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Pope Francis, the Free Market & Commodities Speculation

Posted on Friday, December 13, 2013 No comments

Friday, December 13, 2013

We have had a couple weeks to digest Pope Francis unnecessarily controversial Apostolic Exhortation (1) about how the world's economies affect the poor.  His use of "trickle down" - a loaded term in our American political/economic lexicon - seemed to provoke the strongest reaction.  The Pope has been called everything from a Marxist to a fool.  There really is only one thing to say in response to the critics:

Forgive them, father, for they forgot to read.(2)

But before we go back and do what it seems so few have actually done - that is, actually read the Holy Father's Apostolic Exhortation - we have to make sure we understand exactly what it is.  When the Catholic Church promulgates doctrine considered to be binding on the faithful it does so in a number of different kinds of documents.  And while an Apostolic Exhortation is not to be taken lightly, it is not a 'legislative' document under canon law. (3)  As such, it is a mistake to think that Francis' reflection here on economics and poverty is the same as binding church teaching - as in on something otherwise controversial like contraception.

In light of this we have to come to terms with a couple things about Pope Francis.  First, he is a Jesuit priest who has spent his entire life ministering to the poor.  He has seen, first hand, how economics works itself out in real life among the poor.  Second, his is not an economist, and does not pretend to be one here.  What he has done here is bring a distinctly Christian conscience to the larger issues of macro-economics and the much more local and personal issues of poverty.  He is exhorting us - even those of us who do not consider ourselves Roman Catholic -  to attend to the formation of our conscience on these issues.

As an example, Francis calls us to reflect on new kinds of power: "We are in an age of knowledge and information, which has led to new and often anonymous kinds of power."

Of everything the Holy Father has said in his exhortation, this is probably the most insightful of his observations.  While I do not know if he intended the words "knowledge" and "information" in the technical sense I as an information technology professional would use them, in the IT discipline known as 'Knowledge Management' (KM) data is collected and brought into context with other data.  That collection of data-in-context-with-data is called information.  And as this information grows, it becomes possible to detect trends and discern statistical profiles such that one can predict something into the future.  To be able to make such predictions with high degrees of probability is called knowledge.

For those who have access to the necessary sources of data, computing power, and the expertise to bring those two things together, there is a tremendous amount of economic power available.  And that power reaches down to the poor in almost exclusively harmful ways, and does so with almost complete anonymity - unless you understand what is actually happening.

Let's take the oil market as an example.  If I have access to a large array of data about the energy market - something I would get not from 'Big Oil', but from 'Big Data' - I could bring that data together into a sophisticated IT system and begin to engage in this 'Knowledge Management'.  I would take the data, bring it into the proper context with other data (information) and derive predictions about price activity in the oil markets (knowledge).  If the spot price today is $80/bbl., and my system spits out a prediction 90 days into the future which shows a $100/bbl. price, I will hit the market and sign a 'futures contract' to buy, say, 1,000 bbl of oil at $80 per within the next 90 days.

But wait a minute... I am blogging from my home office in my pajamas...  I don't have a refinery.  What the hell am I doing signing a contract for 1,000 bbl of oil?

I am gambling, of course.  No, actually, I am card-counting at the Blackjack table of the energy market.  This is what my sophisticated KM system allows me to do.  Where this kind of commodities futures play used to be a highly risky proposition, my KM system increasingly reduces those risks as the probability of its predictions increases proportionally to the amount of data to which I have access.

But why would this be something I should subject to my conscience?

First, let's follow what is happening here.  If, as my KM system predicts, the spot price does hit $100/bbl within 90 days, my contract now represents a discount to that spot price.  My contract is for 1,000 bbl at $80 per.  If the spot price hits $100 per, that's a $20 discount on each barrel.  Multiply that by 1,000 and you have a contract which represents a $20,000 discount to the spot price.

So let's do a deal.  You have a refinery and need the oil.  I sell you the rights under my contract (I 'assign' the contract to you) for which you pay me $10K.  You then buy the oil for $80K.  You have just bought 1,000 bbl of oil for a total of $90K where your competition will have to spend $100K.  Basically, we have split the discount.  You win.  I win (albeit for doing nothing more than signing a contract).  Isn't this what the free market is all about?

Maybe, until you consider what happens down the line with the price of home heating oil in the winter - and to the pensioner who needs to buy it to stay warm.

This is where our conscience comes in to the picture.  If I do not have a refinery - if I am merely card counting at the Blackjack table - I have neither the ability nor the intention to make use of the oil.  That is to say to produce something with it that others need and will buy.  But the market registers my contract as demand just as it would if you - who actually can refine it into fuel products - were to contract for the oil.  My demand is thus false demand; I cannot actually take the commodity and produce something useful with it.  Your demand is true demand - you can and do produce a supply of something needed in the economy.

My false demand for oil - being added to your true demand - pushes the price up higher and faster than it would otherwise go without adding that false demand to the true demand of those who can produce something with the commodity.  This is not an argument against the law of supply and demand.  Supply and demand is working perfectly - to my advantage, of course.  But in an inner city neighborhood somewhere in the Midwestern United States, for example, an elderly retiree can no longer afford her home heating oil.  The price has gone up too high, too fast, and for almost entirely anonymous reasons.

This is the most compelling example of the "new and... anonymous kinds of power" about which the Holy Father warns us.

Now, lest someone mock me for suggesting we do away with commodities futures contracts, the problem is not with futures contracts, per se.  It is with speculation in commodities futures.  Southwest Airlines is rightly famous for how it hedged against aviation fuel inflation with futures contracts (4).  While its competitors were 'paying at the pump' in 2007 when prices spiked dramatically - prompting the start of those hated baggage and fuel surcharges - Southwest was buying its fuel against its contracts, in some cases at nearly half of what was being paid by their competition.  Ever wonder how it is that 'bags fly free'?  Here is your answer.

When a supplier of a commodity and a buyer - who can actually use the commodity to do something like fly you and me from here to there - enter into a contract like this it guarantees the supplier a buyer at a set price.  And it guarantees the buyer the availability of the needed commodity at a set price.  Both gain predictability to their income and expenses.  In this case, though, the flying public wins as well.  Southwest is not trying to profit by selling its discount to the spot price to a third party.  They are sending that discount on to their customers in the form of lower fares.  This is true demand, and represents the commodities futures market working perfectly.

The essential difference here between true demand and false demand is the ability to 'assign' the futures contract.  If I cannot 'assign' my rights to a third party - for that $10K fee, of course - there is no reason for me - without any intention or capability to produce something with the commodity - to sign the contract to begin with.  And this means my false demand is no longer combining with true demand to push against supply, causing prices to rise higher and faster than they otherwise would.

This same dynamic can be seen in any commodity for which futures contracts are created.  When Ethanol was the rage, speculators poured into the market to sign futures contracts for corn.  And the wife of the subsistence farmer in Central America - who only wanted to make tortillas for her family - panicked as she saw prices in her local market soar.  When Australia's rice harvest came up short one year, speculators piled into the market for rice futures.  Rice riots followed in the markets of Asia. (5)

What is happening here is the false demand of speculation is distorting the price signal on the commodity, reducing the purchasing power of the little money the poor have available to buy that commodity or the food produced from it.  The poorer the end consumer is, the greater the economic injury.  The solution, though, is amazingly simple: disallow assignment for commodities futures contracts.  Proper hedging will still be possible; the producer will still be able to guarantee a buyer at a given price and the buyer will still be able to guarantee a supply at that given price.  But, unable to 'assign' a futures contract, the speculator will no longer be able to insert false demand.  This, then, allows the free market to calibrate supply to true demand, sending a more reliable - and just -  price signal.

To attach an adjective like just to price discovery might sound odd coming from a conservative.  But it is coming from a conservative who is taking his background in information technology and combining it with a conscience formed by Christian tradition to respond to the Holy Father's observation about how today's technology forms "new and often anonymous kinds of power."  It is an attempt to attend to the formation of a Christian conscience on the issue of macro-economics.

This, I believe, is exactly what the Holy Father asks of us in his Apostolic Exhortation.

----------------------------------------------------
1. Pope Francis, "Evangelii Gaudium"

2. In fairness I have to credit a certain Mr. Tyler Buchanan, a frequent commentator on Marketwatch.com articles, with that very concise - and hilarious - response.  See comments on Darrell Delamaide, "Pope Francis attacking greed, not capitalism"

3. See Helen Hull Hitchcock, "The Authority of Church Documents"

4. For a brief description, see Jeff Bailey, "Southwest Airlines gains advantage by hedging on long-term oil contracts" in NY Times.  For a more in-depth study, see Dave Carter, et. al. "Fuel Hedging in the Airline Industry: The Case of Southwest Airlines"

5. See Timothy A. Wise. “The Cost to Developing Countries of U.S. Corn Ethanol Expansion”  See also “Food speculation: 'People die from hunger while banks make a killing on food'” and a WikiPedia article on the “2007–08 world food price crisis”.

A Shout Out for Great Public Schools

Posted on Friday, December 6, 2013 No comments

Friday, December 6, 2013

There is what we hear in the media about our public schools, and then there is what is actually happening in our public schools.

As Chairman of our Mira Mesa Community Planning Group and Treasurer of our Mira Mesa Town Council I am tapped in to what is happening in the community.  Right across the street from the school near our home a large complex of apartments is being built.  It will add to the student population at the school, so as the plans for the complex were being developed, we invited the developer to meet with the former (since retired) principal of the school to discuss how the developer could assist with streamlining traffic in and out in the morning and afternoon.

Much was accomplished in those discussions a few years back.  But one issue - paving over decomposed granite on one of the lots - was left undone.  The PTA president revisited that issue with the new principal and asked me about previous discussions.  I told her I would see what I could find out.

Now at this point I have to add a disclaimer.  Our family is Evangelical Christian and we value having our faith at the center of our kids' education.  So we send them to private school.  Not, mind you, because we do not like our local public schools.  If anything, I think we have the finest elementary and middle schools and high school (Mira Mesa High) in the San Diego Unified School District.

And I have had the pleasure of meeting the family of the owner of the apartment complex across the street from our local elementary.  He, like us, values having his Jewish traditions at the heart of his kids' education.  So his son's high school sports teams (basketball and football) plays our boys' varsity team. We get to talk family and the like together every once in a while as the kids square off against each other.

Having heard about the local elementary school's issues with the dust from the decomposed granite lot causing asthma problems for some of the kids, he asked me about it one night along the sidelines of a football game.  He encouraged me to set up a meeting between his people, the PTA and the principal.

I just got out of that meeting.

We have a school in Hage Elementary here in Mira Mesa that is led by a "how we can" principal.  "Dr. T," as he is known, directs traffic himself in the mornings and afternoons, so he experiences the dust first hand.  He is also one of those people who chooses to look for "how we can" instead of "why we can't."  The apartment complex, Garden Communities and owner Stuart Posnock, sent their fine people.  And if the school can get the paperwork in place in the expected time frame, we should have a paved lot over Spring Break 2014 supported by Stuart and Garden Communities.

Now for the shameless plug.  Sitting at that table in Dr. T's office watching this come together is exactly what I mean in my book "Community Conservatives and the Future: The Secret to Winning the Hearts and Minds of the Next Conservative Generation" when I write about ownership, responsibility, community and dignity (Chapter 3).  Ownership is that sense we are putting down roots in our community; it is what gets me to the evening meetings of the Town Council and Planning Group.  Responsibility follows ownership; you see an opportunity to do good and you seize it.  Because you have a sense of responsibility born of a sense of ownership, when something is broken, fixing it - or just taking the opportunity to do good - is not someone else's job; its yours.  And once you purpose to seize the opportunities to do good that come your way, you run into others who are like minded; you discover your community.

And then you sit down in the principal's office with others in your community and get some good work done.  That is what I call dignity.

The Problem of the Minimum Wage

Posted on Thursday, December 5, 2013 8 comments

Thursday, December 5, 2013

[Updated on 7/25/2014 - See the bottom for some more info]

Today (12/5/2013) portends protests across the country at fast food outlets.  Labor unions will be stirring things up to argue for a $15 minimum wage so that fast food workers will be able to earn a "living wage."  There are a few problems with this, but in order for us as conservatives to be heard on the matter we have to show that we are willing to come to terms with the underlying problem.

It is easy to point out that minimum wage jobs, like those fast-food outlets offer, have never been intended to be "living wage" jobs.  While my "working" life technically started as a 14 year old paperboy for the San Diego Union, my first "official" job (in the sense that I got a paycheck and a W2 at the end of the year) was cleaning the lobby of the McDonald's on Broadway and I Street in Chula Vista.  I got $3.35/hr., then the minimum wage.  This was never meant to be a wage that I could "live" on.  It was meant to be an entry level job at which I gained experience and showed I was reliable while still living at home and going to school.  And it served me well exactly in that respect.

But there is something else going on here.  Where adults are holding down these jobs, they often have more than one and often are part of a household where multiple people are contributing to the the overall cost of living.  And this was working - albeit perhaps in a difficult, "grind it out" sense.  But it isn't working out so well anymore.  Even though government statistics tell us inflation is low, ask these folks how far their minimum wage dollars go today in comparison to how far they used to go.  Utility bills are higher.  Water rates are increasing.  Food is costing more.  There is a serious disconnect between the inflation statistics reported by the government and the lives our neighbors are struggling to live.

Where labor has this wrong is in pointing to the minimum wage.  This is wrong for two reasons: the harder of these two to understand is that the problem is not wages, but the fact that those wages are paid in a currency that is worth less and less.  The easier of these two problems can be understood by asking this question: If I can magically add a zero to your bank statement, that might make you feel better today.  But if I do this in a way that will also add a zero to your grocery and utility bills, how have I helped you?  You are getting more dollars for each hour of work, but the everyday things you rely on are getting more and more expensive.  When you add this to the first problem - the value of the dollar is going down - that hike in the minimum wage has left you no better off for having it.

At this point I have to explain that I am not opposed to the minimum wage - as are many, and maybe even most, conservatives.  I believe in the inherent dignity of the human person.  And if the human person has an inherent dignity, their labor must have an inherent worth.  The minimum wage is how we as a society express our underlying conviction about the dignity of the human person.  To suggest that labor is just another commodity to be traded in the economy is to embrace what ethicists call a "utilitarian" morality.  The worth of a human being is measured by his or her utility to society.  We have seen this before: it was called eugenics.

Where the minimum wage goes wrong, as described above, is when it is used to address (or to attempt to address) income inequality.  It goes wrong for a very simple reason: It does not work.  It never has, and it never will, simply because it leaves unchanged the more fundamental problem of why our money is worth less and less.

If income inequality is the central issue for our neighbors who sympathize with the Occupy Movement, and for the labor unions organizing today's protests, it needs to be pointed out that income inequality - measured by the percentage of total income received by those in the top 1% - has been trending up from a bottom of a little less than 8% in 1973, recently peaking at a little over 18% in 2008.  (It also has to be pointed out that the trend upward in the gross public debt started right about the same time.)

The problem is not with wages, it is with the money in which those wages are paid.  The problem is allowing the banking sector to tell us what our money means.  The Treasury used to hold gold in reserves and our money was tied to it; you could exchange a dollar for a set amount of gold.  That is money that means something; it is money that represents the wealth of the nation.  In 1971 the dollar was taken off of this standard and both income inequality and the gross public debt have been rising ever since.  [UPDATE: Steve Forbes has a new book out which discusses this and many other problems which have been created since the dollar was taken off the gold standard.]

And with that debt now surpassing the ability of the Treasury to service it, the Federal Reserve had to step in to create new money in order to keep the government's borrowing costs down.  As each dollar is added to the money supply, the ones in your wallet are worth less and less.  Or to put it another way, that minimum wage - in real terms of how much it will buy you - is actually going down!  It is no wonder labor is stirring for a minimum wage increase.

But again, to increase the minimum wage in dollars that represent the wealth of bank shareholders is to ensure that we - that is all of us - will never catch up as we watch our standard of living slip away.  Our neighbors working minimum wage jobs will just be the first to feel the effects.
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