Thursday, May 01, 2008

THE DUTCH DISEASE -- HAVING TOO MUCH

Back in the mid 1960's when a barrel of oil sold for $2.90 (the increase has been 4,134% over 40 plus years or about 8.3% compounded), the Netherlands struck an abundant supply of natural gas. The country was suddenly resource wealthy. In short order, the countries manufacturing base fell apart.

Over the years after the Dutch gas discovery, economist noted what is now called the Paradox of Plenty or the Resource Curse. The country that strikes oil or gold or other natural resources, is the country that grows more slowly than other countries. Even worse, the country with great resources is likely to experience inequality, conflict, corruption, and excessive reliance on borrowing, in addition to the elimination of the manufacturing base.


Once one understands the Paradox of Plenty, one can easily see it in history, including the history of ones own family. The child who grows up with everything, has difficulty developing a set of marketable skills. The same deal with the poor person who is taught to rely on the welfare of the state and the gifts of charity. Of course, there are exceptions that prove the rule.

In the history of the USA, in the early 1800's the south enjoyed an abundance of good farm land. The Europeans had already subdivided all the good land in Europe into small, relatively unproductive, plots. The American plantation owner had the opportunity for great wealth by using the Ricardo law of comparative advantage. In other words, to make big money, the Southern American needed to grow hundreds of acres of crops.

The industrial revolution was in full swing. Industry was building up all around the world. The average standard of living was making great strides. The average family could suddenly afford more things. In the thousands of years prior to this time, extra clothes were a great luxury. Only Kings and Queens had worn underclothes in the prior centuries. Soap was just becoming cheap enough to allow the average man to bath once a week or even to wash his clothes. Prior to this time, when and if clothes were washed, human urine was the commonly used soap. By the mid 1800's, many a person could afford to buy tobacco, soap and under garments.

As the industrial revolution progressed, some industry built up in the South but, as the demand for cotton grew, the price and profits soared. Suddenly, the southern factory found it could not compete with farms and plantations for labor. Even slave owners moved the slaves out factories in town and to the country plantations. By 1850, the economy of the south was dominated by wealthy plantation owners. The largest and most profitable included rice, cotton and tobacco plantations.

THE WAR

US wars have been re-fought in hundreds of books. Yes, if the brilliant commander, Southern General Lee, had done this or that differently the outcome would have been different. Yes, Japan could have followed through after Pearl Harbor and doomed the US. Yes, Hitler was on a roll until the US converted its manufacturing capacity into a "war machine". Yes, the South was wealthy before the Civil War but it did not have the manufacturing base to compete with the "manufacturing war machine" of the North.

The USA manufactures more capital goods than any other nation. The doomsters have declared that the US is caught in a great downward spiral but they are absolutely wrong. The USA makes more goods today than ever before. The big thing that has changed in the past 50 years has been that we have used good old American know-how to reduce the number of people it takes to make a quantity of goods. We have automated manufacturing processes to such a degree that we can afford a higher quality of life. We can now afford service providers such as dentist, dental hygienist, travel agents and stock brokers. The USA is not suffering from too little but from the Paradox of Plenty.

Millions of Americans have grown up with hardly a care in the world. Parents have given children all the comforts without teaching them what it is like to have to work for supper. View the countries with a super abundance of oil and you tend to see the rise of "control freaks", dictatorships of one form or another. You see Kings in the Middle East who oppress women and the crazy man in Venezuela who uses government power to confiscate control of one industry after another. Those in power in rich resource economies tend to be very willing to take away the freedom of others (often "for the other persons own good"). Those in power tend to think they are smarter than everyone else. A few months ago, when a women in Saudi Arabia was raped by two men in a car, she was imprisoned. The law of the country is that she should not have been in the car with strange men. The leaders "protect" the women by keeping them out of "dangerous" situations. In the deep south, slavery was the path to great wealth for the plantation owner and many owners truly did offer slaves a better economic standard of living than that enjoyed by millions left in Africa.

Today, Americas face a great risk. Millions of Americans have lived their lives under the Resource Curse. As a result they have developed attitudes much like those of the plantation owner, the Middle Eastern King and the benevolent dictator of Venezuela. These Americans believe they know what is best for all Americans and they are willing to force their goodness upon the rest of us. A large group of these "smart people" believe it best to confiscate the wealth of some Americans so that this wealth can be redistributed to those who need it most. Benevolent dictators do their good deeds because they really care. The socialist movement in America is pretty strong right now. The socialist now call themselves progressive but it is socialism in which they believe. They believe it is right for the poorest half of Americans to have free health care, free retirement funding and free necessities and equally fair for the wealthiest half of Americans to pay for all of these services. Of course, they would argue that they only want to confiscate wealth from the top 2% but the numbers show the reality.

Today, a very large percentage of Americans pay no income tax. Slap on free health care and this large percentage will have become wards of the benevolent legislators. They will have become dependent people much like the slaves of the old south. The risk is that this voting block will continue to grow and the power to take more will lead to the power to take more.

Many a reader will think that I have over stated the risk, but the risk are not just economic. The risk of war is greater than the risk perceived by those who suffer from the Paradox of the Plenty. The resulting attitude includes a perversion of the concept that War is never necessary.

I hate war. I was not in the thick of any real battle while in Vietnam but I am still shaken to my very core by the deaths of 56,000 American soldiers. As the great majority of people know, war is terrible. Still, there will always be some bully somewhere who is willing to confiscate the property of others. Done through "legal" or illegal means, the risk is strong for an eventual reaction of equal and opposite force.

The way to prevent great wars is to "nip them in the bud". Yes, this often can and should be done through a battle of words. It must be made clear to the bully that taking the lives or property of other people will be met with the combined force of those who seek free and peaceful living.

PEACE IN THE MIDDLE EAST

Peace in the Middle East still sounds like a great fairy tale. Most observers of history say it is not gonna happen. On the other hand, one has to be impressed by the fact that the Israelis and the Syrians have negotiated a rough draft to a peace agreement. The terms include the deeding over of the Golan Heights to the Syrians while Israel will retain the water rights (Stratfor.com). There will be a demilitarized zone between the Israel and Syria and Israel and Lebanon. Syrian armed forces will move back into Lebanon to insure the peace.

The Israelis have never suffered from a natural resource curse. They have learned to use drip irrigation to turn a desert into a fertile valley. For the protection of peace, they have built a power military. When Syria brought nuclear materials from North Korea, the Israelis destroyed the materials in order to "nip the war in the bud". Sometimes it is right to hit a bully in the nose in order to get him to talk.

Time after time, America has tried to enjoy a peace dividend. George Washington initially did not see the need for a permanent army. US military might was dismantled after WWI. Bill Clinton and other Americans enjoyed a great economy, partially at the expense of reducing the power of our military, only to be "surprised" by the attacks of 911.

SOVEREIGN WEALTH FUNDS

How can the super resource rich country avoid the plague of the Paradox of Plenty? One of the ways is to "sterilize" the huge but depleting cash flows by creating sovereign wealth funds. This is a great solution as there are always other countries in need of cash and willing to pay interest for the use thereof. The arguments for sovereign wealth funds are the same as the arguments for borrowing and lending in general. The typical Christian and non Christian American believes that the bible says, "neither a borrower or lender be". The reality is that this quote is from a man who lived life to the fullest, William Shakespeare. Many Christian and non Christian Americans believe that "money is the root of all evil". The correct quote is, "the love of money is the root of all evil". Money or debt are not bad or good. They are the tools by which we are able to treat one another fairly. The old person needs to safely loan money for income to the young person who needs to borrow money for shelter. The nation with great natural resources needs to avoid creating dependent people by spending all the cash generated from the sale of natural resources. The resource rich nation needs to gradually find productive and efficient ways to use the cash. This is nothing more than the age old idea of teaching a man how to fish rather than constantly giving him free fish. When the oil is no longer of great value, will the investment of the cash have created another source of income?

The way to teach a man to fish is to offer to buy his fish from him. The way to help the old lady earn an income off her savings is to borrow those savings from the bank. The way to help the people in a resource rich country is to allow them to invest their cash is the most attractive industry that you have to offer.

For some months, we have been bombarded with the words of politicians running for office. The vote buying attempts have been one sided, transparent and laughable if it were not for the potential consequences. The offers made boil down to telling the obese person that the US Government is going to provide them with free exercise classes, free new clothes two sizes smaller and free ice cream and soda. Of course the free clothes will never fit but, hey, they were free!

Politicians want to abolish free trade and increase American jobs. They want to tax productivity and create new jobs. They want to dramatically increase the total cost of employment by adding free health care while creating new jobs. They want to withdraw from engaging terrorist while enjoying world peace. They want to provide mortgage holders with reduced payments while telling sovereign wealth investors to keep their money out of the USA. They want to solve the shortage of low cost fuel by adding taxes on oil companies. They want to reduce pork barrel spending while adding a cap and trade boondoggle. They either want to increase spending dramatically more than any possible increase in revenue or they want to reduce taxes by more than any possible decrease in spending. They want to pay farmers to not grow food while they want lower food prices. They want lower oil prices but they do not want to drill for oil. They want to spend billions to subsidize corn ethanol and to reduce the cost of a Pepsi. They want college tuition cost to go down and for the government to pay the full cost for the majority of students. They want the education system to improve but they do not want to reward the best teachers or to allow the parents to choose the best schools.

THE GREATEST GENERATION

Tom Brokaw wrote about the great generation of Americans who lived through the Great Depression. I am thankful that I did not have to live through such a tough time. However, I sure would like to bottle the good that ultimately came out of the Great Depression. It turns out that mild recessions are a good thing. Prior to a recession, it is always true that large groups of people have begun to suffer greatly from the Paradox of Plenty. This time, people were buying extra large homes and second homes that they did not need and could not afford. The attitude had become one of "I deserve it".

THE CLEANSING HAS SERVED ITS PURPOSE

Today, the people of the world are much less wasteful than they were a couple of years ago. The sale of massive 6,000 pound vehicles with unused off road capabilities has fallen. Today, if one wants to buy a huge home, he is permitted to do so if he has a down payment, good credit and the ability to make the payments. Businesses have "leaned down". They have made the tough choices necessary to eliminate employees who are no longer needed. Businesses such as airlines have cut costs, cut costs and cut costs again. The airline business model has turned from one of growth no matter what, to profit no matter what. The situation has reached clearing price after clearing price. Top executives are even willing to surrender their jobs (with handsome parachutes attached) in order to rationalize these businesses. As a result, companies such as NWA have hit bottom and bounced 30% off the bottom in just a few days.

Another clearing price that has been reached is the price of oil. Over the past couple of years, so much new oil has been discovered that even the number of oil drilling rigs being leased has recently declined. The discovery of 210 Billion Barrels of Oil in India was announced yesterday. The fact that this oil is underneath 2,000 feet of very old volcanic rock is not the impediment to discovery that it was 2 years ago. The price of oil is so high that 210 billion barrels has a retail value of 30, 870 billion dollars or $30.87 Trillion. Two thousand feet of rock looks pretty small next to 30 Trillion Dollars.

The daily lease rate on the large floating drilling rigs runs in the neighborhood of $300,000. Every day counts. In a 365 day year, the total lease bill comes to $109 million. Perhaps you can see why the discovery of numerous new supplies has caused about 10% of these rigs to be sitting idle. And, the rest of the market is awakening to the new situation. This morning, the futures price per barrel is down to $111. The demand from the billions of emerging middle class will keep the demand from collapsing but the closure of big SUV plants and other measures will gradually weigh on the price of fuel. Thousands of other significant "discoveries" are being announced daily. An Israeli company claims to be able to produce 7 cent per kilowatt electricity from cheaply made solar panels and concentrating lenses! The price of oil cannot stay in the $110 to $120 range while under the barrage of so many other discoveries.

CAL UP 7%, AMR UP 7%, DAL UP 4% NWA UP 3% THIS MORNING.

Those who catch the full ride on these highly levered companies will be surprised by how much money they make!

1 comments:

Bond Investing said...

i think we should use both for investment because bond is a fixed income investment.