Wednesday 9 November 2011

~supply and demand~


Gasoline: Supply and Demand

Gasoline has exceeded or approached $5.00 per gallon in some parts of the United States long before the normal peak travel season has begun.  Already the politicians, headline writers, and some cable and talk show pundits are pointing to the usual suspects.  But they have avoided or are unaware of where the fault actually lies.



One of the foundational tenets of economics is what is known as the law of supply and demand.  Normally whenever a product or commodity is in short supply the cost to acquire it increases; on the other hand, if there is a glut on the market the price decreases.  However, over the past three years, thanks to the profligate fiscal policy of the Obama administration and the Democrats in Congress combined with the money creating monetary policy of the Federal Reserve, this law has been turned on its head.


There are two commodities deeply affected: the first is oil, which is a basic modern day necessity; and the second is gold, which has always been a safe haven against economic downturns that reflect this upside down world.


The fluctuations in the price of oil have been primarily demand-driven, and to a lesser degree impacted by world conditions which is reflected in supply.  Since 2003 world oil production has maintained the following relationship with global oil consumption.
Year
 Ratio
 Average Price per Barrel (adjusted for inflation)
2003
 97.0%
 $38.66
2004
 97.7%
 $39.87
2005
 97.4%
 $48.29
2006
 96.7%
 $69.94
2007
 95.1%
 $65.74
2008
 96.4%
 $88.40
2009
 95.0%
 $87.60
Current
 98.8%
 $110.00


As a general rule, the above table follows the anticipated supply and demand equation (with slight variations due to political or weather instability etc).  That is until the present, where the correlation is completely thrown out the window.  Despite the ongoing stalemate in Libya and general unrest in the Middle East, supply is keeping up with demand.  This was underscored by the Oil Minister of Saudi Arabia when he recently announced that the Saudis were cutting production by 700,000 barrels per day due to "market oversupply."


While it is always fashionable and populist to blame the "speculators" and oil companies, those entities are fully aware of the supply situation and would not be taking undue risk when a futures contract in that market situation could easily backfire on them.  But they are also aware that another factor has come into play.  That is the wholesale creation of money by the Federal Reserve in response to the massive deficits run up by Washington D.C.  In reality these are quixotic attempts by both entities to jump start the US economy.  Their most significant accomplishment in doing so is to enrich Wall Street and the huge financial institutions deemed "to big to fail" at the expense of the American people.


Oil, as are all worldwide commodities, is denominated in US dollars.  The dollar is also the world's reserve currency.  What happens in the corridors of power on the banks of the Potomac has an immediate and potentially devastating impact on the rest of the world. 


Gold, which has been considered a safe haven and hedge against not only inflation but the follies of an unrestrained government, reflects more dramatically than any other commodity the effect of Federal Reserve policy.  During 2007 the average price of an ounce of gold was $695.00 an ounce.  In the past week the price has hit $1,509.00, more than double the 2007 price or increased by a factor of 117%. 


It is no coincidence that during this same period the Balance Sheet of the Federal Reserve showed assets of $825 Billion throughout 2007; however today it exceeds $2.7 Trillion, a phenomenal increase of 223% or more than triple.  Of the $1.8 Trillion increase is $1.4 Trillion of US Treasury debt that the Fed bought and in essence printed money to do so.  This has flooded the marketplace with US currency and driven up commodity prices across the board.  Additionally this tsunami of greenbacks has created massive problems for emerging countries as the influx of dollars looking for higher returns has overwhelmed their economies, triggering inflation and currency and exchange rate problems around the world.


The Fed, in league with the federal government, chose this course of action in order to underwrite the ongoing crippling deficit by buying the bonds of the US Treasury, which had to be offered as the result of fiscal policies that were supposed to stimulate the economy.  The Fed justified their actions by claiming this program, also known as quantitative easing, would make more money available for borrowing by the private sector.  It has done neither.  Instead it has sown the seeds for stagflation (high unemployment coupled with high inflation).


comment:
This article is related to demand and supply. Demand is the quantity of a good or service that buyers are willing and able to purchase at different prices in a period of time in a given market holding non-price factors constant. The law of demand states that there is an inverse or negative relationship between the price of a good and the quantity buyers are willing to buy.For example,if  a product’s price(oil and gold) increases,ceteris paribus,the quantity demanded for the good will fall. And vice versaWhile,supply refers to the quantity of a good that is offered for a sale at all possible.The law of supply refers to the principle that there is a direct relationship between the price of a good and the quantity sellers are willing to offer for sale sale in a given market,ceteris peribus. For example,if the product’s price (oil and gold) increases, ceteris paribus ,the quantity supplied for the good will increase.

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