Economics & Finance

Energy, Productivity, and the Middle Class

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It being Labor Day, there will doubtless be many political speeches and newspaper articles touching on the rise of the American middle class and crediting this rise to labor unions and perhaps also to FDR’s New Deal.

I don’t mind giving some of the credit to unions. But the primary driver of middle class affluence has been the availability of plentiful and low-cost energy…especially in the form of electricity…coupled with a whole array of productivity-increasing tools and methods, ranging from the horse-drawn harvester to the assembly line to the automated check sorting machine.

The middle class affluence enabled by these factors is gravely threatened is gravely threatened by the Democratic-“progressive” hostility toward energy production and distribution in all practical forms, and by the endless set of productivity-sapping policies advocated by the same group of people.

Over the long term, or even the medium term, a nation cannot consume more than it produces. It doesn’t matter how aggressive the unions are, or what tax policies are in place, or how much Oprah-like sympathy for the unfortunate is exuded by politicians–if you harm the productive power of a nation, its average standard of living is going to go down.

Low-energy, low-productivity societies can support a very wealthy elite, and have historically often done so, but they cannot support a broadly affluent middle class.

Thatcher’s Economy

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[T]he British economy began its long boom, combining economic growth with price stability. Loss-making industries were closed down or reduced in size. Manufacturing industries shed labor, often while increasing output, as they restructured to meet foreign competition. New companies or entrepreneurs from academic and non-industrial backgrounds established new industries in the financial services, information, and high-tech sectors. Privatization transformed inefficient state-owned industries into dynamic private sector enterprises. New financial instruments allowed entrepreneurs to take over sluggish low-earning companies and put their assets to more profitable uses.
 
In general, Thatcher’s British economy, like Reagan’s revived U.S. economy, was characterized by change, profitability, growth, the better allocation of resources (including labor), and the emergence of new industries—indeed of an entirely new economy—based on the information revolution.

John O’Sullivan. RTWT.

We are so far into the era of the Big Lie about Mrs. Thatcher and what she accomplished, that it is good to refresh our recollections from time to time.

The Return of the Risk Premium

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Back in early 2007 I wrote an article about the bond market that noted the lack of a “risk premium” for corporate bonds. The “base” rate for corporate bonds is what the US government pays for treasuries of equivalent duration – at the time I wrote that article corporate bonds with good credit were paying only 1% higher than treasuries and “junk” bonds only 4% higher than treasuries. The conclusion of my post was that it made no sense to take on all the known and unknown risks of these bonds for a paltry 1% incremental return (or 4% in the case of the riskiest assets).

Per this article in August 16, 2008’s WSJ titled “American Express Joins the Payees”:

“American Express Credit Corp. joined the growing list of highly rated financial institutions that are paying steep financing costs when they raise money in the bond market… the premium to compensate investors for perceived risk was 4.25 percentage points over treasury rates.”

These financial institutions are finally offering returns that might be worth considering, given their high risk (as Bear Stearns showed us all, and that Fannie Mae and Freddie Mac would have if the government would have allowed them to go under without their now-explicit guarantee).

Here is the kicker, though:

“From credit-card issuers to investment banks to commercial lenders, financial firms are looking to raise capital to offset potential losses.”

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A Scary Ratio

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Barrons (7/14) contains the following sentence:

Even more impressive is the value of the oil reserves of petroleum-exporting countries, which now total an estimated $140 trillion, nearly three times the size of global equity markets, which have a combined market value of around $50 trillion. (emphasis added)

There are a couple of things wrong with this comparison. It is not correct, IMNSHO, to compare a cash flow stream which will be recognized over years/decades to a current market value–the cash flow stream should be discounted to present value. (Equity market values already represent, at least in theory, the discounted present value of their corresponding free cash flow streams.) Also, I’m pretty sure reserve value is a gross value, which doesn’t take production costs into account. For a place like Saudi Arabia, these may be minimal at present, but they will not remain minimal over the life of the asset.

But even after these adjustments are applied, you will probably come out with something like:

The value of the oil reserves of petroleum-exporting countries is equal to the size of global equity markets.

Think about what this means. Ownership of the land under which oil resides is roughly equal in value to ownership of the equity interest in all the world’s publicly-traded companies, with their factories, mines, brand values, and intellectual capital…the accumulated work and knowledge of centuries.

This represents in a sense a return to the pre-industrial age, in which the ownership of land was the predominant form of wealth. If this situation is sustained, it will represent a tremendous change in the world economic order, and not at all a positive one.

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