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ABSTRACT: The speculation versus fundamentals controversy is in some respect what Sherlock Holmes might have called ‘The Final Problem’. It is final because the peak-oil quandary has, to a considerable extent, been settled: a majority of observers now accept that a global peaking of the oil output is quite conceivable, and could – not will – happen in the near as opposed to the distant future. What we should be considering though is the geopolitical rather than the geological peak, as implied in a brilliant article in 321 Energy (2008). This is because the bottom line where conventional oil is concerned is its price, rather than the peaking of output. Should a new price escalation commence after the international macro-economy has been put in order, then a physical peak (or ‘plateau’) becomes a secondary issue. The background to this update of a previous article with almost the same name is a short piece in the New York Review by George Soros, based on his testimony before the US Senate Commerce Committee Oversight Hearing on June 3, 2008, at which time he stated that “there is a bubble superimposed on an upward trend in oil prices”, where this trend is caused by “demand growing faster than the supply of available reserves”. Readers should focus on this remark, and especially the word ‘available’, because as emphasized in my new energy economics textbook (2007), it tells almost the entire story of the latest oil price increase.
If Mr Soros is correct, an important issue is the size of the bubble (where a bubble is usually defined as a price movement unsupported by fundamentals), or more elegant, the size of the ‘speculative premium’. My answer to this question is ‘not very large’, because most of this speculation is taking place in the ‘paper’ as opposed to the ‘physical’ market. Unfortunately, many observers refuse to understand this, although last year the students in my course on oil and gas economics at the Asian Institute of Technology (Bangkok) understood it perfectly, because I made it clear that if they experienced a crisis of comprehension, they would be rewarded with a failing grade.
Something else brought to the attention of those ladies and gentlemen is that the preposterous ideas about speculation largely originated with persons in or near the OPEC directorate, who claimed that it was speculation and not the inability or unwillingness of OPEC exporters to deliver the goods that was the main cause of the unexpected and drastic rise in the oil price. Our political masters and their experts did not believe this explanation, but for various reasons it could not turned into an object of contention, even though the sudden increase in the oil price was recognized as a major factor behind the present deterioration of the international macro-economy.
Before continuing, let me make it clear that this paper is NOT the kind of anti-OPEC rant that is going around the blogosphere these days, because for several years OPEC repeatedly proposed cooperation between the major oil exporting and importing countries, arguing that oil was an exhaustible resource, and to some extent – formally or informally – its extraction and/or price should be programmed so as to provide all market actors with an optimal level of satisfaction. This proposition was rejected by the governments of the importing countries, because they were convinced by people like the late Milton Friedman that the price system would always ensure the adequate discovery and production of oil, regardless of the amount of reserves that were actually present in the crust of the earth.
In any event, there is an articulate and very wise and/or well placed group of advisors, consultants and students of the oil market who are fully aware that the cause of the oil price escalation can be traced to fundamentals, however they say ‘speculation’ because it is in their personal (financial and/or social) interest to promote this absurd allegation. Senator Hillary Clinton might have been one of these people in order to inject a populist note into her bid for the Democratic presidential nomination, and a similar innovation has been hatched in the executive suites of some of the largest oil firms, in a bizarre attempt to quash the ongoing criticism of the super-profits being realized by these enterprises. Then of course there is a very much larger group of half-baked academic economists and casual onlookers, who say ‘speculation’ because no thinking is required. Accepting and/or supporting another claim might require a laborious effort to obtain at least a fragment of specialized knowledge about this very complex market.
The steadily rising oil price that we have witnessed of late is basically explained by the relation between ‘flow’ supply and ‘flow’ demand, as distinguished from the demand for stocks (i.e. inventories). As discussed in my textbook, the latter mostly influences the short term movement (or variability) in price. As a result, with or without speculation, the trend result would be almost the same, as I have pointed out for years, and George Soros now affirms. What has happened – as you know as well as I – is that ‘normal’ demand is tending to exceed ‘normal’ supply, causing a fundamental supply-demand imbalance that is independent of speculative activities. Where details are concerned, this imbalance leads to the premature production of a certain quantity of oil, although later production of the same amount might reduce the present value of intertemporal production costs by allowing a less intensive exploitation of high cost deposits. This is the main explanatory factor for recent price dynamics, when the oil price increased from about $60/b at the beginning of 2007 to a peak of $147/b in July, 2008, before declining in the wake of the international macroeconomic and financial market deterioration for which the rising oil price rise was at least partially responsible.
It cannot be denied though that the financial market occasionally plays a weightyl role in the forming of (oil price) expectations, and this may be especially true at the present time due to the oil price rising higher and/or faster than the great majority of observers thought possible. One result of this state of affairs is that the oil price is being observed and thought about much more intensely than before. The allusion to very close observation brings to mind the ‘uncertainty theory’ of the Nobel laureate Werner Heisenberg which, transmuted from physics to financial economics, suggests that misleading signals are often generated. For instance, when the influential oil investor T. Boone Pickens stated that oil could surge to $150/b, prices immediately moved higher. This display of respect for Mr Pickens’ acumen was impressive, although the term ‘over-reaction’ immediately flashed through my brain.
In l992 Mr Soros was responsible for a magnificently correct bet that the British government would be forced to devalue sterling. Ostensibly, Soros’ Quantum Group of hedge funds had ten billion dollars on the table, and London wine-bar gossip then and later was prone to claim that a billion of the resulting windfall ended up in Mr Soros’ pocket. Some of the persons who were employed by Mr Soros on that glorious occasion may still work for him, but if not similar associates have probably played a key role in helping that gentlemen to reach the correct conclusions about oil.
Readers who want to learn more about this topic should focus on the word “expectations“. For the most part the financial market impinges on the physical market via expectations, which means that e.g. the price of paper assets (such as futures) has a certain amount of influence where consumption, production and inventory decisions are concerned. What does “certain amount” imply in this context? It implies some but not nearly enough to convince a serious student of financial economics that it makes sense to claim that an upward trend in the price of physical oil that has lasted almost 18 months should be attributed to speculation in the paper market. There are also no movements in (physical) inventories of oil which suggest that extraordinary speculation is taking place, as people like Paul Krugman and James Hamilton (2008) point out. Or, as Charles Hall has noted, speculators react to market conditions, they do not create them, which tells me and should tell you that regardless of the actions of speculators, it is the enormous demand for oil in coming decades that will establish the tone of the oil market.
An important person who has insisted that traders are responsible for driving the oil price up is Abdullah el-Badri, secretary-general of the Organization of Petroleum Exporting Countries (OPEC), who recently summarized his thinking on the oil price by saying “The market is really crazy”. In a broad sense this is absolutely correct, because much of the craziness can be attributed to politicians and civil servants in the oil importing countries, who liked to postulate that OPEC would never get its act together, and as a result the oil price would ‘tank’ rather than move north. The delusions of some of these persons have intensified, since many of them still entertain an irrational conviction that the OPEC countries would genuinely like to see lower oil prices, and are willing to help to bring this about. What should be believed instead is that very high oil prices have provided some of these countries with the wherewithal to continue the diversification of their economies ‘out’ of the export of crude oil (and possibly gas).
SOME ASPECTS OF ‘PAPER’ AND PHYSICAL MARKETS
Recently I received a mail from the director of the International Energy Agency (IEA), saying that it was a “pity” that Professor Banks keeps insisting that IEA oil experts were responsible for an absurd forecast of the 2030 global output of oil, when in reality – he said – his organization only forecasts consumption. This assertion by Mr Mandil is remarkable, because a consumption forecast for so distant a year in the future that does not take into consideration the constraint imposed by production hardly attains the status of nonsense. More confusing, the Wall Street Journal (May 22, 2008) noted that the IEA was reducing its “oil-supply” forecast for 2030, which I remember constantly describing to my students in Bangkok as ‘nutty’ or ‘looney-tune’, while on the same occasions emphasizing that a director of the oil ‘major’ Total (in the same city as the IEA) once said that the output of oil would never exceed 100 mb/d, which is 21 million barrels per day less than the IEA prediction.
Now you perhaps understand why articles like this have to be written! Mr Mandil and I share the same belief about nuclear energy, but like many street-corner and wine-bar economists he possesses only the faintest clues as to the interior logic of the global oil market, and apparently he has made no efforts to correct this lamentable shortcoming. Similarly, my new energy economics textbook (2007) devotes a chapter to energy derivatives (i.e. futures, options and swaps), but I have yet to see any indication that students and teachers of energy economics have gone beyond the useless Hotelling model of resource depletion in their efforts to understand what the oil future will bring.
When asked about how the present topic should be approached, I tell my students that the place to begin is NOT in my textbooks or lectures, but with GOOGLE. There are at least three prices (or sets of prices) that should be recognized and understood before the interaction of speculation and fundamentals can be systematically examined. These three sets of prices are spot and forward prices for physical oil, as well as a range of futures prices that apply to ‘paper’ oil, and take into consideration the maturity – or ‘running time’ – of these contracts. Spot prices usually involve comparatively small amounts of a commodity that moves from seller to buyer almost immediately; while forward prices generally refer to larger transactions that are arranged privately between buyers and sellers, and which could be delivered periodically over a fairly long time horizon, at prices that generally are NOT quoted publicly. Futures prices and spot prices are for the most part highly visible, and a good example of the latter are spot prices for West Texas Intermediate (WTI) oil or North Sea (Brent) oil.
The beauty of paper oil is that it is bought and sold on an exchanges that are analogous to a stock exchange, and with highly transparent prices that can occasionally serve as a proxy for the price of physical oil. In my textbook a gentleman is walking down a street on the South Side of Chicago when he suddenly gets the urge to buy a million barrels of paper oil with a maturity (= expiry period) of one month. Thanks to his cell phone, this purchase is completed before he reaches the next corner. At the same time a number of what Mr Bill O’Reilly would call “little guys in Las Vegas” might also decide to ‘go long in’ (i.e. buy) a few million barrels of paper oil, with the same maturity. Regardless of whether these little guys are actually in Las Vegas, or enjoying the café and disco life in Guadacanal or Pago-Pago, the transaction might be concluded in the New York Mercantile Exchange (NYMEX) in New York, or the International Petroleum Exchange in London. Given the high level of liquidity in these markets, it should not be a problem to immediately find sellers of this paper oil – that is to say market actors who are willing to sell ( or ‘go short’) without a large (upward) movement in the price of this paper oil.
Professor Paul Krugman of Princeton University has taken part in the speculation-fundamentals discussion (2008), and he classifies the actions of e.g. the South Side of Chicago person and the Las Vegas ‘guys’ as gambling, which has no influence – “nada” he says – on the price of physical oil. This is almost but not quite true, because the price of paper oil is a component – strong or weak – in the forming of expectations.
By way of rounding out this discussion, it might be useful to present an example of how speculation would work if it were provided an unlimited range of options. The example concerns the actions of Nelson Bunker Hunt and his brother almost thirty years ago, when these two very rich men from Texas decided that it was a good idea to purchase a great deal of silver. Had they merely treated this as a superior investment opportunity, very little might have been said, but somehow the authorities came to the conclusion that they were intent on establishing a corner in that market. They not only purchased the actual bullion, but also ‘paper’ silver (in the form of futures contracts), and eventually the price of silver increased from 6 dollars an ounce to 50 dollars an ounce. At that point regulators and officials from the futures exchanges got into the act, and before the smoke cleared the price of silver declined to under 10 dollars an ounce, and the Hunt brothers found themselves in personal bankruptcy – an embarrassment which led Bunker Hunt to remark that “A billion dollars isn’t what it used to be”.
Please note the following. Had the Hunts confined their activities to the futures market, they would indisputably have been within their ‘rights’ to buy as much (paper) silver as they desired, and to make (or lose) all the money that they and other ‘longs’ were capable of making or losing, but as David L. Crawford pointed out (2008), “bets on the future do not determine the future”. More pertinent, as with oil, they would have been taking a very large risk if it had not been possible to manipulate the price of silver bullion by acquiring and storing the real thing. When the government moved against the Hunts, the principal object of their concern was the impressive inventory of silver bullion in the possession of the Hunts, because had those two gentlemen or other speculators – who included, it was said, members of the Saudi Royal family – decided to augment their fortunes simply by betting on the price of paper silver, they might have eventually found themselves with even more billions, or cashing welfare checks.
FINAL COMMENTS: DRILL BABY DRILL!
At pep meetings and rallies of the Republican Party in the US, the cry Drill Baby Drill often goes up when the subject turns to oil. It has been said that the persons joining in this chorus believe that America’s energy future can be solved if the offshore regions of the US are more thoroughly probed. This belief is probably a flight of fancy.
Arnold Kling has concluded that Paul Krugman is wrong when he thinks that the buying or selling of futures by speculators is merely a wager (or ‘bet’). Dr Kling unambiguously says that futures markets determine oil prices, because they substitute for a “planning bureau”. If this were fact rather than fancy the cry should be Buy Baby Buy, because futures market participants might have enough muscle to get the drills humming at a record pace, and thus bring cheap motor fuel back to the Republic. I have also been informed that two econometricians at Hofstra University have “proved” that the oil price escalation can be attributed to speculation rather than fundamentals.
Having taught econometrics at two universities, and having been visiting professor of econometrics in Sydney Australia, my position is that econometrics is mostly a pompous con, and over the past two or three decades has revealed hardly anything about the oil market that is interesting or useful. As for Dr Kling, his reference to a “planning bureau” is something that I have not heard since the Berlin Wall came tumbling down, which was just about that point in human history when reckless and pretentious adventurers in cyberspace declared war on mainstream economic science. Fortunately though, since I have gradually come to disbelieve most of the moonshine raining down on the earth from the Blogosphere, neither hearing that Gordon Gekko clones function as a planning bureau that can move the price of oil, or that drilling in the middle of the Atlantic and Pacific oceans are worthwhile projects, brought a wrinkle to my brow. I will admit though that on the basis of his CV, Dr Kling – like my good self – is very likely a dedicated teacher and student of economics, even if the structure and purpose of futures markets appear to be beyond his compass.
Confronted with these confusions it pleases me to note that the billionaire George Soros has not fallen victim to the Drill Baby Drill syndrome, even if his short essay is depreciated somewhat by remarks which identify global warming as a “fundamental” problem. Politically it may turn out to be the most fundamental of all, and I can remember being willing to occupy one of the cheaper seats on the global warming gravy train if given the opportunity, but since I now fail to see a great deal of merit in any of the proposed remedies for dealing with this matter, especially emissions trading, and I have little or no faith in the other passengers, I have decided that the less I hear about climate dilemmas the better. This is not to deny however that Mr Soros may be correct when he pictures the optimal solution to the “perilous” oil issue – or better, the perilous ENERGY ISSUE – as a crucial prerequisite for optimally addressing climate warming.
REFERENCES
Banks, Ferdinand E. (2008). ‘Economic theory and the price of oil’. Forthcoming.
______. (2007) The Political Economy of World Energy: An Introductory Textbook.
London, and New York and Singapore: World Scientific.
______. (2001). Global Finance and Financial Markets. London, New York,
and Singapore: World Scientific.
Crawford, David L. (2008). ‘Oil futures are a phony target’. Philadelphia Daily
News (August 4).
Donnernv (2008). ‘Peak oil and nuclear power’. 321 Energy (September 18).
Hamilton, James (2008). ‘Kling’s oil speculation question’. Seeking Alpha (June 27).
Krugman, Paul (2008). ‘Speculative nonsense once again’. New York Times (June 23).
Soros, George (2008). ‘The perilous price of oil’. The New York Review (September).
For information on purchasing reprints of this article, contact sales. Copyright 2013 CyberTech, Inc.
I have to confess that you lost me in a few places but I agree with what appears to be your central premise, which is that speculation is not the principal driver of oil prices. It's also true that the general public in my country just doesn't want to hear that, especially if it means buying smaller and more fuel efficient vehicles, living closer to their jobs, and driving a bit slower. Much easier to blame someone else.
The "drill baby, drill" mantra in the US is based on a wholly misplaced notion that producers are willing (or can be coerced) to exploit domestic resources irrespective of the market price, but there are no more domestic resources that simply gush out of the ground. Even drilling and producing in offshore areas that are off limits now is quite expensive.
Current prices reflect a combination of production constraints and the cost and difficulty of finding and exploiting new petroleum resources. There actually may (or may not) be plenty of oil in various forms (see http://www.ucei.berkeley.edu/NewsletterHTML/EN_June_2008.pdf). A lot of it is probably either unrecoverable with existing technology, not worth exploiting at current market prices, or off limits due to political and environmental opposition. Hence, higher prices are required to ration demand, motivate technological improvements, and provide the proper incentives for exploiting what are now marginal resources.
Sam DeLay 6.16.09
Yesterday I saw a program on methane hydrates found off the Florida coast. I have really started to wonder if there aren't some better choices than oil. Oil has had a 100 year head start and that makes a big difference. But if the price goes high there do appear to be some new alternatives worthy of consideration.
Malcolm Rawlingson 6.16.09
The reason I became a nuclear engineer was because it seemed to me that there must be a finite amount of oil, coal and gas on the planet. Since it appears the planet earth is not producing any more of these materials the availability of those resources for the long term future of mankind was necessarily limited. Production by planet earth = zero. Consumption by people not zero oil WILL run out it is just a matter of when.
Nuclear physics demonstrated that nuclear reactors can produce more fuel than they consume (fast breeder reactors) so if humanity has any long term future at all here it cannot possibly continue to rely on limited deposits of carbon buried in difficult to get at holes in the ground.
After a couple of hundred years all fossil fuel resources are gone. What do we do then. While I will not be here to witness that unfortunate event it is necessary to develop the nuclear technologies that will be all that is left on the scale necessary once the fossil fuels run out.
So all this talk of finding new oil/gas/coal reserves is simply prolonging the agony when what we should be doing is converting everything to nuclear electric which also gets dependent nations off the fossil fuel habit.
It seems like a no-brainer to me but like the idiots that shutdown Barsback - there are a lot of people without said organ.....or one that functions properly.
Malcolm
Ferdinand E. Banks 6.17.09
Jack, you say that I lost you in a few places. Well, that makes sense. This paper is NOT the paper I would write today, and in fact I have written another in which I attempt to make certain things clearer - by which I mean clearer to myself also.
Among other things I point out now that the 'spike-like' phenomenon that took place in 2008 happened before, and on those previous occasions there was no threat of sustainability, with the price going off the Richter Scale(as in 2008). Why didn't this happen in 2008. Because in 2008 the people who make the decisions in the oil market understood that oil was scarce - it is scarce given the future demand for it. OPEC had gotten its game together, and China (and perhaps India) were going to be huge consumers, and the old consumers were going to continue to consume in roughtly the same fashion as before. Moreover, in a rational world Russia - which is one of the largest producers and exporters - would copperate with OPEC, and this is what is happening or going to happen.
So, the supply and demand of physical oil will call the tune in the future. The question then becomes why did the price of oil decline from 147 dollars/b. Well, that's the macro and financial market meltdown, isn't it? Of course $147/b for oil doesn't make any sense at all to me, but the decline would not have been to $32/b. It would have been to perhaps a little under what it is today.
And speculators? Speculators are also human beings, and before they do their speculating they talk to each other or look at Bloomberg and come to some conclusion as to the situation with PHYSICAL oil, by which I mean the demand and supply of physical oil. On the earlier occasions they reasoned e.g. that if the price stayed up new deposits of oil would be exploited, but now when they think about physical oil the conclusion must be that there are no new deposits to exploit or, if there are, they will not be exploited in the near future, because their owners like money as well as the rest of us. And as Malcolm implied, their owners are not worried about new oil, gas, coal etc, because that is going to take time. Therefore I can say to Sam that while somebody might get rich exploiting or saying that they are going to exploit those methane hydrates, they wont mean anything for the rest of us for a long time - if ever.
Interestingly enough, people seem to have forgotten that at one time OPEC offered to cooperate with the oil importing countries, but the importing countries were influenced by the wrong kind of 'scholars'. A little cooperation might still go a long way.
Fred
Ferdinand E. Banks 6.17.09
If you feel that a different opinion than mine is useful, I can recommend the article OIL PRICE MOCKS FUEL REALITIES, in Petromin, Dec. 2008, and written by F. William Engdahl. I'm tempted to say that the failure to understand the great world of oil is shocking, however on this occasion I admit that the cause of some of the trouble might be the failure of yours truly to write a clearer article on the subject of speculation than the one above. Eventually however my new article will be in circulation, although it will not say more than I said in my comment above.
BEFORE SPECULATORS 'SPECULATE', THEY EXAMINE THE AVAILABLE INFORMATION ABOUT THE SUPPLY AND DEMAND OF PHYSICAL OIL, OR THE FUNDAMENTALS. Some of them obtain their information from CNN, Fox News, late night adult entertainment channels, or for that matter comic books, but it happens that on the average they know as much about the mechanics of the oil market as any group of human beings on the face of the earth. As a result I feel it correct to argue that - ON THE AVERAGE - the basis of the actions of speculators are fundamentals.
One more thing, Speculators are the people that you commonly accuse of speculating - for example, the people working for Gordon Gecko. But according to a French publication I read about an hour ago, Singapore Air bought a lot of fuel on forward contracts, at a given price, without putting in a hedge (with e.g. futures). When the oil price went down they took a big lost. Some people might, therefore, suggest that Singapore Air is also a speculator (in the fuel market), but that kind of contention doesn't lead anywhere.,
Fred Linn 6.17.09
Prof. Banks---what would be your ideas on returning to Silver Certificates as our monetary standard rather than Federal Reserve Notes? What would be the effect on the economy to have our currency backed by something of real value rather than just IOU's?
Bob Amorosi 6.17.09
Malcolm,
"After a couple of hundred years all fossil fuel resources are gone. What do we do then. While I will not be here to witness that unfortunate event it is necessary to develop the nuclear technologies that will be all that is left on the scale necessary once the fossil fuels run out."
Do you know of anyone or any business or any government that will proactively plan and spend substantial sums of money now to develop a contingency for anything that far into the future? Historically a crisis must develop near the end of the resource's availability before anything substantial gets done. The time horizons of government programs are usually until the next election, and for businesses and people the time horizons are even shorter when it comes to investing money in future projects to get a return on the investment.
In other words your advice and vision to invest in nuclear may have good intentions for all the right reasons, but it is less likely to be taken by those with influence within our lifetimes.
Len Gould 6.17.09
Despite all the apologetics for speculators, I'm still convinced that in net they do the average person considerable harm. Without speculation we couldn't have had most of last years dramatic swift price increase nor this year's total colapse in price. The first served primarily to transfer billions of extra dollars from joe average to the investor class, while the latter has set back by years any hope for developing and orderly transition to some more sustainable energy structure. And to the argument that speculators are required in order for real customers to be able to hedge against future swings, the obvious response is that it is strange to perscribe living among grizzly bears as protection from wolves.
Jeff Presley 6.17.09
Fred, Another "gold star" article, even if some folks were put off by the meandering. Personally I always enjoyed your stylistic manner, too much of this stuff is dry as ten day old toast. I assume you already saw this WSJ article, but I post it here for your amusement.
In the presentation we gave last month to the DOE in D.C. I mentioned your favorite (maybe not) prognosticator Simmons stating that the next oil shock wasn't years, but months away. Of course, "way" back then oil was less than $50 / bbl.
Enjoy the slide show, Fred, especially I think number 23
Len, study up on what Mr. Simmons has to say, then we can discuss this with some intelligence. Remember, he said all this back in December! (BTW he talked about the next oil shock later, he only implies it in the sideshow, but you get the drift.)
Sweet dreams.
Jeff Presley 6.17.09
Whoops, picky parser doesn't like my typo's much, back to the vino - enough with this typing: WSJ article
Ferdinand E. Banks 6.17.09
Len, I'm not apologising for speculators. I suppose that a large part of the trouble we are in now is due to speculators - speculators in debt in the big finance establishments. But as for being able to hedge against *price swings* in the oil, gas and copper markets - which actually are the only derivative markets that I really and truly am interested in and know a lot about - speculation is almost essential in order to get the desired/necessary liquidity for large numbers of risk-avoiders to turn their worries over to 'risk-lovers'..
And my arguments above - especially in my comments - are designed to express the simple fact that speculators also take the physical market into consideration, and probably have taken it into consideration.to the extent that as a group they know more about it than any other group of people on the face of the earth. Naturally, accepting a sustainable oil price of 147 dollars is impossible for a guy like me to understand, but it appears to me that some very serious people were informing the TV audience that a price of 200 dollars was right around the corner Its also very likely that $147/b was the straw that broke the camel's back where the macroeconomy is concerned. In any event speculation couldn't keep the price up once the bad news arrived from Wall Street and the City of London.
By the way, that Qinshan reactor took 54 months from ground break to full power, but to me that means that in a few years a 1000MW reactor will be constructed in 4 years or less.
And Fred Linn, I can't see any change taking place in the present system where a backing for currency is concerned. I remember - though vaguely - the arguments for going off gold, one of which was that there wasn't enough gold in the crust of the earth to keep the international monetary system jazzed up.. Something like that must be relevant for silver, and except for a couple of Austrians I don't remember ever hearing about any top-drawer conservative economist in the US or UK arguing for a return to metal, although they might have been thinking about it.
I don't see how it can be denied that some terrible mistakes have been made by financial institutions in the US and elsewhere, but one problem must be that the world is changing, and I don't just mean the rise of China. I try to be optimistic to the extent that every day I tell myself that the smart people now in Washington will find all the necessary answers, but then suddenly I find myself confronting the discussion about energy and a new energy policy, which turns my thoughts to aspirin and liquid refreshment.
Fred Linn 6.18.09
---------"I remember - though vaguely - the arguments for going off gold, one of which was that there wasn't enough gold in the crust of the earth to keep the international monetary system jazzed up.. "------------
The presidential election of 1896-----William McKinley R vs. William Jennings Bryan D.
The main issue was whether to keep the Gold Standard(deflationary)----or adopt Free Coinage Silver Standard(inflationary).
However, I think either choice would be deflationary in comparison to Federal Reserve Notes which have no real backing at all.
Thanks for the reply
----------"I try to be optimistic to the extent that every day I tell myself that the smart people now in Washington will find all the necessary answers, but then suddenly I find myself confronting the discussion about energy and a new energy policy, which turns my thoughts to aspirin and liquid refreshment."---------
Ahhhhh.............so you are turning out to be an ethanol supporter after all!(LOL) Just be careful mixing it with aspirin---that can really tear up your stomach lining.
Ferdinand E. Banks 6.18.09
Let's keep this discussion going a little longer.
Regardless of how many books or articles have been written, or interviews or conversation that have taken place, when you are stopped on the street by someone in a short dress who wants to know what went wrong, you tell her that the people in the financial sector made bets that they shouldn't have made - not for thousands or millions, but for billions. Without those bets, she might still be on Wall Street in front of a computer in the Gekko Building.
Why did they do this betting? Well, why do I play lotto every week. When you have a salary in the millions, and millions more in the bank, you don't mind taking a few chances with your career. After all, if things go wrong, there is always Monaco or St Tropez.
Unless I'm mistaken, Fred Linn wants to argue that if the US on on a silver or bronze standard or something, then all that illogical betting by the finance big wigs couldn't have taken place. Maybe not, and when they moved from gold to 'Special Drawing Rights' managed by the...the...IMF, I thought that they were crazy, but eveything worked out OK. After all, if money is the life blood of the international trading network, there is no reason to put yourself in a position where you can't obtain transfusions when you need them., As for FR notes having no real backing at all, they are US government liabilities, and their backing is the reputation and good sense of The Uncle. That was good enough for most people until recently, and it will be good enough again...I hope for all our sakes.
Jeff, the opinions of Simmons and the others like him are very important right for speculators, as well as some very serious people who hate speculators. Those opinions explain to them that oil is scarce, and that is the way to bet. When I got the opportunity this was the way I explained it too, and long before Simmons and Co., but I don't think that I displayed the right body language with my sermons, nor the spirit of compromise. I gave a great lecture on oil in Paris last year, but when I offered my opinion of nuclear (PRO) and saw a couple of frowns, I was forced...forced mind you, to make some remarks that one does not always hear in an academic setting.,
Suppose Simmons & Co had gone the other way, and convinced speculators and governments and all concerned parties that oil was really plentiful, and the oil price might fall to five or ten dollars in the course of time, as Milton Friedman attempted to do - and in fact did for a while Then, when reality caught up with the market actors, $147/b for oil would have seemed like a bargain. By the way, thanks for the gold star, but please allow me to insist that I don't deserve it for this article. I deserve it for my comments above.
Finally, I can't see anything wrong with being optimistic on the US. I know in much greater detail than most what was done in the Republic during WW2. No country in modern times could have matched the efforts of American workers and managers, and the statistics don't really tell the story.. But of course, optimism has become politically incorrect. It's considered arrogant, judgemental, and indicates an inability to relate...to damn fools.
Len Gould 6.18.09
In re: speculation in oil, here's an interesting sequence of information from "Linlithgow-based Cook, head of compliance and supervision at the International Petroleum Exchange for six years until 1996, wants to wrest control of the sector from middlemen and give supervisory power to a trade body that also includes consumers and producers." (according to The Herald of Scotland). In comments to an article at The Financial Times, http://ftalphaville.ft.com/2009/02/25/52879/a-self-propelled-pyramid/, Mr. Cook states in part, regarding the fact that Brent Lite is the price which is actually used most in international trade, but the Brent Lite price is very easy to manipulate, given that only about $6 billion worth of it are produced each month and speculators have at least $260 billions of investor cash to play with.
"I am pretty sure that is where the problem was, and I have my suspicions as to the sort of thing going on, and the people doing it, but hey, what do I know? Those people are beyond criticism in polite newspapers. :-)"
There;s also a lot of interest starting up on the probability that many oil futures tracking investment funds are essentially ponzi schemes with the primary purpose of paying huge fees to fund managers and are getting setup for a dramatic collapse in the near future.
Fred Linn 6.19.09
-------"As for FR notes having no real backing at all, they are US government liabilities, and their backing is the reputation and good sense of The Uncle."-------
LMAO!!! You are right, but I'm afraid there isn't too much left of either right now.
My thoughts on a commodity based currency(gold, silver, cotton, sugar, oil and others have been used in the past)----is that Federal Reserve Notes,(non backed currency) allows unrestricted expansion of the currency pool. Sell T bonds, and spend money like sailors on shore leave. This leads to inflation. A backed currency can not be expanded unless you either a) expand the reserve of the backing commodity or b) issue a separate monetary (supplemental) system as was done in the Civil War with the Union issue of greenbacks, promissory notes.
The Gold standard was deflationary during the rapid rise of industrialization during the Gilded Age. Free Coinage was inflationary because the output of silver mines in the Western US was expandable enough to curb the deflationary effect of not enough gold to expand the $ supply enough to keep pace with the amount of expanded goods markets due to industrialization.
The point being that a backed currency forces fiscal responsibility on government. I think we could use some of that now.
Fred Linn 6.19.09
Jack Ellis-------"Current prices reflect a combination of production constraints and the cost and difficulty of finding and exploiting new petroleum resources. There actually may (or may not) be plenty of oil in various forms (see http://www.ucei.berkeley.edu/NewsletterHTML/EN_June_2008.pdf). A lot of it is probably either unrecoverable with existing technology, not worth exploiting at current market prices, or off limits due to political and environmental opposition. Hence, higher prices are required to ration demand, motivate technological improvements, and provide the proper incentives for exploiting what are now marginal resources."-----------------
Bingo!!! THE definition of Peak Oil. Production falling, and what there is, is getting harder and harder to get to, get at and get out.
Prices have no where to go but up. But that does not mean that profitability will go up. The rising demand and falling profitability (I think) will probably mean that instead of a long period of decline in oil use---we'll probably see a very sudden drop in availability---leading to even faster price increases. It is my guess that the down hill roller coaster ride is going to pick up speed very quickly, high prices, falling production, and rising demand.
"Hold on to your hats, we are in for a VERY bumpy ride."(as the Jamacian bus driver said in Harry Potter)
Ferdinand E. Banks 6.19.09
The present money and banking system has been taught to miillions of students in the United States - millions, not thousands - and they are not going to change it because some people in the financial establishment made some bad bets, and got everyone in trouble. I don't work in that field any longer, but if I was I would have to get very academic and very unacademic (language-wise) with persons in my near space who argued for a change.
When I was teaching finance and macro 4 hours a day, every day of the week, I didn't detect any fundamental shortcomings in the financial system of the US. There might have been some, and I was too careless or dumb to spot it, but I really don't think so. I don't see why a silver standard is necessary just because Gordon Gekko told his traders to take a few more chances.
The present problem for the US (and by extension the rest of the world) is that the US elected Bill Clinton and George W. That problem cant be erased by claiming that the present government is fiscally irresonsible. I know that people dislike Bernanke and Summers, but at bottom they are disliked because they are so smart, not because they are...irresponsible. The dislike of Obama is best not discussed here.
Len Gould 6.19.09
There is simply no logical reason to restrict the money supply to some arbitrary amount of industrially used metal or any other commodity for that matter. Why simply one (tiny) part of the economy ( the jewlery trade)? That stuff is complete nonsense. All that's needed is some mild restraint and independence from political control of the central bank decisionmakers, which unfortunately has been sorely lacking in the US for the past 16 years.
David Barge 6.19.09
Two other points with bearing on oil.
1) The truly massive runup corresponded in time with a particular phenomenon, the Beijing Olympics. Given that it was physical demand that drove the price movement, how much of the physical demand corresponded to chineze resource demand associated with that specific event? I do not have the data to answer that, but for a grad student looking for a quick hit question to publish I suggest that one... The point there is marginal pricing.
2) The clearest indication that speculation did not drive the oil price movements is that was the OPEC party line.
In my own mind, I think point 1 probably had a lot to do with the appearant bubble in oil (obviously, why else would I make it), but also that it is possible that real economy effects from the Chineze taking a breath after the olympics compounded the financial effects of Lehman and AIG.
Fred Linn 6.19.09
---------" All that's needed is some mild restraint and independence from political control of the central bank decisionmakers, which unfortunately has been sorely lacking in the US for the past 16 years."----------
True. And we are seeing restraint now? Sorry, you'll have to remind me, the smoke gets in my eyes and I don't see too well anymore. (LOL)
Ferdinand E. Banks 6.19.09
You don't need to worry, Len. The probability of gold or silver or something like that making a reappearence on the monetary front in the US or Europe is probably less that one-tenth of one percent. As a matter of fact if the democrats had not won the US election, that idea would have been confined to the crank corner of some of the UK Redbrick universities.
The whole concept is really grotesque. I can imagine Sarah Palin buying it though, but John McCain never. In fact when those nutty Austrians were hawking it around the University of Chicago, it was only Milton Friedman who was really keen. Remember him, the guy who though that OPEC would collapse, and who in addition wanted to return to the gold standard, and dope legalized.
David Barge is moving in the right direction. To me 'fundamentals' means demand outrunning supply, and behind that situation is the inflexible oil requirements of China, North America, Asia, and on the other hand what Mr Barge calls the OPEC party line.
Jeff Presley 6.19.09
The key points Simmons was making concerned oil being both a physical commodity and a paper one, and that oil companies are price >b>takers rather than price makers. The paper component of oil reminds me of the story I told here on this site about the Hunt brothers supposedly cornering the silver market. Just like some of the folks making posts here, the Hunts posited during the late 70's when inflation appeared infinite that converting useless dollars (of which they had quite large piles) into useful silver was a good idea. As it turned out of course, they might have been smarter to keep the oil in the ground and wait until later to make their conversions, but that is beside the point. What upset the silver apple-cart was the fact that the commodity market itself illegally sold far more silver than they had, assuming that their counter-parties weren't going to take possession of the product. Unfortunately in that assumption they were wrong, but they had enough political clout that they could call foul and turn the Hunts into the villains on this, before their own malfeasance came to light.
It is entirely possible if not probable that something similar happened in the run up on the oil futures market because the ultimate delivery of WTI was likewise constrained and some folks may have found themselves in a "squeeze play", said folks including Nymex itself. This wasn't a fault of "speculation" per se, but the inattention to details that has bedeviled financial firms elsewhere.
Unfortunately even though the day to day pricing of oil is something of a chimera, oil companies don't have much else to focus on price-wise so they do a lot of planning in that intellectual vacuum. Therefore, projects which are regularly difficult to budget anyway have the additional constraint of calculating NPR (Net Present Value) based on somewhat imaginary numbers 5 years into the future when the production might actually see the light of day.
Jeff Presley 6.19.09
Fred, First let's see if I can get my typing squared away this time as I italicize your quote: The present money and banking system has been taught to millions of students in the United States -
I really wonder if this is true. Indeed people "seem" to understand banks, but as I've delved deeper into the subject I find that understanding is superficial at best. To illustrate, I'm going to give a little thought puzzle below.
Let's say we have the Bank of Ferdinand. As a commercial bank, Ferdinand gets to accept deposits. Well and good, I like Fred, so I give him $100. Because he is a bank, Fred gets to turn around and borrow $3000! Strictly based on my $100 deposit. He's not the best of the Tier One's at this capitalization rate, but he's not the worst either at 3.33%. Now Fred has $3100 in his "bank". Ostensibly he can turn around and start loaning out the $3000, but he has to worry I might come along and ask for my $100 back. What happens then? Does he take $100 out of the $3000 and "pretend" he still has a deposit? A big problem in the current banking crisis is that banks don't trust each others' books. One of the reasons I suspect this is so is because they've been playing a variation of the game I just described for some time now, with "phantom" deposits propping up their over-leveraged empires. Since they are doing it, they suspect the other banks are doing the same and are worried about the house of cards tumbling down on them.
Back to Fred's quote above, I believe if Americans really understood how banks operated there would be rioting in the streets instead of a continuation of business as usual. My own son with his accounting and finance degrees was quite surprised when I explained "banking" to him with the above thought model.
Fundamentally, banks get to borrow ridiculous amounts of money (as a percentage of their assets, which aren't even really "theirs") at ridiculously low interest rates. The rest of Wall Street was understandably jealous of this arrangement and contrived to game their own system with AAA rated credit "cards", not quite as good as the banks, but they weren't constrained in the kind of bets, er I mean investments they were able to make. The number one guarantor of AAA credit was of course AIG, whoring out its own great rating to anyone who could pony up the premiums, pretending it was a new kind of insurance. Over time, the true value of a AAA credit rating diminished as every Tom, Dick and Harry came to the party with one. Everyone having an AAA rating was like the Lake Woebegone quote, "Where all the children are above average". Unfortunately everyone doesn't get to be above average or the math makes no sense.
AIG may have started down this road with the best of intentions but as we all know by now, the road to hell is paved with good intentions.
Malcolm Rawlingson 6.19.09
Bob, I agree completely that presently it is impossible to get Government to think past the next week let alone 200 years hence but that does not mean it should not be done and pushing our politicians and business leaders into giving the longer term future at least a passing thought. And it is not true that modern business leader do not have long term plans for their businesses. The very successful Mitsubishi Corporation of Japan has a 200 year business plan and I do not accept that business leaders all think in the short term. In fact their very job should be to provide the long term plan. It is usually already far too late to affect the short term. GM is a classic case in point. A long term plan would have had them developing cars to get off the US petroleum dependency. But what did they do - for short term profit they built Hummers and big trucks exactly the sorst of vehicles NOT required. Now they are broke.
So while I agree with you - the fact it is difficult trying to educate some of our dunderhead politicians to think long term - it is not impossible and I will continue to try.
Planning for nuclear power needs the long term thinking that is notably absent but with oil and gas shortages looming the consequences of not planning for such future shortages have major consequences for every CEO in the US and Canada. I strongly suggest they get their long term energy thinking caps on and working.
Malcolm
Malcolm Rawlingson 6.19.09
Fred, I do not share your optimism on the United States. This is not the same country as the one that saved our bacon in WW2. All I see now is that greed avarice and entitlement have replaced hard work, and innovation. The world IS losing faith in the US currency and there is no capacity left in the US to back it up. The world knows the US is essentially bankrupt and while I have the utmost respect for what the US did in WW2 this is simply not the same country that it used to be. And that is a very very big shame.
Malcolm
Malcolm Rawlingson 6.19.09
In the history of mankind all fiat money systems have failed sooner or later. We are seeing another failure unfurl before our very eyes. Money is a belief system that is all. The piece of paper with $100 dollars printed on it is just a piece of paper. It ONLY has value if the person you hand it to believes what you do. If the belief that the useless bits of paper you handed over for your bag of useful groceries disappears then the system starts to collapse. That is why money must eventually be tied to something of enduring value. That is how you maintain the system of belief. Whether that is gold or silver or anything else doesn't really matter. Any one who purchased gold in 1999 or 2000 has made a rate of return of about 35% per annum. I suspect as confidence fades that the US will ever be able to honor all of the tons of paper and phantom money it has generated people will demand some sort guarantee. Like I said above a very big shame. M
Ferdinand E. Banks 6.20.09
Why am I being persecuted? What have I done...this time? I'm glad that I'm not in the business of teaching macroeconomics right now, because if I was some horse laughts might be coming out of your computers. (If it is possible to send horse laughs through computers).
The present macroeconomic/financial-market set-up has made at least half of every country in the civilized world - and a few others - rich beyond their wildest dreams. As for the present economic foul up, I say so what! Things like that can't be avoided. They have happened since the beginning of time and they will happen again. Ideally the people who caused the trouble shouldl be the ones to pick up the bill, but as we all know that happens only in fairy tales.
Gentlemen, where the macro is concerned you just have it wrong, but this is NOT the place to go into details. I can say though that for the first time in 15 years I have pulled a macro book out of the garbage can where I had stored it, and will take the first step in giving some informal instruction to the unlearned in that subject next fall. I also want to assure you that I would hate to be anyone who shows up at the Institute of Economics (Ekonomikum) at this university with what I consider to be the wrong kind of ideas. And I mean anyone.
About the United States. This is no longer the country I grew up in, and some very bad tendencies have developed, however for that reason the present meltdown and so-called war on terror might be the best thing that could have happened - at least in theory. As a Democrat I'm satisfied with the present government, although I could easily have voted for McCain and Romney. And let's be clear on something here, you would NEVER have convinced those two that the failure of the US fiat money system was at hand. NEVER. Of course Ms Palin would have bought a crazy idea like that, but that is neither here nor there.
I can close by saying to Jeff that his son's teachers were - on average - pretty sad, because that's what teachers of economics and finance are - on average. I'm a great teacher, one of the absolute best, but In looking back I never taught macroeconomics the way that I now believe it should be taught. I taught finance the way it should be taught however, but maybe that was because my students here in Sweden invited me to their parties, and perhaps more important, the main reason was that my students were eager to learn finance in order that someday they could buy and sell teachers like me, which some of them can do now.
Ferdinand E. Banks 6.20.09
Before I forget, A few years ago Brad Delong ( of the University of California) and Martha Olney showed that on the average Americans were fifty percent richer than their parents at the same age. Of course that isn't sufficient for some people, since all the money in the world wouldn't be enough, but the question that needs to be asked now is would a system not based on a fiat money have provided better results.
When several Austrian creeps visited the US and tried to argue in favor of abandoning fiat money, even Milton Friedman couldn't go along with them: he came up with his own nutty solution of a steady growth in the money supply in order to deprive the chairman of the Fed any prerogatives. As I enjoyed pointing out to my students, that led to trying to figure out WHICH money supply he meant, and he couldn't give any help on that.
And Malcolm, you say that a $100 bill is just a piece of paper with some numbers on it, but as far as I am concerned when you are walking through Paris on a warm night with that piece of paper in your pocket you are a very lucky person.
Fred Linn 6.21.09
-----"As for the present economic foul up, I say so what! Things like that can't be avoided. They have happened since the beginning of time and they will happen again. Ideally the people who caused the trouble shouldl be the ones to pick up the bill, but as we all know that happens only in fairy tales. "---------
Yes. Those who do not learn from history are doomed to repeat it.
It seems to me that we have not learned from history, and we are repeating it now.
Rampant unrestrained speculation and margin leverage in the stock market and a laissez-faire government policy toward regulation led to the stock market crash in 1929 and the Great Depression. The same things led to our current problems.
---------"And Malcolm, you say that a $100 bill is just a piece of paper with some numbers on it..........."--------------
I agree with Malcolm.
The only reason that currency is worth anything is because people believe that it is worth something. When people stop believing that currency is worth anything, then it is worth nothing. It seems to me like people are losing faith very rapidly in US currency.
Ferdinand E. Banks 6.21.09
Mr Linn, in l982-83 the unemployment rate in the US was about ten percent, or maybe more, and a few years later full prosperity was back. This time it may go higher, but I hope for your sake that Mr Obama doesn't cure this meltdown during his first term, because if he does you may never see another republican president.
Íncidentally, the present problem wasn't caused by fiat money or the Fed. It was probably caused by an ignorant president and lazy voters who listened to his lies and gave him a second term.
This streetcorner macroeconomics of yours simply misses the point. As I pointed out somewhere, THE AVERAGE AMERICAN IS FIFTY PERCENT RICHER THAN HIS PARENTS AT THE SAME AGE. I can give you the name of a professor at the University of Berkeley who has researched this issue and published more than 100 papers on macro. You can argue your case with him, although unlike the generous persons in this forum he may find these statements of yours unworthy of an answer. Insofar as fiat money is concerned, it was the gold standard that made the 'Great' depression so ungreat for so many people. This talk about a metallic backed currency is crank, and you arn't going to see a gold or silver backed currency no matter who is president. The same concerns abolishing the Fed. These things are here to stay, and neither you nor anybody else can or will do anything about it, and that includes your favorite politicians. Of course, your favorite politicians don't want to do anything about it, and they and their experts ignore ravings in the bloggosphere.
As far as I know, there are few countries in the world now where gold cannot be purchased during business hours. If you and Malcolm feel that dollars are worthless, turn them into gold, or silver. The international economy is going through a bad patch, which is nothing new, and it will happen again. As for people losing faith very rapidly in US currency, this is an empirical question. Obviously there are countries where the US dollar is increasing in value. Sweden is one of them.
And so on and so forth.
Fred Linn 6.21.09
--------"Íncidentally, the present problem wasn't caused by fiat money or the Fed. It was probably caused by an ignorant president and lazy voters who listened to his lies and gave him a second term."------------
The problem was caused by rampant speculation in the real estate market fueled by sub prime loans---bestowed on us by a Republican administration that was anxious to gain approval and distract attention from their war to secure rights to cheap oil reserves by showing a strong economy. They bestowed blessing on rampant speculation in overly risky practices in banking by all but dismantling the regulatory oversight system and manipulated the markets to show good economic numbers. Wnen it started to become appearant that this was not working---they manipulated the numbers to make things appear better than they actually were. Then they continued and even expanded their efforts. It was no surprise to me whatever that we had a meltdown I think we'll be extremely lucky if this recession is over in ten or fifteen years, let alone four years. It took a World War to finally pull us out the last time----I HOPE that is not the case ths time.
Fred Linn 6.21.09
PS------
------"If you and Malcolm feel that dollars are worthless, turn them into gold, or silver."----------
I am.
Len Gould 6.21.09
Good luck with that speculation, Fred (Linn).
So, have any of you heard of any failing banks in Canada? That socialist country with fiat currency? I repeat. "All that's needed is some mild restraint and independence from political control of the central bank decisionmakers" If bank regulators had kept tabs on the bankers and other lending institutions lending out at ridiculous total loan-to-asset ratios and stepped in to stop them, none of this mess would have either started or continued to the present mess.
The problem has nothing to do with a metal-backed currency, and everything to do with criminal political influence.
Ferdinand E. Banks 6.21.09
Let's no forget one thing Fred (Linn) and Malcolm.
FIAT MONEY SYSTEMS INEVITABLY COLLAPSE - which may or may not be true - BUT IF THEY DO COLLAPSE THEY ARE REPLACED BY OTHER FIAT MONEY SYSTEMS!
About this speculation in the sub-prime market, you are obviously correct about that, and one of the key villains there was Sir Alan Greenspan. But Greenspan was considered a miracle man for years, and when he went off the deep ene he could not be removed.
I wonder if we are dealing with a Ron Paul supporter here?
Fred Linn 6.22.09
------"Good luck with that speculation, Fred (Linn). "----------
It isn't speculation(buy low, hope to sell high) in my opinion----it is more of a hedge. Gold, silver, or any other commodities that have intrisic value are hedges against the loss of value of paper currency. It is saving for a rainy day. It looks to me like it is raining already out there.
--------"So, have any of you heard of any failing banks in Canada? That socialist country with fiat currency? "-------------
No. Canada is exporting oil to you in the US. Canada is pulling wealth out of the US to finance itself. You are paying for social medicine in Canada by buying oil. And you are paying for it by taking value out of the dollar with every barrel of oil that comes from Canada, or anywhere else. That is what inflation does.
--------" I repeat. "All that's needed is some mild restraint and independence from political control of the central bank decisionmakers" If bank regulators had kept tabs on the bankers and other lending institutions lending out at ridiculous total loan-to-asset ratios and stepped in to stop them, none of this mess would have either started or continued to the present mess.
The problem has nothing to do with a metal-backed currency, and everything to do with criminal political influence. "-----------
Yup----but that is not what happened. The fat is in the fire now. The only way I see to get it out is to FORCE fiscal responsibility by backing currency with a commodity that will prevent just cranking up the printing presses and deluging the market with pieces of paper that lose more and more value with each one that is passed out. The only alternative to flooding worthless pieces of green paper into circulation, is to increase products and services----then, when G&S(goods and services) increase, and the monetary pool remains the same, the price of G&S decreases-----fewer dollars chasing more G&S.
-------"FIAT MONEY SYSTEMS INEVITABLY COLLAPSE....."-------
Yes. You are seeing it now.
------"BUT IF THEY DO COLLAPSE THEY ARE REPLACED BY OTHER FIAT MONEY SYSTEMS! "--------
Which also collapse. Seems to me like an excellent reason to abandon fiat money systems in favor of a backed currency. ----------"I wonder if we are dealing with a Ron Paul supporter here?"----------
I have no idea what Ron Paul would have to say about the matter. However, if he is in favor staunching the flow of wealth out of the US in the form of deficit of trade payments to pay for oil, and introducing some fiscal responsibility and ending the increasing strangle hold of monopoly business on government-----I am for that.
Jim Beyer 6.22.09
Though quite a bit off topic, I don't think there is any easy way around this metal-backed vs. fiat money problem.
Any metal-backed currency would be pegged to some physical commodity which would greatly impede growth (and contraction) of the money supply if and when needed. It might be quaint to believe that these machinations are not needed, but in a modern economy, they are.
Second, if one had a metal-backed currency, then it would need to be produced by multiple private concerns, as the gov't wouldn't have the resources to produce all of the currency. Well, this could lead to shenanigans as well, as the private backer might not actually keep the metal in reserve as they say they do. (They only need to have as much around to make do with calls, the rest is just sitting there, waiting to be "invested" as the backers see fit.)
Not that even commodity exchange traded funds, like SLV or GLD, are precisely clear how much bullion they are actually holding. Furthermore, whatever IS held contributes to holding costs and thus, an erosion of ETF value (as a percentage of the bullion held) over time. Maintaining Fort Know is not a free lunch, and even less so with respect to private entities.
So no easy answers here folks, move along, move along......
Len Gould 6.22.09
I'd just like one re-direct, since Fred Linn chose to obfuscate my point by separateing it into several responses. The point is that a fiat currency system is the best system to operate for many reasons IF you maintain proper regulatory oversight of the issuing entities. Canada does do that, though probably the only reason that is possible is because the Canadian economy is primarily a branch-plant subsidiary of the US economy with insufficient ROE for the corportate HQ movers-and-jigglers to bother influencing the Canadian federal overseers. Until the US people are able to wrest oversight control away from the overseen, the world will continue to suffer consequences such as the past year.
Ferdinand E. Banks 6.23.09
There is an easy answer for me, Jim. You didn't hear anything about a metal backed currency until Obama won the US electrion, and then the crank chorus began to screech. The answer to why top macroeconomists of all political persuasions are against a metal backed currency is in the second paragraph of your last comment.
Nothing more needs to be said, however let me mention that suddenly the crank chorus has singled out 'pointy headed economists' as an enemy of civilization. As far as I can tell the only thing those ladies and gentlemen are enemies of is hard work and conventional logic.
Fred Linn 6.24.09
Jim Beyer-------"Second, if one had a metal-backed currency, then it would need to be produced by multiple private concerns, as the gov't wouldn't have the resources to produce all of the currency."-----------
We never needed that before---I see no reason why we'd need it now. The government is the only entity that is constitutionally allowed to produce legal tender(currency). The only difference is that with a backed currency, the government can not just crank up the printing presses and issue currency in an amount greater than the supply of the backing commodity on hand, they either have to increase the amount of commodity---spend less----or raise taxes. Politicians, especially of the late, want to buy votes by spending more and taxing less. Which only puts a double whammy added burden on the future. Future generations will not only have to pay for spending needed then(in the future)---they will also be under a burden caused by debt from spending now, and the added burden of interest on that debt.
Not good economic policy if you ask me. And it is easy to see. Tell anyone on the street that you are going to give them $1. Then ask them if they want a Morgan Silver Dollar or a Sacajawea brass subway token. At the end of the day, my bet is that you will have a whole sack full of subway tokens and an empty cartwheel(Morgan Dollar) bag. The government has spent millions of dollars trying to get people to use Sacajawea dollars without success.
Len--------" The point is that a fiat currency system is the best system to operate for many reasons IF you maintain proper regulatory oversight of the issuing entities. "-----------
But the "IF" ain't happenin'.
Len--------" Canada does do that, though probably the only reason that is possible is because the Canadian economy is primarily a branch-plant subsidiary of the US economy with insufficient ROE for the corportate HQ movers-and-jigglers to bother influencing the Canadian federal overseers. "-------------
According to the US Treasury, you owe the branch-plant subsidiary Canada $13.1 Billion as of April 2009. And that amount is increasing everyday with interest and with every barrel of oil that crosses the border. Canada has less than 10% of the population that the US has. One of these days, the tail is going to be wagging the dog.
Len--------" Until the US people are able to wrest oversight control away from the overseen, the world will continue to suffer consequences such as the past year. "-----------
That sounds like a pretty good arguement for a backed currency to me.
Ferd--------" Nothing more needs to be said, however let me mention that suddenly the crank chorus has singled out 'pointy headed economists' as an enemy of civilization. As far as I can tell the only thing those ladies and gentlemen are enemies of is hard work and conventional logic."---------
An economist professor came into town one day, He said, "I'll make you a star if you'll just sing and play along." But Billy's Mule just smiled and said, "I don't wanna be a star....... .'cause all that worthless paper ain't gonna get you far.
Oh, Billy's Mule can tote a wagon, he can pull a plow. He can fig' arithmetic and milk a muley cow. The only thing that he can't do---just 'tween me and you--- Is make a greenback dollar buy the things that it used to.
Jim Beyer 6.24.09
Fred Linn,
The current money supply in the U.S. is between 6 and 10 trillion dollars depending on whether you consider the M2 or M3 money supplies. Some think that the U.S. M3 supply is around 15 trillion dollars at this point.
Compare this with the current gold supply at Fort Knox, which, at $1000 per ounce, is worth only $147 Billion dollars. This is a hundred-fold shortfall!
I am afraid you simply aren't being realistic about the money supply demands of our modern economy, and how difficult it would be for a metal-backed currency to support it.
Fred Linn 6.24.09
---------"I am afraid you simply aren't being realistic about the money supply demands of our modern economy, and how difficult it would be for a metal-backed currency to support it."------------
Yup. That's a powerful tall heap of worthless paper.
Maybe we ought to use it to buy toxic assets----that otter be 'nugh to make us all rich.
Malcolm Rawlingson 6.24.09
Jim, All that tells me is that gold is seriously undervalued. I am not an economist but my personal observation is that tying the supply of money to a real commodity like gold or silver provides the necessary stability to economic activity and prevents the idiotic creation of money out of thin air. The value of gold in terms of paper money can be any number you like. The commodity can be any commodity you like as long as it has some scarcity. But I do like gold mainly because while everyone was selling it in 1999 I was buying it and I just made a small fortune selling some of it. Nearly 40% annual rate of return...do I like gold or what!!
Since the US is now printing money because it is not so easy any longer to sell treasuries and Government bonds to the Chinese the result will be rip roaring inflation which will be used to reduce the US debt by devaluing it out of existence.
And Professor Fred please do not misunderstand me....I have great affection for the US and its people. Unfortunately the fiasco created by the greedy few is in the process of completely wrecking the future of the hardworking people who create real wealth. I do not see this disaster ending any time soon. Billions of dollars of ALT A mortgages are about to reset in the next 18 months. If you think sub prime was bad wait for this Tsunami. It is a big one.
As Fred Linn puts it a big heap of worthless paper. Gold looks to me a much better bet. At least you can fill teeth with it. Can't do that with paper dollars.
Malcolm
Malcolm Rawlingson 6.24.09
I recalculated my rate of return on gold and it came in at 39.8% which includes currency variation between the US and Cdn dollars. My estimate of 35% was a bit low. Gold is sold in $US so one has to convert the currency then buy the metal. So I am very pleased with that. I would not call it speculation just smart management of assets. I did not buy any dot com stocks because it all seemed phoney to me. As it turned out it was. Maybe I should have been an investor not a nuclear engineer.
If you think as Fred Linn and I do that the rampant creation of money out of thin air is a real problem for the US and the world then I would suggest that you but real commodities that you can store easily. That is what the Chinese are doing right now - stockpiling commodities while they are cheap. Since I do not have room for a few tankers of oil or truckloads of potash in my back yard I have to resort to things that I can store easily such as gold and silver. They will always have value - a very high value when the belief in printed paper falls apart.
I could be wrong. But I cannot logically see why anyone would do otherwise.
Malcolm
Ferdinand E. Banks 6.25.09
Malcolm, I would never accuse you of being anti-American, but not being American you must....MUST understand what Jim Beyer says above: there isn't enough gold or silver to institute a metallic standard. The idea of a metallic standard is absurd, and no government in the US or e.g. Canada would do something so self destructive.
As for you buying gold and silver, that probably makes more sense than the activities of somebody like me who wastes his time cycleing and playing tennis, and is simply too lazy to buy these items during the relatively short Swedish summer.
What about Fred Linn? He might be a better Democrat than yours truly - since I occasionally vote for Republicans - but his observations are similar to those of the hate and crank chorus that started up a few seconds after Obama was pronounced president of the US. The issue here is not paper money or gold or even race, but the possibility of the Democrats occupying the White House for the next 4 or 8 or 12 or 100 or ....years. Of course if the US government issued a pronunciomento that a metallic standard was being introduced, it would be out the next day, and most of its members in prison or a hospital.
That being the case, Jim and Malcolm, the good Fred Linn IS being realistic, because what he wants to do is to put another government in Washington that will do the kind of crazy things that George W's government did. But I can tell you one thing, Fred. John McCain would never listen to the kind of sermon you preach.
Fred Linn 6.25.09
It looks to me like you've made up your mind based on hearsay and opinion.
You guesses and assumptions about my political associations are astoundingly wrong.
Fred Linn 6.25.09
--------" That being the case, Jim and Malcolm, the good Fred Linn IS being realistic, because what he wants to do is to put another government in Washington that will do the kind of crazy things that George W's government did. But I can tell you one thing, Fred. John McCain would never listen to the kind of sermon you preach."------------
Ferdinand Banks---you are completely loony tunes.
You have a very smug, superior and condescending attitude. I'm not an economist---but if I were, I wouldn't be telling people publicly that I'm an economist but I don't know what the issues in the US presidential election of 1896 were. You should look into it---history is very relevant--to economics, to technology, to everything that man does. History is the sum total of all the experience of mankind.
If economics students are not studying that---and you are turning them out to make the same false assumptions and erroneous conclussions that you have been making here---then it is no wonder that we are in the mess we are in.
Ferdinand E. Banks 6.25.09
Fred Linn, I think you mean FRED, YOU ARE COMPLETELY LOONY TUNE.
You should look into something too, Fred. The comments above of Jim Beyer will do for a start, and especially his reminder that there is 100 times as much fiat money as gold. Going from a fiat money system to the gold standard under those circumstances would turn the US into a gigantic poorhouse.
As for the importance of history, you are completely correct, but even so you should learn enough English to read my international finance book, because I make it clear that history is more important than mathematics IN ECONOMICS, and even in FINANCE.
Bob Amorosi 6.25.09
I tend to fear the US is already on its way into a gigantic poorhouse because of the monstrous debt Washington is piling up with massive budget deficits.
Yes.... it's me again, an ignoramus who doesn't understand what I am talking about.
Well, as a Canadian I have lived through what the Obama administration is facing. Canada had a horrendous ballooning federal debt back in the mid-1990's after running budgetary deficits for nearly 20 years. The deficits started back in the 1970's by our legendary Pierre Trudeau prime minister and his liberal party in power. He saw the gap steadily growing between rich and poor people during the 1970's as was inflation growing too, creating much social unrest especially in the French province of Quebec where Pierre came from. In a brilliant stroke of political cleverness, he introduced more social programs by borrowing money and starting to run a budget deficit. It worked politically as it bought massive numbers of votes among average and poor people.
Subsequent governments in Canada throughout the 1980's, including the opposition Conservatives, kept running deficits because everyone thought the growing economy would just keep funding ballooning budget spending. It was too good to give up. But during the 1990's the Liberals came back to power, and all it took was simple algebra to calculate that if the growth in the total federal debt load, which was running nearly $20,000 per citizen, wasn't stopped, compound interest on it would send it into outer space and bankrupt the federal government. They would never be able to borrow money again from foreign lenders because they would soon realize we could never pay it back. Sound familiar to what is unfolding in the US?
It took draconian budget spending cuts and tax increases by the Liberals to run consecutive surpluses ever since to stop Canada's debt from growing and in fact pay some of it down. The result was gutted social programs, most of which we still have in place but drastically under funded now with much lower benefits, and under constant criticism of being failed socialism.
I don't envy the future for the United States, for as others are saying here, if they merely print more fiat money to pay for everything, massive inflation will rear its ugly head again.
Jim Beyer 6.25.09
I think it's pretty clear that the Obama administration is aware they need to rein in the money supply before inflation becomes a problem. Paul Volcker did this in the early 80's by raising interest rates. The trick for the Obama folks is when to do this. Too early and they stifle the recovery. Too late and they may let the inflation genie get out.
Jeff Presley 6.25.09
Bob Amorosi, to your above missive I would add the following: The tremendous GIFT that Alberta has been to the Canadian government. Without the oil and oilsands investments, and the tremendous revenue they generate, the minor social program reductions you have seen would be considerably more draconian. In fact, take away Alberta as a province and the government in Canada would ALREADY be completely bankrupt.
Mr. Lin, we don't need to go back to the 1800's here, we only have to look at a few of our neighbors to the south to see what happens when you try to print your way out of a budget problem.
To the rest, I recommend reading up on mercantilism and understand that for some countries this is still the preferred modus operandi regardless of what their economists and politicians say. Recognize what our Herr Banks said earlier (and elsewhere) concerning the desire of the Mideast oil producers to move their way up the food chain towards more finished goods (ie diesel versus crude export). With entities "too big to fail" we may well see new government backed monopolies such as car companies and banks that gov't policies "encourage" citizens to patronize instead of their nimbler and more efficient competition. Of course those rules and regs only carry to the borders, where the neighboring countries may well decide to do the same, and instead of the wealth for all opportunities of the 20th century, we may see captive consumers within domestic borders that will look more and more like fortresses. We've seen that movie before and it ain't pretty, but this one ain't over yet either.
Whether the US performs the needed cranial rectumectomy in time remains to be seen, but the only hope that I see is for the US to stop its pogrom against productivity in this country and allow us to earn our way out of this mess. Some short-sighted politicians believe they can, to paraphrase the words of the ex-president of the United Pilot's Union, "[not] kill the golden goose, but wring its neck until we get every last egg". He made that statement not very long before his actions took United Airlines into bankruptcy and destroyed all the equity in the company that the pilot's union held the majority of. Killing or even wounding golden gooses is never a good idea.
The "real" gold Fred and Malcolm should be concerned about is the gold between some inventor's ears, coupled with the management teams to create the transformational industry of the future. Remember all that gold buried in your backyard is effectively worthless UNTIL you covert it to paper money. You can't take bullion to the store and buy beans with it, and even if you could, do you think you'd get a "fair" shake from the merchant?
Fred Linn 6.26.09
Bob A.-----"I tend to fear the US is already on its way into a gigantic poorhouse because of the monstrous debt Washington is piling up with massive budget deficits. "------
Thank you Bob, that is what I think too. And it isn't just budget deficits---there are also balance of trade deficits transfering wealth out of the country in the form of oil imports.
Jeff P.------"Mr. Lin, we don't need to go back to the 1800's here, we only have to look at a few of our neighbors to the south to see what happens when you try to print your way out of a budget problem."----------
Yes, you are right. However, looking at one country in particular, Brazil, I found that they went from riots, communist revolution and bankruptcy to a booming economy today. 8th or 10th largest in the world depending on which list you choose to use to rate them.
They did it with government/business partnerships to provide jobs and industrialize. They also set out on the most aggressive program in the world to end oil dependence. The program to convert to biofuels went slowly at first. They had a mandate that all cars sold had to be able to use ethanol. They built the infrastructure to produce the ethanol. Ethanol produced from locally grown sugar cane. When the price of crude spiked last year--they were in the perfect position to exploit it. They went from being an oil importing country to being an oil exporting country. They are now financing new industrialization, jobs and social programs with new found wealth acquired from exporting oil.
It seems to me that we should be doing the same thing.
Jeff P.---------"The "real" gold Fred and Malcolm should be concerned about is the gold between some inventor's ears, coupled with the management teams to create the transformational industry of the future. "---------
I agree. I think we should look at what works. I think the Brazilian model is a very good place to start looking.
Ferdinand E. Banks 6.26.09
Yes Brazil is a wonderful country. I stopped by there coming back from Peru, and that sun, those beaches...absolutely marvelous, and the best of all that music
As for Brazil as an economic or social model, I dont see how anybody in their right mind could suggest that Americans or Canadians should be interested. But of course, I'm merely a great economics teacher and perhaps have nothing informative to say.
Fred Linn 6.26.09
Brazil is not perfect----but they are doing some things that work.
Ipanema is one. LOL.
Raquel Baranow 6.27.09
Lol @ U ppl buying gold & silver . . . first thing U'll find out, which was punishable by death before, is that the metals can easily be debased, i.e., counterfeited.
Like it says in the Old Testament: "They shall cast their silver into the streets, and their gold shall be as an unclean thing; their silver & gold shall not be able to deliver them in the day of the wrath of the Lord (i.e., Peak Oil and the fall of Babylon*); they shall not satisfy their souls, neither fill their bowels; because it hath been the stumblingblock of their iniquity." -- Ezekiel 7
I advise my friends to stock up on wine & cocaine but then, as Jesus (if he existed) said, "do not store up treasures on earth . . . where thieves break in and steal."
There's a parable by Jesus about the workman not calculating sufficiently to finish his work . . . that's Peak Oil. IMO: there's no solution to Peak Oil, geometric world population growth and global warming except the fall of Babylon.
If I had the $$$ I'd buy some land within a gas-take away and rotate stock of corn & soybeans, feeding the old stock to chickens, goats and maybe, pigs.
* Babylon is a city-state of commerce & confusion, a non-sustainable community.
Ferdinand E. Banks 6.27.09
Well, Raquel, I'm glad to welcome you aboard. Your knowledge of the bible is impressive, and agreeable, because my program for the saving of America's soul includes a heavy dose of prayer in school, involving all faiths, but non mandatory, as well as a pledge of allegiance to the US flag for all US citizens, that would be strictly mandatory for any student receiving the US government's fiat money.
Now let's see, Peak Oil, geometric world population growth, and global warming. Peak oil is easily handled. Geometric population growth is bad, really bad, but I see no reason to explain why. Global warming...I live in a country that has one of the best environments in the world, but global warming is an important topic. Do you know why? Well, the answer is that it gives ignorant people something to get their teeth into. They cant add and subtract, speak latin, explain the physics of the moonwalk, etc, but you should hear them pontificating about climate. Incidentally I accept the climate warming story. Why not? Sweden is one of the leading preachers of doing something about warming, but they don't really do anything because like me they know that environmentalists are mostly fools. Mostly, but not all of them, because renewable fuels and some wind and a few other things make sense - up to a point.
Murray Duffin 6.27.09
Fred, I'm late into this one, and haven't read all of the other responses. However, there was no significant change in the oil supply/demand balance in H1 2008 that would have driven much of a price increase, and the new projects scheduled to come on stream through at least 2010 (see wikipedia Megaprojects) were at least sufficient to meet expected demand growth.. The long term curve of oil pricing from about 2002 would have given a price in the range of $80.-90/b for mid 2008. Weakening of the dollar from about 2003 would have raised that price to about $105.-115./b. By June 2008 "paper" contracts (speculative futures) for oil were in excess of 10x the physical buy/sell taking place. It is hard to believe that the price above $115./b was anytrhing but speculative. Kruger's thesis that speculation can't drive the price because for every winner there is a loser is nonsense on a short term basis. When buyers are piling in faster than sellers, the price goes up, until the bubble bursts. In the long run of course he is right, and that is usually why the bubble bursts. This time the bursting of the bubble coincided with an economic crisis (for which the bubble may have been one of the triggers) and demand dropped sharply (about 12% y-o-y as of March 2009 for the USA), with a corresponding drop in price, plus some temporary overshoot. Now, because of the low prices, many of the Megaprojects projects have been delayed or cancelled, so as demand recovers we will ecperience a real supply shortfall, and the next price spike probably will not be a bubble. Murray
Ferdinand E. Banks 6.28.09
Thanks Murray
I don't like this paper of mine. I sent it in and forgot that I had submitted it. When it was published I immediately began work on a very short note that provides the right explanation. The logic goes as follows.
IF X DEPENDS ON Y, AND Y DEPENDS ON Z, THEN X DEPENDS ON Z. In this discussion X is oil prices, Y intelligent and skillful speculators, and Z fundamentals. The deduction is that oil prices depend on fundamentals, via speculators (and other market actors).
There have been oil SPIKES earlier that were stronger (in some sense) then the 2008 runrup. They were spikes because speculators (and others) reacted to a likely shortage of oil, but knew that it could or would blow over. They did not make the mistake of trying to turn it into a sustained oil price rise.
What happened in 2008 was that speculators (and others) reacted to fundamentals, the most important component of which was the supply policy of OPEC. As for paper contracts being 10x physical, that is nothing special. This is open interest and largely a measure of market liquidity. What happened in 2008 was that when OPEC started talking about the price they wanted, what they desired for the future of oil in terms of their children and grandchildren, refused to increase capacity, and dismissed President Bush's request for more oil, the speculators (and others) recognized that a new day had come, and reacted accordingly. Etc, etc. The growth of physical supply was managed downward, while demand continued to expand. The oil price went up. QED
Fred Linn 6.28.09
Soooooooo, what happens when another speculator driven economic bubble runs the price of oil up again, oh, let's say about $250 a barrel or more..........and in the rusulting economic chaos, the value of unbacked currency drops like a lead balloon, oh, let's say to about the value of a post WW1 Duetschmark?
Ferdinand E. Banks 6.29.09
I don't see why an inflation concerns you, Mr Linn. After all, you will have turned all your spare case into gold bars.
And incidentally, the buying and selling of oil involves more than speculators - unless you believe that anyone who buys or sells oil without putting in a hedge is a speculator.
This is one topic however that I do not intend to argue with you about, since you have decided to get most things wrong - except of course your knowledge and appreciation of history. But allow me to repeat:
THE OIL PRICE IS INFLUED TO A CONSIDERABLE EXTENT BY PROFESSIONAL SPECULATORS, WHO IN TURN ARE INFLUENCED BY THEIR KNOWLEDGE OF FUNDAMENTALS. EMPLOYING MAINSTREAM LOGIC MEANS THAT THE OIL PRICE BEING INFLUENCED BY FUNDAMENTALS..
But yes, their are irrantional speculators, sometimes called 'noise' traders, but my contention is that they don't amount to much. They mostly lose, but occasionally they are lucky.
Fred Linn 6.29.09
OK. You can remind me in about a year when the economy is humming along with double digit growth and the price of oil is less than $50 a barrel how wrong I am.
Ferdinand E. Banks 6.30.09
You forgot something, Fred. When President Obama is impeached and replaced by Governor Palin.
Malcolm Rawlingson 7.2.09
Fred (Ferdinand that is), I am not anti-American at all. Quite the contrary. But I think you would agree with me that much has changed in that country in the last 50 years and most of it for the worse. I wish it were not so but it is. I admit to being a simpleton as far as economics is concerned and I am not sure I understand it when you say there is not enough gold in the world to support fiat currencies. Yes I do agree there is not enough gold at $1000 an ounce but that simply means gold is vastly undervalued. The value of gold should simply be the amount of currency divided by the quantity of gold. I suspect that puts gold at and extraordinary price. The brilliant stroke of genius of the British Chancellor of the Exchequer (Now PM Gordon Brown) to sell off half of the gold in the Bank of England cost the British Government billions and billions of pounds. Sold for about $200 an ounce now its worth 5 times that. I think he thought that gold would not be used as currency. Unfortunately there are many including me who consider that only items of intrinsic value are worth owning. I do not hold onto paper currency any longer than I have to. The Chinese think the same way. They are the worlds largest gold producer (larger than South Africa and Russia combined) yet they sell not one ounce of it.....why do you think that is? They (wise people that they are) are busy buying and stockpiling commodities they can make things with using all the accumulated paper dollars. As I said before fiat currencies are simply a belief system and when the promise to pay the bearer on demand becomes nothing more than hot air as is the case right now people will always return to things that have value....as they always have.
In my humble opinion the things that have value are LAND (no more being made), GOLD (in very short supply), RHODIUM and the Platinum Group Metals (in even shorter supply), FRESH WATER (in high demand the world over), OIL and GAS (getting harder to find and no more being made) and ELECTRICITY Production facilities (because people cannot do without it).
These are in short supply when only a Billion or so have a decent standard of living. When the other 5 billion say what about me? Well watch what happens to the value of these things. You can't grow food on dollar bills.
