Tuesday, May 13, 2008


Southwest Airlines is apparently in the hunt to expand. The company with better than 3 billion dollars in cash just raised mortgaged a bunch of planes in order to raise another 600 million million. The management has the authority to buy back up to 400 million dollars worth of shares but after buying 54 million dollars worth it suspended further purchases on February 15. Other reports suggest that the USA is open to allowing foreign buyers to own more than the current maximum of 25%. Jet Blue has already sold a 19% share to foreign owners. Maybe 6 months back, Southwest gave up up on its old one ticket seats all plan. It is clear that Southwest is preparing for major consolidation.

Sovereign wealth funds and all the big carriers are loaded with cash. These companies are not hoarding cash just for the fun of it. The DAL-NWA deal is the first of several deals that will be made in the months ahead.

In the old days, we talked about recycling petrol dollars. Nowadays, the sovereign wealth funds include the dollars accumulated from the sale of other goods. The oil countries of the Middle East have stacks of cash but the BRIC countries are doing alright for themselves. BRIC stands for Brazil, Russia, India and China. Brazil is the latest country to announce the start of a new fund. I don't know the details of Russia's cash position but a recent article said that the number of billionaires in Russia doubled last year. Another article gave Putin credit for the dramatic turn around since the collapse of the Soviet Union. For several years, Russia has produced almost as much oil as Saudi Arabia.


The civil nuclear treaty, negotiated but not finalized, between Russia and the USA is a major development. A knowledgeable friend tells me that the cost of the uranium for a nuclear power plant is small relative to the cost of inputs for other power plants and that there is enough uranium on the earth to produce all our electricity needs for thousands of years. My friend says it is the high capital cost of nuclear power plants that makes nuclear risky to build. The new expectation is that hundreds of nuclear plants will be built over the next 30 years and that the cost will be greatly reduced buy building the same standard plant again and again. What will Russia do with their new uranium dollars?

The details of the treaty are still sketchy but it seems that Russia will sell a lot of uranium. Will Russia import more US made goods? Total US exports are up 15% in just one year. Giving the Russians paper dollars for uranium will make our products more attractive to the Russians. It is amazing to think that less than 20 years ago the Berlin Wall was divided the east from the west and the Cold War was on. The most beautiful thing about trade is that it reduces the probability of war between the trading partners. A recent article says that Ford and GM have added outlets and are now the two car sales leaders in Russia. Ford just built an unusually highly automated car plant in Brazil. This plant can make any one of 5 different models on a single assembly line. This kind of flexibility was not allowed by the unions in America. The shareholders of Ford deserve their share of the profits made by using automation. It would be nice to make these vehicles in America but at least a number of design, engineering and management jobs are the result of an American company producing the cars. Quarter after quarter profits of US companies have been underestimated with the majority of the big surprises coming from very profitable international sales.

Before long, I suspect Continental and other carriers will be adding a number of direct flights to and from Russia. Globalization is not going to go away. It took a very long time for large numbers of people to understand that both consumer and producer surpluses are created from free trade. The Genie is out of the bottle. Win-win is a wonderful concept. Consumers have learned that they save money when foreign made goods become available. Producers have learned that their sales and profits are increased when foreign markets are opened to them.

In 1944, FDR refused to let American citizens of Japanese descent out of interment camps. He felt it necessary to wait until after the November election. When I was a child, few Americans would have considered buying a Japanese product (other than cheap trinkets and dolls). Today, millions of Americans buy Japanese cars while Ford and GM sell their models around the world. Toyota, Honda, GM, Ford and the rest are able to increase production runs and decrease costs by finding the world wide demand. The current silliness about not allowing the sale of American made goods in Columbia is political game like the one played by Roosevelt in 1944. The congress is holding up the trade bill to pacify labor unions that have built up substantial political campaign chests. American businesses are taking a hit while congress stalls. Ultimately the congress will cut a few deals to save face and then allow our goods to be sold.

While International airline traffic will continue to grow rapidly in the years ahead, the number of carriers will be reduced. My guess is that more than half of the 1,600 small carriers in the US will sell or close. The value of the merged carriers will increase by the mathematical laws of networks. High fuel prices and stiff competition will push the weak players into the hands of the strong. Again, Southwest did not need to raise its cash holdings from 3 billion to 3.6 billion dollars for any operating reason. The price of LUV shares is high. Many a seller would rather have cash than LUV shares.