called energy crisis. Perhaps the market can find solutions. This, for example, may not be the answer, but at least someone is thinking: http://www.pickensplan.com/


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NOTE: Your Genteel Moderator apologizes for the dearth of postings in recent weeks but work, travel, and holiday schedules have made coordination with the Bleeding Heart and Bloated Plutocrat impossible. Now, your Genteel Moderator himself heads to Portugal’s beautiful Algarve for several weeks and will not be available to write. Please enjoy the last of our summer weeks and look forward to new and more consistent posting in September.
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Wednesday, June 18, 2008

InBev, in Bid for Bud, Courts Community






It really ought to be called “uncommon sense”. While it may seem that InBev are doing what any company pursuing an unsolicited takeover bid should do by prosecuting a charm offensive with stockholders, the community, and government, you may be surprised how few companies get it right. The sale of the largest US brewer and its iconic Budweiser brand to Brazilian controlled, Brussels based InBev is not sitting well with US lawmakers or many in St. Louis. However, the proposed $65/share offer, that could result in a $57 billion total takeover bid with assumption of debt, should be sitting well with shareholders who have seen little positive share movement in recent years as Bud’s share and historic pricing control over the US market have been eroded by the massive expansion of small micro-breweries, rising imports, and the search by many beer drinkers of the elusive “anti-Bud”.

It would of course be crazy for law makers and community leaders to comment favorably on the proposed transaction. Nobody likes change and a change that sees the country’s leading brewery, and its leading brand, Budweiser, sold to the Brazilians, is not going to be popular. InBev gets this. This is not the first time the company has faced local hostility during its massive expansion and they have learned much over the years. In addition to a charm blitz aimed at wooing the St. Louis media, community opinion leaders, and Missouri’s Congressional delegation, InBev has set up a website to promote the acquisition by providing reassuring facts and grist for the media mill. This is a very smart move and, again, while it will strike most people as common sense, it is not something done with the regularity necessary to make it “common”.
If anyone hadn’t previously noticed the global shift in economic power that is taking place and gaining momentum during the first decade of the 21st Century, this should do it for you. Anheuser-Busch is not a company in trouble. It is not a company without global reach. It is however a tasty target in the on-going consolidation of global brewing that has seen US number two, Miller, become part of South African Breweries to make the world’s current largest brewer, and the nation’s third largest brewer, Coors, merge with Molson of Canada in 2004 to become the world’s fifth largest beer company. Indeed, that consolidation, and the subsequent merger of SABMiller and Molson Coors operations in the US and Puerto Rico just over six months ago, helped make the InBev takeover bid possible by putting further competitive pressure on Anheuser-Busch.
So, when the 'Show-Me State' gets all worked up about Anheuser-Busch being sold to foreigners, they may care to note that there aren’t really any US owned mega-brewers left but Anheuser-Busch. And even if the company somehow survives the InBev takeover bid, its Missouri roots will likely be diluted by the merger of Anheuser-Busch with Grupo Modelo of Mexico (maker of Corona), in which Anheuser –Busch already has a 50% stake. While this strategy is being discussed a means to make a hostile takeover by InBev unpalatable, there is substantial speculation that InBev may like to swallow the Corona maker in the deal anyway. While InBev chief Carlos Brito seems opposed to further upping the deal, it seems unlikely that he would really balk at the opportunity.
The bottom line is that InBev is doing all the right things and making all the right noises. While politicians can volubly declare their opposition to the deal, the fact is that there’s really not much they can do about it as there are no substantial regulatory hurdles to such an acquisition. If Anheuser-Busch shareholders like the offer, that should pretty much be that. The Busch family controls less than 5% of the stock while Warren Buffett’s Berkshire Hathaway Inc., owns over 5% of shares and stands to make some USD $600 million on a three year investment in the company. The largest single shareholder, Barclay's PLC, with over 6% interest in the company, is unlikely to oppose a tidy profit.
“That Buffett is a clever chap. I haven’t been in beer shares for some time. With the economy on the way down, your booze portfolio should be in hard liquor. Beer may be relatively more affordable, but ‘liquor is quicker’ as they say. I can’t see Anheuser-Busch staving this bid off. A Grupo Modelo merger may put InBev off temporarily if they only have Board approval for a purchase in the $50 billion range, but Anheuser-Busch has not grown as aggressively as it should have internationally and this is the price it pays”, said the Bloated Plutocrat. The Bleeding Heart is still so angry with your Genteel Moderator over last week’s Big Oil vs Big Government post that he would not file written remarks. When I did speak with him over the phone, he insisted that “this is all because of NAFTA”. When I explained that the proposed InBev deal had nothing to do with NAFTA, he became very distraught and screamed that I didn’t understand international trade and that this was all just another unwanted side-effect of a free-trade policy. This is of course partly true. But if Anheuser-Busch were buying Tsing-Tao, I somehow doubt the Bleeding Heart would be railing against free trade…
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Thursday, June 12, 2008

Big Oil vs. Big Government

Nobody likes oil companies, except the Bloated Plutocrat of course. They are environmentally unfriendly. And they make way too much profit. Well, right now at least. The last “oil crisis” that I witnessed was rather different. In 1998 I was living in Dubai and the price of a barrel of oil dipped below $20. Persian Gulf governments were in a tizzy over the massive revenue shortfalls and falling budgets they were facing. There was talk of suing EU governments for the disproportionately high taxes that they imposed on the retail selling price of gasoline! North Sea rigs were set to shut because they couldn't produce at that price. Oil companies were losing money then. But ever since then they have made OBSCENE profits according to Barack Obama and his Senate Demagogues, sorry, Democratic colleagues, that introduced a piece of political hustle called The Consumer-First Energy Act of 2008, largely comprised of a 25% windfall profits tax on U.S. oil companies. While I agree that Exxon-Mobil’s first quarter earnings of $10.9 are pretty much obscene, it seems that over the past ten years, Exxon-Mobil and other US oil companies have reaped profits on par with the rest of US manufacturing companies – approximately 8 cents on the dollar invested. Oh. Fortunately the Bill is going nowhere.

Oil prices are high because the US won the Cold War and discredited Godless Communism, the economic aspects of which have been chucked out the window everywhere but North Korea and the London School of Economics, even if China and others maintain the political aspects of Marxism-Leninism that keep the ruling oligarchy in power. Meanwhile with even “socialism” a dirty word outside the retrograde South American countries that Venezuelan President Chavez has purchased with oil revenues, China and the formerly bumbling socialist India, Russia, and most of its former satellites are all witnessing strong economic growth rates based largely on the benefits of a free-market economic system and freer global trade regime that the US has championed pretty much since its independence from Britain. Gasoline costs $4.00 a gallon in the US because you bought that Made in China 64” Plasma Screen TV last year. The plant that made that TV has expanded fivefold in the last 9 months and the shift supervisor when your gargantuan teletheater was produced (he’s now Director of Operations) has upgraded from moped to Toyota sedan. Both these developments mean that more fuel is being used elsewhere in the world (as oposed to the 25% of global oil consumption in the US), driving up your pump prices at home. So when Senator Charles Schumer of New York spews lickspittle while screaming about oil company profits, it begs the question as to whether he, or any of his colleagues in the Senate, understands basic economics.

Mind you, McCain isn’t much better, but he’s marginally more honest about his grasp of economics. He and Senator Clinton’s proposals for a Federal gasoline tax holiday represented the worst kind of pandering. With McCain one hopes that it was at least partly driven by an orthodox view that cutting taxes is never a bad idea. He was at least honest when he almost, sort-of, admitted he was tax-cutting for votes. Clinton was just desperate, but compounded pandering with stupidity by proposing another windfall profits tax on Big Oil to fund her vote-soliciting gas tax holiday. But both of them should have realized that the best they could hope for would be that gasoline retailers would split the difference with consumers, resulting in a massive 9 cent per gallon price reduction (while prices are climbing). Offering gasoline retailers a potential 18 cent per gallon windfall wasn’t very smart. But it didn’t raise serious questions about the mental health of either Senator. Not so for the sponsors of The Consumer-First Energy Act of 2008. Oh, and Obama was opposed to the gas tax holiday. But he was in favor of it before he was against it. (In 2000, he supported a Bill in the Illinois legislature that would have temporarily suspended the state gas tax).

Who do you think would be victorious in the battle of wits between the Seven Mental Dwarves of the Senate (all of them named "Dopey") that sponsored this Bill and the Finance, Taxation , and Law Departments of America’s oil companies? Would such paragons of virtue as Sen. Harry Reid prevail as a latter day Mr. Smith against the rapine oil companies? Or would a 25% tax hike on US oil companies simply be passed on to the consumer, further driving up gas prices? I know which way I would bet. But Sen. Chuck Schumer was particularly irate that the authorization for the US Attorney General to sue OPEC producers for their “monopoly” powers included in the Bill should be voted down. The fact that the US remains one of the worlds Top Five oil producers (number 2 after Saudi Arabia by some measures) and that its single largest source of imported oil is Canada (not an OPEC member to the best of my knowledge) seem to have eluded Chuck.

Can we go back to Economics 101? Supply and Demand. Right now, demand for oil is extremely high at just under 87 million barrles per day. This is higher than markets had envisaged, but already showing signs of falling. New oil fields (and oil fields are being discovered as I write) as well as oil sources that are not profitable at lower prices (Canada’s Athabasca Tar Sands, for example) take time to come on line and meet this higher demand. Similarly, high fuel prices create inflation and slow economic growth as well as discourage oil consumption, which in turn brings down demand for oil. Within 18 months from now, the price of a barrel of oil will be back in the $90 - $100/bbl range. Perhaps the Seven Mental Dwarves who sponsored The Consumer-First Energy Act of 2008 should instead draft Senate guidelines requiring that members of the Senate have obtained a basic educational level that includes passing Econ 101. That of course would thin the Senate out considerably AND substantially diminish eligible candidates. Supply and Demand.

Sadly, the Bleeding Heart refused to speak with me or provide written remarks for this piece. He said that Your Genteel Moderator had gone too far, and that accusing Senate Democrats of stupidity (which I do, but do not believe is confined to the Democrats) and the high price of gas to the failure of Communism (which I do, but he resents, having done a junior year abroad at LSE) was “absolutely unacceptable”. The Bleeding Heart believes that his hybrid SUV is the answer to the oil crisis. The Bloated Plutocrat was unable to file comments. He is at an Exxon-Mobile Board meeting and invitational golf tournament…

PS – Your Genteel Moderator must confess to a degree of bias in this matter. I dislike oil companies. In early 1990 while still at University but looking for a job, I went to interview with Occidental Petroleum in Los Angeles. That day they let go more than 10,000 people. This was because oil prices were low and they were scaling back exploration and refining activities. They didn’t offer me a job.


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Thursday, June 5, 2008

Uh-Oh, Airline Re-regulation?

With jet fuel prices soaring and almost nothing left for airlines to cut (removing the seats altogether appears to have been too much for the FAA), it looks like it’s routes and jobs under the knife now. United announced substantial cuts earlier this week, grounding its 737 fleet, following previous moves by American some two weeks ago, and Continental is following with plans to cut routes and jobs as well. Expect similar moves from other US and international carriers in the near future. United has announced it will shed roughly 15% of its domestic seats on offer and American and Continental are in a similar range. Airline analysts have long talked about the need for domestic carriers to drop nearly 20% total seats on offer to regain profitability, so further cuts could be in order. So far, going back to Delta’s cuts at the end of 2007, most carriers have cut in the 12% - 15% range, but with fuel costs up over 80% in the last year, those cuts are likely to be seen as insufficient.

Despite the economic downturn/recession, demand for flights remains high, at this time. This means one thing. Expect rising fares on remaining routes. Of course should these fare increases work in tandem with further recession, we may see falling demand at some time in the future. That of course may lead to further route cuts, getting to a point where we have very limited service and high expense on a number of routes. But wait, we’ve been there before. Thirty years ago de-regulation was promoted to increase competitiveness in the industry and produce increased service and lower prices. Now after thirty years, and the coming and going of some 200 airlines in the US, the question of regulation is again under discussion.

Is it more regulation or less regulation that is needed to pull the airlines out of their slump? There’s definitely room for debate. On the one hand, deregulation did spur competition and lead to increased airline capacity and lower prices. This was undoubtedly good for consumers. Unfortunately, a lot of short-lived, predatory competitors emerged under de-regulation, rising on the scene under-capitalized, extracting fairly painful concessions from unions with a promise of a brighter future, slashing prices to generate passenger trial (and drive those stock prices up in the short term), and then going out with a whimper after being unable to sustain operations at rock-bottom prices. In the meantime, they succeeded in slashing total industry profitability and causing real pain at the major domestic carriers. If you think about it, have the US carriers ever been “well” since the so-called crisis of the First Gulf War? Of course, one of the major complaints inside the industry is over the 25% limit on ownership by foreign interests of domestic airlines. There is a view that these limits have diminished investment in the industry and contributed to the death by a thousand cuts inflicted by the small-cap, fly-by-night (had to work that in there somehow) come-and-go airlines.

“Limited re-regulation is the only long-term solution for an industry that is continually seeking government assistance," Robert Roach Jr., an executive with the International Association of Machinists and Aerospace Workers, said at a recent Senate Commerce Committee hearing on the state of the airline industry. James Little, international president of the Transport Workers Union of America, believes that to save the faltering airline industry, "I think the time has come for some kind of re-regulation… For labor, we need some kind of transition program, so that pension plans can be saved if there are mergers and acquisitions." With employees having born a substantial cost in the fight for competitiveness over the last decade, this call for some form of “re-regulation” will come as no surprise. Certainly few would argue that while de-regulation brought with it more flights at cheaper rates, it also brought diminished in-flight service and, overall, a less pleasant flying experience.

But hold on a minute. What is it that people want? Lot’s of cheap flights with admittedly Aeroflot levels of service, or fewer, more expensive flights pitched more at the Singapore Airlines level of service? Obviously what consumers want are cheap flights with fantastic amenities, but recognizing that this scenario is unrealistic, the answer is that what the country wants is lots of cheap flights. And in the post de-regulation era, that’s what it got. The result was a massive expansion in airline travel by Americans. According to the Bureau of Transport Statistics (please see last week’s Blog), in 1977, people paid for 149.5 million flights on US domestic airlines. In 2007, that number was 769 million. That growth (five times as many domestic seats sold in 2007) cannot be accounted for by population growth – or growth in corporate travel budgets. The fact is that America got what it wanted: cheap flights. The price it paid was horrible service, massive congestion, under-investment in infrastructure, and vicious competition.

The industry itself is not convinced that re-regulation is an answer, although government measures to limit competition under any other name would be most welcome. They would love to see higher barriers to entry for new airlines (diminishing the number of one route wonders that slash major carrier profits before disappearing in a Chapter 11 cloud), and would likely welcome measures that effectively establish minimum prices on certain less profitable routes (provided it isn’t actually called price controls). But mostly one hears about more deregulation: a freeze on government fees (have you looked at the fees and taxes section of you airfare lately – there’s a healthy tax-farming business afoot if nothing else); a reduction in fuel taxes (unlike the average motorist, a break on Avgas would add up); easing competition rules on airline M&As, and most of all; the removal of the 25% limit on foreign ownership of US airlines.

It is a point well made. There is virtually no other sector of the US economy in which this limit on foreign direct investment exists, certainly not one as mundane as cattle carting. The fact is that that sometime in the next year or so, Emirates Airlines of Dubai will become the world’s largest passenger carrier. Look at booked sales for Boeing and Airbus – the Middle East and Southeast Asia are leading the charts. If consolidation of the domestic industry is generally seen as a bad idea, then direct foreign investment or acquisition is the likely answer. There really are no legitimate security concerns and, before screaming blue murder, the unions should consider that most European airlines are used to much more costly deals with labor than the US unions can even imagine.

Predictably, the Bleeding Heart and Bloated Plutocrat had strong and widely variant views on the matter. “De-regulation was just another excess of the 80s. We saw the folly of big hair, shoulder pads, and Boy George, why can’t we accept that airline deregulation was a Gordon Gecko fantasy gone wild. The unions have been bled dry by successive agreements that saw them paying for bad corporate planning. With the fuel crisis and economic downturn, it’s time to reestablish a regulatory framework for the airlines that will ensure good service for consumers, better safety, and decent wages for airline employees”, said the Bleeding Heart. “Well, I’m torn”, noted the Bloated Plutocrat. “I’d love to get rid of all the commoners who fly and return to the days when flying was an enjoyable experience for the select few that could afford it. But it won’t happen. There’s no turning back the clock. All we’ll end up with is an inefficient, slightly expensive system in which large people in clothes that are too small for them continue to fly. No. Open the doors to foreign investment. When Singapore and Emirates are operating the New York – LA route, we’ll at least have a jolly good First Class service!”
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Wednesday, May 28, 2008

Lies, Damned Lies, Statistics, and the CPI…

If statistics are the highest order of lies in this phrase about the three types of lies commonly attributed to 19th Century British Prime Minister Benjamin Disraeli, then the US government’s Consumer Price Index (CPI), compiled by the Bureau of Labor Statistics (Minicrap for the Orwell aficionados), is the celestial be-all and end-all of lies. Your Genteel Moderator begs your indulgence as he addresses what to some may be an arcane matter of economics. But the continued use by the government of a CPI based on the price of treacle and fairy dust demands our attention.

http://www.bls.gov/CPI/
http://www.victorianweb.org/history/pms/dizzy.html

But why, you may ask? Because, unless you happen to live in Never-Never Land, you may have noticed that treacle and fairy dust do not make up a substantial portion of your monthly expenditures. Off the top of your head, estimate the top 10 costliest expenditures by month that you and your family incur. Would fuel be one of them, perhaps? Do you then imagine that an index compiled to measure the relative increase in the cost of living and from which the inflation rate is essentially derived should reflect that relative weighting? Many people would share your views, but apparently not the Bureau of Labor Statistics. Because they believe that fuel (gasoline and diesel for motor vehicle use) accounts for just under 5.5% of your monthly expenditures. In fact, according to today’s CPI formulation, energy costs account for less than 10% of your total monthly expenditures. That may be so for the Hollywood glamoratti and the Greenwich Hedge Fund Manager, but for rather more ordinary people, not so much.

http://www.bls.gov/cpi/cpihe00.htm
ftp://ftp.bls.gov/pub/special.requests/cpi/cpiri05-06_2007.txt

The easiest way to calculate annual inflation is by using the CPI in the same months from two consecutive years, subtracting the base year from the second year, dividing the result by the base year and multiplying by 100. For example, the CPI for April 2007 was 206.686 and for April 2008 was 214.823. Therefore, CPI derived inflation year-on-year to April was 3.93%. Of course that’s based on a CPI weighting that puts gasoline costs at less than 5.5% of your expenditures and total energy costs at less than 10% of total expenditures. Let’s look at the price of gasoline for the same period. According to the US Energy Information Agency the average price of regular gasoline across the country has increased by just under 73 Cents in the past year (as of May 26). Using the same method of calculation as CPI derived inflation, then average US price for regular gasoline has increased by 22.68% in the past year (although I would like the Energy Information Agency to show me where I can get gas for $ 3.93 a gallon!). We could run through home heating oil as well but suffice it to say that that too has increased, if not as dramatically. For diesel fuel, a significant distribution cost driving food and other price increases, the increase is much more dramatic at 67.66%. That means at least a two thirds increase in the cost of getting goods to market (unless you distribute by sailboat of course). The point is that with gasoline prices having risen by nearly 23% (and diesel by nearly 68%), the CPI derived inflation rate of 3.93% is nonsense.

http://www.inflationdata.com/inflation/Inflation_Articles/CalculateInflation.asp
http://www.eia.doe.gov/oil_gas/petroleum/data_publications/wrgp/mogas_history.html
http://tonto.eia.doe.gov/oog/info/wohdp/diesel.asp

There have been and continue to be numerous criticisms of the CPI based on everything from sound economic theory to politically based tinkering. A quick review of internet based resources alone will give you more information on the subject than you could possibly want. But it is difficult to argue with the fact that a year on year inflation rate of 3.93% seems absurdly low in view of sky-rocketing energy costs. Add to this picture the falling value of the USD (which by some measures has fallen by more than 30% since 2000) driving up the cost of imports (i.e. virtually every manufactured good that you buy these days) and what we have is the portrait of an economy in real crisis. Add to this the substantial decline in relative liquidity, i.e. the widely touted “credit crunch”, and we have a potential Perfect Storm brewing, and certainly a rather sticky conundrum for monetary policy.

http://mykindred.com/cloud/TX/Documents/dollar/

In any event, not only are gasoline prices painful and inconvenient, they are also having a multiplier effect on the much discussed recession that the government is vastly understating through a highly distorted CPI. The Bloated Plutocrat had this to say. “If you are relying on government statistics to understand the economy old boy, you are going to lose your shirt. Run for the Swiss Franc and Gold Bullion. The equity market is a total bear and the bond market is going to be flooded with punters and prats! Nothing’s going to change in the near term and neither one of the esteemed Senators likely to be elected in November have the intellectual capacity or political power to do a damned thing about it. Aside from the global shift in economic power away from the US in general, we are looking at conditions that bear some resemblance to the late 1970s, but without a Ronald Reagan to convince us that everything is going to be just fine.” The Bleeding Heart was somewhat less enlightening. “I suppose that the fuel / energy cost weighting in the CPI should be substantially increased, especially as those costs are disproportionately impactful on lower income groups. I know that fuel costs are definitely driving up the cost of tickets on the Martha’s Vineyard Ferry this summer!”

A CPI that weights total energy costs at less than 10% of one’s total monthly expenditure is at best inaccurate and, at worst, fraudulent. Were these costs more appropriately accounted for, adjusted inflation would likely be upwards of 5%, a level that is extremely disconcerting when looking at interest rates. Nevertheless, don’t expect a change in the CPI basket any time soon, the BLS think it works just fine…

http://www.bls.gov/cpi/cpigm697.htm
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