Carpe Diem

With Derivatives At An All-Time High, US Economy Can Handle $100 Oil, Falling $ and Subprime Crisis?


I blogged before about why “The Energy Efficient Economy Can Handle $100 Oil,” and Greg Mankiw linked to that CD post on his blog asking “Where have all the oil shocks gone?” As Mankiw summarized, “The economy is far more energy-efficient today than it was in the past, in part because economic activity is based more on services and less on manufacturing. As a result, energy prices matter less today.”

Another reason that the U.S. economy today can handle record oil prices, a falling dollar, and increasing credit risks, without going into recession? Price, currency, and credit risks have been hedged effectively using derivative contracts (futures, options, swaps, etc.), insulating the U.S. economy more than ever before from oil shocks, currency risk and the subprime mortgage crisis.

As the top chart above shows, the volume of futures contracts at the Chicago Mercantile Exchange is at an all-time historical high, and have increased by a factor of 6X between 2000 (231 million contracts) and 2006 (1.403 billion).

Likewise, the value of derivative contracts (according to the OCC) held by U.S. commercial banks in 2007 ($152 trillion) is almost 11X 2007 U.S. GDP ($14T), compared to a ratio of 2:1 in 1994 (see bottom chart above) for Derivative Contracts:GDP.

Bottom Line: With derivative trading at an all-time historical high, which allows for low-cost effective hedging of price risk, currency risk, interest rate risk and credit risk, the U.S. economy of 2007 has been able to easily accommodate oil shocks, a falling dollar, and the subprime mortgage crisis, without the risk of recession.

Carpe Diem

U.S. Productivity Growth Is The Highest in 4 Years, Real Compensation Up by 2.7%

According to the BLS’s report today, productivity in the nonfarm business sector grew by 4.9% in the third quarter, the largest gain in four years – since the third quarter of 2003. The 4.9% productivity growth was well above Wall Street’s expectation of 3.4% growth, was also more than twice the average productivity growth over the last 25 years of 2.07% (see chart above, click to enlarge).

The BLS also reported that real compensation, adjusted for inflation, rose 2.7% in the third quarter, well above the average of 2.08% over the last ten years.

Carpe Diem

Why Subprime Mortgage Crisis Won’t Cause A Recession: The U.S. Economy Survived S&L Crisis


Remember the Savings and Loan crisis of the 1980s? Does it offer any lessons about how the U.S. economy and financial system will absorb the current “subprime mortgage crisis” (a phrase so common and popular now that you’ll find 349,000 Google hits).

The top chart above shows the annual number of bank failures in the U.S. from 1979 to 2007, using data from the FDIC. Between 1982 and 1993, 1456 banks (mostly S&Ls) in the U.S. failed, and at the peak of the banking crisis in the late 1980s about 200 banks were closed in each year from 1987 to 1989 (see bottom chart above). That’s almost one bank failure on each business day of the year, for three years in a row!

One lesson we can learn is that even at the peak of the “S&L crisis,” the overall economy performed well, with pretty impressive real GDP growth at above-average rates (3.4%, 4.1% and 3.5% from 1987-1989), and most importantly, the economy did not go into a recession even at the peak of the most serious banking crisis since the Great Depression!

In some ways, today’s economy is in much better shape than the U.S. economy of the 1980s, e.g. unemployment rates today (4.6% average over the last two years) are much lower than the 1980s (7.3% average).


Consider also that not a single U.S. bank failed in 2005 or 2006 (see chart above), and only 3 banks have failed in 2007, which a very impressive record of only 1 bank failure per year on average over the last 3 years. I am pretty sure that there has never been any two-year period in U.S. history without a single bank failure in the U.S., and no three-year period in U.S. history with only 3 bank failures. The U.S. banking system has never been as strong and as stable as it is today.

Bottom Line: If the economy of the 1980s could withstand a banking crisis as serious as the S&L crisis (with almost 1500 bank failures) without going into a recession, a much stronger and more resilient 2007-2008 U.S. economy and banking system will not go into a recession because of the current “subprime mortgage crisis.”

Carpe Diem

Why A Recession is Not Pending: Jobless Rates for Educated Workers Remain Low and Stable

Unemployment facts based on October BLS data:

1. For workers with some college (but no degree), the unemployment rate in October 2007 was 3.5%, almost the same as October 2006 (3.4%), and about the same as the average rate of 3.6% over the last three years (see chart above, click to enlarge).

2. For college graduates, the October unemployment rate was 2.1%, exactly matching the average unemployment rate for that group of workers during the last three years (see chart above). The jobless rate for college grads has moved in a tight range between 1.8% and 2.5% for the last 24 months, with a slight downward trend.

Bottom Line: As long as unemployment rates remain stable for workers with: a) some college or b) a bachelor’s degree or higher, there is no indication of a pending recession. Unless and until we see an upward trend in the unemployment rates for these two groups, the economy will continue on its expansionary path.

For example, in the last recession of 2001, the jobless rate for college grads increased in almost every month during the year, hitting 3% by December 2001; and the jobless rate for workers with some college increased from 2.7% to 4.2% during 2001.

The continued stability of unemployment rates for the most educated American workers, those whose role is most important in a knowledge-based, intensively-competitive, global economy, suggest that the Goldilocks economy will continue its healthy expansion into 2008.

Carpe Diem

EU vs. USA Smackdown: EU Still Below Mississippi

We’ve been having a lively discussion on Sweden and the EU, vs. the USA for standard of living, per capita income, etc., based on this post, this post and this post.

Thanks to Ironman at Political Calculations blog, there is now an updated, dynamic, sortable database at this link based on 2006 data.

If you click on the last column and sort from highest to lowest, you’ll see that:

1. Based on 2006 data, if the EU countries as a group became the 51st U.S. state, it would be the poorest state in America, with only $27,394 in per capita GDP (PPP adjusted), below even Mississippi (GSP of $28,937).

2. If Sweden, Netherlands, UK, Germany and France were added individually as the 51st U.S. state, they would all rank #49 in per-capita GDP/GSP, ahead of only West Virginia and Mississippi.

3. In other words, updated data show that the results in 2006 are almost exactly the same of the previous posts based on 2002, 2003, 2004 and 2005 data.

Carpe Diem

Some Inconvenient Questions: How Much Should We Sacrifice Today for Future Billionaires?

From economist Steven E. Landsburg’s recent Slate.com column (“Save the Earth in Six Hard Questions: What Al Gore doesn’t understand about climate change”):

There is nothing particularly peaceable about Gore’s rhetorical approach to climate policy. At his most pugnacious, Gore has depicted the fundamental trade-off as one between environmental responsibility and personal greed. Of course, as everyone over the age of 12 is perfectly aware, the real trade-off is between the quality of our own lives and the quality of our descendants’.

In other words, climate policy is almost entirely about you and me making sacrifices for the benefit of future generations. To contribute usefully to the debate, you’ve got to think hard about the appropriate level of sacrifice. That in turn requires you to think hard about roughly half a dozen underlying issues.

Here are two of Landsburg’s inconvenient questions:

1. Many people (myself excluded, however) believe we should care more about our countrymen than about a bunch of foreigners—hence the sentiment for a border fence. If we are allowed to care less about people who happen to be born in the wrong country, why can’t we care less about people who happen to be born in the wrong century?

2. If you expect economic growth to continue at the average annual rate of 2.3%, to which we’ve grown accustomed, then in 400 years, the average American will have an income of more than $1 million per day—and that’s in the equivalent of today’s dollars (i.e., after correcting for inflation). Does it really make sense for you and me to sacrifice for the benefit of those future gazillionaires?

MP: And if the economic growth rate is 2.5% instead of 2.3%, the average American would make more than $2 million per day in 400 years. Increase economic growth to 3%, and income for the average American would be $15 million per day in 400 years, in today’s dollars!

Further, IBD reported in March that the average American household has a net worth of about $487,000. If real net worth grows at only a modest 2.5%, the average American household in 400 years would be multi-billionaires, with a net worth of almost $10 billion.

Question: Most people favor income redistribution from the wealthy to the poor through progressive taxes, estate taxes, etc. Isn’t it then inconsistent for those people to show concern for the future rich, and advocate that the relatively poor (people living today) make sacrifices today for the relatively rich of the future (people living 100 years from now)? Won’t that be a transfer of wealth and income from the poor (today) to the rich (tomorrow)?

And if one’s position is that we should care about the rich in the future and make sacrifices today to leave them a cleaner environment, why doesn’t he or she treat the rich living today with the same respect and concern, e.g. advocate a flat tax on income instead of a progessive income tax?

Carpe Diem

PetroChina is World’s Largest Company, Tops $1T

SHANGHAI, China (AP) — PetroChina became the world’s first company worth more than $1 trillion on Monday, surging past Exxon Mobil as the Chinese oil producer’s shares nearly tripled in their first day of trading in China (see chart above, click to enlarge).


Adding the value of PetroChina shares traded in Shanghai, Hong Kong and New York — and those still owned by the government — the company’s total market capitalization ballooned to just over $1 trillion, compared to Exxon Mobil Corp.’s $488 billion.

Bottom Line: PetroChina, at $1 trillion market capitalization, is worth more than Microsoft, Google, Procter and Gamble ($217 billion, not pictured above) and Wal-Mart combined ($966 billion), and is worth 5.5X the value of Wal-Mart.
Carpe Diem

Let a 1,000 Millionaires Bloom in China, And U.S.

BEIJINGChina has the world’s fifth largest number of households with more than $1 million in liquid assets, trailing only the U.S., Japan, Britain and Germany, said a report released by the Boston Consulting Group.

There were 310,000 Chinese millionaires at the end of 2006, up from only 124,000 in 2001, more than 48,000 of which have more than $5 million in liquid assets. Given China’s continuous and rapid economic growth, the report also predicted the number of millionaires to double by 2011, reaching 609,000.

These households, which only account for 0.1% of the total number of households in China, possess 41.4% of the country’s total wealth, said the report.

According to this WSJ report, America’s inequality peaked in 1929, when the top 1% controlled about 48% of the wealth.

We hear a lot of hand-wringing about income inequality in the U.S., but perhaps there are some lessons from China. When a country experiences significant, dynamic change from new technologies, innovation, globalization, opening of markets, increased competition, etc., income inequality increases because talented entrepreneurs are able to generate huge amounts of wealth at levels that are not possible in a static, insulated, uncompetitive environment. Some of the same dynamics that are creating more millionaires and more income inequality in China, are probably also creating the same outcomes in the U.S. Not to worry.

Bottom Line: Wouldn’t most Chinese agree (and wouldn’t you agree) that the average person in China today is better off today than 10, 20 or 40 years ago, even though income inequality has never been higher?

Carpe Diem

Harvesting Cash: Big Sugar Invests $1.5m to Make $100m/Year. IRR = 6,666%; A Satan-Like Return

From yesterday’s Washington Post:

When U.S. sugar farmers needed help this summer defending a $1 billion, 10-year subsidy plan in a new House farm bill, they found it in some surprising places.

The House sugar vote illustrates the hold that agricultural interests maintain on farm policy even as the number of full-time commercial farmers has shrunk to a few hundred thousand. Sugar groups have used campaign cash and far-reaching alliances with labor unions and politicians to expand their influence far beyond the 15 states and few dozen congressional districts where sugar is grown by fewer than 6,000 farmers.

So far this year, nine sugar farm or refinery groups have made more than 900 separate contributions totaling nearly $1.5 million to candidates, parties and political funds, according to federal election records and CQ MoneyLine. American Crystal Sugar Co., a Minnesota-based sugar-beet cooperative with 3,000 members, has made 317 contributions totaling $819,000. In July alone, its political fund contributed more than $70,000 to 26 House members, 24 of whom sided with it on the July 27 sugar vote.

Bottom Line: Wouldn’t you invest $1.5 million today to get $1 billion over ten years ($100 million per year)? Your annual Internal Rate of Return (IRR) would be 6,666.67%, a return that would certainly catch the attention of Satan.

Question: Why is Congress selling special-interest legislation to Big Sugar at such a low price? They are giving $1 billion of benefits away to Big Sugar for a mere $1.5 million in campaign contributions. What gives? Couldn’t they have charged $3 million or even $30 million? After all, Congress has a monopoly on special-interest legislation. What could Big Sugar say – “If you give us the sugar subsidies we want, we’ll take out business elsewhere?”