Monthly Archives: July 2008

Oil Price Declines Unrelated to Supply and Demand

All spring and into June we have been told by the media that the rise in oil prices was related to the “supply and demand for oil.”  Journalists and economists told us that the doubling of the price of oil, from $72 per barrel in September of 2007 to $147 at the beginning of July was the market responding to (and you can take your pick) China and India buying more oil, guerrilla bands attacking oil rigs in Nigeria, oil companies being unable to find new oil supplies, or tensions between the U.S. and Iran.  Then, once again, reality showed that most economists and journalists are merely putting a positive spin on anything that puts money into the pockets of big corporations.

In the two weeks between Friday, July 11 and Friday, July 25 the price of oil fell 16.3%, from $147 per barrel to $123.26 per barrel.  Did China or India stop buying oil, were tensions eased betweent the U.S. and Iran, did Exxon-Mobil find a new oil field, is there peace and justice in Nigeria?  No – yet the price fell 16.3% in 14 days.  What better evidence that most of the price rise was speculation; speculation based on the falling U.S. dollar, speculation based on low U.S. interest rates, speculation based on U.S. trade and budget deficits.  The price fell in July because the speculators went too far, the U.S. dollar is not collapsing, it is gradually sinking, so they overshot their mark.  This is cold comfort as we spend $50 to $100 dollars filling our tanks.

Let’s be clear, this is not the kind of illegal, market manipulation speculation that the Democrats in Congress say they can wipe out with legislation.  This is financial managers at multi-national corporations, traders at hedge funds, investment banks in Switzerland and London and New York, doing what they do every day, year after year, move money around the globe to find the best pay-off for their cash.  Countries that have suffered runs on their currency at one time or another since 1990 include Mexico, Russia, South Korea, Indonesia, Malaysia, and Argentina.  Now it is the U.S.’ turn – our budget deficits, trade deficits, and low interest rates are a classic set-up for a run on our currency – and the traders are doing the run in oil futures because oil is paid for in dollars.  Check out my post from June 27 for a more detailed explanation of why the oil price rise is a run on the dollar.

There is a solution to this problem, but it can’t be done overnight.  It will take rare leadership ability for the U.S. to change the way it operates in the world.  If the oil price speculative frenzy is at heart a run on the dollar, then the cure is:

1) Reduce the U.S. trade deficit by greatly reducing imports of oil (take out the cost of imported oil and our trade is roughly in balance) and do it by conserving energy and ultilizing alternative energy, not by making ridiculous claims about the amount of oil that can be drilled off-shore.

2) Raise U.S. interest rates above their artificially low levels so that people can get decent interest rates when they save money and then resolve the mortgage/financial crisis by targeting aid to people who are either in foreclosure or verging on foreclosure.  It sounds expensive, but direct subsidies to homeowners in trouble would be way cheaper than what doubling the price of gasoline has cost us.  Plus, every dollar spent would stay in the United States, while our oil dollars line the pockets of companies in other countries.

3) Reduce the U.S. federal deficit by ending the Bush tax cuts for the rich and reducing military spending by ending the War in Iraq.  Most of the federal deficit run up during the Bush years is a creation of the tax cuts for the wealthy in 2001 and 2002 and by the $150 billion per year we are spending to occupy our new colony in Iraq.

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Why the Economic Slide Hurts

Some people are surprised at the amount of anguish being expressed by consumers this summer as the stock market embarks on a roller coaster ride and gas and food prices jump and then jump again.  After all, unemployment has only risen to 5.5%, not bad compared to the 7.8% rate at the bottom of the recession in May of 1992, and the rise in food and gas prices only really got going in January.  However, these short-term afflictions come on top of many years of stagnating income for the 90% of the population that receives most of its income through a paycheck.  For middle-income professionals, hard-working blue collar families, and folks who must get by on low-wage jobs in the vast service sector, this recession is the straw that breaks the camel’s back.

Stagnating real wages (that is, wages adjusted over time for the effects of inflation) are deeply rooted in the post-Vietnam War economy.  By 1971, the U.S. was experiencing growing inflation and mounting trade deficits spawned by out of control spending for an army of 500,000 American soldiers bogged down in an unwinable war.  These woes allowed international financial firms to make “runs” on the American dollar, turning their greenbacks in for a piece of the gold supply at Fort Knox.  President Nixon stemmed the melt-down by taking the dollar off of the gold standard, but inflation with no growth resumed in 1974 when the first Arab oil embargo doubled oil prices.  (Is any of this starting to sound familiar?)  Since then, like Alice in Through the Looking Glass, Americans have had to run faster and faster just to stay in the same place.

A couple of facts.  Between 1971 and 2001, the real income of Americans at the 90th income percentile rose an average of just 1% each year.  Since then, they and everyone below them in the great middle class has done worse while people in the top 10% of the income pyramid have seen great jumps in their income.  In 2005, more than 45 million individuals lived in a family with at least one person working, but had no health insurance.  While the price of electronic toys have plunged, the prices of key parts of the middle class dream – college and home ownership are the major examples – have multiplied much faster than income growth.  For more data on income stagnation, just google ‘running faster and faster’.

To keep up in the years after 9/11, consumers have taken on piles and piles of debt.  In addition to credit card debt, which afflicts all classes, millions of families refinanced their houses, took out home equity loans, or financed their educations with student loans.  These methods, which financed home improvements, bedroom and living room sets, sophisticated home entertainment systems, large SUVs, and thousands of degrees that don’t lead to good jobs have left homeowners and their children saddled with boatloads of debt.

The squeaky sound you hear as the housing bubble loses air is the current of fear running through the average family.  The Center for Economic and Policy Research has released a new study showing that if housing prices decline by another 10% between now and the end of 2009 “the median household in the ages 45 to 54 cohort will see a 34.6% loss in wealth compared with the median in 2004 while families in the 18 to 34 cohort will lose 67.6% of their wealth.”  The study suggests that millions of people thought they were going to finance current major expenditures and their retirement through the equity they were gaining in their homes.  Uh, no.  Ain’t going to happen.

So when gas costs $4 per gallon, food costs more each week, and mutual funds fall 20%, millions of Americans don’t have a lot of extra income to make up the difference.  The real question now is how this affects the election, not in terms of who wins, but in terms of what changes politicians feel they must make to keep unhappy consumers from becoming angry citizens.