No President has had a higher approval rating that Bush on the days after September 11th. This was while he was still in hiding and had not even gotten to New York City. Since then, as everyone with a political pulse knows, he has blamed September 11th for every economic, political and social ill that is laid at his doorstep, and blamed Clinton for it. Deceptive speeches, reports and bias have been used to accomplish this.
It is a life long pattern of George Bush: to burn the last straw for having broken the camels back. And whether the public buys it is a key test of where the public mood is. If Bush spikes up, then it means Americans want one last lurch to the right. If not, it is the end of the road for the Age of Nixon.
As inflation spirals upward - the real kind, unmasked by economic gamesmanship - Bush will be blaming the hurricane. Many people will be telling you how oil just hit an all time nominal high. A few people will tell you how that high is now at a producer price index record - that is, measured in producer costs, oil is now nearly as expensive as it was when the USSR was making its last great thrust outward and two of the world's largest oil producers were involved in a life or death struggle.
In otherwords, things haven't even gotten bad yet. There were four oil driven recessions in the 169-1982 period (the long 70s), the first a mild one in 1969, and then a much deeper one after the oil shock of '73. And finally the massive double dip recession whose foreshock was in 1980, and whose massive quake was in 1982.
But oil is a symptom of economic trouble, not, yet, a cause of it. It is crowding out other spending, and it is reducing people's living standards - which is making them unhappy. But it is not the driving force in the world's economic problems.
What is the driving force is this: political economy.
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Political economy is the grand game of economics. It isn't about who gets the money, it is about how money works, and what its basis is. The First International Gold Standard - which ran roughly from 1871 to 1928 - was one such era of political economy. The present era of political economy began with Nixon "closing the gold window". For almost thirty years, if America overspent, the only way to do anything about it was to raise prices of what was sold to America. If Americans didn't need to buy as much as others needed to sell, then commodity prices went down.
This is important, so I am going to unpack it. Imagine you are someone in Chile who owns a copper mine. Now America needs copper, lots of it, for plumbing and other needs. But you, they guy with the mine, have bills to pay - and you can't easily turn the copper mine into something else. The Reaganomics era basically worked in just that way: keep real wages flat, growth only as fast as could be managed with flat commodities consumption, and let the producers twist in the wind until they had to sell.
The result was "the Great Commodities Depression" of 1983-1998. For 15 years, oil, metals and other commodities got cheap relative to other things. This allows America's economy to trundle along. The problem is that it also pulverized real investment as a share of GDP. In reality, corporations grew less profitable, people invested and saved less, and we hoped that the rest of the world would both invest in new capacity, and would send money to us.
Without pricing power on what they sold to the US, there was no easy way to exploit America's consumption binge. Remember, economics sides with the hidden flaw, but until that flaw is big enough, life goes on. Protect the flaw, and even badly managed economies can do well for a generation. It works, until it doesn't.
The underlying problem then is not that oil is going up. On the contrary: oil has wanted to go up in price for a long time, as have other commodities. Ask the gold bug commodity traders, they will tell you have over and over again the signs of a great gold revival was in the works, and yet never happened. While I don't practice gold buggery, what they were looking at was quite real.
The real problem, in simple terms, is that Americans spent more and more of the national effort on consumption, and less and less on production.
Which brings us to the short term problem, shown on the graph above, and the long term problem, which I will put in another graph later.
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The graph above is the tale of a recession coming. It has four lines on it. The "yield spread" is the difference between the yield of the shortest treasury for sale - in this case the 13 week t-bill - and the longest - in this case the 20 year. It used to be the thirty year, but they don't sell that right now.
The second is the "long spread" the difference between the first of the long maturities - the 2 year - and the 20 year.
So the first line tells us that the difference between short term money and long term money is going down in cost. The second tells us that long term money is starting to cost all the same.
The two remaining lines are trend lines - the first is the long yield trend line, the second is the total yield trendline. What is important here is that they are parallel. The difference between these two lines is the amount of ammunition that the Federal reserve has to fight inflation. Since they move in quarter point increments, in bond speak that is "25 basis points" - or hundreths of a percentage point of interest paid.
That these lines are parallel means that the economic program Bush has pursued has failed. It isn't Greenspan's fault, he has been doing the best he can to keep things going, by dragging his feat on raising interest rates. He's given Bush every minute, and then some, that is possible.
Now what does all this mean? How can we read this graph?
OK people who buy bonds take a risk, that risk is that inflation or interest rates will go up while they hold the bond. Imagine you open a 12 month CD one day, at 1% interest, and the next day the bank raises what they offer to 1.25%. That means you miss out on .25% on that money for a year. For bond traders, it is even worse, because they hold bonds for longer, and because if the interest rate hasn't gone up, they can sell their bond on the open market.
The open market for bonds determines "the yield curve". This is simply the effective interest rate that a bond of a given length would cost if it were trading today. There is a mathematical method using third degree, or cubic, equations, to figure out what this imaginary bond would yield. Slight differences in methodology mean that the yield curve quoted in different places can be off by a couple of basis points. This generally does not matter very much, if at all.
Now there are two parts of the yield curve that matter. The "long end" and the "short end". The long end represents goverments parking money, and large investors, as well as companies that loan money balancing their portfolios. The short end represents active money in the market, which just happens not to be in stocks or some other activity. Roughly speaking, the long traders are the people who are financing big structural projects, and the short end represents people who are investing in stocks or other things.
The long spread, the difference in cost of long term money, tells you how sunk the present economy is. The flatter that part of the curve, the more money is sunk into big expensive projects - whether by goverments or real estate developers or what have you. The short end tells you how worried the fed is about inflation.
If there is a big difference between the cost of long term money and short term money, that means that the fed isn't worried about inflation, and there is an economy that is about to throw its resources back into investment. This is called "a steep" yield curve.
If the difference is small, then it is a shallow yield curve. That is what we have right now - the "total yield" has been getting flatter and flatter.
If there is no difference, then the yield curve is "flat". It means that the fed is not really pushing the economy one way or another. The economy will grow if it has things it can do without generating inflation. Flat yeild curves can be good, and can last for quite sometime. The late 1990's featured a flat yield curve, and it helped push people into stocks, because there was no money to be made borrowing short and lending long, and then getting out. This process, called "the carry trade", flattens the yield curve over time.
But an economy with a flat yield curve is living on the edge. It will take only one burst of inflation for the Fed to get spooked and raise short term rates - remember, that is all they can do.
If short term money is more expensive than long term money, it is an "inverted yield curve". That has almost always meant a recession. The only exception was when LBJ's guns and butter spending program produced the late 1960's boom. Otherwise, its been a lock - invert the yield curve and get a recession - or if there is a recession coming, the yield curve inverts. No one is sure which way it goes.
So what this means is that as the long yield flattens - and it is now all but flat - the fed can raise short term rates by the difference between the long end and the short end. Let me say this in a bit longer form: the fed can raise short term rates to fight inflation, if the short term rates go above the long term rates, then it is a sign of recesion - the economy has run out of ideas.
Now, if the fed is going to engineer a "landing", then when the yeild curve on the long end is nearly flat - as it is now - then the fed wants to see long rates going up. This distance is their ammunition. Alan has 75 basis points, or three more interest rate hikes. This will not slow energy inflation down, and that means that the dollar - as soon as Europe's contraction is over in about a year - is destined to drop like a rock. As soon as people can figure out how to buy Yuan, they will, as China needs oil, it will let them do it to buy the oil. The dollar is going to take a nasty shock - but not for at least 9 months.
So what does that mean? Well it means that from here, the Fed can raise interest rates by the difference between those to parallel lines, and not get a recesion. If that isn't enough to fight inflation, then one gets a recession, or one gets inflation. Some choice.
The belief from the bond trading world is that the yield curve is going to invert - this is based on bond futures. However, as is almost always the case, bond traders are convincing themselves "this time is different", that some how there is going to be no inflation, and no recession. The only way it is going to work that way is if Bush borrows a nother metric ton of money.
Which finally brings us back to oil.
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You see, oil is cheap. Really. Compared to both the supply cost of oil - that is, there is a limited amount of it, or "peak oil" - and the sink cost of oil - that is to say, global warming - it is cheap. New Orleans is about to get some of the bill for cheap oil. It is also cheap compared to the price of land, which is what consumers can use it to get - and it is cheap compared to the cost savings of moving production to China.
These four things are tied together. The more expensive land gets here, the higher wages have to be. The higher wages here are, the more to be gaind from moving jobs to China. That Americans want to make a killing on their house is part of what is kiling our ability to create jobs.
This means that oil producers, and other commodity producers have pricing power. That means, just as in the mid 1970's, when Nixon and Ford tried to spend their way out of recession, any money that the Federal Government dumps into the system to produce more growth, will only end up raising the price of oil.
That is why high oil prices are a symptom not a cause of problems. However, once they are there, they will continue to go up - in that fits and starts way that markets have - as long as you, the consumer, are willing to keep consuming.
This is why Iraq was stupid, even from the perspective of oil. You see, the problem isn't that oil is really in "short supply". It was, in fact, in shorter supply last year, when oil prices were lower. It is that the money in the world knows that it can park itself in oil, and you, or someone else, will buy the oil.
This also reinforces the failure of the yield curve. An economy is like a plumbing system - put pressure on it, and the water goes someplace. What Uncle Alan hoped was that people would put their money into stocks. At which point money would drain out of the long end of the yield curve, and while it would still flatten, the distance between the two curves on the graph would have gotten larger.
Instead, money was parked into oil. Uncle Alan hoped that higher interest rates would pull back consumption enough to do this. It didn't happen.
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So what does all of this mean. Well, first off, the recession that should have hit the US this year is now coming next year. What should have happened, had Uncle Alan been being an honest central banker, as opposed to a Republican Party Hack, is that he should have turned the screws on in 2004. It would have meant Bush losing the election, and possibly the Republicans losing the house. Uncle Alan is a Republican first, and a central banker second, however, and he let inflation come back into the system.
However, economics sides with the hidden flaw. He bought Bush a year. Bush proceded to fiddle with a few tax rules to get a temporary burst of hiring, and Congress grabbed a ton of money for pork barrel projects. Bush's attempt to loot social security would not have helped things in the short term, and the other Bush priorities for his second term are similarly empty.
In effect, Iraq is a dry hole, and there was no "plan B".
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So let me summarize.
- Oil is how the rest of the world can charge the US for printing too many dollars.
- The US is printing too many dollars.
- The yield curve is flattening.
- Because of this the economy has to come up with a new idea, or have a recession.
- The economy is out of ideas.
The whole scheme was an attempt to fool the economy by raising interest rates more slowly than they should have been. There is a paradox here, and it is why Uncle Alan, the conservative hack, is puzzled.
You see, according to conservative monetary policy theory, as soon as the central banker isn't credible any more, inflation should creep in. This is because traders will reason "of course he is going to print too many dollars, so lets charge him for the privilege". If that happens, long yields should go up - and that would have bought Uncle Alan the time he needed.
But it didn't happen - instead, bond traders are willing to bet that someone, not them, is going to take the shaft for inflation. In fact, they are absolutely certain that when push comes to shove, someone else will get shoved. The very fact that Alan is a reactionary hack has them complacent about this. They are sure that he will break the rules for them, because well, he has done so in the past.
However, that means that they aren't getting out of the way of the recession. It's the way economics works - as soon as everyone knows something, it is worthless. Since everyone knows that Alan will find a way out, there is no way out.
Oil just blew up, and it is all over Uncle Alan.
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So now the description ends and the prediction begins. I predict that the American people are going to make one big lurch to the right. They are going to believe that the Federal Government is rich enough to give them a big tax cut. They are angry at Bush for not doing this. This is what has happened for 25 years - whenever the economy screws up, the Federal Government has borrowed and given people what they though they should have gotten, as opposed to what the market gave them.
Think of it as Socialism for Capitalists.
They are going to say "I've got no leverage with my boss, but damn it, I can vote myself a pay raise." They are also going to vote to shoot themselves in the foot. "I don't see any jobs here, so I will just force big companies not to make jobs elsewhere." Finally, they are going to agitate for big government concrete pouring parties. Because, after all, those jobs go here. And they are going to push for having lots of military bases we don't need. After all, those jobs aren't going to China either. And finally there is going to be one last wave of pressure to reduce restrictions on building, because, well, you can't ship houses in from China.
All of these are not only doomed to failure, they will make things blow up in a rather ugly fashion. However, "nothing is more inevitable than a bad idea whose time has come".
This next recession may not be as deep as people think, but it is going to last a very long time. The odds favor the Republicans holding the Presidency, with a conservative Democratic Party - pushing that Republican to be Ronald Reaganhood again and rob their children to give to themselves.
Because remember, a dying system doesn't die until it kills itself. If there is something to blame - a terrorist, an intern, a hurricane, its adherents will not admit defeat. They will just believe that other people are against them, and they had some bad luck, so spin the wheel again.