U.S. economy struggles despite upturns in some areas

BY MORRIS R. BESCHLOSS
PVF and economic analyst

With the current second quarter economy off to a slow start, it’s beginning to look as if 2007 will generate a U.S. gross domestic product increase approaching 2.5%. This is considerably less than the more-than-3% worldwide gdp projected average for this year. It’s also the weakest rebound since the current recovery began in late 2002.

While U.S. consumer spending will continue to lead the way, the American forward motion will be deflated by the downturn in housing and supplemental furnishings, as well as by the reversal of an already-embattled automotive sector. This traditional bedrock of U.S. industry will also negatively affect thousands of parts suppliers depending on orders from America’s Big Three auto manufacturers. Such production loss will be partially reduced by the growing development of manufacturing facilities for U.S.-based German, Japanese and Korean automakers.

Undergirding U.S. economic growth will be exports, which reached a record $1.3 trillion last year. Also abetting America’s industrial expansion is a substantial increase in a flourishing arms industry, much of which is scheduled to support America’s global allies, as well as the U.S. armed forces. High technology, which is on a fast track, continues to repeatedly reach new achievements, while accelerated commercial, industrial, institutional and commercial construction will soften the blow of declining residential building.

Another shot in the economic arm will be the $300-billion allocation for nationwide infrastructural improvements of highways, dams, bridges, airports and railroads. This unprecedented commitment, signed by the president last year, is the first major infrastructural leap forward since the Eisenhower administration in the late 1950s.

Although housing will probably resume its growth in the foreseeable future, the American automotive boom looks to be over permanently. According to projections by the International Organization of Motor Vehicle Manufacturers, China will be the world’s leading automotive producer by 2011 -- with an annual production of 11 million cars -- with Japan only slightly behind. Although most of these Chinese cars will accommodate China’s domestic consumer sector, they will ultimately be customized for export. German auto production is expected to flatten out at 5 million cars and trucks, with the once-dominant U.S. slipping into fourth place with an annualized 4 million. This will be somewhat mitigated by foreign expansion of U.S.-located auto manufacturing facilities.

With America facing an increasing employee shortage this year, partially due to massive baby-boomer retirements, employee increases will be hard to come by in the near future.

With escalating foreign investment continuing to flow into U.S. fixed and liquid assets, much of these currencies are finding their way into the coffers of American corporations. This is increasing their cash flow positions at an unprecedented rate.

Whereas previous recovery cycles generated an average of 5% corporate profit increases, the current recovery is generating more than twice this amount. Unfortunately, much of this newfound corporate liquidity is being used for stock buybacks and an increased rash of mergers and acquisitions. With current economic growth opportunities somewhat uncertain, major companies are hesitant to make significant capital investments.

Such uncertainty is precipitated by a further weakness of the U.S. greenback, reflecting potential economic fragility.

Although both trade and budget deficits have decreased marginally, the shift of foreign investments from dollars to euros, pounds and yen will continue to devalue the dollar. While this will strengthen exports, it also weakens American purchasing power, opening the door to future stagflation (economic stagnation compounded by inflationary costs).

With the continued overhang of prohibitive wartime expenditures and increasingly bloated entitlements, the expanding deficit will continue to siphon off government funds. Such continued fiscal irresponsibility could make 2007 the year the U.S. finally comes face-to-face with budgetary reality.

Productivity holds key to economic growth

One of the most important, and least understood, aspects of a vibrant global economy is productivity. This has been the main key for the U.S. maintaining solid economic growth with moderate inflation for the past decade. Simply put, productivity is the cost of each unit produced by all sectors of the economy, whether industrial or service. It primarily includes labor costs and benefits, material and overhead related to each unit’s production cost.

Productivity has been the main ingredient that has juiced up America’s economic growth while other mature economies such as those of Western Europe and Japan have been lagging. This happened at a time when the emerging dynamics of Southeast Asia, Eastern Europe and Brazil have leapfrogged their Western antecedents’ productive capability.

The easy answer to America’s ability to maintain a historically superior productivity increase is its ability to avoid the overbearing welfare packages that have been borne by the Western European nations, which are heavily industrialized. These countries have been saddled with inflexible unions, refusing to renegotiate the benefits gained by huge contract deals in the heady 1950s, 1960s and early 1970s. These organized labor-driven contracts took place before the Asian tidal wave squeezed major European companies’ profits and limited their competitive capabilities.

Granted, the major U.S. industrial companies and contractors came under similar pressure, but America was spared because of these significant differences:

• U.S. high technology leadership, both on the shop floor as well as the back office, allowed for a cutback in a substantial number of employees in both manufacturing as well as white collar personnel. At the same time, most companies were able to increase their production capacity with significantly less employment.
• The major U.S. shift away from the industrial sector employment to an all-time post-World War II low by the end of 2006 reduced the pressure of tough, high-priced organized union contracts dramatically in the last 25 years. It resulted in lower wage and benefit increases and a significant tilt toward small business, which lessened the impact of organized labor.
• The diminished role of the U.S. government in forcing the nation to accept universal health insurance and federal pension plans. These have saddled most Western European nations while allowing U.S. labor to be the most competitive among the traditional world leaders.

With America’s world-leading gross domestic product increasingly comprised of lower-paying employment in the service sector, most of these jobs are not beleaguered by undercutting foreign imports. This factor is somewhat offset by immigrant workers willing to work for lower rates of pay.

America’s industrial sector has the additional advantage of focusing its shrinking industrial employment on high technology, military equipment, commercial aircraft, construction machinery and farm equipment, which allowed the U.S. to accelerate its 2006 record export total to $1.3 trillion. Two-thirds of American exports are made up of industrial equipment not made competitively in the nations to which these products are shipped.

As we move into mid-year 2007, leading economists are becoming increasingly concerned that the 10-year run of increased productivity may be rapidly slowing or coming to an end. This pessimism is fostered by an increasing labor shortage caused by accelerated retirements of baby boomers and the anticipation of higher labor and material costs in the months and years ahead.

Such a trend would usher in an era of higher unit costs spurred on not only by increased wages and benefits but also by a rise in import prices due to a weakened dollar. This could put the U.S. back on the dreaded course toward stagflation, with lessened consumer demand accompanied by inflated costs, not seen in this country for the past three decades.

Shrinking global oilfields alarm observers

Almost a year ago, this column reported the conceivable implosion of Mexico’s Cantarell Oilfield, second largest in the world. This prediction proved to be correct, as Cantarell lost a fifth of its production from January 2006 through February 2007. This meant a loss of 400,000 daily barrels of production from this field, dropping from 2 million daily barrels to 1.6 million during this time period.

If this shrinkage continues as expected, Cantarell will be down to 1.2 million daily barrels by 2010 and a possible extinction within a few years thereafter. This event alone could prove catastrophic to Mexico’s economy, which depends on oil exports to fund 40% of its prolific government expenditures. Even worse, this turn of events would foreclose a critical import source for the U.S. and could turn previously oil-rich Mexico into a net importer. Mexican/American border violations would be increasingly significant under such circumstances.

Saudi Arabia, the world’s largest oil exporter, is facing similar problems in its huge Ghawar oil field, as reported in our column earlier this year. In the case of Ghawar, the massive 5.6 million barrels shipped every day is expected to revert to 5 million daily barrels by 2010. Despite Saudi protestations to the contrary, Riyadh’s four other giant fields are also expected to be on a precipitous decline.

America’s massive Prudhoe Bay reserve is another example of declining mega oilfields, falling from 2 million barrels a day in 1988 to the current rate of 900,000 daily barrels.

This continuing oil reserve downturn focuses on the reality that a quarter of the world’s daily output of 85 million barrels is pumped from the biggest 20 global fields. This is confirmed by estimates from Wood MacKenzie, a Scotland-based oil consulting firm. Many of these are expected to follow in Cantarell’s and Ghawar’s footsteps, according to other geological experts.

Replacing such big gushers may be next to impossible. Industrialized countries that tapped out their big fields over the past century are therefore turning to much smaller deposits. But these are proving much more costly to drill and require ever-deeper excavations to gain satisfactory results.

Evolving technology is being introduced as a major alternative to traditional oil finds, making such conventional crude oil substitutes as Canada’s tar sands viable. Even though there may be additional reserves offshore and at deeper levels to satisfy the demand of worldwide consumer growth, the cost factor is destined to rise meteorically. This would almost surely signal costs of $100, or above, a price that could become commonplace in the next decade.

Hubbert’s Peak, a theory that claims an oil production ceiling in less than 10 years, could become a worldwide economy-restricting factor. With inefficient, politically controlled national oil companies accounting for three-fourths of global production, it’s doubtful that these government-owned entities will take the necessary steps to implement economically driven policies. The global oil surplus of 20% that existed in 1986 is now down to a little over 2%, spurred by lack of adequate worldwide funding and a shortage of sophisticated technological management.

This leaves the residue of skilled decision-making to the five major energy multi-nationals, but these are increasingly being shut out from the Middle East and Russia. And they are hesitant to allocate the billions of dollars needed to exploit the few remaining deep-sea drill sites. They are equally obdurate in developing the Rocky Mountain oil shale, or U.S. coal reserves, unless subsidized by U.S. government pricing floors.

Barring an unexpected policy change by America, which seems to be fixated on ethanol and bio-diesels, the Big Five oil companies will be loath to expose their financial strength to increasingly volatile oil prices, heavily influenced by geopolitical global events.

Under present circumstances, where only five billion barrels of new reserves were found and 30 billion were sold by the multi-nationals in 2006, it’s a near certainty that an oil crisis, with confiscatory pricing to cover costs, will face the world by 2010.

Morris R. Beschloss, a 50-year veteran of the pipe, valve and fitting industry, is PVF and economic analyst for The Wholesaler.