"Excessive" Oil Corporation Profits Explained

The blame for increasing gasoline prices is being incorrectly placed on oil corporations. The blame properly belongs with the Federal Reserve. If you print more money, prices go up. Rising gasoline prices are 90%+ due to an increase in the money supply.

Suppose that the price of oil were $100/barrel and oil corporations make a profit margin of 10%. Their profit will be $10/barrel.

Suppose that the price of oil doubles to $200/barrel and oil corporations make a profit margin of 10%. Their profit will be $20/barrel.

If the price of oil doubles, then the oil corporation's profits *SHOULD* double. Why does this make sense? Suppose oil corporations didn't double their profits when the price of oil doubled. In this case, their profit margin would shrink to 5% from 10%. Now, the oil corporation is a stupid investment. It would make sense to sell off the oil corporation business and invest the proceeds somewhere else.

When the price of oil doubled from $100/barrel to $200/barrel, inflation was 100%. (Part of the increase in the price of oil is due to increased demand and decreased supply (oil gets used up, unlike gold), but the primary factor is money supply inflation. If you consider the price of oil/gold, and correct for manipulation of the gold price, then the price of oil is relatively unchanged.) The value of all assets doubled. The value of the oil corporation also doubled. If it wasn't allowed to double its profits, then its investors would be better off selling and investing the proceeds elsewhere. If an oil corporation isn't allowed to double in value when inflation is 100%, then an oil corporation is a bad investment.

The key point is: WHEN INFLATION CAUSES PRICES TO DOUBLE, CORPORATE PROFITS *SHOULD* DOUBLE. When prices double, all asset prices should double and all corporate profits should double.

Oil corporations have an oligopoly. They have a State-granted monopoly/oligopoly. I can't say "Oil corporate profits are excessive. I'll start an oil company!" There are too many restrictions. This makes it tempting to blame oil corporations for rising oil prices. They are a beneficiary of rising oil prices, but they have *NO CHOICE* given the rules of the US economic system. Many oil corporation executives are paid via stock options. They are the recipients of a massive windfall when there is inflation. The value of this windfall isn't free; it's paid by all the holders of dollars in the form of inflation, and by other shareholders of the corporation in the form of dilution of their ownership. The other shareholders don't complain much about stock options, because their shares are also skyrocketing due to inflation.

Oil corporation executives are being interrogated by Congress. It's a charade to distract attention from the real issue. Price inflation is nearly 100% caused by money supply inflation.

If you print more money, prices go up. It's that simple! For other products, people don't notice as much, because money supply inflation doesn't lead to uniform price inflation. Plus, people have bad memories. People remember that they used to pay less than $10 for a tank of gas and they're paying $50+ now. It's hard to maintain the illusion "Inflation is only 2%-3%!" when gasoline prices are skyrocketing. The "core CPI" removes inflation due to rising energy prices.

Gasoline prices rise nearly 100% in lockstep with money supply inflation. The demand and supply of gasoline are relatively inelastic. Therefore, money supply inflation is almost immediately reflected in gasoline prices.

Thimerosal, Mercury Vaccines, and Autism

There is an interesting theory circulating that thimerosal, a common component of vaccines, is correlated with autism. The rate at which thimerosal is used in vaccines is increasing. The rate of autism is also increasing. Thimerosal contains mercury, a toxic compound.

However, from that data alone, you CANNOT draw the conclusion that thimerosal causes autism. The vaccines contain less mercury than the amount generally considered to be toxic. There are *MANY* other environmental factors that could be causing increased autism rates. Increased autism rates could be caused by:

• parents too busy with work and unable to spend time with their children
• parents lacking the skills to properly raise their children, relying on the State instead
• corrupt government schools
• increased time spent watching television
• increased time spent with computers and video games

The fallacy is "correlation and causation are not the same thing". I consider "thimerosal causes autism" to be "not proven". Similarly, "fluoride is bad for you" is also "not proven". Before anyone objects, I also consider "fluoride is good for you" to be "not proven".

It is possible to do a proper scientific study to test this hypothesis. In order to do a proper scientific study, you would need two groups of children. One is given vaccines preserved with thimerosal and the other is given vaccines preserved using other methods. Then, measure autism rates. You probably would need 10,000-100,000 or more children to get a valid conclusion.

Of course, the drug industry has *NO INTEREST* in performing such a scientific study. If thimerosal is proven to be harmful, they would be facing a MASSIVE class action lawsuit. If thimerosal is proven to be safe, they will continue using it. But the drug companies can continue using thimerosal IF NO STUDY IS PERFORMED AT ALL! Under the current economic and political system, corporations are immune from liability when they do something wrong. The pharmaceutical industry has *NO* responsibility when it turns out that a drug or vaccine they are selling is later proven to be harmful.

The only way to settle the "thimerosal causes autism" conspiracy theory is with a proper scientific study. Until then, I consider this hypothesis to be "possible, but not proven". There are *TOO MANY* other factors that could potentially cause autism.

The Unconfiscatable Gold Myth

In 1933, President Roosevelt demanded that US citizens turn over all their gold coins and gold bullion for worthless unbacked paper. Strictly interpreting the US Constitution, this seizure of gold was illegal, but the US Supreme Court ruled otherwise.

The gold recall order had an exception for "collectible" gold coins. If you owned a collectible gold coin, it was exempt from the recall order. Naturally, politically connected insiders knew about this exemption in advance. Politically connected insiders who bought collectible gold coins before the seizure profited immensely.

From 1933 to 1975, it was illegal for US citizens to own gold, *EXCEPT* for jewelry or collectible gold coins. After the gold standard was abandoned, it was declared legal for US citizens to own gold. By that time, people had become accustomed to trading with unbacked paper money instead of gold. If gold ownership was never outlawed, people would have merely boycotted Federal Reserve Points and used gold instead.

People say "The dollar is declining in value. The government may confiscate gold again. Buy collectible gold coins to protect yourself." There are several flaws with this reasoning.

The exemption for collectible gold coins allowed insiders to profit. There is no guarantee that another gold confiscation will contain such an exemption.

The US dollar is no longer backed by gold. The US dollar is backed by debt and violence. The Compound Interest Paradox guarantees that there will always be more debts than money. Government violence enforces this illegitimate debt contract. Also, the US government demands that income taxes be paid in Federal Reserve Points. The income tax creates an artificial demand for Federal Reserve Points. Nobody in the USA can legally work without paying income taxes.

The US dollar is backed by violence. It is much more likely that the US government would attempt a gun confiscation, instead of a gold confiscation. There is no need to confiscate gold anymore. Taxes and regulations make it impractical for people to use sound money instead of Federal Reserve Points.

The Compound Interest Paradox - a Simpler Explanation

A lot of people have asked for a short and simple explanation of the Compound Interest Paradox. I'm planning an updated version my Compound Interest Paradox post, scheduled to be posted in a few weeks. (Now that Blogger offers "scheduled posting", I'm queuing up posts ahead of time. I have 3 months' worth of nearly finished drafts queued up, and I schedule posts a week in advance now.)

There's a fundamental structural flaw in debt-based money. Money is only created when someone takes out a loan. However, only the principal is created and not the interest payments. For example, suppose a bank borrows $1B from the Federal Reserve at 5% interest for 1 year, either directly at the Discount Rate or via the Federal Reserve "monetizing the debt". In a year, the bank must repay $1.05B. The $50M required interest was never created or put into circulation. Therefore, there's a permanent money supply shortfall. Everyone is enslaved under a crushing debt burden.

The key step in the money creation process is when banks borrow from the Federal Reserve to create new reserves. Only the Federal Reserve can create new money, and all the money it creates has debt strings are attached. For each $1 the Federal Reserve creates, the financial industry can create $9 more via fractional reserve banking. This new money is recycled. The interest payments on the extra $9 are recycled as bank profits and expenses. Banks always are "loaned up" to the full reserve ratio allowed by law. Surplus bank reserves are loaned to other banks, or (rarely) back to the Federal Reserve via reverse repurchase agreements. However, the interest payments on the $1 created by the Federal Reserve are *PERMANENTLY* destroyed as the loan is repaid. Total debt is always greater than total money.

When the Federal Reserve creates new money, the Compound Interest Paradox operates with the full force of law. The general public does not have the financial industry's money-printing power, and their access to money is always limited by the Compound Interest Paradox. Banks don't need to collude to cause economic booms and busts, because Fed Funds Rate changes force them to collude. Before the Federal Reserve was created, large banks colluded to create economic booms and busts. The usual "Problem! Reaction! Solution!" scam led to the creation of the Federal Reserve. It was State regulation of banking in the first place that allowed large banks to collude to cause economic cycles, which then allowed them to lobby for the creation of the Federal Reserve.

Consider a quantum mechanics analogy. In quantum mechanics, a proton and anti-proton can be simultaneously created. They later collide and are destroyed, for no net effect. Similarly, dollars and anti-dollars (debt) are always created in matching pairs. However, the anti-dollars multiply via interest, whereas the dollars do not. Therefore, when the dollars and anti-dollars collide and cancel, there always are surplus anti-dollars left over.

In the USA, monopolies are openly discussed as immoral. The Federal Reserve is the biggest monopoly of all. The Federal Reserve's monetary monopoly is more valuable than the monopoly of the State itself. By delegating its money-printing power to the Federal Reserve, the State has delegated most of its power to the Federal Reserve.

There are a lot of consequences of the Compound Interest Paradox.

• Boom/bust cycles are not an economic law of nature. They are a consequence of an unfair monetary system. The people who control large corporations love this arrangement, because their smaller competitors are bankrupted during the bust phase; large corporations can withstand the cycle.
• Boom/bust cycles encourage consolidation of industries. Large corporations are the most common business, because they can most effectively withstand boom/bust cycles and lobby the State for favors.
  
• Real interest rates must be negative, to ensure any money is in circulation at all. Negative real interest rates provide a massive subsidy to the financial industry and large corporations, paid by everyone else as inflation. Banks and hedge funds can borrow the cheapest, followed by large corporations. Individuals cannot borrow on favorable terms, or cannot borrow at all.
• Without a gold standard (sound money), individual savings are stolen by inflation.
• Income taxes and regulations prevent people from boycotting the Federal Reserve and using sound money instead. If you develop an on-the-books alternate monetary system based on real money (gold or silver), the taxes and regulations make it impractical. Whenever someone works, Federal Reserve Points must be paid as taxes/tribute.
  
• Negative real interest rates mean that the cheapest way to finance a business is via the financial industry/State. With fair market-determined rates, growing a business via reinvested earnings is comparable/preferable to borrowing. This places individuals on an equal footing with large corporations.
  
• Individuals cannot easily accumulate capital to form their own businesses. Their savings are eroded by inflation. The stock market doesn't earn a positive inflation-adjusted return. Politically connected insiders can start businesses, because their connections allow them to get funding from the financial industry. In a communist society like the USA, connections are more important than talent.
  
• Individuals cannot profitably loan each other money. If you loan money to your friends at 6%, that isn't keeping up with inflation. If you make a gold-denominated loan, that has an implied interest rate of 20%-30%; it would be cheaper to borrow from a bank.
• Individuals don't have the magic money-printing power that banks have. This means that they will always be slaves of the bankers.
• The financial industry has a unique perk. They get to print the money that everyone else uses to trade. This guarantees that the financial industry will *ALWAYS* be about 10% of the economy.
• Large banks become "too big to fail". If one is forced into bankruptcy, then a bailout is *NECESSARY*, because otherwise the financial system starts to unravel. In a free market, one business' bankruptcy does not threaten the stability of its competitors, if they are prudently managed. There is no need for financial industry insiders to be concerned about negative consequences of bad decisions; there will *ALWAYS* be a Federal Reserve bailout, either directly as was the case with JP Morgan Chase and Bear Stearns, or indirectly in the form of a Fed Funds Rate cut.
  
• With the ability to (literally) print money, the financial industry can lobby the State for perks. They can guarantee that reform will never occur. The insiders bought out all the TV stations and newspapers, guaranteeing their abuses will never be exposed. (The Internet is changing the equation somewhat. I predict that the Internet will enable an agorist revolution.) The financial industry insiders bought control of schools and universities, guaranteeing that only fake economics (Keynesian economics) and fake politics ("Taxation is not theft.") will be taught in schools. The financial industry insiders arranged for everyone else to be educated/brainwashed as slaves ("good citizens/consumers"). (Most politics courses don't even ask the question "Are taxes different from stealing?" It's an undiscussed axiom that taxes are morally acceptable.)
  
• With negative real interest rates, the incentive is for banks and hedge funds to maximize their use of leverage, because this maximizes their profits. Only politically connected insiders can start a hedge fund. There is no true "free market" for hedge fund managers; they are merely a group of people highly skilled at lobbying the State for favors.
• When inflation occurs, wealth is stolen from one group of people and transferred to another group of people, the people who print the new money and spend it first. Most new money is created by the financial industry, rather than by Federal deficit spending. Therefore, the primary beneficiary of money supply inflation is the financial industry insiders and not the government.
  

If this explanation is still too complicated, let me know. Once you understand the Compound Interest Paradox, a lot of economic problems are easier to understand. The Compound Interest Paradox is a key concept, and I agree that it should be my #1 most popular post by a wide margin.

I try to answer are serious reader questions. Pro-State trolls get annoying after awhile. Fortunately, most pro-State trolls get disgusted and leave. I'm continuing my policy of pointing out and ridiculing pro-State trolls.

How Collateralized Debt Obligations Work

By now, you've heard of the subprime mortgage lending problem.

Back in the 1980s, banks held mortgages themselves, instead of selling them to other investors. When interest rates shot up to 10% or more, a bunch of small banks suddenly found themselves insolvent. They owned mortgages that were only yielding 6% while they were borrowing at 10%-15% or more. Of course, only small banks were forced into bankruptcy. As usual, large banks had the capital base to withstand the crisis and survive until they were bailed out by a Federal Reserve interest rate cut.

Rather than fixing the fundamental structural flaw in debt based money, a different solution was proposed. Banks should sell mortgages immediately after issuing them. The problem was not the unsoundness of debt-based fiat money after the abandonment of the gold standard and skyrocketing interest rates (artificially raised by the Federal Reserve). The problem was that banks were subject to interest rate risk. Banks were borrowing at the short-term rate from depositors or the Federal Reserve. Banks were lending at the long-term rate. When the Federal Reserve is forced to jack up interest rates to prevent hyperinflation, this long term debt at a lower interest rate loses much of its value. This, combined with use of leverage, makes banks insolvent.

The solution is that, instead of keeping mortgages on their balance sheet, they are packaged into bonds and sold. However, mortgages are an inherently risky investment. There are three risks associated with a mortgage. The first risk is that interest rates will rise, making the long-term loan an unattractive investment. The second risk is that the debtor will default on his loan. The third risk is that interest rates will fall. When interest rates fall, all outstanding loans are worth more. However, if the debtor still has sound finances, he will refinance his mortgage at a lower rate. There's nothing that can be done about the first risk, but the other two can be alleviated with the invention of the "collateralized debt obligation" (CDO).

To reduce the risk, a bunch of mortgages are packaged into a single bond and sold. Typically, hundreds of thousands of mortgages are packaged into a single group of bonds. This means that there is zero scrutiny of the creditworthiness of individual debtors. However, the risk is not spread equally. The risk is divided into "tranches" A, B, and C. In the examples I read about, there were 3 tranches, but it could be any number.

The "A" tranche is the highest quality. The "B" is in the middle, and the "C" is the lowest. When defaults occur, the "C" tranche loses first, then "B", and finally "A". Similarly, if debtors choose to refinance, the "C" tranche takes the hit first, then "B", and finally "A".

Even when the economy is great, there are going to be a certain number of people who refinance because they move, or a certain number of defaults.

The "A" tranche gets a great credit rating. It can be purchased by insurance companies, who are required by law to invest in high-quality bonds. The "B" tranche is speculative. The "C" tranche is junk.

These mortgage bonds yield around 6% for the top tranche, 8%-10% for the middle, and 15% or more for the bottom tranche. Hedge funds will borrow at the Fed Funds Rate and buy these bonds. Their usual leverage trick enables them to earn huge profits.

That's another important point. Most of the hedge funds who buy these bonds are *NOT* taking a simple long position. They are taking a *LEVERAGED* long position in these bonds, with leverage ratios of 10x or more. When the price of the bonds crashed, they were unable to meet their margin calls. *EVERYONE* who bought these bonds was using leverage. When the hedge funds were forced to sell due to margin calls, there were no buyers. In fact, all the hedge funds were afraid to sell at all, lest all the other hedge funds be forced to "mark down to market". During the crash, if these bonds were fully marked down to their current market value, a huge number of banks and hedge funds would have been forced into bankruptcy.

The problem was extensive use of leverage *COMBINED* with defaults *COMBINED* with a sharp drop in market price. There were literally no buyers, because all of the potential buyers had already maximized their leverage.

The size of each tranche and the risk are calculated using complicated mathematical models. Under the assumption is that the defaults are uncorrelated, the "A" tranche has earned its great credit rating. Even though each individual mortgage may have a junk rating, the tranche structure shifts almost all the risk to the "C" tranche. According to the mathematical model, the "A" tranche has practically no risk.

Do you see the fallacy yet?

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The fallacy is the assumption that defaults are uncorrelated. Due to the Compound Interest Paradox, economic busts are inevitable. The weakest class of debtors is forced into bankruptcy during each bust phase. This time, the weakest class of debtors were people holding subprime mortgages.

The "A" tranche got an investment grade rating UNDER THE FALSE ASSUMPTION THAT DEFAULTS ARE UNCORRELATED. However, defaults *ARE* correlated. It's not because the debtors got stupid or lazy. A certain number of debt defaults ARE GUARANTEED BY THE RULES OF THE MONETARY SYSTEM. During *EACH* bust phase of the economic cycle, it is GUARANTEED that the weakest class of debtors is forced into bankruptcy.

Even though fancy and sophisticated models gave the "A" tranche of the CDO its investment grade rating, this was nonsense. The problem is that the "defaults are uncorrelated" assumption was WRONG.

With CDOs, banks no longer have any responsibility if a mortgage they issue goes bad. They are immediately selling the mortgage and liability to someone else. A bank is now merely a broker who collects a fee for issuing the mortgage and selling it. However, that is *NOT* the underlying problem. The problem is that the CDOs were structured under the false assumption that debtor defaults were uncorrelated. This, combined with extensive use of leverage, caused the crisis.

Banks also issued "mortgage insurance", guaranteeing the investment grade rating of the "A" tranche. If defaults were uncorrelated, this insurance would have been worth something. However, when a bunch of defaults occurred all at the same time, then the companies that issued mortgage insurance wound up going bankrupt.

The important point is that the CDOs were structured under the false assumption that defaults were uncorrelated. Due to the fundamental structural flaw in debt-based money, defaults ARE correlated. A debt crisis like this happens every 5-10 years. It is no accident. The rules of the monetary system *GUARANTEE* that such a crisis will periodically occur.

Naturally, people who buy CDOs are going to be a lot more cautious for awhile. The spread between the Fed Funds Rate and the rate charged on mortgages will increase to compensate. As one bubble bursts, another is being inflated. There *WILL* be another similar crisis in 3-5 years. You don't know where it will be until it occurs. From the point of view of the average person, by the time news of a popping bubble occurs, it's already too late to sell. Only insiders get to profit immensely from each boom/bust cycle.

The Yield Curve

Economists like to talk about the yield curve. Under "normal" circumstances, longer term Treasury Notes and Bonds have a higher yield. Superficially, this makes sense. A longer term bond is "riskier", and should therefore pay a higher yield.

An "inverted yield curve" is considered to be an indication of a coming recession. If you understand the Compound Interest Paradox, you'll understand why this happens periodically. During an economic bust, the money supply is contracting. The Federal Reserve must cut interest rates to prevent a deflationary crash of the money supply. During an economic boom, the money supply is expanding. The Federal Reserve must raise interest rates to prevent a hyperinflationary crash of the dollar.

I originally wrote this article in February 2008. In February 2008, the "yield curve" was, according to Yahoo Finance.

Fed Funds Rate	3.0%
3 month	2.2%
6 month	2.02%
2 year	1.9%
3 year	1.9%
5 year	2.68%
10 year	3.65%
30 year	4.45%

If you look at this chart, you can see the yield curve is decreasing until 2 year bonds, and increasing after that.

Currently, in May 2008, the "yield curve" is:

Fed Funds Rate	2.0%
3 month	1.6%
6 month	1.68%
2 year	2.24%
3 year	2.18%
5 year	2.96%
10 year	3.77%
30 year	4.42%

This is closer to a "normal" upward-sloping yield curve. The Fed Funds Rate is still more than the 3 month and 6 month Treasury rate, which indicates that further Fed Funds Rate cuts are expected.

When analyzing the yield curve, you must understand that Treasury Note/Bond yield will always approximately equal the expected average future Fed Funds Rate. In the above example for February 2008, the 3 month Treasury yield was 2.2%. This means that the expected average future Fed Funds Rate from February to May was approximately 2.2%. Looking back, this was approximately true.

Suppose the expected average future Fed Funds Rate was only 2%. In that case, a bank or hedge fund could profitably borrow at the Fed Funds Rate and buy 3 month Treasury Notes. Suppose the expected average future Fed Funds Rate was 2.5%. In that case, a bank or hedge fund would short sell 3 month Treasury Notes and loan the proceeds at the Fed Funds Rate. There are some transaction costs associated with borrowing and short selling, so the equality is approximate instead of exactly equal.

In other words, the shape of the yield curve is almost ENTIRELY determined by what the Federal Reserve is going to do in the future. An "inverted yield curve" merely indicates that the money supply is contracting and the Federal Reserve is going to be lowering interest rates. An "upward sloping yield curve" means the money supply is expanding and the Federal Reserve is going to be raising interest rates to "fight inflation". (Remember, when the Federal Reserve is "fighting inflation" it really is "decreasing the rate of inflation to stave off hyperinflation". Inflation is usually around 7%-15% or even 30%; the CPI dramatically understates the true inflation rate.)

Why is the normal shape of the yield curve upward sloping? Banks and hedge funds borrow at the Fed Funds Rate to buy Treasury Notes and Bonds. Longer-term bonds are more risky, because you don't know what the Federal Reserve is going to due in the future. This means that banks and hedge funds use less leverage when buying longer-term Treasury Bonds. Hence, the unleveraged yield on those bonds is higher.

Let's consider an example. Suppose the Fed Funds Rate were 5% and never expected to change. Banks and hedge funds want to earn a profit rate of 20% when they invest in Treasury Bonds. Suppose that a leverage ratio of 100x is allowed on 1 year Treasury Notes. In that case, the yield will be 5.20%. Banks borrow at 5% and buy a bond yielding 5.20%, for a profit of 0.20% * 100. Suppose that a leverage ratio of only 10x is allowed on 30 year Treasury Bonds. In that case, the yield will be 7%. Banks borrow at 5% and buy a bond yielding 7%, for a profit of 2% * 10. When you look at this example, it is obvious why the normal shape of the yield curve is upward sloping.

An inverted yield curve signals that the money supply may be contracting (or growing more slowly than usual). The CPI understates the true inflation rate. If you calculate GDP growth using money supply expansion, the US economy is barely growing or shrinking. In a recession, it isn't the economy that's shrinking; it's the money supply that's shrinking. Similarly, in a boom, it isn't the economy that's growing; it's the money supply that's growing.

Summarizing, Treasury Note/Bond prices are entirely determined by what the average Fed Funds Rate is expected to be in the future. If it were different, there would be an arbitrage opportunity for banks and hedge funds. An inverted yield curve means the Federal Reserve is going to have to cut interest rates, to avoid a hyperdeflationary crash of the dollar. A sharply increasing yield curve means the Federal Reserve is going to have to raise interest rates, to avoid hyperinflation. Under "normal" circumstances, the yield curve is upward-sloping, because banks and hedge funds are allowed to use larger leverage ratios when purchasing short-term debt compared to long-term debt

The shape of the yield curve can be *ENTIRELY* explained by expected future Fed Funds Rate changes.

The Robin Hood Story Corrected

The Robin Hood story, as usually told, is completely and utterly wrong. The saying is "Robin hood steals from the rich and gives to the poor." Let's play Overcoming Bias' "taboo your words" game.

Robin Hood steals from the people who are productive and gives to people who are not productive. This is Robin Hood as the evil State. Of course, this is not what the Robin Hood myth really means.

Robin Hood steals from people who use State violence to acquire wealth and gives to people who are victims of State violence. *THIS* is what Robin Hood actually did. Robin Hood *NEVER* stole from someone who acquired their wealth honestly. Robin Hood *ONLY* steals from rich people who acquired their wealth immorally via State violence.

In the present, 99%+ of the wealthy people acquired their wealth through State violence. The Robin Hood story is misrepresented *ON PURPOSE* so that people will confuse "stealing from the rich is acceptable" with "stealing from people via taxes is acceptable".