Me gusta la gasolina

Last week's special report in The Economist was on the shale gas bonanza and was quite an enlightening read. It got me to think about one conversation I had with my dad about shale gas exploration. He mentioned that the US should drill uninhibitedly for as much gas as possible, not for the sake of having an abundant supply of another energy source, but for the sake of lowering the price of gasoline. If a physics PhD who spent over a decade in chemistry academia didn't know the difference between natural gas and gasoline, others might not fare so well either. (It's possible he's just been brainwashed by the endless stream of nonsense coming from politicians.)

 Despite both being called "gas" colloquially, natural gas and gasoline have very different sources and end uses at the moment. Natural gas comes straight from the ground as methane and other gasses (in the sense that they're not liquids or solids). That gets processed into propane, butane, etc. for electricity generation, home cooking/heating, and transportation though that has not caught on yet. Gasoline comes from crude oil that is pumped out of the ground, and is one of many products that is a result of crude oil refinery. Gasoline is almost solely used for transportation. Now you can understand why having all the natural gas in the world won't affect gasoline prices much: you can't just fill up your car with natural gas even if it was free. Only a handful of buses and trucks are designed to run on natural gas (for now, due to technological issues; more on that later), so as long as we keep making cars that burn gasoline, you have only one choice.

*Tangent: One of my favorite stories regarding prices of related commodities is a great lesson in assuming prices of similar goods must behave the same way. In the 80's, airline companies had been hedging their jet fuel costs by buying heating oil futures. Both jet fuel and heating oil are refined from crude oil, albeit by different processes. The catch was, their markets had completely different personalities. Jet fuel is only used by airplane operators, which means there were few market participants. Heating oil, on the other hand, is bought and sold by every home energy and utilities company, so there are many market participants. Now, the airlines wanted to protect themselves from a rise in jet fuel prices, and they noticed that heating oil prices moved in tandem with jet fuel prices as they had theorized. Unfortunately for them, Saddam Hussein decided to invade Kuwait, which sent jet fuel prices skyrocketing, and a mild winter kept heating oil prices low. Needless to say, they lost a ton of money when their hedge failed to recoup their operational losses. (This is also called basis risk in trading circles)

One hiccup in the natural gas market related to the technological issue I mentioned above is the difficulty in transporting and storing it. It's a gas, like a burp or a fart, not a liquid like oil or gasoline. It needs special equipment to keep it compressed so it's useable, which is why it's not feasible on cars yet. And because liquefying it requires even more expensive equipment to cool it and maintain at -162 C, the shale gas produced in America is no good to Europeans, who are starting to ban shale gas extraction, and Asians, who have yet to do much shale gas exploration. I have no doubt that some MIT professor or Exxon Mobil engineer will figure out a solution one day to make natural gas fungible like crude oil.

This post is getting quite long already, but I just wanted to mention something briefly about crude oil. Even though we can ship crude oil around the world, not all crude are created equal. There are 3 major benchmarks of crude oil: West Texas Intermediate, North Sea Brent, and Dubai crude, which differ in sulfur content and other properties. All else equal, refiners prefer WTI to Brent to Dubai. So as a word of caution, the next time you hear a politician exclaim, "Doing XYZ will send oil prices so high, it'll cripple the American economy!", think about which oil price will be affected the most. Though their prices are strongly correlated, it's not always the case. For a long time, WTI was worth slightly more per barrel than Brent crude because oil refiners preferred WTI for its lower sulfur content (or "sweetness"). Recent Middle East tensions have (rightly) increased the prices of all oil, but Brent crude soared as much as $30/barrel higher than WTI. Currently, Brent is about $15/barrel higher, which means Brent has dropped much more from its peak than WTI has.

Logarithmic Scale

***Addendum:
By no means do I think debt is a bad thing and must be eliminated. Debt is a lot like milk: drinking some everyday helps bone growth and keeps you healthy, but take on too much too quickly, if you've seen/done a gallon challenge, and you'll end up puking it out all over the place. Another case for why the US could be closer to Japan than Greece or Italy is that the US has control over its own currency. If all else fails, the US can inflate the debt away by printing crisp new Benjamins for its debtholders (but it would still be a disaster for all of us)
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You've undoubtedly been asked before "On a scale of 1-10..." how tasty is the food / how hot is that girl / how much pain are you in? If you're a math nerd like me, you respond by asking first if it's a linear or a logarithmic scale. It's a fair question, especially if you want to compare a '5' to a '10'. On a linear scale, a '10' would be roughly twice as good/strong/etc as a '5'. On a log scale, it would be 2⁵, 10⁵, or 1024⁵ times stronger depending on the base of your units.

For instance, the scale system used to measure earthquakes, the Moment Magnitude Scale (inaccurately called the Richter Scale, even though it's a modification of it) is a log based 10 scale of the wave amplitude on a seismograph. In terms of energy, it is roughly a base 31.6. This means a magnitude 6 quake releases 31.6 times the energy of a magnitude 5 quake, and a magnitude 7 quake releases 1000 times the energy of a magnitude 5. The Great San Francisco quake was a 7.9, and last year's quake in Japan was a 9.0, 1 million times more energy than a 5.0 quake, and 5.0s do considerable damage already.

But there's a more ubiquitous application than earthquakes that we use everyday that is really a log scale and not a linear scale: scaling large numbers whether it's populations or sums of money by the thousand, million, billion, trillion, quadrillion ... They even have nice little Latin prefixes for 'two', 'three', 'four' that make them seem smaller than they are. We don’t think of 1 million being 1000 times greater than 1 thousand. When we try to visualize 1 trillion, the tricks we use aren’t even very helpful at all. How many people truly understand what a stack of 1 trillion sheets of paper stretching from the earth into space looks like?

With the gross public debt ("public debt" + "intragovernmental debt") sitting around $15,850,000,000,000, how much is that exactly? True, it's possible we can sustain it as long as we remain the strongest economy in the world and keep growing. With public debt at around $11,000,000,000,000 and our GDP at around $15,500,000,000,000, the oft-cited Debt-To-GDP ratio is about 70%. I bet you can see why people would not want to talk about Gross Debt to GDP, which is at about 101%. The scary part is that in 2001 the Gross-To-GDP ratio was only 56% according to the Office of Management and Budget, which means that ratio has nearly doubled in 10 years. Before we laugh too hard at the Greeks and their lazy, tax-dodging lifestyle, they started having trouble in 2009 when their Gross Debt-To-GDP ratio hit 120%. Ditto with Italy this year at 120%. Considering the accelerating pace of debt growth due to increasing budget deficits and interest on the debt ($450,000,000,000 in 2008), we don't have much time.

But wait, you might ask, what about Japan? They've been running at a gross debt-to-GDP ratio of 200% and they're still chugging along. Well the difference is that around 95% of their debt is held domestically while we're at around 65%, which means they have a much safer and more captive audience for their IOUs than we do.

So next time, think again when politicians want to slap on $500 billion dollars to our national public debt like it's nothing. Think again when they trumpet a balanced budget like a panacea. It's certainly a step in the right direction, but for the debt to go down, we need a primary surplus of at least $450 billion. Don't let the rhetoric and seemingly small number of $0.5 trillion fool you (see what I did there?)... or we could be a lot closer to Greece than you think.

June Unemployment Report

I'm back, boys and girls! On the first Friday of every month, unless it happens to fall on the first of the month, the Bureau of Labor Statistics publishes the (un)employment report of the previous month.

Here is the link if you want to read it: http://www.bls.gov/news.release/empsit.toc.htm

A picky employer

Every news source has probably hashed and rehashed the stat of only a +80,000 gain in nonfarm, private payrolls and a unemployment rate of 8.2%. The number was disappointing because recoveries historically require consistent monthly gains of about +150,000. (The BLS estimates a 90% confidence interval of +/- 100,000 using their methodology, so a) +80,000 is not statistically significant using a 90% CI, and b) a real recovery would need consistent statistically significant gains... don't worry if that kinda flew by) As a refresher (and a reminder to be wary of government statistics!), the unemployment rate is calculated by U / (U+E), or the number of unemployed divided by the sum of the unemployed and employed. The employed number is fairly straightforward: if you worked, or were temporarily absent due to vacation, illness, or a strike, you're employed. But the catch is the unemployed number: you have to be not working AND able to work that time (not disabled) AND actively seeking a job. So everyone who has gone back to school or gave up searching for a job aren't even counted. As you might have guessed, that can make a huge difference.

What hits closer to home though, is something not as obvious in the report: the number of unemployed 20-24 year olds (again, this doesn't even count the ones who have gone back to school). In the report, we can count the number of unemployed aged 20+ in the labor force by sex (a total of 11.3M seasonally adjusted), and the number of unemployed aged 25+ in the labor force by education level (a total of 9.3M seasonally adjusted). By taking the difference and ignoring the possibility of people identifying as both sexes or neither, we can derive the number of unemployed between the ages of 20 and 24: 1.99M! I didn't crunch the numbers of past years, but according to Bloomberg news, this number has been rising steadily over the last 5 years. Not only are 2M of the most energetic cohort not working, the economy will be weakened in 15-20 years when we're expected to be the most productive workers in our prime.

What's being done about this? Not much I'm afraid. Our lovely presidential candidates are only focusing on healthcare or espousing Supply-Side economics (which has pretty much been laughed out of town in the econ world).  Remember the American Jobs Act of 2011? Didn't think so. It was a collection of some good ideas with some bad ideas. Tax credits for employing long-term unemployed/students and infrastructure projects were good: incentives with very specific targets tend to work well, and many roads and bridges around the country are falling into disrepair. Many of the city of Chicago's water mains were laid between 1890-1920! That's a municipal and not a federal project, but I would bet on similar levels of neglect everywhere. The bill had some bad ideas: extending unemployment benefits and "protecting" jobs of teachers/police/firefighters. Did you know unemployment benefits have already been extended several times from the original 26-week period? Plus there have been studies showing strong correlations between long benefits and time between jobs, and between long benefits and eroded incentives. As for our teachers/police/firefighters, I value their roles in society as much as anybody, but it's their absurd pension plans that are never mentioned (that their powerful unions would never want to mention), which if reformed, would mean their jobs wouldn't need protecting in the first place... definitely a topic worthy of a future post since it includes arithmetic that probably isn't fully comprehended by the public. The bill also had legitimate concerns of how it would be funded. It wasn't thought out at all past "tax people earning more than $1 million." The only parts of the bill that were passed were a tweak to the tax code, and the JOBS Act, but sadly the JOBS Act isn't even working as intended.

As expected, doom and gloom from the dismal science. Good night!

*Edit: The JOBS Act article link has been changed. Not everybody might subscribe to the WSJ

Motivation

I've wanted to keep a blog for awhile now to comment on the news/trends of the economic and financial worlds. At first the plan was to educate and invite discussion on investment ideas and personal finance. I recently started investing in stocks on my own (and looked into bonds but after learning their jargon and minutiae, decided the few available to the small fry like me weren't worth it for now), and thought my experiences with trading it and learning about them could help other young investors like my friends being paid handsomely in Silicon Valley who have some money sitting in a bank account otherwise earning some ridiculously low amount of interest. (Or they could be spending everything on hookers and coke.)

While I'm sure a few people would certainly benefit from that, it felt like too narrow a focus. So I put this idea on the backburner. Once election season heated up, it was impossible to avoid all the partisan, half-baked economic ideas coming out of the mouths of our wonderful candidates. (For the record, I despise politicians of all stripes: red, blue, green, purple, orange ... you name it, especially when they espouse flawed economic theories to pander to their constituents or attack their opponents).

Aha, so here's a pretty big issue ... but the more I thought of it, the more it seemed like addressing these economic falsehoods would be akin to taping band-aids on a gunshot victim. Polticians will keep gushing ad nauseum and people will keep believing. It wasn't until I read this article in the Economist that I connected it to another big problem I've been all too aware of: mathematical illiteracy. Then it all became clear: so many of our current problems and misconceptions can be directly attributed to a huge and growing inability to comprehend math and numbers. The article isn't even news. Similar studies have been done years ago showing the same results.

An example I'll explain in greater detail later: the student debt issue (Before taking out a loan, do people understand first, what type of loan they're agreeing to? Do they understand what is a percent, much less the difference between 3.4% vs 12%, or how compounding interest works?). From all the stories of students deeply in debt, I'm willing to bet the answers for many of them are a resounding "No."

Fractions???

So maybe this blog won't save my hypothetical gunshot patient from dying anyways. My childhood hero Albert Einstein used to say "Only two things are infinite: the universe and human stupidity, but I'm not sure about the former." At least perhaps it will make you readers think about math, economics, and finance differently from what the tv, the news, or local politician tries to pull over your eyes.

The potential topics are limitless, so feel free to post questions you have, and I'll try to answer as many as I am able to.