Friday, February 15, 2008


You probably do not recognize the names of the "big three" in the airline business, OneWorld, SkyTeam and Star Alliance. The law that prohibits foreign investors from owning more than a percentage of US carriers, encourages the "alliance" net works. New open skies agreements, like the one just made between Australia and the USA, also promotes alliances. These net works help international airlines reduce excessive competition. One difficulty of putting together domestic merger deals is that some mergers are likely to be among airlines that are members of different networks.

DAL, NWA and CAL are all members of the same network. This means that they generally work together to join flights at hubs rather than to compete on the same city pairs. Last week, when CAL announced its move from the Mexico city #1 terminal to the #2 terminal, the purpose was to move to the same terminal as the other SkyTeam members. Passengers can now transfer from CAL to DAL at Mexico City without having to travel within the airport from one terminal to the next.

Should the DAL-NWA deal go through, CAL will probably merge with UAUA. UAUA and US Airways are the two biggest US members of the Star Alliance. The Chair of UAUA has expressed a willingness to switch from the Star Alliance to SkyTeam in order to make a deal workable, the ultimate decision will be one of the most important ones made. It is said that AMR and British Airways are once again discussing closer ties. They currently cooperate as members of the OneWorld alliance. In any event, it is clear that the world is preparing to eventually get down to the "big three". The history of almost any business segment has been that the top three firms do well but the fourth often struggles. Today, there are a several hundred regional airlines. Most need to develop strong partnerships or perish. The days of the stand alone discounter are numbered.


Hugo Chavez is a master politician who has pushed his luck to far. The people of Venezuela are paying the price. In the latest twist to this long story, Exxon did not back down from the confiscation of its Venezuelan assets. Exxon sued in various courts and billions of dollars of Venezuelan assets have been frozen, pending settlement of the dispute. The run up of oil prices for the past week is a result of Hugo's threat to suspend sales of oil to the USA. The problem for Hugo is that the USA does not need one drop of his oil. Oil is a fungible commodity. We can buy our oil from others. If Hugo refuses to sell to the USA, he will sell to others with his net reduced by the additional transportation expense. The USA will pay just a bit more and Venezuela will get just a bit less as a result of the extra shipping, the deal would be similar to having the USA contract with Spain for oil knowing that Spain would buy the oil from Venezuela. The current blow off in oil is the "Chavez Blow Off". James Williams, the "Energy Economist" notes that during this time of year, it is normal for oil inventories in the USA to fall as this is the peak heating season. The last few weeks, oil inventories have risen. While I have argued that there is no recession, I have also noted that a number of economies are growing slower. Slower growth means slower demand for oil and extra time for new production to come on line. The big new fields in Kazakhstan and in Brazil are truly monsters and they will be producing oil in a couple of years. Indeed, the next discovery in Brazil could put Brazil second in size to Saudi Arabia.


Spend some time at and you will enjoy seeing animated socio-economic graphs. They show the incredible progress that has been made in country after country over the past few decades. Still, 20% of all people currently live off of less than $1 per day. The old 80/20 rule still comes close to reality. Eighty percent of the people of the world enjoy only 26% of the income. Twenty percent enjoy 74% of the income. It is the break down of the bottom 80% that is most heart breaking. The bottom 20% receive only 2% of the world income. Many eat mud cakes to supplement a diet of grain.

Again, the good news is that great progress has been made. In the 1960's, poor nations and rich nations were separated by a wide gulf. Now there are usually overlaps. The richest people in the poorest of nations tend to be more wealthy than many of the people in the richest nations.

The progress can also be seen in terms of health. In 1960, 28% of all children born in Egypt died before they reached the age of 5. At the time, the average income was $1,000 per year. Today, 3.9% of all children born in Egypt die before they reach the age of 5. The current annual per capita income is $3,730. Note that the improvement in health is not necessarily in direct proportion to the improvement in income.

The improved health and incomes of the rest of the world is pushing all the people of the world to use resources more carefully. There is suddenly the need to do so. Given there is the need, the people of the world will come up with solutions. To put this problem in terms of America, back in the 1700's it made perfect sense to cut down whole trees and to use the logs to build homes. The work involved in slicing the trees into boards was not worth the effort. The walls of homes today have a 2" by 4" board every 16 inches. We have come a long way in regard to the use of lumber. Over the next 20 years, we will see dramatic new efficiencies in regard to the use of energy.


Between now and then, the railroads are enjoying a building boom not seen in more than a century and a half. Coal fired electrical plants are being built at a rapid pace and trains are carrying huge amounts of coal. Also, the high cost of fuel is forcing tons of long distance freight to move from trucks to trains. Big money is being spent on rail infrastructure. This is true in America, China, India, Russia, Brazil and elsewhere. Once again, we can see big American companies like GE in the thick of things, but "it is different this time"!


Despite my criticism of the FOMC in regard to helping to create the current economic mess, the fact is that a building boom does not have to be accompanied by rapid inflation and the dampening of the violate economic swings of the past show that the central bankers are doing better year after year. During the 1970's, an inflation spiral developed that decimated the savings and incomes of the people of the world. There was too much money chasing too few goods. To get a good deal, you had to buy quickly before the price jumped again. Under such an environment, workers were anxious to push up wages and companies were anxious to push up prices and the results sent people on a fixed income to the poor house. This time, with the exception of a relatively few commodities, there have been plenty of goods to go around. The price of manufactured goods in real terms has fallen and fallen some more. In a number of industries, there have been such an excessive amount of goods available that prices have fallen enough to put weak players out of business. The American textile industry is the prime example.

The goodness in regard to the current cycle is that the buyers of products, the many, are have been helped more than the makers of the products, the few, have been hurt. Indeed, the average American textile worker was not even hurt. The average former American textile worker makes far more money today than he made in his old job. A key point here is that you do not have to be a genius to work in a genetics lab.

The bottom line is that the world is in the middle of an economic boom like it has never seen before. Inflation has reared its ugly head in only a few areas where it has been compounded by policy mistakes. The big mistake has been in trying to use agricultural products for fuel. Never the less, quick progress is being made to correct the mistakes. Numerous breakthroughs will cause the reduction of the use of food stuffs as fuel. The price of corn in real terms will fall by more than half over the next several years. The very powerful law of substitution is gaining strength daily and lower priced alternatives will be used more and more and more.


The next big technology that will make a huge dent in the cost of lots of stuff is "Fixed-Mobile-Convergence" or FMC. Most people could get by very well with only one phone number. A dual band cell phone would do the trick. Walk into your house or office with a dual band cell phone and it would automatically switch to the equivalent of a portable land line phone. This technology has been possible for a long time but it will be adopted rapidly from here. Put another way, make the Internet browser work well on the phone and people will buy that phone. The i-Phone tells the story. The i-Phone user is about 20 times as likely to search the web by phone as are other cell phone users and the i-Phone is a slow connection. AT&T is pushing hard to roll out its 3G network nationwide. In the mean time, scores of phone builders are building their own versions of the g-Phone which will be designed specifically for use on the net. Suddenly, it is becoming more and more economical for people to spend their day connected to the Internet and the rest of the world by cell phone. More and more work is going to be performed outside the office. The cost of production is headed down!


Cell tower companies such as Crown Castle and AMT are in a scramble to provide more bandwidth at more locations. Share prices are up as are lease rates on towers. There are now about 200,000 towers in the USA and there are plans to build another 170,000 over the next 10 years. Many more "sub-stations" will be scattered around in church steeples and flag poles to fill in the gaps. The volume of traffic is going to multiply quickly. Smart highways and smart cars will be just one of the new "users". Lives will be saved when car cruise controls communicate with speed limit signs and with traffic computers. Less congestion, higher speeds and safety are all outputs available from having lanes dedicated to "robot cars only". Of course, restaurants, gas stations and other vendors will want much information to be available on GPS-phone systems. Road warriors will want to order their next Cracker Barrel meal from 20 miles out and Cracker Barrel will be happy to accept electronic prepayment. The "conversations between cars, coffee shops and bank accounts" will add all the more to the total bandwidth needed.


Instant and low cost long distant communications are contributing to tax rate convergence. Why pay high taxes in the USA if you can do the same work overseas and pay less?

Last year, Citicorp lowered its tax rate from 31.3% to 30.6% by moving more operations to countries with lower tax rates. McCain proposes corporate tax rates designed to halt the migration of US businesses to international locations. His plan is simple. He would reduce the corporate tax loop holes but lower the effective rates. Obama talks about ending the incentives for American companies to invest overseas. The vague words, "eliminate the incentives", are code for increasing tax rates. His plan must be to raise taxes quite a bit because he says he will pay for his long list of expensive promises.

Part of the reason people fall in love with democratic promises is because the belief has been planted that America is now economically behind a long list of other countries. Norway has been used as a prime example of a country that is doing more for the poor while being wealthier overall. Norway is a small country that discovered lots of oil. It has 7 Billion Barrels of Reserves. It produces 3 million barrels per day, uses half a million and exports 2.5 million. A couple of years ago, KPMG did a study and adjusted the disposable income by the cost of living to show that the people live like some of the poorest in Europe. This study probably over states the case but the point is that high income alone does not make ones life good. I did my own study in about 5 minutes by doing an Internet search. I found a listing of the "Big Mac Index". The reason I like this index is because it converts the cost of a Big Mac into dollar terms. By looking at prices in terms of dollars, one can see the relative value of a countries income. The price of a Big Mac in Norway is higher than in any country other than Iceland. It even is more expensive than in Switzerland. A relative of mine married a Norwegian woman. They go back to visit every couple of years. The story they tell is paying $18 each for two high balls and deciding that they had better quit drinking.

It is my hope that American will remain a bastion of economic freedom. On the other hand, it is smart for us to learn what works and does not work in other societies and to modify and adopt policies that help to solve our problems. I see two arguments in regard to health care and educational reform. One is in regard to funding and the other is in regard to freedom of choice. In my opinion, a system that forces the wealthy to pay something more than an equal share of cost is an area where compromise is needed. It is the freedom of choice that must be maintained and the funding must follow the choices made. For example, in education, the family should be permitted to chose the school and the government funding should flow to the school chosen. Over time, the system should include much segmentation, such that students might select from more than one math teacher, more than one music department, etc. The successful math program might pay its teachers double the salary of others and it might expand all across the nation while the ability of its students set new records. We will only know how well we can do when we allow all students to chose.


Wouldn't you know that I started writing about how the airline business is in a stage of consolidation and ended by writing about how there needs to be more choice of schools. The common thread is that markets work to a point and that competition leads to improvements. The tricky part is that there is more than one kind of improvement. In the days before deregulation, airline travel and train travel were pleasant experiences, except that they were very expensive. Those who could afford to fly were treated well. Deregulation resulted in competition and cost cutting. Train engineers no longer get a full days pay for each 100 miles traveled (as much as 30 days pay for one 48 hour round trip from Florida to New York) and airline pilots no longer make 10 times the average wage for half the hours, but the planes are flying full and trains are hauling record amounts of freight. The total savings has been hundreds of times more than the reduction in wages. The quality of life has improved for the tens of millions of people who can now afford to visit their loved ones or to enjoy vacations. The lower cost of transported goods has raised millions of people out of poverty and has raised the standards of living for all others. The health care and education "industry" is in need of similar reforms. We can get a better return on our investment. Elections make a difference. This is the year to be engaged.

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