A Basic Guide to Tanking Petrol Prices.

Recent months have seen staggering developments unfolding in the petroleum market. The price of Brent Crude Oil has fallen from roughly $110 per barrel in July 2014 to its current rate of $62.04 (as of the 17th of February), a change that has had huge effects on businesses, individuals and entire economies.

Why has it happened?
Simply put, there has been an oversupply of oil in the market, exacerbated hugely by the decision of OPEC (the Organisation of Petroleum Exporting Countries) in November 2014 to avoid cutting output. More oil, more supply, means cheaper and more open availability.

Source: BBC News

How does it affect me?

Provided that you're neither a business owner nor a Head of State, the most likely effect has been that you will have seen the prices at the petrol pumps fall dramatically. In the UK, the past year has seen petrol and diesel prices fall by around 16.2%, making petrol far cheaper as it approaches the £1 mark. This has meant that, in general, the cost of living has fallen for the public- not only do we need to spend less on petrol now, but the fall in prices have stalled inflation rates. 

Governor of the Bank of England Mark Carney claims that inflation is likely to turn to deflation in the following months, highlighting the economy's deep dependence on petrol; something we must see as potentially threatening as well as beneficial as this appears. Imagine if petrol prices had risen. Devastating events like the 1973 Oil Crisis, when Arab oil producers enforced an embargo on Western Israel-supporting nations, leading to the quadrupling of oil prices in the USA, have shown the chaos our dependence on oil can cause.
Oil plays a massive role in all of our lives; directly through our own use, and indirectly through its use to create and bring to us what we consume. Therefore the fall in prices inevitably has knock on effects that change life for us.

Is there a threat of spiralling deflation?
Not quite. Spiralling deflation is usually caused by an oversupply of money, or overproduction of goods in the economy. A hole is dug that the economy must climb out of itself in this case. However, the deflation caused by falling oil prices is different. Oil prices are more in the hands of oil producing superpowers rather than most Western nations, which in this case is good. Oil prices will inevitably plateau and begin to climb back up, and this will provide the effective counterbalance to deflation experienced in the West. Provided that this occurs before any major deflationary disasters, this means we are relatively safe from spiralling deflation- we are in a hole, but think of it as a whole with an elevator out available to us.

How does it affect national economies?
The price fall has certainly been bad news for countries heavily dependent on oil revenues such as Russia, Venezuela and Iran. Collapsing prices for these nations hit them hard as it means falling oil revenues. The International Energy Agency (IEA) claims Russia will be the hardest hit by this the hardest, as the country is already being hit my Western economic sanctions and a suffering ruble. And indeed, earlier this month the Russian central bank estimated that the price drop will lead to a $160bn fall in government revenue over the next year. According to Alejandro Werner, director of the IMF's Western Hemisphere division, the fall in oil prices is having devastating effects on the Venezuelan economy as well- stating "each $10 decline in oil prices worsens Venezuela's trade balance by 3.5 percent of GDP, a bigger effect by far than for any other country in the region", causing spiralling inflation and intense economic turmoil in the South American oil giant.

How does it affect the environment?
Undoubtedly, the fall in oil prices will have negative effects on the environment. It will cause not just travelling by car but also by plane to become more affordable, and people are likely to try to take advantage of this while they can; leading to increased greenhouse emissions and further damage to the environment. Whether the period of low oil prices will be long enough to make this damage of a substantial nature is yet to be seen, however. 

So what does the future hold for petrol prices?
It is of course impossible to predict the future exactly, but it seems that a relatively unspectacular equilibration of the market will take place. As prices fall, consumers are likely to become more carefree in their spending, enjoying the reduced costs of travelling and goods in general. This will cut down the world's supply of oil, leading to prices rising once more and resurfacing to roughly where they were before they fell. On the other hand, deflation could spiral down if the oil producing nations maintain or increase their oil output, economic crisis could hit the world yet again and a global conflict could emerge as nations suffering from the falling oil prices seek to exact revenge for the world's relative lack of movement over the matter.
Let's hope for the former.

Pros and Cons #2: Quantitative Easing

One of the most prominent national economic policies that has emerged in the 21st century is Quantitative Easing. A practice originating from the Bank of Japan to fight falling spending that was causing damaging deflation in the 1990s, it consists of the purchasing of financial assets (intangible assets, such as stocks and bonds as opposed to properties) from commercial banks by a country's central banking authority. The money these banks gain, theoretically, will allow them to take increased risks in lending more money to individuals and businesses, who, in spending and investing the loaned money, will help spur economic growth. Essentially, the central bank is pumping extra money into the economy- but not, as popular belief goes, in the form of masses of newly printed cash, but rather electronic money that, sometime down the road, becomes part of the national flow of money.

QE is something of a last resort for a faltering economy. Usually interest rates are manipulated; in times of deflation, when more consumer spending is needed, interest rates are lowered, which makes borrowing money cheaper and thus more popular. QE comes in when interest rates head closer towards 0%, and cannot be lowered further.

So, for our second instalment of Pros and Cons, let's look at Quantitative Easing.

PRO - Economic Stimulus
More lending by the banks usually translates into higher spending by businesses. Whether it is on new facilities such as factories or retail stores, or office renovation, extra money is pumped into the economy. When deflation is becoming an issue, spending is low and business as a result is not good for most- however making money more available will mean businesses are more likely to spend more money.
Employment is a particular focal point for QE- hopes are that, being able to lend more money, businesses will invest in more jobs. With more people in work, consumer spending is likely to increase, further revitalising the economy.
It's a stimulus, like a bump-start for a car; the hope is that putting the economy back into motion, even by money created out of thin air, will allow it to recover itself and eventually become independent of such stimulus.

CON - Misuse
However, a dangerous possibility with regards to monetary stimulus such as QE is that the money will be misused; giving extra money to banks has not been such a popular policy in recent times, and perhaps rightly so. Despite the faltering global economy of the past decades, bankers' bonuses and bank profits as a whole have been booming- and there is certainly a strong case for arguing that QE, as well as the bailouts of 2007/08 have only contributed to this.
Companies who benefit from the greater lending power are also not guaranteed to use the money how theory suggests. Executive pay has been just as much an issue as that of bankers, and while it may not be considered a misuse, much of the extra money may go into investments abroad, such it into offshore tax schemes or outsourced employment- these may result in increased profits for the business but not the overall economic stimulus QE is designed to provide to a nation's economy.

PRO - Combat Deflation
The problem of deflation (which you can read more about here) is, in a nutshell, caused by a shortage of money supply in circulation. This means everyones' purses are tightened and thus spending in the economy falls with wages, and subsequently prices fall also. QE is primarily designed to act against falling prices and wages- by increasing the amount of money in the economy, the hope is that spending will recover and prevent spiralling deflation.

CON - Inflation
On the other side of the coin, there is a fear that monetary programs such as Quantitative Easing could tilt the economy the other way. If too much money floods the economy, its worth will fall too much, resulting in inflation, the drastic rise in prices. While the central financial authority can control how much money can enter the economy, it becomes very difficult once it becomes part of it- it's like adding a selection of straws of hay to a haystack and trying to pick out those exact straws after it's all been mixed up. While many claim inflation is a more desirable alternative to deflation, and central banks have of course made reassurances that inflation could be controlled at the end of a course of QE, the world's inexperience of whole QE cycles mean the inflationary potential of the stimulus remains a grey area.

PRO/CON - Alternative to Austerity
This is a more subjective pro; QE is an alternative to austerity with regards to dealing with deficit and growth issues. While a policy of austerity would involve cutting of government spending, balancing the books by cutting spending, the expansionist QE policy is designed more to deal with the deficit by boosting productivity, though at the cost of maintaining spending.
Austerity would be arguably a more risk-free way to deal with the deficits, but its negative effects on government services such as social welfare and public services such as education and health. On the other hand QE would maintain such services, and in many cases would lead to improvements in infrastructure as spending increases as a result of the more accessible money. However some doubt that spending extra to reduce the deficit is the optimal solution, due to risks it presents if the spending does not produce results. This is particularly an argument for those who believe in small government, that the private entities are more successful and efficient participants in the economy than the state.

Pros and Cons: Mixed Economy

A mixed economy is the most common in today's world, and seems to be the most efficient balance of private and state participation in the economy. It is positioned between a complete command economy (in which the economy is totally run and planned by the governing authorities), and a totally laissez-faire, free market economy in which the government has little/no role, rather private companies and individuals operate everything (though no economy has yet fully devoted itself to this, not even the US).

The concept of a mixed economy is by no means a recent discovery, but perhaps its greatest proponent was John Maynard Keynes. Arguably the greatest economist of the 20th century, much of his work investigating the potentially positive effects of state intervention in the economy was particularly relevant in times of crises- FD Roosevelt, US President who led the nation's recovery out of the Great Depression of the 1930s attributed much of his policy decisions to Keynes.

So, let's look deeper into the idea of mixed economy by evaluating the pros and cons of a market economy.

PRO- Monopoly.

Government involvement in the economy can prevent market failures, such as the emergence of monopolies (for more information on these see this previous article). This is largely done by government regulation; the UK has 'competition laws', designed to prevent massive business blocking smaller ones from entering a market. This means companies that, for example, block competition by setting rock bottom prices for their products that they know their smaller competition won't be able to maintain (a practice known as predatory pricing), can be prosecuted and penalised by authorities. Shell and Esso were two fuel companies accused of this malpractice in 2013.

The breaking up/prevention of monopolies means that all businesses in the economy are able to compete on a level playing field, and ensures that the most efficient and popular businesses are those that succeed most.

CON- Monopoly.

There is another side of this argument, however; that is that certain types of government involvement in a mixed economy can itself create monopolies. This was a significant argument behind the privatisation of the Royal Mail; despite its supposed 'loss of monopoly' in 2005 when other competitors were allowed to enter the market, the state-owned Royal Mail, though slightly weakened, maintained its domination of the postal market. Monopoly can encourage complacency- and the Royal Mail was accused of gross inefficiency when the idea of privatisation was being kicked about.

Some argue that state ownership leads to sector monopolies- the energy market a couple of decades ago was another example- and thus reduce competition and innovation. The private sector on the other hand is seen to encourage competition, as long as the barriers to entry are low.


PRO- Motives.

The actions of the government in an economy hold an advantage over those of private entities in that the government is directly accountable to its people. The government is less likely to act against the wishes of its citizens because if it does so it is far less likely to be re-elected and maintain power.

Furthermore, the profit-making motive is not ingrained in state institutions as it is in the private sector. State institutions such as the NHS and (formerly) the Royal Mail were created not to make the government money, but rather to serve the people of Britain; ultimately creating a service more helpful to the patient. Compare the NHS with private health systems across the world; the lack of a profit motive is the reason why, for example, no doctor in Britain will advise for extra treatments/medicines solely to extract money from you, and it is a major reason why the British healthcare is renowned across the world.

Open access to healthcare for all citizens has been of huge benefit to Britain; looking at the masses of debt accumulated by people across the world due to circumstances out of their control (such as accidents), one can see how effective and beneficial for the people the NHS is. It allows the poor to have access to healthcare, and thus prevents the socio-economic gap in Britain increasing to the extent of countries such as the USA.

The governments' motives to maintain favour with the public and genuinely serve the public rather than make profits makes it often more effective in improving the lives of the citizens.

CON- Motives.

One the other side of the coin, however, government economic policy is occasionally branded as short-termist, unsustainable electioneering. Gaining favour with the voting public can often be done via short term economic boosts. The MacMillan government of the 1950s is an example of this; two major tax cuts in 1954 and 1959 (just before elections) of a combined value of £504m certainly gained favour with the people, but this ultimately contributed to a massive deficit of over £800m five years later. Had the tax cuts not been made, it is likely the economic situation later would not be so dire; but the desire of the government to instantly win votes led to pursuit of short term policies that ultimately damaged the economy as a whole more than it benefited it.

Libertarians argue this as a reason why the government should have little/no role at all in economic management; that the primary motive of a politician is to be re-elected rather than benefit the country, reasoning that certainly has credence. Whether there is a better alternative or not though, remains an open question.


PRO- Investment.

Linked to the earlier pro of motives, one of JM Keynes' major contributions to the arena of public economic policy was that the government should intervene in times of trouble to invest in employment, through state-led projects. These could be anything, such as a development of infrastructure (hiring people to design and build roads, public buildings, etc.), or more employment in publicly owned entities like the NHS.

For private companies chasing profits, the best way to do so is often not to try to increase income but to decrease expenditure- and a way to do this is to cut down on employment. In recent times this has not just come in the form of job cuts but outsourcing also; the cheap labour available throughout the world has encouraged companies to cut on jobs domestically and save money by hiring labour elsewhere.

This is something the government would be less prepared to do- Britain's recovery from the 1930s crisis showed this, as the government invested more in jobs in order to get out of its hole, upon Keynes' advice. More people found work, boosting spending again and eventually bringing the economy into recovery.

CON- Taxes

Taxes, the bane of any proponent of 'laissez-faire'. More state intervention in the economy, of course, requires greater investment from the government, which largely comes from tax revenues. Therefore an argument against intervention is that the more there is, the more people must be taxed- and higher income tax for example, is claimed to be a cause of a reduction in motivation to work, as an individual will see a large proportion of the money he earns go to the taxman.

Therefore libertarians often argue that less state intervention in the economy allows taxes to fall, increasing peoples' motivation to work as they see more of the money they earn go directly to them.

15 Scary Facts About The US Economy

1. 1 in 5 American families are totally unemployed- that is no family member holds a job, according to the Bureau of Labour Statistics.

2. Research from UC Berkeley academic Emmanuel Saez shows that while incomes of the top 1% increased by over 11% since the end of the recession, the other 99% saw a decrease in salary of 0.8%.

3. Multinational Corporations have accumulated almost two trillion dollars in accounts outside of the USA in order to avoid domestic taxes.

4. The proportion of US families holding ownership in small business reached an all-time low of 11.7% in 2013.

5. According to the University of Arizona, two years after graduation almost half of college graduates are still relying on parents or family members for financial support, due to a lack of prosperous employment opportunities.

6. Median household income has fallen for the past 5 consecutive years. In today's terms, the average household wage was almost $88,000 in 2003- a decade later, this figure was just $56,335- a 36% decline.

7. US National Debt grew by over a trillion dollars in 2014.

8. The percentage of Americans who own their homes (64.8%) is the lowest since 1995.

9. An estimated 49 million Americans have limited/uncertain access to a sufficient amount of food.

10. During 2013, the Chinese sold $440bn worth of exports to the US, who sold $121bn to China, creating the largest recorded trade deficit in history. 

11. In 2012, there were more American women relying on food stamps than women with full time jobs.

12. One third of Americans would not be able to afford more than a month of mortgage payments if they lost their job.

13. In 2013, female full-time workers were paid on average 78% of that which their male counterparts were paid.

14. Between 2001 and 2011, over 56,000 American manufacturing facilities were shut down- a rate of 15 per day.

15. American consumer debt has increased by 1700% (multiplied by 17!) in the past 40 years.

Sources for these facts can be found in links within.

What are Economic Bubbles?

We reflected earlier in a previous article on whether we, as humans, were rational actors- to be rational is to be objective and well reasoned in all decision-making (it’s an unclear concept, one could say there’s no real definition for it).

Anyway, the main conclusion arose that we are not rational actors as individuals- though perhaps as a large population irrationalities may balance each other out, even still we are humans- subject to emotion (we often get excited easily, and make silly decisions as a result), and often a basic lack of knowledge of the effects of what we are doing- sometimes we are at fault for this, sometimes not. 

Now let’s explore something that perhaps exemplifies human irrationality best in the field of economics- bubbles.

No, not the soapy ones, but economic bubbles are certainly similar in nature (hence the name)- in essence, an economic bubble is a massive economic boom that has grown so quickly and expansively that it is, like a soap bubble, in danger of being popped in an instant. An economic expansion, followed by a prompt plunge- that’s pretty much the basic structure of an economic bubble.

The South Sea Bubble caused spectacular devastation.

Bubbles aren’t some abstract theoretical idea, they have occurred numerous times throughout history- the earliest formally recorded bubble is believed to be from the early 18th century. The bursting of the South Sea Bubble of 1720 was the result of wildly heightened expectations of the South Sea Company, which had taken responsibility of the entire British national debt in exchange for total control of all trade in the South Sea. In January 1720, SSC stocks were priced at £128. February 1720, £175. April 1720, £330. By June, a whopping £1050- almost 10 times what it had been just 6 months ago. 

But this was the peak. The bubble had grown too much. 

Pop.

By September, just 3 months after South Sea Company stocks had reached a record price, it was almost back to square one- stock price shrunk to just £175. 

This had devastated numerous investors- who were caught up in the initial hype of this company ambitiously taking on all of Britain’s debt in promise of finding profit. But in truth, the South Sea Company had little chance at all. They were a massive failure; partly during to their own mismanagement, partly due to the crippling debt they had just taken on and partly due to the huge reduction in South Sea trade after the Treaty of Utrecht was signed in 1713. Whatever/whoever was responsible, the bubble had burst and proven all the hype, all the investment, all the trust, to be false.

The California Gold Rush, the ‘dotcom' bubble of the 1990s and early 200s, the 2008 financial crisis- all examples of bubbles and/or their catastrophic burstings. 

Take the most recent financial crisis of 2008. Now there’s much to talk about when it comes to the causes of the crash, but simply put, it was caused by a massive housing bubble that had developed not just in the US (although perhaps most seriously here), but throughout the world. 

Like all bubbles, the housing market in the USA had initially seen a massive boom- caused by radically low interest rates (which had been at an all time low of 1% in 2004), irresponsible lending from financial institutions and the power given to banks to be able to conduct such activity.

Low interest rates made purchasing housing a very attractive option- a rate of 1%, set by the Federal Reserve with the aim of boosting spending after the 2002 post-dotcom recession, was almost a free loan, and therefore many Americans went on to grab the opportunity and buy their own houses.

For the financial institutions (the banks), this 1% provided an issue- it meant their profit margins would be far lower than before, when the rate was closer to 5%. In seeking increased profits, they took on more loan requests. The regular system of financial discretion was almost abandoned, and banks began lending to more and more risky individuals, many of whom ended up being unable to pay their loan and thus homeless.

The banks had such a huge pot to lend from because every bank has customers- people who deposit their money, in the trust that the bank will keep it available for them whenever they need it. But gradual recession of the Glass-Steagall Act, which initially prevented the lending side of banks to use the customers’ deposits, meant that banks eventually were able to use money deposited by customers to fund lending and other investment activity. This gave them a huge amount of money- and thus the banks could afford to be more reckless and risky with their money management. 

Wall St.- responsible for the 2008 financial crisis?

This increase in house buying caused a surge in house prices- causing even more people to jump onto the bandwagon, presenting what seemed to be a great investment in an asset that appeared to be endlessly growing in value. The bubble was pumped up more and more- house prices peaked in 2006, then the big burst came in 2008- the burst that cost the USA an estimated $648 billion lost in economic growth between September 2008-December 2009, roughly $5,800 in lost income for every US household, and is still haunting the global economy.

The bubble had popped, and the liquid stains are going to take a long time to rub off. 

The problem with bubbles is that their usual steps of boom then bust are very tricky to work out. The initial boom is by no means a promise of an oncoming burst; indeed an economic boom is often good, providing employment, wealth that can potentially itself prevent a bubble from arising.  

Economist Hyman Minsky is famous for calling out symptoms of an oncoming bubble- yet mystery still hovers over which booms of today are going to become the popped bubbles of tomorrow. Will it be the housing market again? The technology industry, again? Another industry altogether, or none of them?

Only time will tell.