I’ve been getting up to speed lately on the carbon cap and trade issue. Up to now, I generally thought it was a good idea, given that something has to be done about greenhouse gasses and global warming. I wasn’t sure that now was the right time, given the big economic mess that we’re in; it seemed better to wait another two years to take on an expensive government program. But overall, cap and trade sounded like a good way to go, once our nation is fully back on its feet.

Since then I’ve learned more about cap and trade. And I’ve become convinced that the whole damn thing needs to be chucked. It sounds like a good idea from a distance, but once you get a close-up look at how it would work and what it could do to our economy over time, it becomes clear that there are some HUGE downside risks. President Obama needs to go back to the drawing board regarding global warming.

I won’t fully explain C+T right here; a good starter explanation is available on this web site, as a PowerPoint slide show. And there are some variations to it. Basically, under the Obama version, the US government would set a number of tons of carbon emissions that could be released from US territory each year into the atmosphere (mostly from combustion of fuels, but farm animal flatulence is actually a significant source). Every year over the next 40 years or so, the target amount would go down. And (in theory), everyone who causes carbon gasses to be released into the atmosphere would need to buy a permit from the federal government to do that. Those permits would be sold by the government at auction, but you could also buy them on a secondary market, sort of a big EBay. If you put out more carbon gas than your permit allowed, the government would fine you, maybe send you to jail. That’s the theory.

So the government only issues permits good for so many tons per year. That’s the “cap” part (and also the TAX part, since you have to pay the government for them; this is how Obama intends to pay for the big expansion of government that he is now carrying out, without raising income taxes). The “trade” part comes with the secondary market; some people or corporations who buy them then decide that it’s cheaper for them to reduce their emissions, so they sell their excess permits at a profit (to others who aren’t so lucky as to be able to cheaply reduce their carbon gas footprint). Supposedly that makes the scheme most efficient, from the overall social welfare perspective.

Unfortunately, there are plenty of things that make the scheme quite inefficient. First off, to truly reduce carbon emissions in the least-cost manner, a cap-and-trade system would need to apply to everyone. And I mean EVERYONE, because virtually everyone burns or does something that throws carbon up into the air. But Obama’s system will not apply to EVERYONE. So not everyone will have the same incentive to reduce carbon. And that will cause economic distortions, inefficient uses of resources.

First off, here in the USA, the politicians will draw a line as to who does and who doesn’t have to buy permits to create carbon gasses. The average person who drives a car or cooks a meal or owns a home and heats it with anything but electricity creates on-site carbon gasses. I do it everyday, you probably do too. But Obama would not be very popular amidst the voters if he told us that we now need to figure out our yearly carbon impact and buy permits for it, or face fines and punishments for driving to work or cooking a meal on the stove or keeping warm in the winter. So the average citizen will be exempted. (A straight-up tax on carbon fuels based on their greenhouse gas content would get around this problem; but it would get shot down because it is clearly a TAX; Obama’s Auction/Cap/Trade system might get by, but only because it doesn’t SOUND like a tax, even though IT IS).

Obviously, the big carbon sources such as utility electricity generators and chemical manufacturing plants will be subject to the permit system,. They would have the technical know-how as to calculate their carbon impact. But what about the in-between cases? Where will President Obama draw the line? What about the bakery up the street? They burn a lot of natural gas (which produces greenhouse gasses, although not as much per BTU as coal does), and maybe some oil too, right on site. And thus they generate a fair amount of greenhouse gas. What about the average restaurant, with all the gas and oil and maybe wood that they burn? What about small charter bus companies? Small construction companies, with all their oil-burning equipment? What about the small dairy farmer or chicken farmer, whose animals spew methane and CO2 just like the corporation ranchers’ animals do? Are owners of mom-and-pop businesses like these going to need to enter the cap and trade market? Will they need to estimate and track their carbon impact each year? Will an EPA / IRS auditor hassle them for allegedly spewing three tons when they only bought a 2.5 ton permit? Ah yes, how will the EPA and IRS monitor gas emissions from each source? In addition to price and resource distortions from exempting the average citizen, the government can either exempt small businesses, and thus allow even more resource allocation distortions; or go after them, with less distortion but at a huge enforcement cost.

Another “EVERYONE” problem in the cap and trade scheme regards how the economic impact will be spread between the rich and the poor. The biggest impact of Obama’s C+T, with its taxation component, will be the price increases it causes for electricity, gasoline, fuel oil and food. Those are products that are made or processed in America by big producers (electric utility companies, oil refining plants, and food processors who use a lot of fuel to make fertilizer, cook / cut and grind farm products, package them in plastic, transport them and keep them cool), and will be most vulnerable to the C+T system. The poor spend much more of their available funds on those basic items than the middle class and the rich. SO, the C+T system will affect the poor in an unfair fashion; as a tax, it is quite “regressive”.

But the biggest gap in the EVERYONE equation is the international gap. Most of the developing economies in the world (the “BRIC” countries, i.e. Brazil, Russia, India and China; plus most of the Middle East, Africa, Latin America and eastern Asia) basically have no interest in making sacrifices to control carbon gas emissions. And they are the ones whose emissions are climbing much faster than America’s and Europe’s, and will soon eclipse the developed world in overall carbon impact. They now manufacture much of the stuff that America used to, e.g. TV’s, refrigerators, washers, machinery, steel, cement, etc. Manufacturing requires burning a lot of fuel, mostly carbon-based fuel. The developing world has access to a lot of cheap coal, which creates a lot of carbon gas when burned; and they want their shot at the good life, as America and Europe have enjoyed over the past 50 years. From what I’ve read, we need to assume that the developing nations aren’t going to get serious about carbon reduction until they have achieved average standards of living equivalent to what we have in the USA and western Europe. And that may be another 10 or 20 years down the road (although it is finally foreseeable, something that could not be said even as late as 1990).

So over the next generation or so, the USA will continue to depend on goods manufactured in China and business services rendered in India, and these goods and services will NOT include a price component to account for their carbon damage. The remaining things and services that we still produce here in the USA will take a beating, as they WILL include carbon damage in their prices. More and more things and services will be bought from overseas, b
eing cheaper, and more and more US jobs will be lost. (Two industries that still make their products in the USA, but might not if the price differential with foreign manufacturers goes up due to cap-and-trade, are the chemical and paper industries; and the already-battered US auto industry might only contract further from this).

That will NOT go unnoticed by the politicians. At some point, it’s clear that they will respond to cries of unfairness from the public, and will set up tariffs on imports as to account for what India and China (and most every other developing nation) SHOULD be charging, if they followed our lead with carbon cap and trade. In the short run, that will save US jobs; but in the long run, it will cause an overall loss of jobs, as everyone becomes poorer when international trade is slowed down. I.e., the developing countries will in turn reduce their buying from the USA, e.g. entertainment, fashionable clothes, education, specialized computer applications and equipment, etc.

But the biggest worry is this: we are extremely dependent right now on loans from those developing nations. China, along with the Middle East, is financing a lot of the US government operating deficit. With the economic crisis requiring stimulus packages and deficit spending, we need their loans more than ever. If we put up tariffs that slow down their exports to us, they may well slow down their loans to us. That would cause interest rates to jump up and stay high, which would keep the stock market from growing for maybe a decade or two (as in the 1970s and early 1980s in response to all the inflation and corresponding interest rate jumps caused by oil price spikes). If the stock market stalls over the next two decades, a lot of Baby Boomers — myself included — are not going to be able to retire when we reach 65 or 70 (or 75 or 80, etc.). We’re will try to work until we drop, which will keep new jobs from opening for young people. EVERYONE would be hurt by this.

What I’ve just outlined is the worst-case scenario. Under that scenario, the USA would take a big economic hit over the next 25 years just as China and India are rising in power, economically and militarily. The USA would lose its status as a world superpower. We would not be able to support the world-wide military establishment that we now do. We’d need to get used to being pushed around by other nations, as we would no longer be the big kid on the block.

Some people, perhaps many Obama supporters, think that might not be a bad thing. But it certainly would be different than today. It certainly would affect the lives of we average Americans, often in the wallet and pocketbook, and mostly for worse and not for better. And it would certainly limit what the USA could do in terms of spreading its ideals and values (such as liberal democracy) throughout the world. Again, some people think that our overall civic values and virtues have been permanently corrupted, and that we really don’t have anything to teach the world regarding politics, economics and philosophy at this point. I believe that these people have a point; but from what I’ve seen in my lifetime, the alternatives out there can be so much worse. Our ideals of personal freedom and open markets as guided by laws and regulations promulgated by a limited representative government, might take a real hit if the USA grows weaker and poorer — they might even decline right here at home (some will argue that they already have).

There is also a best case scenario, of course. Should things fall into place, the US and its expanded government would lead the way to cost-efficient, low-carbon energy and industrial technologies. BRIC and all the other developing nations will soon adopt and adapt these technologies, on competitive economic grounds. Our advanced solar panels and wind turbines and other high-tech green-goodies will turn out to be the lowest cost way to make power and products. The need for protective tariffs in the USA will thus fade away. At that point, maximum world trade will resume, and at the same time carbon-based greenhouse gasses will subside as global warming is contained. Global prosperity will jump and standards of living will resume their growth track in the USA, after a pause for a decade or so. American youth and the the science-technology establishment will rapidly respond to President Obama’s challenge to come up with green technology that beats the old carbon-based way of life. The USA would thus still be a great world power, if no longer THE world power. The world would be grateful for our foresight and our bravery in leading the way to a much better and fairer economic system; they would then take us much more seriously in terms of adopting our democratic political institutions and our visions of freedom.

My point is, Obama is taking a HUGE crap shoot with his cap and trade proposal. The future of our nation really is on the line here. The gains could be tremendous, if the dice roll the right way; but the losses could have equal magnitude. The world, including our comfortable life here in suburban USA, could become much poorer and darker if the green technologies that we develop aren’t as wonderful and transforming as we hope. Some intelligent people are arguing that wind and solar and bio fuels have inherent energy limits, and will never get so cheap as to convince people in Asia and Latin America and the Middle East to voluntarily put aside all the cheap and dirty coal, oil and wood that they have access to. In a well-thought out article, Peter Huber of the Manhattan Institute argues that we should assume that the developing world will continue to burn carbon, and that we in turn will have to follow (or risk severe economic decline and political diminution on the world scene); about the only thing we can do to fight global warming is to direct our collective techno-genius towards airborne reduction schemes on a massive scale.

As I’ve written in my blog many times, the global warming problem is real, and the consequences for our world are great. But we also need to consider what conservatives like Huber speak of, i.e. the need to “keep the fire burning” behind our nation’s best and most enlightened social values. The conservatives are not wrong in contending that the world around us is still a dark, cold and hostile place, in so many ways; and that a weakened American could do less and less to counter that. Before our nation rolls the President’s cap and trade dice, we might want to stop and think about this some more — let’s make sure we’ve considered all the alternatives and scenarios and side-effects, BEFORE we take such a HUGE gamble on our future and the world’s future.

I thought that I’d weigh in on the question of what to do about General Motors. GM would like some federal help in getting it through the big economic downturn that we’re in. They claim that if the taxpayers don’t cough up $50 billion in loan guarantees shortly, GM will go bankrupt, and that all kinds of dire consequences will ensue. Personally, I think that our government should just say no; but it should also get ready to say yes to the damage control that will be absolutely necessary once GM goes into the bankruptcy ringer. The potential long term benefits to our world from a GM bankruptcy are worth it all.

As to a federal bailout: I think it would be the worst of all evils. GM management would like some fast federal cash and nothing else, other than an obligation to pay the money back someday. There’s no way they’re going to get that. The Democratic Party now runs the federal government, and big labor and environmentalists now largely run the Democrats. These parties are not going to give GM a pass to do what it wants with public money. GM would be partly nationalized much as the big financial institutions have been, through public purchase of a significant equity stake. A Democratic Congress will almost certainly require this as part of a bailout package, putting the federal government on GM’s Board of Directors.

From there, the Democrats will require that GM management pursue a contradictory and ultimately self-defeating mandate: to build high-efficiency “green cars” and at the same time be very good to the labor unions. Sorry, folk, but Honda and Toyota didn’t get as far as they did with affordable high-tech cars by giving the UAW cushy terms like GM’s lazy management did. By the end of the second Obama Administration, it would be quite clear that a “GM – Federal Partnership” would be a boondoggle. GM would continue building second-rate cars, but now second-rate GREEN cars like the Chevy Volt. The Volt sounds great, but I remember how great the Chevy Vega sounded in 1975, and what a dog it turned out to be (along with its successor, the Chevette). GM would continue losing market share, and thus continue losing money. It would anticipate and require continuing injections of taxpayer money to keep it alive. It would probably also inspire Congress to enact new trade barriers for foreign auto manufacturers and parts suppliers. Trade restrictions would certainly make the unions happy and might keep a zombie GM going. But trade protectionism was a big factor in sustaining the 1930s Depression. I truly hope that history doesn’t repeat itself in the 2010’s.

There’s a lot about the creative destruction of capitalism that I don’t like, but if any capitalist enterprise seems destined to experience it, it is GM. GM got where it is today by locking itself in the past. Way back in the first half of the 20th Century, GM was the new kid on the block, who had to innovate or die. But eventually it got fat, happy and complacent, and remained so despite decades of warning signs that America was changing and that innovative foreign car companies were overtaking it. So, I believe that a bankruptcy court is the best place for GM right now. Bankruptcy does NOT mean shutting the showrooms and assembly lines down. Many big companies have gone through “reorganization” bankruptcies whereby they continue operating while a long-term plan is made to either sell-off the company’s operations, reformulate the company so as to re-emerge as an independent enterprise, or some combination of both.

I could see GM going through the “both” scenario, although it might take four or five years. During that time, the federal government would have to provide GM with short-term loans to keep afloat. However, the bankruptcy judge – most likely a Republican appointee, thankfully – would have the Constitutional power to keep the Democrats from controlling the destiny of this once-great industrial empire. There would be other federal involvement, and it would be expensive – no doubt about it. GM would dump its expensive worker pension obligations on the federal government pension guarantee fund, requiring a big injection of federal funding to meet the promises made to GM retirees. And the City of Detroit would go from near-collapse to collapse; the Obama Administration would obviously have to get Congress to direct funding there to avoid some really ugly stuff.

So, for the taxpayer, the GM situation is a damned-if-you-do and damned-if-you-don’t proposition. However, if we don’t bail them out, the damnation will end sooner, and the possibility of eventual salvation will be thrown in as a bonus. GM holds a lot of assets that would be attractive to foreign-based auto companies. The Toyota “wanna-be’s” like Subaru and Nissan might shell out for one or two of GM’s marketing names (e.g., “Pontiac” or “Buick”) and part of its dealership and distribution network. If Congress could resist temptation to fiddle with the bankruptcy laws so as to require that union agreements be protected in all GM manufacturing plants and warehouses, perhaps Nissan and BMW and Volkswagen would buy up some of the newer and better GM facilities; even Toyota and Honda will need to get ready for their increased market shares.

But the billion-dollar question is whether a “knight on white horse” will show up to buy a “vertical core” GM complete with manufacturing, marketing, product development, distribution and dealership networks, perhaps based around two or three of GM’s better brands (say Chevy, Cadillac and Saturn). Without that deep-pocketed, risk-taking capitalist knight, a lot of GM operations will eventually close for good. There is an apparent candidate that I can think of: China. This would be China’s chance to get into the automobile big-leagues. They have the money and the know-how. They could wait out the US recession until things get better, and then establish a firm foothold in the US and Euro auto markets. They could use GM’s engineering and design assets to better serve their own growing domestic market. If done right, China could have the next Toyota, based upon the firm foundations that GM built.

I’m sure that a lot of Americans would oppose this. And I’m not one of them. Japan has Toyota and Honda, Europe has BMW, Daimler-Benz and Volkswagen, and the USA would probably still have Ford (which might get a boost if GM went into bankruptcy and “controlled-contraction”, just enough to survive). And then China would have “General Motors”; or maybe they’re re-name it “World Motors”. GM to WM, why not. So you and most everyone else in the industrialized world would have a lot of choice as to buying a car. A different choice from 20 or 30 years ago, but still a choice. That’s how capitalism works (when it works).

And if not the Chinese – then perhaps a Latin American consortium led by Brazil might step up. I could see Lula in Brazil making a bold pitch for GM. Brazil is the rising economic star of Latin America (thank goodness that they finally have one!). This might be South and Central America’s chance to finally get onto the world economic map; it could create all kinds of opportunities for economic betterment throughout this long-stagnant region. Or, another bold thought – Saudi Arabia and the Arab oil states might finally realize that their day is coming to an end. The handwriting is on the wall that the oil-economy is not going to last forever. What better way to use their amassed fortunes than to buy into the industry
that now supports them but is eventually going to abandon them as the Middle East’s underground reserves peter out? What better way to guarantee an economic future for their children and help them avoid the siren calls of an other-worldly medieval fate under the auspices of al Qaeda?

Yes, a GM bankruptcy would be rather unsettling, especially given all the other economic chaos now happening. But the long-term prospects for a more prosperous world arising from GM’s ashes are just so incredible, so mind boggling. President Obama will have the chance to become a truly great President if he can grab an opportunity like this and fight off all of the political forces that will try to stop it. If Obama can JUST SAY NO to the UAW, to Nancy Pelosi, to the greenies who think they can run a car company, and to the GM big shots in Detroit who ran GM into the ground and now want to become industrial bureaucrats – if he can withstand the hellish criticism that his former admirers in the press and academia would unleash against him – well, then he has a big chapter awaiting him in the history books of the future (versus the dismissive footnotes that will be afforded to Bush and Clinton).