Is the US counting too much on the shale boom to fix the economy?

Image Credit: Shutterstock

Image Credit: Shutterstock

Calling the shale gas and oil boom an “energy revolution” is no overstatement. Between 2005 and 2013, US production of natural gas increased by 33% and liquid fuel 52% thanks to advanced drilling technology. But I get the impression that some people — particularly on the right — see fracking as a sort of magic bullet for America’s economic stagnation. Well, that and the repeal of Obamacare.

But I urge caution in equating an America energy revolution with an American economic revolution. It’s a big economy, after all. And it’s tough for any one thing to make a dramatic, overwhelming impact. For instance: the McKinsey Global Institute has projected that so-called unconventional energy production could support 1.7 million jobs by 2020. IHS Global Insight takes its forecast out to 2035 and sees a gain of 2.4 million jobs. Those are big numbers, of course, but they seem less impressive when you consider that total US employment by then might be 160-170 million jobs.

Similarly, people may be overestimating the direct impact of oil and gas product on the US economy in recent years. Goldman Sachs estimates that the sector added roughly one-tenth of a percentage point per year to growth over the past decade. The bank also estimate that “core oil and gas employment and employment directly supported by oil and gas” accounts for less than 1% of total US employment and just 3% of the jobs added since the Great Recession.

The spillover effects from the shale boom, at least so far, also seem to fewer than generally believed. Goldman:

There is little evidence of significant “induced” employment growth in downstream manufacturing industries. Similarly, cap-ex in energy-intensive sectors that might be expected to benefit most from the shale boom has not outperformed cap-ex in other sectors during the recovery, although it did decline by less during the recession. Researchers who expect a large macroeconomic impact from shale often cite the cost advantage it will give to businesses in the US over those in other regions. Access to cheap energy might therefore influence the plant location decisions of both US and foreign businesses. … [Now] there has been a spike in FDI inflows into energy-related sectors in the last few years. … [But] the magnitudes involved are modest. FDI represents only a tenth to a quarter of total investment in these industries in the US. While the spike in energy-intensive FDI is impressive, at its peak it represented about $50 billion in extra investment per year, less than 3% of US investment spending.

Goldman’s bottom line:

Whether shale becomes a true “game changer” for the US in the long-run depends on a number of highly uncertain factors, including technological innovation and the level of investment in downstream industries. In the shorter-term, however, we see only a modest boost to aggregate macro outcomes rather than a revolution.

Now that report is from late last year. But I suddenly thought of it when reading a new report — whose numbers I use above — on the shale revolution over at VoxEU. From the summary:

Our analysis suggests that commentators and policymakers need to better distinguish between the ways in which the US shale gas boom constitutes a ‘revolution’ and the ways in which it does not. The US unconventional energy boom has reversed the decline of domestic production, significantly lowered oil and gas imports, reduced gas costs for consumers, and created a political space for tougher regulations on coal-fired power plants.

But it is not a panacea. Even if current estimates of production turn out to be accurate, the benefits to the US economy in the long run are relatively small, and the benefits to manufacturing competitiveness in most sectors are even smaller.

Supporting the shale boom is an important element of pro-growth public policy. But this welcome windfall shouldn’t preclude creative thinking about other ways to fix the sputtering American growth machine.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas

Economics, Financial Services, Pethokoukis

Is the Fed giving megabanks stress tests or ‘feather tests’?

Image Credit: jaci starkey (Flickr) CC

Image Credit: jaci starkey (Flickr) CC

Maybe I got it wrong. Maybe America really doesn’t need fundamental financial reform of the sort that finally eliminates the cronyist “too big to fail” subsidy for megabanks and establishes a less-crisis prone financial system.

Maybe it’s all fixed. After all, the Fed’s annual stress test of big banks’ financial health showed, according to the WSJ,  “29 of the 30 largest institutions have enough capital to continue lending even when faced with a hypothetical jolt to the U.S. economy lasting into 2015, including a severe drop in housing prices and a spike in unemployment.”

But just how stressful are those stress tests? Bloomberg:

Researchers at New York University have created a tool to answer the question. Drawing on the historical relationship between banks’ stock prices and the market as a whole, it estimates what the value of the banks’ equity capital would be if the market fell 40 percent over six months – similar to what happened in 2008. It then calculates, based on past crises, how much capital the banks would have to raise to be financially sound.

The results aren’t pretty. Using a start date of Sept. 30, 2013, the same as that of the Fed’s latest round of stress tests, the NYU model gives only one of the six largest U.S. banks – Wells Fargo – a passing grade. The other five – JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley – would have a combined capital shortfall of more than $300 billion. That’s not much less than they needed to get themselves out of the last crisis. …

Unfortunately, the Fed’s approach ignores a lot of the horrible things that actually happen in crises – things that NYU’s simpler approach implicitly captures. Banks’ borrowing costs, for example, tend to rise, killing profits that could offset their losses. Trouble at one bank can spread as investors wonder which others will be affected. Credit freezes can force financial institutions to sell assets at a loss, setting in motion downward spirals in which falling prices and banks’ woes reinforce each other.

The Fed also makes a passing grade too easy to achieve. Participating banks, for example, must maintain a leverage ratio of at least 4 percent, or $4 in capital for each $100 in assets. They should not be allowed to get anywhere near such a level, which research and experience suggest is well below what’s needed to avoid distress. In a crisis, banks should be a source of strength, not propagators of panic.

As Charlie Gasparino recently noted, there is a reason bankers call the stress tests “feather tests.”

032414bankFollow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas


The soft Marxism of low economic expectations

Image Credit: 360b /

Image Credit: 360b /

I urge anyone who cares about policy and political economy to read Thomas Piketty’s lengthy Capital in the Twenty-First Centurya book likely to have great influence on left-wing economic thinking — and probably that of many center-right folks, too. I offer my humble take on the famous inequality researcher’s update on Marxism over at NRO. A snippet:

Piketty is making a different and broader argument, one that intentionally rises to the level of grand theory: Embedded within the very fabric of capitalism is a powerful force pushing in the direction of rising inequality. The income generated from owning capital (everything from real estate to financial assets to intellectual property) tends to exceed the rate of economic growth. And when wealth grows faster than output — as it did in the 19th century when Marx was writing and as Piketty forecasts it will again in the 21st — inequality moves toward extreme levels since income from capital is outpacing wages from labor. When capital income gets reinvested, inherited wealth also grows faster than the economy. Even worse, from Piketty’s perspective: Not only will capital owners take more and more of national income, but more and more of labor income will go to a small group of “supermanagers” who rig the executive pay system in their favor.

“Will the world of 2050 or 2100,” Piketty asks, “be owned by traders, top managers, and the superrich, or will it belong to the oil producing countries or the Bank of China?” Actually, the answer doesn’t much matter. Whatever the exact makeup of this global plutocracy, democratic capitalism will be replaced by something more like Putin’s or Xi’s cronyist authoritarianism — unless populist progressive forces can implement a global wealth tax ASAP. And if that can’t happen right away, 80 percent top income-tax rates would be a solid first step.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas


Obama’s manufacturing hubs: Yet another example of economic reality tripping up government planners

Fitting that Reuters quotes economist Enrico Moretti in this piece “Obama manufacturing hubs face uphill struggle to create jobs.” Reporters Julia Edwards and Jason Lange note Moretti’s research showing job spillover from manufacturing jobs, particularly high-tech. Team Reuters also should have cited Moretti’s analysis that government-planned innovation and manufacturing hubs have a terrible record of success. Here is a quote from Moretti in a blog post from earlier this year:

If you look at the history of America’s great innovation hubs, they haven’t found one that was directly, explicitly engineered by an explicit policy on the part of the government. It’s really hard. This is not how innovation hubs and clusters get developed. They often get developed because of idiosyncratic factors like a local firm succeeds and it starts attracting more firms like that. And this creates a cluster that then becomes stronger and stronger, and that feeds on itself.

Not to mention that manufacturing is a high-automation business. You may get lots of output without much job growth. Edwards and Lange tell the story of how a Youngstown, Ohio, hub is doing:

The lab, called America Makes, is the first in a series of so-called “manufacturing innovation hubs” that President Barack Obama has launched with the promise that they could revitalize America’s industrial sector and spur jobs growth in downtrodden communities like Youngstown. Seven more hubs are planned by the end of the year, including projects in Chicago, Detroit and Raleigh, North Carolina, that will follow the Youngstown model of bringing together businesses, non-profits and universities to pursue technological breakthroughs.

But after more than a year of operation, the Youngstown hub underscores the challenges facing Obama’s goal of ensuring “a steady stream of good jobs into the 21st century,” as he put it in remarks at a White House event last month.

One of the biggest challenges is the nature of factory innovation itself, which often reduces, rather than bolsters, the need for workers who aren’t very skilled. That means the manufacturing initiative could help create jobs for people with highly specialized skills, such as engineers, but it may do far less to help people struggling to find work after the shuttering of local steel mills.

Three-D printers, the focus of the Youngstown project, are an example of this. Once they are programmed and loaded with raw materials, they work their magic with nary a human hand. If they are ever widely adopted, researchers say a big reason will be that they use less labor than traditional manufacturing. “A lot of the equipment can be run automatically, so it is less labor demanding,” said Don Li, senior manager of process modeling at RTI International Metals, a Pittsburgh-based titanium manufacturer working on an America Makes project.

The Youngstown hub is still in its very early stages but so far, at least, there are no obvious signs of a wider impact. About 29,600 people held factory jobs in the Youngstown metro area in January, the latest month for which data are available. That’s actually slightly lower than the number of manufacturing jobs there when the administration awarded the hub to Youngstown in August 2012 and when it opened its doors that October. Total employment in the area was flat in 2013, while it grew nationwide.

Of six organizations in Youngstown and Cleveland – the nearest major city in the state – working on America Makes projects, none has made new hires for the work. But the non-profit managing the initiative, the National Center for Defense Manufacturing and Machining, has added 10 employees to run the lab and oversee the application process, said executive director Ralph Resnick.

Ashley Martof, an intern at America Makes, is studying 3-D printing as an industrial engineering major at Youngstown State University. Her friends and family tell her she is wasting her time because manufacturing jobs have dwindled. “I tell them there will not be as much need for the working class, but there will be more engineers,” Martof said.

The availability of such jobs probably won’t do anything to help people like Dennis Church, 60, who is retraining for a maintenance job after 31 years at RG Steel. “Those are tech jobs,” Church said. “My personality is more hands on.”

By the way, Obama would to set up 45 hubs around America if Congress would give him the dough.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas


‘We are back in the land of discretion. Rules did not work, because the Fed set the wrong rules’

Good stuff from Robert Brusca:

In the end, the Fed has eliminated the 6.5% trigger that wasn’t a trigger. Yellen has replaced it with a laundry list of things that matter with no objectives for any of them. We are back in the land of discretion. Rules did not work, because the Fed set the wrong rules. But the policy objective of price stability- and that means 2% inflation- is still there and still not being met. Moreover, the Fed is willing to hike rates and slow progress toward the 2% goal long before we get there, an act that slows the drop in the already too-high rate of unemployment.

The Fed continues to see lower rates of unemployment than it was projecting in the past. But the Fed’s own projections of growth are being trimmed. How does the unemployment rate make this accelerated progress? It’s all due to the magic of demographics. The Fed is relying on a continuation of a process it really does not understand and did not anticipate. It is willing to PLAN to raise rates on the notion that this process will continue. Who says the Fed ain’t got religion?

The Fed has not told you using its fabled transparency that this is the process by which unemployment rates will drop faster. Janet Yellen registers deep concern about all sorts of labor market characteristics but she is stopping QE which is the one thing the Fed was doing that might have helped. Moreover, the Fed is planning to raise the fed funds rate with inflation below target and expected to remain below target. Fed policy amounts to hoping that demographics will reduce the rate of unemployment faster. … While Janet urges you to ignore ‘the Dots’ I urge you to shred the Fed statement and to look only at ‘the Dots’ and the other projection materials. They describe the lay of the land and conditions where the Fed really plans to live. The statement is a cover story.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas


‘America’s educational productivity appears to have collapsed’

Cato Institute

Cato Institute

Cato’s Andrew Coulson:

Adjusted state SAT scores have declined by an average of 3 percent. This echoes the picture of stagnating achievement among American 17-year-olds painted by the Long Term Trends portion of the National Assessment of Educational Progress, a series of tests administered to a nationally representative sample of students since 1970. That disappointing record comes despite a more-than-doubling in inflation-adjusted per pupil public-school spending over the same period (the average state spending increase was 120 percent).

Consistent with those patterns, there has been essentially no correlation between what states have spent on education and their measured academic outcomes. In other words, America’s educational productivity appears to have collapsed, at least as measured by the NAEP and the SAT. That is remarkably unusual.

In virtually every other field, productivity has risen over this period thanks to the adoption of countless technological advances—advances that, in many cases, would seem ideally suited to facilitating learning. And yet, surrounded by this torrent of progress, education has remained anchored to the riverbed, watching the rest of the world rush past it.


Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas


Creating a Fed safety net for borrowers

From Debt and Incomplete Financial Markets: A Case for Nominal GDP Targeting:

Financial markets are incomplete, thus for many households borrowing is possible only by accepting a financial contract that specifes a fixed repayment. However, the future income that will repay this debt is uncertain, so risk can be ineciently distributed. This paper argues that a monetary policy of nominal GDP targeting can improve the functioning of incomplete financial markets when incomplete contracts are written in terms of money. By insulating households’ nominal incomes from aggregate real shocks, this policy effectively completes financial markets by stabilizing the ratio of debt to income. The paper argues the objective of replicating complete financial markets should receive substantial weight even in an environment with other frictions that have been used to justify a policy of strict inflation targeting.


Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas


Here’s what Janet Yellen’s economic ‘macro dashboard’ looks like


From MKM’s Mike Darda:

Fed Chair Yellen’s Macro Dashboard came into further focus yesterday. In the table [above], we emphasize some of the labor market indicators that Fed Chair Yellen has mentioned specifically and look at their current position relative to where they were when the Fed initiated tightening cycles in 1994 and 2004. Although the U3 unemployment rate isn’t far from where it was when a Fed tightening process commenced in 1994, we would note three material differences.

First, broader measures of labor slack are much more elevated than they were in either 1994 or 2004.

Second, inflation is lower and running ~100 bps below the Fed’s 2% goal on a core PCE basis.

Third, as we mentioned on Tuesday, the ZLB (zero lower bound) on short rates was not widely perceived as a likely constraint on future Fed policy in either 1994 or 2004 as it is today.

Thus, the FOMC emphasized a grace period between when LSAPs would end (late this year/early next year) and when the Fed would eventually begin to sell assets/lift short rates (likely not until the spring or summer of 2015 at the earliest). … We thus expect the FOMC to be patient, which is what Fed Chair Yellen tried to reinforce in saying that short rates were likely to be below “normal” levels even after inflation has returned to target and unemployment has normalized.”


Why universities have become like shopping malls


Universities of today are a far cry from those of the 1940s, having been transformed from a focus on educating students and taking care of patients, to placing a high—if not the highest—value on research. In many ways universities in the US have come to resemble high-end shopping malls. They are in the business of building state-of-the art facilities and a reputation that attracts good students, good faculty, and resources (Stephan 2012). They turn around and lease the facilities to faculty in the form of indirect costs on grants and the buyout of salary. To help faculty establish their labs—their firm in the mall—universities provide start-up packages for newly hired faculty. External funding, which was once viewed as a luxury, has become a necessary condition for tenure and promotion.

The shopping mall model puts tremendous stress on universities, especially in a time of flat resources.

Three are noted here and discussed further in my research. First, incentives have arguably led faculty, as well as the agencies that fund faculty, to be risk averse when it comes to research. Applications are often scored for “doability” (Alberts 2009). The pressure on faculty to receive funding quickly in their academic career—at the end of their third year at many universities—means that faculty can ill afford to follow a research agenda of an overly risky nature.

This proclivity for risk aversion should be of concern to the university community and more importantly to society. Incremental research yields results, but in order to realize substantial gains not everyone can be doing incremental research. Moreover, recall that one of the main reasons for research being placed in the university sector was the view that society needed to undertake basic research of an unpredictable nature. When university research begins to be practiced in a way that closely resembles the practices of industry, much of the rationale for federal support vanishes.

Interesting implications for innovation and government funding. Maybe we will have to rely on the privatization of research for the high-risk ideas. Anyway, read the whole thing at VoxEU.

Economics, Monetary Policy, Pethokoukis

Janet Yellen and the Great Woman Theory of monetary policy

Image Credit: United States Government Work (Flickr) CC

Image Credit: United States Government Work (Flickr) CC

A “market rattling” press-conference performance from Janet Yellen, and Wall Street is suddenly thick with Ben Bernanke nostalgia. “The more experienced Bernanke knew to avoid clarifying deliberately vague statement language,” wrote JPMorgan economist Michael Feroli in a research note. Feroli was referencing Yellen’s squishy, off-the-cuff remark that interest rate hikes might start earlier rather than later next year, or “about six months” after the end of the central bank’s bond buying program. A “rookie gaff” is how economist Paul Edelstein of IHS Global Insight put it.

Judge the new Fed chair’s debut as you will, but the bottom line is that Fed policymakers now expect rates to be a bit higher in 2015 and 2016 than they did previously. Also of note: The Fed de facto downgraded the efficiency of the US economy as seen in its projection of reduced GDP growth and unemployment. These changes suggest, from the Fed’s perspective, more structural weakness in labor markets and an economy that, the WSJ’s Justin Lahart explains, “generates more inflation at a lower rate of growth — a notion reinforced by the Fed’s stepped-up expectation of when it will be time to raise rates.” Despite the decline in labor force participation and the share of adults working, the Yellen Fed is suddenly concerned about the inflation risk of tight labor markets.

But there is a bigger point here, one identified by Dan Greenhaus, chief strategist at BTIG:

We are not Fed ‘haters’ by any means, but the manner in which policy is currently being conducted is just … too much. The statement is too long; paragraphs 4 and 5 are totally unnecessary as both can be summed up in one sentence. ‘Rates are going to stay low until such time the FOMC feels inflation and unemployment dynamics warrant an increase.’ There, was that so hard? Instead we’re looking at dots. Seriously. Dots.

I’ll go even further here: rather than edging toward a clearer, more rule-based policy – as originally seen in the adoption of the now-discarded Evans rule – the Yellen Fed’s forward guidance is becoming more discretionary. It will factor, according to Yellen, a “wide range of information, including measures of labor market conditions, indicators of inflation pressures, and inflation expectations and readings on financial developments.” The WSJ counted ten different jobs stats on Yellen’s self-described dashboard. This snark from First Trust Advisors economist Bob Stein seems appropriate:

032014fedIf only there was some measure that took in account a whole bunch of stuff like, I don’t know, nominal GDP! It’s a comprehensive measure whose level the Fed should be targeting as part of a rule-based monetary policy. Good heavens, monetary policy shouldn’t depend on the abilities of one person, on a Great Man or Great Woman, even one as intelligent and experienced as Yellen or Bernanke … or Alan Greenspan or John Taylor or Christina Romer or Glenn Hubbard or your monetary policy expert of choice. Nor should it depend how the central bank “feels” about a slew of factors. Scott Sumner is dead on: The US central bank doesn’t have a coherent policy regime.”  And it sure could use one, even more than a smooth-talking, media savvy Fed boss.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas