Should Oil and Gas Prices Be Capped?
Now that Katrina has passed, a significant portion of our nation's refining capacity has been taken off line at least temporarily. As a result, gas prices have increased significantly (who thought we'd be nostalgic about gas at $2.50 per gallon). For example (using the gas station on the corner I drive past each day), on Wednesday a gallon of regular was in the mid-$2 range. On Thursday morning, it jumped to $2.99, and was up to $3.49 by Thursday afternoon (it's stayed around there since).
Let the public outcry about "price gouging" begin. For a few examples, see here (San Diego) here (Wisconsin) and here (randomly picked blogosphere rant).
I'd expect that people who read finance/econ blogs are a bit more knowledgeable about prices, supply and demand than the average moonbat. But just in case, Steve Verdon at Outside The Beltway has a great piece titled "Elementary Economics - The Price As A Rationing Mechanism". He does an excellent job of explaining that 1) There's not enough gas for everyone to use unlimited amounts, 2) As prices rise, demand for gas drops, and 3) As prices rise, supplies of gas will increase.
Click here for the whole thing.
I'll add a few points:
1) Gas is a "scarce" resource". That means there's not enough gas to satisfy all demands for it. In other words, if gas were free, there wouldn't be enough to go around.
2) This means we have to have some mechanism to allocate the available gas among the people who want it. You can do it by lottery, by government fiat (i.e. you get a "ration card"), by random chance, by staying in line, or by market mechanisms (i.e. prices).
2) There are always alternative uses for any resource. For example, if there's limited amounts of gas, it can be used to drive your car 100 miles to visit your favorite restaurant, or it can be used for driving someone else for work. If supply decreases (say, following a hurricane), prices rise. If they rise high enough, you might decide that it's not worth it to drive to your favorite restaurant, and instead you might choose to drive to one closer so that you have more money to spend on other things. This leaves more gas available to the folks who place a higher value on it.
3) As article above explains, Demand and Supply aren't fixed - they're tied to price. In other words, as prices increase, the demand for gas drops (people drive less). More important (at least as far as the current gas situation goes), as prices increase, supply increases. So, higher prices give gas producers greater incentives to bring refineries back on line faster.
The end result of the effect of supply and demand is that prices give signals to suppliers (to produce more) and demanders (to drive less, unless it's really, really important) that make them change their behavior. As a result, things correct over time.
Of course, there will be many calls for government to "do something about gas prices". Those making these calls have probably forgotten the not-so-good old gas rationing days of the Carter years. A little history shows that if the government sets prices lower than the "market clearing" price, it messes up both the demand and supply sides of the equation.
From the demand side: since the price is "low", there will be excess demand. In other words, people will want more gas than is available. So, there has to be some way to allocate the available gas (government rules, "first come, first served", etc...).
From the supply side: there will be less gas supplied than there would be at a higher price. In the Carter years, there was little incentive for the producers to make a lot of gas available, since it would sell at a lower price. The supply of gas isn't fixed - just "fixed at a given price". In other words, some oil can be refined into gas at at a cost below $1 a gallon. So, this gas can be sold at a profit at $1+ per gallon, but not below that point. Some oil can't be refined into gas at a cost below $2 per gallon. So, this gas wouldn't be produced unless it could be sold for more than $2, and so on.
One last thing to think about - once the Carter price controls were rescinded (following Reagan's election), supplies increased and prices quickly fell.
Or, as Santayana said, "Those that forget the lessons of history get to enjoy them all over again."
Let the public outcry about "price gouging" begin. For a few examples, see here (San Diego) here (Wisconsin) and here (randomly picked blogosphere rant).
I'd expect that people who read finance/econ blogs are a bit more knowledgeable about prices, supply and demand than the average moonbat. But just in case, Steve Verdon at Outside The Beltway has a great piece titled "Elementary Economics - The Price As A Rationing Mechanism". He does an excellent job of explaining that 1) There's not enough gas for everyone to use unlimited amounts, 2) As prices rise, demand for gas drops, and 3) As prices rise, supplies of gas will increase.
Click here for the whole thing.
I'll add a few points:
1) Gas is a "scarce" resource". That means there's not enough gas to satisfy all demands for it. In other words, if gas were free, there wouldn't be enough to go around.
2) This means we have to have some mechanism to allocate the available gas among the people who want it. You can do it by lottery, by government fiat (i.e. you get a "ration card"), by random chance, by staying in line, or by market mechanisms (i.e. prices).
2) There are always alternative uses for any resource. For example, if there's limited amounts of gas, it can be used to drive your car 100 miles to visit your favorite restaurant, or it can be used for driving someone else for work. If supply decreases (say, following a hurricane), prices rise. If they rise high enough, you might decide that it's not worth it to drive to your favorite restaurant, and instead you might choose to drive to one closer so that you have more money to spend on other things. This leaves more gas available to the folks who place a higher value on it.
3) As article above explains, Demand and Supply aren't fixed - they're tied to price. In other words, as prices increase, the demand for gas drops (people drive less). More important (at least as far as the current gas situation goes), as prices increase, supply increases. So, higher prices give gas producers greater incentives to bring refineries back on line faster.
The end result of the effect of supply and demand is that prices give signals to suppliers (to produce more) and demanders (to drive less, unless it's really, really important) that make them change their behavior. As a result, things correct over time.
Of course, there will be many calls for government to "do something about gas prices". Those making these calls have probably forgotten the not-so-good old gas rationing days of the Carter years. A little history shows that if the government sets prices lower than the "market clearing" price, it messes up both the demand and supply sides of the equation.
From the demand side: since the price is "low", there will be excess demand. In other words, people will want more gas than is available. So, there has to be some way to allocate the available gas (government rules, "first come, first served", etc...).
From the supply side: there will be less gas supplied than there would be at a higher price. In the Carter years, there was little incentive for the producers to make a lot of gas available, since it would sell at a lower price. The supply of gas isn't fixed - just "fixed at a given price". In other words, some oil can be refined into gas at at a cost below $1 a gallon. So, this gas can be sold at a profit at $1+ per gallon, but not below that point. Some oil can't be refined into gas at a cost below $2 per gallon. So, this gas wouldn't be produced unless it could be sold for more than $2, and so on.
One last thing to think about - once the Carter price controls were rescinded (following Reagan's election), supplies increased and prices quickly fell.
Or, as Santayana said, "Those that forget the lessons of history get to enjoy them all over again."
Is a Hedge Fund Shakeout Coming Soon? This Insider Thinks So (from the New York Times)
The NYT just had a very interesting article on risks associated with hedge fund. This piece, titled "Is a Hedge Fund Shakeout Coming soon? This Insider Thinks So" highlights some of the work done by Professor Andrew Lo of MIT. Professor Lo has done a lot of work with hedge funds and is involved on the practitioner side. His paper (available here) details some of the risks associated with these vehicles (caution: it's an academic paper and is written for "quant jocks", so its' pretty mathematically dense).
One of the key points of the NYT article is that hedge funds' returns are associated with risks that aren't nearly as common in other alternative investments. One of the major ones is "liquidity risk". A lot of the assets traded by hedge funds are infrequently traded. So, the reports issued by hedge funds profiles are either based on "stale" prices (if they don't trade, you don't have "market" prices), or are based on estimates of asset values made by the hedge fund sponsor. This makes allows the sponsor to make the hedge funds' reported returns appear much "smoother" than they actually are.
There are additional problem associated with liquidity risk. One of hedge funds' greatest appeals is that they are relatively uncorrelated with the market as a whole. However, this 'uncorelatedness" may not hold in times of market stress. In particular, their returns may become highly correlated in the event of an exodus of investor capital from these funds. This effect is driven by the same illiquidity of hedge fund assets - if you have to sell an illiquid asset, you have to accept a big discount to unload it quickly.
The article finishes by listing a number of factors that could trigger a hedge fund meltdown - like oil over $100 a barrel (I think the article was written before Katrina) or a tightening of rules at Fannie Mae.
All in all, a piece worth reading - click here for the whole thing.
One of the key points of the NYT article is that hedge funds' returns are associated with risks that aren't nearly as common in other alternative investments. One of the major ones is "liquidity risk". A lot of the assets traded by hedge funds are infrequently traded. So, the reports issued by hedge funds profiles are either based on "stale" prices (if they don't trade, you don't have "market" prices), or are based on estimates of asset values made by the hedge fund sponsor. This makes allows the sponsor to make the hedge funds' reported returns appear much "smoother" than they actually are.
There are additional problem associated with liquidity risk. One of hedge funds' greatest appeals is that they are relatively uncorrelated with the market as a whole. However, this 'uncorelatedness" may not hold in times of market stress. In particular, their returns may become highly correlated in the event of an exodus of investor capital from these funds. This effect is driven by the same illiquidity of hedge fund assets - if you have to sell an illiquid asset, you have to accept a big discount to unload it quickly.
The article finishes by listing a number of factors that could trigger a hedge fund meltdown - like oil over $100 a barrel (I think the article was written before Katrina) or a tightening of rules at Fannie Mae.
All in all, a piece worth reading - click here for the whole thing.
Off To Sesame Place
Blogging will likely be light today - we're taking the barbarians (the Unknown Son and the Unknown Daughter) to Sesame Place. It's a couple of hours each way, so I doubt I'll put anything up until late tonight (if at all).
Update: We're back - kids loved it (except for the roller-coaster - they were still a bit young). There are few things better than seeing your kids faces when they get a hug from Cookie Monster or Elmo.
Update: We're back - kids loved it (except for the roller-coaster - they were still a bit young). There are few things better than seeing your kids faces when they get a hug from Cookie Monster or Elmo.
This Is a Show I'd Like To See
I'd clear my schedule for this show:
Here are a few highlights from the hottest Hollywood script you will most likely never see produced on a television or movie screen: • Abu, Ahmed, Musab and Salar, a cell of Islamic terrorists sent to Chicago by a nefarious network resembling Al Qaeda, are getting chewed out by their murderous boss, just in from Afghanistan. (They have been spending the organization’s money like crazy but haven’t blown anything up.) Just then, two deliverymen knock on the apartment door, bearing a huge flat-screen TV.HT: Scott Scheule at Cattallarchy.
File Synchronization Software
I usually work on my laptop, but from time to time, I also use the desktop in my office, and (since the antenna in my house has on the fritz), my home desktop. As a result, I spend a lot of time shuffling files from one computer to another.
Most of you probably are aware of this, but there's file synchronization software that automatically synchronizes selected folders over the internet. Thursday's Wall street Journal (subscription required for online access) has a good article on two programs - FolderShare and BeInSync. When installed, updating a file in one of the "synchronized" folders results in it automatically being updated on the others over the internet. Pretty cool.
This looks like just the ticket. I recall all the grief I went through when my laptop went down (and the last time the College techies "upgraded" my office computer). I had backups (I am, after all, neurotic), but it was still a pain in the you-know-what, and I had to do too much needless running around.
The article favors FolderShare, but if any of you have experience with file-sync software, feel free to share it.
Most of you probably are aware of this, but there's file synchronization software that automatically synchronizes selected folders over the internet. Thursday's Wall street Journal (subscription required for online access) has a good article on two programs - FolderShare and BeInSync. When installed, updating a file in one of the "synchronized" folders results in it automatically being updated on the others over the internet. Pretty cool.
This looks like just the ticket. I recall all the grief I went through when my laptop went down (and the last time the College techies "upgraded" my office computer). I had backups (I am, after all, neurotic), but it was still a pain in the you-know-what, and I had to do too much needless running around.
The article favors FolderShare, but if any of you have experience with file-sync software, feel free to share it.
"You Gotta You Debits, You Gotta You Credits"
Today's online New York Times has a very revealing article titled "The Opportunity Costs of Economics Education". It comments on a recent study by Paul Ferraro and Laura Taylor of Georgia State University. They asked a simple question on opportunity cost to economics PhDs at a major academic conference. Most got it wrong. Here's the best part:
Unfortunately, however, most students seem to emerge from introductory economics courses without having learned even the most important basic principles. According to one recent study, their ability to answer simple economic questions several months after leaving the course is not measurably different from that of people who never took a principles course.
What explains such abysmal performance? One problem is the encyclopedic range typical of introductory courses. As the Nobel laureate George J. Stigler wrote more than 40 years ago, "The brief exposure to each of a vast array of techniques and problems leaves the student no basic economic logic with which to analyze the economic questions he will face as a citizen." (emphasis mine)
Click here for the whole thing.
I see the same problem in the way finance is taught. In the introductory finance course at many schools, they cover something on the order of 14-15 chapters in a semester. When you ask why, they invariably say, "We simply HAVE to cover (fill in the blanks)". So, the students end up racing through all these topics, and understand very little. If you ask them, "did you cover portfolio variance", they'll answer in the affirmative, but if you ask them to calculate the variance of a portfolio, they can't. Likewise for most topics. I know - in my upper division course, I have to spend the first couple of weeks reteaching the basics of time value (the most important concept in finance). But, after all, they did "cover" all the topics...
At my alma mater, they taught the same class in a way that totally spoiled me for the purpose of working at most other schools. In a rare (for academia) fit of common sense, they realized that you can teach a lot of topics poorly, or a few topics very well. So, they limited the introductory course to a few critical concepts (like time value of money, how to read financial statements, how to value a security, etc...), but completely beat these topics to death.
Father Guido Sarducci used to do a routine where he talked about "Sarducci University". It went something like this:
"In the typical college, you go to school for 4 years. You might spend a whole year studying a couple of accounting classes. After you're done, what do you remember - "you gotta you debits, you gotta you credits". At Sarducci University, we only teach the basics -- "you gotta you debits, you gotta you credits". So you can get all your coursework done in one year instead of four. We got a beautiful campus on the beach. You tell your parents that it takes 4 years - $10,000 per year. You give us $30,000, and you keep $10,000. This way, you can spend three years on the beach, and at the end, you'll still know "you gotta you debits, you gotta you credits"
While humorous, it gets across an important point. Pick what you want people to remember. Then spend more time on those points and drill them home, over and over. The students won't be exposed to as many concepts, but they'll know those few things very well.
It works for classes, and it works for any presentation. Don't try to cover too many points, but if you think it's important, drive it home (over and over).
Update: Truck and Barter and Marginal Revolution just weighed in on this topic. The comments following up on their posts are also worth reading.
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