The title of this diary may be obvious, for when did Newt ever utter a sentence that was predicated on actual fact? But his plan to reduce the price of gasoline at the pump to $2.50 a gallon is not just flawed, it’s a lie.
His three point plan is really only one point: increase domestic production of crude. Get it from Alaska, get it from the Gulf, get it from shale, and get it piped through Keystone. Forget about the technicalities of refining and the lag time to get all the permits and machinery in place. His theory is that imply increasing supply will decrease the price.
That’s actually not a bad idea (Econ 101), in a world where speculators are not involved or are controlled/regulated’’…like they used to be. Right here in the old U.S. of A. But they no longer are (controlled), and thus, we have really high gasoline prices today.
As a wealth advisor for a major Wall Street firm, I am fortunate to attend seminars and lectures from some of the finest professors and economists in the United States. A few years ago, when the price of gasoline was also rising very quickly, I received a white paper from one of the firms I do business with about the effect of the Gramm-Leach-Bliley Act and speculation. I would source it here, but unfortunately I didn’t think to save it. The bullet points of the white paper went like this:
• The Banking Act of 1933 (aka “The Glass-Steagall Act”) set up many banking reforms, including strict rules on the activities of speculation and speculators
• One of the rules was to limit the amount of speculators in the market
• Speculators were there to keep a market efficient and liquid
• Gramm-Leach-Bliley (as hard to type is it is hard to enunciate) eliminated these pesky regulations, opening up the markets to as many speculators as wish to “gamble” in the commodities markets
Now, it’s not 100% fair to say that the Gramm-Leach-Bliley act is 100% responsible for the situation we have today, as much of the banking industry (retail and investment banking) from the 80’s forward was already on the path of ignoring the rules (or sidestepping them with Federal approval). So the passing of the Act in 1999 was, in some people’s perspective, simple codification of the trending changes in the banking industry. But it is fair to say that once it passed, it fostered a Wild West atmosphere in the speculation markets.
A speculator’s job is to take risk. We all know that airline companies (and other industries that heavily rely on the price of fuel for profits) will have traders in the commodities markets to you know, actually take delivery of the stuff they’re buying. Speculators don’t. They buy the product, and hold legal rights to it, and are required (still) to take delivery of the product unless they sell their contract before it matures. The classic examples for econ classes involve cattle or bushels of wheat. If you’re a food manufacture, like Kellogg’s, you really do want to take delivery of the wheat to make your cereal. If you’re a speculator, fielding the question of where you want to store your new 10,000 bushels, may make your life a bit uncomfortable. The garage perhaps?
Be that as it may, the reality is, the quantity of barrels of crude, just like the quantity of cartons of eggs in your grocery store…is ”inventoriable.” That is, once a barrel is owned by somebody, it is off the market. In the good ol’ days of the 60’s and 70’s, the quantity of speculators physically allowed into the markets were limited. They stood there, in the middle, simply to buy or sell a commodity so the markets stayed, level. Sure prices would fluctuate due to the myriad of variables that commonly effect price, but by-and-large, the speculators really did do a good job keeping the machine gears greased.
Enter the late 80’s and the Reagan era mantra that government is bad and regulation is evil has taken root. Wall Street banks, empowered by several private rulings allowing for the introduction of new kinds of products (e.g. credit default swaps, over-the-counter derivatives, all falling out of the rule of established regulations, and thereby, not regulated by the SEC), and you set the stage for the Gramm-Leach-Bliley Act passage becoming a fait accompli. It took a decade, but it worked.
Now the act itself didn’t change the speculation world, per se. But it did set up the environment for passage of the Commodity Futures Modernization Act of 2000 (signed by Clinton). This act effectively ensured the deregulation of financial products and permitted an investment firm to enter as many speculators into a market as they felt necessary. What will motivate a person or a firm to enter a market? Profit. In the past, let’s say a commodities market like oranges were permitted to have only 25 speculators. The rest of the market participants were actual customers of oranges. The price would only move so much due to speculation, because their numbers were small and they could only control a very small part of actual inventory at one time. This is not the case today. The number of speculators is essentially unlimited. As long as someone or a firm believes they can make a profit from the commodity, and they’re licensed to do so, they will enter the market.
If you were a speculator, and you bought 100,000 barrels of oil at $3.50/barrel, in a contract that expires in 30 days, you hope beyond hope that you can unload those 100,000 barrels at $3.51 or more. When the quantity of your speculative brethren increase, and they’re all buying more and more barrels, the supply of worldwide oil actually is consumed -- not actual oil burning, but removing the oil from the market like buying those eggs off the grocery store shelf. Once you own them, no one else can. Until you sell back. If you’re trying to buy, you need to buy at the new price, reflecting the lack of inventory. Classic economic reaction. Airlines have to now purchase their barrels at a much inflated price. Everybody loses, except the speculators. Who’ve manipulated the market to their advantage.
Getting back to Newt: he’s lying to you. An increase in the supply of barrels of crude, by his proposed higher production, will simply make it so that the a) numbers of speculators will continue to increase, and b) the ones that are there will absorb more of the barrels. Price is unlikely to come down. If he were being honest, he’d say that he wants a repeal of Commodities Future Modernization Act and the Gramm-Leach-Bliley Act. Or he’d simply say, we need to regulate the speculation market like we once did. Until that time, no president will have any influence on the price of oil.