The Inflation Podcast

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Example 1:

Imagine a person making $50,000/year. Divide that by 12 and they earn $4,333/month. Back in July 2000, 22 years ago, the House Price to Income ratio was 4.5, so if you made $50,000 then a house would cost roughly $225,000. Average mortgage interest rates were 8.2%. Assuming you put down 20%, let’s run the numbers for a 30-year fixed rate mortgage. At an 8.2% interest rate, the monthly payment (principal and interest) is $1346. Assuming 1% annual taxes (so $2,250 per year, or $187 per month) and $750 per year for insurance, we are at $1597 for a monthly all-in. Is that affordable? Let’s look at what mortgage brokers use to qualify lenders: monthly housing expenses divided by gross (pretax) income. 1597 / 4333 = 36.8%. This is workable — lenders like to see this so-called “Debt-to-income” ratio as low as possible, but anything under 43% is allowed. If the person has any other debt to consider (student loans, car payment, credit card debt, other mortgages) that also has to be factored in. 

Example 2:

Okay, so let’s zoom forward to November 2021 and run the same calculation. Interest rates on 30-year fixed rate mortgages are around 3.1%. Houses have increased in value, both in absolute terms and, more importantly for this calculation, compared to incomes. The Home Price to Income Ratio went up from 4.5 to 7.5, so at the same income of $50,000 the house is now $375,000 but we have the lower rate — so let’s see how it plays out. One note — we now need $75,000 to put down rather than $45,000 before, but let’s assume we find that $30,000 somewhere. Okay:

Hooray, the loan is only $1,281 (principle and interest) so actually cheaper than the other one. I kept the insurance the same, $750/year, and kept the property tax at 1% of value, so $3,750 per year or $312.50 per month. All-in we are at $1,657, so $60 higher than the first example with the lower house price and a higher interest rate. Great! All’s well in the world. Now our debt/income ratio is 38.2% instead of 36.8%, but we can still get a mortgage and get on with our lives. 

Example 3:

And how does it look now, 8 months later, with rates at 5.73% (today’s average rate) and Home Price to Income Ratio at 8? 

Our house now costs $400,000 and we need another $5,000 to put down (80K total), and just the loan costs $1,863. With taxes and insurance, our all-in is now above $2,000, at $2,259. This represents a 52.1% debt/income ratio, and it’s going to be nearly impossible to get a loan at this amount. Remember, this is pretax, and lenders want you to have some room in your budget for non-housing expenses, like, you know, food. 

Links: 

https://www.weforum.org/agenda/2019/04/50-years-of-us-wages-in-one-chart (mentioned) 

https://www.numbeo.com/property-investment/rankings_by_country.jsp?title=2022-mid&displayColumn=0

https://www.longtermtrends.net/home-price-median-annual-income-ratio/

https://fred.stlouisfed.org/series/MORTGAGE30US

https://www.cnbc.com/2022/06/30/housing-shortage-starts-easing-as-listings-surge-in-june.html

Yesterday the Bureau of Labor Statistics issued the June CPI numbers.

We are now running at an annual inflation rate of 9.1%, up from 8.6% last month. This is the largest 12-month increase since November 1981. The BLS defined the increase as broad-based, with energy, shelter and food being the biggest contributors.

Energy

The energy index rose 7.5% overall after rising 3.9% in May. gasoline 11.2%, natural gas at 8.2%. Electricity index also rose 1.7%. The energy index overall rose 41.6% for the year, with gas rising

Shelter

The shelter index increased 0.6% in June, as it did in May. Rent index rose 0.8%, and owner’s equivalent rent rose 0.7%. Lodging away from home (hotels and such) actually fell 2.8% in June after a string of increases in recent months.

Food

The food index rose 1% in June, the sixth consecutive increase of at least 1% in that index. Food away from home rose 0.9%. The only major grocery group to decline in June was the index for meats, poultry, fish and eggs which fell 0.4%.

Overall, food at home rose 12.2% over the last 12 months.

CPI

To review, the bulk of the CPI is made up of Shelter (32%), Commodities (21.2%) like apparel, new/used vehicles, alcohol, tobacco, Food (13.4%), Energy (8.6%), Medical Services (6.8%) and transportation services (5.8%)

My main take away is that the longer this elevated inflation continues, the longer it will continue. Anyone not asking for a significant, 8-10% raise from their employer at this point is effectively getting a pay cut. Eventually people are going to take their financial lives in their own hands, and when they do, I think it’s going to lead to a wage-price spiral where people get raises, but everything becomes more expensive because everyone is getting raises just to keep up.

The Fed now knows it needs to act, and it needs to act quick. So what are the likely results from this higher-than-expected inflation print? It will likely lead the Fed to a 75-100 basis point (fancy way for saying .75% or 1%) federal funds rate hike in at the July FOMC (Federal Open Market Committee) meeting. This is pretty significant — the current federal funds rate is 1.5%-1.75% (it’s set as a range between an upper limit and a lower limit) so with an increase of 75-100 basis points it would go up to 2.25-2.5% or 2.5-2.75 depending on how aggressive they choose to be. 

The popular viewpoint at the moment is that the fed will continue tightening until they “break something,” and then they will ease up. A bit of historical context here might be helpful.

For the last 20 years we have had both historically low interest rates and quite low inflation. Post financial crisis in 2008 they had many years of 0% rates (which was a first at the time), until 2015. When they tried to raise rates up to 2.5% in the period of time from 2015 to 2019, the hiking cycle was cut short when the economy was showing signs of stress.

The Fed has what they call a “dual mandate” which is 1. Stable Prices and 2. Full employment. They really shouldn’t be concerned about asset prices (real estate, the stock market, etc.) but they have started to be more and more influenced by the markets.

In the covid period, The Fed responded by moving rates back down to zero, by resuming Quantitative Easing, by sending out stimulus checks and increasing the amount of unemployment, pausing student loan payments, and that sort of thing.

Links:

BLS.gov news release

https://www.bls.gov/news.release/pdf/cpi.pdf

Reuters

https://www.reuters.com/business/past-fed-hiking-cycles-sanguine-severe-may-say-little-about-this-one-2022-03-17/

Brookings:

https://www.brookings.edu/research/fed-response-to-covid19/

You may have have heard the term Greedflation floating around lately. What is “Greedflation,” where did it come from, and are there merits to the idea? In this episode we will be looking at a NY times article by Linda DePillis called “Is Greedflation Rewriting Economics, or do Old Rules Still Apply?” A link to the article is in the show notes. 

From the article:

Since prices started to escalate a year ago, politicians and economists have seized on inflation to tell their preferred story about what went wrong, and what policies would bring it back into line. Some say it’s very straightforward: Supply and demand, Economics 101.

The White House and progressive organizations, however, say wait a minute: This time is different.

In a time of extraordinary disruption, they contend, increasingly dominant corporations are taking the opportunity to jack up prices more than they otherwise could, which is squeezing consumers and supercharging inflation. Or “greedflation,” as the hypothesis has come to be known.

Robert Reich, former secretary of labor and Berkeley professor, just tweeted (and got 10K retweets):

“Let’s be clear: inflation is being driven in large part by monopolies that are driving up prices for the sake of profit.  

On the other side, we have Lyn Alden, a prominent macro commentator and investment strategist with a finance and engineering background:

For people saying that “corporate greed” is the main cause of inflation… corporations are always greedy. They didn’t randomly get more greedy in 2022. A lot of broad currency was created in a short period of time while real supplies (commodities, infrastructure) were limited.

You can probably guess which side of the argument I land on. In my opinion, Whenever prices go up, there is always one or two unhappy people who say “we need to do something about “”Price Gouging”” with serious looks on their faces. But they never get very far with this argument, because the market sets prices and any effort to have the government set prices has always led to inefficiencies and shortages. When no one supports your policy or idea, it’s time to move on. And if you don’t want to move on, it’s time to change the name. I think that's what we're seeing here with Greedflation. But we have to give this argument a full chance, so I’ll read a portion of this article and analyze it. 

Links:

1.  Is "Greedflation" rewriting economics, or do the old rules still apply? https://www.nytimes.com/2022/06/03/business/economy/price-gouging-inflation.html?searchResultPosition=1 

by Lydia DePillis, @lydiadepillis

2. https://twitter.com/RBReich/status/1538283894901862400?s=20&t=n_mCEoOPv-4bjzLDVv0XJQ

@RBReich

3. https://twitter.com/LynAldenContact/status/1533210428238614529?s=20&t=n_mCEoOPv-4bjzLDVv0XJQ

@LynAldenContact

4. Tyson Foods earnings call: 

https://www.fool.com/earnings/call-transcripts/2022/02/07/tyson-foods-tsn-q1-2022-earnings-call-transcript/

5. "Corporate Profiteering" PDF with transcripts of earnings calls: 

https://groundworkcollaborative.org/wp-content/uploads/2022/06/RESEARCH-Corporate-Profiteering-Findings-22.06.08.pdf

Other Mentions:

Michael Faulkender

John Zhang

Donnie King

Brett Briggs

Samim Bassul

Today Nicolás Águila will be joining us from Germany. Nicolas is a doctoral researcher in Economics (@nicolasaaguila) at the Unizersitat Witten in Germany. He co-authored a paper with Juan M. Grana in the International Review of Applied Economics called “Not All Zombies are Created Equal."

https://www.tandfonline.com/doi/full/10.1080/02692171.2022.2045911

He also co-authored a more conversational article in Jacobin discussing Zombie companies which I will link to. It’s called “The Rise of Zombie Firms Risks Another Disastrous Crisis”.

https://jacobin.com/2022/05/zombie-firms-neoliberalism-debt-productivity-crisis

What are Zombie companies?
Firms that can’t make enough profits to even cover the debt payment on their interest. The phenomenon started in the mid 1960s and then skyrocketed in the beginning of the 1980s. There are two types of Zombie companies, making up around 40% of firms in the United States.
1. Negative profitability even before the payment of interest
2. Negative profitability only after payment of interest.

The share of Zombies, on the whole, is increasing in the economy and may be a reason for stagnation.

How do they manage to survive?
They manage to get more debt to pay back their existing debt, or to sell off some of their equity.

Why are firms investing in these unproductive businesses?
Some zombies are startups that we wouldn’t expect to be profitable (Uber, for example) — but as a startup gets older it should start to show some profitability. Some won’t (Theranos, WeWork) but some will. Others are retailers like Macy’s that investors think may become profitable one the future. Some, like Boing, have a great history.
Another reason is because of the financial context of the past decade with lots of credit, liquidity and low interest rates. This can prop up some sketchy firms.

Will this crisis be as big as the Great Financial Crisis of 2007/2008?
Nicolás is worried this is a much bigger problem than most people think, and that the results could be way bigger than the recession in 2007/2008. He thinks we need to be very careful about how we plan for the potential tsunami of bankruptcies to come. He recommends a government jobs guarantee as a buffer against the unemployment crisis to come. He hopes for eventual transitioning of these employees to the private sector, once the private sector begins to heal.

Could the U.S. itself be considered a Zombie Company?
No — the US’s debts are always denominated in dollars so it can always issue more of its own currency to pay its debt —so it always has an escape hatch. The crises in other parts of the world (Global South, for example) will probably lead to a flocking to the dollar, also, which will make it easier than ever to sell their bonds. They can just inflate the debt away, which Ray Dalio and Lyn Alden have mentioned recently. He also said that the flight to safety from countries in the global south will likely lead to

What does Nicolas think about Bitcoin adoption?
El Salvador has suffered a lot with the collapse of crypto, and this should give a clear warning sign to other countries. Central bank digital currencies may have a future, but he’s not an expert and didn’t want to speak too much on it.

The Crisis

Sri Lanka has recently fell into default for the first time in history (since it’s independence in 1948) as the government is struggling to halt a full-scale economic meltdown. 22 Million people live in the Southeast Asian island nation officially known as the Democratic Socialist Republic of Sri Lanka.

The government recently missed a $78 million interest payment, even after the 30-day grace period. There is a $105 million payment to China that is also late and its grace period is approaching. They currently owe $25 billion to foreign creditors but cannot pay them. $7 billion is payable this year, and the rest, with interest, is due by 2026 under current terms.

They have recently announced that they are halting scheduled debt payments on a whole pile of foreign liabilities to preserve cash for essential goods like food and fuel. They currently have 5 days worth of fuel, and are waiting on a $500 million credit line for fuel from India. India has been a key supporter during this crisis, having poured in about $3B in assistance. The United Nations plans on pledging $48 million, which is will last Sri Lanka roughly 2 weeks according to their own estimates.

Announcing you’re not going to pay your debts usually doesn’t do wonders for your credit rating, or your cost of borrowing money. A year ago, Sri Lankan 10-year bonds were yielding 8.5%. Today they are at 21.3%. It’s getting harder and harder to borrow money for Sri Lanka, but they have few other options as they have spent through their reserves. At the end of 2019 they had $7.6B in reserves , declining to $5.7B by the end of 2020, $3.1B by the end of 2021 and $0.05B now, or $50 Million.

Besides India, Sri Lanka’s best option is the IMF. As of last week, Sri Lanka’s government is seeking $6 billion to keep the country afloat for the next six months. This was increased from the $5 billion the finance minister Mr. Wickremsinghe told parliament that he would be asking the IMF for:

$3.3 billion for fuel imports

$900 million for food

$600 million for Fertilizer

$250 million for cooking gas. 

Inflation

Sri Lanka has recently experienced high inflation (33.8% officially for April), which is only increasing, —39.1% for May, and likely over 40% currently. Food prices in Colombo, it’s largest city, have raised by 57.4% in May.

The government has also increased their Value Added Tax (VAT) by 50%, from 8% to 12%. Their corporate taxes are also increasing from 24% to 30%.

The Rajapaksa Family

The Rajapaksa family has been a powerhouse in Sri Lanka for decades and they are being blamed for many of the policies that have led to this crisis. Mahinda Rajapaksa, the former Prime Minister, resigned last month, and his brother Basil just resigned yesterday.

A state-run power entity, the Ceylon (salon) Electricity Board (CEB) has been planning a strike soon that, if enacted, will create blackouts. They recently agreed with the president to temporarily call off the strike, but meanwhile the capitol has still been experiencing rolling blackouts.

How did it get this bad?

1. Fertilizer Ban

2. 2019 Terrorism and Covid reducing tourism

3. Poorly timed tax cuts

4. Unnecessary infrastructure projects

5. General corruption and mismanagement

Sources:

https://www.reuters.com/markets/commodities/fertiliser-ban-decimates-sri-lankan-crops-government-popularity-ebbs-2022-03-03/

https://www.business-standard.com/article/opinion/is-sri-lanka-the-next-argentina-122040401320_1.html

https://www.nytimes.com/2018/06/25/world/asia/china-sri-lanka-port.html

Ben Bernanke recently wrote a guest essay in the New York Times where he compared the current inflation situation to the 1960s and 1970s inflation episode, which he called "The Great Inflation". Mr. Bernanke explained what he saw as the differences and similarities to our current inflation, and how we are "almost certainly not" going to repeat that experience. 

His argument seems to hinge on two facts:

1.) The Fed currently has much more policy independence than it had in the 1960s and 1970s, so they will be able to do their job more effectively without presidents or Congress trying to meddle with their mandate, and;

2.) The American public has more confidence in the Fed keeping long-term inflation rates down, which makes us less vulnerable to a wage-price spiral which would keep inflation higher for longer. 

With regards to the Fed's independence, I think that the Fed hasn't seen pressure from the President or Congress lately because their policy has been historically accommodative. The Federal Funds rate is at an almost all-time low while inflation is at 40-year highs. Back in "The Great Inflation" as Bernanke is fond of calling it, the Federal Funds Rate was between 4% and 8% during the times when the Fed and other policymakers butted heads. As interest rates rise, and the economic stakes rise, I don't know if we can count on the better angels of the President and of Congress to continue to respect the Fed's mandate. 

As far as a wage-price spiral, we have a very strong labor market, and those labor market participants aren't going to not ask for compensatory raises to offset inflation because they believe in a vague way that the Fed is going to reign in inflation. They are more concerned with paying their bills now -- and with two job openings for every job seeker right now, employees are in the catbird seat for compensation negotiations. Ask yourself: would you be happy with a 3% raise this year? 

Links:

Op-Ed:

https://www.nytimes.com/2022/06/14/opinion/inflation-stagflation-economy.html

https://www.richmondfed.org/publications/research/econ_focus/2016/q3-4/federal_reserve

Graph of Federal Funds Rate:

https://www.macrotrends.net/2015/fed-funds-rate-historical-chart

US BLS Job Openings:

https://www.bls.gov/charts/job-openings-and-labor-turnover/unemp-per-job-opening.htm

The Balance, Fed Funds Rate History:

https://www.thebalance.com/fed-funds-rate-history-highs-lows-3306135

For this episode I'm reading selections of two reports -- The World Bank's June 2022 Economic Prospects Report and David Wilcox's "The case for a cautiously optimistic outlook for US inflation." Links to both reports are at the end of the show notes. 

Economic Prospects Report

The global economy is in the midst of a sharp growth slowdown following the extraordinarily strong rebound last year. This slowdown coincides with a steep run-up in global inflation to multi-decade highs. Looking ahead, growth over the next decade is expected to be considerably weaker than over the past two decades. Although global inflation is for now projected to return close to its 2019 average by 2024, there is a growing risk that it may remain elevated as global supply disruptions persist and some structural drivers that depressed inflation over the past three decades dissipate.

These developments raise concerns about stagflation—a period of both weak growth and elevated inflation similar to what happened during the 1970s. The experience of the 1970s is a reminder of the damage this could cause to the global economy and, especially, to emerging market and developing economies (EMDEs). The stagflation of the 1970s ended with a global recession and a series of financial crises in EMDEs.

There has been considerable debate about current stagflation risks. Some researchers have warned that the recent surge in inflation around the world could mark a permanent ratcheting up of price pressures after two decades of low and stable inflation. Some have also noted parallels between the current episode and the stagflation of the 1970s, including similarly negative real interest rates in both periods and the possibility of a wage/price spiral set off by rapid wage growth (Blanchard 2022; Summers 2022). However, others have pointed to material differences from the 1970s, especially in the conduct of monetary policy, which may help prevent another bout of stagflation: the inflation-fighting credentials accumulated since the 1980s and recent evidence of broadly stable long-term inflation expectations (Wilcox 2022).

This edition of the Global Economic Prospects report offers the first systematic assessment of how current global economic conditions compare with the era of stagflation of the 1970s—with a particular emphasis on how stagflation could affect developing economies. The insights are sobering: the interest rate increases that were required to control inflation at the end of the 1970s were so steep that they touched off a global recession, along with a string of debt crises in developing economies, ushering in a “last decade” in some of them.

The danger of stagflation is considerable today. Between 2021 and 2024, global growth is projected to have slowed by 2.7 percentage points -- more than twice the deceleration between 1976 and 1979. Subdued growth will likely persist throughout the decade because of weak investment in most of the world. 

Links:

World Bank Global Economic Prospects Report:

https://openknowledge.worldbank.org/bitstream/handle/10986/37224/9781464818431.pdf

David Wilcox's Report (Peterson Institute for International Economics), "The case for a cautiously optimistic outlook for US inflation"

https://www.piie.com/publications/policy-briefs/case-cautiously-optimistic-outlook-us-inflation

Cleveland Fed Inflation Expectations:

https://www.clevelandfed.org/our-research/indicators-and-data/inflation-expectations.aspx

My Twitter Thread with questions for David Wilcox:

https://twitter.com/InflationPod/status/1536072114742124545?s=20&t=G5-WlEU0xGYPQqXb9RqWKQ

Inflation was expected to “remain elevated” ahead of today’s announcement, but instead it roared ahead to a 40-year high to 8.6% from 8.3% last month.

Groceries are up 11.9% year-on-year, gas is up 48.7%.

For the last few months, we have March: 8.5%; April 8.3%, May: 8.6%.

Analysts were hoping that that the 8.5% in March was going to be the all-time high and we were going to taper from there, but it’s looking like we may not have even topped out yet.

Also, it’s worth noting that prior to 1980, the CPI was simply the cost of a basket of goods. Now we have substitutions, Owner’s Equivalent Rent, and adjustments for quality improvements which, in my mind, are questionable. 

Trueflation is reporting just under 10.75% for the last 12 months (https://app.truflation.com/) 

It’s going to be painful to reverse this inflation, because debt loads are higher than they were the last time we saw inflation this high in the 1970s and 1980s. Back then the rates for 10-year T bills had to be raised to 15% to finally tame inflation. Now we think that raising them to 3% is going to do the trick? I think people are in for a big surprise.

The next issue is that our Debt/GDP is much higher now than it was in the 1970s. Can you imagine the balance on your mortgage going up at the same time as your interest rate was increasing from 3% to, say, 9%? Another bitter pill.

In March 2022, total receipts for the government were $315 Billion and net interest was $43 Billion. That’s 13.6% of the taxes collected going to debt service. This is at a borrowing cost of ~1.6%. If the borrowing cost increases to 5%, nearly half of our national income will be going towards debt service. In order to snap out of this current inflation, we need to embrace some sort of austerity while simultaneously raising interest rates and slowing the economy down. This is a bitter pill to swallow, and I don’t think we’ll do it.

Global Sovereign Debt

https://www.cnbc.com/2022/04/06/global-government-debt-set-to-soar-to-record-71-trillion-this-year-research.html#:~:text=Global%20government%20debt%20jumped%207.8,1.6%25%2C%20the%20report%20said.

“Even if politicians were to attempt to take the pure austerity route and cut spending programs and let system-wide defaults happen, the economy gets more and more painful, and after a few years, people vote those politicians out of office in favor of politicians promising stimulus.”

How much retirement savings does a person need to retire safely, making sure they don’t run out of money?

As someone with relatively simple tastes and I’ve always imagined that with a nest egg of a couple million dollars I wouldn’t have trouble retiring without touching the principal. I came to this conclusion by using the 4% rule — a conservative investing rule that seems more like a rule of the universe than any specific thing someone came up with. But there is, of course, a history to the 4% rule.

The History of The 4% Rule

William Bengan, a financial advisor, first devised the 4% retirement rule in 1994. Since then it has been in the air as a fairly cautious approach to retirement spending. According to his original paper (linked below) withdrawing 4% of your portfolio (adjusted for inflation, so starting with 4% and increasing distributions slightly each year to adjust) would have protected retirees from running out of money during every 30-year period since 1926, even considering the Great Depression.

The 4% rule dictates that you should able to safely withdraw 4% from a 50% stock / 50% bonds retirement portfolio without risking the principle too much. So the 4% rule has typically been thought of as a safe, conservative drawdown strategy to aim for, but if you needed to, you could probably let your withdrawals creep up to 5% or so. Here’s the theory:

Historical Yields of SP500, DOW and Bonds

Stocks have historically yielded between 8-10%. SP500 has yielded an average annual return of 10.49% since its inception in 1957 (it actually existed in some form, only 90 stocks originally, as far back as 1926, but we won’t go there). The Dow Jones has yielded an AAR of 7.75% in the last hundred years (since 1921) without adjusting for dividends, which is currently yielding 1.81% because of some big dividends yielders like IBM, Verizon and 3M. So that nets out to 9.56% for the DOW. Let’s take the lower of these two and call stock performance 9.5% on average.

Bonds are trickier to calculate. We have been in a declining bond yield environment for 38 years — (bonds were paying 13.75% in 1984). I downloaded a historical 10 year treasury 54-year historical dataset and ran the average, which came in at 5.9%. If we use a shorter average (we have the data set, why not), for the last 20 years we get 2.92%. They are currently paying 3.04%. So let’s use 3% which seems fair.

Now that we have our historical rates of return, let’s figure out what our hypothetical $2,000,000 nest egg will earn us.

The 4% Rule In Action

We’ve divided our portfolio into 50% stocks and 50% bonds, so we can easily average 3% and 9.5% and get 6.25%. 6.25% will earn us $62,500 per million in the bank, so our hypothetical retirement portfolio should increase by $125,000 per year without us touching it. But, of course, we do want to touch it. We need it to produce enough income to live on. Recent census data shows that the median retirement income in 2021 for retirees 65 and older is $47,357. The 4% rule dictates that we can withdraw $40,000 per million, or $80,000 per year, safely from out $2,000,000 portfolio. Great! That doesn’t even account for social security income or any other income we might have in retirement. With this calculation we have a 2.25% margin of safety, too, which should allow our investments to continue to grow as the cost of living increases, or if there are any unexpected extra expenses.

Links:

The DOW Jones

https://indexarb.com/dividendYieldSorteddj.html

https://tradingninvestment.com/stock-market-historical-returns/

Bonds

https://fred.stlouisfed.org/series/DGS10

https://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart

Bill Bengan Paper:

https://www.retailinvestor.org/pdf/Bengen1.pdf

Episode 2: Why are gas prices getting so high? Will we see $10 gasoline?

Gasoline is something that economists call a relatively inelastic product, meaning that changes in price have little influence on demand, at least in the short term. This makes sense, as much travel isn’t discretionary (commuting, etc.). In contrast, air travel is highly elastic, with a 10% increase in the price of air travel leading to an around 12% reduction in the demand for air travel. With car gasoline purchases it is closer to 3.4% reduction for a 10% increase. There has been some recent data suggesting it’s becoming more elastic, but now we’re getting into the weeds.

So, what this is all getting to is that when gas gets more expensive, people still have to buy it in the same quantities, for the most part.

How much more expensive has gas become?

As of recording, the average gas price in the USA is $4.85 cents per gallon for regular and $5.63 per gallon for diesel. The most expensive state is California at $6.33 per gallon.

A year ago, regular gasoline was $3.05 average in the nation and $4.22 in California. That represents a 59% increase YoY.

What causes the state’s variation in prices?

Some states tax gas more heavily than others — California for example has a 61 cents per gallon tax, whereas Alaska only charges 14.6 cents per gallon. There is also a federal tax of 18.4 cents per gallon. The distance to a refinery also makes a difference, because that gas at the gas station has to be hauled in, one way or another. Some states (such as CA) also have certain blend requirements that can also drive up price.

Okay, so what can the government do about it?

Lyn Alden is one of the clear voices on inflation and macroeconomics that I follow. She has been saying lately that the government can print money, but they can’t print oil.

In the last episode we heard from President Biden that he announced on March 31st that he would be releasing 1MM barrels a day from the nation’s Strategic Petroleum Reserve. This will be the biggest withdrawal in the 46-year history of the reserve. In this speech Biden also blamed oil companies for leaving drilling prospects idle — this doesn’t make a ton of sense because his administration recently announced (after his March 31st speech) that the Biden Administration will not hold a lease sale for offshore drilling this year. They are also letting a 5-year plan for offshore drilling expire next month.

This prompted Frank Macchiarola Match-E-Roll-A of the American Petroleum Institute to respond: “Unfortunately this is becoming a pattern— the administration talks about the need for more supply and acts to restrict it. As geopolitical volatility and global energy prices continue to rise, we again urge the administration to end the uncertainty and immediately act on a new five-year program for federal offshore leasing.”

Links:

AAA Gas Prices: https://gasprices.aaa.com/

Strategic Petroleum Reserve: http://www.spr.doe.gov/dir/dir.html

DOE Strategic Petroleum Reserve Fact Sheet: https://www.energy.gov/fecm/strategic-petroleum-reserve-9

Air travel price elasticity of demand (IATA): https://www.iata.org/en/iata-repository/publications/economic-reports/air-travel-demand/

https://divestmentdatabase.org/

https://www.bloomberg.com/news/articles/2022-06-01/uk-windfall-tax-hits-north-sea-focused-oil-firm-valuations#:~:text=The%20UK%20government%20announced%20May,commit%20to%20fresh%20capital%20expenditure.

https://www.marketwatch.com/investing/future/brn00?countrycode=uk

https://www.wsj.com/articles/a-decade-in-which-fracking-rocked-the-oil-world-11576630807

On May 31st Joe Biden wrote an op-ed for the Wall Street Journal titled: "My Plan for Fighting Inflation: I won't meddle with the Fed, but I will tackle high prices while guiding the economy's transition to stable and steady growth." I think it's important to read this op-ed to see where the administration is thinking is regarding inflation and how much of a priority they are going to make lowering it.