Tuesday, March 29, 2011

US Oil Production, Self-Sufficiency, and Fuel Price Futility

I think the US ought to produce more energy.  I think we probably ought to produce more oil and gas. But I do not believe that we should do these things so that we can keep the price of oil low in the USA. I keep hearing people talk about oil or energy self-sufficiency as a means to keep oil prices low in the USA. This is crazy talk or maybe just wishful thing.  Let’s produce more oil here but let’s not raise expectations about something that isn’t going to happen. We are not going to become self-sufficient and even if we did it would not allow us to control the price we pay for oil.

We can no more protect US citizens from the global price of oil than we can stop a tsunami going 550 miles per hour. Oil prices are determined by global supply and demand. In economics we often begin our thinking about pricing as a process of determining full cost and then adding a mark-up for a reasonable profit. This makes us think about production and distribution costs. Let’s suppose it costs about $60 to produce and distribute a barrel of oil. Add a $20 profit and you get a price of $80 per barrel. I don’t know if those numbers are accurate but let’s suppose they are close. But that’s nothing but a starting point for the price of a barrel on the world market on a given day. If the world economy is booming and the demand for oil is very high, then firms will produce more and that raises their costs – and may also be a time when they take higher profits. So a barrel might be priced at $100 or more when the world experiences strong economic growth. Next consider a time when the demand for oil is very low – it is possible that the price of a barrel of oil is only $60 on that day. Add psychological effects, speculators, government or OPEC announcements and you can easily see why the price on a given day could be well above $100 or well below $60. Fun, eh?

But you might protest. If we can produce a bunch of oil in the US – who cares what the world price is? We produce it here and we consume it here. Suppose we are self-sufficient. We could price US barrels at US prices. With lots of US production we could keep the home price low. That’s a nice story but it ignores two other economic ideas about prices – opportunity costs and replacement costs.

An opportunity cost is what you have to lose in order to gain something else. Let’s see how opportunity cost comes into play if the US were to be self-sufficient in oil.   If I can sell a barrel of oil on the world market for $100 and I can sell that same barrel of oil in the US for only $60, then what is a barrel of oil really worth and where would I want to sell it? You can play the Star Spangled Banner all you want – but in that case economics says the price of oil is $100 and the economy is made more efficient and productive when we buy and sell at the market price. Clearly US suppliers would rather receive $100 per barrel and they will attempt to do so. Resurrecting legal and other barriers to prevent this sort of behavior is possible but not consistent with a market economy. If, on the other hand, temporary conditions had the world price of oil at $40 while US prices were $60, you can bet you’d see the benefit in letting US consumers buy oil on world markets. 

More production in the US marketplace does not insulate us from world oil prices. The replacement cost story arrives at a similar conclusion. I fume about replacement costs every time my local gas stations are so quick to raise prices after a rise in world oil prices. It seems to take them only 10 seconds to translate a rise in the world price of oil into another 10 cents per gallon for gas in Bloomington. I may fuss and fume but this is really good business on their part. Sure, the gas in their pumps at that moment came from cheaper oil. But what does it take to replace the gas in those pumps? What is the real price of oil? It is now higher and the gas station would be wasting resources if it charged for its gasoline as if oil prices were much lower.  If higher oil prices are a sign of relative scarcity then stations that do not quickly raise prices are wasting a scare resource by setting gas prices as if oil with highly abundant.

In short, oil prices reflect the world demand and supply of oil. While a country or a single business can deviate from the world price for a time, it makes no sense to continue to do so. The more you try to create barriers between your price and the world’s, the more pressure there is to subvert your effort – because strong global economic forces will be impacting those who demand and supply the oil at home.

Consider the issue in a broader sense. All of us trade. There was once a day when we lived in caves and we did everything for ourselves. We learned quickly that families could form and they could allocate specific assignments to the members. This division of labor made it possible for individual family members to specialize with the result that family leisure and output would increase.  Some members were hunters and some were gatherers – and then they traded. This result from division of labor and specialization continues today. We trade unthinkingly for almost everything. Most of us are very specialized and we trade the money we earn from this specialization for everything we need. All countries trade and we have learned that the benefits of trade come regardless of the size or income of a country.

We are not forced into trading – we do it to reap the benefits of division of labor and specialization. The United States buys a lot from the rest of the world and oil is part of that trade. We may not like it when the world price of oil rises but we clearly gain overall from not doing everything ourselves. Trade is a net positive for us despite the fact that there are times when we feel imprisoned by it.   

The best thing the US can do is to try to influence the world demand and supply of oil. Since we are a very large and influential nation we have the clout to try to raise world supply relative to world demand. If we want the price of oil to be lower we should forget about separating ourselves from world markets and do the opposite – engage with other countries to solve the problem.  After the oil shocks of the 1970s we learned that both conservation and production incentives can succeed. These lessons need to be applied on the world level. Most nations are like the US – primarily importers of oil who would gain from a lower world price. So we should have plenty of allies as we seek real solutions. Engagement is the key.  We have a strong selfish incentive to work harder at home on production and conservation. Success means fewer imports and a stronger trade balance.  A stronger trade balance means higher growth and less needs for foreigners to support our international debts.  The idea here is NOT to be self-sufficient and to make our price lower than the world’s price. The idea here is to contribute to a more orderly world market for oil and energy.

In summary we may never be able to control oil prices at home but there is plenty to gain by working hard at home while negotiating with trading partners to raise world energy supply while incentivizing conservation of these scarce energy resources. Even if other countries do not follow, A US plan to conserve and produce oil and other forms of energy will pay dividends. 

Tuesday, March 22, 2011

The National Debt is okay because we owe it to ourselves. Right?

We owe it to ourselves. Nancy Pelosi among others has uttered this phrase as part of a rationale for why we should not worry about US Federal government deficits and debt. There are a couple of issues I would like to address. First, it is not true that we owe it to ourselves. Second, even if it were true, there would be good reasons to address the deficit issue. Let’s start with a simple but useful analogy.

I am retired so let’s suppose I need some money to finance a cruise to someplace really nice, like Alabama. 
So let’s say I need $1,000. I have some choices:
o   I can borrow the money from myself – that is, I can take the money out of my saving account. I promise to not spend some money later so I can replenish my saving account.
o   I can borrow the money from Betty. That is, I can ask her to take money out of her saving account. I promise to repay her in the future.
o   I can borrow the money from a bank in the USA. The IU Credit Union will deposit money into my checking account and after filling out 3000 pages of forms and leaving a blood and sperm sample, I promise to repay them in one year.
o   I can borrow the money from a bank in China. The People’s Bank of China will deposit money in my account along with coupons for three egg rolls at my local Chinese restaurant. I promise to pay my loan at the end of a year’s time.

If I repay the loans as promised then there is no big deal. But let’s suppose that after the Alabama cruise I get cruise-fever and can’t stop myself from going on cruise after cruise until I have ballooned to 300 pounds, sold my house, traded my collection of IU coffee cups, and basically declared bankruptcy. Does it matter how I borrowed the money? The answer is both yes and no.

It doesn’t matter how I borrowed the money in one sense – since there will be a negative repercussion in any case if I don’t repay. But the kind of unintended consequence depends on the source of the borrowing.
If I borrowed the money from myself then I cannot repay my own saving account. No big deal, right? Wrong! That saving account is what I was planning to use for important things in the future. Perhaps I was going to use that saving account to pay healthcare expenses or assisted-living housing. Getting into financial difficulty today has a real cost. It matters even if I borrow the money from myself. Postponing the repayment of the debt to myself means I transfer enjoyment from the future into the present. I might regret that later.

If I borrowed the money from Betty then we have a somewhat similar dilemma. If I do not repay her then we have an intra-household distribution effect. She has savings for important reasons too – for example all the nails on her fingers and toes must be attended to regularly by a licensed nail-professional. (I know I know – I am being very sexist here and I deserve whatever you decide to heap on my head. Please be nice.) Not paying my debt to Betty or postponing it means living with her ugly, ragged but personally-sharpened nails. I will regret that later.

If I borrowed the money from a USA bank and I do not repay it, then we have a national distribution impact.  My repayment was counted on by the bank to meet account withdrawals. If I fail to repay then bank depositors cannot withdraw funds they need for payments. Or perhaps the bank has lower profits or bigger losses. The stock values of my bank may decrease. Someone gets hurt financially and this has further impacts on others. Not paying my debt to the bank or postponing it means that the nation suffers.

If I borrowed money from a foreign institution and I do not repay it then we have an international distribution effect. This would be the same as the national distribution effect except that the impacts go to the foreign bank, foreign depositors, and owners of the foreign bank’s stock. Since fewer renminbi would be purchased in this case it would also reduce the value of the foreign currency. That raises the value of the dollar and makes it more difficult to sell US exports to trading partners. Not paying my debt leads to future impacts on foreign countries and the US (since we trade with China).

So Yes, it matters where I borrowed the money since the identity of the lender determines the nature of the distribution effects. But notice that in all cases there IS A DISTRIBUTION EFFECT and it is negative.  So in that sense it doesn’t matter.

You might say, I am missing the fact that an expected positive current impact was created and we have to pay for that benefit in the future. The expectation is that I will be able to pay my loan in the future. The problem arises only when something happens to prevent that. So it depends very much on what I presently use the loan for. If I use the loan proceeds for a productive investment, then the investment promises to pay enough to me so that I can pay the loan balance in the future. If I used the loan to finance a temporary change in consumption, then there is less chance for the payoff.

When Nancy Pelosi says we owe it to ourselves she is using a concept called net debt. Gross debt of the USA rises when the US government sells bonds or borrows – it is the value of the liability. But some or all of those bonds become assets to US citizens who hold those bonds. Suppose all the bonds were held by US citizens. When we subtract this asset value from the gross debt value we get a net debt equal to zero.  As a nation, we simply owe the debt to ourselves and thus we have zero net debt. But as the above cases suggest, we cannot ignore the expected distribution effects that arise when a debt is not repaid – or when we expect the debt will not be repaid.

When Nancy Pelosi says we just owe it to ourselves she is implying that we don’t have to worry about US gross debts that are owned by US citizens. But clearly she is being myopic and not considering the implications to ourselves once it becomes apparent that we are not managing that debt. We should worry about that debt to ourselves precisely because not paying it causes real and painful distribution impacts. Not paying off the debt means that the tax payers gains from the reduction of the liability. But not paying off the debt also means that holders of the debt do not receive their due. The net change debt change to the nation is zero – but the effect on the nation goes well beyond the concept of net debt as explained above.

We should have learned a great deal about debt mismanagement and how citizens of countries that have endured financial crises were harmed by it. Notice how much interest rates in Greece and Ireland rose once it became apparent that these countries might not be able to fully honor their debts. Those high interest rates insure slower economic growth and higher unemployment. And what about all those pensioners who held “safe” government bonds only to find out they were worth much less today than they were yesterday? When they are forced to cut back on their spending or sell their houses, how does that help them or their countries? These are the real world distribution effects arising from a nation that goes into debt because of unwise spending.

There is much risk of future declines associated with reneging on one’s debts even if we really owe it to ourselves. But it is not even a close call to say that we owe the debt to ourselves. Foreigners owned about $1 trillion in US government bonds in 2001 – by 2010 they owned over $4 trillion. They now hold more than 50% of federal debt owned by private investors and 31% of the total public debt. Should events lead to the US government being considered more like Greece or Ireland in the future, we would clearly have strong negative impacts on investors around the world. In addition to the government bonds, foreigners own another $13 trillion or so in private US bonds, stocks, and bank accounts – assets whose worth would also suffer from a US government debt problem.  

We need to face the facts. We spent decades getting into a fiscal crisis. We cannot wish it away with silly notions like “we owe it to ourselves.” Even if we did owe it to ourselves a debt problem would have very harmful impacts. But we owe the debt to countries everywhere and the harmful impacts will come from everywhere. The bottom line is that it doesn’t much matter if panic selling of US assets starts with John Smith or Lan Huang – if people think that US assets are worth less the results will not be pleasant. 

Tuesday, March 15, 2011

Aftershocks and Afterthoughts about US Economic Vulnerability in 2011

As I write this moment world stock markets are down again -- perhaps over-reacting but reacting nevertheless to a new bout of major uncertainty. Some forecasters believe this is the beginning of another economic meltdown. It is too soon to be making judgments like that but ff nothing else it should remind us about the fragility of the US economy and how vulnerable we are to shocks. In this post I continue my ranting about the urgent need to come to some agreement about future US deficits and debt. To not make progress makes us ever more susceptible to every shock that comes around. We are not making adequate progress largely because our political parties would rather squabble about traditional and sensitive issues than do the hard work of finding a way out of our debt mess. One morning last week, the headline in my local newspaper featured Vi Simpson, a respected leader of the state’s democratic party, declaring that the Republicans had declared war on the working man and the middle class. Yes, this usually intelligent and helpful representative of the Hoosier government used the “W” word. And she said it in public.

So now we are at war in Iraq, Afghanistan, and Indiana. Of course, the war she speaks of also has fronts in Wisconsin, Ohio, and DC. So I will now scream at the top of my lungs – YOU STUPID REPUBLICANS – YOU GOT WHAT YOU DESERVE. And the result is that moderate Americans who just want to see the economy improve have yet again been sucker punched by extremes in both parties. Are we so myopic (nice word for stupid) that we don’t see the game they play to perpetuate their own power? When are we going to recall all these extremists in our government and replace them with people who will focus on the whole country?

Surely when the Republican leadership meets they sometimes discuss the fact that their Democratic opponents and especially the extreme wing of that party can be pretty rough if not loud and ugly. What were the Republican leaders thinking when they decided that 2011 was the opportune time to take back all they had lost in recent years? Let’s make it impossible for gays to marry. Let’s throw water balloons at union members. Let’s re-write abortion laws. Let’s gut really popular government programs. Let’s make schools more like they used to be in the1950s during the Sputnik scare. Did I miss anything?

Really – was 2011 with a divided government the best time to irritate the other party by focusing on all their hot buttons? Really – was 2011 the time to let all the extremes in both parties elevate all their hot buttons so much that the REAL ISSUE does not have a chance to be debated and confronted in a contentious but eventually cooperative environment?

Some people say that this is politics as usual. But I beg to differ. This is politics at its worst because the leaders of both parties let their extremes dominate. I am not kidding when I say that I wish for the time when parties acted like real parties. They always had extreme factions – but there was a time when these extremes were thrown a few crumbs and told to sit in the corner. But look at Reid and Pelosi – they are a joke.  Boehner isn’t much better. They help these extremists throw Molotov cocktails at the rest of us.

The way we all go along with this destructive behavior makes you wonder if there is some elusive or hidden benefit we receive by smiling as the USS Titanic leaves port. Perhaps we like the freedom that allows all sides to express their opinions. Okay – that’s fine. Whether or not the armed forces have a “don’t ask don’t tell” policy is very important to many people. But do we really want to spend all our time RIGHT NOW debating that issue instead of coming to a real compromise on government deficits and debt? When the Titanic was going down people didn’t argue about unions. They focused on how to save themselves. The times require a solution to the most pressing issues. Yet we let the extremes persuade us that it is better to let the ship go down while we spend our last precious moments arguing whether Miller Lite is less filling or less tasty. 

Why do we sanction this destructive behavior? I think there are three key reasons. First, none of us like to admit that we have to go backward before we can move forward again. We got hit by a car, have numerous injuries, face a long rehab, and we are faced with the fact that there is no wonder drug to makes us immediately well again. Second, the rehab program is not without controversy. Good physicians disagree on the best programs because the body is complicated enough that no one can know exactly how a program will work. Third, we know there will be side-effects from the treatments and we fear the unknown. Faced with a very difficult situation it is understandable that we humans may want to postpone decisions even knowing that postponing may make things worse. As a result we are easily distracted and those at the EXTREMES see this as easy fodder for them.

So what do they do as we worry about very difficult and imminent challenges? They divert our attention to things that are guaranteed to arouse us emotionally. Hey guys, don’t worry about the Titanic going down – let’s watch re-runs of Charlie Sheen? Or maybe you would prefer Oprah? Let’s solve poverty today. Or maybe we should make sure rich people pay a larger share of taxes. PLEASE. These ARE important issues and we need to address them – but right now we have to sober up and focus all our energy on deficits and debt. Let’s not be duped by the extremists. We are smarter than that. Spillovers from the recent earthquake and tsunami ought to remind us of that!

Tuesday, March 8, 2011

Government Spending and the Law of Gravity

Despite having no real propensity in physics, I found myself in that course at Georgia Tech in 1965. I vividly remember a tutor, Professor E. E. Bortell, chanting for the benefit of us slow learners “What Goes Up Must Come Down.”  Actually Professor Bortell would say loudly – “What goes up must…..” and we could chime in “Come down.”  We did it over and over. It was fun and it kept us awake.

So what does that have to do with government spending? I checked the historical record and found that the federal government of the USA spent almost $93 billion in 1945. In subsequent years it went down to $55 billion, $34 billon, and $30 billion. It was pretty clear why the government spent less in those years – World War II was over and it was not necessary to keep spending at that rate. It took until 1961 before government spending reached $93 billion again.

We all understand that some things are temporary. We wear braces for a while but then discard them when our teeth are straighter.  Girls wear training bras until their stuff gets trained and boys get in fights until they learn that stuff about the girls. What goes up eventually comes down. Or does it? Even in the case of World War II there was some debate about the government reducing its spending. Alvin Hanson was a professor who believed in the Secular Stagnation Hypothesis and argued that reducing government deficits after WWII would bring back the Great Depression. In his view spending from the war only stopped the Great Depression temporarily. Without government spending the economy would forever be destined to economic purgatory (or worse).

Is that beginning to sound familiar? If we reduce government spending today, some experts believe surely we will have a double dip and it won’t be chocolate chip. The government didn’t listen to Hanson in the 40s and government spending was allowed to return to a more normal peacetime level. The government deficit had reached an intolerable $15 billion (almost 22% of GDP) in 1945 and returned to surplus for the next three to five years. Today we have a similar situation – we had a temporary surge in government spending during the recession of 2008/2009 and it is time to remove the surge. Or is it? Listening to our friends in government, you would think that what goes up ought to stay up.

Let’s think about the rhetoric as it relates now to the current budget-cut debate.  Think about the emotional and spirited language and gesturing you are seeing on the television. “By God man, you can’t cut that program. Think of all the misery you will cause.” But what does CUT really mean? What I show below is that most of what people are calling cuts are really what we might call a Restoration of Trend – or a return to a more normal growth path.

My focus in this posting is on what is called Federal Discretionary Spending (DS). What I am showing here could easily be expanded beyond the roughly $1.4 trillion we spent on discretionary programs in 2010. DS increased by $306 billion in the three years between 2007 and 2010. That was a 29% increase in three years. In the three years before, 2004 to 2007, DS increased by $146 billion or by 16%.  By any description, the last three years showed a HUGE growth of government wherein spending on DS was approximately double the growth in the previous three years. What value would DS have reached if it grew by the 16% instead of the 29%? Answer – about $1.2 billion or about $135 billion less than the actual amount achieved in 2010.  If in 2011 you took back or removed that extra $135 billion would that be a CUT or a Restoration of Trend?

You say I am playing with words. But this exercise is not about games – it is about making clear that HUGE TEMPORARY INCREASES in government spending are not entitlements that must last forever.  Taking back the $140 billion is NOT A CUT – it is restoring government growth to a sustainable pattern.  Notice that in the above exercise we are letting DS grow buy 16% in three years.  How many of you had increases in spending of 16% between 2007 and 2010?

Below I show the Restoration of Trend Amounts (in millions of dollars) for specific components of DS. The first column shows how much could be reduced from the program to allow it to grow in 2007 to 2010 by the same growth rate as it grew in 2004 to 2007.

Because of the technique used the items for the components do not add up to the total outlay amount. What you see here is how much we could reduce the spending in 2011 compared to its amount in 2010. For example, the education budget could be reduced by $44 billion dollars – and still allow the growth rate to have been 9% from 2007 to 2010. Notice that education spending actually increased by 83% in those three years. Would it really be a huge negative impact to give up some of that explosive growth? Did people become so addicted to the temporary increase that they cannot live with a 9% raise?

I won’t go through the table line by line but notice the last column and the extremely fast growth of spending during 2007 to 2010. Spending on Energy in those years increased by 179%. Except for the two line items at the bottom of the table, spending in 2007-2010 was much faster than in 2004 to 2007. This implies a few things. First, these increases were meant to be temporary.  Second, they are clearly unsustainable. Third, as the first column shows, there is much that could be reduced from 2011 spending and still allow a very rapid increase in spending. I am not suggesting that we remove exactly those amounts in the first column. We could remove more – we could remove less. But surely a prudent policy begins with understanding that these are in no way real cuts.

Note -- I had some trouble getting this table into the post. If it looks too  small to you I think you can just click on it and it will expand to a larger size. Sorry I am pretty lame at this kind of thing!


Tuesday, March 1, 2011

Debt, Democracy, and a Double-Dip Economy

We are used to planning for the future knowing that things never work out exactly like we thought they would. Formally or not, we base our plans and actions on highly probable outcomes. I know that whenever I eat pasta I get sauce on my shirt and sometimes in my hair. It is predictable. So I wear a shower curtain at the dinner table. That’s what we do. We plan and prepare for events that have highly likely outcomes. And accordingly we do NOT plan for EVERY possible outcome. Some things are highly unlikely with almost zero possibility. While eating, I might learn that Madonna is going to join us for pasta primavera. For such a possibility I should be wearing only my best shower curtain. But, of course, I don’t because there is no way she is going to show up in Bloomington for dinner at my house. Accordingly we don’t worry about Martians or Charlie Sheen at the dinner table.

But there are events that fit in between the highly probable and improbable and we give them our attention.  We might say that we have a contingency or back-up plan for things that might happen, even if the probability is low. We buy life insurance policies when we are young because it is a prudent thing to do despite the fact that we might live through seven colonoscopies. Business firms hold costly inventories in the case that buying for their products is higher than normal. To NOT prepare for these possibilities is to be imprudent or we might call it risky behavior. NOT preparing for one-in-a-million unlikely events is excusable. Not preparing for somewhat unlikely events is not.

Today we don’t seem to know one unlikely event from the other. A terrorist plot to fly airplanes into tall buildings on US land used to be unthinkable – but now we spend a lot of money protecting ourselves from that kind of behavior. A financial crisis grips the US and the world – something that few of us prepared for but now has governments rethinking regulation and how markets should function. A revolution breaks out demanding democracy in Northern Africa and the Middle East – surely a plot for a futuristic novel but now all of us are scrambling to deal with the likely contagion.  One might argue that we should have known that all these things would happen. But the truth is that not enough people REALLY thought any of them would around the time they unfolded. They were pretty-much black swans. A black swan is a major event with very low probability – sort of like me driving to town without Betty telling me I picked the wrong route.
Today we are pausing to ask about the possibility of another major economic crisis or if such an outcome fits this black swan description right now.  To resolve this issue we have to calculate the probability of another economic collapse.  If a strong downturn is really highly unlikely, then it would be wasteful and costly to try to prevent it. But if it is not a black swan and there is something we could do, then we would conclude that our policy makers have their heads in the sand.

Recent events make me want to revisit the likelihood of another recession. We were cruising along pretty well in the last months – with lots of data pointing to a firmer economy. We are now seven quarters beyond the official end of the last recession.  Risk factors are well known and discussed frequently – the housing market needs more time to heal, government budgets need fixing, and emerging markets are causing threatening price rises of commodities, including oil. But the general consensus of most economists and the stock market is a rosy outlook with a small probability of a recession.

So why is Larry so cranky? I ranted recently about jeopardy – the idea that these risk factors should be given more of our attention. I particularly believe that government deficits and debt need our immediate attention.  Can we handle the debts now? Sure! But that’s not the point.  The point is whether or not we can handle the consequences arising from a few low probability events or shocks.  And last week pointed out how very unprepared we are.  Last week the political disturbances abroad caused oil prices to shoot up and our journalist herd quickly taught us how to spell S-T-A-G-F-L-A-T-I-O-N.  Last week we read and heard again about the 1970s and how and why a large and sustained rise in the price of oil might cause simultaneously higher unemployment and inflation.

A few journalists and economist s wrote more thoughtful explanations about why an oil crisis of the proportions we are experiencing today might not lead to as much economic wreckage as in the recessions of 1974 and 1980. But the point has been made. A black swan flew into our lake and left a big poo-pee. Maybe our economy will stick its nose up and go on with growth anyway. Or – maybe some white swans will join her and make the mess much worse. Right now we don’t know.

But this illustrates our choices. If we had a more normal debt position such an event might knock us around for a while – but having a large chain around our necks make us weaker and unable to deal with a large oil/commodities price shock right now.  If you had six months of earnings saved and in the bank when a bout of unemployment hit you, life would go on. If you have nothing but debts when unemployment strikes that is a much different situation. In that case it really hurts and you have few good options.

If stagflation hits the US – whether because of oil or the prices of other commodities – the US government budget position and debt will worsen even further.  The recession part of stagflation means that tax revenues will decline and spending will increase. The inflation part means many things – but surely interest rates will rise and cause mandatory government spending to increase.  And as most people know – stagflation puts the government and Fed in a no-win battle with inflation and unemployment.  Using traditional demand-focused policy tools, any policy designed to slow the rising inflation will make the unemployment worse. A policy more focused on the recession and unemployment will make the inflation worse. With fragile confidence today, can we really flirt with these outcomes?

Is the probability of stagflation high enough to warrant a faster and stronger approach to US debt problems? I think so. Clearly recent days indicate that the demand for democracy and the impact on oil prices is no longer a black swan.  But is the probability of continued disruption of oil markets high enough to warrant all the difficult political and economic changes that go with a fiscal solution? Clearly the expected payoff of a solution is huge. Imagine the newspaper story detailing the immense losses connected with the following headline – US unemployment rate rises past 10% as the consumer price index reach 6% in 2011. Why don’t we demand more from our representatives in government?  Let’s get this debt under control before the next sneeze becomes pneumonia.