Important articles you may have missed this week!

Here are some interesting articles about the financial crisis.  Reports from the front lines…

  1. Crude mathematics“, Michael Meacher, op-ed in  The Guardian, 28 November 2008 — “A plunging oil price means cheaper petrol now – and no fuel later as industry investment shrivels.”
  2. Vallejo’s Fiscal Freefall“, Governing, November 2008 — “Are other cities with budget trouble on the verge of asking the courts for relief?”
  3. Schwarzenegger Calls Fiscal Emergency in California“, Bloomberg, 1 December 2008 — California is just the first of many States to see their finances collapse in this recession. 
  4. Record number of Americans using food stamps“, Reuters, 3 December 2008 — In September, before the full force of the recession hit!  Imagine what the total will be 3 months after unemployment skyrockets, when people run out of savings!

Excerpts

1.  “Crude mathematics“, Michael Meacher, op-ed in  The Guardian, 28 November 2008 — “A plunging oil price means cheaper petrol now – and no fuel later as industry investment shrivels.”  Excerpt:

A snip at $48.50. Now that the price of a barrel of benchmark Brent crude continues to fall like a stone in the global recession, a drop of no less than two-thirds since the high point of $147.50 just four months ago, the relief is huge among motorists and hard-pressed consumers.

Conversely, for the oil-producing countries (especially Russia, Iran, Saudi Arabia, the UAE and Venezuela) it is potentially cataclysmic, though some, such as the US, may rejoice at that. But there is another dimension to this oil-price slide which has been little noticed, but which long-term is extremely serious.

If oil prices remain well below a certain critical level for any significant period of time, large amounts of investment in expected oil production capacity will simply be written off, and the consequence could then be a recovery-stopping supply-side crunch within little more than two years.

That critical level is widely reckoned within the oil industry to be $90 a barrel. A current price as low as half that critical level is already forcing many companies to drop oil projects, and the banking crisis is also squeezing project financing for foreign oil companies operating in OPEC and outside.

… A prolonged slump in the oil price at below $50 a barrel will thus inevitably lead to another cycle of shortages and soaring prices. This intense price volatility is the first stage of the devil’s see-saw that is likely to accompany the coming of Peak Oil, which is widely expected within the next five years.

These very sharp boom-and-bust capitalist cycles in oil may well turn out to be even more globally destabilising than the credit crunch. What is clearly needed, though sadly highly unlikely, is an international conference (perhaps as a serious offshoot from the lightweight G20 conference a week ago?) to reach a binding agreement on the oil price for a five-year period rolled forward, which might then avoid the massive overshoot in prices at both peak and nadir which we are seeing at the present time, with potentially calamitous consequences.

2.  Vallejo’s Fiscal Freefall“, Governing, November 2008 — “Are other cities with budget trouble on the verge of asking the courts for relief?”  Excerpt:

When the town of Vallejo, California, declared bankruptcy this spring, Mayor Osby Davis predicted – and rightly so – that he’d get an earful from his constituents, employees and retirees. What he didn’t anticipate was the chorus of phone calls from mayors outside the city, both close by and clear across the country. They told him they were watching Vallejo’s bankruptcy proceedings closely, and some of them, he says, indicated that “they find themselves not too far behind us.”

Vallejo, a city of 120,000 about 35 miles northeast of San Francisco, flat-out went broke this year through a combination of generous public-safety salaries, declining property values and fiscal mismanagement. The city is estimating a $17 million deficit for the current fiscal year.

Previous municipal bankruptcies generally arose from adverse legal rulings or poor investment decisions. But Vallejo’s predicament stems largely from economic conditions felt by cities across the nation, namely declining revenues and rising employee costs. And that scares the dickens out of cities, unions and municipal bondholders.

“Vallejo was sort of the canary in the coal mine – the sickest patient goes first,” says Dean Gloster, an attorney representing Vallejo’s unions. “Even better-run cities are going to be facing similar issues as health care costs rise and the baby boomer generation reaches retirement age.”

A September report from the National League of Cities points to precarious fiscal conditions in cities across the nation, due to falling revenues from property, sales and income taxes and rising costs from inflation, energy, infrastructure, salaries, health care and pensions. “Vallejo is significant in the sense that the reasons they are doing it are factors that are going to be in place in cities across the country,” says Chris Hoene, director of policy and research for the National League of Cities. “You can see the Vallejo situation as something that cities across the country watch as a way to bring costs under control.”

3.  “Schwarzenegger Calls Fiscal Emergency in California“, Bloomberg, 1 December 2008 — California is just the first of many States to see their finances collapse in this recession.   Excerpt:

California Governor Arnold Schwarzenegger, saying his state is going broke, declared a fiscal emergency and ordered the incoming class of lawmakers into a special session to fix a widening $11 billion deficit.

Schwarzenegger, a 61-year-old Republican, wants lawmakers to raise taxes and cut spending to narrow the gap that is projected to swell to $28 billion over the next 18 months. He invoked powers granted him in 2004 to declare a fiscal emergency, which gives the Legislature 45 days to plug the shortfall. If they fail to find a solution in that time, they are barred from doing any other legislative work until they do.

“Without immediate action, our state is heading for fiscal disaster,” Schwarzenegger told reporters today in Los Angeles. “I’ve had to make tough choices that I wish I didn’t have to make, and I know this is a terrible time to raise taxes, but it’s also a terrible time to make cuts to very important programs. But in an emergency like this, we have to take quick action to avoid even worse problems, even if they include decisions that we don’t like.”

Lawmakers were unable to agree on a plan to close the gap during a three-week special session that expired yesterday. Schwarzenegger has warned that the state will run out of cash in February and can’t borrow money from Wall Street to pay bills such as payroll until lawmakers trim the deficit. The state’s finances are reeling from declines in stock markets that have sapped tax revenue from income and capital gains.

4.  Record number of Americans using food stamps“, Reuters, 3 December 2008 — Excerpt:

Food stamps, the main U.S. antihunger program which helps the needy buy food, set a record in September as more than 31.5 million Americans used the program — up 17 percent from a year ago, according to government data. The number of people using food stamps in September surpassed the previous peak of 29.85 million seen in November 2005 when victims of hurricanes Katrina, Rita and Wilma received emergency benefits, said Jean Daniel of the USDA’s Food and Nutrition Service.

One in 10 Americans were participating in the food stamp program as of September, said Dottie Rosenbaum, analyst with Center on Budget and Policy Priorities, a think tank. That’s approaching the all-time high of 10.5 percent of the population that used the program in 1994, and is similar to levels seen in the early 1980s, she said.

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12 thoughts on “Important articles you may have missed this week!

  1. The Governor Schwarzenegger story is interesting. How many US states faces similar problems. And how would those tax hike/budget cut policies undermine the effects of any federal fiscal expansion. A coordination of federal & state economic policy would be desirable.
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    Fabius Maximus replies: California is typical, not exceptional of state and local governments. Large numbers will run monster deficits. I suspect many local entities will go broke, hammered by deficits and underfunded pension plans.

  2. It’s interesting to see that Arnold rode into office promising to fix the gaping deficits and credit card mentality of Gray Davis, but instead he (along with a compliant legislature) now has at least twice as bad of a situation as the one he inherited. Oh well, pass the spam.
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    Fabius Maximus replies: Arnold proved to be a fool. He called the Legislature’s leaders “girlie-men“, in reality they totally rolled him. Under their guidance, he talked the sheep of California into borrowing $30 billion (papering over a structural $10B deficit) — then increased spending 40%. Now the State is in deep trouble.

    This is IMO paradigmatic of what we might get from Obama. The promise of change used to entrench the ruling regime, in a mindlessly short-sighted — even self-destructive — manner.

  3. Excellent articles, particularly the first. I only recently realized that oil-related companies (particularly refineries) are under enormous stress and may well go bankrupt if the price of fuel doesn’t go up soon.

    I’ve been following the California budget story for some time and most of the blame for the problem (at least lately) can be laid at the feet of the legislature that is so badly divided and confrontational that the state should install metal detectors at the doors of the capitol. Worse, both sides are using the current crisis to drive away moderates and sharpen their rhetorical knives so there is very little chance of anything constructive happening. If I were Schwarzenegger I’d go with the Canadian solution and temporarily suspend the legislature.

  4. Here is an interesting author, in my opinion: Demitry Orlov (per Wikipedia: “He is an engineer and a writer on subjects related to Peak Oil. He was born in Leningrad and moved to the United States at the age of 12.”) Previously, his forecasts seemed to be overly gloomy. But not now.
    And he discussed not financial crisis itself, but it’s consequences.
    * Closing the ‘Collapse Gap’ (no date, first publication I see was December 2006).
    * The Five Stages of Collapse, 22 February 2008.
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    Fabius Maximus replies: I glanced through “Closing the collpase gap”, which IMO is nonsense. The similarities are at the highest level of abstraction, and disappear on close examination. Bizarre doom-mongering. We could draw such similarities between almost any two societies in history.

    Just to mention one detail: let’s assume he is correct (I doubt it) that both the US and USSR had “out of control military budgets.” The USSR spent some bizarre fraction of GDP on the military (I do not recall the number: 1/3, 2/5?); the US spends aprox 4%.

  5. Whats really interesting is that Arnold made the problem worse. He got elected based on the “Car Tax”, a cut in the vehicle liscence fee (effectively a property tax on cars, based on the purchase price & depreciation schedule) that had a sunset clause: if the state budget got bad, it would be restored to where it was.

    And the press was full of deceptive averages. The mean cost per household was fairly high. But the median was low. After all, if you havee 1 family with a $100K lexus or mercedes (so 2K Vehicle liscence fee), and 9 with a current value of $10K depreciated cars (so a $200 vehicle liscence fee), you would say the average tax would be $380, nearly double the median impact…[1]

    So Arnold’s “balancing the budget” meant huge debt, debt, and more debt. (The state can’t technically deficit spend generically, but enough tricks work). He cut the tax back down, resisted other attempts to raise taxes, but didn’t cut spending, as most of the state budget is committed (eg, education, prisons). So when the stock market prices shot up and real estate prices shot up [2], there was no rainy-day fund and in-fact, a still out of control debt spiral.

    Now what’s happened is revenue is falling, and the debt well has dried up, making the situation quickly catastrophic. The state is having full liquidity issues, and Arnold is now stuck reaping what he sowed.

    [1] (Note, for those who support a tax, the opposition is better at naming it. The “Lexus tax” vs “Car tax”, “Paris Hilton tax” vs “Death Tax”, etc)

    [2] Prop 13 acts as a ratchett on the state’s 1% property tax: the property can’t be reassesed up until sold, but it CAN be reassessed down. So those $500K+ houses in Temecula and Merced are all being reassed down.

  6. The oil story is interesting, what goes for oil goes for most commodities, which hit new lows yesterday. If you have any spare cash start buying now, in 5 years there going to be through the roof!

  7. vc: I found those 5 stages of collapse quite interesting. Witty too despite the gloomy subject matter.

    “If Stage 1 collapse can be observed by watching television, observing Stage 2 might require a hike or a bicycle ride to the nearest population center, while Stage 3 collapse is more than likely to be visible directly through one’s own living-room window, which may or may not still have glass in it.”

  8. The comparison between the USSR overspending on the military and the US overspending may be apt if the US classifies things that the soviet’s left to the military as civilian tasks–the intelligence budget comes to mind, as does the state dept, the FBI, etc.
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    Fabius Maximus replies: Agreed, 4% is understated. Parts of both homeland security and the Department of Energy (nukes) should be included. Still, the total would be perhaps 6% of GDP, still nothing remotely like that of the USSR at its peak — nukes but 3rd world health care.

  9. Fabius Maximus replies:

    I glanced through “Closing the collpase gap”, which IMO is nonsense. The similarities are at the highest level of abstraction, and disappear on close examination. Bizarre doom-mongering. We could draw such similarities between almost any two societies in history.

    I think most interesting part of his reasoning is part focusing on differences between these two events. The proof of inevitability of economic collapse isn’t his strong card, IMO.
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    Fabius Maximus replies: The Internet is filled with the rubbish of doomster rants. A dime a dozen.

  10. It is interesting in a train wreck watching sort of way to see how an economy that zipped itself up through borrowing is now unzipping itself. The domino analogy is shop worn, and I like zippering as a substitute. Like a zipper fastening on clothing, our economy appeared to be strongly fastened together until the clasp was pulled by the housing crisis. Now it appears we will soon be standing naked with our knees knocking wondering how our economic garments could come off so quickly.

  11. “One in 10 Americans were participating in the food stamp program as of September”

    There needs to (and under President Obama probably will) be a significant increse in funding of this program. That would be a whole lot better than paying General Motors, Ford and Chrysler to build cars no one wants to buy.
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    Fabius Maximus replies: There is quite a literature on the effectiveness of different forms of fiscal stimulus, with no clear answer. The greatest short-term stimulus comes from things like food-stamps (“Assessing the Macro Economic Impact of Fiscal Stimulus 2008“, Mark M. Zandi, Moody’s Economy.com, January 2008). Of course, that is just funding consumption — digging future generations in to a deeper hole. But essential to mitigate suffering during the downturn.

  12. With regards to energy investments for the future is the present economic climate not prefect for the Chinese?
    They have the money and cashflow to think longterm. A perfect moment to enter into joint ventures with Russia and other energy producing nations and insure a more stable supply situation in the future.

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