"Kee" Points with Jim Kee, Ph.D.

Although some markets hit all-time highs last week, there was nothing in the data (e.g. payroll numbers, ISM indices, personal income) that indicated anything other than continued, modest growth. As I mention on this quarter’s webcast, the rebound in stocks has been strong but below average as far as rebounds go, taking four years from the March 9th bottom to get back to mid-2007 peak levels. The average is around two to two and a half years, depending upon how far back you go and how you classify a plunge.

Quick Global View: One simplifying lens that economists use to analyze the world is the notion of the “policy mix” between monetary policy (central bank driven) and fiscal policy (taxes, government spending, regulations). For example, the press tends to describe the current global landscape as one of central banks printing money and engaging in a global currency war (who can depreciate their currency the fastest?). But a policy mix view would suggest that perhaps the major economies are getting half of the equation (the monetary part) correct by being accommodative and ensuring liquidity and credit availability. So the problem is not on the monetary side but on the fiscal side.

For example, in Europe, the development of Outright Monetary Transactions (OMT) and of the European Stability Mechanism (ESM) has brought risk measures down there, but they still have key fiscal issues, like labor market flexibility, entitlement reform, and overall bureaucracy. In Japan, the bold new agenda of the Bank of Japan to achieve 2 percent inflation through asset purchases (creating money to do it) might end the mild deflation that has characterized that country for the past 15 years. But Japan’s problems aren’t really monetary. For example, as I’ve mentioned in Kee Points before, capital allocation in Japan is distorted by government policy, and as a result, very few companies in Japan earn their cost of capital (they destroy wealth, rather than create it). So BOJ’s actions, like the European Central Bank's actions, can only do so much. And so it is for the U.S., where the Fed has been accommodative, keeping the monetary side of the policy mix from constraining growth. But uncertainty on the fiscal side has risen dramatically over the past 10 years, and that’s the key problem right now, not Ben Bernanke and the Fed. [aside: China fixed its currency (the yuan) to the U.S. dollar from the early 1990s at 8.3 yuan per dollar until 2005, at which point it started allowing its currency to appreciate within a pre-set range. It is currently 6.2 yuan per dollar, so the yuan has actually appreciated].

Finally, the most interesting thing I saw last week was from a BCA (Bank Credit Analyst) economist who visited our firm. He asserted that Saudi Arabia, still the world’s largest oil producer, used to need about $20 a barrel in order to meet governmental/social spending commitments for the country. Over the past ten years, however, that number has increased to around $80 a barrel because of things like increased social welfare commitments for the purposes of ensuring domestic tranquility. So that would put a floor beneath oil prices of $80-$85 a barrel. The Saudis would maintain a high oil price by curtailing production if needed.

That interested me because the next day the Financial Times printed an article with the following title: “Saudi Oil Head Says Capacity to Stay in Place Until 2040.” The piece stated that “Saudi Arabia does not plan to increase its oil production capacity in the next 30 years as new sources of supply fill the demand gap.” This was a flip-flop by the Saudis from their plans just a few years ago, and largely attributable to the fracking revolution.