America: The Future is Bleak

I am not bullish on the macroeconomic future of the United States. Let us cast aside issues of which party will win the presidency next November (though I will go on record to state that it will certainly by the Democrats). Let us pay no mind to the "political issues" of our age: healthcare, taxes, Iraq, terrorism, etc. No, travel along with me for a moment down to the sub-dermal layer of our society's future... Down to the fundamentals. The meat and potatoes of our destiny.

1) America is a free-market capitalist society, with some socialist elements (the Postal Service, utilities, roads, welfare, Social Security, Medicare, etc.).

2) The logic of capitalism is one of infinite growth. All present investments of capital are made with the expectation that the future will witness a larger market to consume the products of the capital inputs. Otherwise, there can be no profit off these capital investments, and rational investors will not apply resources toward them.

3) Ergo, unless the United States' economy is growing, capital will dry up, leaving businesses and consumers with fewer and more restrictive choices for borrowing. Without such ability to take on debt under reasonable conditions, entrepreneurial opportunities will be left to wither on the vine, potential homeowners will not have access to mortgages and homes, and even established businesses will have difficulty mustering the capital to invest in innovation, growth and expansion. Only those economic actors which have sizable amounts of cash saved will be able to finance such expenditures. Considering the savings rate for Americans now hovers consistently at 2% (down from 10-12% a generation ago), this cashflow is impossible for the average consumer. With few exceptions, businesses, especially small businesses, lack the luxury of slapping cash on the barrel for capital outlays. Thus, without cheap and easy capital to fuel it, the economy could "run out of gas."

4) Which brings us to our next point. The American economy is an energy-hungry one. This is evident to anyone who drives to work in the morning. Americans have few attractive alternatives for transportation to the internal combustion-powered car. Only two cities, New York and Washington, DC, offer public transportation systems for commuters attractive enough to display wide usage. Domestic shipment is reliant upon trucking, domestic and international travel rely upon air travel, and the vast majority of electricity generation in the nation emerges from coal, natural gas, gasoline, and oil-fired plants.

5) Every industrial economy relies upon energy inputs for economic output. The relationship between the units of energy required for every unit of GDP is referred to as energy intensity. The United States has a higher energy intensity (more energy required for each unit of GDP) than Japan, most of the nations of Europe, China and India. With only 3% of the world's people, the US is responsible for a quarter of world resource consumption. This is partly due to the geographic difference between the smaller, more densely populated economies of Japan and the European nations, and the larger, more disparate demographic of the United States (making transportation costs more of a factor). More than 80% of the economic output of the United States is produced in urban zones, and this is consistent among other well-developed nations. This due to the "clustering effect" of reduced transportation costs from density, university research-innovation pipelines, more educated pools of talent, cross-over between firms and industries, etc. However, this geographic difference cannot account for all the disparity, because the Netherlands actually suffer a higher energy intensity than the United States, and India and China are large nations as well (albeit with much more dense populations). The important point here is that the United States requires relatively more energy for every incremental increase in economic output than most other well-developed nations. Furthermore, because Americans have few attractive alternatives to cars for transportation, gasoline is a very inelastic good. In other words, gasoline, like food, is an essential good to Americans, and prices do not affect consumption patterns very much. This is born out by the fact that Americans have not significantly reduced their driving habits, despite spiraling oil prices. Energy costs, from the pump to the thermostat, merely eat up more of the American consumer's income.

6) For this reason, the United States is much more susceptible economically to rising energy costs than its global competitor nations. This is exacerbated by the continued weakness of the US Dollar. Consumers shopping for oil at the world price will have more buying power with the British Pound, Euro, or even Canadian Loonie, relative to the US Dollar.

7) This in the midst of the American housing crisis, which is already putting tremendous strain on the American financial system. More and more signs are emerging of an imminent recession in 2008, with the weak employment numbers this week only being the most recent. If world oil prices continue to increase to and above $100/barrel, the flagging American economy is kicked as it is down.

8) Though I've instructed us to lay aside the political issue of Iraq for a moment here, it will play into this scenario in important ways. Aside from the obvious human costs and geopolitical turmoil resulting from the conflict, estimates for its economic cost have ranged from $1-1.5 trillion. The tremendous outlay by the federal government for a war that is costing $1 billion a day is not being financed by taxpayer monies. It is instead being thrown on top the already tremendous federal debt. This debt is contributing to the weak dollar, increasing economic risk, and a strained regime that requires continued confidence among foreign central banks to continue buying up more debt through US treasury bonds. Furthermore, this debt has merely borrowed against the future, with the requirement that it be paid back eventually. The electorate faces talk of a looming Social Security crisis with mass Baby Boomer retirement, plans for universal healthcare, chronic homeland security costs, an inflating defense department budget, and bleeding sores in Iraq and Afghanistan. Unless the economy grows appreciably in future years--and tax revenues increase substantially from present levels--the government will be hard-pressed to pay its debts while addressing the expensive concerns of Baby Boomer retirement, healthcare woes and the War on Terror.

9) If the primary owners of America's national debt in Japan, China, Britain, and the oil-exporting nations decide that the United States is a credit risk, they will cease to finance more government debt. Furthermore, the flagging dollar may likely convince more and more nations to reduce their dollar reserves in favor of the Euro, or a basket of currencies. Without enjoying the unique status of the world reserve currency, the dollar will continue to grow weaker. Thus, imports, and energy imports, most importantly, would grow increasingly expensive for Americans.

10) Beyond all the slogans for reducing our reliance on oil imports, increasing energy independence, and moving past the fossil fuel economy, any significant changes will be costly and take several decades. Infrastructural projects to give consumers and businesses transportation options beyond automobiles will take political will, many years, and many more billions. Furthermore, technologies to make solar or wind energy cost competitive with fossil fuels for energy are years off. The "hydrogen economy," if it ever materializes, will take decades to develop proper distribution infrastructure, cost-competitive vehicle offerings, and a cost-effective method of sustainable hydrogen generation. Right now, the vast majority of hydrogen is derived by burning fossil fuels. Similarly, ethanol and biodiesel production right now consumes far more energy than it produces. Since modern agriculture requires chemical fertilizers derived from oil, ethanol producers are literally "growing oil with oil." Since electricity is mostly generated from coal, oil, and gas-fired plants, this offers no way out of the fossil fuel trap. Nuclear plants take over a decade to build, face severe "not in my back yard" opposition, present safety and security concerns, and their electricity is far from "too cheap to meter." The price of natural gas has been increasing right along with world oil prices, and will likely soon be organized into a global market (meaning increasing world demand will bear even more heavily on price domestically). There now exists no viable alternative to gasoline that can match its cost-effectiveness, energy density, and portability.

11) China, home to a quarter of the world's people, has grown 9% per year for the past decade, and shows no signs of slowing. It's average household savings rate is a massive 30%, it is a global creditor rather than a debtor nation, and it shoulders no costly wars or overseas military commitments. The United States spends 48% of all world military spending, almost as much as every other nation combined. China only shoulders a seventh this cost for its military. With endless growth, no debt burden, small military expenditures, and easy sources of domestic capital, China is on increasingly good footing relative to the United States.

Implications: What Does All This Mean?

1) America is a big and self-sufficient enough economy that increased import prices from a weak dollar do not matter much per se. However, increased oil import prices do matter--a lot. As oil gets more expensive from increased world demand, peaking supply, refinery undercapacity, and the weak buying power of the US Dollar, the economy will suffer.

2) Until we are able to transition to a more sustainability energy regime beyond fossil fuels (a generation or more hence), the fossil fuel crunch will hurt the United States, and hurt it more than most other industrialized nations.

3) Transportation costs for both businesses and consumers will be a major and increasing percentage of spending. Finding ways to reduce transportation costs will be decisive. Expect the suburban sprawl of the past half century to begin to reverse, as businesses and consumers realize the benefits of density for energy cost reductions. Workers will choose to live closer to their places of work, and to telecommute more often. Political pressure for light rail options will increase. Also, expect the benefits of the aforementioned clustering to increase, drawing more firms toward metropolitan areas, despite the higher real estate costs.

4) The 20th Century shift from rail to trucking in domestic shipment will also begin to reverse, with the energy efficiency of rail preferred over diesel-thirsty trucking. As demand for rail shipment increases, more investment from the public and private sectors will be forthcoming, increasing the versatility and convenience of rail, and decreasing its cost further. This positive feedback loop will ensure the primacy of rail in domestic shipping.

5) Container shipping will be more and more preferred for international applications, over air shipping, which will only grow more costly. A high premium on fast international shipping will call into question the feasibility of the Just in Time (JIT) inventory strategy pioneered by Toyota and in wide use in global business today. Warehousing costs, though significant, will be more and more preferable to even more significant air shipment costs. Improved inventory models may reduce this problem, but in general the paradigm of expensive real estate and relatively cheap transportation will begin to tilt back in favor of real estate.

6) Economies that can increase their energy intensity will win in the world economy. As energy costs increase, those who can eek out more GDP growth on less energy input will enjoy competitive advantage. For now, this confers much advantage to European and Japanese firms relative to American ones. There are many more variables at play, so this is not to suggest that America will be left behind. However, it will occupy a less competitive position relatively than it has.

7) The United States will face an inevitable and painful day of fiscal reckoning within the next decade. With birthrates declining, the workforce aging, and a glut of Baby Boomers entering their winter years, Social Security outlays will be gigantic. Furthermore, there will be fewer and fewer productive workers feeding into the system for every non-productive retired person drawing from the pot. This problem is far more pronounced in Japan, Singapore, and Europe, where birthrates have now dropped to as low as half the replacement rate (the births per woman required to maintain the population steady). In the US, this fiscal crisis will be compounded by the problem of healthcare (which will be very expensive whether the system is universal or not), the massive federal deficit and debt, and a slowing economy. Furthermore, if the dollar is foresaken as the world reserve currency, and central bankers and investors loose confidence in America's economic future, capital will dry up in a negative feedback loop. With potential sources of capital not forthcoming (from either non-saving American citizens or risk-averse central banks and foreign investors), and with a recessionary economy and large fiscal commitments, the federal government will either have to raise taxes (inflaming the economic distress) or cut back on services to close up the deficit and begin paying back the principal and interest on the national debt.

8) All-in-all, you might want to either demand to your boss that you get paid in Euros, move to Canada, or invest a sizeable portion of your pension or 401K in global markets.