Feb

11

GregReading the papers over the last few weeks, it is weird how thrilled financial reporters seem to be at the idea of a major recession. Maybe the excitement is just that a bone-jarring recession is so rare. Like a volcano exploding after a long dormancy, it is big, big news. Most reporters were taught in college to expect market failures and fragile markets jolting everyday folks with greed-fueled mergers, takeovers, downsizing, and spectacular corporate frauds and flameouts. Instead, by and large, the American economy has powered ahead for a couple decades creating millions of new jobs and trillions in new wealth.

Twenty years ago recession fears were more justified. But modern recessions may be a far different and less dangerous animal. (The stock market drop may more reflect the reasonable fear that hapless politicians will overreact to a short recession with a wide range of monetary mischief and fiscal pork spending.)

Across developed economies, manufacturing coordination depended on months and years of lead time. Factories carried vast inventories of parts and raw materials. When demand for cars, houses, machines, or clothes dropped unexpectedly, sunk inventory costs had to be written off. Unions ruled, and when labor demand fell, wages were fixed and payrolls hard to reduce.

But the dot.com boom that brought the dot.com bust and the housing boom that brought the housing bust are much, much smaller distortions than the inflation and price and wage controls that distorted the U.S. economy in the 1970s. Prices carry vast flows on information driving adjustments and innovations. Price controls stop all that, whether in Zimbabwe today or the U.S. (Nixon's 1971-74 wage and price controls). So for a few years the economy ran blind, facing backwards and using past prices to guess the way ahead.

The very good news for investors today is that the hint of recession may blast the latest speculative boom in commodities. Novice day-traders that brought foolish bets and blew air into the last years of the dot.com bubble, moved after the crash into leveraged real estate investments, and those that survived that debacle are now in oil, minerals, and gold. I don't claim to know how much of the recent boom in these materials is driven by inflation and how much is speculative. But the third factor for the boom in oil, coal, and other minerals is the long fall in prices of the 1990s. As many others have noted, much of today's oil high prices are a consequence of the very low oil prices of the early 1990s. Major oil companies dramatically cut back exploration and sacked thousands of workers. New oil exploration was not profitable at $15 a barrel oil, and industry had nifty new exploration technology based on every cheaper computer processing power. Oil industry executive imagined they coast to new oil discoveries and scaled by expensive exploration.

But on the demand side, billions of people in China, India and Eastern Europe gained economic freedom and prospered far faster than economists expected, pushing energy demands up faster. And on the supply side, government interventions hampered new exploration and investment in Russia, the Stans, Africa, Indonesia, and Latin America. Suddenly, not only had investment in new exploration and technology been scaled way back by low prices, but the vast barely-explored territories expected to be available for current technology, was again buried in murky red tape and corruption.

High energy prices, however, bring new minds to both the supply side and demand side of energy. We have today a vast array of massive investments in energy production, both new and old. Government regulations and subsidies are of course wasting billions on the wrong technologies (like corn-based ethanol, wind, solar, and hydrogen power), but high prices are pushing energy production and raw materials expansion like never before.

Dozens then hundreds of huge new oil, gas, coal, and mineral production operations will come on stream in the coming months and years. A hint of economic slowdown now may shake out overly-leveraged resource speculators and drop prices significantly. But once the tens of billions of dollars have been invested in new infrastructure in Australia, Brazil, Africa, and the Middle East, these resources will flow to markets based on marginal costs, so price drops won't slow the flow.

So, for the U.S. economy the news is good. Energy and resource prices will fall. And these prices aren't even considered much of a problem in today's economy. Reporters have no idea how fast today's firms can adapt to shifting demands for their products. (They are learning, though, how media firms respond to dropping circulation and advertising, and the public's reduced demand for distorted print media stories.)

Modern service and manufacturing industries no longer depend on extensive parts inventories and cumbersome long-term supply contracts, so production can be slowed at much lower cost. Suppliers have the same flexible and just-in-time relationships with their suppliers, who can shift production and throttle back with much less disruption.

For transportation, instead of the heavily regulated trucking industry of the 1970s and 1980s, America today has hundreds of fast-evolving trucking and logistics firms. And hundreds of companies now rely on Penske and other truck-leasing firms for a significant part of their distribution, so they can reconfigure or downsize cheaply.

Booms are disruptive and slow-downs are healing. Boom times are when money too easily made flow to careless investments colored by vain optimism. The easy-money and bubble mentality throws money at many ventures that maybe might work, but always drawing human and material resources from less exciting but more proven ventures.

We see this in Silicon Valley today. The smartest and best-positioned people in the world are spending their lives and fortunes to address the non-problem of CO2 emissions. The newspapers and magazines are all aglow with news of the super-cool electric sports cars and alternative energy projects where high-tech venture capital and venture capitalists are pouring their money and time. What is the opportunity cost of having folks like Al Gore shaping technology investments? Well, what are they not doing and funding? A billion people in India are mostly impoverished, and the richest Indian in Silicon Valley spends his time and money on wind and solar power projects for America. Where is his real expertise? (At least Bill Gates has the good sense of focusing his philanthropic efforts on what is actually killing people in the developing world.) Will the Google's leadership in search engine suffer from endless Google alternative-energy projects?

The Great Eye of the Market is a fusion of millions of minds focused on specific tasks. The Great Eye today searches all aspects of natural resource markets. Every undiscovered underwater drop of oil and underground lump of coal is being searched for by the largest pool of capital and array of technology in the history of the world. As powers greater than the greatest armies of the past wrestle with these challenges, millions more around the world search of ways to save energy, invent new energy, and find substitutes for expensive minerals. The fruit of the massive worldwide search will come to market over the next decade, no matter how far oil and mineral prices over the next decade.

The Great Eye of the Market is a vast collective force, but driven by free thinking individuals set on finding and funding new innovations. As millions around the world turn their manic energy to finding and developing energy sources, energy technologies, energy innovations, they push the energy and natural resource envelop, and some few will no doubt uncover dramatically disruptive undreamt-of discoveries. Markets may overreact, but in the process they push billions of dollars and focus millions of minds at making a better world.


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