Another fracking Saudi conspiracy story, or Chapter 11 is a marvelous invention

Mike Smitka

Let me revisit a topic that matters a lot to the auto industry, what's happening in the energy sector. Frank Gaffney, of the Center for Security Policy, is pushing a case against Saudi Arabia. While this may be a good thing for him to do to drum up business in the national security arena, the claim that "Saudis Waging ‘Economic Warfare’ Against U.S." (this is as reported on the web site of something called the Open Fuel Standard). This is laughably wrong, except for it involving a set of serious policy issues.

low prices can’t destroy the fracking industry, they can only change who owns the debt

To quote:

“You know, they said explicitly when they were driving down the price of oil ... that they were doing it to destroy our fracking industry. That is a hostile action. They’re now talking about dumping Treasury bills ... That’s an act of economic warfare as well."

First, the Saudis are desperate for cash flow, but the only thing they can do is to produce more. They’re simply not big enough. If they cut output 10% global output drops by under 2% and prices only go up by less. Let's be wildly optimistic and assume prices rise 2%, more than any demand elasticity estimate I've seen. That means their total revenue drops 8%. [The arithmetic is P(1+2%)Q(1-10%) which is original revenue PQ(1-8%).] So if they cut output they cut their own throats (or more accurately, invite a palace coup or worse that will cut their throats for them). Next, the secondary recovery they’re using also makes cutting output hard, they lose output permanently. [Once they stop forcing high-pressure water around the perimeter of fields and the compensating withdrawal of oil from the center, oil will flow back towards the edges and they'll be unable to get it out.] Third, OPEC is not a functioning cartel where the Saudis can get others to coordinate to cut output. It’s too big a group and there’s no enforcement mechanism, everyone cheats to the point that agreements are meaningless. That's been true in the past – empirical work by both economists and political scientists – and nothing has happened to change the incentives of Saudi Arabia's erstwhile co-conspirators. [The theoretical case requires that members can monitor output, and that they have some option to punish cheaters. For OPEC neither holds.] It’s a convenient boogeyman so the myth doesn’t go away.

The Saudis make a good foil for energy debates; it helps that no one feels much sympathy for them. But oil is a global market, and while it's not perfectly competitive, as economists define the term, changes in supply or demand in one part of the globe (the US and China) affect prices throughout the world. Furthermore, the market for petroleum interacts with developments in supply and demand for other sources of energy. In that context, the Saudis have stood out in periods when short-run increases in demand were large relative to the ability of energy suppliers to respond. But that’s not because they held back output, or otherwise did much beyond pump what they could.

Today they are desperate for revenue. What they do is thus dominated by the short run. They have not always been so thirsty, and so short-term in focus. In the past those in the government and Aramco could think about the long run, whether they should pump less when prices were low to have more oil to sell when prices were high. However, even in the past they reacted to the market, they didn't set the market. Their strategic space has shrunk, and they no longer have the option to hold oil production back. Yes, people watch Saudi Arabia. Perhaps their strategic concerns are sufficiently representative of the Middle East that this disproportionate focus isn't entirely silly. But it doesn't mean that their pronouncements will have more than a fleeting impact.

Finally, there's the US end. How long does it take to restart production? Fracking wells see output decline about 60% in the first year, it’s not like wells in Texas that have been producing for decades. [There's one under the state capital building.] If you have cash, you can kit yourself out for the next bump in oil prices at pennies on the dollar, and there are businesses that are doing exactly that. Plenty of pipes in inventory, too, not just rigs. Chapter 11 is a marvelous thing: low prices can’t destroy the fracking industry, they can only change who owns the companies and their debt.

Oh, and dumping treasuries is an old canard that is constantly touted by fearmongers but never observed in practice. If you have a lot of Treasuries and you try to dump them, prices fall and you lose a lot of money. And if you're Saudi Arabia, what will you buy with your dollars, Euros? Those will become more expensive, a double whammy. Now the reality is that the Saudis are issuing debt, not buying debt. So are they selling some Treasuries? Maybe. Have they stopped buying? Already. Have US interest rates spiked? Not at all. OK, I can't resist: what we have is one short, albeit oft-repeated paragraph, Ney-deep in Gaffs, replete with claims that are not fracked up to what they ought to be.

I've updated the content a couple times based on email interactions with others.

Thank you Baby Boomers: The new norm is 60,000 jobs

Mike Smitka, Economics, Washington and Lee University

A simple projection from pre-Great-Recession levels suggests we need 150,000 new jobs each month to keep up with population growth. (See this WSJ blog post.) This is wrong. Lower fertility 20 years ago means that we are not seeing a steady climb in the number of young people are entering the labor market, while we are seeing the baby boomers gradually exit the labor force. My bottom line: 58,390 jobs a month. Now such precision is illusory, labor market data aren't that precise, and these are projections. So let's use 60,000 as a rough guide.

The implications are significant. If we use the sort of simple projection that lies behind the WSJ projection, then (using 2007 as a base), then in a normal economy we would today have a labor force of 160 million million. With an actual labor force in the latest survey of 151 million, this would indicate that we are 9 million jobs short of where we should be, and thus still deep in recession. That's clearly not the case. Across a variety of metrics we're approaching "full employment" (which ought not be pinned to a specific number as measured using one particular data set). Jobs are easier to find, even if wages are not yet rising. To give one qualitative indicator, during the depths of the recession in 2009-2010 "quits" in the JOLTS survey (Job Openings and Labor Turnover Survey) were at 1.3%, the lowest in the history of the data. The level is now 2.0%, near the pre-recession average of 2.2%.

Why 60,000? Prior to 2007, the labor force participation rate of prime-aged workers was nearly constant. So the core of my projection was to use the Census Bureau population projections by age, and multiply by this "normal" level of participation to get the number of jobs. I did the same for younger ages (16-24, where in the Great Recession participation fell by far more than other groups), and older ages (where participation actually rose – the "Boomers" have been slower to retire than their elders). I've not redone this estimate to use the most recent population projection, but today's the last day of the W&L Winter Term, so I won't do that now. When I do, I'll provide an upper and lower bound, but I don't anticipate much change.

So how do things stack up? I provide below my own projections of "normal" employment versus where's we're at in the March 2016 data. To that I add a graph of age-specific participation levels. (Data are available to do that by gender; I don't report that here.) The bottom line is that at the current rate of job creation, we'll be back to normal in about 2 years.

One apology: at the bottom of the WSJ post they do quote FRB Chair Janet Yellen that the number is now under 100,000 jobs a month. You have to read to the bottom, however, to see that. For regular commentary on labor force development, see the Atlanta Fed's blog.

Indeed, the Atlanta Fed's latest post notes these various factors, including the one I've not built into my formal projections: the increased participation of older, post-normal-retirement, Americans. Their estimate is that over 2007-2011 increased participation fully offset the onset of "boomer" retirement. (Click HERE to see their graph.) Now that's not the case the past 5 years, but I still ought to revisit my baseline and put in adjustments for this, which shows up so vividly in the age-specific participation rate graphs I generate.

Are our candidates Conservatives? Not Fiscally

Mike Smitka, Washington and Lee

It's still the primary season, and positions are pitched toward those voters who participate in that process. So any analysis of policy proposals needs to be read in that context: candidates do (must!) change positions come the general election campaign.

presidents propose budgets, but Congress has the real say

Now as an economist "not unmindful of the future" [W&L's motto] I note that Federal debt is at present increasing faster than the economy, while the aging of our population will lead to expenditures for which funding has not been budgeted. There are several ways of crunching the numbers, and these require using a measure of real interest rates. At present inflation is low but interest rates are even lower. At the moment that makes Federal debt well-nigh costless, so we face no crisis, and in my judgement will not be near such a point during the tenure of the next two presidential terms. Nevertheless, the longer we wait to narrow fiscal gaps, the more challenging closing them becomes. So not increasing deficits is one of my criteria for whether someone is a conservative.

These provisos noted, at first reading the most conservative candidate is actually Bernie Sanders. He's also the one who has offered the most detail. At this point neither Ted Cruz nor Donald Trump takes Federal deficits or national debt as issues worth the time needed to employ basic arithmetic. According to the Center for a Responsible Federal Budget, which compiles proposals and analyses from various sources, the proposals of our "conservative" candidates would each add $12+ trillion to debt by 2026. In contrast, Sanders provides proposals that would "enhance" revenue, offsetting the cost of his goal of providing free college, family leave and a proper national healthcare system. So his proposals might cost only $2 trillion ... but are subject to a range of assumptions that on the pessimistic side push the total up to the $12+ trillion range. That is, his proposals might not pan out on the low side. But among the candidates he is at this point the only one who takes the issue of fiscal balance seriously.

A final reminder: presidents propose budgets, but Congress has the real say in what eventually happens. That adds an additional layer of "gaming" to proposals made during campaigns. Unless a candidate trims back national security expenditures, there's insufficient fat in the budget to make good management: relative to the budget, saving a hundred million here and there is insignificant, and in practice neither Congress nor, in their proposals, our last last half-dozen Presidents have been able to do that.

So trimming the deficit requires enhancing revenues. There is no painless way to do that. Despite almost everyone wishing they owed less in taxes, our rates are well below 40%, and basic arithmetic makes it clear that cutting taxes can't deliver higher revenue. For example, at the 25% Federal income tax rate that a household with two workers likely faces, a 1% cut in rates leads to a 1/25 or 4% drop in revenues. In principle people will work more; in practice most people are employees who cannot add to their weekly hours. The actual boost in hours worked and taxable labor income will thus be very small, below the 4.2% boost that would be needed for the cut to be revenue neutral. If we had tax rates of 90% the story would be different: the revenue loss is less, the incentives are greater, and the indirect effect of moving income out of the "shadows" becomes significant. But that's not the US economy.