Stirling Newberry: The Black Gold Window

We have come to this place: the party that captured Presidency, the House and the Senate less than a year ago has only 37% of the American public convinced that the country is heading in the right direction, according to a Gallup poll. Newsweek's poll shows much the same thing, with 36% saying that they are satisfied. AP/Ipsos found 37% declaring America "on the right track." Part of this is surely gasoline prices; for months, only a bit more than 30% of Americans have felt that Bush is handling energy policy correctly. Pollsters should recognize this political moment. It is the end of a regime - not merely a presidency, but an entire way of doing business. The last days of the Carter and Nixon administrations had such a moment, as did LBJ before he decided not to run for re-election in 1968.

There seems to be a disconnect is between economic numbers and poll numbers. If you asked a political scientist what the approval number of a President would be if unemployment were at 5%, inflation at a bit over 2% and mortgage rates near all time lows, with the stock market having rebounded almost 30%, he would without blinking say, "60%, easily." Clinton's approval numbers were in the high 50s and low 60s through his second term. Instead, depending on which poll you follow, Bush's approval number lies between 41% and 45%. In short, for every two people who approved of Bush after 9/11, one of them has changed their mind.

So what is the source of this disconnect? Are people ungrateful and deluded? Are the economic numbers cooked? Neither. The economic numbers are like a speedometer - they tell you how fast you are going, but not whether you are lost. The economic numbers aren't cooked, they are telling us that the economy is doing what it is supposed to do given the policy levers that are being pulled. The problem is that this economy is no longer the economy people want to live in. That is the real source of the disconnect.

The current US economy is designed to sell paper and buy oil - create paper assets and sell them; in return, buying oil and inexpensive manufactured goods. What the economic numbers are telling us is that the US is doing this moderately well, pressure on consumer inflation is not high by historical standards, and wages are not adding to inflationary pressure in themselves.

However, this paper for oil economy is not capable of creating jobs or creating sustained increases in wages. And since most of us live in the part of the economy where we sell our labor, this means most of us are falling behind. Until recently, what many Americans did was borrow money against the increase in their home price. Thus the disconnect is that the economic numbers are measuring pressure on consumer goods and the inflationary pressure that demand for jobs is placing on the economy. The economic numbers tell us that the operation was a success, but the patient is dying.

Now comes the unpleasant part: this next year is going to be as good as it gets for Bush's economy. This is because what Bush has managed to do is create a good old fashioned dollar glut. In the short term that will prop up demand, but only in the short term.

What's a dollar glut?

A dollar glut is when dollars pile up in the hands of those who have dollars. Now they don't want to spend them, because that generates inflation - which would make all of their other dollars less valuable. So they want to park them someplace so that they breed little dollars. But if there are a lot of dollars parked already, then there has been asset inflation. This can continue for some time, as long as there is no way for anyone to cash in on it. However, economics always sides with the hidden flaw. While it is possible to put up barriers to arbitrage - people buying something cheap in one place and selling it more expensively someplace else - eventually, a way is found to cash in.

In the late 1960s and early 1970s there was a dollar glut, and the way to cash in was to get dollars, buy gold from the US at the official price of $35 dollars an ounce, and sell it at the London Gold Fix price. Now, in the early days of a dollar glut, this doesn't do much. If someone tries to take advantage of the glut, it simply pushes prices back to equilibrium. As soon as too many people do it, the price drops enough so that it isn't worth it. So early on, it was possible for governments to form a "London Gold Pool" and push the price of gold down.

However, the mistake was when the Johnson administration failed to understand that this was a warning sign. While Germany wasn't going to dump dollars, there were others that would. Nixon, rather than facing the music and restructuring the American economy and the Bretton Woods financial system, decided to throw a match on a pool of gasoline. The system exploded, and while there were attempts to save it, it was clear that there wasn't enough gold on the planet for the US to buy the oil it needed. Nixon "closed the gold window," and the era of floating currency began.

The same thing is happening now. There has been a growing dollar glut in the world. Now, China and Saudi Arabia have no reason to either consume too much or to dump dollars wholesale; it would hurt them more than it would help them. Their willingness to park dollars in low interest rate treasuries is what keeps the whole system afloat. As long as there was no "gold window" in which those betting against the US currency could cash out, the federal deficit and trade deficit could seemingly float in mid-air.

However, there is a gold window, or rather, a black gold window: oil. You see, oil is cheap compared to what you can do with it. Specifically, you can build houses farther out and speculate on real estate, and you can move production to cheaper areas and ship the goods. The bigger the difference between the price of oil and the profits from moving housing and production, the bigger the gap.

This means that what speculators can do, and will do, rather than invest in a sluggish stock market, is speculate on oil. As long as oil is "cheap" relative to land and labor arbitrage, people will pay it. Good old fashioned pricing power: charge what the traffic will bear. Quite literally in this case. Since Americans can't quickly sell their homes, and because of the jobs drought, can't easily move - and it is still cheaper to make it in China and ship it to the US, the black gold window stays open. There will be sell-offs, but these are temporary respites, not signs of the return of $1 a gallon gasoline.

So why is this an important problem? Because the economy that we have is designed to produce dollars that are destined to be parked. The dollars are created here, create economic activity, and then they end up in the hands of central banks. The dollar glut is the objective of our economic policy engine, and the fact that the ability to glut dollars is coming to an end means that the economic era it was built on is coming to an end too.

But why is this the end of an era? That's for the next column, and I promise, it will make several readers of this space very angry with me.

Stirling Newberry is an internet business and strategy consultant, with experience in international telecom, consumer marketing, e-commerce and forensic database analysis. He has acted as an advisor to Democratic political campaigns and organizations and is the co-founder, along with Christopher Lydon, Jay Rosen and Matt Stoller, of BopNews, as well as the military affairs editor of The Agonist.

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