The Lost Decade – Ted Pomeroy
Two recent economic downturns have occurred in a relatively benign tax and monetary environments. Loss of wealth in our US equity markets caused the recession of 2001-2002 and now what appears to be an even deeper decline for 2007 – ???. Capital market professionals are calling the period from 1998 to 2008 the “Lost Decade”; end of February 2009 Standard & Poor’s 500 (S&P 500) level is below 750, returning to 1999 levels. Both meltdowns have one thing in common; disinvestment in the Energy sector of the Standard & Poor’s 500 (S&P 500) and overinvestment in another sector: Tech in the late 1990’s and Real Estate/Financial in the late 2000’s.
The cause is the lack of opportunity afforded our US energy companies by world governments that fail to permit the creation of wealth by private investment in energy development. Some of these rogue states include Vladimir Putin’s Russia, Saudi Arabia, Venezuela, Mexico and more important, the United States. President Clinton’s veto at the urging of Vice President Al Gore in 1996 of energy development in the Arctic National Wildlife Reserve (ANWR), Senators John Kerry and Joe Lieberman’s filibuster in 2002 and now, Interior Secretary Salazar’s obstruction to off-shore energy development has and will continue to render the US and the world , poorer.
Trillion, it is the new Billion. Or, as one joke of the summer of 2008 had it, “Fifty, it is the new twenty, just ask a gas station attendant”! We are going to hear the word Trillion a lot in the coming years. The incoming President is telling us to get used to trillion dollar federal budget deficits. Debt, is another word that has been and will be in the forefront. There is good debt and there is bad debt. Good debt is usually accompanied by equity. What follows is the Federal Government has been making good equity and good debt disappear and how it relates to what the public experienced in 2008 and will now experience in the times to come.
This is the second winter of the White Witch. The first was the recession of 2000 to 2002. There are two White Witches, first is Carol Browner, now President Obama’s US Energy Department’s “director of energy and climate change” who had then Vice President’s Al Gore’s ear in 1996 and second, the Speaker of the US House of Representatives, Nancy Pelosi, who laid her body in front of off-shore energy development during 2008. A twenty gets a good amount of gasoline in the early days of 2009, it is only temporary and more important, many of us are out of work.
The economic mayhem of 2008 has left us in shock and awe. The United States in 2008 saw its Presidential election dominated by a rapid and tragic series of events answered by Federal appropriations for financial asset purchases, loan guarantees and capital infusions and/or bailouts; all to be funded by the American taxpayer. It can only be likened to a dreamlike walk through a city devastated by aerial bombing. This past fall, Americans found themselves in such a state; reduced to choosing a President over his opponent believing the chosen one would be more likely to save families from burning buildings.
The year of 2008 brought popping of bubbles, the price of a barrel of oil reached over $145 on July 3 and popped to under $45 by December 31. The price of gasoline went from over $4.00 per gallon as of July 2008 to under a $1.90 by December. The median price of a home peaked in July 2006 at $230,900 and popped to $180,800 as of November, a decline of over 21.5%. Popping prices is volatility. This effects productive capital formation raising its cost and reducing its availability.
The United States has been whip-sawed by two cataclysmic boom and bust cycles in the last ten years. The first was named the Tech Bubble (2000 – 2002) and more recently, we have had the real estate/financial bubble. Both generated on the upside unprecedented broad-based stock market participation and gains; followed by skidding to broad-based declines in the Standard & Poor’s 500 Stock Index from 2000 – 2002, 49% and in 2008, 38%. The current wealth meltdown is estimated to be $6.7 Trillion since the stock market high of October 9, 2007 leaves us facing a deflationary period with a guaranteed increase in unemployment and a retrenching Gross Domestic Product.
Government is not the solution to our problem, government is the problem.
The policies of the Federal Government are greatest source of systemic risk to our capital markets. Until Reagan revolution of 1981 it was either the tax or monetary policies of the Federal Government that represented the greatest source of systemic risk. Two bubbles, same result; Nobel Prize winning Princeton economist and New York Times columnist, Paul Krugman has recently chosen to link the two. Every serious student of capital markets understands systemic risk and seeks to ride it by eliminating the risk of individual stocks through diversification. Think of systemic risk as another word for a pandemic of sick stocks from one disease. The source of the problems can be traced throughout the last century; the Federal Government’s tax and tariff increases of the Smoot – Hawley and the resultant stock market crash of 1929 and the default by inflation of obligations of the two Federal Government wars of the 1960’s, the Vietnam War and the War on Poverty and the resultant bear stock market of 1974 to 1981.
The First and Second Winter of the White Witch
Now we had the two recent bubbles occur in a relatively benign tax and monetary environment. The loss of wealth caused the recession of 2001-2002 and now what appears to be an even deeper decline for 2007 – ???. Richard Bernstein, Chief Equity Strategist at Merrill Lynch said concerning the Tech Bubble of the early part of the decade in January 2003. “Capital poured into the technology companies, starving other industries, the biggest loser? Energy.” A misallocation of capital is the recipe for a recession. Too much money flowing into one sector will erase adequate returns to those investors. During the Tech Bubble from 1995 to 2000 why was there no opportunity for investors to invest in the Energy sector? Congress voted in 1996 to open up energy development in the Arctic National Wildlife Refuge (ANWR). President Clinton stopped it with a sustained veto.
The disinvestment of the energy sector has continued in this decade. Congress and President Bush tried to open ANWR in 2002; only to face a filibuster led by Senators Kerry and Lieberman of Massachusetts and Connecticut over the objections of Alaskan US Senators. From 2005 to 2007, the major United States energy companies being Exxon-Mobil, Conoco-Phillips, Chevron, British Petroleum and Shell returned $194 billion to the public in stock share buybacks. The energy companies have little or no place to invest the shareholders money due to being shut out of Saudi Arabia, Venezuela, Russia and the United States, so they did the right thing and returned the money. John Hofmeister, former President of Shell Oil that the Federal Government is banning the development of 110 billion barrels of oil on the Federal lands and on the continental shelves of the oceans and the Gulf.
Two Hundred Billion Will Lose You A Trillion
The US energy company’s stock buybacks held down the sector’s market capitalization. Energy sector share prices skyrocketed while the relative size of the energy sector market capitalization went from 7% to 12% from 2004 to 2007. But where might have the $194 billion gone? It poured into the financial sector including Fannie Mae, Freddie Mac, and the Wall Street/major bank residential mortgage ventures. By 2006, over 20% of the entire US mortgage market was subprime and 81% of these loans were securitized. From 2004 to 2007 plenty of financial and real estate stocks were added to the Standard and Poor’s 500 stock index. By October 2007 market peak, the financial sector represented 20% of the S & P 500 market capitalization surpassing the longtime leader, the tech sector at just over 16%. Now the Congressional Budget Office estimates that Fannie and Freddie losses will cost $240 billion in fiscal year 2009.
The Gross Domestic Product of the US economy grew from 2003 to 2007. The five year annual average was 3.2% per annum adjusted for inflation, a very good record. Federal tax revenues grew by 35% from fiscal 2003 to 2006. United States household wealth grew by 7.2% in 2006 following growth of 7.9% in 2005. However, one sign of trouble was the fact that half of GDP growth in 2006 was the real estate sector.
The nearly $200 billion the energy companies returned to the public was a trillion dollars lost. The energy companies had the Federal Government not been in the way would have leveraged that $200 billion with debt to at least a trillion of capital. This money could have been employing people, buying steel and trucks while the bankers of Wall Street could have been put to good use raising $800 billion of debt for energy development instead of sub-prime mortgages.
The collective wisdom of the American people has and will continue to be the best source of governance. The problems we face are surmountable and the citizenry had the answer. The Congress of 2008 shut down due to its inability to face up to its duty. The American people said DRILL, DRILL, DRILL. The leadership of the House of Representatives shamefully would not permit a vote and let the bans on off-shore energy development expire on September 30 deferring the decision to the individual States. Unfortunately, new Interior Secretary Salazar is blocking off- shore by calling for “more study”.
Had ANWR development had commenced in 1996, it is estimated that would have been 800,000 barrels per day of US production starting in 2006.
We are stuck in a roller coaster ride. Prosperity will inevitably result in skyrocketing energy prices as long as the Federal Government restricts future US energy development. Economist Larry Kudlow has stated that the run-up in gasoline prices in 2008 was the straw that broke the economy’s back. Consumers were stretched too far. Mortgage payments were missed. John Hofmeister believes that China’s demand for diesel fuel instead of polluting coal during the Olympic summer of 2008 drove us to $145 oil. Mr. Hofmeister states that a mere increase in US energy production of 2 -3 million barrels per day would greatly enhance the supply and demand balance. Had ANWR development had commenced in 1996, it is estimated that would have been 800,000 barrels per day of US production starting in 2006.
Finally, there has been a great deal of attention in Washington, DC as to who or what to blame for the current economic crisis. The Right blames the politicians who provided political cover for Fannie and Freddie; the Left blames the Wall Street crowd and banker greed. The true victim of 2008 was the American consumer who carries the economic water for the World providing nearly 70% of the US economy. Did we really expect the US consumer to afford a doubling of fuel prices and to pay their sub-prime mortgages? Change will not come until we get new politicians. However, we are stuck with obdurate and stentorian Congressmen who tie up the energy company’s hands and then lecture them about not doing enough.
We can stimulate the economy. We need to have the Federal Government to get out of the way of the US energy sector. A trillion dollars of private money could flow to energy development. There are States that can use the money from off-shore oil drilling. There is a natural gas pipeline out of Alaska that needs to be fast-tracked. The States that have grown in population in the last 30 years need oil refineries. Norway is permitting energy development in its arctic region. Will the US government continue to pauperize its people with the economic winters of the White Witch and lose another decade?