Babeled

Trickle-down economics is actually a political term that has been referred to in various capacities as, “Trickle-down theory”, “supply-side economics”, or my personal favorite, “Reaganomics.”  This ideal is based on the premise that when the wealthy get to keep more of their money in the form of paying less taxes, that incremental income will “trickle” down the economic ladder in the form of increased payrolls and pay rates, as well as increased consumption of goods.  This assumes that the incremental income will be invested in business infrastructure and equity markets, thereby decreasing the cost of goods while increasing jobs and wages.

There are many reasons this premise is flawed, and I shall be over-joyed to share them with you.

• There are many investment options for the wealthy, as they are minimally constrained with what they can purchase.  Typically, investment into business infrastructure no longer comes in the form of a larger payroll.  Instead, companies are decreasing their payrolls via outsourcing, layoffs of higher-earning employees subsequently replaced by younger, cheaper employees, streamlining processes, and implementing technological solutions.  This is smart business because it increases the companies earnings, leading to an increasing stock price.  Most executives are the “wealthy” being discussed, and executive compensation is mostly comprised of equity (stock) compensation, with a typically much smaller percentage of income from actual salary.  Increase earnings, stock price goes up, rich get richer without any money trickling down; rather, they actually achieved this through taking jobs aways from those in the lower economic brackets.
• Production of goods, and thus the price of goods, is determined by supply.  If 1% of the population has more money to spend on consumables but the other 99% have less (or even the same) amount of money, the demand is actually decreased (or not sufficiently increased) and certainly not prompting higher production (which is the basis for the increased job portion of Reaganomics), and therefore prices don’t budge.  There is also the issue of product mix.  The wealthy are not purchasing all of the same goods as the rest of the country.  They are typically the ones who purchase the imported goods as imports are more often than not the “luxury” items.  Those consumables went straight to another country.  Not that stuff from Wal-Mart doesn’t eventually get traced back to China or Malaysia somehow, but at least the American retailers get most of the profit first.
• As you go up the scale in wealth, there is a corresponding increase in the craftiness of the people handling said wealth.  What I mean is that usually extremely wealthy people pay very intelligent and creative business people large sums of money to be good stewards of their fortunes.  These financial experts also have to compete with one another to obtain the patronage of wealthy clients, especially since they are so few in number.  The results of this competition are things like groups of mortgages with a certain guaranteed return (interest rate for the borrower…) being sold by banks to investment groups.  These investment groups are financed by money from the wealthy as an alternative to things like stocks and bonds.  So, in this instance, the higher the interest rate on the mortgages, the higher the return for the investment group, the higher the return for the wealthy.  Another example of how the rich get richer off of the lower economic classes.
• This is a bipartisan theory, no matter what anyone tells you.  Bill Clinton and George W. Bush both extended and increased the reforms put in place by Reagan’s administration.  This includes the 15% capital gains tax, the lowest in U.S. history, which strictly benefits those with enough income to invest in financial markets.  Proponents would argue that this makes sense based on trickle-down  principles and is clearly the proper course of action.  I think that the first bullet shows exactly why this is false.  The lower capital gains tax makes it more appealing for the wealthy to obtain more of their income through stock and the like.  It is not a coincidence that executives’ compensation is mostly derived from stock, it is because they know that they pay about half of the amount of income tax on capital gains as opposed to their salaries.  The top 1% earners of the country are all heavily invested in the stock market, no matter where their fortune was built.
• In addition to lower capital gains taxes, the Reaganomics reforms also lowered taxes on corporations.  This is in perfect line with the logic that the more money the company gets to hold onto, the more jobs, goods, etc.  Again from the first bullet: business infrastructure is undergoing a metamorphosis.   Corporate investments are being made overseas and in personnel-reducing areas.  They are not taking these increased profits and hiring more people.  They are paying higher dividends to their shareholders, who as we have demonstrated earlier, are mostly the wealthy.
• In order to offset the lowering of the two types of taxes above, the Reaganomics solution in the Tax Reform Act of 1986 was not to reduce spending (this would be too Republican, I mean, ACTUALLY a smaller government? Pretty please?), but to increase individual income taxes on the lower earners by decreasing the top tax tier from 50% to 28% and increasing the bottom tier from 11% to 15%.  In actuality, these became the only two tax brackets.  This restructuring of income-level brackets left a segment of the population which was previously classified in the 11% bracket now a part of the 28% bracket to bear a 154.5% increase in their income tax expense.  If they were previously in the 11% bracket, that means they were in the bottom portion of income earners.  The situation is such that people who were not making a lot of money to begin with are now having about 3/4 of what they used to before the tax reform.  This is where the government made out big on economies of scale.
• Don’t go giving me the Home Mortgage Interest Deduction argument.  This benefits a large number of non-wealthy Americans, so it would seem to be a more equitable piece of the Act?  Not so, because the people that just had their tax rate increased from 11% to 15% or even 28% do not necessarily have the requisite liquid cash to obtain a mortgage.  So they rent, and the landlord who owns the property may benefit from the deduction, but not the renter.  I would venture to guess the landlord is the one in the better financial situation of the two.  The Low-Income Housing Tax Credit was added for some semblance of balance in the Act.  This has been an effective tool for low-income households, but those who worship to the bust of Ronald Reagan condemn the people who are benefiting from the one thing he did to help the less economically fortunate.

To be honest, the list goes on and on.  There will be more to come including episodes on how Reaganomics resulted in the recession from the early 1990’s, the tech stock fiasco, and the current mortgage and home price situation.

Image used in this post courtesy of flickr user pingnews.com and provides some foreshadowing about what economic policies McCain probably has to offer.  Forget it, Obama won’t change this either.

Popularity: 6% [?]

Yes, I know I am beating a dead horse. Whatever. The cost of fuel is a hot topic, widely covered and discussed, and often misinterpreted. I tend to babel on oil and gas prices and the tangential issues that influence these moving targets, and have a new piece of the puzzle today.

A common statement that you will hear some U.S. citizens say when the topic of high gas costs is broached is, “Europe still pays more than we do.” While this may be true in the absolute cost per gallon (3.8L) of gasoline, numbers can be used to deceive when not presented properly. As it turns out, the average cost of one gallon of gasoline in Europe is $8.70 as compared with the U.S. cost of $4.00 per gallon. This is a misleading figure because the components of the two different cost figures are drastically different.

In the U.S., about 11% of the final cost per gallon is from taxes. At the $4.00 per gallon average cost, this means that $0.44 is tax and $3.56 is the pretax cost per gallon. Europe’s prices, on the other hand, are comprised of 70% taxes and 30% pretax cost. Taxes on the $8.70 average per gallon cost are $6.09 and the pretax cost per gallon is $2.61. Wait, did you catch that? If you disregard taxes, Europeans pay $0.95 LESS than Americans for one gallon of gasoline.

How can it be that Europeans pay less than Americans for fuel (without factoring in taxes)? It helps to look at relationships and ratios in this instance. As it turns out, the $0.95 per gallon less that Europeans are paying is 26.7% less than the American cost, which is almost exactly the same percentage of depreciation the U.S. Dollar has experienced against the Euro over the past five years (27%). Coincidence? I doubt it.

The highly disproportionate taxation of gasoline gives me a much more positive view of the U.S. government. However, the low-tax approach may be very short-sighted. By taxing gasoline so heavily Europe has been able to better manage the demand and implement other transportation solutions utilizing the tax revenue. By keeping gasoline taxes low, the U.S. has created a situation where everyone is addicted to gasoline because it was such an affordable commodity.

Either way, this was just an exploratory look at what really makes up the differences in cost experienced at the pump between the U.S. and Europe. Basically, gasoline costs the same amount of money in both places when you take out taxes and adjust for the impact of currency conversions.

Popularity: 68% [?]

Congress is once again trying to utilize the private sector as a scapegoat for the undesirable effects of poor policy and governance. Today, Executives from five major energy companies were grilled by Congress amidst the clamor of the American public on rising oil prices. Unfortunately, given the tone I have been reading in mainstream media, it appears that the government’s spin is being picked up and reported as gospel. This is an attempt to acquiesce voters frustrated by the economic burdens being borne from near-sighted transportation, foreign, economic, and energy policies by the U.S.

How unbalanced does it get? Well, here is a handy quote lifted from CNN’s article on this topic, “Normal supply and demand says prices should be around $55 to $60 a barrel,” said Sen. Patrick Leahy, D-Vt., chairman of the committee. This is a statement (whose legitimacy must be questioned, first of all…) that is intended to generate controversy and ignores basic facts pertaining to the situation.

The price of oil, as with many commodities in the world, is determined by many factors. Supply and Demand, while this is probably one of the most, if not the most, important factor, it is certainly not the only factor. Senator Patrick Leahy, whether out of ignorance or more nefarious motivations, has misled a great many people with his statement above regarding the supply and demand price curve for oil. He is ignoring the following factors:

• International Currency Exchange Rates
• Refining Capacity
• Geo-political factors in oil producing or refining nations
• World Demand - U.S. Demand is not an accurate barometer for the rest of the world as we have remained fairly stable in terms of petroleum demand since the 1970’s and industrializing nations are increasing their demand at much higher rates than the U.S.
• Cost of discovery and drilling oil deposits that are becoming harder to find and more difficult to harvest
• Forced supply restrictions (not allowing drilling for oil to occur in certain areas with known deposits)

My problem with this little Congressional lynching of executives lies within the currency exchange rate factor. This factor has proven to be extremely significant to recent oil prices, whether the media reports it or not. The fact remains, oil uses the U.S. Dollar as its cost basis. This means if the value of the dollar increases versus other currencies, the relative price of oil (controlling for supply/demand price issues) goes up for other currencies and down for the U.S. Dollar. The inverse is also true. Which leads us to today, where the value of the U.S. Dollar is down against other major world currencies anywhere from 13% to 30% over the past five years.

If you were to take the current per barrel price of oil (as reported $132 per barrel on 5/21/08) and adjust the U.S. Dollar’s strength to the level it was at on June 30, 2003, the price per barrel of oil would range from $95 to $100. While this does not coincide with the $55 to $60 per barrel price indicated by Senator Leahy, it certainly does account for one half of the discrepancy between the market price and the theoretical price suggested.

I now ask, “Is it Big Oil’s fault that the value of the U.S. Dollar has been decreasing versus other major world currencies?” No. Why? Because exchange rates are mostly determined by import/export balances, and budget deficit/surplus. Who is in control of those factors? The U.S. government has more influence over these factors than anyone else. By balancing the budget and adjusting trade policies and tariffs, the U.S. government has the ability to strengthen the Dollar, thus immediately decreasing the per barrel cost of oil. Granted, imported oil is a big reason why the U.S. operates at such an enormous trade deficit figure; however, this is also partially under the control of the U.S. government, who repeatedly refuses to open known oil deposits for drilling based on fear and propaganda from twenty years ago when people were in a frenzy over oil spills. Less oil imported, smaller trade deficit, stronger dollar, lower cost of oil per barrel.

There are many other methodologies that can be employed by the government to reduce the trade deficit and balance the budget, but none of these issues appear to be garnering attention from our elected officials. An apathetic approach to the strength of the Dollar is what concerns me the most as this will have a great impact on the price of almost every product, not just oil. Our economic fundamentals need to be corrected before we can expect to see our markets handling price fluctuations for a commodity such as oil with any semblance of stability. Don’t let Congress pin the bad rap on someone else, make them take ownership for that which they have neglected and admit the failures and faults which have led us to this dire economic situation. And then make them work for our best interests instead of organizing committees to talk to baseball players about steroids and bashing U.S. corporations for doing what they do (you know, run a profitable business which employs thousands of our citizens and brings billions in tax revenue to governments).

Popularity: 19% [?]

Let’s get one thing straight: the U.S. Federal Government will not let any major banking and/or lending institution go bankrupt. There may be an intermediary deal where another bank purchases the failing bank for pennies on the dollar (see JP Morgan Chase’s bail-out of Bear Stearns), but there will not be a full bankruptcy. I say this with such confidence for one reason, and the reason is something you have all seen every time you walk into a bank. Federal Deposit Insurance Corporation. The brain child of Republican Senator Arthur Vandenberg and Democratic Representative Henry Steagall, FDIC helped to bring back the people’s confidence in the U.S. Banking industry after the Great Depression.

Why does the FDIC ensure that no major bank will ever go bankrupt? The government does not want to lay out the necessary cash to depositors should the bank not be able to give their members’ money back in the event of closure. It’s true, the government charges every bank an insurance premium based on their relative risk, but that money (similarly to Social Security) gets invested into various financial securities. This would mean the withdrawal and disbursement of those funds.

The money set aside has only one purpose: in the event of a bank closure to make sure that everyone gets their deposits back according to the guidelines set down by the Glass-Steagall Act of 1933 and its subsequent reformations. Why should this be a deal-breaker for the government? Administratively, it is a nightmare from both a cost and organizational perspective. Also, the less money in the FDIC fund, the less return being made in financial markets, the less there is to go around “just in case”. Oh, and there is the whole “have you ever seen the government give back money?” (except for Dubbya, whose economic stimulus is an ill-conceived plan as government spending is not decreasing but the pool of taxes to fund that spending is…enough said).

Let’s assume that a bank does indeed go bankrupt and no deal can be brokered with a stronger bank to purchase the deposits and assets of the failed bank. The FDIC now steps in to provide relief for the failed bank’s customers. Depending on the size of the bank the amount of deposits can be enormous. According to JP Morgan Chase’s 2007 Annual Report the bank had $11.466 billion in deposits. Not all of these deposits are FDIC insured. For the sake of putting some numbers to theory, let’s assume 75% of those deposits are FDIC insured. This equals a total of $8.6 billion of FDIC insured deposits that would have to be funded from the pool of FDIC money.

Guess what happens when someone sells off $8.6 billion in financial markets? Markets crash. Should the FDIC have to withdrawal a sum of money even a fraction of JPMorgan Chase’s deposits the stock market, bond market, and just about every other kind of market would fall to its knees. Since the whole point of being insured is so that people are confident in financial institutions, it is counterproductive to bring about the collapse of financial markets just to save a bank’s depositors. The depositors got their money back and will be confident, but the millions of people who lost countless dollars in the markets that day will have another viewpoint.

Popularity: 8% [?]

Warning: This is what happens when you can’t think of anything revealing or intelligent to write.

As some are aware, these past few months I went back to school, to a county college, to take just one class: Principles of Accounting 1. Due to the fact that I have not been overly successful with my B.A. in Classics, I decided to try my hand in accounting. My desire: To see if I liked it enough to pursue an MBA and make contacts along the way. It also didn’t hurt that my interest was piqued by my lack of understanding business as well as wanting to understand more about what I do for a living (retail). With my hard work and help from fellow Babeler, Jason Morgan, I have excelled in my class. Not only that, but well, I like accounting. Yes, I said it, I like accounting.

From financial statements, such as income statements, balance sheets, and owner’s equity, to accounts receivables to depreciation of assets, I have learned a great deal about accounting and its impact on the business world. I have established a great reputation with my professor and he will thusly write me a letter of recommendation for Graduate school to pursue my MBA. Considering what my desires heading into the class were, I think that I have been successful. Not only did I make a great contact, but I found a new career path.

Accountants are held in the highest regard in the business world because their sole job is to report financial data correctly. I respect that and admire that, especially in a day and age, where bad business occurs. They are the know-it-alls of the business world; the ones that say whether a business can or cannot do what they want. Without them, the entire economy would shut down.

It is because of all these things, plus a good teacher, whose motto is “Accounting is not a science, it is an art”, that I am taking my GMATs this Summer to get accepted into an MBA program with a concentration in Accounting to eventually become a CPA. As an avid learner and “child” so to speak, going back to school was one of the best things that I could have done.

Popularity: 9% [?]

The American Institute of Certified Public Accountants (AICPA), formerly known as the American Association of Public Accountants (AAPA), was established in 1887 to set rules and regulations for the reporting of financial data. For over 100 years, there have been committees governing the legality and morality of accounting principles. In 2001, after Enron was found guilty of accounting fraud, the business world took a closer look at ethics in accounting and has since then implemented many ways to curtail fraudulent financial reporting. Due to poor reporting of financial numbers, businesses have to adhere to a code of conduct (GAAP) issued by the AICPA and their constituents.

The AICPA, with collaboration from the Business & Industry Executive Committee (BIEC), has therefore, presented accountants with an “Ethics Decision Tree” to give guidance to professionals that encounter immoral business behavior and gives them a step by step way of dealing with such issues. The first step is to identify the issue with the preparation of financial documents and then to see if the issue is in violation of AICPA ethical standards. If it is, then it is your duty to ask for your company’s guidance, if you are unsatisfied with the answer, you then need to talk to your manager. If you are continuously unhappy with the answer your manager gives or upper management gives, go directly to the Board of Directors. If you are still unsatisfied with the answer you are receiving, the “Ethics Decision Tree” states that you should seriously think whether or not it is in your best interest to be employed by the company. There are many different ways that the “Ethics Decision Tree” could pan out for a professional that is facing ethical implications at the workplace. For example, if you receive a satisfactory answer or result from your skepticism, then the “Ethics Decision Tree” states that you should document everything so that you have it for any future issues that may arise. Hopefully, these problems never arise; however, many businesses have been exposed as fraudulent financial reporting firms over the years.

In the “Ethics Decision Tree” brochure presented by AICPA there are also eight bullet points that serve as a general set of rules to go by when faced with ethical implications. The 1^st bullet point states to do your best to resolve the situation internally adding that most issues can be easily resolved. If the issue is not easily resolved, then other bullet points maintain that you should document everything, consult an attorney (if necessary), and leave the company. Of course, this is the worst case scenario involving accounting fraud, however it of utmost importance to be prepared for the worst.

Ethics classes have really become an annual mainstay for CPA’s, in guaranteeing that their licensure stays current, for good reason. For too long in the business world, accountants and financial reporters have consciously falsified financial documents for the betterment of their business. Falsifying financial data not only deceives the shareholders, but also puts those responsible or conscious of it at great criminal risk. In the bigger picture, false financial reporting done on a massive scale would accordingly hurt the nation’s economy. It is with good reason that the AICPA is still around 120 years after its establishment for they work hard to ensure the validity of financial reporting and put together a strict code of conduct for all public accountants to follow; along with the resources to deal with such situations as they arise.

Popularity: 18% [?]

As I am wont to babel about the economy: here it goes again. President’s Bush’s economic stimulus package, which pledges to give the average tax payer a $600 rebate check sometime later this year, isn’t going to offset the negative impact produced by the net decline of 85,000 jobs in the first two months of 2008. The unemployment rate is a lagging indicator of the economy, meaning that job losses occur after the economy has already taken a downturn; or, jobs will increase only after the economy has begun to grow. That said, the evidence put forth in this poor start to 2008 would suggest that the economy is indeed in trouble.

Typically, even the promise of an effective stimulus package will uplift Wall Street and consumer confidence, thus leading to increased consumer spending and subsequently a growing economy. As you can see, the plan put forth by our fearless leader has not instilled confidence in the consumer and has not bolstered Wall Street. Therefore, it cannot be considered an effective plan.

How about something new? Legalize marijuana for economic reasons. It is estimated that the legalization of marijuana in the U.S. would lead to a $7.7 billion drop in law enforcement costs and generate $6.2 billion in tax revenue. This is a net $13.9 billion improvement to U.S. government budgets, not to mention the fact that the dollars being spent on marijuana would be included in the consumer spending category of GDP, which would improve economic measures. What the study done by Harvard visiting professor Jeffrey Miron doesn’t take into account is the improved quality of life which arises from less militant policing of a substance that’s use is fairly widespread and has less negative effects on both individual health and society than alcohol. In 2006, there were 829,627 arrests for marijuana, which makes up 43.9% of total drug arrests in the U.S. Of the 829,627 arrested for marijuana-related charges, 738,916 were for possession alone. This is in direct contradiction to the alleged philosophy of the Drug Enforcement Agency, which states, “DEA targets criminals engaged in cultivation and trafficking…”. The statistics seem to contradict the mission stated by the DEA.

If marijuana was legal, then growing and distributing it would not be a crime. Therefore, this would put drug dealers out of business. I am not so naive as to believe that the supply of drug dealers will decrease by the exact same number as the marijuana dealers who were put out of business, because some of these dealers undoubtedly dabble in other substances and others who only sold marijuana before legalization will probably sell something else post legalization. I acknowledge that there are a considerable amount of concerns centered around operation of motor vehicles and individuals going to work while under the influence of marijuana. This should be treated no differently than alcohol is presently: it is not acceptable and/or legal to operate machinery or motor vehicles, or to go to your job while under the influence of a marijuana or alcohol.

The side benefits are also quite substantial. The Cannabis plant can be used for a variety of commercial and industrial products. Paper, rope, soap, lotions, fuel and lubricants are all among these products. The crops grow well in the United States’ varied climates and are relatively easy to grow, making it an ideal cash crop. If the trend could be set by the United States, then other countries may follow suit. This could lead to a situation analogous to the one in the 18th and 19th centuries when America was exporting enormous quantities of tobacco. The trade deficit could be reduced by taking a progressive step forward, one executed with much forethought and wisdom, and enticing the world to join us on our revolutionary quest to change the prejudices of government against its society.

Popularity: 67% [?]

Imagine celebrating your 100th Wedding Anniversary? I bet you think I’m crazy but guess what - chances are one of your kids will. Consider the fact that the average life expectancy at birth in Ancient Greece was only 20 years. In the US in 1900 that number rose to 46 years. In 2001 the average life expectancy reached 77 years! Here is another startling fact - 90% of ALL HUMANS in ALL HISTORY to reach age 90 are ALIVE TODAY.

Now consider that life expectancy on the day Social Security was signed into law was only 58 and the retirement age was 65. What does this mean? This means that Social Security was designed to have everyone pay into the system while most people died before ever collecting a cent. Even if you did reach the retirement age - chances are you would only live a few more years and at that time, most seniors lived with their children and were not forced to support themselves anyway.

What do we have now?

Average life expectancy in the high 70s - this means that best case scenario - one pays into SS for 47 years (18 to 65) and collects for close to 15 (not to mention college years so make that contribution period 43 years for most people). Have you looked at your FICA recently? Do you think you can live for 15 years on that figure alone?

But wait -

Now consider that many people in our generation will reach 100 years old and some may see 120 or even 130! That means up to 65 years of retirement! How is SS going to pay for the health care costs of a 130 year old person let alone the cost of living for over half of that person’s natural life?

Don’t blame Roosevelt. How is a young guy in a wheel chair with Polio on the verge of WWII supposed to predict numbers like that?

For your own sake, look at the facts and figures. Forget the scare tactics used by Social Security’s proponents. Don’t for one second believe these crooked politicians care about you - they will be long gone when we need our money and their kids are already taken care of. The system is doomed and they are STEALING YOUR MONEY!

The truth is no one banks on Social Security anymore because we all know we will never see our money again. So why on the Green Earth of the Supreme Being of Your Choosing do we continue to allow our hard earned money to be taken from us on the BS promise we will be taken care of? We are on our own people!

Privatization is the only answer to Social Security. Don’t believe the lies about squandering our security in volatile stock markets - If the market collapses we’re all screwed anyway, seniors and juniors alike.

~Man Overboard

Popularity: 13% [?]

Note: For the best understanding of the post below, please download the following excel workbook, my Petroleum Demand Analysis.

Petroleum is a commodity that forms one of the cornerstones that make up the foundation of the technological world. Without it, products such as plastics, gasoline, Diesel fuel, kerosene, lubricants, and asphalt would not exist. Unfortunately for us, the supply of petroleum is finite. The more we use it today, the less we have for tomorrow. So the question becomes, “When will the petroleum run out?”The World’s average daily petroleum demand for the first three quarters of 2007 was 85.31 million barrels per day. This sounds like a lot, but without the context of the total available supply this is a meaningless figure.

The Energy Information Administration has graciously posted three estimates for the total available supply of petroleum, which is referred to as the Ultimate Recovery Estimate. The Highest Ultimate Recovery Estimate is 3,896 billion barrels, the Mean Ultimate Recovery Estimate is 3,003 billion barrels, and the Lowest Ultimate Recovery Estimate is 2,248 billion barrels. These estimates are total World supply for all time, meaning that in order to produce a forecast for when the supply will run out, one must subtract the aggregate amount of petroleum already recovered. For the purposes of this analysis 1,000 billion barrels was utilized as the amount already recovered. Note the total recovery was approximately 900 billion barrels in the year 2000, so the 1,000 billion barrels figure came about by adding the cumulative recoveries from 2001-2007 to the 900 billion. This resulted in an approximate answer of 1,000 billion barrels of cumulative recovery (this is conservative, as the cumulative recovery is actually slightly higher than 1,000 billion barrels).

So, “When will the petroleum run out?” The petroleum supply will be fully depleted anywhere from 2028 to 2070, with the highest probability range being between 2036 and 2050. Attached is a Petroleum demand analysis I created that contains all of the detailed assumptions and calculations supporting the conclusions found herein.

Energy Information Administration Analysis

The Energy Independence and Security Act (HR 6), signed into law on December 19, 2007, raised the minimum average fuel efficiency standards for cars, light trucks and SUVs from the current 27.5 miles per gallon (for cars) and 22.5 miles per gallon (for light trucks/SUVs) to 35 miles per gallon by the year 2020. There are a variety of other provisions ranging from efficiency standards on light bulbs to minimum volumes of renewable fuels used as percentage of total fuel. This bill’s goal was to reduce U.S. dependence on foreign petroleum supplies and create an environment that is friendly to renewable energy and fuel technologies. But does it do enough to avert disaster? No.

Carbon Biofuels courtesy of the National Science Foundation, by Nicolle Rager Fuller

Currently, the U.S. represents 24% of total World petroleum demand. The policy changes enacted by the U.S. government therefore only impacts the growth rate of one quarter of the World’s petroleum demand. The remaining 76% of total World petroleum demand is unaffected by The Energy Independence and Security Act. As time goes by, the U.S. represents incrementally smaller percentages of the total World demand. This is because the U.S. demand growth has remained fairly stable at approximately 1% for several decades. China, on the other hand, has seen over 10% growth in their petroleum demand in the last five years. As China industrializes, the sheer magnitude of the country’s population lends itself to massive petroleum demand. China’s petroleum demand will eclipse the U.S.’ as early as 2015. China’s current demand is one third of U.S.’ demand.

Even if China were not such a huge factor in the global petroleum demand picture, U.S. measures to increase fuel efficiency by a paltry 7.5 miles per gallon does not help overall demand decrease at a high enough rate to materially impact the rate at which the Ultimate Recovery Estimate is being drained. What is to be done? There is no doubt about it, the petroleum is running out, and sooner than you might have previously thought. Given the lengthy lead time from development to wide-scale implementation of new technologies, we need to be concerned that the “solutions” scientists come up with for alternative fuels and energy may be too little, too late. Even if developers were able to invent an alternative fuel technology tomorrow, there would be at least five to ten years of research needed to make the technology feasible for wide scale implementation. Then, there is at least another decade involved with actually implementing this new technology. Conservatively, one could say that there is at least a 20 year window from invention to implementation of an alternative fuel or energy source to take the place of petroleum. It is currently 2008, with no development that fits the bill even on the horizon, and the petroleum could run out in as little as 20 years. Granted, the more likely scenario is running out of supply between 2036 and 2050, but that still only leaves less than 50 years to invent a totally new technology and implement it, all the while weaning ourselves from petroleum products. I personally think we are cutting it a little close.

Popularity: 78% [?]

All too often I hear illegitimate talk about “the economy” by people who clearly are not educated to the way an “economy” really works. At the office water cooler, small talk with strangers, family and friends discussing the past, present and future states of the economy are all instances where I have heard complete fallacies spoken of as if they were fact. It is my goal to address this lack of education and disseminate a high-level view of economics so that the next time your co-worker starts pontificating about how the housing market and/or the credit crisis will be the ruination of the U.S. economy, you can reply with knowledge and confidence that they have no idea what is going on…but you now do.

Firstly, when you hear people talk about “the economy” they are referring to the macro economics involved. A country’s economy is typically represented by what is known as the Gross Domestic Product (GDP). This represents the total value of all goods and services produced, distributed and consumed in the country. GDP can be broken down into four major components: Government spending, Consuming spending, Investment (gross domestic capital investments by businesses - international investments do not count), and the net Import/Export value.

So, what does all that mean and how can it help you understand the murky picture of the currently dreaded “economy”? In order to answer that question we will need to expound on each of the GDP components and how they interact.

1. Government Spending: this one is pretty straight-forward in terms of definition - the total value of government spending, from employees to office supplies to tanks for the army. Where does the government get the money to spend? You. Tax revenues are the major source of money that contributes to government spending; however, in recent years with the U.S. government budget being in a deficit, there are various borrowing instruments (Savings Bonds, Treasury notes, etc) through which the government borrows money to fund programs and other purchases. The U.S. Government has also been “borrowing” money from the Social Security fund, which is another contributing factor to all of the talk about Social Security being under-funded. The government has always borrowed using these instruments, but in recent years has relied on them much more heavily. A common misconception is that a government deficit is necessarily a bad thing. On the global scale, if some governments have surplus it means others will have a deficit. This is because countries like the U.S. lend money to developing nations, in hopes that the interest-bearing loans will at least break even in the long run and will assist developing nations build up their infrastructure at the same time.
2. Consumer Spending: the total value of goods and services that the people of a country consume. Things like milk, gasoline, televisions, heating oil, and houses fall under this category. These goods and services can either be purchased with cash or borrowed money (credit cards, loans, mortgages, etc.).
3. Investments: the total value of capital investments made by businesses on property, buildings, equipment, etc. Other expenses for a business fall into the consumer spending category because they are not considered “durable,” or having a life of longer than one year.
4. Net Import/Export: this is the result of taking the total value of exports and subtracting the total value of imports. The United States has almost always experienced a net import/export deficit, meaning that the total value of imports exceeds the total value of exports. It is commonly referred to as the “trade deficit”.

With this knowledge, let’s apply it to some commonly discussed economic situations:

• Housing slump: The housing slump hurts the Consumer Spending portion of GDP. When the rate of housing purchases slows, this has a severely negative impact on the consumer spending component as houses are typically the most expensive thing a family/person will purchase. The strange dichotomy to this situation is that when people aren’t spending on houses they are normally saving more of their money. This results in the banks having a larger pool of funds to lend, but less customers to whom to lend. This ultimately will result in a lowering of interest rates because interest rates are a reflection of the aggregate demand for money. With more money available for lending and less demand, the rates will inevitably lower over time. This will more than likely result in a turnaround in which consumers recognize the lower interest rates and begin to purchase homes again because the cost of borrowing is down. Over time, the “housing slump” will correct itself via falling mortgage rates and property values.
• Credit crisis: the credit crisis is a reflection of consumers who purchased houses they could not afford at the time, but with the “creative” mortgages available were able to meet initial payments. When the interest rates on these mortgages began to rise over time, as they were intended to, some consumers’ ability to repay the higher cost monthly payments fell far short of their personal forecasts. This resulted in an unprecedented number of people deciding to take the one-time black mark on their credit reports and foreclose on their mortgages, thus transferring the property back to the bank that held the mortgage. Economically speaking, the initial capital outlay was what impacted GDP and the foreclosure has little to do with current GDP performance. In fact, these individuals may actually have more cash in the short term to put into the Consumer Spending component of GDP. So, it is technically possible that the “credit crisis” may actually bolster GDP because people have more cash in their pockets to spend. The danger is really to the banks in this instance, now flush with property that they are getting a negative return on because lower housing prices (see above) are resulting in losses on the property, which the banks now have to absorb. This is a problem because when banks are experiencing profitability issues, they raise interest rates on loans and lower interest rates on savings instruments. This will directly conflict with the “natural” solution to the housing slump as described above, because a key ingredient to solving the housing slump is lower, not higher, mortgage rates. This is why the situation involving both of these issues is so concerning: the solution to one problem is in direct conflict with the solution to the other.
• Inflation: like most economic issues, inflation is a result of many factors. One of the most prominent is the production of money. The Federal Reserve decides to print a certain amount of new money each year. If in any given year this amount is more than the annual increase in GDP, then there is a subsequent increase in inflation because more money is in circulation relative to the total picture (GDP) than the year before. Inflation is also at the mercy of supply and demand for money. This is how interest rates come into the inflation discussion.
• Unemployment rate: the unemployment rate of a country is typically a “lagging indicator” of the economy. What this means is that changes in the unemployment rate usually occur after the economy has been impacted one way or the other. This makes intuitive sense because if the overall picture of the economy is good, it means that businesses are profitable and are looking to increase their workforce in order to meet consumer demand. This happens after the economy is already doing well, however, because businesses typically hire reactively, not pro-actively. An increasing unemployment rate occurs after the economy takes a downturn because businesses are looking to cut costs as a result of decreased consumer spending. This will then increase profitability and theoretically maintain a status quo for the Investment component of GDP.
• Falling value of the Dollar: the value of the U.S. Dollar relative to foreign currencies impacts the net import/export component of GDP. As the U.S. almost always operates at a trade deficit with the rest of the world in aggregate, the falling dollar is of utmost concern. A dollar now purchases less product than it used to, thus increasing the total VALUE of imports without increasing the total QUANTITY of imports. However, foreign countries can now purchase American products for less of their native currency and are more likely to import products from the U.S. This will help to counter the increased cost of imports into the U.S. In the end, the declining value of the dollar will have a more negative impact to the net import/export figure since the imports are so much larger than the exports.

Federal Reserve Bank building in New York

There certainly are many more issues and facets to this discussion. This was not meant to be an economics class, but an overview of some terminology and some current events issues. Hopefully this will arm you to be the star of your next office water cooler chat on the state of the economy.

Picture: http://www.nyc-architecture.com/LM/LM056.htm

Popularity: 53% [?]