800 Million Euros in the Side Pocket

Private equity firm partners are starting to play games to ensure at least they get paid. Their fund shareholders will howl if this doesn't work out, but hey the partners have expenses they need to pay. Basically, some funds, rather than selling a portfolio company to someone else (such as the public) are selling companies from one side pocket to another. Side pockets hold investments that are hard to value, like private companies, and incentive fees are only paid when an investment is sold and gains are realized:

Look at ProSiebenSat's €3.3 billion ($4.44 billion) purchase of rival European broadcaster SBS. Kohlberg Kravis Roberts and Permira control both. But different pockets are involved. Permira Europe III is the investor in SBS. Permira IV is the ProSieben shareholder. With KKR, there are no fewer than five pockets involved: two are invested in SBS; but three completely different KKR funds have the stake in ProSieben.

The result is that the €800 million or so of profits that the two private-equity firms make on selling SBS can be credited to their old funds. Even if the deal proves a bad one for ProSieben, the money won't get handed back from one pocket to the other.

This is very good for the partners who work for the buyout firms -- particularly when it allows them to cash in their slice of the profits. But the outside investors, the so-called limited partners, need to scrutinize these types of transactions particularly carefully. After all, if things turn sour, they'll be left holding the bag.

So the firm decides that one of their portfolio companies will buy another of their portfolio companies, but who decides the price? Negotiating with yourself can be exhausting, but I bet the price has something to do with the price they paid for the company originally. Just a guess.

The Fed Meeting

The Fed left rates unchanged yesterday as expected. The statement was only changed slightly to reflect the Fed's belief that core inflation is moderating. This was basically a non event and with the July 4th holiday coming up next week, stock market volume was light. Expect another light day today.

Abolish the Federal Reserve

Ron Paul introduced a bill to abolish the Federal Reserve:

A BILL
To abolish the Board of Governors of the Federal Reserve System and the Federal reserve banks, to repeal the Federal Reserve Act, and for other purposes.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

It has no chance of passing, but it's nice to dream.

BIS Speaks Austrian

This post from the WSJ's Economics Blog links to the annual report of the Bank for International Settlements that analyzes the global economy in Austrian terms. For those of you who are new, I consider Austrian Economics to be the set of economic theories that are closest to the "truth" about economics.

Does the U.S. risk repeating the mistakes that led to the Great Depression? The Bank for International Settlements’ annual report, released Sunday, suggests that it does, and offers a remedy steeped in the doctrine of Austrian economics.

The idea that we could repeat the same mistakes that led to the Great Depression is a frightening one. It is also entirely possible since so few understand exactly what caused it and that the New Deal probably extended it. There is also an editorial in the WSJ today by Amity Shlaes about the limited criticism of the New Deal over the years.

I'll be reading through the BIS annual report this week and will report anything that seems important and relevant to us as investors.

Contrarianism

The NYT has an article about contrarian market theory:

INVESTMENT newsletter editors are markedly less optimistic about the stock market now than they were late last year, when the Dow Jones industrial average was a thousand points lower. This suggests that the bull market may run a while longer, according to the market timing theory known as contrarian analysis.

One of the major factors in our investment process is determining the public's perception of the market. High levels of public participation and rampant bullishness makes us nervous and the opposite tends to make us aggressive investors. Mark Hulbert, who writes the Hulbert Financial Digest, looks specifically at newsletter writers to gain a similar perspective. And based on that research, now is a good time to be in the stock market:

The Hulbert Financial Digest, which has been tracking the investment newsletter industry since 1980, has found that the stock market performs far better, on average, after periods when newsletters are very bearish than when they are quite bullish.

That’s good news today, because the average newsletter editor who focuses on short-term stock market timing is recommending that his clients allocate just 30.2 percent of their equity portfolios to stocks, keeping the remainder in cash. By contrast, at the end of November last year, when the Dow industrials were about 8 percent lower, such editors as a group were advocating an equity exposure of 70.8 percent. That was more than double the current level, and close to the highest allocation that The Hulbert Financial Digest has ever recorded: 79.7 percent.

We are still bullish on Large Cap US stocks.

AIM in the News

Our local paper, the Coral Gables News Gazette, has written an article about AIM and our upcoming 1-year anniversary of operations. Click the title of this blog post to see the article.

We would like to thank the fine folks at Vine Communications for pitching us to the local editors. Without their help, our newsworthiness would likely go unnoticed by the media. Local, energetic, and effective, Vine is definitely the way to get your message out.

Economic Reports Ease Investor's Minds

Today we witnessed a flurry of economic reports before the bell that soothed investors and economists alike.

The Consumer Price Index

The data pointed towards a diminishing inflation risk. Core inflation continues to moderate. Of course if you need to eat or drive, prices are still rising at a brisk pace.

On a seasonally adjusted basis, the CPI-U advanced 0.7 percent in
May, following a 0.4 percent increase in April. The index for energy
increased sharply for the third consecutive month--up 5.4 percent in May. The index for petroleum-based energy rose 9.8 percent while the index for energy services declined 0.2 percent. The food index rose 0.3 percent in May, slightly less than in April. The index for all items less food and energy advanced 0.1 percent in May, following a 0.2 percent rise in April. Smaller increases in the indexes for shelter and medical care were responsible for the moderation.

Industrial Production and Capacity Utilization

Industrial production, ex-utilities output, showed strength across the board. Capacity Utilization eased slightly, which the Fed should find comforting.

Industrial production was unchanged in May after a downwardly revised increase of 0.4 percent in April. Output in the manufacturing sector edged up 0.1 percent in May, and mining output moved up 0.5 percent after declining 0.6 percent in April. The output of utilities fell 1.3 percent in May after being elevated in April because of unusually cold temperatures. At 112.7 percent of its 2002 average, overall industrial production for May was 1.6 percent above its year-earlier level. The rate of capacity utilization for total industry fell 0.2 percentage point, to 81.3 percent, a level 0.3 percentage point above its 1972-2006 average.

Empire State Manufacuring Survey

Meanwhile, the Empire State Manufacturing Survey showed surprising strength, rising much more than expected.

The Empire State Manufacturing Survey indicates that conditions for New York manufacturers improved significantly in June. After three months of lackluster readings, the general business conditions index bounced up 18 points, to 25.8.

The new orders and shipments indexes also rose. The prices paid index climbed several points, while the prices received index fell. Employment indexes were marginally positive. Future indexes indicated a high level of optimism for the six-month outlook, while capital spending and technology spending indexes dropped markedly.

This month, manufacturers were asked a series of supplementary questions about changes in their capital spending plans from 2006 to 2007; similar questions had been asked in the October 2006 survey (see Special Questions tab). Overall, 45 percent of responding firms indicated that they would invest more in capital in 2007 than in 2006, while roughly one in four firms reported reductions in overall capital spending.

The survey results also suggested that, of the broad categories of capital, non-computer-related equipment would see the most widespread increase in investment spending. Sales and demand trends were the most commonly cited driver of both increases and decreases in capital spending in 2007.

More Peak Oil

Econopundit has a chart from a study by the "scientist" that was quoted in the Peak Oil story I highlighted yesterday. Apparently, Dr. Campbell has been predicting peak oil for some time:

The following graphic, from a study by one Colin Campbell, shows world oil production will peak in 1996 (also shown are actual data demonstrating what we all know -- world oil production did not peak in 1996):

The chart is small but obviously, oil production did not peak in 1996. Furthermore, Campbell published either a book or an article predicting near term peak oil production in 1986,1989,1991,1997,1998 and of course now 2007. I suppose he could be right this time, but I wouldn't want to bet on it.

The Face of Global Warming

When a man who lived under communist rule calls environmentalists response to global warming a greater threat than communism, I think it might behoove us to heed his warning:

As someone who lived under communism for most of his life, I feel obliged to say that I see the biggest threat to freedom, democracy, the market economy and prosperity now in ambitious environmentalism, not in communism. This ideology wants to replace the free and spontaneous evolution of mankind by a sort of central (now global) planning.

That's the President of the Czech Republic, Vaclav Klaus, writing in FT.com. Klaus, an economist, recognizes the extreme environmentalist movement for what it is:

The environmentalists ask for immediate political action because they do not believe in the long-term positive impact of economic growth and ignore both the technological progress that future generations will undoubtedly enjoy, and the proven fact that the higher the wealth of society, the higher is the quality of the environment. They are Malthusian pessimists.

That is the essence of the religion known as Environmentalism - extreme pessimism. Their pessimism about the ability of man to adapt to a changing environment doesn't however extend to any pessimism about their own ability to find a solution to the perceived problem. The arrogance and hubris of believing that not only is man primarily responsible for global warming, but also that we have the ability to reverse the process is stunning to me. As Klaus points out, every school child knows that the climate on earth changes:

Does it make any sense to speak about warming of the Earth when we see it in the context of the evolution of our planet over hundreds of millions of years? Every child is taught at school about temperature variations, about the ice ages, about the much warmer climate in the Middle Ages. All of us have noticed that even during our life-time temperature changes occur (in both directions).

So, what environmentalist believe is that our current climate is ideal and that they have the ability to stop a cycle that has been happening on this planet for millions of years. Yeah, good luck with that....I urge everyone to read the entire editorial. Click on the title of this post.

Peak Oil Panic

The Independent carries an apologia for the peak oil crowd titled, "A World without Oil" which attempts to bring some legitimacy to the panic at all costs crowd.

Scientists have criticised a major review of the world's remaining oil reserves, warning that the end of oil is coming sooner than governments and oil companies are prepared to admit.

BP's Statistical Review of World Energy, published yesterday, appears to show that the world still has enough "proven" reserves to provide 40 years of consumption at current rates. The assessment, based on officially reported figures, has once again pushed back the estimate of when the world will run dry.

Sounds like good news to me, but of course, it's too good to be true and we know that because reporter Daniel Howden finds a handy scientist to refute it:

However, scientists led by the London-based Oil Depletion Analysis Centre, say that global production of oil is set to peak in the next four years before entering a steepening decline which will have massive consequences for the world economy and the way that we live our lives.

Well, maybe I'm reading this wrong, but it seems to me that someone working at a place called the Oil Depletion Analysis Centre might have a wee bit of a conflict of interest here. I don't imagine that funding at the Centre would be all that robust if we weren't running out of oil. They would also seem to have an inherent interest in conserving existing oil supplies. After all, if oil is ever actually depleted, there won't be a need for any anlysis about that possibility.

I'm not sure how serious we should take the Centre's scientist either:

According to "peak oil" theory our consumption of oil will catch, then outstrip our discovery of new reserves and we will begin to deplete known reserves.

Colin Campbell, the head of the depletion centre, said: "It's quite a simple theory and one that any beer drinker understands. The glass starts full and ends empty and the faster you drink it the quicker it's gone."

Now that's some deep analysis. Apparently, "two UK grant making trusts" are actually paying for this. That's all I could find about their funding and I've yet to check out anyone on their list of Trustees and Advisors. I've only glanced at their website, but it seems to be full of concern about Peak Oil and Global Warming and Sustainable Development, a vertitable herd of Malthusians.

Apparently, these folks haven't heard of supply and demand curves:

If consumption begins to exceed production by even the smallest amount, the price of oil could soar above $100 a barrel. A global recession would follow.

It seems the end of the last sentence was edited. It should read: "A global recession would follow, which would reduce demand and cause the price to fall, thus perpetuating the never ending struggle between supply and demand." Or maybe that's just me.

The article also has the now required paragraph on global warming:

Jeremy Leggert, like Dr Campbell, is a geologist-turned conservationist whose book Half Gone: Oil, Gas, Hot Air and the Global Energy Crisis brought "peak oil" theory to a wider audience. He compares industry and government reluctance to face up to the impending end of oil, to climate change denial.

"It reminds me of the way no one would listen for years to scientists warning about global warming," he says. "We were predicting things pretty much exactly as they have played out. Then as now we were wondering what it would take to get people to listen."

It seems a little contradictory to be predicting global warming caused by burning oil at the same time you are predicting a peak in oil production that should drastically reduce the use of oil. I know, I know, it's not just oil. But oil is where we get the vast majority of our transportation fuel and if it is truly depleting as rapidly as some say, the market will respond. If gasoline prices rise enough, alternatives will be developed.

Dr. Campbell loses his last shred of credibility when he states:

"When I was the boss of an oil company I would never tell the truth. It's not part of the game."

But I'm supposed to believe him now?

Poppies and Discontent in Flanders Fields

The WSJ carries an editorial today titled "The Accidental Country" about the recent election in Belgium and it's likely consequences:

Only last year, Yves Leterme said Belgium was an "accident of history" and of "no intrinsic value." Now, the 46-year-old Flemish politician is the country's likely new prime minister. If he follows through on his campaign promises, he might just end up strengthening the union.

The problem is that the country is divided between Flanders and French speaking Wallonia. The Flemish pay taxes which subsidize the Walloons to the tune of billions of euros. And they are tired of it:

Belgian unemployment is about 8%, but this figure masks huge regional differences. Joblessness is 6.6% in Flanders and almost triple that in Wallonia, at 18%. Flemings fret that their high taxes and work ethic subsidize the Socialist lifestyle of their southern brothers.

The answer lies in providing more autonomy to each region:

Mr. Leterme suggests that the two federal regions should have a greater say over economic policies, including labor and health policy. The Walloons would then have to assume greater responsibility over their affairs. Devolution is more democratic, too, bringing government closer to the people. With the rise of the EU and smudged borders, regions from Scotland to Catalonia have felt emboldened to wrest powers from national capitals.

I think this is a trend that will accelerate in the future as smaller governmental entities question the value they are receiving from their centralized federal governments. And I don't think it will be confined to places outside the US. Federalism is how the founders envisioned the US; maybe with Belgium providing the example, we can move back in that direction.

Beginning of the End for the Private Equity Party?

The WSJ has a front page article today about the difficulty KKR is having placing equity with outside investors in it's takeover of First Data. This would seem to indicate that the market for private equity deals is starting to saturate:

As Wall Street digests a feast of buyout deals announced during the past few months, one especially active buyout giant, Kohlberg Kravis Roberts & Co., is finding they don't all go down easy.

KKR has tapped out some of the traditional investors it might typically turn to in funding large transactions, setting it on a different course in the $26 billion acquisition of First Data Corp., a processor of electronic payments. People familiar with the matter say the deal isn't in jeopardy, but in its search for new partners in the acquisition, KKR finds itself haggling over terms it once could dictate.

Apparently some of their traditional investors are getting wary of putting more money with KKR:

"We have enough exposure to KKR already," says an executive at one major investor who invests money in private-equity firms on behalf of a variety of pension funds, endowments and wealthy families. "We have concentration limits with the private-equity firms and with KKR, we have reached the limit."

With interest rates rising, making borrowing more expensive for these types of deals, and now apparently some difficulty raising equity money, the beginning of the end of the private equity boom may be in sight. Maybe the Chinese will get in right at the top; just as the Japanese did before them in the 80s.

Cash for Grades

Since my daughter started high school, I've paid her for grades each term. The system works like this; an A gets her a $50 credit, a B is neutral, a C gets her a $50 debit. We don't even discuss anything below that, but in theory it would offset all credits for the term. The results have been more than satisfactory; her GPA is well over 4.0 when you take into account Advanced Placement classes. Even unweighted, here GPA is over 3.5. And that is a significant improvement over middle school where she routinely brought home mostly Bs mixed in with a couple Cs each term. I know, I know; I didn't really have anything to complain about with her performance. She had a choice of three fine magnet schools. But I wanted to see if I could improve the performance through economic incentives. While she disagrees with me, I think it has had an impact.

Now, a Harvard economist is trying to start the same experiment in some public schools:

Roland G. Fryer, a 30-year-old Harvard economist known for his study of racial inequality in schools, is back in New York to again promote a big idea: Pay students cash for high scores on standardized tests and their performance might improve. And he has captured the attention of Schools Chancellor Joel I. Klein and Mayor Michael R. Bloomberg.

Those against it have a familiar complaint that I've heard:

But the idea is controversial. Many educators maintain, among other objections, that children have to learn for the love of it, not for cash.

The way I look at it, my daughter's job is to attend school and learn. The problem is that the payoff for that is so far in the future that it isn't much of an incentive. So I filled that gap and gave her some more immediate incentives.

It'll be interesting to see if this is adopted and if it works. I suspect that those paying will find that it costs them a lot, but that they will enjoy it as much as I have.

Back to the Future Again

A few days ago, in a post titled Robbing Peter to Pay Paul, I said:

I think those who worry about the poor rising up and causing problems because of inequality of income are worrying about the wrong thing. What happens when the rich finally tire of paying the tab?

Well, it seems this is already happening in Europe:

Wealth gap grows and solidarity fades as rebellion of rich spreads across EU

That's a headline from the UK Guardian and it's not really a fair depiction of what I was referring to, but I think the principle is the same. The article is more about the rich regions of Europe who are upset about subsidizing the poorer parts. Northern Italy produces more wealth than Southern Italy and the northerners are pretty ticked about sending their tax dollars south. Or folks from Munich are tired of paying the freight for eastern Germans.

I find it disturbing that a large percentage of the US population wants to emulate the "European Social Model" when it is clearly not working very well. We just debated an immigration bill that would have made our policies closer to Europe's even though Europe is facing major problems because of that policy. The problem, on closer inspection though, is not the immigration policy. I favor a more liberal immigration policy in the US. I believe immigrants are enormously important to our economy and should be embraced. But only if we also maintain a liberal economic policy. And I don't mean liberal in the usual American sense, but in the classical economic sense. Low taxes, free trade, minimal government interference in the market and access to capital are critical if we are to liberalize our immigration policy. Otherwise, we will find ourselves in the same boat as our friends across the pond. A generous welfare state, rigid employment policies and high taxes mixed with open immigration resulted in a large part of the Paris suburbs in flames. Certainly, economic policy has consequences in the social arena.



Besides, the French are now trying to change the system by electing Sarkozy and now electing his party to Parliament in a landslide:

PARIS, June 10 — President Nicolas Sarkozy’s center-right camp was on course to win a landslide victory in Parliament today after the first round of France’s legislative elections, cementing his power to implement reforms in Europe’s third-largest economy.

I am not prepared to praise Sarkozy on economic policy yet, as he hasn't accomplished anything and it wouldn't be surprising if he bails on reform when the strikers hit the rue. But at least he seems to recognize the problem. Economic policy is the key to solving the problems of the Muslim immigrants in the Paris suburbs. Let's hope our politicians don't repeat the same mistakes as the Europeans.

SPR?

The United States has a Stragegic Petroleum Reserve that is intended to be used in the case of a supply disruption. China also has an SPR, but it's a different commodity:

The crisis over pork prices in China, like the jolt many Americans feel when gasoline prices jump, offers one example of how prices can suddenly soar. The Chinese government is struggling to cope — including deliberating whether to sell a snuffling, smelly strategic reserve of hundreds of thousands of live pigs kept at special subsidized farms for precisely the shortage the country is now facing.

Hmmmmm....Strategic Pig Reserve?

WiTricity

This is pretty cool too:

Scientists have sounded the death knell for the plug and power lead.

In a breakthrough that sounds like something out of Star Trek, they have discovered a way of 'beaming' power across a room into a light bulb, mobile phone or laptop computer without wires or cables.

In the first successful trial of its kind, the team was able to illuminate a 60-watt light bulb 7ft away.

It works on the well known concept of electromagnetic induction:

Rather than sending power from a transmitter to a receiver as a conventional electromagnetic wave - the same form of radiation as light, radio waves and microwaves - he could use the transmitter to fill a room with a 'non-radiative' electromagnetic field.

Most objects in the room - such as people, desks and carpets - would be unaffected by the electromagnetic field. But any objects designed to resonate with the electromagnetic field would absorb the energy.

I love it when we find new ways to apply old concepts. Human ingenuity is limitless.

New British Sub

Via Drudge:

The first of the UK's new generation of nuclear-powered attack submarines has been unveiled in Cumbria by the Duchess of Cornwall.

Due to enter service in 2009, BAE Systems' Astute is the most advanced submarine of its kind and comes bristling with the very latest in military technology.

BAE said: "With a radar signature equivalent to a dolphin, it can remain undetected thousands of miles from home and hundreds of metres underwater.

"In the right conditions it can detect the QE2 leaving New York harbour from the English Channel."

As some of you know, I spent some time in the US Submarine service. I enjoyed my time there, but we never had anything like this. Pretty damn cool.

Robbing Peter to Pay Paul

Bastiat said that the essence of government is to rob Peter to pay Paul. Someone also once said that a politician who robs Peter to pay Paul can always rely on the support of Paul. Democrats seem to have taken that to heart:

House Democrats looking to spare millions of middle-class families from the expensive bite of the alternative minimum tax are considering adding a surcharge of 4 percent or more to the tax bills of the nation's wealthiest households.

Under one version of the proposal, about 1 million families would be hit with a 4.3 percent surtax on income over $500,000, which would raise enough money to permit Congress to abolish the alternative minimum tax for millions of households earning less than $250,000 a year, according to Democratic aides and others familiar with the plan.

The AMT was a bad idea when it was introduced and it is still a bad idea, but why should one set of citizens be forced to pay the tab for another set? So much has been written about income inequality in this country and the consequences. I think those who worry about the poor rising up and causing problems because of inequality of income are worrying about the wrong thing. What happens when the rich finally tire of paying the tab? Who will Democrats tax when the rich finally get fed up? Who will the Democrats tax when they've taxed away the wealth?

Bretton Woods II

Randall Forsyth writes the Up an Down Wall Street column for Barron's during the week (and sometimes in the weekly issue as well). Today his column is about the potential unraveling of the so called Bretton Woods II currency arrangement.

IS BRETTON WOODS II heading for the same fate as its predecessor?

Bretton Woods is shorthand for the postwar international monetary system, named for the New Hampshire resort town where its blueprints were laid out by the Allies in the latter days of World War II. The rules called for currencies' exchange rates to be fixed against the dollar, whose value in gold was set at $35 an ounce.

Bretton Woods broke down essentially because our government couldn't decide between guns (Vietnam) and butter (the Great Society). Foreign governments eventually cut off the credit and Nixon removed the last vestiges of the gold standard from the US monetary system. The result was a decade in the economic wilderness known as the 1970s. Dollar collapse, high inflation, gas lines, etc.

Now some believe that the informal system in place since the Asian crisis back in 1998 is also coming unglued.

Central banks have been forced to step into the breach, buying the dollars needed to fund the U.S. current-account deficit, which is equal to about 7% of gross domestic product. In other words, America spends $1.07 for every dollar it earns. Foreign central banks lend us the difference, a form of vendor financing for all those goods produced abroad, especially oil.

In the process, China has accumulated $1.2 trillion of foreign-exchange reserves. Rather than keep piling up Treasuries ad infinitum, China will invest $3 billion of that in Blackstone, which sounds like a lot but equals 0.25% of its reserves.

Less well-publicized is that central banks are just saying "No" to piling up greenbacks. Not selling, mind you, as the disaster-movie scenario envisions; just accumulating at a slower rate.

There are signs that's beginning to happen, as the Bridgewater duo detail. In just the latest, this week Syria became the second Middle Eastern nation to abandon its currency's peg to the dollar, which followed a similar move by Kuwait last month. Meanwhile, a parade of countries has directed an increasing portion of their reserves away from dollars and euros. Among them, the United Arab Emirates, Switzerland, plus America's good friends, Venezuela and Russia. And China announced this week said it, too, will increase the euro's share of its currency cache -- not reducing dollars, but not adding to them as much.

This is the nightmare scenario for US financial markets. If foreign central banks won't take dollars, we've got a big problem. The result would probably be a collapse of the dollar and inflation a la the 1970s. A recession would also be quite likely; a very nasty recession. I don't believe that this will happen because frankly it is not in the best interests of these foreign central banks for it to happen. But if it does.....look out below.

Citigroup Settles

Citigroup Global Markets Inc. agreed to pay $15.2 million to settle charges that a team of financial advisers misled more than 200 BellSouth employees.

The Citigroup Inc. unit, which includes brokerage firm Smith Barney, will pay $3 million to settle the allegations by the National Association of Securities Dealers. The firm will also pay $12.2 million in restitution to the former employees at BellSouth, now a unit of AT&T Inc.

The NASD suspended three brokers and two branch managers, fining them a total of $295,000. Neither the firm nor the employees admitted or denied the charges.

The NASD said Citigroup failed to adequately supervise financial advisers who used misleading sales materials in dozens of seminars in which they promised 12% annual returns. Although the NASD alleged violations of its rules on just and equitable trade principles, it didn't file fraud charges.

Okay, let's review this again; if it sounds too good to be true....well you know the end of that statement. Brokers are not acting in your best interests; they are acting in their own best interests. Get an investment advisor who doesn't sell financial products. Period.

Saudis in Control?

Jim Juback's latest article on MSN Money asserts that the Saudis are in control of the US economy due to their status as the swing producer in OPEC:

Saudi Arabia is running the U.S. economy.

I'm not sure the Saudis want the task, but they've got it. Because the United States still doesn't have a national energy policy, we've thrown decisions about how fast our economy grows and whether our standard of living rises or falls into the hands of Saudi Arabia's oil ministry.

Yes, it's the lack of a national energy policy that allows the Saudis to exert this control over our economy. I would politely suggest that the reason we are so dependent on the Saudis is that we have tried to enact a national energy policy in the past. Every time the government has gotten involved in energy policy over the years - and that is disturbingly frequent regardless of Mr. Juback's yearning for more - it has made matters worse.

Energy policy is not the only area where Mr. Juback seems to yearn for the good old days of central economic planning:

Remember the good ol' days? Back when the U.S. Federal Reserve and its chairman were in charge of our economy? The Fed would try to find a delicate balance in setting interest rates: High enough to control inflation and low enough to encourage economic growth. Once upon a time, those policy changes were actually the most important decisions anyone made about the U.S. economy.

Yeah, that's the ticket! Let's get government employees back in charge of the US economy. If someone is going to exert control over the economy, let's make sure they are US government bureaucrats. The reason this attempt at control always fails is revealed in Juback's own words. "The Fed would try to find a delicate balance in setting interest rates: High enough to control inflation and low enough to encourage economic growth." The key word in that sentence is "try". The Fed can no better "find" the right price for interest rates than the Soviets could the price of toilet paper. In case Mr. Juback hasn't heard, markets are much better at setting prices.

Furthermore, Mr. Juback doesn't seem to get the connection between excessive liquidity, oil prices and oil demand. In one paragraph, he laments the Fed's lack of control due to excess liquidity:

By the Fed's own admission, the growth of global liquidity has reduced the U.S. central bank's ability to control interest rates -- and thus the economy -- in the United States. Think about this: The Fed raises short-term interest rates relentlessly from their 1% low in June 2003, and yet long-term rates sink as global cash flows overwhelm the Fed's domestic policy shifts.

Then he opines that rising global demand is what gives the Saudis some of their control:

One source of Saudi Arabia's economic clout lies in the galloping global -- and U.S. -- demand for oil. The U.S. Energy Information Administration forecasts that total world demand for petroleum will reach 118 million barrels a day in 2030, up from 83 million barrels a day in 2004.

Okay, let's see if we can figure this out. The Fed prints too many dollars. Those dollars are accumulated by the Chinese which causes the Chinese to print too many Yuan in an effort to maintain their exchange rate. The excess Yuan creation causes overinvestment and excess consumption in China which creates excess demand for oil from Saudi Arabia. And somehow that is the source of the Saudis power over our economy. Maybe, just maybe, if the Fed would quit flooding the world with dollars, some of that excess demand would go away. And we wouldn't have to depend on the good graces of the Saudis to maintain our standard of living.

According to Mr. Juback, this situation is set to get worse too:

I have bad news for anybody who thinks that this Saudi control over the U.S. and global economies is a brief phase that will end by itself. The decision among oil producers such as Saudi Arabia to shift away from being a mere producer of crude oil to becoming a producer of value-added products made from oil -- such as gasoline, fertilizer and plastics -- will prolong the economic clout of these countries. Saudi Arabia will go from being the low-cost swing producer of crude oil to being the low-cost dominant producer in gasoline, fertilizer and plastics.

All I can say is Thank God some nation wants to build refineries. Certainly, it is unlikely to happen in the US where environmentalist and their government enablers have succeeded in blocking any effort to build them here. Mr. Juback continues the article by talking about the cost advantages the Saudis have:

The cost advantages that Saudi Arabia brings to the game are huge. Methane and ethane, key feed stocks for petrochemical production, cost about 75 cents per million BTU in Saudi Arabia and $7.50 per million BTU (for methane) on New York commodity markets. Within five or 10 years, new industries now being built in Saudi Arabia are likely to soak up cheap natural-gas-feed stocks such as these.

Well the US has some pretty big natural gas fields too. There are trillions of cubic feet of natural gas lying just offshore. Oh never mind, the environmetalists won't let us drill for that either.

Apparently, the only way for us to regain some control is to conserve and use alternative fuels:

On the other hand, if higher prices lead to less consumption because consumers become permanently more efficient in the ways they use energy, and because consuming economies adopt lasting sources of alternative supply (and don't abandon them at the next dip in oil prices), then consuming countries have a chance to take back some degree of control over their own economies.

Well, here is my national energy policy. Drill for more oil and natural gas in the US. Then drill for more oil and gas in the outer continental shelf of the US. Build some nuclear power plants. Build some refineries. Then if we really want to get radical, enact a carbon tax. That will reduce demand for fossil fuels while also making alternative fuels more competitive. Last and most important, reduce the power of the Federal Reserve. In fact, eliminate the Federal Reserve. And someone tell Alan Greenspan to just please shut up.

Service Sector Outperforms in May

Business activity in the non-manufacturing sector increased at a faster rate in May 2007, say the nation's purchasing and supply executives in the latest Non-Manufacturing ISM Report On Business®.

The report was issued today by Anthony Nieves, C.P.M., CFPM, chair of the Institute for Supply Management™ Non-Manufacturing Business Survey Committee; and senior vice president — supply management for Hilton Hotels Corporation. "Non-manufacturing business activity increased for the 50th consecutive month in May," Nieves said. He added, "Business Activity, New Orders and Employment increased at a faster rate in May than in April. The Prices Index increased this month to 66.4 percent. Twelve non-manufacturing industries reported increased activity in May. Members' comments in May are mostly positive about business conditions. There is continued concern with rising fuel costs. The overall indication in May is continued economic growth in the non-manufacturing sector at a faster pace than in April."

The overall index, employment index, and the new orders index were all better than expected. The employment index confirms the recent drop in unemployment claims. It appears that the economy is recovering from the first quarter slump. We have contended for some time that the housing slowdown would not cause a recession and the economic stats are now starting to bear that out.

Manufacturing Continues to Struggle

The factory orders report released today confirms that manufacturing sector continues to struggle-

New orders for manufactured goods in April, up five of the last six months, increased $1.3 billion or 0.3 percent to $418.0 billion, the U.S. Census Bureau reported today. This followed a 4.1 percent March increase. Shipments, up two consecutive months, increased $3.4 billion or 0.8 percent to $412.7 billion. This followed a 2.1 percent March increase. Unfilled orders, up twenty-three of the last twenty-four months, increased $13.0 billion or 1.8 percent to $719.1 billion. This was at the highest level since the series was first stated on a NAICS basis in 1992 and followed a 1.8 percent March increase. The unfilled orders-to-shipments ratio was 4.85, up from 4.80 in March. Inventories, up thirteen of the last fourteen months, increased $2.4 billion or 0.5 percent to $513.5 billion. This was at the highest level since the series began and followed a 0.2 percent March increase. The inventories-to-shipments ratio was 1.24, down from 1.25 in March.

In a sign that business spending may be picking up, durable goods orders in April were up 1.9%. Inventories rose for the 14th consecutive month.