A Renewable Boom means more Expensive and Less Reliable Electric Power

Posted by PITHOCRATES - October 20th, 2013

Week in Review

The news on our green energy initiatives sounds good.  We’re importing less oil.  And adding more and more wind power.  If you’re a proponent of green energy you no doubt are pleased by this news.  But if you understand energy and economics it’s a different story.  You’ll think the country is moving in the wrong direction.  Ultimately raising our energy costs.  Without making much of an impact on carbon emissions.  And just because we are exporting gasoline doesn’t mean we’re on the road to being energy self-sufficient (see The Renewable Boom by Bryan Walsh posted 10/11/2013 on Time).

Earlier this year, the U.S. became a net exporter of oil distillates, and the International Energy Agency projects that the U.S. could be almost energy self-sufficient in net terms by 2035.

This is not necessarily a good thing.  Being a net exporter of oil distillates.  It means that US supply exceeds US demand at the current market price.  That’s an important point.  The current market price.  The US has been in an anemic economic recovery—though some would say we’re still in a recession—since President Obama assumed office.  During bad economic times people lose their jobs.  Those who haven’t are worried about losing theirs.  And they worry about the uncertainty, too, about the cost of Obamacare.  So people are driving less.  And they are spending less.  Because they have less.  And worry about how much money they’ll need under Obamacare.  So they’re not taking the family on a cross-country vacation.  Some are even spending their vacation in the backyard.  The so called ‘staycation’.  No doubt the 10 million or so who disappeared from the labor force since President Obama assumed office aren’t driving much these days.  So because of this US demand for gasoline is down.  And, hence, prices.   Even though gasoline prices are still high and consuming an ever larger part of our reduced median family income (also down since President assumed office), gasoline prices are higher elsewhere.  Which is why refineries are exporting their oil distillates.  To meet that higher demand that has raised the market price.

But the biggest source of new electricity in the U.S. last year wasn’t a fossil fuel. It was the humble wind. More than 13 gigawatts of new wind potential were added to the grid in 2012, accounting for 43% of all new generation capacity. Total wind-power capacity exceeded 60 gigawatts by the end of 2012—enough to power 15 million homes when the breeze is blowing.

These numbers do sound big for wind.  Like it’s easy sailing for wind power to replace coal.  But is it?  Let’s look at the big picture.  In 2011 the total nameplate capacity of all electric power generation was 1,153.149 gigawatts.  So that 13 gigawatts though sounding like a lot of power it is only 1.127% of the total nameplate capacity.  Small enough to be rounding error.  In other words, that 13 gigawatts is such a small amount of power that it won’t even be seen by the electric grid.  But it gets even worse.

We used the term ‘nameplate capacity’ for a reason.  This is the amount of power that this unit is capable of producing.  Not what it actually produces.  In fact, we have a measure comparing the power generation possible to the ‘actual’ power generation.  The capacity factor.  Which measures power production over a period of time and divides it by the total amount of power that the unit could have produced (i.e., its nameplate value).  Coal has a higher capacity factor than wind because coal can produce electric power in all wind conditions.  While wind power cannot.  If the winds are too strong the wind turbines lock down to protect themselves.  If the wind is blowing too slowly they won’t produce any electric power.

The typical capacity factor for coal is 62.3%.  Meaning that over half of the installed capacity is generating power.  Some generators may be down for maintenance.  Or a generator may be shut down due to weak demand.  The typical capacity factor for wind power is 30%.  Meaning that the installed capacity produces no power 70% of the time.  And it’s not because turbines are down for maintenance.  It’s because of the intermittent wind.

So coal has twice the capacity that wind has.  Does this mean we need twice the installed capacity of wind to match coal?  No.  Because if you tripled the number of wind turbines in a wind farm they will still produce no power if the wind isn’t blowing.  In this respect you can say coal has a capacity factor of 100%.  For if they want more power from a coal-fired power plant they can bring another generator on line.  Even if the wind isn’t blowing.

You could say wind power is like parsley on a plate in a restaurant.  It’s just a garnishment.  It makes our electric power production look more environmentally friendly but it just adds cost and often times we just throw it away.  For if coal provides all our power needs when the wind isn’t blowing and the wind then starts blowing you have a surplus of power that you can’t sell.  You can’t shut down the coal-fired power plant because the wind turbines don’t produce enough to replace it.  You can’t shut down the wind turbines because it defeats the purpose of having them.  So you just throw away the surplus power.  And charge people more for their electric power to cover this waste.  Like a restaurant charges more for its menu items to cover the cost of the parsley the people throw away.

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A Mining Boom has caused Gold to fall while Gasoline continues to Rise

Posted by PITHOCRATES - June 2nd, 2013

Week in Review

Gold and oil share something in common.  We price both of these commodities in U.S. dollars.  Which makes it difficult to hide inflation in these commodities.  Food companies can shrink package sizing to keep from having to raise their prices to factor in inflation.  But you can’t do that when you sell oil by a fixed quantity.  A barrel.  Or gold.  Which we sell by the ounce.  Which means if you depreciate the dollar (with quantitative easing where we print money to buy bonds to increase the money supply so as to lower interest rates to encourage people to borrow money and buy things) you have to increase the price of these commodities.  Because if you make the money worth less it will take more of it to buy what it once bought.

But gold and oil also have a major difference.  While an increase in the price of gold encourages gold mines to bring more gold to market environmental concerns have prevented people from bringing more oil to market.   It is because of this that the price of gold has fallen while gasoline prices are rising again (see The Gold Standard by SARAH MAX posted 6/1/2013 on Barron’s).

Gold prices rise in times of economic malaise—hence its 23% rise in 2009 and 27% rise in 2010. When prices are rising, mining stocks have historically outperformed the physical asset. Yet gold-mining stocks have lagged over the past few years, even before the price of gold plummeted from its August 2011 high of roughly $1,900 a troy ounce to less than $1,400 today. “The main reason is cost inflation,” says Foster, explaining that a global mining boom has driven up the costs of labor and materials, while forcing miners to look farther afield for new gold deposits.

As the government inflates the money supply it reduces our purchasing power.  This erodes the value of our savings.  Making the money we worked hard for and put in the bank to pay for our retirement unable to buy as much as we hoped it would.  This is why people buy gold.  Because gold will hold its value.  If they increase the money supply by 20% the price of gold should rise, too.  Close to that 20%.  So when the Federal Reserve finally abandons their inflationary policies people can sell their gold and put their retirement savings back into the bank.  Adjusted, of course, for inflation.

The price of gold has fallen despite the Fed’s quantitative easing still going strong.  So if the dollar is worth less how come it now takes fewer of them, instead of more of them, to buy a given amount of gold?  Supply and demand.  With the high gold price people mined more gold and brought it to market.  Increasing the supply.  And lowering the price.  But because the Fed is still depreciating the dollar costs continue to rise.  Making it more costly for these mining companies to mine and bring gold to market.  Reducing their profits.  And the cost of their stock.

If only the oil business was free to operate like this.  For with the Fed depreciating the dollar they’re raising the price of a barrel of oil.  Making it attractive to bring more oil to market.  But wherever it can the federal government has shut down oil exploration and production.  To appease the environmentalists in their political base.  So, instead, gasoline prices continue to rise.  While gold prices fall.  And the dollar continues to depreciate.  Which will one day ignite a vicious inflation.  Much like it did in the Seventies.  And then it will take a nasty recession to get rid of that vicious inflation.  Like we had in the Eighties.  But at least in the Eighties we had one of the strongest and longest economic expansion follow that nasty recession.  Thanks to a strong dollar.  Low taxes.  And a reduction of regulatory costs.  Something the current administration clearly opposes. So we’ll probably have the inflation.  And the recession.  But not the economic expansion.  For that we may have to wait for the next Republican administration.

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The Democrats oppose an Energy Boom as it could Reduce their Political Power in the Big Cities

Posted by PITHOCRATES - December 1st, 2012

Week in Review

President Obama’s energy policy has only hindered oil production and raised gasoline prices.  Exploration and production are soaring.  But only on private land.  Any land that requires a federal permit is not booming with activity.

Despite the high gasoline prices and the poor economy President Obama won reelection.  In large part thanks to those states with the big metropolitan cities.  Those cities that border the heartland.  Or flyover country as those on the left call it.  Those cities that concentrate wealth.  Have massive public sectors.  And large social safety nets.  Funded by that concentrated wealth.  So people in the big cities approve of an expanding welfare state.  And have the population to turn out on election night to keep that welfare state expanding.  For awhile, at least (see Oil, gas boom lifts personal income in USA by Dennis Cauchon posted 11/27/2012 on USA Today)

The nation’s oil and gas boom is driving up income so fast in a few hundred small towns and rural areas that it’s shifting prosperity to the nation’s heartland, a USA TODAY analysis of government data shows…

Small-town prosperity is most noticeable in North Dakota, now the nation’s No. 2 oil-producing state. Six of the top 10 counties are above the state’s Bakken oil field.

Could this be the reason why the president’s energy policies hinder exploration and production?  To keep people and wealth out of the heartland?  Where they tend to vote conservative?  Perhaps.  For the last thing the Democrats want is for people to leave the big cities for good jobs in the private sector.  Where they live well thanks to jobs in the energy industry that the president’s base wants to regulate out of business.  So, no, an energy boom in the heartland would not benefit the Democrats.  It would shift the demographics away from their strongholds.  And into flyover country.  Favoring conservatives.

Just something to think about the next time you’re expressing dissatisfaction over the high price of gasoline.  That it would benefit the Democrats not to have good, high-paying jobs that could reduce the price of gasoline.  And their political power in the big cities that help them carry elections.

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The Fed believes the Third Time’s the Charm when it comes to Printing Money so here comes QE3

Posted by PITHOCRATES - September 16th, 2012

Week in Review

The Keynesians will print more money.  QE3 is on its way.  The third round of quantitative easing.  Because QE3 will pull this economy out of recession.  Just as they said QE2 would.  Just as they said QE1 would before that.  And just because they failed the last two times they tried this doesn’t mean it will fail this time, too (see Fed Pulls Trigger, to Buy Mortgages in Effort to Lower Rates by Jeff Cox, CNBC, posted 9/13/2012 on Yahoo! Finance).

The Fed said it will buy $40 billion of mortgage-backed securities per month in an attempt to foster a nascent recovery in the real estate market. The purchases will be open-ended, meaning that they will continue until the Fed is satisfied that economic conditions, primarily in unemployment, improve…

Enacting the third leg of quantitative easing will take the Fed’s money creation past the $3 trillion level since it began the process in 2008.

According to the Wall Street Journal the Fed balance sheet stood at just below $1 trillion prior to the Great Recession.  That is, pre QE1.  Since then the Fed has increased that to $2.8 trillion prior to QE3.  An increase of 180%.  QE3 will take that above $3 trillion.  And increase from the level before the Great Recession of over 200%.    Meaning the monetary base after QE3 will be more than three times the monetary base prior to QE1.  And all during the Obama presidency.  In less than four years.  And just like QE1 and QE2 this latest quantitative easing won’t work either.  For like so many are saying if quantitative easing worked there would not have been a need for QE2 let alone QE3.  So it won’t help the economy.  But it will have an effect.

In addition, he addressed concerns that savers are being penalized from low interest rates, saying that the policy has allowed for growth in other areas.

“While low interest rates impose some costs, Americans will ultimately benefit most from the healthy and growing economy that low interest rates promote,” he said.

Small business owners have no idea of the full impact of Obamacare on their businesses.  So they are not hiring anyone anytime soon.  And then there’s Taxmageddon.  The largest tax increase in history to occur 1/1/2013.  Environmental policy.  And so on.  These are the things preventing people from hiring new employees.  And no amount of cheap money will change that.  Some people understand this.  Keynesians don’t.  In fact, the only thing they understand is spending money.  The key to economic activity is putting as much money into the hands of spenders as possible.  So they spend it.  And the people that get this money spend it, too.  And the people that get this money spend it after they get it.  And so on.  According to the Keynesian multiplier.  Where spending begets more spending.  Spending is good.  But savings is not.  According to Keynesians.  They see saving as lost economic activity.  Leakage from the economy.  So they want people to save as little as possible.  So they like low interest rates.  Because it provides no incentive for people to save.  So Keynesian policies penalize savers.  They understand this.  And they approve of this.

Of course with all the money the Fed is printing there will be inflation.  It’s just a matter of time.  We’d have double digit inflation right now based on the growth of the monetary base if there weren’t worse economies than the U.S. economy.  Some Eurozone countries are so bad no one wants to invest in their economies.  So they’re parking their money in the U.S.  Even at these low interest rates.  Even paying banks (i.e., negative interest rates) to hold their money.  Because it is the safest alternative.  But how long can this last?

The stock market, which had been slightly positive prior to the decision, shortly after 12:30 p.m., surged while bond yields, particularly farther out on the curve, jumped higher. Gold and other metals gained at least 1 percent across the board while the dollar slid against most global currencies…

Washington conservatives have been critical of the central bank’s money creation, which has caused its balance sheet to swell to $2.8 trillion. They worry that the growing money supply will lead to inflation, which has reared its head in food and energy prices but has remained tame through the broader economy.

Bill Gross, who runs bond giant Pimco, said the new round of easing would take the Fed’s balance sheet up to nearly $3.5 trillion if the purchases continue for a year.

“That potentially is reflationary,” he told CNBC. “We’re just to have to see if it works.”

Bonds issued when interest rates were higher have increased in value.  Because you can’t buy bonds today at such a high interest rate.  So older bonds (with higher interest rates) are worth more than newer bonds (at lower interest rates).

Gold increases in value when the value of the dollar drops.  Because the price of gold is in dollars.  So when you put more dollars into the monetary base you depreciate the dollar.  And raise prices.  Because it takes more weaker-dollars to buy the same things the once stronger-dollars bought.

So far inflation has been confined to food and energy.  Where it is harder to hide.  Especially oil.  Because it’s sold by the barrel for dollars.  So when you make the dollar weaker you send up the price of oil.  And everything you make from oil.  Like gasoline.  Which is why gasoline prices are approaching record highs.  Not because of a booming economy.  But because of inflation.

There is inflation in food, too.  But you can hide this a little.  You can keep prices steady while reducing portion sizes.  So the price per unit portion sold is higher.  But people don’t notice this as much as they do the price at the pump.  Where they cannot reduce the portion size.  Because gas is sold by the gallon.  Which means the full effect of Keynesian inflation monetary policy is reflected in the gas price.  Which is why high gas prices anger us more than just about everything else.

So inflation is here.  And at the rate they’re printing money it’s going to explode sooner or later.  For they’re printing it at a far greater rate than they did during the stagflation of the Seventies.  Giving Jimmy Carter that high misery index (unemployment rate plus the inflation rate).  A policy that did not help Carter’s economy.  Nor will it help the current economy.  In fact, it will only take a bad economy and make it worse.

If printing money worked the Seventies would have been a decade of unprecedented growth.  But they weren’t.  In fact all nations that printed money suffered from high inflation.  And poor economic growth.  Yet they pursue the same policy today.  Why?  Because if they don’t it’s an admission that their policies have been failures.  At the same time admitting that the Republican policies are better policies.  And they would rather throw the country into another depression before admitting that.

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Gas Prices continue to Rise as the Number of Working Oil Rigs in the U.S. Fall

Posted by PITHOCRATES - September 15th, 2012

Week in Review

The law of supply and demand tells us when prices rise demand rises.  Causing supply to rise to meet that demand.  And it typically works when the free market is left to market forces.  Apparently that isn’t happening in the U.S. oil business.  So if you ever wonder why gasoline prices are so high this is the reason (see U.S. rig count unchanged at 1,864 by The Associated Press posted 9/14/2012 on USA Today).

The number of rigs actively exploring for oil and natural gas in the U.S. remained unchanged this week at 1,864.

Houston-based oilfield services company Baker Hughes reported Friday that 1,413 rigs were exploring for oil and 448 were searching for gas. Three were listed as miscellaneous. A year ago, Baker Hughes listed 1,985 rigs…

The rig count peaked at 4,530 in 1981 and bottomed at 488 in 1999.

The president may say we are drilling for more oil than ever before but the number of active rigs fell this year to 1,864 from last year’s 1,985.  A drop of 121 rigs.  At a time of increasing gasoline prices.  The rig trend appears to be trending in the wrong direction.  Rising prices mean demand is greater than supply.  So the number of rigs should increase not decrease.  To meet that rising demand.

The last time gasoline prices were soaring like this was during the Carter years.  Because gas prices were so high oil companies rushed in to meet that demand.  So that by 1981 (the first year of the Reagan administration) the number of rigs peaked at 4,530.  Which gave us the steepest fall in gas prices in U.S. history.  Falling from a high of $3.31 to about $1.75 a gallon (prices are in 2007 dollars).  All of those rigs (as well as others throughout the world) created a glut of oil in the market.  And that glut of oil brought gas prices down.

Gas prices are about as high as they were in 1981.  And yet we have fewer rigs drilling for oil.  Far fewer.  President Carter may have asked us to turn down our thermostats and wear a sweater to help in the energy crisis.  But he at least allowed the oil companies to drill for oil.  And they would drill today like they did under Carter for gas prices are as high as they were under Carter.  And the only reason that they are not can be that it is not as economically beneficial for them today as it was under Carter.  Or that the Obama administration is just not letting them drill.  And with prices and demand being as high as ever it suggests the latter.

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Big Inflation in Canada hidden by Steep Fall in Natural Gas Prices

Posted by PITHOCRATES - May 20th, 2012

Week in Review

Canada is doing energy right.  They’re pulling it out of tar sands and shale.  And bringing it to market.  To meet real demand.  For energy is the mighty Atlas of the Canadian economy.  Carrying the rest of the economy along on its broad shoulders.  Because it’s solid economic growth.  And the only part of the economy they’re NOT driving with monetary policy (see Inflation increase in April fueled by gas, car prices by Randall Palmer, Reuters, posted 5/18/2012 on The Vancouver Sun).

Inflation in Canada was slightly higher than expected in April, pushed up in part by gasoline prices, providing the Bank of Canada with more reason to launch the interest-rate hike it has hinted at recently.

On an annual basis, the overall inflation rate rose to two per cent in April from 1.9 per cent in March, Statistics Canada said on Friday. The core rate, which excludes volatile items, climbed to 2.1 per cent from 1.9 per cent…

The median forecast in a Reuters survey of analysts had been for both inflation measures to stay at 1.9 per cent. Only five of 24 analysts had expected the overall rate to rise, and none had foreseen a core rate as high as 2.1 per cent.

Interesting.  Only 5 Keynesian economists guessed right.  Which means about 80% were wrong.  Which means the consensus opinion was wrong.  Typical for Keynesian economic projection.  Yet we still turn to them for their ‘expert’ opinion.  But it’s never their fault when they’re wrong.  There’s always something to blame.  And they sound so intelligent when they explain they were actually right.  It was just the market that was wrong.

Though several data points have bolstered the case for the central bank to raise rates, recent economic figures have not all been positive.

The latest reports for manufacturing, jobs, trade, housing and wholesale trade have been strong, while February gross domestic product and retail trade were weak.

In the past month, the bank has said several times it may have to withdraw stimulus from the economy…

A 3.2-per-cent rise in gasoline prices and 1.3 per cent in passenger vehicle prices pushed up the monthly inflation data, but this was tempered by an 8.2-per-cent fall in natural gas prices.

Could they be creating a bubble with those low interest rates?  Are people hopping aboard the Keynesian train and borrowing money at cheap rates to expand production?  And most likely inventories.  For if the consumers aren’t buying this stuff the stimulus is making it must be collecting somewhere.  Just waiting to turn profits into losses.  As the bubble will inevitably burst.  As all bubbles do.  Causing prices to fall because the stimulus created a surplus of unsold goods in the market.  Requiring deep price discounting to clear those bloated inventories.  Kind of like the price of natural gas is falling because there is so much of it on the market.  Thanks to shale gas and hydraulic fracturing.

It is interesting to note how much higher the inflation would be if it wasn’t for all that cheap natural gas holding it back.  Probably the one thing in the economy they’re producing to meet a real demand.  For consumers can skip the retail stores.  But they can’t live without energy.  Whether it’s the electricity they use (generated from natural gas).  Or the gas that cooks their meals.  Or the gas that heats their homes.  And their hospitals, universities, coffee shops, restaurants, businesses, etc.  Energy moves the modern economy.  And our personal lives.  So energy needs no stimulus.  But to encourage us to move into a bigger house we don’t need?  That takes stimulus.  It’s this inflation that exceeded the deflation in natural gas prices that gives them their overall increase in the inflation rate.  And why 80% of Keynesian economists guessed wrong on inflation.  Because they always do. 

So if you want to know what the best economic policy is for a nation just ask a Keynesian.  And then do the opposite.

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Keynesians, Gold Standard, Consumer Price Index, Money Stock, Nixon Shock, 1973 Oil Crisis, Gasoline Prices, Hidden Tax and Wealth Transfer

Posted by PITHOCRATES - April 24th, 2012

History 101

With the Increase in the Money Supply came the Permanent Increase in Consumer Prices that Continues to this Date

Keynesians hate the gold standard.  Because it puts a limit on how much money a government can print.  Keynesians believe in the power of government to eliminate recessions.  And their cure for recession?  Inflation.  The government prints money to spend in the private economy.  To make up for the decline in consumer spending.  But it turned out this didn’t work.  As the Seventies showed.  They printed a lot of money.  But it didn’t end the recession.  It just raised consumer prices.  Because there is a direct correlation between the amount of money in circulation and consumer prices.  As you can see in the following graph. 

 Source: M2, CPI

 The consumer price index (CPI) data comes from the U.S. Department of Labor.  The data is at 5 year intervals.  The CPI is a ‘basket’ of prices for a selection of representative goods and services divided by another ‘basket’ of prices from a fixed date.  The resulting number is a price index.  If you plot these for a period of time you can see inflation (a rising graph) or deflation (a falling graph).  M2 is the money stock (seasonally unadjusted).  M2 includes currency, traveler’s checks, demand deposits, other checkable deposits, retail MMMFs, savings and small time deposits.

The Breton Woods system established fixed exchange rates for international trade.  It also pegged the U.S. dollar to gold.  The U.S. government promised to exchange U.S. dollars for gold at a rate of $35/ounce.  Making the U.S. dollar as good as gold.  This set the rules for international trade.  Made it fair.  And prevented anyone from cheating by devaluing their currency to make their exports cheaper to gain an economical advantage in international trade.  The system worked well.  Until the Sixties.  Because of the Vietnam War.  And LBJ’s Great Society.  These increased government spending so much that the U.S. government turned to printing money to pay for these.  Which depreciated the dollar.  Making it not as good as gold anymore.  So our trading partners began dumping their devalued dollars.  Exchanging them for gold at $35/ounce.  Which was a problem for the Nixon administration.  For that gold was far more valuable than the U.S. dollar.  They could print more dollars.  But once that gold was gone it was gone.  So Nixon acted to keep that gold in the U.S.

On August 15, 1971 Nixon decoupled the dollar from gold.  Known as the Nixon Shock.  Reneging on the solemn promise to exchange U.S. dollars for gold.  And ramped up the printing presses.  Which you can see in the graph.  After August 15 the money supply began growing.  And continues to this date.  With the increase in the money supply came the permanent increase in consumer prices that, also, continues to this date.  In lockstep with the growth of the money supply.

Prior to the Nixon Shock Gasoline Prices were Falling at a Greater Rate than the Rate Consumer Prices were Rising 

Since August of 1971 the U.S. has maintained a policy of permanent inflation.  Which caused a policy of permanently increasing consumer prices.  Those high prices we complain about, then, are not the fault of greedy businesses.  They’re the fault of government.  And their easy monetary policy.  In fact, if it was not for government’s irresponsible monetary policy the high price we hate most would not be as high as it is today.  In fact, because of the efficiency of the industry bringing us this one product its price has not followed the general upward trend in consumer prices.  And what is this product?  Gasoline.  Which, apart from two spikes in the last 60 years or so has either been falling or holding steady in comparison to consumer prices.

 Source: CPI, Gas $/Gal

 These prices are from DaveManual.com.  And reflect generally the price at the pump over this time period.  Using at first leaded gasoline.  Then unleaded gasoline.  Using inflation adjusted average prices.  Then chained 2005 dollars.  These prices are not exactly apples-to-apples.  But the trending information they provide illustrates two major points.  The two spikes in gas prices were due to demand greatly outpacing supply.  And that even with these two spikes gasoline prices would be far lower today if it wasn’t for the government’s policy of permanent inflation.

Note that prior to the Nixon Shock gasoline prices were falling at a greater rate than the rate consumer prices were rising.  These trends stopped in the Seventies for two reasons.  The Nixon Shock.  And the 1973 oil crisis.  When OPEC punished the U.S. for their support of Israel in the Yom Kippur war by cutting our oil supply.  These two events caused gasoline prices to spike.  But then something interesting happened with these high prices.  It brought a lot of oil producers into the market to cash in on those high prices.  This surge in production coupled with a falling demand due to the U.S. recession in the Seventies caused an oil glut in the Eighties.  Bringing prices back down.  Where they flat-lined for a decade or so while all other consumer prices continued their march upward.  Until two of the most populous countries in the world modernized their economies.  India and China.  Causing a spike in demand.  And a spike in prices.  For it was like adding another United States or two to the world gasoline market.

Inflation is a Hidden Tax that Transfers Wealth from the Private Sector to the Public Sector

Keynesians love to talk about how great the economy was during the Fifties when the high marginal tax rate was 91-92%.  “See?” they say.  “The economy was robust and growing during the Fifties even with these high marginal tax rates.  So high marginal tax rates are good for the economy.”  But they will never comment on how instrumental the gold standard was in keeping government spending within responsible limits.  How that responsible monetary policy kept inflation and consumer prices under control.  No.  They don’t see that part of the Fifties.  Only the high marginal tax rates.  Because they don’t want to return to the gold standard.  Or have any restrictions on their irresponsible ways.

Keynesians believe in the power of government to manage the economy.  And they really like to tax and spend.  A lot.  But taxing too much has consequences.  People don’t like paying taxes.  And don’t tend to vote for people who tax them a lot.  Which is why Keynesians love inflation.  Because it’s a hidden tax.  The higher the inflation rate the higher the tax.  Because government also borrows money.  They sell bonds.  That we buy as a retirement investment.  But if there’s been a good amount of inflation between the selling and redemption of those bonds it makes it a lot easier to redeem those bonds.  Because thanks to inflation those bonds are worth far less than they were when the government issued them.  Even Keynes noted that inflation was a way to transfer a lot of wealth from the private sector to the public sector.  Without many people understanding that it was even happening.

If you ever wondered why it takes two incomes to do what your father did with one income this is why.  Inflation.  This never ending transfer of wealth from the private sector to the public sector.  Leaving us less to retire on.  Making it harder to save for our children’s college education.  Not to mention the higher cost of living that shrinks our real wages.  While they tax our higher nominal wages at ever higher income tax rates (income tax bracket creep is another inflation phenomenon).  Everywhere we turn the government takes more and more of our wealth.  All thanks to LBJ increasing the government spending (for his Vietnam War and his Great Society).  And Richard Nixon decoupling the U.S. dollar from gold.  Instead of doing the responsible thing.  And cutting spending.  But much like high taxes you don’t win any friends at the voting booth by cutting spending.  So thanks to them we’ve had permanent and significant rising inflation and consumer prices ever since.  And as a result a flat to a falling standard of living.  Where soon our children may not have a better life than their parents.  Thank you LBJ and Richard Nixon.  And thank you Keynesian economics.

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Inflation, Prices and Wages (Real and Nominal)

Posted by PITHOCRATES - April 23rd, 2012

Economics 101

Inflation is Good for those who Owe Money but Bad for Bankers 

There is a direct correlation between the amount of money in circulation and prices.  The more money the higher the prices.  The less money in circulation the lower the prices.  During the Great Depression the Federal Reserve contracted the money supply and prices fell.  And it caused havoc in the economy.  Low prices a problem?  Yes.  For some.  It was good for anyone buying anything for their money was worth more and could buy more.  But it wasn’t good for people who owed money.  Or banks.

Farmers had borrowed a lot of money to mechanize their farms in the Twenties.  So they owed the banks a lot of money.  When prices fell so did their earnings as the crops they grew sold for less at market.  Good for the consumer.  But bad for the farmer.  For with that big ‘pay cut’ they took they could not repay their loans.  They defaulted.  And when a lot of them defaulted they left banks with a lot of bad loans on the books and little cash in their vaults.  Causing bank runs and bank failures.

This is why farmers are in favor of inflation.  Increasing the amount of money in circulation.  Instead of deflation.  Decreasing the amount of money in circulation.  For when you increase the money supply prices rise.  Meaning more money for them at market.  Making it easier for them to repay their loans.  For although the money supply increased loan balances remained unchanged.  Higher earnings.  Same old debt.  Therefore easier to pay off.  Even though the value of the dollar fell.  So inflation is good for the farmer.  But bad for the banker.  Because the dollars they get back when the farmer repays his loan now buy less than they did before the inflation.

To Fully Appreciate the Impact of Inflation we must talk about Real Prices and Real Wages

Think of a grocer.  He buys from a food distributor to stock his grocery store shelves.  His distributor buys from farmers and food processing companies.  These purchases and sales happen BEFORE a consumer buys anything from a grocery store.  Now BEFORE the consumer goes shopping let’s say the Federal Reserve doubles the amount of money in circulation.  So the consumer goes shopping with a dollar worth HALF of what it was worth when the grocer stocked his shelves.  So if the grocer doesn’t raise his prices to account for this inflation he’ll be able to replace only HALF of what he sells with the proceeds from those sales.  Because his distributors will have doubled their prices to reflect the halving of the value of the dollar.

Of course doubling prices throughout the food supply chain will ultimately lower sales.  Which no one in this chain wants.  Which creates somewhat of a problem.  Especially when consumers don’t like paying higher prices.  Food processing companies will raise their prices.  But they can do something else to make it look like they’re not raising their prices that much.  They can reduce their packaging.  So boxes of cereal and bags of chips get smaller while prices increase only a little.  This lessens the perception of inflation on both consumer and seller.  At least, for those who can do this.  We sell gasoline by the gallon.  Which means they have to pass on the full impact of inflation in the price at the pump.  Which makes it look like gasoline prices are rising faster than most other prices.  Which is why consumers hate oil companies more than food companies.

The price we pay in the grocery store and at the pump are nominal prices.  Prices noted in dollars.  Nominal prices rise to factor in inflation.  But they don’t tell us the real impact of inflation.  That is, how it reduces our purchasing power.  For prices aren’t the only thing that rise.  Our wages do, too.  And if our nominal wages rise at the same rate as nominal prices do we won’t really notice a difference in our purchasing power.  If our nominal wages rise faster than nominal prices then we gain purchasing power.  If nominal prices rise faster than our nominal wages we lose purchasing power.  So to fully appreciate the impact of inflation we must talk about real prices and real wages.  Not the dollar amount on the price tag.  But the affect on our purchasing power.  In times of increasing purchasing power a single earner may be able to meet all the financial needs of a family.  In times of declining purchasing power it may take a second income to meet the financial needs of the family.  This is what we mean when we talk about real prices and real wages. 

Government causes the Erosion of Purchasing Power Always and Everywhere

You may get a large raise at work giving you a high nominal wage.  But if nominal prices are rising (as in a higher price at the gas pump) real wages are falling.  Because you can’t buy as much as you once did.  Meaning you’ve lost purchasing power.  So even though you got a nominal raise you may have taken a real pay cut.  Pretty much everyone today earns more than their father did.  Yet today we struggle to have as much as our fathers did.  Even with a second income in the family.  This is the impact of inflation.  Which causes real prices to rise.  Real wages to fall.  And our standard of living to fall.

As real prices rise and real wages fall we have to make choices.  We can’t have the same things we once did.  If we lose too much purchasing power our spouse may have to provide a second income, spending less time with his or her children.  Or people may work more overtime.  Or take a second job.  Or simply cut back on things.  And enjoy life less.  Cut out movie night.  Or going out to dinner.  Not renew their season tickets.  Or give less to charity.  This is the true cost of inflation. 

This all goes back to the amount of money in circulation.  As Milton Friedman said, “Inflation is always and everywhere a monetary phenomenon.”  Meaning that only government can create inflation.  Because government controls monetary policy.  And the amount of money in circulation.  Which means government causes the erosion of purchasing power always and everywhere.  Even the price at the pump.  As oil is a global commodity priced nominally in U.S. dollars.  So whenever the Americans inflate their money supply the oil producers raise their prices to offset the devalued U.S. dollar.  So government causes much of the pain at the pump.  Whose monetary policies decrease real wages.  And increase real prices.   

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High Gasoline Prices blamed on Wall Street instead of Where it Belongs – Environmentalism

Posted by PITHOCRATES - April 15th, 2012

Week in Review

Is Wall Street to blame for high gasoline prices?  Or are governmental environmental policies.  Most like to blame Wall Street.  Because they have no understanding of the oil business.  Even though it’s pretty straight forward.  And follows all the rules of supply and demand.  Where most of the current price pressures are coming on the supply side of the equation.  But Wall Street isn’t to blame for that.  We are.  For our collective attacks on the oil industry.  And our acquiescence of the environmental movement (see If the U.S. is now an oil exporter, why $4 gas? by Leah McGrath Goodman posted 4/11/2012 CNNMoney).

The U.S. is now selling more petroleum products than it is buying for the first time in more than six decades. Yet Americans are paying around $4 or more for a gallon of gas, even as demand slumps to historic lows. What gives..?

Americans have been told for years that if only we drilled more oil, we would see a drop in gasoline prices. (Speaking to voters last month, Newt Gingrich made the curious assurance that more oil drilling could drive down gasoline prices to $2.50 a gallon, prompting the White House to accuse him of “lying.”)

But more drilling is happening now, and prices are still going up. That’s because Wall Street has changed the formula for pricing gasoline.

Until this time last year, gas prices hinged on the price of U.S. crude oil, set daily in a small town in Cushing, Oklahoma – the largest oil-storage hub in the country. Today, gasoline prices instead track the price of a type of oil found in the North Sea called Brent crude. And Brent crude, it so happens, trades at a premium to U.S. oil by around $20 a barrel.

So, even as we drill for more oil in the U.S., the price benchmark has dodged the markdown bullet by taking cues from the more expensive oil. As always, we must compete with the rest of the world for petroleum – including our own…

To put it more literally, if a Wall Street trader or a major oil company can get a higher price for oil from an overseas buyer, rather than an American one, the overseas buyer wins. Just because an oil company drills inside U.S. borders doesn’t mean it has to sell to a U.S. buyer. There is patriotism and then there is profit motive. This is why Americans should carefully consider the sacrifice of wildlife preservation areas before designating them for oil drilling. The harsh reality is that we may never see a drop of oil that comes from some of our most precious lands.

It’s not Wall Street.  It’s the crude oil.  The refineries.  And the fact some refineries can only refine the Brent sweet crude oil.

The stuff we import, Brent sweet crude, is a higher quality crude.  It’s cleaner.  And easier to refine.  But it’s more expensive.  Which is a problem for the refineries on the east coast.  And on the Gulf Coast.  Because that’s the crude they can refine.  Because their crude costs are higher their refined gasoline costs are higher.  Therefore, these refineries lose money when selling at the prevailing market price.  So they export their gasoline where they can sell it at a higher price that covers their costs.  Or they shut down refineries.  Which they have done.  Shutting done some 5% of refinery capacity within the last 6 months.  Bringing total online capacity to about 60%.

The stuff we get from Canada, North Dakota and the Gulf of Mexico is West Texas Intermediate.  Which is a heavier, dirtier crude oil.  The refineries that can refine this oil are located in Oklahoma, Kansas and outside Chicago.  And because the gasoline they sell starts with a crude oil priced about $20 less a barrel than their east and Gulf Coast rivals they can sell at prevailing market prices and make a profit that recovers all of their costs.  Which is why these refineries are operating at about 95% of capacity.  Which explains why gasoline is cheaper in Midwest than on the coasts.  Well that, and California’s own emission standards that require an even more costly blend of gasoline than your typical summer blend (to reduce the polluting affects of gasoline at higher temperatures).

(You can read more about refining costs in a February Bloomberg article.  And more about gasoline blends in an Energy Policy Research Foundation article.)

So, no, it’s not Wall Street causing the high gas prices.  It’s environmental policy.  Which requires costly blends of gasoline to reduce emissions.  And makes any expansion of the refinery infrastructure cost prohibitive.  Environmental impact studies alone can take years to complete.  And cost hundreds of millions of dollars.  So the aging infrastructure strains at the seams.  Whereas if those policies weren’t so cost prohibitive we could build new refineries along the east and Gulf Coast to replace those underutilized and shuttered facilities.  And flood them with domestically produced West Texas Intermediate.  Which would make gas prices fall.  At least it would lower the east and Gulf Coast prices to that enjoyed in the Midwest.  But not in California.  Who will forever have the highest gasoline prices thanks to their emission standards

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Britons respond to Possible Strike with Panic Gas Buying, some Topping their Tanks as much as Two-Thirds Full

Posted by PITHOCRATES - March 31st, 2012

Week in Review

Gasoline haulers just TALK about a strike and it causes a panic of gasoline buying (see Fuel Strike: Unleaded Petrol Sales Rise 172% posted 3/30/2012 on Sky News).

Ministers have held crisis talks with haulage bosses after panic-buying saw sales of unleaded petrol shoot up by 172%…

Meanwhile, the Government discussed contingency plans with company bosses to try to mitigate the effects of any walkout by tanker drivers.

Energy Secretary Ed Davey – who has advised drivers who usually only fill their tanks by one-third should consider upping this to two-thirds – lead the talks…

The Petrol Retailers Association, which represents around 5,500 garages, blamed advice from the Government on keeping tanks topped up, including the much-criticised call by cabinet office minister Francis Maude to fill up jerry cans.

This is what President Obama and his energy secretary Steven Chu want for the U.S.  High gasoline prices.  And less of it.  Which is what their policies will do.  They’ve stopped drilling in the Gulf.  They won’t open up new federal lands to oil exploration.  And they said ‘no’ to the Keystone XL pipeline from Canada.  All of these things would have helped bring the cost of gasoline down.  But they said ‘no’ to lower gasoline prices.  By saying ‘no’ to increasing oil supplies.  Instead they want to be able to tell Americans to only fill their tanks up to one-third full.  Banish the idiom “fill ‘er up” from the American lexicon.  And make you pay European prices for what little they would like you to have.

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