Tuesday, June 10, 2008

Recession or Reallocation?

I've been fairly outspoken on my opinion that the US is not in, and likely will not enter, a recession this year or next. I'll argue for that point again today, in light of oil at $137/barrel, but first I want to address an important issue in psychology. Other people (not me!) are susceptible to getting so invested in a belief that they begin to view new information that tends to either confirm or disprove that belief with what psychologists call "confirmation bias"--that is, they discount information that goes against their belief as either insignificant or biased, and see information supporting their belief as credible and weighty. Since, to the best of my ability to investigate, I seem to also be similarly wired as a human who evolved the ability to think rationally on top of (primate/human brain, mostly prefrontal cortex), not in substitute for, my ability to think reflexively (reptilian/fish brain), it seems that I may be susceptible to the same hard-wired tendency to engage in faulty reasoning! Fortunately, thanks to my awareness of my own limitations, I'm trying to review my opinions here with extra care to identify exactly that kind of bias. Take it for what you will--I think I'm presenting this information as objectively as I am capable, which may or may not be very objectively objective. Fortunately, I seem to have been modestly but consistently right with regards to my predictions to date (2006 2007 2008), but, again, I need to remind myself that correlation between my predictions and reality does not necessarily prove that I am anything more than a highly biased and highly lucky person :)

So, given my attempt to look at the situation without confirmation bias, how can I still think that we're not in for a near-term recession when so many economists are worried about the impact of high energy prices, when so many pundits think that the economy simply can't survive on $5 gas (or $6 gas or $10 gas)? First, I think that our current media/pundit complex is very, very biased--much more so than me (confirmation bias?). Second, I can remember strikingly similar calls that the economy would collapse at $3 gas, at $4 gas, at $60 oil, and at $80 oil (and even that $40 oil would have serious negative effects). The key to discounting these renewed calls is in following the money. What happens when we pay $5/gallon for gas? Where does the money go?

Well, as a net-importer of oil, much of that money goes overseas. Where it is spent. Generating economic activity. The portion of that money that goes to domestic oil producers stays in the US, where it is spent. Generating economic activity. This is the key: high energy prices alone do not lead to recession, but rather to reallocation. While the two may feel the same if you're one of the people who's money is being reallocated out of your pocket and into the hands of Exxon or ARAMCO, they're very different animals. Recession is an aggregate decrease in economic activity. It means less opportunity overall. Reallocation, on the other hand, is not an aggregate decrease, but rather a shifting of who gets the benefit and who gets burned. It means the same--or even greater--opportunity, but in different places and in different manner than in the past.

Therefore, this is my working theory: the US, along with the global economy, is not facing a recession, but rather a reallocation. I don't think that actual economic activity will decline until actual energy availability declines (something that might not be too far off). Until that begins to happen--when we're just facing increasing prices, but not yet declining availability--we will instead see reallocation. Take a look at this graph from the latest edition of BusinessWeek:



Overall, the US economy grew at an annual rate of 0.9% in the first quarter of 2008 (yes, you can legitimately dispute those numbers due to inflation, etc.--I certainly do--but I'm looking at the official numbers so that I can compare apples to apples). Excluding autos and housing--two areas on the losing side of economic reallocation--the economy grew at nearly 4%, which is higher than the optimist's expected long-term growth rate for the US.

What to do in the face of reallocation? Reallocation hurts the most those who are not expecting it. Expect it to continue, and to intensify. Don't follow the moronic investment advice offered over at CNN Money, but rather try to tease out where the money will be reallocated to, and put yourself in position to take advantage of those new opportunities ("get yourself to the non-discretionary side of the economy," get linked to the energy economy, the local food economy, etc.). Reduce your exposure to having costs reallocated to you (e.g. by reducing commute times or transport modes, by establishing partial food self-sufficiency, by generating your own electricity/growing your own woodlot, etc.). Reallocation is change, but it is not necessarily "bad." If you're assuming that you can keep driving your F250 to work 20 miles away at the Ford plant, reallocation will feel--quite convincingly--like a recession. But that won't make the pundits who proclaim that we're already in a recession correct. It will just mean that they, like you, have fallen prey to confirmation bias and are mistaking reallocation for recession. Well, at least that's my opinion, subject to all the standard disclaimers of human thought processes.

15 comments:

Jeff Vail said...

Despite the focus of the article on measuring GDP, here's a particularly germane quote on the topic of GDP/GNP from Robert Kennedy:

"We will find neither national purpose nor personal satisfaction in a mere continuation of economic progress, in an endless amassing of worldly goods. We cannot measure national spirit by the Dow Jones Average, nor national achievement by the Gross National Product. For the Gross National Product includes air pollution, and ambulances to clear our highways from carnage. It counts special locks for our doors and jails for the people who break them. The Gross National Product includes the destruction of the redwoods and the death of Lake Superior. It grows with the production of napalm and missles and nuclear warheads.... It includes... the broadcasting of television programs which glorify violence to sell goods to our children. "And if the Gross National Product includes all this, there is much that it does not comprehend. It does not allow for the health of our families, the quality of their education, or the joy of their play. It is indifferent to the decency of our factories and the safety of our streets alike. It does not include the beauty of our poetry, or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials... the Gross National Product measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America -- except whether we are proud to be Americans."

From TOD

James Kielland said...

Jeff,

I think your thoughts about reallocation are probably pretty close to the mark. While we're undoubtedly experiencing some inflationary pressures there are also a lot of people who are deciding to make different decisions about how they spend their money.

It's quite interesting that Obama's supporters are seemingly rather intoxicated by the promise of change. Change is certainly occurring - and more is undoubtedly on the way - but it seems as if many people have yet to realize that change can be a very uncomfortable and even painful experience.

Theo_musher said...

I think what it is, is that oil...there was so much of it...that it had to be gotten rid of fast, even wasted,to make any money. Its like the Saudis and other Middle Eastern Monarchs with money. They have all this money and nothing to do with it.

Its like Sugar. You have all this sugar coming in and not being burned, you get diabetes.

Waste makes oil scarce enough to be profitable, while at the same time flooding he market with it. monopolistic Capitalism is about creating and controlling bottle necks. You have a few companies controlling all the oil and going through it as fast as they can, otherwise its worthless. Because if people aren't using it, what good is a monopoly?

So what would mess up this strategy?

Innovation into alternative energy and conservation.

The oil barrons knew it would run out, thats why they own all the patents on nuclear. They didn't forsee everyone hating nuclear power.

This strategy was worked out 60 years ago.

But anyway, as far as your predictions, I think you are predicting the middle of various "s-curves"

Things have to get worse before they get better. Then you get a new level of complexity organized at a higher level of energy.

Theo_musher said...

I think all that is really happening is we are getting a change of the guard. And some new people will get rich from it.

There already was an electric car. It got killed. If prices get too high it will come back. People will demand it.

.

Theo_musher said...

I think what it comes down to, that is, the difference between "doomer" and "cornucopian"

is philosophical, even theological.

I believe in an "Omega Point" Evolution is thus teleolgical and driven by a benevolet force. RAW believed this. If evolution is blind and purposeless, why not make it stop, right? It can only get worse. If it gets better it will be an accident.

But if its a positive force, it should be embraced. The only thing that is hard to gauge is time frame. A person can have a great idea or invention, that will greatly increase the wealth of mankind as a whole, but its time hasn't come.

I think there is a lot of technology like that that is already around.

But anyway, Malthus was wrong.

halfaglass said...

You seem to be viewing everything through the lens of oil. The US (and world) is headed for a recession alright, however, high oil prices are not the cause, they are the symptom. You have a fed and a govt that is devaluing the dollar at an incredible rate and we now have to live with the downside of the huge credit bubble of the last 10 years. Peak oil may also be a factor but it is not the single cause here. People are desperate to put their money into hard assets. Why would the middle east want to keep pumping oil to store the proceeds in USD butt wipes, they may as well leave the oil in the ground.

Are you suggesting that only energy can cause recessions and all past recessions (including the great depression) were caused by oil?

Jeff Vail said...

I'm not in any way suggesting that all recessions are caused by energy. Quite the contrary. See Timing: Peak Oil and the Credit Crunch for my thoughts on how the current economic problems are largely the result of the credit crunch. It's the NEXT set of economic problems that will be caused by oil--not via high prices, but because at some point relatively soon total available energy for the economy will begin to decline. Until that actual decline begins, there will be lots of crying about the pain of high energy prices, but this will just be a reallocation, not a recession. To the extent that the credit crunch has accelerated recessionary forces (the graph I included suggests this isn't very convincing or widespread), it's a very solvable problem, and it is, in fact being solved. Recessions are cyclical and caused by bubbles, just like this one. Peak Oil is a very different animal, because it foreshadows the larger trend of declining total energy availability, something that is likely to be non-cyclical (as in, there's no recovery).

In that sense, I don't think that we're headed toward a recession. I think that we're coming out of a credit-bubble recession, and looking at entering a permanent energy-driven decline in the not-too-distant future.

I disagree that high oil prices are a symptom of this bubble. High oil prices are a symptom of inelastic demand and tight (and increasingly expensive) supply. Inflation is certainly a contributing factor, but not the key. The key is supply--regardless of inflation, if there was excess supply available at the present price, it would be brought on line and the price would go down (relative to other inflation-resistant value holders). That isn't happening (compare the price of gold and oil side-by-side to see this clearly over the past few months), demonstrating that the main driver is the supply/demand issue, not the inflation issue.

Cycling in Hollywood said...

Jeff, I agree with many of your posts and find you to be one of the most insightful commenters online. However, this post doesn't make sense to me.

I see your point about reallocation vs. recession -- certainly the total amount of economic activity should still be directly proportional to the total energy consumption, even if this activity is reallocated into different economic sectors as you said.

But aren't you missing a crucial point? Since the US is a massive oil importer, much of the new economic activity will be reallocated to other countries, namely the oil EXporters. Some of their increased oil earnings may be recycled into the US as investment, but this is far from certain.

How can this not mean a deep recession for us in this country even if total world GDP stays the same (at least until peak oil really starts to bite)?

I understand your distinction that our short-term economic problems are more because of the credit crunch than oil prices so far, and I even agree. But I can't see how the US won't be a loser in the global economic reallocation process you describe.

Jeff Vail said...

I agree with you--it seems likely that the US will be a loser in this "reallocation" because we won't adjust fast enough. As a nation, we'll keep buying into the opinion that if we just "get those darned speculators" or if "government just opens up ANWR" we'll be OK. I don't think we realize just how much we need to adjust, and fast...

However, we also have the opportunity to be a beneficiary of this reallocation. We're still the most conducive environment for innovation, research, entrepreneurship (debatable, but you can certainly make an argument for it). Additionally, we're home to many of the global corporations that will make a killing on this reallocation (and, admittedly, some of the ones that will get killed). For this reason, I still don't think we'll enter a recession as a country as a whole. Many, many people (and even some whole regions) will do very, very well under this reallocation. However, what I think we will see is a great increase in disparity between those who don't adjust quickly and those who do. So, I think this will be covered heavily by the media--all those car parts factory workers out of a job, and all those mortgage brokers in suburbia in foreclosure and unable to afford their Hummer payments. I think we won't see nearly as much coverage of the people who are doing better--much better--as a result of their ability to adapt with the times (not as heart-wrenching of a story). For that reason, I think we'll hear increasing cries about how bad economic times are in America, but not much about how there are huge new opportunities. I think the sum total of this will be much like the graph in my post--some sectors will get killed, but on the whole we'll do OK (as long as you assign no social value to equality of wealth distribution!).

I could be very wrong here--there could be some tipping point where consumer spending just freezes up--but I think we're really getting over the worst of this as it was a credit issue, not a high energy price issue. I think it's all about adjustment and adaptation at this point, and, despite what populist politicians and the mainstream media will be reporting, I think that's one area where America is still leading the world (I apologize for sounding like Larry Kudlow for a moment there). It's just that the new innovators who are making a killing by adjusting in time, and the people who are prospering by adapting their career plans to the times, don't make nearly as good a story, and don't sell as many ads...

David said...

This is very interesting. I was referred to this place from a conservative blog although I am not 'conservative'.

Being a contractor/carpenter/builder I have been in energy efficient construction for a long time and have seen the rises and falls of energy conservation interest in relation to building techniques. When oil became cheaper again during the later Reagan years and on into the 21st century 'til recently. A falling off of interest in energy conservation allowed people to build profligate big house as well as drive huge SUVs.

It seemed that energy conservation was dissuaded by the political as well as the financial sectors in dominance. Now with oil probably showing a more truthful economic evaluation, it seems 'history' has come back to bite us.

But despite that I can see that 'recession' isn't quite what is going on. As there is general growth in most places, just less than in the 90s. And maybe now with more creative, and energy conservationist innovations what growth there is might be positive. But so far I see more like a commodity spec. type of short term gain. And the public dissatisfaction is justified as Most people are feeling a recession because most people's income isn't keeping up with people's costs.

The GNP growth if it goes primarily to the 'investor' class and the few innovators who have capital to innovate with would still show positive growth even if the average or even the 'mean' of family/individual income/costs show individual cases of 'recession'. I'd say 'reallocation' is an euthemism for widening of the income inequality crisis that concerns many pundits and observers both right and left.

The fantastic growth of commodity futures investment into primarily oil, food, would be again suggest banking on income inequality as those who need necessities would be forced into paying more for them. On the production side of investments we also see more of the same negative investments into parasitic industries like pharmacology, health care, and security which require negative human afflictions to make a profit.

Reallocation could be just a word meaning income mal-distribution. Money again going into unproductive hedges on misery: higher fixed costs for most people (e.g. higher gas cost to get to work combined with lower wages). Instead, I hope for energy conservation technologies, education inputs, better farming techniques and much labor intensive distributions of wealth rather than the current trends.

Interesting to see someone bring up Obama as just today NPR did an interesting comparison of McCain's tax policies and Obama's. McCain advocated more tax cuts for higher income folks (lower corporate taxes which I agree is good but still effective for the higher investor class) while Obama suggested higher taxes for high incomes and less than current tax rates for wage earners in the social security wage range.

James Kielland said...

"... certainly the total amount of economic activity should still be directly proportional to the total energy consumption.."

I would not say that this is certain at all. In fact, it's highly suspect. Let's say all of us removed half of the spark plugs in our gasoline engines. About half of our car's fuel would just go through the cylinders and out the exhaust. We'd consume much more energy. But we would not see an increase in economic activity.

A big chunk of our energy consumption is spent in uneconomic activity. Sometimes, I just go for a drive. I don't really need to. Sometimes I'll make a few trips in the course of a day that could be consolidated into a few trips a week.

Low petroleum prices facilitate economic activity. They reduce various costs of doing business and living. But we've had cheap access to it for so long that we've come to take it for granted.

Americans could reduce their energy consumption substantially and the only economic repercussion would be a reduction in our trade deficit. People might do less of other economic activities, as well, but that would only be if they decided to maintain their level of driving in the midst of higher petroleum costs.

PaulHunt said...

I personally think that a recession is going to happen. A lot of people just can not afford gas. Unless you experience this, you really don't understand. Driving a car is no longer an affordable luxury. I literally only use my car to get groceries or if theres an emergency. And if prices continue to rise me and my neighbors are going to start a car pool and split gas money to pack as many groceries into somebody's large vehicle as possible. I'm pretty much confined to my house and the places within in walking/biking distance. This article I was reading worsens my fears even more. Its called Energy Recession or Energy Depression... and is scary but it at least is letting me know whats going to happen. I really trust this site.

Jeff Vail said...

I agree completely that many more people will be unable to afford driving in the near future. However, I think that will be offset in aggregate by people who are profiting handsomely from the reallocation of wealth. That will (my prediction, at least) keep us out of recession by the standard definition because overall GDP will continue to grow. That won't make the process fun for most people. I think it's certainly "bad" to increase the disproportionate allocation of wealth in our society for a variety of reasons, but "bad" alone isn't enough to make the situation into a recession.

Two important caveats here:

1. Once total available energy begins to decline, we'll continue to see reallocation, but then we will ALSO see recession/depression. I don't think we're quite there yet, but there's a reasonable argument to be made that we are due to EROEI issues.

2. I'm continually baffled by the lack of hedging on the part of the consumer population--I don't expect "average Joe" to understand how to hedge, but I am amazed that the financial industry hasn't seized upon the huge opportunity to market hedges to the retail consumer.

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