Tuesday, November 28, 2017

American Current Account Deficits in Relation to Taxes and Capital

This post will be with regards to the issues the US faces due to its large, persistent current account deficit (CAD), what causes that deficit, and how it can be resolved. I have previously written a good deal about what drives the American current account (mostly balance of trade from Eurasian capital flows) and why it's a concern. This post will begin where the last post ended and will be split up accordingly:
1. Why has US run large, persistent CAD going back 40 years?
2. How US corporate tax law results in more total debt?
3. Reversing these structural imbalances can be relatively painless

1. Why Has the US run a Large, Persistent CAD for 40 Years?
As I began earlier, the US has been running LARGE AND PERSISTENT current account deficits almost continuously since the late 70s/early 80s. Also note that the US is the world's reserve currency, which means other countries need to accumulate USD or USD assets in order to make payments to one another. Due to the fact that they need to accumulate net USD assets, that implies the rest of the world has no choice but to run a capital account deficit.

Now that we've established how the rest of the world runs a capital account deficit, that implies the US must run a capital account surplus since those two must net out to zero (the world cannot export capital outside of the planet). We also know that the capital account balance plus the current account balance must net out to zero by definition. Hence, the capital account surplus ran by the US implies the US has no choice, but to run current account deficits.

That said, the US can run current account deficits to ensure other countries can accumulate USD assets without those deficits being large and persistent like they've been for most of the past 40 years. Problem right now is that some countries abuse the system by taking up policies to turbo-charge capacity and recycle the excess savings they don't invest by capital exports.

When Asian (and European) countries run those surpluses, someone else must pick up the slack. The only economy that is both large enough, willing enough, and flexible enough to absorb those corresponding surpluses is the US. There are, quite literally, no other options because every other country is either not large enough or is too unwilling to run those deficits (i.e. the other countries generally run surpluses).

2. How the Structure of US Tax Law Results in More Debt?
Note that US tax law provides friendly deductions for things like interest on mortgages for homes, which increase consumption. That pushes upward pressure on current account deficits and funnel them into housing booms. There's many such provisions in the US tax code that create a misallocation of capital and need to be removed.

US tax law also has a very high statutory corporate tax rate with somewhat high deductions. Eliminating all deductions from corporate tax law would fully fund a shift in corporate tax rate from 35% to ~26%. If we compare OECD statutory corporate tax rates, we see that ~20% is the middle of the pack. High corporate tax rates create many economic and financial distortions--we are comparing corporate taxes relatively and not talking about absolute terms.

In a nutshell, high corporate taxes creates the following distortions:
1. Incentivizes companies to offshore (why stay when they can pay lower tax elsewhere)
2. It's double taxation cuz income taxed on corporate side is also taxed as individual income
3. Labor or consumers usually eat the tax, and when they don't, it shows up as lower profit margins
4. Incentivizes companies to register export income in other countries (cuz they pay less tax)
5. Companies end up holding cash abroad that's technically tax-deferred

As a direct result of high corporate taxes, we witness American companies like Apple registering >60-70% of their export earnings offshore. Due to the fact that their export earnings aren't showing up as American exports, the US current account (trade) deficit shows up as higher than it otherwise should be. We also have a policy that taxes capital gains and dividends at a preferential rate to income. A better policy alternative is to simply eliminate the corporate income tax and finance it by taxing capital gains and dividends as income.

Identity: current account balance=private sector balance+public sector balance.
Given the identity above, we can pretty easily show that a larger current account deficit either has to show up as a private sector deficit (borrowing) or a public sector deficit (higher public debt). There is no other option. Any policy that either expands current account deficits directly or directs capital flows into private sector or public sector deficits (like the mortgage interest rate deduction) automatically increases debt for the economy as a whole.

3. Reversing Structural Imbalances Painlessly
It becomes very important to recognize that global structural imbalances, and US domestic imbalances, are not due to the US running current account deficits. These imbalances are driven due to the fact that the US is running LARGE AND PERSISTENT current account deficits. If current account deficits are either relatively large, but not persistent; or persistent, but not large; we do not have a problem.

Hence, correcting these imbalances necessarily means either reducing the overall size of the current account deficit or it means reducing the persistent nature of the large current account deficit. There's two aspects to this. One is the large surpluses coming from most of the Eurasian landmass due to the high savings rates of Eurasian economies which gets recycled into the purchase of USD-assets and results in the accumulation of USD-assets in foreign banking systems, often by central banks. The other factor is tax law. High corporate tax rates encourage companies to shift export earnings abroad which pushes upward pressure on the current account deficit longer-term due to lower exports from global tax minimization efforts by corporations. Also, policies like the mortgage interest rate deduction.

Offshore earnings show up as "reinvested earnings receipts" abroad. The gross amount of reinvested earnings receipts abroad annually amounts to ~1.5-2% of GDP for the last ~7-10 years, but we're more interested in the net reinvested earnings receipts because that's what determines the impact of high corporate tax rates on the current account. If we look at that, we see that net reinvested earnings receipts add up to ~1-1.5% of GDP for the last ~7-10 years.

If we look at US current account deficits for the past few decades, we notice that they've been ~3% of GDP ever since the 2008 crash (which makes sense since a housing investment and consumption boom collapsed). Due to the fact that net reinvested earnings abroad have been ~1-1.5% of GDP for since 2008, we can definitively say that US current account deficits would be ~1-1.5% lower if the US did not have a corporate income tax because all that profit registered abroad would now be registered here.

There is one caveat to the directly lower current account deficit: if companies that do register these export earnings in the US and they invest more as a result, there is no reason for the current account deficit to fall by that much. Instead, the current account deficit would fall by the difference between the exports now registered in the US and the amount of new investment.
Note: That said, I do not buy the idea that reducing corporate tax rates will create more investment. Private investment is driven by demand for goods and services in a normally functioning market economy and corporate tax rates do nothing to increase demand for goods and services.

If NGDP growth is ~4%, the US can run current account deficits of ~4% of GDP without having total debt grow faster than the economy as a whole. So even slicing the current account deficit from ~3% of GDP to 1.5-2% of GDP via elimination of corporate tax rates could easily bring down the growth of debt to levels low enough to allow the US economy to deleverage very rapidly (both public and private sectors). These are MEDIUM-TO-LONG-TERM effects, not short-term.

So the simplest ways to rebalance are to:
1. Eliminate corporate taxes and replace revenue stream by taxing capital gains/dividends as income
2. Eliminating mortgage interest rate deduction and other similar policies
3. Taxing the accumulation of USD-assets in foreign banking systems, especially by central banks

If we only care about reversing the large and persistent nature of US current account deficits going back 40 years, then any one of those policies could do the trick (especially (1) and (3)). If you'd like to see the current account deficit eliminated completely, then all three of those policies outlined above would do the trick if put into practice.

Wednesday, October 4, 2017

US Healthcare Structure, Costs, and Potential Solutions

In this post, I'll discuss the financial structures of American healthcare. This post will mainly be about the cost structure and also relative comparisons to the rest of the developed world. First comes first: the US healthcare system is mostly private (unlike most OECD). Secondly, the US spends more on healthcare as a percentage of its income (GDP) than any other country in the planet. And when we look at absolute costs, there's only 1-2 countries that have higher healthcare costs and that's only because they're smaller and much wealthier per capita--largely cuz those aforementioned places are international financial centers (ex. Switzerland).

The basic structure of US healthcare is that it's mostly driven by employers providing health insurance for their employees. In addition to that, the US government provides health insurance for the elderly (those >65). The bill passed in 2009 called the Affordable Care Act ("Obamacare") set in place some set of laws that banned insurance companies from discrimination for those with pre-existing conditions, it forced employers with >50 employees to provide health insurance for their employees, it forced all insurance companies to cover some basic services called "Essential Health Benefits", set up state exchanges where insurance plans could be purchased, and set up an insurance mandate so that everyone who doesn't buy insurance must pay a fine.
Note: There were many other changes in the ACA, but they're way too long to cover. If you care that much, just read the entire bill.

Problems and Cost Structure of US Healthcare:
As I said, the primary problem in US healthcare is the cost. In relation to every other OECD country, the US is the only country to not have a universal healthcare system. Not only does the US not have a universal healthcare system, but the US also pays more for healthcare per capita by any other country BY FAR. It is not close (as seen in the chart below).

If we look at the cost of health care as a histogram of the population, we notice something very interesting about the US. It turns out that the total costs of the American healthcare system are actually quite low for most of the population, BUT a small percent of the population every year accounts for a disproportionate amount of total cost. I have found distributions for 1996, 2002, 2009, and 2012 and virtually all of them look almost exactly the same in terms of the structure of the histogram. Since 2012 data is the closest to today, I'll use 2012 data.

As we can see from the histogram above, ~1% of the population accounts for ~22% of total cost, ~5% accounts for ~50% of total cost, and ~10% accounts for >65% of total healthcare costs. What does that mean? It means that most of the cost is only accounted for by a few percentage of people. If we look at spending on sicknesses like heart disease, cancer, asthma, trauma, and mental disorders, we see that most of the spending from those key factors are from only 5% of the population.

On top of this, we have a rapidly aging population that's relatively unhealthy. Naturally, there'll be more sick people as a population ages. That will mean total costs will rise unless there's some kinda cap or government directed rationing or something of the sort put in place (which can happen by high prices for certain treatments). We've also seen a rise in the amount of administrators relative to doctors and medical practitioners. The rise in administration as a part of healthcare is also a part of what's driving rising costs.

So that brings me to my final point: the biggest problem with US healthcare is THE COST. It is extremely expensive and there isn't much bang for our buck. Due to the fact that employers pay for most of their employees' healthcare costs, it becomes very costly for businesses and employers to ensure that their employees have decent insurance. I have spoken before about wage stagnation in the US for the past ~40-50 years. If we include wages and fringe benefits as employee compensation, they have risen but most of those "fringe benefits" are healthcare costs. When we add in that corporate margins have been rising for ~35 years and have effectively tripled in the last ~30 years.

When you have an explosion in employer side costs for employment due to rising healthcare costs and combine that with surging corporate margins, that means it'll be very difficult for wages to rise. Increases in nominal income, in the end, have to end up in either business profits or higher wages unless they're sucked up by costs. It's commonly thought that the problem with wage gains and the economy in the US is a demand-side issue. That is not correct. The problem with wage stagnation in the US is actually a supply-side issue.

Due to the structure of the American healthcare system and the structure of American business, we've seen wage stagnation driven by supply-side factors. The first factor in driving these costs is rising healthcare costs that're primarily borne by employers. The second factor is rising corporate margins for 30 years that've happened for a whole host of reasons. If we look at inflation, US inflation has been well below the Fed's 2% target but it's also been entirely driven by housing costs, healthcare costs, and education costs. If it weren't for the skyrocketing cost of healthcare and education, US inflation would be close to 0% and we might even be seeing deflation and falling prices. Note that all of this excess cost in healthcare reduces labor productivity and total factor productivity.

Possible Solutions:
Single-payer--The basic premise of a single-payer system is that the government nationalizes health insurance to some degree. This can happen to various degrees. For something like the NHS in the UK, almost all of health insurance and health care is nationalized wherein doctors are actually employees of the government. In Singapore, there's catastrophic single-payer which means that it's a single-payer program with high deductibles. So this would be like a Medicare for All system of health insurance with $5,000 or $7,000 or $10,000 deductibles. For procedures or medical appointments below that threshold, there's other options like HSAs or reimbursements or whatever. One possible solution in the US is some kind of government nationalization of health insurance that allows the government to capture the tail of the cost distribution (or more) and then crush costs by direct rationing or government decisions.

Individual Mandate System--The ACA was designed to be an individual mandate system, but the design of the ACA from 2010 (along with its sabotage) was inherently unstable. As discussed earlier, most of the costs are in the tail of the distribution, so if you place a ban on companies discriminating against those with pre-existing conditions, companies can no longer remove themselves of the costs of clients in the tail of the distribution. So now the costs must be borne by everyone across the distribution, which means the healthy will see their coverage drop and their premiums/copays rise substantially. In essence, we now have a private sector rent-seeking insurance oligopoly of a few large providers that's effectively acting like a monopolized cartel. In that, there's large amounts of rent-seeking which's affecting consumers overall. The most common parallel of an individual mandate system working properly is Switzerland. In Switzerland, they effectively restrict insurance companies from increasing in size and force them to work with healthcare providers in local networks to keep a lid on costs.

Hybrid (Government Tail Support) System--The basic idea here is to use private insurance as the norm for low-risk cases and public support for those who're very sick or have high-cost pre-existing conditions (like cancer). So in other words, the essential idea here is a "high-risk pool" separate from the rest of the insurance pool. There's several ways to design this. One way is to just let anyone with high-cost pre-existing conditions enroll into a single-payer government program (like Medicare) and let everyone else be on private insurance. Then use government bargaining power and direct rationing to bring down costs. Another way to ensure the same thing is to effectively separate the population by age. So older people are either on a direct single-payer program (like Medicare for those >65) or are allowed to buy into Medicare if they're >50-55. Considering most of the healthcare costs are in the tail of the distribution and older people are far more likely to be in the tail, such a system is a way of splitting up the federal insurance pool into two groups: a relatively healthy one consisting of mostly younger people and a sicker one consisting of mostly older people. The latter group will have a single-payer program while the former will be on private insurance. In essence, you'd end up creating a high-risk pool on one side and a low-risk pool on the other.

Hybrid System (Bismarckian social insurance)--The basic idea here is that there's a few things that're necessities which everyone needs and other things are simply things that we want or may desire, but aren't necessities. So in the set of "necessities" like emergency room care or preventative coverage or so forth, the government will provide those to everyone at either affordable levels or totally free of charge at the point of service (it usually depends on income). For all of the healthcare that isn't a "necessity", the system is entirely private. So it's usually the upper-middle class, upper-income, and the wealthy who use the partially private part of the system and the rest is public.

Note: There are many ways to design and structure such systems, but that'd entail a very long, long list that I do not have the time for. Not only that, but it seems rather pointless when I outlined the basic ideas of each solution.

Saturday, September 9, 2017

Real Growth, Nominal Growth, Productivity, Demographics, and Inflation

Usually, most of my blog posts are pretty structured into key parts. This post will be a bit different. It'll be more of a rant that flows through the parts outlined in the title: real growth, nominal growth, productivity, demographics, and inflation. The rant will detail my view of why inflation, growth (both nominal and real), and productivity will lag across the world going forward.

In the global economy today, we're in a period of low productivity growth across the developed world. In combination with that, demographics in the developed world are aging rapidly while little inflationary pressure exists. Global growth has been very slow in this period. In response to all of these issues, we've seen governments take up policies of low interest rates and central bank balance sheet expansion.

With the exception of the Federal Reserve at the US, almost every single major OECD country has a central bank either a zero interest rate policy or actively expanding its balance sheet including the ECB, Japan, Canada (which just increased interest rate to .75%, but is still effectively close to 0) and others. The countries who aren't at the ZLB or at low interest rates more generally are in bubble territory including Sweden, Australia, and some others (see chart below for bubble economies). Of course, there's also countries that crossover between these groups.

On the other side of the global economy, we've seen a huge over-investment in emerging market production (especially China). Also note that ~45-50% of the German economy is exports while much of Northern Europe runs large current account surpluses. So in effect, we can say that this part of the world has excess capacity. Due to excess capacity (overproduction), there's enough supply for industrial good globally to keep a lid on prices. This has been a key factor in low inflation.

As I've explained in other posts, shutting down excess capacity isn't easy. In a normally functioning liberalized economy, excess capacity gets shut down cuz investors or banks start closing production facilities and factories that operate at a loss. Then, they consolidate resources, streamline production processes, and crush costs while choosing to not run what operates at a loss. However, we have many countries across the globe (especially China) that don't have liberalized markets or financial systems. So instead of having waves of takeovers and corporate consolidation, they're actively encouraging excess capacity via policies that continue to drive and perpetuate imbalances for social reasons.

What do I mean by social reasons? Shutting down factories or production facilities operating at a loss, streamlining production processes, and increasing efficiency in supply-chains by crushing excess cost are all policies that increase unemployment and place downward pressure on wages. Instead of taking up these policies and dealing with the social unrest they create, we have many governments across the globe actively engaged in supporting these supply-side structures. How do they support them? It varies from country to country, but all of the primary mechanisms fundmentally transfer resources to producers--usually implicitly.

In essence, policies like ZIRP or NIRP (negative interest rate policy) effectively let zombie companies roll over excess capacity at little to no cost. Central bank balance sheet expansion creates liquidity expansion that shifts risk profiles of portfolios creating a rotation to higher risk assets. In other words, the policy of QE effectively causes risk spreads to converge. By doing this, it allows firms using items like junk bonds to get much lower yields. Deflationary pressure pushes down yields more generally as does low growth overall.

What ends up happening is that more and more capital gets (mis)allocated into share buybacks or into supporting excess capacity for firms that effectively become zombie companies. In Germany, excess capacity is being sustained by a very weak currency (Euro) and policies to basically drive down wages that make German manufacturers high competitive. That also applies to Northern Europe, albeit to a lesser extent than Germany.

In open economies, firms stay competitive due to advances in technology or through human capital investment. In closed economies, firms profits come from either suppressed wages, undervalued currencies, or through interest rate policies designed to prevent unemployment or other social issues. In effect, entire countries are refusing to adjust economic imbalances in order to not create social dislocation. As we all know, this comes at an economic cost.

When firms using bad production methods are not being closed down, when inefficient supply-chains continue to persist, and when production is sustained via government policy to make corporate financials seem okay, there are real costs to be borne. Rather than the traditional policy of creative destruction in capitalism where bad firms are shut down and production processes are streamlined, there's none of that. That's a key factor in driving low productivity. When a firm has no incentive to increase the level of technology it's using, it doesn't improve its productivity. It doesn't produce more outputs per input. Instead, it keeps doing what it's doing knowing that the government will provide it a backstop.

In terms of inverted demographics, resources must be diverted from future investment to take care of the elderly. That creates a productivity drag. Not only can aging demographics create a productivity drag, but they also necessarily imply a large portion of your populace is shifting from a very high income base to a lower income base--almost necessarily meaning lower consumption levels. That places downward pressure on demand for consumer goods. If we see rapidly aging populations in economies with real consuming power, that acts as a deflationary force globally as well as internally.

In other words, we have structural forces across the global economy that create both deflationary pressure and lead to low productivity across the OECD. Considering real growth is a function of workforce size and productivity of the workforce, it's no surprise real growth rates are low. Low inflation means relatively low nominal growth as well.

The idea of inflation magically appearing with high growth in this kinda economic environment, especially when we consider the fact that the world is basically in depression, is pie-in-the-sky thinking. These are things that will not happen anytime soon. The world will not magically see significantly higher growth or significantly higher inflation unless there's some serious correction of structural global imbalances first.

Tuesday, June 27, 2017

20th Century Economic Models (ex. Fascism, Communism) Fail in 21st Century

Recently, one of my personal favorite historians (Adam Tooze, whose books are excellent and what all of you should read) had a great post on the structure of the Phillips curve today. That is an excellent start to transition to the topic for this post: traditional 20th century economics (ex. Phillip's curve) may not apply in today's world. I will hammer this point home in this post and how the difference in structures has created a totally different kinda world.

I'm gonna use three key cases to demonstrate where the old models don't work:
1. Impact of Global Supply-Chains and Falling Transport Costs
2. Phillip's Curve Doesn't Exist
3. Increasing Productive Manufacturing Capacity Needs Private Capital and Labor Partnership
4. Conclusion

1. Impact of Global Supply-Chains and Transport Costs:
First off, we live in a world where transport costs have collapsed. What does that imply? It means that, as a result, supply-chains have become very elongated--especially in technology. If you take a look at your typical smartphone or computer, it's constructed in ~800-1,500 factories across ~30-50 countries. In other words, supply-chains are constantly reorganizing and capital has become global.

So if we were to look at 20th century economic models that were used by many governments (notably most common in authoritarian regimes) as a way to mobilize a large industrial workforces as a way to deal with unemployment, they basically used excess labor for direct increases in infrastructure and manufacturing capacity. Supply-chains were relatively small and short, so that means it's easy to redirect production to the whims of the government without huge disruptions provided you could secure the raw materials.

Today, supply-chains are much longer, which means that increasing manufacturing capacity basically means onshoring more of your supply chains. Taking up nationalist policy to centrally direct and produce industrial equipment with rapid increases in manufacturing capacity by forcibly allocating savings will drive capital out of the country, leading to offshoring of supply-chains. In other words, 20th century policies to increase industrial output and manufacturing capacity sharply will actually lead to less productive output in manufacturing and industry.

Instead, the way to onshore supply-chains today is by lower regulatory costs for firms to operate, creating incentives for global capital to onshore supply-chains (like cutting corporate taxes), and by providing other incentives for domestic investment more generally (which can come in the form of financial repression, like we saw last decade in China (that no longer exists)). The nationalization of capital to be used for productive industrial build-out will fail because capital will simply fly out.

2. Phillip's Curve Doesn't Exist:
Historically, the Phillip's curve has signaled a short-term tradeoff between employment and inflation. Today, we live in a world of unwinding excess capacity (as I've written previously). So if there's excess capacity that can't be sustained with demand, it means the costs of inputs begins to come under serious downward pressure. The reason is because inputs are, by definition, used in the production process. So if input prices got bid up on expectations of rising capacity after decades of rising capacity, the minute capacity starts falling and expectations of further rising capacity shift, critical inputs like industrial commodities or energy begin to fall precipitously.

If you're in the part of the world that's undercapacity or under full utilization, expanding productive capacity modestly will place upward pressure on employment and productivity. Expanding productive capacity is also deflationary for consumer prices cuz production is rising faster than consumption. The kicker here is that rising capacity normally means rising input prices, but if the world has unwinding excess capacity, the modest input price increases that should come from rising productive capacity simply get dwarfed. In other words, input prices are unaffected, which further places downward pressure on consumer prices.

So we're in a particular situation in much of the Anglo-sphere (and India) wherein it is possible to see higher employment, higher growth, higher producitivity, and falling prices by increasing productive capacity. In other words, it is possible to see falling unemployment and falling inflation, which violates the logic expressed in the Phillip's Curve.

Another way to think about this is that the economies across much of the Anglo-sphere (and India) are in a suboptimal equilibrium where there's less growth and less employment at the same (or higher) rate of inflation. The logic and reasoning of 20th century economic ideas would tell us that this is absurd on its face. But alas, this is the world we live in.

3. Increasing Productive Manufacturing Capacity Needs Private Capital and Labor Partnership:
In the 20th century, both Communism, fascism, and many other ideas were built off labor and capital having divergent interests (in the Marx-based sense). So the political battles that were set up were those where capital and labor came into constant conflict. In today's world, for manufacturing or tech labor to do well, they must work with capital looking to invest in that. There's a need for more mutual gain than there is for animosity.

If the old movements relying on animosity are tried, capital will simply fly out because capital is global. If you want firms to hold more of their supply-chains in your country, closing off your country to capitalists, seizing their assets, and telling them to "f*ck off" will create outflows of both capital and skilled labor. Firms will simply not cooperate by onshoring part of their supply-chains. They'll go elsewhere where they're treated better. When supply-chains are small, it's easy to takeover and command where things need to go provided the resources and manpower are available. When elongated, capital has options.

If you do see governments resort to takeover of capital and over the means of production, their build-outs will not be, and cannot be, productive in today's world. Instead, they will have chosen to take their economies back by 50 years and send them into a world of permanent backwardness until those policies are reversed. It will lead to a drop in the currency, capital outflows, and the holders of monetary assets in the banking system (usually households) to take the hit. Actually, this is what's happening in Europe with these "bail-ins". That's probably what Italy's "bank bailout" will look like as well.

4. Conclusion:
To sum all of this up, the fundamental underlying financial and economic structures of the 20th century have totally fell apart. Those fundamental factors began to shift in ~1970 after the fall of the USSR and the beginning of the globalization of capital, especially American capital. The entire precipice of Bretton Woods was capital controls. When Nixon closed the gold window, we went to a world of floating exchange rates. In other words, financial openness and globalization of capital took the day.

In the mean time, transport costs (especially across oceans) have fallen precipitously. That means firms can elongate supply-chains, which means supply-side structures are much more flexible with respect to movement across borders. If any country tries to impose borders to restrict capital (provided it's not tiny or an international financial center) without giving some corresponding handout to capital, it will be tough for that country to improve its domestic manufacturing capacity productively.

The result ends up with the traditional short-term trade-off between inflation and unemployment as nowhere near reality. Instead, the possibility of multiple equilibria has been opened up. In this world, capital imbalances tend to drive trade imbalances (doesn't apply to energy and commodity imports used in production processes IMO).

In today's world, increasing manufacturing capacity requires creating a partnership between workers and capital. Using old mid-20th century tactics from fascist or Communist governments to centrally push up industrial capacity instantly and rapidly, it will fail. It will not allow any country to get high on the value-added chain and will dissuade those with knowledge or skills or access to the social networks to be able to do so.

 Note that capital today is global, not national. So it means governments need to basically work with capital and labor. For example, governments providing better education and training for capital helps firms onshore due to more accessible labor. Governments that provide health insurance take it off the back of companies to provide it for their workers, hence making firms more competitive. Other policies like liberalization and elimination of distortions in supply-side structures or distortions in the tax code and so forth. 

Sunday, May 21, 2017

Demographics, Development, and Growth Models

In this post, I'll be discussing the impact of demographics on economies, development, growth rates, and economic models more generally. This post will discuss a model that uses demographics and productivity growth to determine a country's growth potential over a longer-time horizon. In order to do so, I'll split this up into the different kinda demographic profiles. Then, I'll go into development levels which'll lead me to the differing structure of growth models and their adaptability to different kinds of economies. After all that, I'll summarize the point of the model.

Demographic Profiles:
We can split up demographic profiles into three broad groups: pyramidal, stable, and inverted (as shown in chart below). A normal demography for a developing country is pyramidal wherein there's lots of young people and not many old people. Due to the cost of providing basic infrastructure and social services, countries with this demography are often in the 3rd world and poor.
Image result for population pyramid

A stable demography is most commonly seen in a developed economy or a developing economy with rising productivity. It's a population structure that can replace itself over the long-term, but the society won't see much population growth without immigration. The only OECD country in this position today is the US and France.

An inverted demography is the most common demography in the OECD today. Almost every OECD country has an inverted demography (as does China along with a few other poorer countries in Eastern Europe). The only thing that differs across the OECD, China, and the other poorer countries is the degree of the inversion. In places like Scandinavia, the demography is inverted, but not that inverted as TFR has been ~1.8 or so. So while there's an inversion, it's not that bad in places like Scandinavia.

When you're a developing country, having a pyramidal population structure makes it very expensive for the society to provide everyone with basic social services and investments in items like healthcare and education. In such a demography, it may actually be economically healthy to reduce fertility rates cuz that ensures every child basic social services and investments in health and education that can really cause productivity to soar. In this type of demography, it's very feasible to see improved growth with reductions in populations from soaring productivity of investments in health and education.

So in the 3rd world, shifting from a pyramidal population structure to a stable or inverted structure may not be bad at all. On the contrary, such a shift may actually be necessary, healthy, and positive--especially over long time horizons. In the developed world, it's a very different story.

Most developed countries will see much slower productivity increase than the developing world simply cuz they're ahead and aren't playing catch-up, so they can't import technologies and things of the sort to rapidly cause a surge in productivity. Developed countries also often have much larger welfare states (especially in Europe, though less so in Asia). What that means is that the large welfare state with an inverted demography imposes a high cost burden on those paying into those welfare systems.

In order for first world countries with inverted demographics to cope with the pressure on their working populations, they must either let in more immigrants or cut benefits or suffer from the drag of higher debt/taxes. What this does is reduce resources for entrepreneurs and risk-takers while the inverted population makes consumption led growth more difficult. Due to the inability for future consumption levels to sustain themselves, this demography leads to a drop in productive investment opportunities.

In other words, the direct conclusion of an inverted demography without mass immigration is structurally lower growth unless you see large productivity increases, which're being seen in places like Japan and South Korea largely due to a mix of their reliance on commodity/raw materials/energy imports in a time of collapsing commodity/energy prices and improvements in automation, industrial robotics, etc..

Growth Models:
Obviously, demography has a large impact on a country's economic growth. A country with a growing population can sustain higher levels of consumption, and thus absorb higher levels of productive investment whose purpose is future consumption. This is true for both a developing and developed economy with a growing population.

In a developing economy, the potential for rising productivity is much higher cuz they're playing catch-up. In such a case, it's not necessary for a falling population to lead to lower growth in consumption over a medium to long-term horizon. In the short run, very high growth rates are possible under cases when a developing economy has a growing population or a falling population. In the long-term, there will be problems in terms of the dependency ratio though.

In higher income countries, low population fertility rates and low (or the wrong kind of) immigration are a certain drag on growth unless productivity growth grows very sharply. What's the likelihood of high productivity growth in large welfare states and rigid bureaucracies? It's not very high, so growth becomes very difficult in countries with these kinds of demographics and economic models that rely on large welfare states. In these kinds of countries, future economic growth will be tough to come by without serious structural reform.

In countries with stable demographic structures, both developing and developed countries will see long-term per capita growth that stays roughly in line with productivity. For a developed economy, a stable population and well-controlled immigration will generally yield ~3% economic growth, maybe a bit higher depending on productivity increases.

Developed countries with growing populations have the institutions to absorb more amounts of investment productively than developing countries, so it's actually the developed world with stable demographics and positive immigration that's best fit for a controlled infrastructure build-out. In addition to that, a consumption drive growth model can work as well.

The fundamental point of this post is that long-term growth rates are always determined by structural factors. These structural factors are mathematically driven by productivity growth, population growth, and how people work (which's also structural, dependent on labor policy, etc). Hence, the applicability of growth models and economic models is entirely dependent on these structural factors.

What does this model of demographics tell us about future growth rates in the world today? It tells us that most of the developing world will continue to see surging productivity. That means many of them (like China) will be able to offset falling populations and falling workforce size by a surge in productivity. However, it also implies that most of the OECD will be stuck with low to no growth for decades unless productivity surges.

The primary exception in the OECD will be the United States. Another exception in the OECD may be France simply due to demographics. The rest of the OECD will see little to no growth unless they open themselves up to immigration, can filter these new immigrants effectively, have effective structural reform, and all while seeing surging productivity growth.

Tuesday, March 28, 2017

Structural Goals of Development Model and Basic Ideas/Fundamentals of New Development Model

In my previous post, I proposed a new development model to correct economic imbalances. In this post, I'll discuss the structural goals of the model alongside the basic ideas of the development model and the foundational underpinnings of the underlying economic goals of the model. This post will be split up into 7 sections:
1. Introduction
2. Energy Infrastructure
3. Immigration and Wages
4. Manufacturing and Economic Diversification
5. Taxation
6. Preventing Imbalances and Allowing for Economic Adjustments

1. Introduction:
The primary goals of this development model are:
1. a well-diversified economy
2. high wages to sustain strong internal demand
3. centrally directed investment from both public and private sources
4. an energy/infrastructure system to serve the needs of the 21st and 22nd centuries

Since ~1970-1980, the US has been running persistent trade deficits alongside a persistent trade deficit in manufactures. We've also seen rising productivity in manufacturing. So the logical consequence would imply that the US has been losing manufacturing jobs while manufacturing drops as a percentage of the economy in exchange for technology, finance, and services. Of course, this's exactly what's happened.

A well diversified economy has strong finance, non-financial services, manufacturing, trade, agriculture, and technology sectors. In order to get a fully diversified economy, a good target is ~15-20% of GDP towards manufacturing. We can also expand the portion of the export section too. In order to do this, we first need to protect development capital invested in manufacturing. The protection policies that I find appropriate for today's world are a destination-based cash flow tax (Paul Ryan's "border adjustment tax") and a tax on American assets held abroad. Not only will the protectionism help protect development capital in American manufacturing, but it'll help exporters as well. So protection would hit two birds with one stone.

In terms of infrastructure, the best way to do it is with a mix of public and private capital. Public capital will be able to supplement what private capital could not do. The infrastructure needs to be the basis for an economy that can sustain and provide a base building block for the country for the next century or more. This infrastructure will range from a core energy base to a manufacturing base to other strong sectors.

2. Energy Infrastructure:
In the case of energy infrastructure, one of the biggest problems in the 21st century is the negative impact of extractive industries that entrench rent-seekers and don't embed into ecological life-cycles. The solution for this problem is to shift to other forms of energy ranging from nuclear energy to renewables. When I speak of nuclear energy, I specifically mean the thorium reactors which're much more environmentally friendly. By renewable energy, I mean things ranging from solar energy to wind to geothermal to even biomass.

Nuclear energy investment never comes from the private sector due to its inhibitive cost. So investment into new nuclear technology, new nuclear power plants, and adaptation of existing nuclear power plants must come from the government. For new technology, the goal should be the development of thorium nuclear reactors. As time goes on, the costs of investment will fall while technology gets better. Currently, the US gets 10% of its energy consumption from nuclear energy. Getting to 25-35% nuclear energy within 15-20 years is not only within possibility, but realistically achievable--provided political idiocy doesn't get in the way (a big if).

Then, we've got investment in an infrastructure grid to deal with renewable energy. When an economy starts using renewable energy, the energy coming from solar and wind doesn't necessarily show up all at once. So an electric grid needs the ability to switch fuel sources on a dime from when the energy source turns off. Also, we'd need to adapt the federal grid so that it's possible for solar power in California or Arizona at 3-5 PM (during peak energy collection) can be sold in the East Coast at 6-9 PM (where there's peak energy demand). All of this requires a ~$1 trillion investment (>33% more than Peter Zeihan's estimate) in grid infrastructure over ~10-15 years to totally revamp the US electric grid (although a full federal grid infrastructure investment is not necessary and most of this can be financed by private capital--and already is).

In the case of renewable energy, there's many hydroelectric dams in the US that generate power, but those dams use old technology and need to be rebuilt. An infrastructure investment in those dams amounting to ~$50 billion over a decade is more than enough (more than double estimates from Stratfor) to produce ~3 times output in hydroelectric power within 15-20 years. All forms of renewable energy will triple within 15-20 years except for biomass. That should put the US at ~40-50% of energy coming from either nuclear power or renewables (as a conservative estimate, but in reality, I suspect we'd see a much faster increase in renewables than we'd expect).

Also, we've see significant improvements in issues resulting from extraction (like greenhouse emissions) as we transition from use of coal to use of natural gas. We also have new technologies that can use released carbon or methane, dissolve them into fuel, and then get another combustion cycle. This can really help reduce emissions to the point where the 40-50% from renewables or nuclear would end up becoming 60-70%.

3. Immigration and Wages:
One of the ways in which the world is moving in is in the direction of automation. Due to automation, many jobs will become automated rather quickly. We also know that wages have been stagnant for ~30-40 years. So our immigration policy must be designed to deal in a world where automation is rampant, where we need to sustain social safety nets for a society where people are living longer, and where we can increase wages.

The first step to shifting an immigration policy that makes sense is to first reduce the amount of unskilled labor immigration. In the short-term, such a policy will create labor shortages to drive up wages. In the medium to long-term, you'll see firms begin to invest more in automation, which'll only accelerate.

In order to keep the dependency ratio from getting out of whack (which either forces higher debt or higher taxes), the US will still need immigration as birth rates are unlikely to spike any time soon. What that means is immigration must be mainly focused on capitalists, the wealthy, skilled labor, and selectively chosen refugee populations. Skilled labor has capital inputs, which means that more skilled labor doesn't necessarily reduce the wages of other skilled labor--and certainly not in the same way unskilled labor can.

4. Manufacturing and Economic Diversification:
As I've said from the beginning economic diversity is valuable cuz it creates economic and financial structures robust to shocks. Diverse economies require several powerful sectors ranging from manufacturing to finance to technology to services, all are necessary in a strong economy. Our current economy is largely built on tech, finance, energy, investment, and services. What's lacking is manufacturing and investment. The goal of diversifying the economy implies that we'd want manufacturing and exports (combined) to be ~20-30% of the economy.

The investment problem can be fixed by incentivizing both private/business investment while also including some public spending. In terms of incentivizing business investment, a simple solution is a corporate tax cut to 20% in addition to a 20% destination-based cash-flow tax (DBCFT) that'd combine to function as a 20% business flat tax. In addition, there'd also be tax cuts for further business investment that'd turn the US into a gigantic tax haven for firms doing real business investment in the US. Public spending can fill in the gap to help profits of capitalists where private capital will not go (and cannot go) like nuclear power.

The DBCFT would also help manufacturing by taxing cash flow of good made abroad being sold in the US. It'd tax offshore earnings, discourage corporate inversions, and encourage firms to onshore manufacturing cuz the entire country would be turned into a massive tax haven for business investment.

Other things we need to be doing involve building modern infrastructure networks to interlink powerful city-regions across the country. What does this imply? It implies a federal high speed rail network. It implies rebuilding and redesigning the interstate highway system to keep up with current geopolitical and financial needs (mainly, this involves rebuilding and some minor expansions).

5. Taxation:
The goal of taxation (other than raising revenue) should be incentivize the accumulation of wealth and upward class mobility among the lower classes while taxing away what's destructive an economy long-term. In order to incentivize the accumulation of wealth, flexible class structures are necessary. Financial history tells us that what creates wealth is a capacity for risk, a value for work, institutional flexibility, sound incentive structures, and an avoidance of debt for most purposes. The goal of taxation should be to promote this.

So if we'd like to reduce the use of debt, we should promptly impose a tax on leverage across the financial system. If we'd like to reward work, we need a progressive tax system wherein workers are taxed less and are encouraged to save more. In order to do this, we can begin by eliminating the payroll tax and raising the standard deduction to $30,000. On top of hiking the standard deduction, the goal should be to implement a flat tax of 20-25%. The flat tax would also tax capital gains as well.

Also, I've previously called for a tax on all extraction. I stand by that, but if that's not possible, then we should go for a tax on carbon or issue securities for carbon ("cap-and-trade"). All environmental degradation should be heavily taxed or the costs on those guilty should be ruthlessly imposed by courts.

With respect to corporate taxes, I outlined what our goal is earlier. We should target a flat 20% business tax with tax cuts for business investment. That way, we'd incentivize exports by not taxing them and it'd allow for a level playing field considering most major countries are either severely protectionist (like Japan, China, and most of East Asia) or are implicitly protectionist or have a very high VAT (usually ~20% in Europe). The goal is to promote development capital, especially in manufacturing.

6. Preventing Imbalances and Allowing Economic Adjustments:
The most likely imbalances this economic model would promote is one of excess capacity, as most of the goals in this model are designed to increase capacity. The part that'd rectify these issues is high wages, which can only be sustained by large amounts of skilled labor. However, high wages will not be enough on their own for a model that promotes capacity as much as this.

Hence, another goal needs to be a strong currency. If the strength of the currency is at risk of shifting the current account balance into a very large negative, we can use protection to offset those impacts long-term. A strong currency is useful because it increases the purchasing power of consumers and helps to sustain a strong consumption base internally.

Another goal also needs to be investment in workers, in their skills, and in their education. Currently, one of the biggest problems we face is young people walking around with a massive debt overhang from going to college. So we need a new system. What I'd suggest is a system wherein the tuition is paid for by the government, but in exchange, the government would receive 7-10% of your income for the next 10-15 years of work after you leave REGARDLESS of how much the person makes. This'll help us deal with the social cost of college without making debt slaves out of our future population. It'd also free us from the idea of "free college" where people go to school to study worthless subjects like women's studies and sociology without suffering a cost. In this case, it'll create incentives wherein those who go to college to get high-paying jobs and the universities who support such structures will benefit. If they choose not to go into higher paying jobs, they'll still be able to go, but they'll be punished without becoming lifelong debt slaves.

Another goal should be to make sure there's some kind of floor for health insurance. Single-payer systems are terrible cuz they control costs by rationing care. The government caps demand in order to control costs, which makes rationing necessary since capping demand removes the flexiblity of price and of supply. In the end, health services have to be rationed. Instead, the goal should be to adapt the ACA to deal with the high premiums in the ACA exchanges. The easiest solution would be to get everyone on the exchange and let them form into a gigantic pool wherein one person can negotiate for tens of millions of people. If we did that, costs would come down and almost everyone would have a base level of health insurance.

Wednesday, March 1, 2017

American Economic Development: A New (or Ancient) Model

In my last post (regarding the structure of American energy), I said that the post was the first post in a series about our energy model in conjunction with an overall American development model going forward. This post will be the second post in that series. This post will be broken into several sections:
1. Introduction
2. Development Model from World War II to the 1970's
3. Development Model from late 1970's to Today
4. New Development Model to Correct Imbalances
5. Conclusion

In order to get into this post, I'll need to begin with the structure of the old development model beginning in the late 70's and early 80's until ~2008. Then, I'll get into the development model that got us here after discussing the history. After that, I'll discuss how our current development model created the existing imbalances in the American economy. From there, I'll propose a new development model that'd systematically eliminate those aforementioned imbalances over decades.

The proposed development model lays out a set of policies specifically designed to rework the entire structural base for our economy by setting key, clear, and decisive economic development goals over the next couple decades including a diverse economy with high, value-added manufacturing that's ~15-20% of the economy within a few decades combined with a reversal of the trade deficit and sustained public investment in an economy where private investment is waiting to multiply on the benefits of public investment. Such a policy can easily achieve 4-5% economic growth rates for the American economy for the next 15-20 years.

Development Model From World War II to 1970's:
The old development model came from an economy designed for very high inflation and government control in the 50's and 60's. This model works fine in a world devastated by war wherein half the world is closed off from the rest cuz there's no risk of flight in capital. What're capitalists gonna do? Go to a place where some strongman took over, is fighting a civil war, and is actively gonna confiscate resources of everyone? If they do so, they don't deserve to manage any capital (and they won't be doing so). Are you gonna go to a war-torn place that's rebuilding? Yes, but that'll happen via capital exports and those places'll end up being net exporters as a result--which'll imply a likely trade surplus, especially in manufactures.

The structure of the financial system was explicitly geared towards creating a consumption driven economy via tight labor controls, tight wage restrictions, restrictions on corporate consolidation, restrictions on liquidation, and restrictions on finance more generally. In a rapidly connecting world on the verge of a tech revolution, these structures just didn't make sense. If they'd been kept in place, many of the innovations we saw over the past ~25-30 years would never have been seen due to the inability to develop and create financial structures over technology networks (something as simple as Google being able to network it's satellite infrastructure across its corporate networks and capital structures in order to provide a service like Google Maps across all its mobile phones would've been impossible due to "regulation").

In the 60's, there were policies designed to prevent free liquidation of assets at 50-80% discounts which could've been used to create tons of value due to "regulation". Instead, the system resolved the costs with high inflation cuz households lost out even though such trade-offs actually destroy long-term capital by removing incentives for a restructuring of financial structures. Hence, the dismantling of these regulations and the entire structure of the progressive world set up in the 20th century had begun. The result was that growth was unleashed, but that growth and all gains of productivity only went to a few at the top.

Growth Model from Late-1970's to Today:
The new growth model reversed those restrictions and allowed for an increase in value creation that all accrued to private capital. This process led to a rise in leverage among households funding a consumption boom with debt that ended up collapsing in 2008. Since 2008, there's been a rapid consolidation across private infrastructure networks which's been unseen in >100 years. What this's done is backlog economic growth by wiping out excess capacity and created huge efficiency gains along with more sound underlying financial structures linking both federal private infrastructure networks and corporate networks more generally. We're still getting ~2-3% growth with ~.5-1% growth in real GDP/capita in spite of this consolidation and the exacerbation of inequality. The use of this as a bad economy is something that is rooted in a fundamental misunderstanding of economics. There's a difference between real wealth creation and economic growth rates.

This growth model has created huge income inequality, pushed value creation into hands of a few, allowed a few to capture all productivity gains, and also forces the US to adopt persistent demand leakages through "free trade" (which really means persistent current account deficits, although they've been strictly limited since the beginning of the Obama administration). All of these factors are acting as a drag on growth in the middle of a global depression.

New Growth Model:
So an economic adjustment involves a restructuring of economic policy that'll create opposite pressure on those existing imbalances. In other words, it means that if our previous economic model resulted in persistent demand leakages, the new economic model reverses those demand leakages, reduces inequality, allows households/workers to receive gains from rising productivity, and increases wages more generally. It also means we need a redirection of resources that'd expand productivity in the private sector and spur private investment across federal networks.

In other words, we need policies to reverse our current account deficit. The US has seen rising productivity in manufacturing while running a persistent trade deficit in manufactures. Such a policy wipes out large portions of the manufacturing base. An economic correction would imply an reduction/elimination of the current account deficit while protecting development capital in domestic manufacturing. In other words, there needs to be some form of protectionism, although it mustn't be too large.

We need policies that'll reduce inequality which means we need to target high wages for workers to raise household income. Such policies involve restructuring immigration to cut off unskilled labor immigration to levels that're only absolutely necessary. It means incentivizing high wages by the creation of high, value-added jobs in both manufacturing and the service sector alongside policies designed to restructure personal debts (including student loan and household debt).

In terms of a policy to spur private investment across federal networks, we need a comprehensive infrastructure package and policy across the entire US connecting states, localities, and city-regions to one another in productive ways. For this, we need centralized financing of investment in infrastructure networks that'll create a flow of private investment to follow across the country.

So what are these policies?
(i) The first will be some kind of a destination-based cash flow tax (called a "border adjustment tax" as proposed by GOP in February 2017) combined with a restructuring of corporate taxes to bring them down. That'll cause onshoring of manufacturing which's only offshored for marginal financial factors. In doing so, such a policy would transfer resources from rent-seekers abroad towards productive, value-added manufacturing domestically while driving growth and helping bring down our trade deficit.
(ii) The second policy is increasing funds in internal investments (ex. infrastructure spending, public works, etc.). Such a policy will bring a wave of private investment to follow in behind it while also driving up growth rates and creating investments that'll pay for themselves in due time.
(iii) The third policy that needs to be resolved is immigration. Unskilled labor immigration needs to be dramatically reduced in order to create labor shortages to increase wages short-term while firms go towards automation and capital investment long-term.
(iv) The fourth policy is to reduce or restructure unsustainable debts (like student debt) across the population. Such a policy would transfer resources to those at the very bottom, redistribute resources, and reduce inequality structurally.

Those four policies from the previous combined (each in small amounts) could easily take an economy growing at 2% to one growing at 4-5% over the next 15-20 years sustainably while setting forth a massive private sector deleveraging. How so? Use public investment of ~1% of GDP to drive growth up by ~1-1.5% minimum (it'll probably be closer to ~1.5-2% or higher due to Keynesian multiplier), combine that with a border adjustment tax that'd onshore manufacturing firms and reduce trade deficit driving ~.5-1% growth annually, and we're already at 4-5% from our 2-3% today. Combine that with some debt restructuring for those truly suffering, a restructuring of immigration laws, further liberalization, and it's easy to see how we can get to even 6-7% growth for 10 years sustainably.

How does this speed up a private sector deleveraging. If the government runs 2-3% of GDP deficits while our current account deficit goes flat, it means the private sector deleveraging in nominal terms is +2-3% of GDP. When we add in 4-5% real growth with ~2% inflation, we get NGDP growing at ~7-8%. In real terms, the value of the debt could be falling by ~10% of GDP in real terms. However, this deleveraging only takes place if we adjust our growth model.

This will transition into my next post regarding the basic ideas and fundamentals of the new development model I've laid out here in regards to the future structural goals of the economy for the 21st (and 22nd) centuries. I'll talk mostly about the kind of energy, geopolitical, and financial shifts we'll need to see in economic structures and in infrastructure.

Friday, February 17, 2017

On American Energy (Including Fracking, Renewables, Big Oil, and the Whatever Else)

This post will be a little bit different from most of my posts and will be purely focused on energy. It'll be the first in a series of posts regarding the current structure of American energy. The next post(s) in the series will discuss where our energy goes from here and how it'll fit into economic development in the 21st and 22nd centuries. This post will be split up into several sections:
1. Introduction
2. American Oil Production (Fracking vs "Big Oil")
3. Geopolitics and Energy Networks of American Energy
4. Renewable Energy
5. Nuclear Energy

1. Introduction:
For most of human history, almost all energy used has either been from animals or fossil fuels. In what we consider "civilization", it's been mostly predicated on fossil fuels or wood. In global energy consumption, the biggest consumers consist of the largest economies (the US, China, Japan, Germany, France, India, etc). The largest producer and consumer of energy is the US.

In the US, the primary sources of energy are oil, natural gas, and coal. Coal in the US is primarily used in electricity production, but it's use has been rapidly falling due to the fact that it's just not profitable. The collapse in oil prices that occurred a few years ago hasn't affected American energy production negatively. Instead, American oil production has actually risen in spite of an oil price collapse--largely due to advancements in fracking.

In terms of the sources of American energy, almost all American energy comes from fossil fuels. According to the EIA, petroleum accounts for ~36%, natural gas accounts for ~26%, coal for ~16%, nuclear for ~10%, and renewable energy for ~9% as of 2016.

2. American Oil Production (Fracking vs "Big Oil):
In the 2000's, almost all American oil produced domestically came from offshore drilling that was from the "big oil" companies. Today, the US produces more oil even though almost all offshore oil production in the US has been shut down. The primary reason is due to technological advancements in hydraulic fracturing (or fracking). After the oil price crash in 2014, there was a wave of consolidation among fracking firms. The amount of active rigs FELL BY >60% even though oil production was flat.

Note that fracking isn't just used for crude oil, but for natural gas as well. In addition to the drop in the necessity for imports, natural gas has been displacing coal as the primary source for electricity production (with natural gas overtaking crude in 2016) last year. Due to the advancements in fracking, most frackers in the US are profitable at ~$50/barrel of crude. The natural gas that comes from fracking is a byproduct, so our frackers don't actively search for the natural gas. They just get it as a byproduct. One of the biggest reasons fracking has been so impactful is cuz it produces BOTH crude oil AND natural gas.

Now, notice natural gas is very different from crude. Crude oil can be put into basically any container and shipped. With natural gas, it must go from pressurized point A to pressurized point B. Hence, it requires an extensive pipeline infrastructure to carry the energy. Due to the advancements in fracking over the past ~6-8 years, we've seen a rapid buildout in natural gas pipeline infrastructure that's the most sophisticated the world has ever seen.

3. Geopolitics and Energy Networks of American Energy:
In terms of consumption of petroleum liquids as of 2016, the US consumes ~19 million barrels/day (mbpd) of petroleum liquids--as defined by the EIA. Petroleum liquids consist of crude oil, natural gas, and biofuels (there's others, but those numbers are negligible). In terms of production, the US produces ~9 mbpd of crude, ~3.5 mbpd of natural gas, and ~1 mbpd of biofuels. So the net gap between production and consumption is ~5-6 mbpd. Keep in mind that in the 2000's, the importation of crude oil alone was almost double the net gap between production and consumption of total petroleum products today.

So, what's the impact of the US producing more petroleum products with the consumption of these products staying relatively flat (or falling)? The impact is that the US needs to import much less of these products from abroad. In the 2000's, the largest American importer of petroleum products was Saudi Arabia. Today, the largest importer is Canada. Almost all energy consumed by the US economy is produced domestically or is sourced from Canada, Mexico, Venezuela, Colombia, and Saudi Arabia. To put simply, >90% of American petroleum liquids come from the Americas and are totally unreliant on supply-lines from the Middle East.

In other words, the US is no longer dependent on foreign oil outside of the Americas implies that the US can effectively retrench from its position as the "global policeman" without facing a risk of disruption in its internal energy flows. Also note that almost all of the refining is done in the US. Actually, the US is a net exporter of refined products (like gasoline, diesel, liquefied natural gas, etc). So what happens is that there's many countries (*cough* Venezuela *cough*) that export the raw materials, our refiners refine the product and ship it back to these countries--or across the world.

4. Renewable Energy:
In terms of the future of energy, fossil fuels will still be used over the next few decades. Renewable energy would seem wonderful because it can embed itself into life-cycles of ecosystems, but it requires a whole host infrastructure and other prerequisites that make it very difficult to rapidly increase energy use from renewables overnight. Renewables create several problems:
1. They don't produce all the time (solar only produces during sunlight, wind only when there's wind, etc.). So storage becomes a problem.
2. They require an energy grid that can go back and forth between different sources of energy. So you need a grid that can handle the ebbs and flows of renewable energy which can turn to fossil fuels when renewables don't produce.
3. Battery technology is nowhere near what it needs to be for energy storage to become a serious alternative. For example, there isn't even enough lithium in the world for it to store 10% of the energy needs necessary if the US were to go to renewable energy.
4. Raw materials (like silicon and lithium) need to create many of these items are environmentally damaging to extract and refine. In fact, they're so environmentally damaging that most developed countries ban their extraction and refinement on domestic soil.

In order to shift to renewable energy, building out the grid infrastructure alone would cost ~$1 trillion and take about a decade. So switching over to >50% renewables won't be feasible for another ~15-20 years. But in the mean time, what renewables can do is to supplement the structure we already have. For example, once you build a solar farm, it just generates energy on its own. You don't have to go out and extract anything or do anything more other than to capture or use the energy. So we're already developing two-tiered systems wherein solar farms or wind farms or geothermal energy is being plugged into the grid and being used whenever it's generating while fossil fuels are used the rest of the time. This process is only accelerating.

5. Nuclear Energy:
My personal favorite kind of energy is nuclear energy. With the latest technology, the issues that've plagued old power plants are issues ranging from nuclear waste to bad design that allows for flooding of the water cooling systems to a whole range of factors. Of course, more recent technology (like thorium reactors) wipes many of these risks or drastically reduces the scale of the impact of these risks.

My point with nuclear energy boils down the fact that the risks of nuclear energy are drastically reduced with more recent technologies. In other words, the most recent technology in nuclear allows for energy that's got low environmental cost and is equivalent to free energy. However, the problem is one of geography. Building nuclear power plants in areas where there's lots of earthquakes or flooding may not be wise. Similarly, nuclear waste needs to be dealt with and all of the infrastructure necessary to link the energy to the grid must be suitable for the geography.

However, there isn't that much energy the US receives from nuclear energy. Going forward, it'd be wise to expand the portion of energy consumed from nuclear energy produced domestically in the US.

Wednesday, January 11, 2017

On All Things Russia

In this post, I'll be talking about the geopolitical financial aspects of Russia alongside it's position to and relationship with the rest of the world, especially the United States. Before I get into this discussion regarding Russia's position in the world and its relationship to the world, I'll first need to get into the geopolitical financial structure of Russia.

Russia is the largest country in the world in terms of landmass, is home to ~143 million people, and has an economy whose size is ~$2 trillion. Russia's the largest producer of energy in the world, and has the second most nuclear capability in the world. The Russian geographic landscape is very sparse and it's very harsh as roughly half (probably more than half) is frozen half the year. It's geographic terrain combined with its heavy reliance on commodities, natural resources, and energy extraction/production makes it a very fragile economy that sinks very quickly when the prices of commodities and energy come under pressure. To emphasize Russian reliance on natural resources extraction and commodity exports, we'll note that 2/3rds of Russian government revenue came from oil, oil products, and oil/natural gas exports in 2013. Of course, Russia also extracts oil and other commodities that feed into aggregate demand for the Russian economy more generally.

Also notice that the sheer size and scope of the Russian landscape imply large borders that're mostly indefensible and virtually impossible to protect. In other words, Russia really has no choice but to have open borders because defending, monitoring, and policing its borders is just unrealistically costly based on sheer size alone. Hence, if we go by Donald Trump's view that you can't have a country without borders, Russia's not really a country.

Now that we've established Russia's dependence on natural resources, commodities, and extractive industries, it becomes important to note that the current international economic situation is one of depression in half the world with large asset bubbles and excess capacity (that's begun collapsing) in the other half of the world. In other words, there's supply/demand imbalances globally where supply's much larger than demand and the adjustment occurring is that aggregate supply is beginning to collapse globally, as I've written before. Of course, commodities, energy, and natural resources are all inputs to production--and hence aggregate supply. So what's the chance that, in the middle of a worldwide depression unseen in ~80 years, we see a sudden rise in the prices of energy, commodities, or natural resources? If you legitimately think high commodity prices are just around the corner, you're delusional (the only chance of this is if there's a very large price split that occurs between Brent and WTI, but even that's something which I find unlikely though it's remotely possible).

Also note that Russian demographics are downright horrible with the population already having peaked. The public health crises in Russia are numerous with alcoholism and STDs rampant across the population. When you add in Russian economic reliance on commodities, energy, and natural resources with a rapidly aging country and a falling population, you get a financial system that's built on a pile of sand. In other words, Russia's utterly incapable of maintaining defense expenditures at current levels, which's why the Kremlin's even begun to cut defense spending. These financial pressures are forcing the Russian government to slash defense spending by ~25-30% in 2016.

Essentially: Russia's barely able to maintain its current geopolitical structure while its economic difficulties will continue to persist for at least the next decade although Russia still does have a lot of nuclear weapons from the days of the USSR. Russia doesn't have the financial power to maintain its current empire for the next few decades. If we look at the current map of Russia, we'll notice that the current borders are less than the ones agreed upon at Brest-Litovsk after Russia lost the war on the Eastern Front to Imperial Germany in World War I. In other words, after a prolonged period of peace in the region, Russia's current borders are what they were after the loss of a war ~100 years ago.

Russia's the weakest it's been--in terms of borders and military power--since before 1775, which was ~250 years ago. And this weakness isn't something that happened to Russia after the loss of a war and internal collapse like after Brest-Litovsk either. On the contrary, this weakness has occurred after decades of peacetime with the world under American hegemony. When you add in Russia's structural economic issues, it means Russia's barely able to financially survive.

From an imperial standpoint, Russia may temporarily be able to make some territorial gains and grab some loot now, but demographics make a military move even 5-10 years down the road virtually impossible. So if Russia doesn't move now, it'll won't be able to expand later. Considering that Russia's cutting defense spending while updating its nuclear capabilities, I doubt they'll even have the financial power to move forward even if they wanted to unless they're willing to risk a total revolution and likely wars on all of its borders. I can spend a lot of time going through the scenarios, but my point is very simple: it's questionable whether Russia has the financial means to maintain its current empire nevertheless expand out further.

As I stated above, Russia's the weakest it's been since the days of Catherine the Great. In today's geopolitical climate, Russia's only a regional power with serious internal difficulties. Russia's a very fragile empire being held together geopolitically by its financial system of oligarchs who're able to hold the space together via financial control over the natural resources, energy, commodities, and the supply lines to transmit all of those resources.

TO SUM UP: Russia isn't really a country. It's a gas station (by gas station, I mean energy more generally) masquerading as a country.

Russia isn't really a world power anymore. It's a regional power that only has power on the world stage because of its nuclear stockpiles from the Cold War Era in the 20th century. Russia is waning in strength and facing lots of internal difficulties. This's why Russia's now being outspent by the US, China, India, and Saudi Arabia on defense spending today. Russia's naval capabilities are virtually non-existent. Hell, the entire country has only one warm water port at Sevastopol which Russia only recently got with the annexation of Crimea.

However, there's plenty of areas of common interest in regards to the relationship between the US and Russia. It's pretty clear that the Kremlin did not want Hillary Clinton to be President and did everything possible--like using a front for the GRU (*cough* Wikileaks *cough*) to leak "hacked" emails by John Podesta--due to Putin's personal dislike of Hillary Clinton and out of fear for her foreign policy. With that being said, on places like the Middle East or in ideological battles against Jihadi Islamists, there's lots of common ground for Russia and the US to work with one another.

So while Russia has basically been reduced to a regional power, it still wields a decent amount of power globally although that's only due to its nuclear stockpiles from the Cold War. It's having difficulty keeping itself together, but it's not in the interest of the US (or any other country for that matter) to fragment the Russian Federation simply because of the nuclear problem.