Silly Kudlow!

by: Stone Street Advisors

Kudlow Larry Kudlow says a alot of things which the remotely sane and/or knowledgeable among us immediately dismiss as nothing short of head-flapping punditry.  Despite having been a fan of his since my High School days, now, all-too-often I find myself among the ranks of this group of critics.  While I remain committed to many the basic tenants Kudlow espouses, it seems that over the past few years, he has finally reached the point where some of the things he says are just so ridiculous, so devoid of any ties to economic, social, or political reality, that he's finally become a caricature of himself (an accomplishment for which I suppose congratulations are in order, cheers!). 

This fact was (even more) firmly cemented in my head this past Tuesday morning when Kudlow - filling in on CNBC's morning show - spouted off his uninformed "Go America" propaganda like a broken record.  If I can summarize, his convoluted logic went something like this:

  • Cheaper oil makes gas (amongst many other products) cheaper for American households
  • ...which in turn leaves these same households with more money left over to spend on other things, like actually paying their mortgage, and spending more money on clothing, electronics and other discretionary products/services.
  • Because homeowners will have that much more money available to put towards paying their over-extended mortgages, the value of the here-to-fore toxic MBS paper the Banks and other Financial Institutions have on their balance sheet increases substantially.
  • All things considered, these factors all combine - along with a strengthening dollar - to bolster our waning stock market, sending asset prices up UP UP!!

I'm not quite sure what data Larry's been looking at (or what he's been smoking perhaps), but the data I'm seeing suggests that this utopian thesis crumbles under even the slightest scrutiny.  I put together a little spreadsheet to examine the basic savings from lower gas prices based upon a variety of mile per gallon and annual mileage variables.  According to the U.S. Department of Transportation, as of 2005 the average passenger vehicle was driven slightly more than 12,000 miles each year and got about 23 miles per gallon.  The below picture (a screenshot from one output of the model) illustrates the annual gas costs for vehicles of various fuel efficiency at different gas prices for an average passenger vehicle based upon the DOT data. 

The yellow section shows an expected range of realized savings this year (assuming a slight increase in average mpg since the 2005 data was compiled), as fuel prices have dropped from their highs of over $4.00-$4.50/gallon and now appear to be settling down to the $3.00-$3.50 range across much of the country.

click to enlarge


Let us posit a hypothetical American household operating two vehicles, for the purposes of our example lets also imagine one is mid-size SUV and the other a mid-sized sedan getting 20 and 25 mpg respectively (the discussion on actual vs. observed fuel economy is another topic altogether so we'll save that for another time).  If we assume that year-over-year fuel prices fall from an average of $4.00/gallon to $3.00, we'd expect the annual savings over the prior year's fuel costs for our hypothetical household (ceteribus paribus) to come out to $1,080 ($480 for the sedan and $600 for the SUV). 

$1,000 is by no means an insignificant amount of money for many households, but Larry, come on buddy, lets get serious here: the majority of homeowneders being foreclosed on are falling far more than $90 a month short on their multi-thousand-dollar a month mortgages.

While pundits like Kudlow and many of our elected and appointed Government officials continue to promote the false belief held by many Americans that high gas prices are one of - if not the - root cause of our current economic woes, when we actually examine the data it becomes readily apparent that this is not, in fact, the case.  As the simple model I've uploaded and the screenshot from the output illustrate, many families have felt a measurable (although likely not material) effect from increased gas prices. 

However, we would expect an increase of $100 in fixed expenses (keeping miles-driven constant) to result in significant financial duress for only the lowest-income and most over-extended households   Its worth noting though, that due to the long-negative savings rate in this country, many families who've been living the good life for years thanks to the combination of cheap credit and low cost of living (cheap energy, commodities, etc) are now starting to feel the squeeze without having much, if any semblance of a safety net to support them in troubled times. So, even if gas is cheaper, the absolute last thing we should be hoping for in terms of long-term well-being is the continuation of our entitlement-driven spend-spend-spend economy.

In that vein, despite Kudlow's "drill, drill, drill" rhetoric and incessant finger-pointing, higher gas prices are not the primary cause of our current economic doldrums.  We're now paying the piper for years of largess and irresponsible financial and economic decision making.  Scapegoating isn't going to get us anywhere in the grand scheme of things, and bailing out those whose poor financial decision making contributed to our current situation is only going to increase the already significant moral hazard in the system. 

While cheaper gas may slow the economic bleeding we've experienced over the past year, its hardly the miraculous stimulus that perma-bulls have been waiting and hoping for.  I expect any increase in stock prices tied to the price of gas (retail, for example) to be due to peoples' perception that they have more discretionary money available to spend than they actually do.  Remember, our average household is only saving $90 each month versus a year-earlier period where gas was $1.00 per gallon more expensive, and importantly, that only represents a relative savings, not an absolute one.  Unfortunately, most people fail to distinguish between the two, which is why I expect the "increased wealth" effect observed by most people will result in increased spending, as opposed to increased household savings. Interestingly enough, this phenomenon is exactly what opponents of moral hazard like myself have been afraid of this whole time. 

In addition, we cannot allow ourselves to forget that cheaper gas prices in the short-term severely decrease the public's perception of the necessity for large capital investments in alternative fuels and modes of transportation for long-term sustainability.  We've finally started to see a shift in the buying patterns of Americans away from large trucks and SUVs towards smaller, more efficient cars and crossovers.  In this regard we're decades behind the rest of the world, where due in large part to much higher gas prices smaller vehicles have been de rigeur from the get-go.       

Will allowing drilling in ANWR and the Gulf result in cheaper gas and hence greater economic growth?  In the short-to-immediate term, perhaps, but what we must remember is that in the long-term, there are far more important issues we need to address, issues which pose a far greater threat to our continued economic growth and well-being than making sure Joe and Jane 6-pack can fill up their stretch Escalade on the cheap.