Welcome To Josh's Blog O' Thoughts: Economics

It has been quite an amazing decline from the record high prices we had in July 2008. In just the past 6-7 months we have seen oil come from upwards of $140 per barrel to as low as $33 per barrel. Likewise, gas has come from almost $4.00 per gallon (where I live) down to almost $1.50 per gallon. That's roughly a 75% decrease in oil prices and a 60% decrease in gas prices.

As I had said in the past, those high prices were well beyond the normal market changes for supply and demand. Likewise, this massive decline is probably more radical than supply and demand principles would dictate. While the massive rises in the past couple years have been fueled by fear of supply shortages and speculative buying, the recent declines, I believe, are also being exaggerated by fears of the global economy slow down.

It is my guess (granted, I'm not expert) that oil and gas prices will come back up until they find a point of stabilization. In my opinion, that will probably be around $75 per barrel for oil and $2.10 per gallon for gasoline.

That said, I'm definitely not complaining about the cheap gas. I'm just going based on what I've seen and read. I will be watching to see how these predictions turn out and I'm sure you'll see another post from me on the subject in the future. Until then, buy that gas while it's still cheap!


By the way, what's the lowest gas made it in your area? I think I saw about $1.55 here.

A question came to me the other day, as often they do, and I thought it interesting so I've decided to share it with you. First for some background.

Up until the end of this summer, there were concerns of rampant inflation in the US economy. The cost of nearly everything (fuel, commodities, food, retail) everything was on the rise. Generally speaking, the term inflation strikes fear in the heart of people. It generally is considered a bad thing because a dollar will no longer buy the same amount of goods as it would have before the inflation. However, there is a general consensus that some amount of inflation is a good thing, and that it is problematic when we have rapid bursts of high inflation.

In terms of money availability, inflation means that there is more currency circulating than there used to be. This dilutes the value of that currency. If it used to cost $1.00 for a loaf of bread, it now costs $1.20.

In a domestic-only economy, higher prices would mean higher revenues for the businesses that sell these products. With the higher revenues it is likely that employee wages will increase so that the company can retain good employees and stay competitive in the market. So, although prices of goods are going up, wages are increasing too. In a domestic-only economy, there would be a greater chance that prices and wages would increase relative to each other so that the products one buys still cost the same proportionally to their income.

Inflation really becomes a problem once you start to examine a global economy. If our country has rapid inflation, our currency will be devalued against the other foreign currencies. So for example, maybe $1 used to get you 1 Euro but now it takes $1.50 to get 1 Euro. That means we would be paying more for products that we import from other countries. In the domestic-only economy, the rise in prices is countered by the rise in income, but in a global economy that does not happen. The increased prices are all going toward monetary exchanges and not revenue for a domestic company thus there is no corresponding increase in wages.

Since the US deals in a global economy, it is apparent that inflation is something that could truly hurt us. Our dollar needs to remain strong versus foreign currencies or we hurt our economy.

So the question that occurred to me the other day was whether or not there were ways that rapid inflation could actually help the average person.

Of course, if you were making investments in currency against the US dollar you could make some money. But the average person does not have the understanding or funds to make this a reality.

Inflation certainly doesn't help your savings or idle money. If you have money in savings accounts, which typically come with fairly low rates of return, inflation will dilute your money faster than it can grow.

If inflation is also inflating your income, then it is a good thing for any fixed-rate debt that you might have. This would commonly be a home mortgage. If you have a 30 year loan with a fixed interest rate, then your monthly payment will never change. So if your monthly payment on day one is $1000 and your salary is $40,000, your monthly payment stays $1000 even when inflation increases your salary to $60,000. That is very helpful. Unfortunately, if we are currently in a rapid burst of inflation in which costs rise disproportionately to income, then this is no help.

What about people who invest their money in physical goods like art or other collectibles? These people might feel they are making a lot of money because their investment rapidly increases in value with inflation. However, they really are only making money at the same rate as inflation. While this is probably better than leaving your money sitting in a low yield savings account, you really aren't making any money, relative to the costs of everything else.

What about stocks? Stocks are a better way to keep your investments on par with inflation. And if lots of people understand this, the new demand for stocks will also increase their value above inflationary increases thus actually making you some money. But that's only assuming that there is a higher level of demand for stocks. However, the reverse may be true because with the increase of costs, people will have less extra cash to invest. So stocks could see a possible benefit, but only if demand increases as well.

So is there any single thing that can be good about rapid bursts of inflation? Is there any way inflation can help the average person make some money or reduce debt? While a modest amount of inflation is a good thing, right now, I'm not seeing any silver lining in rapid inflation. I'll keep thinking though, and if I come up with something I'll be sure to let you know. If you have any ideas, drop a comment.

I'm sure everyone has noticed lately that gas prices have been coming down. In my part of the country, we are almost back below $2 per gallon. (I still can't believe we're happy to be paying $2 per gallon). Part of the reason for the decrease in gas prices is the decrease in oil prices. Oil topped out somewhere around $140 per barrel back in July. It is currently trading around $65 per barrel. That's about a 50% decrease in just a few months.

So what about all these people that a few months ago said oil would NEVER come back down below $100? They said that oil prices going up was purely a function of increased demand and stable supply. Well some of us (myself included) disagreed. Check out a few of my previous blog posts:
More Signs Of Oil As The Next Big Market Bubble - June 16, 2008
Are Crude Oil Prices A Bubble Waiting To Burst? - November 7, 2007

My take on the situation was that while there probably was some increase due to demand, the increase in oil prices was disproportionate to the demand increase. This led me to believe that investors were throwing their money into oil to try to make a quick buck. It's one of the things we do best in this country. We see someone else get rich and we copy them so we can also get rich. Eventually TONS of people are involved in the same investment plan. But when we find out that most of the people buying are just get-rich-wannabes, prices collapse. In recent history you could easily refer to the housing market bubble, or the tech industry bubble.

So, I hate to say it, but...

"I told you so"

It's pretty obvious now that a huge portion of this price increase was due to speculative buying by investors. Check out this interview with Scott Bleiler, president of CreateCapital.com. He claims the price increases were solely due to speculative buying. I won't go quite that far. While I do think that maybe 90% of the price increase & decrease was due to speculative buying, I also think prices were also moved a little by changes in demand and the strength of the US dollar. But again, spec buying was the largest part.

Now that I got that out of the way, I can comment on how annoying OPEC is. When prices where out of control this summer, we were practically begging OPEC to increase supply to help lower prices. Their evaluations showed that supply and demand were matched fairly well so they did not increase output. Now that prices have come back to reasonable levels, they decide that they liked it better when they were getting $100+ per barrel so they've decided to decrease output. That is a pretty obvious slap in the face to us. I'm so glad that the recent ncreases in the strength of the dollar helped nullify their supply reductions to meaningless. It literally had no effect on the price of oil. Yet another indication that the price of oil does not move based solely on supply-demand.

That pretty much sums up how I view the whole oil market situation over the past 2 years. Now when will prices of other goods (food, retail, air travel, etc) that went up "due to the increase in fuel costs" go back down? Not any time soon is my guess. Many retailers tried to wait as long as possible to raise prices. This means some may have taken significant losses during those periods. As a result, they will probably be hesitant to reduce prices so they can recover some of those losses. And good luck for airfare. The only way that will come back is if one of the airlines starts a fare war.

To conclude this post, I just want to say that it was a great marketing ploy run by Chrysler this summer. Buy a new car and they would guarantee you $3/gal gas for 3 years. They got a person to buy a car with this deal in mind and now they don't have to pay anything out for it. Great job marketing, Chrysler.


If you want to leave a comment, I'd be interested in hearing what gas prices are doing in your neck of the woods.

Last November, I wrote a post stating my opinion that crude oil prices are in a price bubble that would eventually pop similar to the tech stocks in the early 2000's and the housing market in 2007. To me, it just seems to make sense. The VERY rapid increases in oil prices that we have seen in the past year alone can not be simply related to supply and demand fundamentals. The increases have just been too huge.

Today, Yahoo! Finance has a video interview with David Herro who was named one of the "World's Greatest Investors" in 2007. In the interview, he reaffirms my position that oil, as well as other energy commodities, WILL see a price bubble burst. After that, he expects oil to retreat to the $60-80 per barrel range. Those numbers are still much higher than they were a few years ago, but that has been SOME increase in demand since then, primarily in developing countries.

So even though we are currently paying around $140 for a barrel of oil, and around $4 for a gallon of gas, we can expect better prices to follow.

If you've been a reader of this blog for a while, you know that I've had a history of commenting on mortgage interest rates. The main reason was that I was in the midst of building a house and was watching to determine at when I should lock in my mortgage rate for the next 30 years. Well I'm happy to say that the research paid off.

Let's go back in blog history here and see what happened. I started really watching the rates about a year ago when we started doing the math to see if we could afford to build a house. At the time that I was crunching numbers with the bank (May 2007) the interest rate for a 30 year fixed mortgage at my lender was 5.625%; which I considered to be a decent rate. By the time we got ready to build, the rates had risen to 6.25% which was a substantial increase. I wondered if there was a correlation between gas prices and mortgage rates since gas prices had been steadily increasing at that time as well (doesn’t seem to be now).

By early July, I stated in a blog post:

I fully expect to interest rates to come down the second half of the year here. Actually, I've already seen a little bit of a dip.

I knew our build process wasn't supposed to be done until the end of January, 2008, so at this point I was just watching to try to identify trends. Well, interest rates DID start to come down, slowly, throughout the entire second half of 2007.

By the time January hit, I was really watching hard. I was now in the 30 day lock range and was just waiting for a good rate. One day in mid January, a 5.375% became available. I had only seen the rate this low 1 time in the past 7 month, so with 3 weeks until closing, I locked in. I was pretty happy with this rate considering it had come down from 6.25% since we started building.

However, over the next couple weeks, it would inch even a little lower. Then, 2 days before my closing, the rate at my lender took a huge dip to 4.875% (with no points and no early payment penalties)! I was beside myself. I called the bank to see if I could switch even though I'd already locked in. I was surprised to find out that for a $400 flipping fee, I could switch. The $400 would be made up in no time by the lower monthly payments. This switch also moved the closing back a week, but it didn't really matter because they still let us move in on time.

Now, I see that within that past 3-4 weeks, mortgage rates have risen drastically. They are currently 5.75% at my lender. On the day of our closing we were told that the 4.875% was only available for about 3 hours! I guess watching the rates for a year paid off. I was able to predict the drop at the end of 2007 that led me to an ideal time to lock in a rate.

Researching in this way could help you get a low rate as well.

I'm sure you've seen the massive amount of new headlines stating that the economy is headed for the hole. Well so have thousands and thousands of investors. The result is a massive flock of scares shareholders selling off all their investments because they think the stock market is going down the tubes. Well, I got news for them: YOU'RE CAUSING THE DECLINE!

By over saturating the market with sell orders, the demand for these shares diminishes and so does the selling prices. Other investors see their stocks going downward and they decided to jump ship also which only enhances the downward spiral. Smart investors (the people that get rich off of times like this) are just waiting for the right time to start snatching up all of these stocks at discounted prices. Once these big time investors start buying, the little guys will say "Hey, they know something I don't so I will follow their lead and buy also." And low and behold, demand increases and stock prices go back up. The people who made the most money were the ones who bought in at the bottom and started the upward climb.

So, to those of you who are private investors, don't dump your declining stocks just based on outlook. Don't be part of the problem. Hold on to those stocks. If it's a decent enough company the price will come back. In fact, many of you may want to pad your investments by buying some more of these companies at discounted prices. I know I will be looking heaving at this.



Disclaimer: I'm just an amateur investor and have had no formal training. Please do your own research on a company before deciding to invest wisely. I can not be held responsible if you lose money on the stock market.

For the past couple years, complaints about rising gas prices have been met with responses such as "When you adjust for inflation, it's still much cheaper than it was in the late 70's early 80's". Well, we can now say that this is no longer true. Even when you adjust for inflation, we are currently hovering right around the all-time high prices. Take a look at the graph:


Source: http://www.inflationdata.com/inflation/Inflation_Rate/Gasoline_Inflation.asp

In the graph (yearly average price), you will see that the previous peak in 2007 dollars was around 1980 when the average price for the year was around $3.05/gallon. Obviously, since this graph is averaged out per year, some of the high peaks we have already seen this year will be smoothed out. But there may have been enough high days in this year to push our yearly average above the previous high.

So, we might end up having to say that 2007 was the most expensive gas year ever.

Lately, with crude oil hovering near $100 a barrel and setting record highs nearly daily, I have been wondering if all of these price increases are simply due to the economic principles of supply and demand or if a large part of it is driven by assumptions that demand is higher (or going to be higher) than it really is. Or for that matter an under estimation in supply could cause the same situation. At any rate, there could be a certain amount of panic being caused that is helping drive these prices higher.

Additionally, with crude being traded on the commodities market, it wouldn't surprise me if the demand is being created simply by traders and investors rather than actual consumers. Normally, with a supply and demand situation you would expect the price to rise if consumers were demanding more of the product. However, in this situation the product passes through a middle-man first. The middle-man wants to make a profit too. People have seen that oil is on the rise. When that happens, they think "Maybe I should buy into that and make some money for myself?" They think they can buy in at $90 and sell at $100 and make a profit. This causes extra demand, not by actual consumers but by people trying to make a profit by trading oil commodities.

So, does anyone else see how this might resemble another situation in the past decade. Let's think back to the late 1990's. Tech stocks were a huge boom. Any little startup company could get funded, go public, and have their stock skyrocketing. The reason is that people had seen the successes being made in the technology sector so they didn't bother to think about real consumer demand. So you had investors buying into a lot of companies that were losing money and had no customer base. What happened? The technology bubble burst around the year 2000. Stocks across the board fell.

Now if we apply the same thinking to oil trading, we could expect to see a peak point before a bubble burst. The bubble burst will be caused by some big holders selling off or some bad news about actual demand. Once some people sell off others will follow suit and prices will fall.

Again, this is one of my things that is totally up for debate. I'm no economic wizard so this seems feasible to me. Let me know if you have other opinions.

It was announced yesterday that the Federal Reserve Board approved a rate cut of half a percent. This move is aimed at stimulating the economy to avoid a recession. Apparently, the recent troubles in the housing and job markets have outweighed the threat of increasing inflation despite rising energy prices.

This cut in rates should be good news for the stock market. Yesterday, the Dow Jones rose over 200 points within the first 10 minutes of the announcement. Likewise, this should be good for anyone who is planning on purchasing a home in the near future. Mortgage interest rates are expected to follow suit and show begin lowering today.

So far, this is all working into my master plan. I've been predicting that interest rates would come down in the second half of the year. I also predicted that we'd see some decrease in gas prices after the relatively strong rises we saw in the first half of the year. If that happens too, I'll call myself clairvoyant.

This just goes to show you how much prices are based on speculation and worry. Over the past few years we have seen oil and gas prices skyrocket from hurricane activity in the Gulf of Mexico. Hurricane Katrina is a prime example. Now with Hurricane Dean going through the area, oil and gas prices have fallen. Once news broke that Dean would miss U.S. oil operations in the gulf and on the gulf coast, oil prices began to fall.

It's almost as if the price was just waiting for news one way or the other. If Dean were going to affect U.S. oil operations, then worry would probably drive prices to new highs. However, the price level is breathing a sigh of relief that this is not going to happen.

It's almost funny to watch how the price responds so drastically to news like this. In the aftermath of Katrina, I didn't notice any gas stations running dry in my area. I guess there WAS enough supply left to fuel the country. However, you wouldn't have guessed it by the price levels. Price levels should be determined by SUPPLY and DEMAND. After Katrina, I've heard that demand actually decreased because people thought they'd do their part to help conserve our "low supply". So if demand decreased and price skyrocketed, supply must have taken a HUGE nosedive, right? But if that were true, wouldn't we have seen lines at gas stations, or stations that were running out of gas? I don't remember seeing any of this. It appears that the price levels of oil and gas are based more on fear than actual economics.