Working Papers

An ‘October Surprise’ on US Q3 GDP?

Kevin Hassett argues that US Q3 GDP may play a role in the upcoming US congressional elections:

here is the kicker for Republicans: The data calendar indicates that GDP for the third quarter will be reported by the Bureau of Economic Analysis on Oct. 27, right before Americans enter the voting booths.

You might call it the “October surprise,” but in this case, economists will have seen it coming. Republicans, who have found themselves in the political equivalent of a nightmarish ballgame for some months now, will probably not be surprised that this break has gone against them as well.

My associates at Action Economics are arguing that any ‘October surprise’ will be up:

The market seldom watches U.S. wholesale trade reports, but this morning’s figures have revealed a robust growth trajectory for both sales and inventories that has further reduced prospects for a meaningful slowdown in GDP growth in Q3, as some still fear.  We have not revised our 2.7% GDP growth estimate for Q3, but economists focused on a “1-handle” will have difficulty supporting such low forecasts.

Meanwhile, Nouriel Roubini is arguing that falling oil prices are a negative for the US economic outlook.  Back when Nouriel was forecasting oil at $100/barrel, it was a different story:

I fully agree that oil prices will remain high for a long time; worse, they are likely to significantly rise towards $100 in the medium term (and some are already expecting oil at $90 by year end). Indeed, the factors that [Robert] Feldman suggested that may lead to lower oil prices in the future are all unlikely to take place. So, expect higher and higher oil prices and, at some point, another ugly stagflationary outcome.

Nouriel has only ever been interested in one story: his perverse hankering for macroeconomic ruin for the United States.

posted on 11 October 2006 by skirchner in Economics

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Are you seriously suggesting the Republicans deserve the support of the American people after leading them into the quagmire/fiasco/calamity/catastrophe that is Iraq in 2006?

I mean, the GOP has done such a stirling job of fiscal management in recent years they’re clearly the right party for the job!  I doubt those bleeding heart tax-and-spend Democrats could have possibly found a way to piss away so much money so quickly on something that makes everyone worse off.

It was truly an awesome achievement to go from a $236B surplus (2000) to $455B deficit (2003) in three short years:

As for oil prices, don’t you think its a little premature to start declaring victory over the doomsayers?  A cold snap this (northern) winter could turn things around very quickly.

Posted by .(JavaScript must be enabled to view this email address)  on  10/12  at  11:50 AM

Oil has all but given up its 2006 gains, so even a rebound in oil prices from here would leave us well short of Roubini’s $100/barrel scenario of just a few months ago.

Posted by skirchner  on  10/13  at  02:51 PM

I’m not suggesting we’ll see $100/bbl oil this year or next (unless there is some unforeseen event like another cat. 5 hurricane in the GoM or say, a terrorist attack on a crucial piece of refinery infrastructure) but I can’t see the long term trend reversing can you?

Oil was ~$20/bbl in 2001, its ~$60/bbl in 2006, where will it be in 2011?

I can’t see demand slowing and that means an awful lot of oil has to be discovered, produced and refined in the next decade.

China’s Nine-Month Oil Imports Rise 16% YOY.

Posted by .(JavaScript must be enabled to view this email address)  on  10/13  at  04:36 PM

See, I have trouble reconciling this kind of chart (onwards and upwards forever)

...with this kind of chart (heading south for 40+ years):

Does that make me a doomsayer?

Posted by .(JavaScript must be enabled to view this email address)  on  10/13  at  05:44 PM

Ulimately, these trends are dominanted by behavioural responses to changing prices and increased long-run susbstitutability in energy.  See Julian Simon and Bob Bradley Jr’s books if you want to understand why the long-run secular trend for real commodity prices is down.

Posted by skirchner  on  10/13  at  06:28 PM

Of course all of this assumes millions of years of buried sunshine (aka crude oil) *can* be substituted.  Can you nominate something (biofuels, tar sands, coal-to-liquids, hydrogen)? or are you saying humanity is infinitely ingenious, and because a new energy source has always been found in the past it will therefore always be found in the future?

I’m aware of the Simon-Ehrlich wager.  Seems to me Ehrlich was about 20 years too early.  Doesn’t mean he was wrong.

Posted by .(JavaScript must be enabled to view this email address)  on  10/13  at  07:25 PM

There was an interesting piece on George Negus’ Dateline programme about a month back, regardng electric cars. 

These things are not only viable, and have been mass produced in test-runs by big-name motor companies:  they can also out-perform petrol cars.  The torque that they produce is so substantial that there is no need to install a gearbox.

With this technology, it would be very easy to substitute electricity produced from coal, nuclear power, wind, the tides, etc - name your poison - for oil.

All that is missing, it would seem, is profitability and infrastructure.  Diminishing oil reserves will make sure that profitability and the ‘charging stations’ emerge.

There is certainly no technological barrier.

Regarding commodity prices, my money is with Julian Simon.  Have a look at commodity prices over the very long term - you’ll see a beautiful curve falling sharply at first, and then levelling out - but still falling - as real cost approaches zero.  Given the constancy of human nature, I can’t see why this would change any time soon.

Posted by .(JavaScript must be enabled to view this email address)  on  10/14  at  09:31 AM

Easy?!  Possible maybe, but certainly not easy.

Petroluem is the source of ~40% of energy consumed today:
Note: almost all of the renewable energy is hydro.

It might take 20-30 years to substitute petroluem with alternative energy sources.  It would represent a change in energy infrastructure that we have not seen for 100 years or more.  In many countries the electricity grid is already close to maximum capacity.

All of this assumes there will be an appropriate price signal 20-30 years in advance that tells us we should start overhauling our energy infrastructure.  Its not clear that will happen.  Look at the profile for oil production in the lower 48 states of the US.  Show me any indication of an imminent production decline that would have been apparent in late 1960s:
And we all know what happened in the early 1970s when the US was forced to import oil.

On the generation side, where does all this electrical energy come from?  It will become increasingly difficult to build new coal-fired power stations as the evidence for AGW mounts.  New nuclear power stations will always be difficult politically.  Renewables can’t provide base-load power.

There are also several technological barriers with electic vehicles, battery range and time-to-recharge being the most important.  Perhaps standardised swappable battery packs will solve the problem.  Who knows.

Don’t get me wrong, I’m a big fan of electrifying our transportation infrastructure (converting electrical energy to kinetic energy is way more efficient than any kind of internal combustion engine) but it won’t be easy.

Only an economist would believe that the price of non-renewable (and non-substitutable) resources would approach zero in the long term.

Posted by .(JavaScript must be enabled to view this email address)  on  10/14  at  10:25 AM


I still reckon it will be easy - if we let market mechanisms work.  Rising oil prices will ration the supply of this commodity as it runs out, as well as spurring demand for alternative forms of transport - which will in turn spur demand for more power generation capacity, infrastructure etc.  The political process, as always, will allow us to find a balance between meeting our energy needs and not aggravating (beyond what the middle class can cope with, anyway) the damage to the environment.

I suppose I should have said feasible, and not inherently difficult.  I can see that ‘easy’ can be read as ‘quick and painless’, which the transition most likely won’t be.

Regarding price signals, they’re not the only way to indicate future trends and direct investment.  Visionary leadership which can see opportunities and gain the confidence of shareholders has its place:  I’m thinking of Essington Lewis at BHP, or the bloke at Supermarine who invented the Spitfire - they saw the writing on the wall, they devised plans, won the backing of shareholders and gave their countries (some of) the means with which to survive and triumph in a life and death struggle. (I have no idea if such leadership does or doesn’t exist in industry today).

Resource prices:

I don’t think ANY natural resource used in industrial processes is non-substitutable. 

Once, when my work required me to forecast commodity prices, I saw a long term graph of real copper prices exactly as I described it to you.  I think it was in one of LME’s monthly publications. Falling real commodity prices isn’t an article of faith, it’s an empirical fact (that I can’t support with evidence found using Google, I’m sorry).

And approaching zero doesn’t actually mean that it will reach zero - think of the hyperbolic curve.

I can’t help it, I’m sorry:  I’m an incorrigible fan of Julian Simon.

Posted by .(JavaScript must be enabled to view this email address)  on  10/14  at  03:37 PM

I’d prefer to say falling real commodity prices are a *historical* fact, and I don’t dispute that.

“I don’t think ANY natural resource used in industrial processes is non-substitutable”

I would agree that HAS been true for the 200-odd years since the industrial revolution, but I think crude oil will be particularly difficult resource to substitute.  I mean, if it was easy would the industrialised world still be hostage to a bunch of medieval fiefdoms in the Middle East?  Of course not, we’re addicted to the stuff partly because its cheap, but mainly because its so difficult to substitute.

Crude oil is truly magical stuff.  Its easily transported, liquid at room temperature, has spectacular energy density, and until recently it just spurted out of the ground.  The energy required to extract the stuff is minimal, but the energy returned is stupendous.

You’ve suggested we could replace petrol-powered cars with electric vehicles, and in the long term I think that will happen.  Can you suggest what we would replace jet fuel with, because aviation is a particularly thorny problem in the post oil age.

Posted by .(JavaScript must be enabled to view this email address)  on  10/14  at  10:33 PM

Crude oil:

It is always feasible to substitute away from crude oil, but only at the right price.  We rely on the fiefdoms because the price we pay at the pump is not yet high enough to encourage us to use something else.  If we’re hostages, then we’re hostages of our own choice.  We don’t have to buy the stuff, we choose to because it’s cheap.

And you’re right - it is wonderful stuff, in an engineering sense.  Oil goes into the making of plastics and polyesters, too, and fertilisers, and bitumen for roads.  In an environmental sense, it’s rather yucky, and health-wise it’s cancerous.

Jet fuel and air transport

First - why do we need jet fuel at all?  If we can push a car down the road with electricity, then why not a jumbo jet??  Surely it’s just a matter of scale?  The principle of ‘lift’ will still operate.

Secondly - will we ever run out of jet fuel?  I suspect jet fuel comprises a small proportion of the products emerging from the cracking towers.  If the car fleet converts to electricity, that will leave a lot of surplus oil to power jet engines - for many years.

Thirdly - the supply of crude oil will never actually ‘run out’.  Used oil wells have plenty of crude oil in them - it’s just that the pressure that made the stuff spurt out of the ground has gone.  We can extract that crude - but at a price.  If the returns from air transport are sufficiently large to encourage people to pay the extra (and probably substantial) cost for extraction, then we’ll have air transport for a long time to come yet.

Ah - self-correcting markets!

PS:  whenever I see your moniker, I can’t help but think that you’re Westpac’s David Morgan, reading IE for some monetary policy tips.

Posted by .(JavaScript must be enabled to view this email address)  on  10/15  at  10:06 AM

Jeremy, I think we agree on most things, where we disagree is whether market mechanisms will give us enough time to transition away from oil.  As I’ve indicated, I believe it would take in the order of 20-30 years to completely overhaul our transportation infrastructure, but IMO market mechanisms won’t give us anywhere near that amount of time.

I have tried (and failed) to find a chart that combines oil production in the lower 48 states of the US with the price of crude.  This is the closest I could find:

We all know what happened to the price of crude in the 1970s, but what I’m really interested in is what (if any) price signals the market gave us in the 1960s that US oil production was about to peak.  The answer is:

Of course, it wasn’t world oil production that peaked in 1970, so domestic oil could be (relatively) easily substituted for imported oil.  (If you call a couple of oil-shocks and a decade of stagflation ‘easy’)

My point being, when global oil is approaching peak production there’s no guarantee there will be a price signal until after the fact, and then there will be no easy substitution.

Now you may say we’ve seen a strong price signal from the oil markets already, but I would argue that much of the recent spike in oil prices was due to:
a) speculation about another horror hurricane season in the GoM which didn’t eventuate
b) geopolitical tensions such as the Israel-Hezbollah conflict
c) continued strong growth in demand from China, India etc

Besides, all that has resulted from the recent run up in oil prices is a little bit of conservation.  Oil has a very low price elasticity.  We’d need $100/bbl or even $200/bbl oil before we see the massive changes required to overhaul our transportation infrastructure.

RE: jet fuel:
First - because nothing has the energy density of kerosene, unless you count nuclear fuels.  The energy density of a battery is 0.72 MJ/kg.  The energy density of jet fuel is 43 MJ/kg. (Physics trumps economics, sorry Stephen)

Secondly - True, but that pre-supposes we can move the car fleet to electricity which won’t be easy.  It is also possible that we could produce aviation fuel from biofuels if a significant portion of ground transporation is electrified.

Thirdly - Of course it will never run out.  The crunch comes when production cannot be increased to meet demand.

Another consideration: A lot of the alternatives produce much more CO2 per kilometre driven than crude.  This is true of tar sands, shale oil, coal-to-liquids, biofuels (if you chop down a rainforest to grow the crops) and burning coal to power electric cars.  While the market does not put a price on CO2 emissions these alternatives will become more attractive, and will accelerate climate change.  (Note: Stephen Kirchner conveniently ignores this fact because he holds the increasingly absurd position that human activities are not responsible for global warming)

Posted by .(JavaScript must be enabled to view this email address)  on  10/15  at  03:03 PM

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