Wednesday, April 22, 2009

Prosperity and Decline

In an Earth Day speech, President Barack Obama said “The choice we face is not between saving our environment and saving our economy – it’s a choice between prosperity and decline. We can remain the world’s leading importer of oil, or we can become the world’s leading exporter of clean energy."

I may be a big critic of Obama, but this is one place where we totally agree. And even though I spend most of my time attacking the president, I have also offered solutions. In fact I believe I have offered the most ambitious and realistic 20 year plan for completely eliminating all foreign oil imports. That plan is outlined in the 21st Century Interstate Highway Project. This is not some pie-in-the-sky idea that has no basis in reality. It is a highly scalable solution that does not rely on ANY technology that is not yet proven, such as battery packs that can deliver 200 miles of range at a reasonable cost. Yes, it will be at least 20 years before we have the battery technology to build vehicles that can travel 200 miles on a single charge, at a price that is reasonable.

Consider the fact that it would cost $250 billion just to build the batteries for 50 million cars, assuming that each battery costed $5000 apiece. But $5000 wont get you more than 50 miles today. And a decade from now we'll be lucky to get a 100 mile range out of a $5000 battery. That is why we still dont have any appreciable number of electric cars on the road. Who is going to spend $5000 on a battery when even at $4 a gallon, $5000 worth of gasoline will fuel the average Toyota Camry for about 4 years? The math just doesnt work. At $2 a gallon, $5000 will fuel the average Camry for nearly a decade. Who is going to spend that much on a battery when there is no guarantee that the thing will even last 10 years? Before you scoff at the thought of $2 gasoline being used in a longer term calculation, be aware of the fact that electricity prices rise and fall along with gasoline prices. And surely you are not forgetting that it is going to cost a couple grand in electricity bills to charge the battery over the course of many years? If gas prices double, it is a good bet that electricity prices are going to go up by at least 50%. And here's another thing to consider: the cost of a battery is an upfront capital cost. By using gasoline, you are able to put off paying the upfront capital cost. How much is that worth? Well figure instead of buying that battery for $5000, you take that money and put it in a bank making 4% interest. In one year that gives you $200. Over the course of a few years you get quite a bit of free gasoline out of the deal. This illustrates the huge advantage of not having to pay upfront capital costs. Now imagine having to take out a loan to buy that battery! So instead of getting free gasoline, you are now paying ungodly amounts of interest just for the honor of having that big expensive battery that still costs money to recharge.

See, you have to run through an awful lot of numbers and do a lot of math before commiting to a certain national policy. I'm not convinced that most greenies have done their homework. What I've outlined above I can assure you is merely scratching the surface of the hidden costs of trying to replace gasoline with a battery. But even if you could make the math work, you then have to answer additional questions, like this one: "what happens to the cost of raw materials if we try and build millions of batteries quickly?" They could end up costing more if we have lithium supply problems. That illustrates another huge set of unknown variables that prevents anyone with deep pockets from investing down this path. Yes there is a very clear reason why we are "addicted" to foreign oil. Anyone who thinks that we can magically wean ourselves off of black gold without some very serious effort is simply deluding themselves.

The only realistic option that I see is to build a modular mass transit grid for automobiles. The grid doesnt require many exotic raw materials. Just steel and concrete and lots of labor primarily. (These are things we have in ample supply.) Once the grid is built, it will only cost $1000 per battery. That enables a completely electric vehicle to cost LESS than its gasoline-fueled counterpart, once mass production begins. And make no mistake, money talks. A lower price tag is required to make the transition. And this is without any subsidies at all.

The last time we embarked on an ambitious national highway grid, time proved it to be a valuable investment. Only after 50 years is the basic design starting to become a serious liability. It is that basic design that needs to be updated. By focusing our engineering efforts onto the grid itself and how vehicles travel on it, we allow the individual vehicles to shrink in weight and complexity, and thus shrink in price. That in turn allows more people to own a vehicle. At any rate I dont want to hear anyone say that all I do is attack Obama and never offer solutions. This IS a workable solution. It wouldnt be easy, it would requires many millions of man hours in both engineering and manual labor, but it CAN be done. Building a bunch of windmills and hoping that we somehow magically invent the means to transfer that energy into an affordable battery is not a workable solution. Not to mention there is a whole host of issues involved in the logistics of building a massive number of windmills. Dont forget that those pretty spinny things also require massive resources to build. Why spend all those resources building things that require unproven technologies in order to bring a usable product to the end user? That is a recipe for disaster. We are masters of steel, concrete, and automation. The 21st Century Interstate Highway Project requires only these things in mass quantity.

With all that being said, it is now time to resume my slugging on Obama. There is a problem in the economy that Obama just doesnt recognize. Global crude oil production has been flat for the last 4 years. This year it will register a very significant decline. Given the massive decrease in investment in the oil sector, as well as the severe decline in natural gas rig count, it is safe to say that it will be a long time before energy production reaches 2008 levels. There is a good possibility that we may never see as much total energy produced as was produced last year. That is going to make recovery problematic to say the least. I've been arguing for ages now that it was our energy situation that led to the financial collapse... that's been beaten to death so I'm not even going to get into it now. What I want to focus on right now is the disastrous consequences of Obama's bailout + stimulus strategy.

When we go into a recession, what brings us out of it is a more efficient use of resources and capital. Ideally, what will happen is that all the irresponsible debtors are forced to default. Then the people who know how to manage money and capital are able acquire assets at depressed prices. Meanwhile the irresponsible borrowers are forced to live within their means. This includes a reduction in the consumption of resources. This then causes a reduction in the price of all forms of energy and energy-related commodities. Anyone not in debt is able to take advantage of those lower prices. They are then left with more money to invest how they see fit. Since these are the people who have proven themselves to be best at managing money, they are the ones who are able to allocate capital most efficiently. This is how the free market is able to bring an economy out of recession.

In the bailout & stimulus scenario, here is what happens. Those who have proven themselves unable to manage money and resources are bailed out, which means their bad behavior is given a subsidy. This is ideologically flawed for obvious reasons. However, there is another negative effect. Because they are bailed out, they are not forced to reduce their consumption of energy and all other commodities. This creates a greater demand for these commodities, preventing the price from falling. Since the prices do not fall as much as they should, the responsible people who know best how to manage resources are unable to acquire a larger share of those resources and capital. So they are unable to perform their natural function of increasing resource efficiency in an economy. So the economy is unable to recover. If this dynamic is allowed to continue, the result will be that resources will continue to be wasted, the economy will be unable to restructure itself through free market means. The government simply cannot perform this role effectively. Even Obama concedes that this is a fact, by saying that his stimulus plan is aimed at the private sector. He wants to create private sector jobs, not government jobs, etc. By making such statements he admits that the private sector is more efficient at allocating capital. But what he fails to understand is that the very act of stimulus + bailout prevents the private sector from being able to restructure itself more efficiently. Bad debts must be allowed to be purged from the system. Money needs to change hands. Capital needs to be transferred from debtors to creditors. Only then can the capital be put to more efficient use. And only then can we begin to make more efficient use of resources.

Obama thinks its a good idea to try and keep 5 million people in their homes when they would otherwise be foreclosed upon. By doing so, he is creating an unjustified demand for 5 million extra loads on the electric grid. And 5 million extra loads on the natural gas supply. And 5 million cars sitting in those driveways that all need fuel. It also creates an artificially elevated demand for housing. This means that prices for wood and concrete and drywall and a hundred other things are all artificially inflated. Dont forget that it takes massive amounts of energy to produce or procure ALL that stuff. All that extra energy demand raises energy prices for everyone, including those that did nothing wrong. Thus the economy is not able to recover as it otherwise would. It is this bailout mentality that has, over the course of many years, created artificially high prices and has prevented capital from flowing into hands that can make best use of it. There can only be one result of this type of command and control economic system. Look what happened to the Soviet Union and every other economy that tried to do things this way. It is not capitalism that brings about this type of systemic failure. It is the failure to allow capitalism to run its course. The cycle of bankruptcy must not be impeded. If every insolvent person, corporation, and government were to declare bankruptcy today, the end result would be a massive transfer of ownership to those who best know how to manage resources and capital. As long as the rule of law were upheld, this would result in the most productive allocation of capital.