Kent on Current Events

Umbilical Oil - Part 2 (demand)

2009-11-03T22:31:00.001-07:00

'Organic' Demand

It should come as no surprise that oil is the most valuable widespread global commodity in Western civilization. In relative value terms, oil has surpassed gold. A broad range of uses including energy, transportation and non-energy/material uses are, in large part, the reason for this. Industry uses just under ten percent of the refined crude oil in order to manufacture goods and services. Commercial, residential and agricultural sectors use just under thirteen percent--much of that for heating and electricity. Non-energy uses of hydrocarbons include plastics, synthetic clothing (eg. polyester), cleaning and lubricating agents, as well as binders like asphalt. Eighty percent of the asphalt refine is used for building roads. Which leads to the sector that consumes the largest volume of crude oil--transportation. Only a few modes of widespread transportation don't consume any oil; walking, cycling and electric trains are among the few examples of these. I don't have statistics on this, but the percentage of motorized vehicles that don't consume refined oil products is probably less than 1% (hybrid-electric vehicles are still powered by oil). Between cars, trucks, boats and planes, the world consumes about sixteen billion barrels of oil each year.

Industrial consumption is already at it's lows. Heating and electricity loads are unlikely to change much in the near term (alternative energy and efficieny improvements could chip away at this in the long term). Non-energy sources are also pretty static as far as demand goes; there is an obvious reluctance to return to cotton diapers and no one likes driving on gravel roads. That pretty much leaves transportation sector to the task of reducing demand.

There are essentially two ways to reduce organic demand in the transportation sector (1) improve efficiency and (2) reduce volume. Improving efficiency implies activities like purchasing new, fuel efficient airline fleets and passenger vehicles. This requires significant capital investments and thus time before it can become a reality--even if it makes economic sense to do so. Industry leaders such as GM and Tesla Motors estimate it will take ten years and lots of government subsidies before hydrocarbon-free transportation vehicles start to become competitive in the mass markets. It will take even longer (30-40 years)^* before significant market share is acquired by alternatively powered vehicles. On the volume side, while per-capita car ownership in the United States has probably peaked, passenger car ownership in emerging economies continues to skyrocket. This is part of the reason why the transport sector only amounted to 45% of total oil consumption in 1973 and is now over 61%. China and India alone would need 2 billion cars to approach the rate of car ownership that the United States has.

Given that any major initiatives to reduce dependency on oil will take time, there is really only one way to reduce near-term organic demand for oil--higher prices.

That being said, there is a level above which the price of oil will not only be self-limiting but potentially even catastrophic in contributing to a recession. In early 2008, when oil prices pushed well past $100, the transportation sector began to collapse along with the eventual low at the end of that year. This was made worse by other issues such as the subprime housing crisis, but the bottom line was that people could no longer afford to fill up their gas tanks and thus prices necessarily fell.

Given the continued weakness of the U.S. economy, along with rising unemployment expected to peak in 2010, a high enough price could contribute to another recession and result in another price collapse. This instability price point is probably above $80 and not as high as $150. Filtering out price corrections, the trend for oil prices would appear quite bullish based on supply and demand alone.

There is however, one final part to this story: the measuring stick (the dollar).

Umbilical Oil - Part 1 (supply)

2009-10-19T23:31:00.000-06:00

Crude oil, unlike natural gas, is a commodity in much shorter supply at current prices. While a vast amount of total reserves still exist, the marginal cost of production of these reserves continues to increase. Impressive technological improvements have only partially offset the increase in finding, development and operating costs of these deeper, tighter and less permeable hydrocarbon reservoirs.

Worldwide, average recoverable oil reserves have historically been around 30-40%. In other words, for every 100 barrels of oil we find, we can only economically produce 30-40 of those. Natural gas recoveries, by comparison, have historically been in the 70-90% range. Of course, if market prices are higher, economic recovery rates also go up as energy companies can spend more capital and energy to improve efficiency. Physics and thermodynamics however, ensure that this relationship is typically a logarithmic one--doubling the oil price could, for example, only lead to 5% more recovery. On the gas side, it's much easier to move the relatively small independent methane molecule across the reservoir rock and to the wellbore than a large viscous molecule of crude oil. Two of the largest undeveloped reserves of oil in the world are deep offshore oil and unconventional resources like the oilsands. Both have the potential to produce a vast amount of oil, but it will take a lot more to fill up the gas tank if we are to rely exclusively on fuel derived from these sources.

Offshore Oil
For comparison's sake, I will compare BP's recent 'huge' Tiber oilfield find to Ghawar. Ghawar, the world's largest and most prolific developed oilfield, has produced 48% of the 131 billion barrels it's operator, Saudi Aramco, expects to recover. It has a very favorable set of geological preconditions that we have yet to find anywhere else in the world. The number of large oil discoveries is dwindling and those that have been made also have more fragile economics because of the engineering (and political) complexities involved. BP's recent Tiber oil sits 10.6 km below the ocean floor--that's more than the height of Mount Everest. It also sits in 1.2 kilometer deep water--deeper than the crush depth of the most advanced military submarines. Some submersibles and special unmanned vehicles can get this deep, but it speaks to the challenges involved. Challenges that will ensure the oil does not come out of the ground cheaply. Even when the infrastructure is in place and capital expenditures have been made, early recoverable estimates for Tiber of up to 1 billion barrels would only sustain current global oil consumption for 12 days (a thousand barrels a second is about how much the world currently consumes).

Oilsands
Unlike offshore oil, oilsands are typically very shallow and geographically accessible. It is the quality and flowability of the hydrocarbons that present challenges--the oil is too viscous to be produced using a conventional oil well scheme. The oil is typically either mined and extracted from the sands using steam, or it is produced 'in-situ' using a steam-assisted gravity drainage (SAGD) technique where high-energy steam is injected to lower the viscosity of the oil enough that it can be produced in a horizontal well. Both techniques use vast amounts of steam, which itself requires lots of energy to produce (currently most of the steam generation is produced by burning natural gas). Unlike conventional crude oil, the resulting hydrocarbon slurry then needs to be either upgraded or mixed with lighter hydrocarbons before it can be pipelined to a refinery. These processes often involve several steps such as distillation, cracking the large molecules into smaller ones, removing sulphur and heavy metals and in some cases dilution with lighter hydrocarbons (i.e. condensates). One of my textbooks from elementary school said that the oilsands would never be commercially viable. The authors were wrong--but producing the heavy oil isn't cheap by any means. Not to mention the potential of added costs due to environmental regulations and CO₂ reduction or sequestration.

"Currently oil at about $60 to $70 per bbl we think is not enough to justify some of the significant projects we are contemplating, especially on the mining side," says Jean-Michel Gires, CEO of Total E&P Canada. The energy company CEO went on to predict a sustained price of at least $85 was needed to make many these projects commercially viable.

From the supply side, it appears as though the fundamentals might support an oil price of around $80/barrel, with a continued ascent upward as the elephants* mature and decline. But that's just the supply side--stay tuned for the demand side (part 2).

*the term 'elephant' refers to a very large oil field, typically one that contains at least 100 million barrels of recoverable oil.

Swamp Gas

2009-08-24T20:49:00.018-06:00

Swamp
-noun
5. to overwhelm, esp. to overwhelm with an excess of something: He swamped us with work. [Dictionary.com]

Swamp Gas
-noun
An organic decomposition product gas which is mostly methane, the primary component of Natural Gas.

The Natural Gas Story
As crude oil prices continue to rise to pre-recession levels, prices for natural gas, the other base hydrocarbon commodity, continue to flounder. Last week NYMEX Natural Gas futures for September fell to a seven-year low below US $3/mmBTU.

The spikes are indicative of the vast reserves of natural gas, which unlike peak oil, can come on stream relatively quickly and cheaply. Liquefied natural gas technologies have also created a 'pipeline' for inexpensive natural gas reserves that were previously stranded. Worse yet is the high price of oil, which has in recent years, been in lockstep with the Canadian dollar, meaning Canadian gas producers will get even less for molecules produced north and sold south of the border. Storage levels are near all-time highs and hundreds of cubic feet per day have been shut in awaiting higher prices. The U.S. economy remains slow to return to growth compared to emerging economies despite all the stimulus. Some analysts believe a number of small and mid-cap producers will simply need to go out of business before prices for the commodity fall back in to balance. North American workers in the Oil & Gas industry have been relying increasingly on drilling natural gas wells as oil production on the continent continues to decline from it's peak (with the exception of the oilsands and other unconvnetional reserve plays). A cool summer will likely mean a tame hurricane season and forecasts of a mild autumn will keep heating demand low. All of this has been fueling rumours that the North American Exploration and Production companies will need to begin layoffs in the fall while M&A activity will increase.

Not quite apocalypse...yet
Despite all the bearish news, it's not quite time to predict an apocalypse yet for North American producers. This could still happen, if the U.S. economy were to fall into a second recession in the next 18-24 months from a economic stimulus hangover, prices could fall towards $1/mmBTU or less. For now though, contract futures beyond December 2009 continue to be sold above $5/mmBTU, a level at which most producers can be marginally profitable. Most of the hedging contracts made in 2008 when prices peaked are now expiring, leaving buyers free to spend more on new contracts and push prices higher. A U.S. government bailout could also come in the form of tax incentives for natural gas powered vehicles, furnaces or power generation, which would also push prices upwards. We're probably near the bottom, but I wouldn't hold out on $15/mmBTU gas prices anytime soon.

Coming next is the Crude Oil story.

Tax Time

2009-05-30T20:27:00.008-06:00

Many Canadians and Americans are wondering if taxes will go up, when they'll go up, and how they will will go up. The answer to the first (if) is quite easy, the second (when) a little more difficult and the third (how) is still on the drawing board. Nonetheless, the scribbles are happening...

If?
With unsustainable debt and deficits in Canada and the U.S., every political insider knows that taxes are going up. They just won't talk about it because it's unpopular. Furthermore, they'll try and use clever names to try and avoid the word 'tax', which has always had negative connotations. A quick look at the projected numbers (table below) makes it pretty obvious that without an unfathomable decrease in government spending, taxes are going up. An additional problem is the large projected increases in entitlement costs (pensions and health care) over the next several decades.

Fiscal Year	US Deficit^*	Canada Deficit^**
2008/2009	$459 billion	$9.1 billion
2009/2010	$1.7 trillion	>$50 billion (up from $33.7 billion)
2010/2011	$1.1 trillion	$13 billion (not revised)
2011/2012	$693 billion	$7.3 billion (not revised)

*Congressional Budget Office
**Canada's Economic Action Plan

When?
The economy is showing signs of reflation with commodity prices increasing. Rising Treasury yields are a clear sign that cost of borrowing cannot be held artificially low for much longer. The foreign apetite for holding U.S. debt is falling. It is "time to sell" treasuries, said Kim Heeseok. Heeseok is the head of South Korea's National Pension Service, the country's largest investor in U.S. treasuries. All of this is an indication that the answer to the question of 'when', is likely sooner rather than later.

How?
There are three general classes of options for increasing taxes:

Sales Taxes (Value-Added-Tax, Sales Tax, Point-of-Purchase Tax, etc.)
This class of tax is added whenever a 'taxable' good or service is purchased. Everyone in Canada is familiar with the GST. It was the Mulroney version of a "tax shift". The next government (Chretien) promised to eliminate it and failed to deliver. Ultimately, the GST was reduced by two percentage points. While it was a popular political move, the annual government revenues were reduced by an estimated $10 billion, nearly the same amount as the current account deficit. A federal sales tax is now the leading candidate for a universal tax increase in the United States, according to sources.

Income Taxes
Income taxes are levied on all legitimate forms of compensation for services rendered. The structure of these taxes is often complicated as they are often 'marginal' to allow for higher tax rates for higher income earners. Capital gains and dividends are also typically taxed, albeit at different rates than 'standard' income. There is usually little room to maneuver upwards on income tax because these rates need to be competitive in order to keep people and businesses from migrating to other regions with more favorable income tax rates. They can also be evaded in instances where stringent records of income is not kept--as is the case with many small businesses.

Duties, Royalties, Excises and Levies
These are miscellaneous taxes charged towards specific items. Politicians like this type of tax because they don't necessarily have the word 'tax' in it and the amount of the tax can usually be hidden inside the cost of the item itself. For example, most people have no idea how much excise taxes are on alcohol and cigarettes. California is now considering monetizing its underground marijuana industry by legalizing and taxing the substance. The resulting potential revenues for California would be massive in this case, but this example is the exception, not the rule for this class of taxes.

Savings and Property Taxes
This type of tax is the most controversial as it is a direct raid on the savings of the citizens. One common example is an estate tax--when some of the savings of a deceased person are transfered to the government instead of to their designated beneficiaries. Properties are often subject to annual taxation indefinitely despite the perceived ownership by the landowner.

Phantom Taxes
This is an indirect tax that tends to be the easiest for politicians to implement without creating public backlash. That's because citizens don't even realize that their savings are being raided. It occurs when the government decides that instead of borrowing money to finance deficits, they will print it to make up the shortfall. This leads to inflation and devaluation of the currency. The effective reserves (savings accounts) of the currency holders will fall. Many people attempt to use gold and other precious metals as an inflation hedge to hold value during this decline in the purchasing power of the dollar. The only trouble with using this inflation hedge strategy is that any 'appreciation' is subject to another type of tax--a capital gains tax.

No matter what you word it, the tax man is coming. Politicians will try and evade the question because any hint of an increase is unpopular; but the question still stands.

Getting Back To Prosperity

2009-05-10T13:32:00.004-06:00

The pace of job losses in is slowing. This is apparent looking at the 16-month payroll chart for the United States, which shows that although the economy lost jobs for the fifteenth straight month, the pace of those losses is up off it's lows. The picture in Canada is similar, although the data is reported slightly differently. There will probably be at least another 3-4 months of negative job growth but there are other signs of "green shoots". That being said much of the appreciation in equity values that we have seen this past month is due to inflation as I mentioned in the previous post. The same is true for commodity prices, which are also up sharply off their lows earlier in the year. This trend is likely to continue, and without cheap oil, the extent to which the United States economy can recover is really quite dim. While the emerging economies still have a long way to go in terms of manufacturing quality, the productive capacity and thus growth potential of these regions far exceeds that of the 'developed' nations and at a much lower labour cost.

One of the biggest delusions I've heard is that the health services sector (drug research, health care, stem cell research, and so on) will lead us out of recession. While it's true that everyone is willing to pay more for their health, the reality is that they can still only pay what they can afford. The aforementioned speculation seems to be largely based on the premise that people will pay anything for good medical treatment when practical realities dictate otherwise. Further to this, the government will need to spend less, not more, on health care costs. Even with the health care sector outperforming other sectors, it alone cannot single-handedly sustain any economy of scale.

"Well, first of all, it's our money. We paid the taxes. We're just asking for some of our money back." - Buzz Hargrove, former Canadian Auto Workers Union president on why the union should be bailed out (April 26, 2009)

The attitude of Buzz Hargrove and thousands others needs to change. Hargrove did not finish high school and yet he feels that compared to international workers, he is entitled to better pay for equal work, simply because he was born in Canada. This is an indication, unfortunately, that the 'correction' is not quite finished yet, and we'll need to see a subsidence of the corporate welfare state, reduction in entitlement expectations and a notable improvement in workforce value generation. This means better service and quality for globally competitive prices. This is where America has diverged so far away from it's founding principles in recent years. In a free economy, jobs can, and should be outsourced unless the domestic workforce provides greater competitive value. Not only is this a critical component of a free economy, but it is also critical in a free society and any protectionist government measures to artificially maintain jobs domestically will only hurt the economy in the long term. There are no shortcuts on the road back to prosperity.

The Inflation Tease

2009-05-10T12:22:00.007-06:00

The principle of inflation in economics is actually not much different than the principle of inflation in physics. When a balloon is inflated with hot air, for example, we see a very large increase in volume without any appreciable increase in mass. Similarly, in economics, inflation represents an increase in monetary supply without the corresponding increase in the value of that money. It looks like growth at first, but like a Ponzi scheme, it’s only a matter of time before the bubble pops and a correction occurs and everyone sees what’s really there; thin air.

There is no perfect way to measure inflation, but many different indicators exist. The most commonly accepted indicator is the Consumer Price Index (CPI); a sampling of the prices of the most commonly is purchased consumable goods. Using this indicator of inflation, the CPI chart indicates a step change in slope around 1971, the year the gold-based Bretton Woods system was officially abandoned because it was preventing government from running large deficits. The average annual increase in CPI jumped to a 4.6% average annual rate of increase from a more stable 2.5%.

The cause of inflation is a significant increase in money supply. Imagine playing a game of Monopoly where the bank decides to add a zero to the end of every new note it issues. Pretty soon, the old money becomes useless and each player would be forced to raise the selling price of his or her properties to reflect this new reality. It wouldn’t be so bad if we just added a zero to the end of every note, but the way it happens usually benefits some people quite a bit more than others. The first person to pass ‘Go’, for example, would find themselves flush with cash, and would likely go out on a spending spree. By the time the player in ‘Jail’ realizes what’s going on, he will probably have sold off all of this properties for what he thought was a great price, when in fact he got ripped off. This is exactly what happens in the real world, the first people to get the increase in money supply—the large financial institutions, hedge funds, very wealthy and so on, get to spend the new money at old prices. By the time this money gets into the pockets of the middle class and the poor, prices have already increased and they simply find that their savings have been rendered worthless. This is exactly what we are seeing today—wage depreciation occurring at the same time that consumer prices are either increasing or staying flat.

It’s no surprise that central banks such as the United States Federal Reserve, a pseudo-private, pseudo-public entity which is essentially run by banks and backed by government, makes their policy that creates the biggest benefit to their friends at large financial institutions. Government, which essentially owns (but does not directly operate) the central bank, is usually complacent to this policy because inflated economies look good—at least until the bubble bursts. And yet no president including Regan has been able to successfully balance recessionary and inflationary forces since the idea of having a naturally stable currency was abandoned in 1971. This is the main argument for why central banks should be abandoned—government has proven itself incapable of maintaining a stable currency in nearly four decades since it decided it could do a better job of this than free markets could.

"I'll bet you a lot more than a penny" - Peter Schiff predicting the credit crisis and collapse of the purchasing power of the USD (2006).

This reality is often underreported by the mainstream American media. Some claim this is because the media, including many so-called experts and economists, are mislead by the way the government reports on it's monetary policy. For example, the U.S. Federal Reserve decided to stop reporting M3, the total money supply in March of 2006, claiming the data was too difficult to accurately compile. It still reports M2, which is part of the money supply, but the M3 wedge has grown from less than 5% in 1971 to over 30% of the total in February 2006 when this figure was last reported (see chart). Not everyone is fooled though. The video below shows economist Peter Schiff on major U.S. television networks predicting the subprime and credit crises in 2006 and 2007 despite being ridiculed by his naive counterparts at the time. It is also worth noting that these counterparts recommended buying equity stake in firms like Bear Sterns, Merrill Lynch and Washington Mutual, all of which became insolvent and were forced into distressed mergers with more solvent financial institutions. Each of these transactions was facilitated by either the Federal Reserve or the Treasury with some kind of taxpayer-backed debt guarantee or subsidy. Hopefully these guys stay low-key for awhile until people forget how bad their recommendations really were. Enjoy watching the video.

Swineophobia

2009-05-03T20:24:00.005-06:00

Let me first assert that infection from the active strain of the H1N1 virus does indeed cause serious illness which does have the potential to cause death--this is indisputable. However, it is important that any and all responses by the public, health officals and government remain both appropriate and contextual rather than hasty and irrational. This particular strain is not necessarily any more virulent than that of the 'human' influenza virus. For example, with the swine flu 'epidemic' of 1976, more people died from the recklessly synthesized vaccine than from the virus itself--one of the reasons many people still fear the influenza vaccine today. It is now reported that only 19 of the deaths in Mexico to date can actually be attributed to the virus rather than the hundreds they initially thought. Preliminary research suggests the current strain has a cleavage site that may reduce it's virulence. The 'mild' virus would need to mutate further in order to cause more serious danger to the general public.^[1]

Outbreak: A disease outbreak is the occurrence of cases of disease in excess of what would normally be expected. A single case of a communicable disease [may] constitute an outbreak.

Pandemic: The emergence of a disease new to a population involving infectious agents. The disease is spread across a large geographical region and can be transmitted easily and sustainably among humans and cause serious illness.

While the Swine Flu or H1N1 virus may meet the technical World Health Organization definition for both an outbreak and a pandemic, this classification is misleading as the disease is far from widespread. Confirmed cases in Canada affect 0.00027% of the population. Mexico's confirmed infection rate is 0.00036%, while the United States has 176 confirmed cases out it's 300,000,000 people. The actual number of cases is undoubtedly greater, but even if it is one hundred times greater, the risk of infection to the general population remains insignificant at this point in time (less than one tenth of a percent). This begs the question of whether the additional $1.5 billion president Obama has asked congress for to fight this virus could be more effectively deployed for other public health issues. There's a good chance the money won't even provide any assistance to the cause before the pandemic subsides. We won't know the answer for a while yet, but few people, including government, will hesitate to ask for more money when an opportunity arises.

The 'cartoon' model of a molecular protein. The label H1N1 is derived from the two proteins found on the surface of the Swine flu virus: Hemagglutinin subtype 1 (H1) and Neuraminidase subtype 1 (N1).

This does not mean preventative measures by health authorities do not need to be taken. It can certainly make sense for large businesses, for example, to encourage employees to take paid sick leave if indeed there are reasonable grounds to suspect they are sick with any respiratory infectious agent that has a high rate of transmissibility. From a company-wide perspective, this is not just a matter of ensuring the health of it's employees, but it's also a matter of maximizing the productive capacity of the workforce. If a single employee takes two weeks off, this outcome is much less disabling to the company than if he or she returned to work and infected tens or hundreds of other employees.

The standard preventative measures to reduce the risk of infection should always be taken, whenever possible. These include handwashing and personal hygene, as well as measures to maximize your body's immune system such as adequate sleep and good nutrition. I wouldn't plan a vacation to Mexico for next week, but if you already have a trip booked and can't get a refund, deciding to proceed won't exactly mean you're facing "certain death".

My next post will deal with Human Physiology--the impressive amount of knowledge we've accumulated on the subject and how much we still don't really know.

USA: Success or Secession?

2009-04-21T18:07:00.012-06:00

It's pretty hard to imagine why anyone would be willing to pay a 90% income tax rate without any improvement in public services. Especially if it's to repay debt incurred by somebody else. Anyone that has the means would simply pick up and move somewhere else. Investor Jim Rogers already relocated to Singapore for this very reason; many others will follow. Naturally, it will be impossible for 300 million people to do the same. The alternative therefore, will be secession. Canada had it's own debates about secession with Quebec trying to withdraw from the country. Americans will have similar heated discussions about the legal right of American States to secede from the Union. Nonetheless it is the most probable and perhaps even inevitable outcome, particularly if economic recovery does not happen sooner rather than later. As I've said before, I think crude oil prices of no more than $20 a barrel will be necessary for sustained economic growth to occur in the United States.

The bad news is that when a country splits up, the breakup is nearly always preceded and/or succeeded by some form of civil war. Debt holders could be wiped out or suffer significant losses. The good news is that the Soviet Union, the only nuclear power to secede, was able to keep it's inventory of nuclear weapons secure and unused during the process.

The Precarious Peace

2009-04-05T20:42:00.007-06:00

In times of abundant resources and economic wealth, living in harmony, peace and civility is a relatively simple thing to do. In times of economic hardship and resource scarcity, the instinct of survival takes over. I suppose this is why the Obama administration wants to reduce the number of active nuclear weapons in the world as futile as the effort may be. Here's a brief look at the science and the politics of nuclear armament.

The Science
Several years ago, I read a book called E=mc²: A History of The World's Most Famous Equation. In Chapter 13, author David Bodanis provides an explanation of the events that occurred, from micro to macro at 8:16am in Japan when the first nuclear weapon was used against man. It is a visceral, awesome and terrifying account of the ultimate weapon of mass destruction.

Virtually every state possessing nuclear weapons developed them as martial insurance against a potential nuclear attack from another antagonistic nation with such capabilities...

The death and destruction caused in Nagasaki and Hiroshima makes the attacks of September 11th seem rather insignificant in terms of civilian death toll, injury toll and infrastructure destruction and long-term effects such as radioactive contamination. Yet these were only fission-based weapons delivering 15-20 kilotons of TNT equivalent. Since then, thermonuclear (fusion-based) weapons have been developed which will theoretically deliver over 100 megatons of TNT-equivalent energy. Tests of high-yield bombs are typically done below theoretical maximum yield to minimize both environmental destruction and for secrecy purposes; the mushroom cloud can be seen by anyone as far as 1000 kilometers of the blast and if below-ground tests are done, the seismic signatures can be detected. Russia's Tsar Bomba, the most powerful device ever built by man was tested at about 50 megatons or 2.1×10¹⁷ Joules. It's a bit hard to grasp what a megaton of TNT means, but the image of the mushroom clouds produced below may help put it into perspective.

Fat Man (1) is the 22.5 kiloton fission bomb that was detonated in Nagasaki, Japan while Castle Bravo (2) was the 15 megaton thermonuclear fusion device tested by the U.S. in the Marshall Islands. (Image: U.S. Federal Government)

The peak temperature is about 350,000,000 degrees Celsius--a temperature for which all matter exists in a state called plasma. Steel near the blast epicenter would be instantly vapourized and there would be no forensic trace of any humans unfortunate enough to be nearby. Those far enough to survive instantaneous death would receive severe third degree burns to any soft tissue with a line of sight to the bomb. Depending on wind directions, radioactive fallout could cause hair loss for people hundreds of kilometers from the blast site. My guess is that a single high-yield thermonuclear device could eradicate 20 million people if it were detonated in the right place.

The Politics
Since Hiroshima and Nagasaki were bombed, the world has made well over 65,000 nuclear warheads of which over 10,000 are currently active (the weapons have 'expiry' dates). Ninety percent of these are held by the U.S. and Russia, with the balance in the U.K., France, China, India, Pakistan. Israel never signed the nuclear non-proliferation treaty and thus does not report on its nuclear weapons program, but is believed to possess a significant stockpile of nuclear warheads. North Korea withdrew from the treaty and is believed to have successfully conducted a nuclear weapons test. Iran and Syria are following a similar path to that of North Korea, but are not believed to possess viable nuclear warheads at this time.

Virtually every state possessing nuclear weapons developed them as martial insurance against a potential nuclear attack from another antagonistic nation with such capabilities: The USSR as a deterrent to the U.S.; the U.K. and France in response to the USSR; China to counter the U.S.; North Korea to oppose U.S. nuke stockpiles in South Korea; Pakistan to retaliate against India's tests; and Iran and Syria to retort Israel.

Hopefully each and every person with the authority to deploy these weapons will hold them as a nothing more than a deterrent and never use them. Otherwise the world will find a new peace without too many humans, if any left in it.

Copying right? The Digital Age of Consumer Media

2009-03-30T20:43:00.007-06:00

High-speed internet, CD and DVD burners, personal video recorders, high-capacity hard drive, iPods, mp3 players, satellites and receivers made it effortless to transfer, reproduce and store trillions of bits of data at the touch of a button. Few groups, with the exception of the consumer have kept up with the technologies in their rapid state of flux.

Is 'file sharing' really stealing?!?
The entertainment industry put out an advertisement condemning the pirating of intellectual property. Their assertion is that stealing a television is the same as stealing a satellite signal. The list price of the service could be the same as a television, yet there is an important philosophical distinction. While intellectual property has apparent value, it does not have any tangible value. A person stealing a satellite signal only causes lost revenues for the provider if the thief would otherwise have paid for it. This does not make such a theft ethical; by law the violator could face penalties as if he/she stole a tangible good of equal value. It is still stealing, but it does require the distinction from someone who steals a material thing effectively removing a salable product from inventory, thus causing more apparent harm to the rightful owner. Many people continue to have little sympathy for entertainment executives and pop artists and movie stars that continue to earn millions despite the fact that it is the smaller artists that rely the most on record sales for their revenues.

The Law
The legal process is far too slow to keep up with the latest technologies and proved ineffective. By the time Napster was closed by the courts, peer-to-peer networks like Kazaa and BitTorrent were already set to take their place. The industry then went after the individuals that 'shared' the most content. This strategy had minimal success and created a PR mess in the process. Some of the violators were children using their grandparents internet account to do all their illegal downloading. People sympathize with ninety year old grandmothers accused of copyright infringement who don't even know how to write an email. The approach failed to dissuade large masses of people from downloading illegally.

The Lawmakers
The lawmakers (politicians) are part of an older generation that generally does not use or understand the technologies being used in potential copyright infringements. In 1998, President Clinton signed the Digital Millennium Copyright Act into law. Despite a modern-sounding name, the act did not provide the protections the record industry had hoped for. Less than a year later, Shawn Fanning released the original Napster that popularized 'file sharing'. Canada has yet to pass it's own version of copyright reform for the new millennium, but proposals have been tabled. A version of Bill C-61 will likely get re-introduced since the bill did not get passed before the 39th session of parliament was dissolved. The law will likely not have no more success at curbing illegal and/or unethical copying than it's American counterpart did.

While Canadian copyright laws have yet to be overhauled, the Canadian Private Copying Collective (CPCC) was created by the Federal Government in 1998 to collect and distribute royalties on blank media on behalf of music rights holders hurt by illegal copying. The tariff amounts are based on statistical data of music downloads. The table below shows current levy rates being charged to all blank CD's purchased in Canada. The proposed tax on music-based digital storage media and devices (such as iPods) was struck down by the Canadian Federal Court of Appeal on the basis that the CPCC does not have the legal authority to impose such a tariff (link). Others argue that it's unconstitutional because it is based on the presumption that consumers are not paying for the media on their digital devices. Some even argue the tariff encourages 'file sharing' because it compensates artists. It's certainly hard to believe that someone buying a digital camera should have to pay up to $10 to the record industry for their flash memory card.

	Tariff
Audio cassettes of 40 minutes or more	29¢
CD-R or CD-RW	29¢
CD-R Audio, CD-RW Audio or MiniDisc	29¢
Removable electronic memory cards over 256 MB (MMC, SD, Compact Flash, etc.)
no more than 1 GB	$2
more than 1 GB and no more than 4 GB	$5
more than 4 GB	$10
Digital Audio Recorders (iPods, mp3 players)
No more than 1 GB	$5
more than 1 GB and no more than 10 GB	$25
more than 10 GB and no more than 30 GB	$50
more than 30 GB	$75

Source: CPCC Tariff Backgrounder

The Enforcers
Without entering into the offices and living rooms of millions of private citizens, it's very difficult and in some cases impossible to monitor the massive amounts of data that gets transferred between electronic devices. In some cases, it's virtually impossible to determine who downloaded or uploaded something using an unsecured wireless network from a laptop that leaves little to no trace of itself. Recently, several police agencies complained that Blackberry's (made in Canada by RIM) are too secure--they can't intercept and monitor drug dealers who are using them. The trouble is that if security holes are deliberately built in to the devices, they become more susceptible to hackers. This extremely reliable security of the device was likely the only reason President Obama was allowed by the secret service to be the only standing president with a mobile communications device.

Asleep At The Switch
The CRTC is the "Independent public authority in charge of regulating and supervising Canadian broadcasting and telecommunications." Radio waves and satellite communications typically prove to be a very difficult thing to regulate since they pass through Canadian airspace whether the CRTC wants them to or not. Broadcast radio was not too difficult to control in urban settings because U.S. broadcast frequencies could simply be overpowered by stronger signals on the Canadian side of the border. Satellite radio did not have the same overwriting capability. During the first three years of the service, satellite radio was not officially available in Canada. Still, many Canadians were using the American service 'illegally' by registering 90210 as their zip code since the signal could be picked up even in northern parts of the country.

Another example is Pandora internet radio. The US-based service provides 'radio' stations customized to the users individual tastes. The CRTC forced the Music Genome Project (Pandora) to block its content for Canadian IP addresses in 2007. This did not stop some Canadian internet users from circumventing the block. In other cases, the blocking algorithms on the site simply do not work allowing Canadian IP addresses to access Pandora content freely (albeit violating the terms of use of the site).

It seems clear to me that everyone from lawmakers to enforcers, record industry execs to artists have a long way to go when it comes to adapting and bringing themselves into the twenty first century. The neo-luddites will lose the war against the Digital Revolution just as their counterparts lost their fight against the Industrial Revolution.

1.3 Billion Pounds of Thrust

2009-03-26T19:16:00.017-06:00

It flies more than twice the speed of sound. Radar absorbing materials (RAM) in conjunction with fan blade design making it virtually invisible to direct radar. It's the F-22 'Raptor'. Most men marvel at one exuding 70,000 pounds of thrust let alone one fully loaded with eighty thousand pounds of bombs, missiles and cannons. An engineer gets excited like a kid in a toy store at the sight of one of the beasts you don't even hear coming, provided they're on your side. My office wall has a picture of two of them flying next to the F-15 'Eagle' they were built to replace.

On Wednesday March 25, an F-22 Raptor crashed in California killing the test pilot. The cause of the crash was not immediately known but obviously the smallest oversight becomes catastrophic at 2,500 km/h. This was by no means the most expensive crash at $140 million dollars either. About 13 months ago, a B-2 Spirit crashed in Guam just after takeoff. The two pilots ejected safely but the hull was completely destroyed at an estimated cost of $1.4 billion.

I don't think the 1.3 billion Chinese from the People's Republic realize just how powerful they are yet.

When you add up all the numbers, the United States military budget totals about $500 billion a year. While it's obvious that president Obama doesn't have much of an appetite for military spending, the United States' creditors, rather than it's citizens will effectively decide how much capital it can sustain on the military. As we've already seen China flexing it's economic muscle in the past several days just by mentioning concern about the inherent risk of their treasury holdings. The USD's universality is currently the only thing holding the United States economy back from hyperinflation in the medium term. I don't think the 1.3 billion Chinese from the People's Republic realize just how powerful they are yet. The use of military force against Iran will hinge upon China's agreement. China would likely take exception since Iran provides discounted oil in exchange for economic protection. I talked about this 'nuclear option' in previous posts (see America In Recession). Now I think this may take years instead of decades to happen. The world may need to get used to five yellow stars on red rather than fifty white stars on blue.

White Out

2009-03-04T21:38:00.010-07:00

The White House, Wealth and the Economy

Larry Kudlow of CNBC always talks about mustard seeds in relation to the economy. The trouble is that his optimism, while refreshing, had been unrealistic over the past year. As I've said before, there is a difference between optimism, pessimism and reality. It's now becoming clear that some of those who were previously labeled pessimists are actually perpetual optimistic realists. Today however, it looks like the mustard seed is finally in the ground. It will need plenty of water, nutrients and time to grow, but the seed has been sown nonetheless. I've penned some Q&A-style perspectives below..

Isn't the market supposed to be forward-looking?!?
Many people have said the markets are forward looking and that the next 6 months are already factored in to the stock market. Obviously they were wrong if they said this three months ago. The reason they were wrong is that the stock market is not some kind of oracle but merely an indicator of economic sentiment and perception. The perception was wrong as CEO's and analysts were continually making downward revisions to their guidance leading to a negative feedback loop in the economy. The popular perception is now much closer to reality now, in my opinion, which means we are at, or near a bottom in the stock market.

What did the Obama administration have to do with the economy?
Thus far they haven't done anything measurable. The market correction paused to determine if the smart guys in the administration had a magic bullet that would stop the declines. They didn't, and when this fact became apparent, the declines resumed their course. Sporatic reactions to announcements and press releases are never a reflection of long term equity value with the very rare exception of events that act as a catalyst for catastrophic events (the Lehman Brothers failure for example).

So the Obama administration actually knows what it's doing?
Not really. In his testimony yesterday Treasury Secretary Timothy Geithner admitted that if the administration's GDP growth projections for the next decade are off, the public debt may no longer be serviceable. He emphasized that he didn't see any better alternative to the current direction given their inheritance. He's probably right and certainly transparent; but this does not inspire much confidence in their ability to fix the economic problems.

Is now the time to buy stocks?
Yes and no. One certainty is that anyone predicting a bottom will be wrong. However, my outlook several months ago was that the Dow Jones Industrial average would bottom out in the 4000-6000 range. My outlook has not changed (as it sometimes does), and the stimulus packages could help push this bottom higher than my estimate. I'd be ready to diligently put long-term investment capital to work. Traders beware of expecting large returns and high long-term growth rates. Profit taking will ensure that volatility remains in the markets for the next 3 months as the economy moves towards a rebalanced state. A structural debt problem that still exists in the United States economy should be considered very carefully.

Does this mean the economy is turning?
Yes and no. More job losses are on their way. House prices still likely have further to fall to eliminate the excess in homes. There is still more downside. When growth does resume it will not be a sudden dilation back to 2007 activity levels. On the other hand, the light at the end of the tunnel is becoming visible. Just realize that the path to get there will be a difficult one.

Every obstacle forges fortitude, every hurdle appraises fitness and every challenge tenders opportunity.

-You're smarter than you think.

Economic Stimuloids

2009-03-02T18:34:00.016-07:00

"Suplement Me" by SMmeaLLuM [cc]

"The biggest problem with steroids is that you can only inject so much before the patient goes into cardiac arrest."
-Anonymous

Many of the smart people on Wall Street continue to call for more stimulus in response to falling investor confidence. Major executives like billionaire Mortimer Zuckerman continue to call for more stimulus. They say the current stimulus package is way too small and that Washington will need to ask the Chinese if they can borrow more money on behalf of the unborn American taxpayer before the end of the year.

The U.S. debt levels as a percentage of GDP has now has not been seen since the 1940's. The main difference between then and now is that the debt holders then were mostly domestic; it was considered patriotic to be a bond-holder of national debt. The trouble is that now the U.S. is relying on foreign creditors to buy up public debt. Should these purchasers decide they don't like something the United States is doing or consider their credit risk too high, they may simply stop buying their debt. This leaves two basic options, (1) print more money (inflate and devalue the currency), and (2) raise taxes, and several other more complex but less effective ones, such as raising interest rates.

The most likely response would include an array of the aforementioned strategies, none of which are desirable.

"It's going to take World War III to get us out of this."
- Don Luskin on the state of the economy

E-Papyrus: Reinventing Paper

2009-02-28T20:05:00.019-07:00

The Heracles Papyrus

One of the first transportable media to carry information in the form of written language was Papyrus, which dates all the way back to the First dynasty circa 3000 B.C.E (over 5000 years ago). Modern (wood pulp-based) paper is believed to have been invented in China during the Han dynasty circa 200 C.E. We are now on the dawn of a new type of paper, plastic paper.

The idea of digital or plastic paper is not a new one, and has been hypothesized and researched for years. The problem has been figuring out how to produce something with the following four criteria:

Portability - If it weighs more than about 500g you may as well just carry textbooks.
Durability - It needs to stand up to moisture, mild G-forces and variable temperatures.
Cost - Few people will want to carry around a device worth thousands of dollars when they can just buy a newspaper for a dollar.
Ease of reading - standard screens (LCD, plasma, etc.) are not comfortable on the eyes for reading lengthy documents. That's because they have non-ideal text contrast, back-lighting and/or screen refresh rates that lead to eye strain.

With advances in material science, manufacturing and miniaturization, it looks like we are finally approaching the electronic paper era that many people erroneously thought would come with the invention of computers. The Plastic Logic eReader, Sony Reader, iRex iLiad and Amazon Kindle are just some examples of the first generation of electronic readers. It may not be long before high school and university students can carry all their textbooks on a single device.

Plastic Logic's e-Reader is to be piloted in mid-2009.

This exciting new reality won't be a boon for everyone. The forestry sector will see their demand dwindle, as will the pulp and paper mills and the printing businesses over time. The aforementioned should have time to restructure since demand for paper won't drop overnight. The intellectual property holders will need to adapt much more quickly. Within seconds, a NY-Times bestseller can make its way to thousands of internet users without proper compensation. Digital Rights Management (DRM) will likely continue to prove ineffective as it is too easy to circumvent. They will need to discover new ways to generate revenues going forward or technology will simply leave them behind. Which leads me into my next topic: intellectual property and copyright reform.

You're smarter than you think.

The TARP, optimistically..

2009-01-15T22:27:00.022-07:00

Some philosophical context

I think it's both timely and important to note the distinction between optimism, pessimism and reality. Most people think that forgetting reality is the way to remain optimistic. This is the wrong way to approach reality. The truth is that understanding reality is the only way to manage expectations and remain optimistic. Expectations are usually met for someone who has a tangible grasp on reality. The optimist also understands that they can mold their own reality but they can't choose the clay. On the other hand, the person who does not have a tangible grasp on reality finds themselves is always disappointed by unrealistic expectations. This psychological house of cards is sometimes made even worse as they create more undue optimism to fill their void in troubled times, which can only lead to a terrible downward spiral in the end.

TARP (tar⋅pau⋅lin) - [tahr-paw-lin, tahr-puh-lin]

-noun

a protective covering of canvas or other material waterproofed with tar, paint, or wax.

When it comes to the economy, it's clear that many people still misplace optimism with optimistic realism, despite a notable improvement in this regard in recent days and weeks. Many people still believe the purpose of the TARP (Troubled Asset Relief Program) was to increase lending and stop foreclosures. It wasn't. The purpose was simply to stabilize financial markets and stall the market correction following the failure of Lehman Brothers collapse. Major banks were failing by the week at the time, with no clear end in sight. The system was collapsing and the fall had spread to the broader market. The economists that saw the current problems of the market predicted the fair (unadulterated) value level of Dow Jones Industrial Average was (and still is) about 4,000 (Thursday's close was 8,212). The program eventually passed congress and equity markets stabilized. The .DJI has been flat since October 10, 2008, about the time it became clear that the bailout would pass in some form or another. When the Obama and Bush economic advisers realized is that the correction was about to resume it's course, with more defaults coming from the retail sector in addition to continuing subprime loan defaults, they called for the release of the second $350B bale of the TARP.

The real objective of the TARP was to diffuse the full extent of a free market correction. Without the TARP funds, the mark-to-market net worth of nearly everyone with equity would fall by about half (this includes RRSP's, 401k's, home equity, etc.). Foreclosure rates would have accelerated in the opposite direction of equity. Citibank, Bank of America, Fannie Mae, Freddie Mac, Chrysler, GM, AIG would all obviously have failed with catastrophic consequences, along with many others. The economy would need a combination of pay cuts and job cuts; if fewer people willingly took pay cuts, more people would be forced into job cuts (this still holds true despite the TARP). It's no surprise that no acting government, republican or democrat, would be willing to face such a reality and opted instead for inflationary market interference instead.

I'm not personally in favour of these bailouts unsustainable tax cuts, debt loads, deficit spending and stimulus handouts. They will ultimately just prolong and extend the natural correction as well as stagnate longer-term growth for years, perhaps even decades. Political stability will become rather precarious as it becomes clear that debts cannot and will not be repaid. The greenback will have questionable value as the dollar becomes mortgaged (also see America's Fundamentals). Nonetheless, it's important to be onside with reality. This is the only way to see the glass as being half full.

You're ~~Richer~~ Smarter Than You Think.
Kent Carter

America In Recession

2009-01-11T20:38:00.008-07:00

The United States has already conceded it's title as the world's most powerful nation. Of course, it still has the World's most technically advanced military, most martial firepower and the largest and most capable nuclear arsenal. It still has the World's reigning currency, highest volume of wealthy people in the world and largest GDP (excluding the European Union).^{[1], [2], [3]}

Waning Superiority
The military superiority is a bit misleading because it hinges on America's ability to both finance and fuel the technologies. The massive energy and cost requirements of the U.S. military are becoming increasingly reliant on foreign oil and foreign debt. Even economic superiority is decreasing because of huge deficits and debt. Economic debt is, in principle, no different from social debt: an obligation requiring future reparation (usually with interest). In the decades immediately following the first two World wars, the United States was the lender, mostly to European countries in ruin, giving it unprecedented power as a recipient of Europe's future financial obligations. The United States did had large debts of its own at the time, but the debt holders were largely domestic, leaving its own citizens in control of its own destiny. In 1988, about 13% of the government debt was foreign-owned.^[4]. Currently, about half of the public U.S. debt load is owned by foreign investors. This percentage is certain to rise social security, health care and other entitlements on the rise while the GDP shrinks. The president elect forecasts trillion dollar deficits "for years to come."^[5]

Iran Example (image)
China has formed a strategic alliance with Iran. The arrangement allows China to receive Iranian oil at a discount in exchange for economic support that allows Iran to circumvent UN sanctions. In the spring of 2008, China and Russia blocked a UN Security Council resolution to increase sanctions on Iran in response to Iran's defiance of calls to abandon its uranium enrichment program. ^[6]

The 'Nuclear Option'
Knowing it cannot count on United Nations support, were the United States to decide to attack Iran unilaterally, Iran could plead with China to use its economic nuclear option in order to prevent such an attack. The economic nuclear option is the scenario where a large foreign owner of another nations public debt threatens to stop lending thus crashing the currency value of the indebted country and plunging it into economic ruin. The United States used this approach to help end the Suez Crisis in 1956. In short, president Eisenhower threatened to sell the U.S. reserves of British Pounds and Sterling Bonds and collapse the British Pound if they did not withdraw troops from the region. This tactic coupled with other pressures forced Britain to withdraw it's troops from the region and is regarded by historians as an egregious point in the decline of the British Empire.

Precarious Positions
Tactics such as the 'nuclear option' are not without significant economic risk to the powers considering it's use however. An estimated 70% of China's currency reserves are held in the U.S. dollar (the administration does not make these figures public).^[7] Trying to convert (sell) large amounts of these holdings will inevitably cause the U.S. dollar to fall, leading to a write-down of their remaining domestic currency reserves. Instead, they will likely try to divest these holdings over a period of years or decades, leading to a gradual decline in the value of the greenback rather than a violent plunge. China, India and other emerging economies are also in the rather undesirable position of having large populations but limited domestic resources. The world simply does not have enough natural resources to bring the average standard of living up to the same average level of the wealthy western nations. One of the reasons America was able to become so prosperous was that the country was awash in natural resources: coal, oil, water, minerals and fertile agricultural land. Now that those resources have mostly been exploited domestically, America has tried to create a knowledge-based economy without conceding any reduction in annual economic growth. I think the current economic environment is a reflection of the reality that the global economy was supersaturated with overpaid knowledge-based employees and thus became reliant on inflation and artificial Madoff money to provide illusory growth. Is there really nowhere to go but down? America and the rest of the world certainly face the challenge of finding real and significant growth in a globe that appears increasingly finite. What the world needs is some good ideas on how to succeed in this feat.

You're Smarter Than You Think.
-Kent Carter

International Monetary Fund Report
CIA World Factbook
World Bank Statistics (2007).
Final Monthly Treasury Statement, U.S. Treasury (September 30, 2008).
Obama Predicts Years of Deficits Over $1 Trillion, Washington Post (January 7, 2009).
Russia, China block UN resolution on Iran; MSNBC (March 4, 2008).
China Losing Taste for Debt From U.S., New York Times (January 7, 2009).

The Perfect Gift

2008-12-24T00:00:00.006-07:00

I'm a Boxing Day baby. In my youth, some of my peers were jealous that my birthday landed on the only concurrent pair of statutory holidays. It was definitely great, but not because I get double the gifts. In fact, I'd usually get one combined gift for Christmas and my birthday. Some people assumed it was a bigger agglomerate gift (so to speak) to combine the two events. That assumption often proved wrong--my brother would get the exact same gift even though his birthday is in the spring. The only difference between my present and his was that his card didn't have the 'Happy Birthday' appendage written on it. For a brief time, I felt like I got shafted every single year...

photo by Kasia [cc license]

Now that I'm older, I realize that what I thought I wanted was often an illusion. The bubble was created by the people trying to convince me I needed stuff I probably never autonomously wanted. Unfortunately for Detroit, even the most brilliant advertisers can't persuade people they need a Hummer right now. If you ask me what I want now, I may still mull over the usual suspects. I'm a Toronto Raptors fan; but watching their games is painful enough as it is. I don't think I'd enjoy seeing a Chris Bosh Fathead on my dining room wall every day. I don't need something to provide me with 10 seconds of entertainment like a Tickle-Me-Elmo doll. It would just end up feeding the black hole some people call 'the basement' anyway (anyone who's ever seen my Mississauga basement knows what I'm talking about). I do have a small wish-list of course, but I prefer to keep that one to myself. That's because if Santa Claus, a genie, government or anyone else decides to grant all my wishes, then I'll have no motivation left to work for anything.

Alas, here is my guidance for finding me the perfect gift this holiday season. It's tailored specifically to me, but I suspect it can apply generally to quite a few other adults as well.

If you find the perfect gift and it fits within your budget, I will very much appreciate your bestowal.

On the other hand, if you have no idea what I want and need to ask me what I want, chances are I don't need it and will get by fine without it. Do not feel the need to get me something for the sake of gift giving.

If you feel the exigency to give me something material, get me a cheap card and write something in it. If you're really frugal, you can make your own card out of paper and I'll appreciate it just as much, if not more. The best gifts always have intangible value.

If you feel absolutely compelled to spend money, and you have no idea what I may want, here's the fail safe: ask me to send you a list of charities. As a follow up, I'll send you a list of about five charitable organizations that I consider to be well managed, deserving, underfunded and serving a cause that I feel connected to. You can choose one (or several) from the list I provide, and donate your earmarked gift budget to it. Just let me know to whom and how much you donated and I'll have the peace of mind in knowing that no Wal-Mart employees were harmed in giving such a gift. As an added bonus, you'll get a kickback from the tax guys.

Happy Holidays and Happy New Year.

And don't forget, You're Smarter Than You Think. Kent Carter.

You're Smarter Than You Think: Part 4

2008-11-30T19:01:00.002-07:00

Unlocking Your Potential

I've tried to reinforce that you are likely more intellectually capable than you may think. Unfortunately, I can't offer too many answers to the question of how to maximize these intellectual capabilities (if I could, I think I'd be rich). Instead, I've compiled an brief list based on multiple robust studies and what has historically been effective for many people. I'm sure the list will continually grow as we build better bridges to ply the gap between intangible psychology and pseudo-tangible cognitive neuroscience. In the meantime, here is my rudimentary list:

A wide variety of balanced activities help expand the mind. This includes activities like sports, music and other extra-curricular activities. I already talked about TV and video games as they relate to children, but even in adults their use for entertainment purposes should be minimized. There are many educational TV programs and video games, but on average even the most academic ones tend to be more of a hindrance to learning compared with other activities. That said, there was a recent contestant on Jeopardy who said that she learns her facts from television documentaries and almost never reads books.

In mathematics, repetition has proved very effective when it comes to improving performance. This is the basis of programs like the Kumon method. I do not generally endorse Kumon as as I think it's math fixation lacks cognitive balance. In principle though, these types of mind exercises (crosswords, puzzles, brain teasers, etc.) are all very effective.

Adequate sleep improves short term memory and concentration. That could mean that, pulling an all-nighter to study doesn't necessarily improve performance in the exam that follows. That said, this is only a rule of thumb as adrenaline can reverse some of the effects of sleep deprivation on a temporary basis (i.e. prior to a major exam). Caffeine helps prevent drowsiness but does very little for memory and concentration. Generally speaking, recreational drugs are bad for the intellect and some even cause permanent and irreversible brain damage.

Opening Your Mind

Albert Einstein has acquired the reputation of being one of the smartest minds of the 20^th century. He rejected the assumption that time and space are absolute, and postulated the special theory of relativity. Not surprisingly, even the most respected scientists initially thought the idea that time was relative rather than absolute was nonsense. It was not until several years later when Einstein's abstract theory was considered proven by a celestial event that it became openly accepted by the scientific community. Among other things, Einstein's work produced the world's most famous equation, E=mc², and eventually gave us the ability to recreate the energy of the sun (nuclear fusion/fission). Later in life, Einstein, like many of us, allowed age and experience to become a barrier to openness of thought. Although he was one of the scientists that helped develop quantum mechanical theory, he had notable difficulty accepting one of the philosophical consequences of it (a probabilistic universe rather than a deterministic one). Einstein was better than most in that he gave this consequence due consideration before saying he was "convinced that [God] does not play dice" with the universe.

Quite often people dismiss an idea as being stupid before giving it any real consideration. Unfortunately, this approach deprives them of a potential learning opportunity. That doesn't mean all ideas are good ones; it simply means all ideas need due consideration before they are dismissed. Even the least capable people can have great ideas and the brightest of people can come up with stupid ones. In response to a question, one of my old teachers once joked, "You're ask a really stupid question for such a smart student. [comedic pause] I'm just kidding... you're not that smart." On the other hand, let me end te final installment with an idea that will always be sincere:

You're smarter than you think.

You're Smarter Than You Think: Part 3

2008-11-23T21:00:00.022-07:00

Learning How To Be 'Smart'
Up until this point, I haven't defined what I mean by the word smart. First, I will define intelligence: it is both the ability and capability to learn, comprehend, retain and process information via cognitive function. Note that there is a subtle but important difference between ability and capability. Ability relates to a current skill. Capability has an emphasis on potential and is future-oriented; a young person, for example, can still be considered intelligent even if his adult counterpart currently holds more wisdom and knowledge. This is analogous to how a young sports professional in his rookie year compares his veteran counterpart. We tend to associate the word 'smart' with current intellectual ability rather than capability; with current knowledge rather than potential. I suspect this is because while ability is quantifiable, capability can be very difficult to measure. IQ tests are designed to measure intellectual ability and not capability, which is why they require age adjustments. Even in this capacity IQ tests remain imperfect as they are good at measuring some types of brain functions and not very good at measuring others. Just because a toddler can't solve a complex differential equation now, it doesn't mean he or she can't in the future.

Some people use the analogy of the brain being like a muscle. The brain is of course physiologically very distinct from a muscle, but the key similarity is that both can adapt and grow to meet the demands of external stimuli. This is why the sports professional does weight training: to optimize muscle tone, strength and response. When the analogous response happens in the brain, cognitive psychologists call the process learning.

Neuron Gila interaction by Khazaei(cc)

It's quite astonishing how often people can lose sight of the fact that humans have the prodigious capability to learn. I had a grade three teacher who told my mom on parent's night that she could tell I was "not very smart." She was categorically right; and because she was right, she had a job as an educator to facilitate learning and help make myself and my peers smarter. Recently, The Lens (CBC) aired a documentary on the Arrowsmith School called "Fixing My Brain". The school's curriculum is designed to help students overcome learning disabilities by focusing on cerebral learning and pattern recognition exercises rather than traditional academic fact-based learning. Skeptics of the Arrowsmith program voiced their opinion of the program in this documentary as being unpractical with few demonstrable results. The the efficiencies of the program's methods undoubtedly need to be subjected to scrutiny. At the same time, traditional north American schools can also be criticized in the way they deal with learning disabilities. Currently, students diagnosed with a learning disability are given very lenient time-frames to complete assignments, tests and exams. This is conceptually unpractical at best and excessively magnanimous at worst. On the other hand, the objective of the Arrowsmith program is to resolve the student disability rather than providing the students with a crutch for the rest of their lives (whether it meets this objective or not is not for me to say). In either case, constructive criticism of the existing methods is both necessary and productive, but to question the ability of the children to learn and improve their intellectual ability is fundamentally wrong.

People with learning disabilities (LD) are sometimes misunderstood for people low intellectual capability, yet the two are considered mutually exclusive. Instead they are people who have trouble accessing the traditional learning pathways. Dyslexia (trouble reading and writing), dyspraxia (neural motor skill dysfunction) and ADHD (a nonstandard LD that interferes with learning nonetheless) are some examples of neurological disabilities and disorders, which are considered by neurologists to be independent of intelligence. As I said in my last post, television and video games can increase the probability of a child developing severe learning disabilities, and this increased risk is proportional to the amount of the child spends doing these activities.

It is also important not to become unduly fixated on the idea of learning disabilities or to use them as an exonerating excuse for everything. Many conditions can lead to a medical diagnosis of multiple cognitive incapacities. Improper nutrition, insufficient sleep, psychological depression, drugs and alcohol, emotional stress among many other things can lead to creating an atmosphere where learning is effectively disabled. In poor neighbourhoods, where children go to school hungry, virtually every child effectively has a learning disability although they are rarely diagnosed. Parents and educators alike need to shine the spotlight on how to harness capability rather than find reasons to excuse disability.

In part 4, I will talk about the world of intelletual possibilities that can be opened if we are able to optimize our intellectual capability to learn.

"Fixing my Brain" will be re-aired on Tuesday December 30 at 10pm EST on CBC Newsworld.

Video Promo: "Fixing My Brain" [1:02 min]

The Arrowsmith School will also be looked at in another CBC documentary called "The Brain That Changes Itself", which will air at 8pm on Thursday November 27.

You're Smarter Than You Think: Part 2

2008-11-16T22:22:00.022-07:00

In The Beginning
The first conspicuous opportunity for us to learn starts at birth. Never again does learning happen at such an accelerated pace than in the first few months when a newborn begins to uncover the world through the perceptive stimuli of his or her environment. While developing the senses of sight, taste, smell, hearing and touch, the newborn begins to learn how to consciously interact with this environment beyond the subconscious brilliance inherited through the parental genetic fingerprint.

Baby in Hand by Aldo Risolvo

According to Dr. Robert Titzer, a California-based infant researcher "[t]he natural window of opportunity to learn opens at birth and begins to close at the age of four." In an article written by Matthew Coutts, Dr. Titzer recommends to parents that they should be reading to their babies by the time they are 3 months old (article).

Unfortunately, the National Post article overshoots the purpose of the early-reading recommendation. It's not meant to mold the baby into a child prodigy; it's to give the child a good start to life the same way that a parent focuses on good post-natal nutrition. A newborn is a sponge for the knowledge that their surroundings offer and they will learn considerably more from a used children's book than they will from a Baby Einstein DVD. Unlike the DVD, the book allows the child to interact directly with the learning tool at his or her own pace. Furthermore, the action of reading helps strengthen the communication bond between parent and child in a way that the unilateral television-based visual tool will not do. An increasing number of studies directly link television to decreased learning ability in addition to attention deficit hyperactivity disorder (ADHD) and other learning disabilities. The challenge for most parents is finding the time to read because television is a very effective distractor for babies thus freeing up time in a busy parent's life. This also implies that the parent needs to significantly reduce and ideally eliminate the hours he or she spends watching television, which is by no means an easy lifestyle change to make. There are some who believe that television is exploited by the elite and wealthy as a means to keep people from moving up into higher socioeconomic classes in a globalized world where the opportunity to learn and gain knowledge is so widely accessible. Proponents of this theory note that many highly educated parents do not let their children watch any television at all. Literacy rate is a strong indicator of economic wealth and while even the poorest neighbourhoods in the United States now have television, they also have alarmingly low functional literacy rates. This digression to the connection between television, literacy and socioeconomic wealth is another topic in itself.

Taking a step back to when a newborn first opens his or her eyes, this moment is the only time in a person's life when intellectual capacity exists in a way that is effectively unaltered by the external environment. Psychologist Cyril Burt termed this intellectual capacity 'innate general cognitive ability'. It is essentially the genetically inherited capacity to gain intelligence. Unfortunately, we have no way to measure this quantity and thus there is no way to determine how smart one can realistically become. What really matters though, is that babies are nurtured to make optimum use of the available learning channels.

Coming up in my next post, I will define the 'smart' adjective in 'You're Smarter Than You Think.'

You're Smarter Than You Think: Part 1

2008-11-11T20:23:00.003-07:00

In my June post, I predicted why Barack Obama would be the 44th president of the United States, and at the end of that post, I said that I would discuss his flaws and strengths in detail in a later post. In the spirit of political rhetoric, I will 'refine' this promise: such a posting will be indefinitely suspended due to the over saturation of media coverage on the subject of Barack Obama.

The McCain 'straight-talk express' translation: I don't think anyone needs or wants to hear any more about Barack Obama right now. Anyone wanting to know more about him, his ideals or his policies can (and will) consult the multitude of media on the subject including--but not limited to--the two books he has authored.

photo by allie^TM

Introduction

So instead of talking about Obama, I will use the former Vice Presidential candidates as an introduction to my next topic, a series of posts I call "You're Smarter Than You Think".

Contrary to popular belief, Sarah Palin is not unintelligent. Clearly she has not spent an inordinate amount of time studying political science. For example, she could not name any supreme court decisions other than Roe versus Wade (nor can I, but both of us could learn). Lack of political knowledge could make a legitimate case that Palin was not quite ready to assume the role of vice president, but it says little about her raw intelligence. Her former counterpart, Vice President-elect Joe Biden, has become an expert at giving the public the illusion of political knowledge. He certainly does have political knowledge, but the number of times he misspeaks is quite worrisome if one assumes he makes policy decisions based on this flawed knowledge. In some university and college multiple choice tests, the examinee is penalized marks for incorrect answers. In such a test, I'm not sure Joeseph Biden would score any higher than Sarah Palin on the political science front. It's really quite amazing how many of these smart-sounding people get themselves into positions of responsibility. They make themselves sound smart to create the illusion that the are smart. They often find themselves saying that they are smart, perhaps because they are compensating for their fear that they are not smart enough. The "You're Smarter Than You Think" series is not intended for these types of people who think they are smarter than they are. It is intended for those who underestimate their capability and never reach their full potential as a result.

I was able to predict the winner of the election because of the poor fundamentals of the economy in addition to the low voter confidence in the incumbent party and not because I'm smarter than anyone else. Most people that know me are aware that I'm terrible at remembering names and birthdays, I can't solve a Rubik's cube, I'm not even 'smarter than a 5th grader', let alone a Jeopardy contestant. These facts should not limit myself (or anyone else) from doing anything I want to do in order to be successful. Knowledge is often misunderstood for intellectual capacity. The next series of posts will build on the story of why you very well could be smarter than you think.

The Perfect (Financial) Storm

2008-10-19T20:30:00.008-06:00

Perfect Storm: a critical or disastrous situation created by a powerful concurrence of factors. [Mirriam-Webster's Online Dictionary]

Many people had given dire warnings about the serious problems the economy would be facing. Some even knew it would extend far beyond the United States. But few predicted the severity, scope and timing simultaneously, because of the complex commingling of the events. With hindsight, things become that much clearer.

Three factors--all of which were major contributions--were the reason why the world economy is now facing a global economic downturn of this level of severity. Any of the three occurring on their own would not have caused as much damage as we will now see in the coming months. All three are of course interconnected, but few specialists knew enough about one, let alone three to accurately predict the damage that this storm would cause.

The Road: Questionable Lending Practices
There was of course, Fannie, Freddie and the irresponsible lending practices promoted by government coalitions with free markets. This built a road that led to the edge of a cliff had been construction for decades only to be completed by about 2005. Warren Buffet who is often lauded as the World's best value-oriented investor, divested his entire position in both Fannie and Freddie all the way back in 2000. Buffet said he felt "uncomfortable with certain aspects of the business." It's also clear that many Washington insiders knew a problem was brewing here. In 2006, several Republicans (including John McCain) sent a letter to the majority leader which warned that "if regulatory reform for housing-finance government sponsored enterprises (GSEs) is not enacted this year, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole." The list doesn't end there, many others knew about fundamental flaws and an inappropriate risk profile for these quasi-government enterprises.

The Vehicle: Energy Price Shocks
Then there was the lack of a stable and sufficient energy supply (particularly oil), which served as the vehicle that had also been assembled over the course of several decades. Peter Tertzakian had some very impressive and accurate foresight with regards to oil 'breaking' the economy. In his 2005 book, he says that the world economy would stop, "'firing on all cylinders' in 2007," and in 2008, "a confluence of events [would force] the public and our nations' leaders to finally realize how vulnerable [the economy] had become [to oil prices]." He goes on to predict a plunge in SUV sales and automaker mergers, acquisitions and consolidations we are now seeing (his forecast calls for Toyota partnering with or buying GM). What he didn't foresee is how high gas prices would catalyze a collapse in suburban home values. With this, the assumption which was held by so many now troubled financial institutions--that home prices always go up--also failed.

The Fuel: Monetary Policy
Lastly, there was the fuel: credit money. Because markets are based on a fiat currency (based on a perceived value) rather than the gold standard (based on intrinsic value), the system is subject to bubbles, sometimes resulting very large corrections (the gold standard has its own drawbacks of course, which is why the two standards have been swapped many times throughout history).

Instead of going into too much into detail about how the world moved from the gold standard to a system of credit, I'll give a brief synopsis here (google it if you want to know more). Following the World Wars, the United States was in a very strong economic position (much like China today), as it was spared widespread damage on its own shores while Europe's infrastructure had been devastated. The country was extremely productive relative to other countries and awash in natural resources. Because they were in a position to lend money for the rebuilding of Europe, they formed the Bretton Woods Agreements (1944/1945). Essentially, the U.S. pledged to maintain a stable dollar by pegging its currency to gold, and all other currencies were in turn pegged to the United States Dollar. Several decades later, when the U.S. started to become a borrower rather than a lender as well as overextending itself with several wars, the hybrid gold standard to become incredibly unstable. It was officially abolished in 1971 and all major currencies were subsequently unpegged from the USD by 1976. No politicians in any of the major economic power had the political leverage to go back to the gold standard because fiat money allows for inflation and inflation makes the economy look good. Instead, national banks pledged to control inflation using imperfect price inflationary indicators, such as CPI and later core inflation.

It's not hard to see from the chart that soon after the gold standard was abandoned, the bubble era had begun. Deflation is considered political suicide and therefore the market corrections are always artificially stopped by government (meaning the problems simply build upon themselves). Former 2008 Republican presidential candidate Congressman Ron Paul can offer more on this subject, but the point is it hasn't worked.

It was not oil that was in a bubble at $147; it was the entire economy that was overvalued (homes, cars, equities, etc.). It was not price manipulators, speculators pushing oil prices upward but merely investors moving money from U.S. dollars into commodities to hedge against global inflation. This is why neither gas prices nor equities rooted in these commodities increased by nearly the same amount. Ironically, we now call this a "credit crisis".

In The End: A Terrible Concoction
As I've said, any one on its own, the flawed road, the vehicle or the fuel, doesn't really present instantaneous systemic danger. Had gas prices stayed low, consumer sentiment may have stayed high and home prices may not have plunged with Americans reconsidering the value of homes situated in very distant suburbs. Had monetary policy been better managed, oil prices would have increased more linearly rather than exponential volatility shocking markets (unlike the oil shocks of the 1970's, 2008 had no major supply squeeze). All three would still have presented a very serious threat individually of course, but the "perfect storm" as Bernanke puts it, is why the economy has weakened far more than many of the partitionary experts had predicted. I would caution that conditions are likely to continue to get worse even if global financial markets can be stabilized. Political instability has become one of the spillover effects and history has shown it is very difficult to maintain peace in the case of poor countries (or bankrupt ones). And yet I remain optimistic for the future, because after the storm, nature always rights itself. Always.

The Black Gold Sands

2008-10-12T21:01:00.020-06:00

Image: Terry Bain [cc]

Barring a complete catastrophic collapse of the global economy and credit markets (which happens not to be overly improbable), the Canadian oilsands will remain in a relatively strong position despite correcting oil prices.

In the absence of a breakthrough scientific discovery like cold fusion, there exists neither a viable alternative fuel source for oil, nor a likely prospective one in the near future. It certainly isn't impossible, but a cold-fusion type of discovery is highly improbable. The Manhattan programme and Apollo project are often cited as major scientific investments yielding results; but neither one required the kind of infrastructure overhaul that would be required to reduce demand for fossil fuels. With rising energy costs, nuclear, wind, solar and the other alternatives to fossil fuels will all become more competitive with oil. In fact, from a price-energy perspective, $100/bbl crude oil is already fiscally disadvantaged compared to its alternatives. One joule of oil priced at $100/bbl is even more expensive than the same amount of energy produced from wind energy. Residents of Hawaii paid 24 cents per kilowatt hour for their electricity because oil is the primary fuel used for electricity generation in the state (the cost of electricity produced from wind is on the order of 14 cents/kWh). The only reason oil remains so prominent is that it happens to be convenient (batteries are not well-suited to power cars) and current infrastructure, which will take decades to update, necessitates it.

A common mistake people make is to think that the rate of change of the consumer electronics industry can be replicated in the energy industry. The reason consumer electronics can evolve so quickly is mass (or lack thereof). Replacing a 20 ounce cell phone requires considerably less work than replacing a quarter-ton vehicle. This is because a cell phone has relatively little total intrinsic value in the materials used, which is in part why many electronics become cheaper as the become smaller (for example, a 1 GB flash card now costs less to make than a 1 GB magnetic hard drive).

How Long Will It Take?
In terms of energy substitutions, the change from wood to coal took 75 years. The change from coal to oil took 100 years. Natural gas took even longer because of the extensive pipeline infrastructure that was needed to accommodate it--in fact, over 28 trillion cubic feet of natural gas associated with oil wells has been discarded in the U.S. alone since 1936 (U.S. Department of Energy). The gas is simply burned at the wellhead or vented to atmosphere without capturing its useful energy because the pipeline infrastructure would cost more than the potential revenues from selling the gas. This does not happen much anymore in North America, but continues in places that have no market for natural gas such as deep offshore production and some middle eastern oil producing nations. Liquification of natural gas (LNG) and gas hydrates are emerging alternatives to pipelines, but both are expensive because of the energy inputs involved.

Transportation Industry
The transportation industry uses about 50% of the world's oil. The United States has about 250 million automobiles. Even if automobiles that didn't use fossil fuels were available today at a competitive price, it would take 9 years to replace most of them (9 years is the mean age of these vehicles, according to the Bureau of Transportation Statistics.

Electric vehicles can't be competitively priced today without making significant infrastructure changes. Batteries that meet the range requirements for American automobiles are simply too expensive. Also, too many steps in the electrical conversion process make it an intrinsically inefficient way to turn wheels. The figure above shows potential paths to turning the wheels of motorized land-based transportation. Each step loses energy due to thermodynamic constraints (the fewest number of steps are often the best route). Ethanol and other biofuels have a lower energy density than hydrocarbons as well as other significant challenges (discussed below). Heavy trucks are nowhere close to using alternative fuel sources and the aviation industry does not even know of a potential alternative to jet fuel.

1970's Lessons Learned?

Those who are old enough to remember the oil shocks of the 1970's and early 1980's can recall long lineups at gas stations and the economic chaos it caused. It prompted everyone to rethink the dependency of crude oil because of the economic impacts it had on oil importing economies around the globe. The first crisis occurred in 1973 when the Arabic members of OPEC imposed an oil embargo aimed at countries that gave military and political support to Israel. A resolution was reached between OPEC members and the United States in early 1974, but the shortages it created would leave prices elevated for several years. In 1979 another crisis occurred the Shah of Iran was exiled. Oil production from Iran would fall 75% in the next two years as a result of political instability and the resultant war with Iraq. Over the next several years however, other countries were able to fill the supply gap as a result of higher prices. Virtually every oil consuming nation devised an energy strategy in light of these price shocks. It would be left up to the policymakers to see these strategies through to completion as an oil glut ensued and very cheap energy prices left the general public unconcerned about energy independence for the rest of the 20th century.

United States Strategy
Project Independence was a vision of President Nixon which never got much traction because of extensive costs. Another reason American politicians did not to want to reduce oil consumption was that at that time, the United States was the largest producer of crude oil in the world, meaning that oil production was a very large part of the domestic economy (U.S. oil production peaked just a couple years earlier in 1970). Instead, strategic political measures were favoured such as a strategic alliance with the Saudi's as well as military efforts to ensure unimpeded flow of oil from the producer nations.

France's Strategy
In response to the same crisis, France decided to invest heavily in nuclear energy over a period of 15 years. Today, France leads the world in Nuclear Energy production, and even exports electricity from its nuclear plants to surrounding nations such as Germany. This now leaves them in an economically advantaged position compared to its European counterparts; however, oil consumption per capita only decreased by about 35%. This is because the substitution was only made for electrical power generation and they did not attempt to replace oil the transportation industry (this would have taken much longer and have been much costlier).

Brazil's Strategy
Brazil actually did decide substitute foreign oil in its transportation industry following the oil shocks of the seventies. They used sugarcane ethanol to do it and this conversion took them 30 years to reach a degree of energy autonomy. Flex fuel vehicles are mandated to use the E25 blend of 25% ethanol, 75% gasoline; some can even use E100 (almost pure ethanol). The United States tried recently to model Brazil's strategy, but it is failing for two reasons:

Brazil is a developing nation and its average citizen consumes 1/5^th of the liquid fuel that the average American does. It can't be scaled up in an overpopulated world without creating serious food shortages, as we've already started to see.

Brazil intersects the equator, meaning considerably more energy is available for the process photosynthesis that ultimately creates the energy used in the biofuels. This is why sugarcane ethanol yields about 8 times the energy required to produce it, while corn ethanol in the continental U.S. hovers around breaking even (optimistic scientists say 1.5 while pessimistic ones say 0.7). This means that for every gallon of diesel a farmer uses to cultivate corn, the amount of ethanol can be processed from the crop contains no more energy than a gallon of diesel--but the farmer can still make money provided subsidies are paid by the government.

Where Prices Will Go From Here
Now it's quite possible (but not probable) that oil could return to $40 a barrel depending on the depth of the global recession (some have even forecasted $10 oil). Even if prices did fall below $40 a barrel, such low prices will not stick once the recession has ended. Sector-specific inflation has increased the cost of production quite dramatically. Production and labour costs are out of control and the cost of production for new oilsands projects now sits between $80 and $120 a barrel. This is far too high for receding demand, and it may need to deflate and correct itself along with the rest of the global economy. This will present short-term challenges and if oil did fall to $10 or $20/bbl, this unlikely scenario would certainly mean layoffs; but even so, long-term supply will remain under pressure. The other supply issue surrounds peaking production in the worlds largest oil fields as I discussed in the past. Saudi Arabia's spare capacity (oil it can produce during shortages) is now limited to sour heavy crude, which only a few refineries in the world can handle.

One problem with projections about the Canadian oilsands ultimate recoverable oil estimates is that they often assume demand for this commodity will remain unchanged through 60 years. Instead, its likely that the oil which is hypothetically recoverable at today's prices will simply be left in the ground. This is analogous to the way many coal reserves remain in the ground from when coal was partially substituted for oil. My best guess is that it will take at least 25-30 years to significantly reduce global dependency on oil. The change is happening though, and Fort McMurray could easily end up being Detroit north if city planners aren't smart about economic development of the future. In the transition period from this now disadvantaged fuel, the oilsands should remain profitable. If not by a windfall, then at least by a small margin.

The White House of Cards

2008-10-07T20:55:00.021-06:00

The problem with foreclosures is that often times the pledgor is not cognizant of the severity of the problem until it's too late. It happened with millions of Americans who lost their homes. It happened with large institutions like Bear, Fannie, Freddie, Lehman and Wachovia. Now it is happening with the U.S. government.

Many financial advisers continue their rhetoric about a pending recovery of the U.S. economy, as it 'always does'. As mentioned in earlier posts, the U.S. economy is structured on cheap oil, which despite the crisis, still does not exist right now. In USD terms, oil is still more expensive than it was a year ago. Either the financial advisers don't get it, or they are lying the way Enron executives lied to their shareholders while funnelling their money out the back door. I suspect it is the former. Following weeks of market turmoil, record low auto sales and continuing record high oil prices, Citigroup finally began recommending to investors to sell shares in GM and Ford this week after their shares fell 82% and 67% in the last year. At least they made their statement sound eloquent:

"[W]e believe the risk-reward balance [on automaker stocks] has tilted decidedly negative on both absolute value and relative value versus underperforming suppliers," -Citigroup investment note.

Thanks Citi for the timely advice. Neither Ford nor GM has had a profitable automotive division in over 6 years. Better late than never I suppose.

Many had hoped that swift approval of the bailout plan would restore confidence in the U.S economy. Such an effect has yet to be seen as even the hopeful are growing skeptical. Hank Paulson said it will not prevent all bank failures--which are likely to resume their course now that the short selling ban has ended. Violent and sometimes even more damaging aftershocks continue to ripple worldwide as the USD is still the most widely held currency. The only stable asset right now is gold (it appears moderately unstable because of the gyrations of the currencies in which it is valued). Few signs of a bottom can be seen yet and confidence continues to slide.

Anyone who has been overseas recently knows that the once universal US dollar began to fall out of favour by merchants for other currencies over a decade ago. Unfortunately most Americans have never been overseas and don't even understand what is happening with their 401k's. Even the presidential candidates appear naive (or perhaps it is merely election rhetoric). They appear to think that they can solve the 'crisis' by investing in the economy (cutting taxes, fixing health care, energy independence spending, gas tax holidays, and so on). Unfortunately, it's probably too late for that, as they don't have any more pre-approved credit to invest. They would have to borrow it from foreign investors (or print it and make the USD worthless). The flaw that proved fatal for many of the failed institutions was the assumption that they could always raise more capital, if required.

House prices will always go up, storied institutions can always raise debt, and foreign investors will always buy up U.S. treasuries. The first two cards have already fallen. With foreign investors fleeing, the U.S. government needs to prove to its lenders that it will not default and is serious about paying back its debt rather than running deficits indefinitely. Serious action could take the form of pulling out of Iraq as quickly as humanly possible--this would likely split the country in three and destabilize the region, but the U.S. economy is pretty unstable itself if anyone hasn't already noticed; furthermore, as Alan Greenspan notes, Iraqi oil production has only now recovered to pre-war levels, so staying longer is unlikely to result in significant cheap oil supply anytime soon. It would also be wise to pull out of Afghanistan as soon as possible and negotiate a deal with the Taliban--this may not be in line with offical public policy; but as John McCain said, unofficial policy is often quite different from public policy. Most importantly, they need to sit down with the leaders of economic powerhouses and negotiate a set of terms to repay their debt and stabalize confidence. The first two cards have already fallen, if the third were to fall, it would get ugly. Barack Obama talks about hope and change. Let's all hope someone understands the severity of the problem and is willing to make the change required to avert a catastrophe.

America's Fundamentals

2008-09-20T19:33:00.001-06:00

A Fundamental Subprimer:

1938 - Fannie Mae was created under President Roosevelt as a government entity to provide liquidity to the housing market in the wake of the Great Depression.

1968 - Fannie Mae was pseudo-privatized by President Johnson to remove it from the federal budget. To make this privatization feasible, the company was made exempt from taxation and oversight. To ensure competitive market, Freddie Mac was created in 1970 to perform essentially the same role. Critics say they had no incentive to pay down debt because (1) they were exempt from reporting financial difficulties to the public, (2) they were backed by government as GSE's, and (3) house prices always go up. The effects of President Johnson's overall policy were swift and disastrous (link).

1970 - President Nixon continued tradition by signing the Emergency Bill on Housing, a bill designed to inject "as much as $10 billion a year into the sagging home construction industry." White house construction quotas were still not being met, so interest rates continued to be artificially subsidized. (St. Petersburg Times - July 25, 1970)

2002 - President Bush releases the Home Ownership Policy Book.

The stated mandates of this policy include

home ownership targets, with a focus on minority home-ownership,
a $440 billion increase in the financial commitment made by Fannie Mae and Freddie Mac to fund mortgages,
incentives for other mortgage lenders and
tax credits and down-payment assistance for new and prospective homeowners

2005 to 2008 - The growing American housing bubble bursts. Financial markets around the globe suffer as a result, especially in late 2007 and the first three quarters of 2008. Fannie Mae and Freddie Mac are put under conservatorship in September, 2008.

September 19, 2008 - In response to market turmoil, Treasury Secretary Henry Paulson announces a plan to buy the toxic assets that were plaguing markets. Critics say it emulates the tradition of creative accounting--moving garbage around in the hopes that it won't start to stink until it becomes somebody else's problem. They say Henry Paulson has just named himself CEO of a new enterprise called Hermie Max. Supporters say they have finally taken the first step in accepting responsibility for these problems.

Obviously, last week's developments in the mortgage crisis have been developing for some time. But it is by no means the only problem the U.S. Economy is facing. In fact, many of the problems have been exacerbated by others which are not mutually independent from the credit crisis.

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John McCain has refined his position that the U.S. economy is fundamentally strong to saying that American workers are the fundamental strength of the economy. Many take issue with both claims. The following is a disquisition as to why.

The Myth of The Hardworking American
As a generalization, the hardest working Americans are actually the landed immigrants. They believe in working hard to obtain 'The American Dream'. Although they are often unable to reach this dream, because of either lack of education or lack of credential recognition, they continue to work hard to ensure their children can live out their dreams. Unfortunately though, n^th generation immigrants (children of landed immigrants and their children) often lose this value of hard work. They tend to feel they are entitled to the American Dream rather than believing it is something they have to work for. They believe the living in America is a birthright rather than a privilege. In a lot of ways, they are technically correct--but that doesn't help labour productivity.

How hard Americans work in absolute terms is not really all that important with respect to the fundamental economy. What really matters is how hard the American citizen works relative to citizens other countries around the world. There is no question that labour unions have done very great things for the working class. However, in well-established societies, unions have basically become an extension of government and their value at present is now rather questionable. In American society today, government already mandates minimum wages as well as reasonable and safe labour conditions. The only purpose left for unions is to squeeze every bit of corporate profits out of the corporation for more benefits and higher pay. Competitive compensation is good, but union practices now make western business uncompetitive in increasingly globalized markets. They have actually caused job loss rather than increased employment. Meanwhile, developing nations were able to produce goods and services without the excessive labour costs exasperated by entitlements and labour unions. There was a very lengthy period of time when this labour cost discrepancy did not matter much for the western world. That's because the west held something more valuable than work ethic: knowledge. The concentration of literacy, education and knowledge in the western world meant that while Dollar Store items were 'Made In Taiwan', expensive technological items like cars and computers were still 'Made In America'. With globalization, the Internet, and other technologies, knowledge is more widely accessible than ever before. Computer science jobs are now being outsourced to India. Japan has taken over the automobile manufacturing industry. In China, the automobile industry is rapidly gaining ground although it is currently still in the 'pathetic' phase at this point. Critics who think they will never be able to make cars suitable for the western world should note that the same thing was said of Japanese automobiles when they first entered the industry. Relative to the American worker, productivity of the developing nation labourer is closing in fast. This is part of the reason why U.S. GDP growth has been declining over the years, while it has been increasing rapidly in developing nations like China and India.

History Does Not Side With US
Many advisers are saying now is the time to make long-term investments in the U.S. economy because markets are undervalued. This is likely true, and markets are indeed likely to be higher in 12 months than they are today. These advisers are saying to look at history as proof that the markets will recover; that markets have always recovered from downturns in the long run. This idea that history is a key to the present is very important--but they are using a panoramic lens instead of taking the 360 degree view. The panoramic lens goes back to the start of the twentieth century; the 360 degree view goes back to the first dominant human civilizations. Dominant superpowers have always overextended themselves to the point that their decline of power becomes an inevitable conclusion. This doesn't necessarily mean the American Empire^* will go the way of the Roman or Ottoman Empires; but it may go the way of the diffused and diluted British Empire. Some historians think this happens because the intrinsic rigid nature of empires leaves them incapable of adapting to change.

: *Many Americans are reluctant to call the America an empire, and prefer the term 'superpower'. I suspect this is because of stigma surrounding the fact that no empire in history has ever maintained its hegemony status for more than several centuries. Ultimately though, it will be up to historians to decide on an appropriate title for America's global influence.

The Swinging Pendulum
Turning the focus back to the economy at present, most analysts estimate there is still another 6-18 months before the fundamentals of the United States housing market hit bottom. The reason, they say, is an excess inventory of homes and historically low federal lending rates poised to rise in the coming months when the economic outlook improves. Confidence in U.S. markets has been shattered and it will take some time to repair. Money is on the sidelines and everyone is blaming it on the regulators, greed, and white-collar criminals. By 'everyone', I include those who would normally call themselves libertarians and 'ultra-free-market-capitalists'. They concede that Freddie Mac, Fannie Mae and AIG were too big to fail and in need of a government bailout. They will give very serious consideration to Paulson's plan for two reasons:

By not moving toxic assets to the taxpayer balance sheet, it could cause a depression. All but the most idealist free-marketeers will accept government intervention if this scenario proves realistic.

The credit rating of the U.S. is being eroded. If the government doesn't bail out China and the other creditors that hold the bad debt, then the foreign creditors will stop lending the U.S. money. It would be like trying to refinance a mortgage after declaring bankruptcy--creditors don't lend to clients who don't repay prior debts.

This is a sign that the ideological pendulum is swinging from right to left, and it is now poised to swing too far to the left. Regulation is a necessary part of markets; but only to provide stability and sustainability in an otherwise chaotic 'free-market'.

Under-regulated markets lead to volatility and unpredictability, while over-regulated markets lead to predictability and stagnation. Growth is good, and so is predictability; it's just a matter of finding the desired balance of the two. The swinging pendulum should be stopped somewhere closer to the center rather than the extremes where it was, and where it is now headed. When the Republican presidential nominee says "the regulators were asleep" and wants to dismiss the SEC commissioner for not regulating markets more, this is rather disturbing for the growth side of the equation.

Debt and Deficits
In defence of George W. Bush--the 9/11 hero that has now fallen out of favour with the American public--his policies are now, like those of most presidents at the end of their terms--more responsible since he doesn't have to worry as much about political backlash. He has threatened or tried to veto virtually all of the fiscally irresponsible bills put forth by a democratically-controlled congress (mostly to no avail). None of the recent bailouts were part of the budget.

Bail Out Recipient	Guaranteed (Public) Debt
Bear Sterns	$30 billion
Freddie, Fannie	$200 billion¹
AIG	$85 billion²
'Toxic' Mortgage Nationalization	$700 billion
Big 3 (GM, Ford, Chrysler)	$25 billion³
Total	$1.04 trillion

Notes:

Freddie Mac and Fannie Mae could cost taxpayers much more or less, no one really knows yet as this depends on how many more defaults there are.
AIG was made to sound like a great deal for taxpayers. The balance sheets of AIG aren't public but there is an unlikely scenario that taxpayers could profit and actually get a good deal. Note that free market enterprises would not capitalize on this potential 'bargain' given the high degree of risk. $27 billion of the 'loan' was reportedly used within a day of the takeover.
The big 3 deal is currently being lobbied to U.S. congress. GM is most desperately in need of these funds and some think the figure could be as much as $50 billion.

The U.S. Government Accountability Office states in a 2007 fiscal report that "The government is on an unsustainable fiscal path." It is their job to be alarmist, as this department is meant to hold congress accountable. But even if the debt projections are reduced by an order of magnitude, the picture still doesn't look pretty. This is on top of government deficits that are expected to be US $500 billion (excluding bailouts) for 2008 and only slightly less in 2009.
Neither presidential candidate has a realistic policy platform. Both tax increases and spending cuts are required just to stop the deficit, let alone reduce the $10 trillion federal debt. This figure excludes health care and social security entitlements that are expected to increase in the coming years.

In Canada the health care entitlements are an even bigger problem because of a public health care system. The baby boomers will begin reaching the standard retirement age of 65 in 2011. Health care costs will continue to rise as they have been in recent years and perhaps this rise will become exponential with the aging population blip. At some point in the very near future, Canadians will need to decide between privatizing health care and raising taxes. As the fiscal surplus is gone, there is simply no alternative; but at least in Canada the problem is not compounded by an increasing trade deficit as it is in the United States.

GDP Against Black Gold
America is addicted to oil. Furthermore, it's domestic supply continues to decline meaning it needs to export an increasing amount of wealth to feed it's addiction (see 500 billion dollar problem). As this happens, the U.S. GDP begins to work like the mirror image of oil prices. There aren't too many people left that believe the price of crude oil will go back to $40 a barrel. Given the current level of energy dependence, a sustained price of $40/bbl or less is the only likely way for the American GDP to grow at the same average annualized percentage this century that it has over the last century. This doesn't mean I think the economy can't still grow, but the higher the oil price, the more stagnant it will become. And right now at least, oil prices and the economy are in lock-step--as the economic outlook of the largest oil consumer appears strong, oil prices rise; when economic outlook is weak, prices fall. I can't see how the United States economy can be considered fundamentally strong with oil priced over $100 for each barrel.

It is for this reason of course, that energy independence (or more accurately reduced foreign oil dependence) is now such a hot topic. From this perspective, offshore drilling will help. Though as parties debate how much it will help, oil from this source won't hit markets for at least another ten years. Contrary to popular belief, there is no technological fix to America's energy dependence problem. Any realistic political fix to this problem would need to focus on facilitating revolutionary social change. Most of this required change relates to an incredibly powerful and convenient device called the automobile. There are 250 million registered passenger vehicles in the U.S., more than 8 for every 10 people. The transportation industry consumes half of America's oil, yet no feasible fuel exists to replace gasoline as oil prices rise. The much-hyped alternatives have some potential, but none will result in a seamless transition from oil.

: Natural gas
If a T. Boone Pickens-type plan were implemented, NYMEX natural gas prices on the continent would double to approach or exceed prices in Europe. Driving range between refuelling of natural gas-powered vehicles is considerably reduced. While the U.S. has more recoverable reserves of natural gas, they are not that much more, and it would also turn Russia into the new Saudi Arabia.
: Ethanol
Brazil's sugarcane-based biofuel model can't be scaled up to meet the transportation requirements of the United States, especially using corn-based ethanol. This fact only became apparent to some legislators when corn and grain prices began to skyrocket to unprecedented levels due to artificial biofuel subsidies.
: Hydrogen
This fuel is not an abundant natural resource as it does not exist in its elemental form anywhere on Earth. Currently, most industrial-use hydrogen is generated from steam reforming of natural gas (CH₄ + 2H₂O → CO₂ + 4H₂). Hydrogen can also be split from water using electricity but the process is thermodynamically inefficient--it requires considerably more energy input than a fuel cell will ultimately output. This is why hydrogen fuel cell development has been slow.
: Conservation and Fuel Efficiency
Gains here are limited, and the more significant gains come at a price--automobiles that are more expensive and unaffordable. First-generation hybrids (those that don't plug in), are a good example of this.
: Electricity
The electric car in its current form can't replace the automobile. They simply don't have the speed or range to meet the current social requisites of America. Batteries just aren't amenable to energy storage the way liquid fuels are. No one had to kill the electric car in the conspirator sense some have suggested. The Chevy Volt is a plug-in hybrid that will to come close to meeting social requirements with an optimistic 2010 production date, but at an estimated cost of $30-40 thousand apiece. GM's Vice Chairman Robert Lutz says that hybrids will never be as cheap as gas-powered vehicles for one simple reason: they require two power-trains instead of one. Instead of trying to meet the social requisites, the auto industry should focus their efforts on creating and marketing electric cars as 'urban utility vehicles' rather than as standard cars.

Given that technology will not provide a seamless transition from oil to other fuels in the transportation industry, Americans will be required to undertake social change. In terms of social lifestyles, what energy independence means is not that air travel, trucks and gasoline-powered cars will disappear completely. However, it does mean that the "soccer mom" who drives three kids to extra-curricular activities in different corners of the city in an H3 Hummer will cease to exist. She will find different activities closer to home without compromising the developmental opportunities of her children. Many people, including policymakers, find this new reduced dependency on the automobile very difficult to visualize because it requires a change in the way we think about transportation. This is why it will likely take 40-50 years before any significant degree of U.S. energy independence is reached, perhaps a decade or two less with political facilitation. And yet, the wheels for this have already been set in motion with the collapse in the sales of gas guzzlers and material reductions in air travel (the gas guzzlers of the skies). High gas prices also served as a catalyst in the collapsed assumption that 'house prices always go up', particularly in distant suburbs requiring excessive commute times. In time, the white picket fence will fall out of the American Dream. Unless the world can continue to produce oil at well over a thousand barrels a second, these changes will continue. Unfortunately for the United States, it continues to lose its grip on oil production, which means the change must be financed from within, and this will hurt GDP and growth as a result.

In Brief
As the western countries continue to lose their monopoly on knowledge, the higher work ethic will allow developing nations to continue to steal market share in terms of productivity for goods and services. As America's domestic supply of natural resources continue to decline, and the overpopulated world continues to consume them at an unsustainable rate. An incredible amount of energy will need to go into a structural change in the American way of life. As this happens, the U.S. will continue to lose its grip on control of strategic resources in countries like Venezuela, Iraq and Nigeria. Even domestically, resistance exists to the exploitation of coal and offshore oil reserves because of concerns about the environment. All of this means America's public and private debt is likely to continue increasing to the point where America will not own itself anymore, its foreign creditors will. Government will become incapable of acting on behalf of its citizens as it will become forced to appease its creditors. Useful work will go towards change, and repaying debt, and it is this that will circumvent growth. This is why the fundamentals of the U.S. economy are not all that good.