The problem with households not saving is that over the long run, it ruins the economy.

Lack of savings means there are not enough long-term private bank reserves. Broadly, it translates into lack of investment in new business capital. Over time, that runs down the capital base of the economy. And improving business capital is, of course, the key to increasing productivity within an economy.

If productivity doesn’t increase, wages and living standards will stagnate - at best. Eventually, living standards decline. Don’t believe me? Have you been to Detroit lately?

Decades-Long Trends

Last year’s lack of savings was not a short-term phenomenon. The savings deficit was part of a long-term cultural phenomenon. The low savings rate in 2008 was one more data point in a string of many bad years for savings.

The personal savings rate in the U.S. makes for an interesting chart (see below, for 1930 to the present). The first thing that pops out is that savings were very high (near 25%) during World War II, when there were few consumer goods available to purchase.

All that wartime saving had much to do with kick-starting the U.S. economic explosion after the war ended. While the war was raging, many economists expected a postwar crash. That’s what had happened all the way back to the days of Napoleon.

In fact, the prospect of postwar mass unemployment, involving millions of demobilized soldiers, was one of the key drivers behind creating the G.I. Bill of Rights. It was better to send former soldiers off to college for a few years than to have them sitting around with no jobs, muttering into their beer mugs.

Instead of a postwar crash, however, the large pool of U.S. aggregate savings aligned with pent-up demand to spark a historic economic revival. In the 1950s and into the 1960s, the World War II generation settled down to raise its baby boom offspring. While savings rates cooled down, they still averaged a very respectable 8.5%. And this was in an era of very low inflation.

The national savings rate actually increased toward 10% during the 1970s and early 1980s. But from the mid-1980s onward, the national savings rate declined steadily. The rate was in the low single digits - and falling - by the early 2000s, and went negative in 2006 and 2007. For the U.S., these recent numbers were the lowest savings rate since the Great Depression.

What Was Going On?

Let’s review some large-scale trends that occurred during the past four decades. Starting in the 1970s, many women entered the U.S. labor force. More accurately, women exited the unpaid world of homemaking and entered the paid labor force.

The demographic shift of women into the labor force started as a trickle, but turned into a flood. Indeed, over the past 30 years, many traditionally male-dominated occupations and professions opened wide for women to pursue careers. Enrollments in U.S. law and medical schools, for example, are now well over 50% women. Just this year, over 50% of undergraduates majoring in earth sciences in the U.S. are women.

More women in the work force led to a fast-growing number of two-income households. But as pointed out by Elizabeth Warren, a professor and bankruptcy specialist at Harvard Law School, those extra paychecks often went to consumption, rather than savings.

For example, working couples took the second paycheck and bought a second car, if not a second house or condo. Working couples took more high-end vacations, as you can observe by driving past the cruise ship terminals at most major U.S. port cities. And the average size of new homes has increased during the past 25 years, even as average family size declined from over three to about 2.1 children per couple.

In short, Americans saved less over the past 35 years. But U.S. consumer spending took off and grew faster than the broad economy. Consumption accounted for 62% of gross domestic product (GDP) in the 1960s. But consumption grew to 70% of GDP between 2000-2007.

Looking at the numbers another way, “investment” in the economy plummeted from 38% of GDP to 30% - a drop of over 21% from the 1960s baseline. So it makes sense that much of the increase in consumption in recent years was of imported goods. Thus did high consumption and low savings help to decapitalize the nation, as trillions of dollars wound up in foreign accounts.

And Then What Happened?

With high consumption and low savings, when the current recession hit, it hit hard. In fact, the effects of the recession were aggravated by the national pattern of high consumption and low savings over the past decades.

Let’s begin with the fact that many households spent every dollar that came in. Then they borrowed against the so-called “equity” in their house (often as not, the equity was mostly a product of inflation) to finance further consumption. But there’s a funny thing about borrowing money. Usually, the lender wants it paid back.

As Harvard’s professor Warren has pointed out, many two-income households painted themselves into a “two-income trap.” That is, when both wage-earners devote their entire paycheck to consumption, with nothing going into savings, the loss of one job can be a financial catastrophe. A household at the margin almost instantly goes underwater.

Also, it’s becoming clear that in the past year, many job losses in the U.S. economy are permanent. Instead of temporary layoffs, many jobs are being eliminated as part of a structural retrenchment of the U.S. economy. Think about the job losses in the auto and auto parts industries, in banking and finance, or in real estate. Many of these jobs are just plain history. These industries will never recover to the glory days of old.

Along these lines, a recent survey conducted by The Wall Street Journal reveals that 52% of companies polled expect to employ fewer people over the next five years. That can hardly be reassuring to the rapidly expanding ranks of the unemployed in large states like California, Michigan, Illinois and others. Big states with large numbers of jobless people make for big, long-term, intractable social and political issues.

The “Recovery-Less Recovery”

So the job cuts, and long-term unemployment, are here to stay. Much of this has to do with the previous lack of savings and long-term investment. After two decades of falling savings, and related underinvestment in new business capital, there is not enough momentum within the job-creation engine of the U.S. economy. The machine is stalled.

It’s not like you can accelerate the process of job creation, either. Sure, government can spend a lot of money (borrowed money, as it turns out) in a hurry on so-called “stimulus” programs. But what will that accomplish? People still can’t find long-term employment - let alone careers and employment security - in industries that don’t exist or never took root. Nobody gets hired in a firm or factory that never got built. So now we’re experiencing what many economists are calling a “jobless recovery.”

Jobless recovery? That might be whistling past the graveyard. Indeed, the lack of job creation going forward could also lead to a “recovery-less recovery.” Or to paraphrase former President Richard Nixon, speaking of the idea of Keynesian economics, we’re all living in the Rust Belt now.

Some Households Are Saving Again

There is some good news from the savings front, however. As 2009 unfolds, it appears that debt-burdened American households are desperately beginning to save. In April 2009, the national savings rate jumped to 5.7%, the highest level in 14 years.

Still, savings has to come out of something else. Households “saved,” but the other side of the coin is that “consumers” ratcheted down their spending - and did so even faster than aggregate incomes fell. That means empty shopping malls and auto lots. It’s a vicious cycle.

“Americans have learned a cruel, cold, hard lesson,” according to Bernard Baumohl, an economist for the Economic Outlook Group of Princeton, N.J. “People are scared. And that’s led them to replenish their savings because they now realize that their retirement nest eggs will no longer increase on automatic pilot.”

There’s no disputing the extraordinary shock to household wealth in the U.S. From mid-2007-March 2009, according to the Federal Reserve, household net worth plunged $14 trillion, or 21.5%. Just during the second half of 2008, household net worth plummeted nearly $8 trillion - with an eye-popping $4.9 trillion dip in the fourth quarter.

Meanwhile, the broad-based Standard & Poor’s 500-stock index shed 57% of value between October 2007-March 2009. While the S&P 500 has increased 36% since its March low, it is still 41% below its 2007 peak.

According to Mr. Baumohl, the economist, “There has been a fundamental shift in the behavior of American households.” That is, savings are now a priority of financial planning. Mr. Baumohl believes that we’ll continue to see the savings rate increase to between 7-9%, where it will likely hold steady for at least several years. Many of the 75 million baby boomers are now revising their retirement plans, figuring out how to work longer, save more and spend less. (Meanwhile, the federal government is working to figure out how to pay lower Social Security and Medicare benefits to those baby boomers.)

All in all, we should expect to see U.S. consumer spending grow more slowly than GDP over the next decade. As a percent of GDP, investment will increase as some fortunate households replenish savings. But any recovery will be slower than most observers expect - particularly the politicians, who cannot abide large numbers of unemployed people near Election Day.

Rooting for the Savers

The good news is that over the long-term, more savings will translate into more business investment. That should create new jobs and raise productivity, which are the basic building blocks for a rising standard of living.

Of course, there are problems with any significant shift in the direction of capital flow in the U.S. economy. But despite any issues, the unemployed of the U.S. need to root for the savers. And the politicians, of course, need to respect the process of saving. Because without those savings, the economy will continue to wind down.

And what if the political rhetoric descends into class warfare? What if the savers of the nation become objects of ridicule, subject to punitive levels of taxation and regulation? In that case, we get back to the idea that capital is portable.

If savings cannot find a safe harbor in the U.S., then the capital flows will keep moving offshore. And if that happens, all bets are off for the U.S. economy. We can just sit back and listen as the band plays “Nearer, My God, to Thee.”

Until we meet again,
Byron King

July 2, 2009

This article was originally featured on Whiskey and Gunpowder

Too Much Spending, Not Enough Savings: Destruction of an Economy

The year was 1959. The geologists were in the Netherlands, near a small town named Groningen, at the southern edge of the North Sea. They worked for Shell and Esso (now Exxon Mobil) and were drilling a well. Instead of oil, however, the drill bored into a massive deposit of natural gas. All that hard work and expense for a disappointing find of natural gas.

But the politicians of Europe weren’t so disappointed. They soon sat up and took notice, because…

With further drilling near Groningen, it became clear that the Dutch gas field was gigantic. We now know that in its early days, the Groningen field was the largest gas field in Europe. In fact, it was one of the largest gas fields ever discovered anywhere in the world, holding over 100 trillion cubic feet of natural gas. Today, that would be enough gas to supply the entire U.S. natural gas market for almost five years. Back in 1959, it was enough gas to last the Netherlands more than a century. Indeed, the gas of Groningen paid for much of the economic development of the Netherlands in the 1960s, turning a relatively poor nation into one of the wealthiest nations in Europe.

Furthermore, the geologic evidence from Groningen was enticing. The rock that held the gas was sandstone, but not just any sandstone. This rock was deposited in an ancient desert. The rock cores and seismic work actually showed the giant sand dune structures. And based on the regional structure, it looked like the sand dunes extended far out beneath the then-unknown North Sea. Was there more energy wealth out beneath those choppy waters? A great race was on.

Nations Staked Their Claims to Subsea Riches

Almost immediately, the nations bordering the North Sea began a complex legal process of claiming and allocating the mineral rights beneath the rough waters offshore. In keeping with their historically assertive Viking heritage, the Norwegians were in the forefront.

By the early 1960s, Norway struck agreements with the United Kingdom, Sweden, Denmark and Germany. And the boundary agreement that Norway struck governed the economic and industrial fate of that nation for the rest of the 20th century. In fact, the North Sea boundary division will probably control Norway’s fate for several centuries into the future.

The North Sea Made Norway Wealthy

That division of the North Sea in the early 1960s turned Norway from an economic backwater into one of the wealthiest nations in the world.

But just owning hydrocarbon deposits beneath hundreds of feet of water, and thousands of feet of rock, is not enough. You have to be able to exploit your riches. And that’s what happened in Norway. It’s quite a tale, and better yet, it’s something in which we can invest.

The Explorers Arrived and Found Texas (Three Times)

By 1966, the world’s oil explorers were arriving in Norway. They were looking for oil, and the North Sea is a big place to search. Norway’s territorial waters, including the Barents Sea in the north, cover an area about three times the size of Texas.

Everyone who understood the challenge knew how tough the exploration job was going to be. According to a historical account published by the Norwegian Ministry of Foreign Affairs, people in and out of industry described the North Sea as “the world’s harshest exploration area for oil and gas.”

The development of Norway’s oil riches involved considerable trial and error. At every step, people had to adapt exploration concepts, seagoing platforms, drilling equipment and production facilities to the challenging environment of the North Sea. By 1971, the first barrels of oil flowed to the surface of a massive steel and concrete platform called Ekofisk, operated by Phillips Petroleum and located entirely within the Norwegian sector of the North Sea. The Ekofisk complex is still producing oil today, almost 40 years later.

North Sea Technology Laboratory - for the Chosen Few

The North Sea quickly acquired a reputation as a laboratory for developing offshore oil and gas technology. The big difference between large land-based projects and offshore development is that the offshore installations are hidden from people by the sea. Only the chosen few who build and work on the platforms can truly experience how far the boundaries of technology have been stretched to pump oil and gas from the depths beneath the ocean.

Initially, the equipment and know-how for offshore development came from outside Norway. But over time, Norway built up competencies and technologies adapted to the special conditions of its continental shelf. The linchpin of North Sea development was technology to build massive structures called “Condeep platforms.” These are the gargantuan steel and concrete production platforms that, if placed beside the world’s largest and best-known buildings, would dwarf the Eiffel Tower and even the Empire State Building.

Until we meet again,
Byron King

June 15, 2009

This article was originally featured on Whiskey and Gunpowder

Black Gold of the North Sea

Much of Brazil’s South Atlantic development will require drilling wells in waters up to two miles deep, through four-five miles of rock beneath the seabed. The prize at the end will be oil deposits with reserves estimated in the tens of billions of barrels. With access to this offshore bounty, Brazil expects to take its place among the first ranks of energy-producing nations in the world.

Brazil’s state-controlled national oil company (NOC), Petroleo Brasileiro SA (Petrobras) plans to spend over $175 billion in the next five years just on offshore development. The immense investment involves buying and building dozens of new drill ships and seagoing platforms, along with many dozens more support and servicing vessels. Petrobras will lay thousands of miles of pipelines on the seafloor, connecting massive complexes of subsea equipment that will sit atop hundreds of oil wells.

To finance much of this development, Brazil has turned to China. With the active support of the Chinese government, many Chinese banks are lining up to extend loans to Brazil’s energy sector. Right now, there is an agreement for a Chinese consortium to lend Petrobras $10 billion. In exchange, Petrobras will eventually ship 200,000 barrels of oil per day to Chinese refineries. There are more such long-term finance supply deals in the works.

The Chinese government has established strategic guidelines for its national firms. That is, the Chinese government has set goals for Chinese firms to supply China’s long-term needs for energy and other natural resources. The Chinese are looking well ahead into the rest of this century, and even into the 22nd century. They want to ensure their future access to a diverse global supply chain, as well as win entrée into resource-rich regions of the world for Chinese industries and support firms.

Why are the Chinese receiving such a warm welcome in Brazil? According to Sergio Gabrielli, CEO of Petrobras, “The U.S. has a problem. There isn’t someone in the U.S. government that we can sit down with and have the kinds of discussions we’re having with the Chinese.”

In other words, there is a new geopolitics of oil at work. In the olden days, it would have been large international oil companies (IOCs) like Exxon Mobil, Shell and BP walking into a room to meet with the Brazilians. The IOCs were the only game in town. They controlled the financing and the technology for large developments.

But today, the biggest deals begin with a political understanding at the top, hammered out between the highest levels of the respective governments. This top-down political deal making cuts out the IOCs, except where they have technical expertise that can be hired on a contract basis.

In essence, we are witnessing the end of the post-World War II economic construct of the world’s financial system. That construct always had a Western bias. But the 2008 crash of the Western business and financial model has changed everything. It has left a barren worldwide financial landscape for large development projects. Most traditional Western financing is simply not available for large projects. And as French author Francois Rabelais (1494-1553) once noted, “Nature abhors a vacuum.”

Thus has the Western financial crisis handed well-capitalized, government-backed Chinese banks and industrial firms an unmatched competitive advantage. With the traditional credit markets dry, Chinese banks have transformed into key lenders for the resource developments that will fuel the next generation of humanity. Indeed, for now, the Chinese are the world’s ONLY lenders for large resource development projects. See Brazil, Exhibit 1.

China’s Rare Earths Monopoly - All But Insurmountable

China’s support for Brazilian energy development is not the only angle that the Chinese government is pursuing for its future gain. China’s large reserves of foreign exchange, as well as its national strategic focus, has enabled incomparable - even insurmountable - progress for the Middle Kingdom to corner the world supply of substances called rare earths. Here’s the production chart for the past half century. Obviously, something is going on here.

Now that we’ve seen this chart, the questions arise: What are rare earths? And why are they important?

Rare earths are the 15 elements within the lanthanide series of the periodic table, plus the elements yttrium and scandium. The best known are lanthanum, cerium, neodymium, praseodymium, gadolinium, europium and samarium.

Here’s why rare earths are important. They’re used in a wide range of industrial and electronic applications. For many years, large amounts of lanthanum and cerium have been used in petroleum refining, with the result of increasing yields from each barrel of oil by about 10% while extending the life of other expensive catalysts like platinum. And rare earths find their way into myriad other applications, from aerospace super-alloys to rechargeable cell phone batteries.

More recently, large volumes of rare earths (especially neodymium) have gone into magnets. In fact, rare earths are a key component in strong, permanent magnets. It’s not those cute little refrigerator magnets; your computer contains a number of tiny magnets in its hard drive. If there are no permanent magnets, there are no computers. Or DVDs or DVRs or iPods, etc. Say farewell to your wired way of life.

And then there are the giant 1-ton magnets used in large windmill assemblies. Each windmill magnet is about the size of a car engine and uses 560 pounds of neodymium. The implication is that if the U.S. wants to erect windmills to generate electricity, the nation is making a long-term commitment to buy and use unprecedented amounts of neodymium. And there are NO substitutes. For just this one “clean energy” application, large amounts of rare earths - and the ores and mines to produce them - are essential.

There are many other clean-energy applications for rare earths as well, particularly in the now forming electric car industry. Neodymium magnets are key components in electric motors and regenerative braking systems used in hybrid vehicles. Without these magnets, no electric cars will ever roll off an assembly line, let alone whiz down an American highway.

Another significant demand for rare earths will come from large rechargeable batteries for electric cars. Nickel-metal hydride (NiMH) rechargeable batteries, for example, contain cerium and lanthanum in a form called “mischmetal.” And right now, NiMH batteries are the battery of choice for many hybrid vehicles. Overall, a typical hybrid electric vehicle can use about 50 pounds of rare earths - between the rechargeable battery pack, the permanent magnet motor and regenerative braking system. (Plus other tiny magnets for the sound system, power windows, power seats, windshield wipers, etc.)

So clearly, demand for rare earths is set to skyrocket. Just clean energy applications will drive unheralded demand for metals of which most investors - let alone consumers - have never heard.

It’s also important to keep in mind that almost none of the rare earths used in large power systems (like windmills) or electric vehicles (such as with NiMH batteries) are currently being recycled. The long lifetimes of the magnets and batteries, coupled with the lack of recycling technologies and dedicated facilities, means that any increase in supply can only come from new mining.

Another factor is that there appears to be an official Chinese policy to slow down export of rare earths. Chinese exports have decreased by 8% or so each of the past three years. Chinese suppliers have placed foreign customers on allocation, at reduced quantities from years past. The Chinese explain that they have closed mines for environmental reasons. Yet the Chinese also promise adequate supplies of rare earths if foreign users will move their industrial facilities into China.

According to Yoichi Sato, head of the Rare Earths Department of Japan’s Mitsui Industries, China is displaying its long-term strategy toward these critical elements. Mr. Sato believes that China is playing a complex game with the world’s rare earth consumers.

First, China is restricting rare earths exports, to provide its own high-tech industries with the chance to flourish and gain a competitive edge over rivals in Asia, Europe and the U.S. And second, it will force many foreign firms to move their high-tech factories and research centers to China to circumvent quotas. China, to be sure, has a small army of highly capable scientists and engineers who focus on rare earths applications - over 15,000 Ph.D.-level individuals, by one count.

Mitsui’s Mr. Sato believes that China will use its existing monopoly status in rare earths production to crush any competition that emerges. While about 42% of worldwide rare earths resources are outside China, there are NO non-Chinese sites with any significant processing or refining capacity. In the game of rare earths, China holds almost all of the cards.

Mr. Sato has stated, “Many people are looking at establishing alternative refineries and sources outside China, but the investment is not necessarily a sound one because of the threat of price revenge by China. If new projects emerge, as they have recently in Malaysia and Australia, China could just drop its prices and force rivals out of business.”

And as if on cue, in April 2009, Chinese firms used their financial muscle to buy large stakes in potential foreign rivals in Malaysia and Australia.

I hope that you now understand the importance of rare earths to the 21st-century economy of the West, particularly to the energy future of the U.S. I’m following this situation very closely. There ARE some potential investment opportunities in rare earths, but only in very small, thinly capitalized firms.

Until we meet again,
Byron King

June 12, 2009

This article was originally featured on Whiskey and Gunpowder

Brazil’s National Commitment to Energy - Bankrolled by China

I could write a book on precious metals and mining — and energy and capital formation — which is something that Agora Financial publisher Addison Wiggin wants me to do. On that one, well… stand by. But as I await my inner Johannes Gutenberg to surface — and keep in mind that Gutenberg was a goldsmith as well as a printer — I’ll just continue to publish these weekly notes to keep you up-to-date on what’s going on.

Precious Metals on a Tear

So what’s going on? Gold had a heck of a month in May, rising about 9%. And silver did even better, moving upward by over 26%. It’s that silver slingshot effect, in which silver occasionally makes up for the time spent in the shadows of gold.

Gold and silver were on a tear last month, and that’s great. Can they do it again in June? You surely know that price of gold and silver can go down as well as up. Don’t be shocked at a pullback. But for the medium and long term? Precious metals look good.

The “Insurance” of Gold

I’ve often referred to owning gold and silver as a form of “insurance.” And now, guess what? According to a recent report from Bloomberg, Northwestern Mutual Life Insurance Co. — the third-largest U.S. life insurer by 2008 sales — has been buying gold. This is the first time in its 152-year history that Northwestern has purchased gold.

According to Northwestern CEO Edward Zore, “Gold just seems to make sense; it’s a store of value.” Then Mr. Zore added, “In the Depression, gold did very, very well.” (And I’ll discuss that same point below).

According to Bloomberg, Northwestern has accumulated about $400 million in gold. CEO Zore believes that the price of gold could double “or even rise fivefold” if the economy continues to weaken. “The downside risk is limited, but the upside is large,” Zore said. “We have stocks in our portfolio that lost 95%.” But gold “is not going down to $90.”

So here’s a large, sophisticated company like Northwestern Mutual putting gold where its money is. I guess it wants to be around for another 152 years.

You Can’t Cheat Hephaestus

Meanwhile, the central banks, money center banks and most politicians of the world (except Germany’s Angela Merkel) HATE monetized gold and silver. Why? Because precious metals require these worthies to suck it up. They have to live in an economy based on hard work, long-term investment and honest governance. Can’t have that, can we? So there are serious forces out there attempting to manipulate the precious metals back down. Expect it.

But you can’t cheat Hephaestus, god of the forge. So if the metals retreat and share prices pull back for mining companies, use the opportunity to acquire more metal and shares at a discount to the future price. And remember that my basic precious metals recommendation is that you should have 5-10% of your portfolio in physical metal — and TAKE DELIVERY!

I’ll be plenty happy if our six new precious metals plays move upward in the short term — say, over the next few months. But if we have to wait for the medium term, say, six-12 months, that’s OK too. And surely, over the long term, a year or more, these guys ought to shine (no pun).

In my view, the politicians are spending the country so deep in the hole that the nation will never be able to work and pay its way out. Thus, the monetary stars are aligning toward economic hard times and future inflation. And as we see with Northwestern Mutual above, one investment idea that has historically worked out during hard times and inflation (as well as deflation, I should add) is the precious metals angle.

The Homestake Story

Along those lines, let’s look at the share price of the old Homestake Mining Co. back in the 1920s and 1930s. (See the chart, below.) Homestake was among the world’s largest gold miners in its day, digging gold from the Black Hills of South Dakota. Due to a dearth of records, many historians use Homestake as a proxy for the entire gold-mining industry in that era.

Notice how between 1929-1935, the Homestake share price rose — along with a significant rise in both earnings AND the dividend. Homestake’s earnings per share (EPS) increased from $4.16 in 1929 to $32.43 in 1935. In other words, the gold miner showed annual compound EPS growth of 41%. Wow.

And notice how much of the rise took place in 1930, 1931 and 1932, before Franklin Roosevelt became U.S. president — and seized the nation’s gold, in April-May 1933! But even FDR’s gold seizure didn’t stop the upswing for Homestake. The stock, and its earnings and dividend, kept appreciating and held strong through most of the early years of the New Deal.

That is, the rest of the U.S. business economy suffered from declining earnings during essentially ALL phases of the Great Depression. The overall U.S. economy was awful, with national unemployment rates well over 25% at times. But through it all, the gold mining industry was a hot spot of economic vibrancy.

Gold Miners Versus Banks

While we’re looking at the history of gold in the Great Depression, let’s consider what was going on with the banks in the U.S. According to economist John Walter, writing in 2005 in the Economic Quarterly of the Federal Reserve Bank of Richmond, the U.S. went from over 31,000 banks in the mid-1920s to under 15,000 banks by 1934. That is, over HALF of all banks FAILED! In 1933 alone, over 4,000 banks failed — that’s about 80 per week, or 16 per business day.

And back then, a bank failure was almost always a total wipeout for depositors. There was no federal deposit insurance until late 1934, and the initial coverage was just $2,500. Most depositors in those 16,000 failed banks of the 1920s and early 1930s just plain lost everything. There was no relief at all. If you were a depositor, you went down with the ship.

Banks that didn’t fail paid depositors a paltry 1% (or less) in “earned interest” on their savings. Makes you wonder why people kept any money in banks at all. Risk losing it or get paid 1% interest. Not much choice, right? No wonder that a lot of Depression-era people spent the rest of their days saving money in coffee cans in their basement.

Gold Mine Shareholders Did Well

All the while, Homestake shareholders collected dividends in the range of 8-10%, plus capital appreciation. The Homestake dividend went from $7.00 in 1920 to an astonishing payout of $56 per share by 1935.

It’s interesting that “hard times” are somehow good for gold miners and gold mining stocks. One explanation I’ve heard is that the aftereffects of the 1929 stock market crash caused a sustained contraction of the money supply (thanks to the Federal Reserve), along with a reduction of bank credit.

The result of less credit was that lending just plain froze. (Sound familiar?) Many businesses, households and individuals simply could not obtain credit no matter what their story. And most of the early New Deal programs — “relief,” the Civilian Conservation Corps, the Works Progress Administration and the like — were just transfer payments to otherwise idle individuals. The New Deal may have institutionalized humanitarian government policy toward the unemployed, but it was NOT capital investment.

So with most private capital investment halted during the New Deal, there was a dearth of fundamental capital formation in the economy. The economy couldn’t get traction to move ahead.

Tight credit extended even to governments, and by extension to their fiat currencies. As world trade tightened due to protectionism, public credit evaporated as well. Eventually, investors fled from paper currencies (even U.S. Treasuries). The big players in international finance converted paper currency into the only “money” that was not someone else’s liability — and not subject to counterparty default: gold.

“Gold Has Worked for 2,000 Years.”

Let me sum up by quoting one of America’s legendary financial geniuses, Bernard Baruch (1870-1965). He said, “Gold has worked down from Alexander’s time… When something holds good for 2,000 years, I do not believe it can be so because of prejudice or mistaken theory.”

Until we meet again,
Byron King

June 9, 2009

This article was originally featured on Whiskey and Gunpowder

Gold, Gold and More Gold

The Shift to Heavy Oil, with an “Energy Microsoft” at the Forefront

But a significant portion of the world’s oil is much lower quality than the light, sweet stuff. Indeed, most oil that’s found in nature is a heavy, viscous hydrocarbon with the consistency of cold molasses. This heavy oil - defined as API gravity 22.3 or less - is difficult and costly to produce and refine. That’s why people have pumped and burned the light, sweet oil for the past 150 years. Throughout its history, the oil industry has usually bypassed the heavier oil fractions. Why go to the trouble and expense, right?

But now conventional oil resources are drying up. The reasons have to do with geology, politics, macroeconomics and the investment cycle. Boiled down, it’s the Peak Oil argument, which focuses on the worldwide decline in output of light, easy-to-get oil. And Peak Oil is a serious matter. As light oil gets scarce, however, a lot of new heavy oil plays are coming out of the industrial shadows.

Indeed, with the breakout of heavy oil into the marketplace, the world energy business is about to change dramatically. It’s kind of like what we saw with the computer revolution that began about 30 years ago. Big, heavy mainframes gave way to small-scale, distributed and personalized computing power. At the heart of the revolution was the operating system, much of which wound up coming from Microsoft.

Today, the energy industry is on the cusp of a revolution equally profound. And in the forefront of that change is the company that I’ll describe in this issue of Energy and Scarcity Investor. This visionary firm is sort of an “Energy Microsoft.”

How Much Heavy Oil Is Out There? A Lot!

First, let’s define a few terms and look at some numbers. According to oil service giant Schlumberger, only about 30% of the total world oil resource is the conventional, light, sweet crude (technically, API gravity 22.3 and above). Heavy oil (API 22.3 and below), by comparison, makes up about 15% of the world’s oil resource. Extra-heavy oil (API gravity less than 10) makes up 25% of the world’s oil resource. And nearly 30% of the world’s oil resource is in the form of tar sands and bitumen (with API gravities in the low single digits - it doesn’t flow at all).

Schlumberger estimates that there are between 6-9 TRILLION barrels of heavy oil in the world. Big numbers, right? Especially since the current total world demand for oil is in the range of 30 billion barrels per year. With heavy oils, we’re talking about 200-300 years’ worth of potential supply. (That’s at current rates of use. If we can get it all. Which we can’t. So it won’t happen. But it illustrates the point.)

Where is all of this heavy oil? Here are the nations with the largest estimated deposits:

This list goes on to include other nations with significant heavy oil deposits, such as Brazil, Saudi Arabia and Indonesia. Further down the list of countries holding sizeable heavy oil resources are Australia, South Africa, Nigeria, Libya, Argentina, Peru and Vietnam.

So you can see that heavy oil (and extra-heavy oil, tar sand and bitumen) is a vast and underutilized energy resource. Of course, keep in mind that nowhere near all of this resource is recoverable under even the best scenarios. But the point is that heavy oils, of all types, constitute immense energy potential - many decades worth of supply. And it’s all but certain that, as conventional oil becomes scarcer and more expensive to extract, the world’s energy industry will turn to heavy oils. It’s already happening.

Early and Current Efforts with Heavy Oil

Looking back in history, people and nations used heavy oils when necessity demanded. During World War II, Italy supplied its military (and the military of Germany) with oil products from a modest-sized heavy oil deposit in Albania. The Soviets, desperate for oil products, utilized several heavy oil deposits in south-central Russia. The Japanese exploited heavy oil deposits in Japan, Indochina and Indonesia.

Today, the energy industry has an array of projects that exploit heavy oils. Chevron, for example, lifts about 80,000 barrels per day of heavy oil from its large complex (of 8,000 wells!) at Kern River, California. Venezuela’s national oil company PDVSA produces about 400,000-500,000 barrels of heavy oil per day from projects in the Orinoco region. Offshore Brazil, Petrobras has a deep-water project targeted at a string of heavy oil deposits. And BP has several billion barrels of heavy oil resources located under the Arctic tundra near the conventional oil fields of Prudhoe Bay, Alaska.

When it comes to tar sands and bitumen, the massive developments in western Canada offer a $500 billion example. The Canadian tar sands projects currently yield nearly 2 million barrels of oil per day out of bitumen, strip-mined from the near-surface prairies of Alberta.

Next week, I’ll be in Denver for the American Association of Petroleum Geologists (AAPG) convention. I’ve been a member of AAPG for 30 years, and it’s been a source of great professional education and growth for me. I’ll attend the exhibits and talks and meet with several energy companies to get the latest insight into what’s going on out in the field. I’m even scheduled to be a judge on some of the programs for geothermal and heavy oil. All that, and I’m visiting with some hard rock miners while I’m in the area.

Naturally, I’ll look for great investment ideas and keep you posted.

Until we meet again,
Byron King

June 3, 2009

This article was originally featured on Whiskey and Gunpowder

Heavy Oil Becomes More Appealing As Light, Sweet Crude Runs Out

This is a critical matter and here’s the takeaway point: We’re about to see an UTTER TRANSFORMATION of the U.S. economy.

Your life will be regulated — directly and surely indirectly — by the Environmental Protection Agency (EPA), mostly through its powers under the Clean Air Act (CAA). And the parts of your life not regulated by EPA will fall under the jurisdiction of your friendly state or provincial environmental authorities. Many of the policy details will be rounded out via litigation in state and federal courts, mostly initiated by the likes of the Sierra Club and other environmental organizations.

You should expect to see STRICT controls on carbon emissions, via taxes, regulation and outright bans on many energy-using systems. And since 40% of North America’s electricity comes from burning coal, you can plan on having less electric power and on paying much higher electric rates. The utility companies will just pay the fees and costs for cap and trade and pass the bill on to you in your monthly statement, for example.

But it goes beyond just the utility companies writing checks to the government. We’re talking about BIG money, from every nook and cranny of the economy. One panelist compared the amount of money in play with cap and trade to completely rewriting the U.S. tax code. “Just tear up the tax code. Abolish it. Pulverize it so it goes away completely,” he said. “Now, rewrite it to raise even MORE money than before, and do it by taxing energy usage.”

United States of Clean Air Act?

So the CAA — which came about in the early 1970s as a way of fighting smog — is now morphing into the new constitution for the U.S. Really, I’m not exaggerating. I know some of you think I overstate my points every now and then. But I’M NOT KIDDING!

We’re seeing a new “American Revolution.” Except the key players are not exactly Ben Franklin and George Washington and James Madison. In the name of fighting climate change, there is a new class of bureaucrats, regulators and judges who will control your life down to what time you plug in your coffeepot. And with “smart metering,” they’ll know if you leave your water heater on for too long. (“Well,” is the reply, “just get a solar heater for your roof.”)

One university professor who spoke at the seminar said that if the U.S. adopts a per capita approach to sustainable worldwide energy usage — a serious proposal that’s in front of several powerful international bodies — we’ll have to reduce carbon-based energy demand in the U.S. by 97%. Basically, if that happens, the environmental true believers will take the U.S. back to an energy state that existed in the 1850s. No typo. The 1850s.

Heck, the energy future of the U.S. might make the scenes in James Kunstler’s 2008 book World Made By Hand look like a day at the beach.

So you can see why I’m saying you should accumulate gold and silver. And while you’re at it, own those geothermal power producers. They’ll be the gold mines of the future.

The “Axis of Overspending,” Inflation and the Rush to Precious Metals

Why am I banging the drum so hard for precious metals? Well, you must know the drill by now. Government spending is out of control. We have a big-spending Congress in Washington that can’t say no to anything (except the token defense cut, or taking away school vouchers from inner-city kids in the District of Columbia). It’s been going on for way too many years, under both previous and current party management.

Everybody who’s anybody in this country, it seems, gets a permanent, pet government program, if not a large bailout. (Huh? You didn’t get your program or bailout?) How long can it last? I think we’re about to find out.

As Bernie Madoff might say, “Bailout, schmailout.” Still, the axis of overspending leads to inflation. It’s the 1970s redux. And inflation will soon rear its head and roar so loud that even the wizards of Washington will have to admit the obvious.

Washington Is Awakening! But Clueless!

Actually, our betters in Washington are waking up to the issue of inflation and the decline of the dollar. Just yesterday, I received an inquiry asking if I want to appear on a nationally syndicated show that originates from Washington, D.C. (well, Alexandria, Va., to be exact). The audience is Washington people — you know the type — and their intellectual and spiritual kin in “blue spots” across the country.

Here’s the exact inquiry:

“We’re doing a story on hoarding behavior and I am looking for people who have taken some (or all) of their savings out of traditional investments and are now storing money as cash or in the form of physical gold or some other precious metal in a safe or secret place. I am having trouble finding anyone like this. Do any of you know of someone who fits this description, who might be willing to talk to me about it? I am looking for someone in Boston; Washington, D.C.; New York; or maybe Chicago. If anyone has any leads, please let me know!”

Oh, man! That’s rich! Verbatim! Honest to God, I have not edited this inquiry by EVEN ONE WORD! These people are clueless!

The producer wants to interview gold bugs for the show. In an anthropological fashion that would do Margaret Mead proud, the subject of the story is “hoarding behavior.” But the poor producer says, “I am having trouble finding anyone like this.” (Like looking for a registered Republican at the Harvard Faculty Club?) And how about that request to find somebody in Boston, Washington, New York or Chicago? If you’re from, say, the silver mining town of Wallace, Idaho, you need not apply.

Here was my reply: “People who’ve taken their savings out to buy gold and store it or hide it probably don’t want to brag about it on NPR.”

“Houston, We Have a Problem”

Remember that line from the movie Apollo 13? “Houston, we have a problem.”

Wow. Do we have a problem in this country, or WHAT? It’s WORSE than Apollo 13. We should be so lucky as to be in a small capsule in the cold of space heading away from Earth toward the moon with almost no oxygen or electrical power. Instead, we’re watching the national currency declining and dying right before our eyes. And the opinion makers of the nation don’t know anybody who owns gold. Amazing!

Meanwhile, Over in Dubai…

Well, the producer could always go find somebody in Dubai. Because from that distant desert kingdom comes word that the Dubai Multi Commodities Centre (DMCC) has finished building a state-of-the-art precious metals vault, with world-class tracking and security systems. Think Fort Knox, but in the desert and without the trees and pretty landscaping we see in the hills of Kentucky.

You want “hoarding behavior”? The new vault will become the home for the exchange-traded fund (ETF) of Dubai Gold Securities. Also, “It’s a natural home for the central banks in the region to store their gold in Dubai, rather than in London, where they have typically held their gold,” said a Dubai-based gold dealer INTL Commodities DMCC’s CEO Jeffrey Rhodes. Yep. “Natural home.” (Margaret Mead, call your office!)

A DMCC official stated that the new vault will be used to store precious metals associated with precious metal-based ETFs that are on the drawing boards and scheduled for launch later in 2009. This can only add to worldwide demand for gold and silver, especially from the traditionally gold-friendly Middle East.

Here’s the Bottom Line…

OK, so here’s the bottom line. When the American people realize that the dollar is in for another round of inflation, they’re going to look for a way out. When people envision the future decline in their purchasing power, we’ll see a rush for the monetary exits. It’ll be the “Gold Panic” of 2009, or 2010 or 2011… Whichever year gets the naming rights.

When the reality sinks in, people will flock in droves to physical precious metals (yeah, try to get some!), as well as mining shares. I’m old enough to remember the last time it happened, in the 1970s and early 1980s. And I’ve studied enough history to know it won’t be pretty.

So beat the gold rush! Hoard now!

Until we meet again,
Byron King

May 28, 2009

This article was originally featured on Whiskey and Gunpowder

Gold, Climate Change and the Cap-and-Trade Revolution

Wrapping Your Brain Around the OTC

Sometimes when 70,000 people head to Reliant Stadium, it’s to watch the Houston Texans play football. The spectators understand what’s going on down on the field. In true Texas fashion, they know the rules of football. There are 22 players moving back and forth, with the rest of the two teams and coaching staffs on the sidelines. It’s something around which you can wrap your brain.

But the OTC? How do you wrap your brain around the OTC, its several thousand exhibitors and many dozens of speakers?

Do you want to know how to do seismic work on the other side of the world? How to build work ships the size of aircraft carriers? How to anchor a 75,000-ton rig in swift-moving water, while dangling a 20,000-ton riser-string that’s nearly two miles deep? How to drill oil wells 250 miles out at sea? In 9,000 feet of water? Through 14,000 feet of rock? Through 8,000 feet of salt? Into fluids with pressures of 25,000 pounds per square inch? (By comparison, your household water pressure might be about 40 psi.) Into super-heated oil filled with poisonous gases? How to move that super-heated oil to the seabed from beneath four miles of the earth’s crust? Then how to move that oil across hundreds of miles of ocean bottom, and do it in the freezing waters of the deep ocean, even at the equator and, of course up in the Arctic? Do you know how to do that? Where does the technology come from? Who builds the equipment? How do you pay for it? Where is the work force to accomplish these tasks? What about the government policies that influence it, for better and worse? How do you make 25- and 50-year plans — yeah, it takes THAT long — in a world where prices and policies change by the month? How about the national cultures that nurture (or suppress) the whole process?

Which Battle? Which War?

Let’s look at things from the standpoint of national cultures. When I attended the Naval War College a few years ago, going through a course for senior officers, one professor said something that stuck with me: “Your job is not to fight the last battle of the last war. It’s to fight the first battle of the next war.”

“The first battle of the next war?” Damn right. Sure, you’re going to study history. Sure, you’re going to read about the last war and its last battles. But you have to understand that things change. You have to realize that everybody else is studying the last battle of the last war. So you probably have no real advantage going into the next great effort. The other guy has read the same book.

Thus, if you want to succeed, you have to get ahead of the future. You have to write a new book. It’s YOUR book. Indeed, you have to invent that future. You have to decide what you want to do, and then acquire the people and equipment to get it done.

Brazil — Gearing up for the First Battle of the Next War

Where am I going with this? Let’s look at Brazil, for example. The Brazilians are gearing up for the first battle of the next war, so to speak. They intend to survive as a prosperous, industrialized country in the 21st century, despite intense future competition across the world for energy fuels and other natural resources.

Down in Brazil, they’re in something like national rapture at the prospect of drilling up the deep pre-salt hydrocarbon plays in the offshore basins. The estimates are that the deep basins off Brazil hold between 20-100 billion barrels of oil. Maybe more.

The entire nation of Brazil, apparently, revels in the prospect of investing over $120 billion in offshore development in just the next eight years. They have a plan. It’s their moonshot. The Brazilians believe that the offshore environment will bring their industries firmly into the modern era. Brazil wants to be a world power in the 21st century. And the oil? Well, of course they have plans for that oil.

As a nation, Brazil cannot wait to move ahead into its offshore realm. Just Petrobras, the national oil company, wants 40 new drilling rigs, each over 60,000 tons; and 32 new production units, each near 100,000 tons; and about 130 large supply vessels, each over 100,000 tons.

Petrobras has plans to emplace HUNDREDS of subsea systems on the deep ocean bottom to bring that oil into production. The Brazilians will lay thousands of miles of underwater pipeline, with all the associated ship-support and other equipment that entails.

The Brazilians are not living in the frozen past. They’re not hostage to paralyzing myths. The Brazilians envision a future for their nation, and they’re acting on it. They see hundreds of deep-water oil wells pulling petroleum out of the crust from many miles down and piping it ashore to their refineries and industries. Indeed, Brazil plans to win that first battle of the next war. And it’s cutting the steel with which to do it.

Meanwhile, Back in the US of A…

Meanwhile in the U.S., the policy battles rage endlessly over offshore development. Authorize? Don’t authorize. Explore? Don’t explore. Lease? Don’t lease. Drill? Don’t drill. Produce? Don’t produce.

Whenever the proponents of offshore development score a win, the opponents take it all to federal court for years on end. Years later, some judge makes a decision. Then comes the inevitable appeal. And then everyone goes back to litigate some more after the appeal. There’s no end. I’ve spent my adult life watching this ping-pong match play out.

What’s at the heart of the issue? A broken political process. Or you might call it a political “process” that works too well. Really, it seems that much of the U.S. energy mind-set is stuck firmly in the past. In essence, the debate is over how to fight the last battle of the last war.

Living in a 40-Year-Old Past

For example, again and again, the opponents of offshore development in the U.S. summon up their favorite bete noir — the images of the Santa Barbara oil spill of 1969. An event from four decades ago — before most Americans now living were even born — has become the iconic reason not to develop, say, offshore California. And this is despite the fact that the exploration, drilling and environmental technology of today is far advanced from what existed 40 years ago.

Think about it. Do you have a better computer today than 40 years ago — if you even used computers back then? A better television? A better car? Are there better airliners? Better heart transplants? You get the idea. But some people learn something and never let it go.

Along those lines, the other day, I visited the facilities of Cameron Intl., here in Houston. Cameron makes blowout preventers for deep-sea drilling, and a large host of other drilling-related equipment. Having been around the oil industry for over 30 years now, I can say that the new technology for safe drilling is beyond astonishing. Just the quality control alone is awesome. For example, EVERY HEAT of steel that goes into certain of Cameron’s subsea products goes through a rigorous quality-assurance check. Every heat.

Meanwhile, it’s not just California where the offshore is off-limits. Most of the rest of the U.S. offshore is locked up as well, except the western Gulf of Mexico and (grudgingly) some of northern Alaska. As one wag has put it, when it comes to offshore development, much of the U.S. political class is living in “The No Zone.”

The Future Is Right Now

But the last battle of the last war — the Battle of Santa Barbara — is over. The images of oil on the beaches led the U.S. to shut down much of its offshore drilling effort, and for many decades. Meanwhile, the mess got cleaned up. It’s history. The energy industry figured out what happened and fixed a lot of problems. Now where do we go? Because you have to go somewhere, sometime. You can’t live in the past — at least not for too long. Or can you? Well, you can try to live in the Good Old Days, but eventually, the future will overtake you. And in the world of energy, the future is right now.

Welcome to the Future

A year ago, the price of oil was $120 per barrel and rising. Indeed, by last July, the price was $147 per barrel. And when that happened, you might recall that the world economy didn’t work very well. It was oil prices; it was bad banks; it was a lot of things that went wrong. And then the economy cratered. That took down the oil price. So now the price of oil is in the $50s.

Look back. How did oil ever reach $147 per barrel? Was there really not enough to go around? That’s what some people thought. But then why did the price suddenly tumble, if not just plain drop off a cliff? Did people anticipate a demand crash? Again, that’s what other people thought.

Now we have oil in the $50s. What does that mean? With oil in the $50s, does it mean that the world has “too much” oil? Or not enough? Well, what’s your time frame? A day? A week? A month? A year? Five years? Fifteen years?

With oil in the $50s, yes there will probably be adequate supplies for the next few months. You can calm down. The oil you’ll burn in September is being loaded onboard distant tankers right now.

But with oil in the $50s, will there be adequate oil supplies in, say, 2012, if not 2020? I doubt it. At least not for the U.S. Because with oil in the $50s, some of that 2012 oil — and much of that 2020 oil — won’t see the light of day. There’s just not enough cash flow for the energy business to do its thing — like drill enough wells. Hey, the future is now.

Future oil production requires current exploration and development. Except we’re not drilling. We’re not developing. So welcome to the future. With oil in the $50s, it’s a no-brainer to predict future shortages.

For Now, Keep Drilling

One thing is certain. If the energy industry does not stay focused and capitalized, we’re in a lot of trouble — and I mean sooner, rather than later. That’s why a big trade show like the OTC is so important. The OTC embodies the new developments in offshore technology. It gets right into your face.

Almost every booth at OTC has some item on display that’s better than what used to be on display. Yesterday, for example, I saw a remarkable new invention from FMC Technologies that dramatically improves the safety and efficiency of the “fracturing” process (“frac-ing”) by opening up shale beds to yield natural gas. It’s what the late efficiency guru Edward Deming would have called an “incremental improvement” to an existing process. But it’s brilliant and elegant. And when this new equipment goes into widespread use, it will offer a dramatic improvement.

Ideas and improvements like this from FMC Technologies — and countless more on display at the OTC — will allow the energy industry to keep providing hydrocarbon molecules to us earthlings for as long as we want to burn them. (Burn them? That’s another story entirely.)

The OTC shows off what the U.S. has at its disposal, if it chooses to develop its offshore energy resources. Here are the tools with which to fight the first battle of the next war.

And the OTC also shines a light on how many U.S. policymakers and opinion leaders are living in the past, patting themselves on the back as they fight that last battle of the last war. Meanwhile the energy clock is running down, and other nations and cultures are shopping their wares.

That’s all for now. Thanks for reading…

Until we meet again,
Byron King

May 20, 2009

This article was originally featured on Whiskey and Gunpowder

Brazil Forward Looking on Oil Production

“Climate Change” Driving Policy Now

According to the satellite builder, the dominant elements of the political and media culture are “completely in the tank” when it comes to believing in the dangers of “climate change.”  It’s not as if climate change is demonstrably true, he pointed out.  There are valid scientific data from both sides of the climate change issue, and many valid data points in between.  But according to the aerospace executive – some of whose satellites were built to track climate change — “For at least ten years, if you have not been promoting the dangers of climate change then you have not been receiving government grants.  So the research community is following the money.”

Thus the research literature is coming out strongly in favor of “doing something” about climate change.  And policy-makers are using this research literature to justify doing what they’ve wanted all along, which is change the world as we know it.  As a class, the activists want to change the world into something else.

“Pathological Hatred” of Carbon-Based Fuels

According to the steel executive, the climate change issue has spurred what amounts to “a pathological hatred” of carbon-based energy systems.  “It doesn’t have to make practical sense,” says this source.  “It doesn’t even have to work with economics.  It just has to support a policy to utterly transform the nation’s energy system.  The people making policy now have a crusader’s mentality.  ‘The past is trash,’ is how many of the new policy makers view our world.  So the new policy makers want to promote radical change in energy policy.  They’re going to jam it down the throat of the economy.”

According to the steel executive, the steel industry expects to see inflation-adjusted, baseline energy prices triple or quadruple within ten years.  “Whether the government taxes carbon-based energy at the source, or whether they pass ‘cap-and-trade’ legislation, it’s going to cost us.  So we’ll pay.  Of course, we’ll pass along the new costs to the steel buyers.  If demand goes down, we’ll close facilities.  Then the TV cameras will show up at the plant gates to watch us shut the doors and click the padlocks.  And we’ll get called bad names by the people who never much liked us in the first place.”

Can the Economy Support What the Government Wants to Do?

The former Treasury official added that a new “policy paradigm” has yet to form in Washington DC.  “It’s like during the Cold War, there was a bi-partisan consensus to confront and contain the Soviet Union.  It was expensive, but we agreed to do it.  We made the national sacrifice.  Well, that foreign policy consensus ended when the Berlin Wall fell and the USSR came down.”  The groupthink in the early 1990s was that another kind of broad consensus had to take the place of the confrontation with the Soviets.  And by its very nature, that consensus was fragile.

“Let me back up,” said the former Treasury official. “Confronting the Soviet Union gave the U.S. an excuse to continue with Franklin Roosevelt’s Depression Era, New Deal, big government for 45 years after World War II.  But after the USSR fell?  Why did we still need big government?  To run a modern welfare state?  That was the justification.  Remember the talk about that ‘Peace Dividend?’  People were drooling over the idea of cutting the military budget and paying for more and better social welfare through more big government.”

“So what happened?” asked the Treasury guy.  “Some people thought they were going to run a big government welfare state using modern monetary theory.  They convinced themselves that we could do that.  They didn’t understand the long term problem.”

What was the long-term problem?  “The welfare state was never going to last.  Especially because the nation collectively wanted it to support a rank, consumerist culture that could not earn its keep within the world economy.  We imported, imported, imported.  And we paid for it with cheap dollars.  After the U.S. left the gold standard in 1971, the fundamentals of the American productive economy could never support what the nation was trying to do.  We’ll look back eventually and realize it was delusional policy-making.  All we did was run down the economy for a couple of generations.  It finally collapsed in 2008.”

Whatever “post-USSR consensus” existed in the U.S. in the 1990s shattered during the 2000s.  “People went nuts because of the Bush Administration,” said the Treasury official.  “The white-bread explanation – call it ‘Decline and Fall for Dummies’ — was that it was all about the evil George Bush and his wars in Afghanistan and Iraq.  Well, Bush and the wars were visible, so that’s what people blamed.  The real problem for the U.S. was that the whole foundation for post-war American society, economy and governance was caving in under our feet.  The timbers were rotten.”

The Barn Burned Down – Did Anyone Notice?

According to the Treasury man, the U.S. economy is now confronted by “block obsolescence” of many of the economic and political assumptions with which we’ve lived for decades, since World War II.  “Chrysler isn’t the only big institution that’s bankrupt.  We ought to burn down a few universities, while we’re at it,” he added.

And he noted that Republicans and Democrats both fed at the trough while the going was good.  “But while the politicians had their heads buried in the trough for all those years,” he said, “they didn’t notice that the barn was burning down around them.”

The Treasury-man continued:  “Look at the destruction of former industrial titans like General Motors, and with GM the annihilation of much of the rest of the automobile industry.  Who’s going to invent whatever will take its place?  We used to say that 40% of the U.S. economy was based on the auto industry, directly or indirectly.  Are we ever going to see 40% of the U.S. economy based on putting solar panels on roofs, or tuning the gearboxes of windmills?”

“Free-Traded” to the Poorhouse – We’re at the Edge of the End

The former Treasury official looked at the ongoing economic crash.  He placed it within the context of the long-term decline in U.S. manufacturing.  “As a society,” he said, “we’ve made a lot of very bad choices of both moral philosophy and economic policy.  Those bad choices have brought us to the edge of the end.  We’ve spent, borrowed and ‘free-traded’ ourselves to the poorhouse.  Now the Chinese own us.”

Helping Embryonic Industry – Creating a Success Story

The venture capitalist chimed in with some thoughts.  “If the feds are going to spend billions on stimulus, then they ought to direct some of that money to help fund promising research.  How about some money to pay for every fossil-fuel power plant in the country to siphon off some of its CO2?  Then run the CO2 through a facility to grow algae to make biofuels.”

“We’d be killing about four birds with one stone,” explained the venture capitalist.  “We’d be taking down CO2 emissions.  Not much, maybe, but some.  We’d be helping an embryonic industry that can be competitive in coming years.  Heck, turning algae into fuel is easy.  The basic part is just high school chemistry.  So we’d be creating a new supply source for the liquid fuels industry.  And we’d be able to point to at least one success story where people can agree that we all did something right.”

Then the venture capitalist added that one of his startups is “working on coal-eating bugs.”  He explained that “There’s a lot of coal buried so deep, or under other conditions that we can’t mine it.  That coal will never get out.  So why not put bugs down in the deep seams, and let them eat the coal?  Then we can harvest the gases that come out the back end of the bugs, and use that as feedstock for other things.”

“Well, What Do YOU Think?”

At one point, one of the lunch participants turned to the silent person at the table, who was busy taking it all in and making a few discrete notes.  Then came the dreaded question, “Well Byron, what do YOU think?”

I focused my comments on geothermal development.  I pointed out that for all the anti-carbon sentiment out there, the most under-appreciated, “clean and green” energy source is geothermal.  There appears to be strong support for geothermal development via tax incentives and other, policy-based standards.  Combine this with the growing social focus on clean, renewable energy sources.

Right now, 24 states have renewable portfolio standards (RPS) for electricity production.  And Congress is leaning towards setting a national standard of 20% to 25% RPS power production by 2025.  We’re at the point where a utility like California’s Pacific Gas and Electric is so desperate for “clean” energy that they’re contracting with a privately-owned company to build a satellite to harvest solar energy from space, and “beam” it back to earth.

The companies that are out there now are in relatively advanced stages of developments.  The big problem is that the follow-on pipeline is almost empty.  The problem has been lack of access to capital for the past year or so.  In other words, lack of capital is the strongest headwind to progress.  If the funding delays can break down, then we’ll see decreased complexity for funding, and project schedules moving ahead.

That’s all for now.  Thanks for reading…

Byron King

April 30, 2009

This article was originally featured on Whiskey and Gunpowder

The Direction of Energy Policy

Old Whiskey Rebellion and Modern Tea Party

During the Whiskey Rebellion of old, irate Western Pennsylvanians burned down the house of George Washington’s appointed tax collector, General John Neville.  This wasn’t without provocation, of course.  The bonfire started after one of Neville’s federal marshals shot and killed an unarmed tax protester.  Lesson to the feds:  Be careful who you shoot, especially when they can shoot back.

The recent Pittsburgh Tea Party was far less inflammatory, although some of the issues and basic sentiments are much the same as those of the 1790s.  The original Whiskey rebels opposed a distant and aloof government that reflected the interests of an East Coast cultural aristocracy.  Despite the personal popularity of George Washington, his federal government was imperial and out of touch.  To answer a summons in federal court, for example, a Western Pennsylvania farmer had to trek near 300 miles across the mountains to Philadelphia.  And the lack of a useful national currency – one of the key functions of any government — handicapped economic growth.  In fact, for lack of real money on the western frontier, people used whiskey as a form of currency.

The final straw came in 1792 when Treasury Secretary Alexander Hamilton proposed raising revenue by taxing the capacity of stills.  And in those days, stills were no mere means of making recreational moonshine.  By 1794, the draconian collection of Mr. Hamilton’s new tax placed at risk the ability of farmers to transform their surplus grain into more transportable and saleable whiskey.

In other words, the whiskey tax damaged the farm economy, which was about all there was west of the Alleghenies.  Inept government economic and monetary policy placed the future at risk.  Thus did many citizens rebel.  And rightfully so, some say.

Rooted in Citizen Anger and Frustration

What’s behind the modern “Tea Party” sentiment?  I believe that it’s rooted in citizen anger and frustration that the federal government just spends and spends and spends, with no evident heed for tomorrow.

The justification for heedless increases in government spending – even worse, increased spending with borrowed money — is along the lines of Pres. Franklin Roosevelt’s famous comment that “If we borrow funds, then we owe it to ourselves.”  The modern justification, as a Federal Reserve official once explained to me, is that “As long as we can afford to pay the interest on the debt, it’ll be OK.”

But the people are not blind, let alone stupid.  It is clear that the federal debt just grows and grows.  How much longer can this last?   Today many informed citizens understand that the national debt is way too big.  The rate of growth is out of control.  We don’t “owe it to ourselves.”  We owe it to the Chinese, the Japanese, the Middle Easterners.  And we cannot afford to pay the interest anymore.  Well, not if we want to be able to do anything else as a nation except work like tax-slaves to pay interest on past debt.

By any technical measure, the federal government is insolvent — except for that quaint custom of inflating the currency with fiat dollars.  So really, the nation is long overdue for a national discussion on the fundamental nature of its money.  Hence the Tea Parties.

The Pittsburgh Tea Party Crowd

In Pittsburgh a crowd of several thousand (estimates range from 2,500 to 5,000) formed last week in the city’s old, historic Market Square.  Market Square dates to the 1700s, and perhaps the bedrock still recalls the events from the days of George Washington.  The mid-April weather was characteristically lousy, with drizzle and rain falling in 50-degree temperatures.  If you were there, it was because you wanted to be there.

The Tea Party attendees struck me as a cross section of Western Pennsylvanians.  There were many Steelers jackets, and ball-caps with military logos and veteran patches.  I asked around, and met business owners and office workers, factory workers, lawyers, health care providers, restaurant workers, and a few people who are, as they put it, “between jobs.”  There were off-duty cops and firefighters, courthouse employees, bus drivers and even a few bikers resplendent in their leather and tattoos.

The Tea Party brought out the creative side of attendees as well, with people dressed in Colonial period costumes.  To my observation, it was an orderly and respectful crowd, filled with sincere people who appeared to know their American history.  My gut feeling was that the Tea Party attendees understood why they were out standing in the cold rain.  (One 30-something woman told me, “I’ve never been to a political rally in my life.  But I’m just scared for the country’s future.  We’re going to be broke.”)

The makeup of the crowd was young and old, men and women.  There were retirees (as indicated by their hats and T-shirts), middle-aged people, and young people complete with pink hair and metal in their ears.  There were parents with children.  (One participant told me, “I brought my son with me because I want him to remember this day.  I think we’re at the beginning of something that’s going to change the country.”)  There were white and black, Asian and Indians.

Many Tea Party attendees carried signs, all apparently homemade.  The verbiage ranged across a conservative to libertarian political spectrum.  Some signs were historical, with deep roots in the 1913 coup d’etat of American Progressivism under Pres. Woodrow Wilson.  (“The Fed is Illegitimate.” and “Abolish the 17th Amendment.”)  You don’t see many signs like that these days, that’s for sure.

Other signs were rock-ribbed statements of protest about taxes and spending.  (“Give me Liberty, Don’t Give Me Debt.” and “Born Free, Taxed Beyond the Grave.” and “Abolish the IRS, Support the Fair Tax.”  and “Wall Street Banks Got Billions, and All I Got Was This Lousy Sign.”)

Other signs – not many — knocked Pres. Obama; but I would not characterize the Tea Party as just an anti-Obama rally.  There were indications of deeper dissatisfaction with the federal government, at a systemic level.  One sign knocked the “Bush-Obama Ripoff.”  Other signs were along the lines of “Abolish Congress,” which is not exactly realistic, considering the wording of the U.S. Constitution.  (Vote the bums out, maybe?)

One sign hit on the corruption of the process of governance, stating, “Big Fraud from Little ACORN Grows.”  These were not the usual mass-produced, “union-label” signs that you see at those “other” kinds of political rallies.  I’m sure you get the idea.

The Tea Party Organization

The 2009 Pittsburgh Tea Party was organized by a suburban housewife, albeit one with an MBA from the Harvard Business School.  From what I heard, a few politicians volunteered to speak.  The terse reply from the organizers was along the lines of, “No, this is where the people will speak.  You politicians need to shut up and listen.”

There was no indication that the Tea Party was an “Astroturf” event.  The Tea Party received almost ZERO media coverage in the days leading up to it.  It had all the markings of a “flash rally,” organized on the Internet.  The local talk radio guys scarcely mentioned it, to my knowledge.  (If they did, I missed it.)  The local newspapers gave no advance publicity.  The local TV stations were too busy covering the usual pabulum about car crashes and house fires.  If it doesn’t bleed, it doesn’t lead.

It seemed to me that the attendees of the Pittsburgh Tea Party were there of their own volition.  I sensed no mind-control from the evil Fox-News Network, and I wasn’t even wearing my radio-blocking aluminum skull-cap.  Contrary to the defamatory stereotype pushed by the incompetent mainstream media (the LA Times characterized Tea Party attendees as “insane”), the Tea Party people seemed to be decent folk, able to think for themselves and form independent opinions.  And many Tea Partiers have apparently formed the opinion that the federal government is spending the country into ruin.  To those of us who follow the issue, it’s a valid point.

The Tea Party Festivities

The Tea Party stage was decked out with flags.  Festivities began with a musical mixture of patriotic tunes and Country-Western music.  The Tea Party kicked off with a brief welcome from the organizers, followed by a moment of silence in memory of three Pittsburgh police officers who were killed in the line of duty a couple weeks ago.  Then a prayer.  Then the Pledge of Allegiance.  Then the national anthem.  In other words, it was as patriotic as the 4th of July.  Nothing radical.

The first speaker discussed the ever-expanding federal budget.  If you’ve seen the movie I.O.U.S.A., produced by Addison Wiggin of Agora Financial, then it was nothing new except that this was a Tea Party protest in downtown Pittsburgh.  And criticizing federal spending in downtown Pittsburgh is not something that happens very often.

Another speaker gave a spirited history lesson about the origins of the Federal Reserve.  It was Creature from Jeckyll Island-kind of stuff.  It was surprising (to me) how much of the discussion the crowd appeared to understand.  It was astonishing, really.  I think that most of the Federal Reserve scholars in town must have been in the audience, because people seemed to know exactly what the guy was talking about.

A third speaker gave a solid speech about the evils of ever-expanding government.  This guy is a multi-millionaire who built his own nationally-ranked high-tech business and made a fortune.  He’s met a few payrolls in his career.  He discussed the exploding levels of federal expenditures.  He hit on the ballooning national debt, and asked rhetorically how the nation ever intends to pay just the interest, let alone the principal.

And so it went, with more speakers giving talks along the same lines.

The Hecklers in the Crowd

Of course, a few hecklers showed up to make noise.  While one of the early speakers was discussing how federal borrowing is crowding out private investment, a group of five (I counted them) people started to chant, “O-Bam-A!  O-Bam-A!  O-Bam-A!”

At first, the crowd ignored the hecklers.  Then the hecklers realized that they were having no effect, so they yelled louder.  Eventually, it was kind of hard to hear the speaker.  A few members of the Tea Party crowd turned to the hecklers and told them to shut up, have some respect, etc.  That was like throwing kerosene on a fire.  Now the hecklers were hollering at the top of their lungs.

There were a few TV cameramen from local stations covering the event.  Needless to say, the camera-guys rushed over to film the hecklers in action.  By now the five hecklers were having a great time, yelling and making enough noise to disrupt the proceedings.  Then some Pittsburgh cops and event organizers walked over to tell the hecklers to keep it down.

The cops must have said something, because the hecklers broke up and started walking around the edge of the Tea Party crowd, yelling epithets like, “You’re all racists.  You can’t deal with a black man in the White House.”  To which a black guy standing next to me said, “I’ll bet these punks are ACORN activists.”  He turned and talked right at one of the hecklers, saying, “Why are you causing a disturbance?  Get out of here.  Go home to your mama.”  So the heckler called the black guy an “Oreo,” as well as a few other words that I thought were banned from modern vocabulary.  Then a Pittsburgh cop walked up to the heckler and politely asked him to “move along, unless you have some other reason to be here.”  Pittsburgh’s finest.

Media Coverage

The local media gave almost no coverage to the Pittsburgh Tea Party.  The TV stations focused on the hockey playoffs between the Pittsburgh Penguins and the Philadelphia Flyers.  One station ran a short, insubstantial fluff piece, with plenty of attention to the five hecklers.

The Pittsburgh Post-Gazette, located three blocks from Market Square, buried its next-day coverage within a critical, anti-Tea Party story distributed by the Washington Post.  The photo on the inside pages of the Post-Gazette was from a Tea Party in Cincinnati.  On its editorial page, the Post-Gazette ran an insulting cartoon by the predictable and pedestrian Rob Rogers.  The cartoon showed three raw-looking, hirsute men sitting around a table, sipping tea and bellyaching (get it?  Tea Party?)  Meanwhile, the circulation of the Post-Gazette is falling and the newspaper is laying off staff.  Gee, I wonder why people don’t bother to read the Post-Gazette?

What Were the Tea Parties About?

But it’s not just the Pittsburgh Post-Gazette that’s missing the boat.  The talking-head androids of Big Media also missed the point of the Tea Parties.  To the extent that there is any remotely accurate reportage going on, the focus seems to be that the Tea Parties are well-off people bitching about high taxes.  Even the Gallup Poll organization took the bait, publishing a recent report stating:

“A new Gallup Poll finds 48% of Americans saying the amount of federal income taxes they pay is “about right,” with 46% saying “too high” — one of the most positive assessments Gallup has measured since 1956. Typically, a majority of Americans say their taxes are too high, and relatively few say their taxes are too low.

But focusing on the level of taxation is the wrong issue for Gallup to track.  It struck me that the Tea Party attendees in Pittsburgh were worried more about the use of their tax dollars, and the explosion in federal deficit spending.  The Tea Party movement strikes me as more about the dangerously growing size of the federal government.  From what I could gather, the Tea Party attendees opposed the unalterable trend of endless federal growth.  And coupled with this there is, of course, a deep fear about the eventual decline in value of the dollar.

Like I said earlier in the article, it’s about time for the U.S. to have a national discussion about the nature of its money.  What is a U.S. dollar any more?  Where does national wealth come from?  We ought have that national chat while we still have some money, and while we can still create wealth.  Because a lot of people appear to sense that something important is coming to an end.

And when things fall apart, we’ll be in for a generation or two of very tough times.  So the political class, and its Big Media androids, are ignoring the Tea Party movement at their peril.

Until we meet again,
Byron King

April 22, 2009

This article was originally featured on Whiskey and Gunpowder

The Pittsburgh Tea Party

But what if it was the US that closed the Straits of Hormuz?  What would the world think if the US directly precipitated the end of ship traffic in the Straits, or at least severe restrictions on transit and passage?

Closing Hormuz?  We Almost Found Out…

Well, we almost found out last Friday, March 20.  That was when two US Navy ships collided during an otherwise routine transit through the Straits of Hormuz.  And one of the vessels was a nuclear-powered submarine, the USS Hartford (SSN-768).  Hartford is a Los Angeles-Class attack submarine.

In those dark hours of collision and confusion — and as is often his custom and courtesy — the god of the sea Poseidon favored the US Navy.  That is, we did not experience the catastrophe of a nuclear submarine sinking in the Straits of Hormuz. Now THAT would have altered the shipping and energy patterns of the world.

But one cannot but wonder “what if” in situations like this?  “What if” worse things had happened?  “What if” the worst occurred?  Remember the Russian submarine Kursk, which tragically sank in 2000 in the icy waters off northern Russia.

Here Is What We Know…

Early in the morning of March 20, submarine Hartford was transiting into the Persian Gulf through the Hormuz Straits.  Hartford was accompanying an amphibious surface ship, the USS New Orleans (LPD-18) which was making her first extended deployment.  Hartford was “submerged but near the surface” at the time of the collision, according to Navy officials.

For reasons not yet known, the two ships collided.  According to one report, submarine Hartford rolled 85-degrees to starboard.  The impact and rolling caused injuries to 15 Sailors onboard.  The bow planes and sail of the submerged Hartford ripped into the hull of New Orleans.

According to a Navy statement, the collision punched a 16-by-18 foot hole in the fuel tanks of New Orleans.  Two interior ballast tanks were also damaged, the statement said.  USS New Orleans lost about 25,000 gallons of diesel fuel, which rapidly dissipated in the ocean and could not be tracked after a few days.  There were no injuries to New Orleans crew of 360 or the embarked unit of 700 US Marines.

Nuclear-powered submarine Hartford was severely damaged.  Indeed, the submarine’s sail was torn from its mountings to the vessel’s pressure hull.  (See photos below, courtesy of US 5th Fleet.)  The submarine’s sail is clearly bent by several degrees to starboard.  It’s not part of the builder’s specs, that’s for sure.  Apparently, the submarine’s communication masts and periscope are warped and inoperable.  The watertight integrity of the pressure hull is suspect.  After the collision, Hartford transited on the surface to Bahrain, where the vessel tied up to a military pier.

“It’s important to point out that Hartford’s [nuclear] power plant was not affected in this at all,” said a Navy spokesperson.  Also, according to the Navy, “Despite the roll, engineering investigations have confirmed the propulsion plant of the submarine was unaffected by this collision. … However, Hartford sustained damage to its sail and periscope, as well as the port bow plane.”

Deployment Ending, Now for the Long Trek Home

According to a report in the latest issue of Navy Times, this is a “deployment ending” event for the USS Hartford.  The submarine cannot fulfill its combat mission.  The vessel must move to a nuclear-capable shipyard to undergo extensive repairs, costing “in the tens of millions of dollars” according to one source.  Coincidentally, USS Hartford ran aground in 2003 near La Maddalena, Italy, damaging its bottom and rudder.  Repairs then cost near $10 million and involved installing equipment that had to be cannibalized from another, decommissioned submarine.

In all likelihood, in its current state Hartford will be restricted from submerging.  So the question is how to bring the damaged vessel on a long, transoceanic trek back to the US for repairs.

The submarine may be able to transit back to a nuclear-capable shipyard in the US under her own power.  A voyage like that would have to be made entirely on the surface, due to the risks of submerging the damaged pressure hull.  Nothing is easy, however.  A surface transit would require extensive preparations and effort, to include armed Navy escort.

Sailing a damaged nuclear submarine from the Middle East to the US would likely require avoiding many of the busy sea-lanes of the Indian and Atlantic Oceans.  Just the fact of a damaged nuclear submarine re-transiting the Straits of Hormuz, on the surface and within sight of Iranian spotters, must give chills to US Navy planners.

Suez?  Or the Cape of Good Hope?

The shortest route home would involve transiting the Red Sea, Suez Canal and Mediterranean Sea.  But this is problematic, considering the public relations nightmare of a damaged US nuclear-powered vessel moving through busy seas adjacent to densely populated regions that are critical to world commerce.

Or Hartford could transit south around Africa, and sail around the Cape of Good Hope.

Doubtless, the South African Navy would take an interest in any southerly transit by USS Hartford.  South Africa has a fine, modern navy that includes three brand-new, German-built Type-209 diesel-electric submarines.  Indeed, the South African Navy Base at Simons Town — home-port to its Type-209s, relatively remote and very secure — might be a suitable locale for the US Navy to consider for logistic and/or emergency support.  However the South African government might also be concerned at the presence of a damaged nuclear vessel in or near its waters.  Last fall, the South African nuclear regulatory authorities waited until almost the last minute to give approval for a port call at Cape Town by the (undamaged) nuclear powered aircraft carrier, USS Theodore Roosevelt (CVN-71).

If Hartford does not sail home on her own, the US Navy would have to arrange a “lift” for Hartford.  This would entail placing and securing the 2,800-ton submarine on the flat deck of a large transport vessel, such as occurred with the USS Cole in 2000 after that ship was bombed while at anchor in port in Yemen.  But removing Hartford’s hull from the sea would also require jury-rigging a continuous means to pump seawater and cool the ship’s nuclear reactor.  Nothing like this has ever been done before.

Money, Assets, Favors, Political Capital – and Luck

Whatever happens, the damage to the USS Hartford is going to take much money, many Navy assets, and a lot of favors and political capital to fix.  We in the US are certainly not finished hearing about the USS Hartford, let alone paying for it.  Then again, we were very lucky.  For both our Navy and our country, it could have been much, much worse.

As a long-time student of both Naval history and disaster, I commend Poseidon that, once again, he has favored the US Navy — even in adversity — and that the Straits of Hormuz are still open.  Going forward, we had better absorb the lessons and not press our luck.

Whew…

Until we meet again,
Byron W. King

April 2, 2009

This article was originally featured on Whiskey and Gunpowder

Closing the Straits of Hormuz and the Effects on Oil Prices