Oil >>> Gas Prices, It’s Starting

Big Red Car here. It’s beginning to happen. I told you it would.

Here is a picture from Michigan showing gasoline prices dipping to lower than $1/gallon.

Note it is a “price war” and that isn’t the exact same thing as the entire country.

Remember two anecdotes do not a trend make nor a database. But it IS a start.

But, hey, what the Hell do I really know anyway? I’m just a Big Red Car. Gas prices. Low gas prices. It’s what’s for breakfast.

  • Strong dollar will make gas prices even lower. If the Fed raises another .25, corporations will hate it by the general public will love it.

    • sigmaalgebra

      PnF, explain it to someone who wants to learn: Why is the dollar so strong? E.g., Wal-Mart takes dollars and buys stuff from China. At some point the Chinese swap the dollars for Yuan on the foreign exchange market (FX). So, dollars get sold, and the value should come down. With a big trade deficit, dollars should keep coming down.

      Okay, if believe Trump, then the Chinese manipulate their currency, that is, decree and declare that it will be cheap so that they can have a price advantage on the shelves at Wal-Mart. But, when the dollar is high,its high for Yen, Pounds Sterling, the Euro, and everything else, and tough to think that the US has a trade surplus with the countries of all of those currencies.

      Also, who the heck wants to hold dollars with interest rates so low? So, no holding dollars should make dollars weaker in FX, not stronger.

      Okay, politically and economically the US is relatively stable and, thus, less likely than some banana republic to darkest African country to print money until its worthless, but can that be the main reason the dollar is high?

      • It’s not an easy explanation, but I will give it a try. This is highly simplified.

        1. The value of the US dollar is expressed in terms of it’s value relative to other currencies. Dollar/Yen, Dollar/Euro, Dollar/Swiss etc. There are also exchange rates between those currencies: Yen/Euro etc. Think of it as the combination of x currencies x ways. C (X, X). It becomes a big matrix. Obviously, if the Thai Baht moves against the dollar one way or another, it doesn’t have the same impact as the Euro. So, the dollar is also more sensitive to major currencies versus less major ones.

        2. Interest rates also determine the value of native currency because they change demand for it. If a nation decides to increase rates, it decreases the amount of float a currency has because some of it will be invested in the interest bearing instrument. (Right now, the US has the highest interest rates of any developed economy, which changes demand at the margin) If a country raises interest rates, it makes their currency stronger relative to other currencies because there should be less of it in the market.

        3. Forex markets determine the value of the currencies relative to every other currency. These markets are huge, trillions trade hands overnight.

        4. The US Dollar is the world’s reserve currency, which gives it value over every other currency. You can use dollars in almost every country in the world. I have heard in Argentina, they will give you pretty big discounts if you use US Dollars (not credit, real paper money) to pay over their indigenous Peso.

        5. Central banks use other operations besides interest rates to control and help set the value of their currency. For example, if they do overnight matched sales, they are sopping up extra money and increasing the value. If they do overnight repos, they are releasing money out into the market. Matched sales are Feds selling treasuries-member banks buy them with currency and it takes currency out of the market. Repos are the opposite, purchases of treasuries that infuse the market with currency.

        That’s the bare bones basics on how currency value is set.

        Let’s look at the specific examples you cite in your comment.

        1. Walmart contracts to some Chinese supplier for goods. The Chinese value these goods in Yuan. Let’s assume that they get all the raw materials from Chinese suppliers that deal in Yuan. Walmart carries these goods on their balance sheet in terms of US dollars. There is a dollar/yuan peg that theoretically doesn’t fluctuate outside of an upward and downward band.

        But, because of the currency discrepancy, there is risk. If the value of the dollar plunges relative to the Yuan, Walmart has to pay more for the goods at delivery than they negotiated. On the flip side, if the dollar gets strong, the Chinese supplier loses, because the trade is going to be consummated in USD, not Yuan.

        That’s why Forex markets exist-so these guys can hedge away the risk. The market is so big that there are always two sides to the market. It’s hyper liquid, meaning even seemingly large transactions don’t bump it up or down too much. Even if the Chinese manufacturers sell a lot of Yuan and buy dollars, there are just as many people buying yuan. When it gets imbalanced, the Chinese central bank steps in and puts things where they want them because of the transparent dollar/yuan peg.

        The US will always have a trade deficit as long as the cost to manufacture goods and ship back to the US is lower than it is to manufacture goods inside the US. It’s really no big deal if you think about classical economics. We don’t care where the goods are made, as long as they are of the quality we want and at the price we want. Assuming there are plenty of substitutes, one single source can’t monopolize the good so the elasticity of supply is not steep.

        Ironically, if I was a big Chinese supplier that had existing business; I’d be FOR a tariff because I could use it to stop competitors. See how Toyota and Nissan used quotas and tariffs in their favor to crush GM, Ford and all their other competitors.

        Trump says the Chinese manipulate their currency. They do! They manipulate everything. They manipulate their stock market, their economic figures and virtually everything. There are no individual rights in China, and no property rights. They are a centrally planned communist nation that has embraced some facets of capitalism to grow. Because they are trading so with the world, it stands to reason that demand for their currency should be higher-which increases the value of it. Additionally, internally their costs of production (primarily labor) have increased exponentially too. Vietnam now does a lot of the manufacturing that China did.

        Who wants to hold US dollars at these prices? You and I find it stupid, but someone in Argentina or Venezuela doesn’t. Additionally, due to increased capital requirements the Big Banks have to carry more capital on their balance sheets. That means they hold US dollars or US Treasuries.

        If we think in terms of what a US Dollar can do at the margin, it’s also insightful. A USD can be invested in US Treasuries, Foreign Debt, Corporate Debt, Muni Debt, Stocks, Real Estate (Domestic and foreign), Private Equity, Startups. There are costs/opportunity costs to each. If I am uncertain, the safest most liquid place to put it is in UST. I know that I am getting a poor return, but I also know I am not going to lose anything relative to what I could lose in other asset classes.

        When governments increase the amount of money they spend, they crowd out dollars from entering the market. When they increase regulations, taxes etc, they make the cost of investment and the realized return one needs higher (higher hurdle rates). That also pushes dollars into the Treasury market.

        Trump is very wrong on trade. Rubio was correct when he said the US consumer pays the tariff. This is also true with corporate income tax which is why the optimal rate for Corp tax is 0%.

        What domestic policy should be doing is figuring out how to decrease the cost of labor in the US to change the costs/opportunity costs of manufacturing overseas. But, they need to do it without increasing taxes and tariffs. They need to be looking at unions, workman’s comp, payroll taxes and other regulations that would make US labor cheaper. It’s not a race to the bottom either, because US citizens have free will. They can always choose not to work-which is why we need to figure out how to liberalize lots of laws and regulations for starting your own business.

        • JLM

          Please send an address for the tuition checks. Wow! What a lesson. Thank you, JC.


        • sigmaalgebra

          Thanks, I needed that! A keeper; I kept it.

          I don’t know in any realistic detail what the heck Trump wants to do with trade negotiations, tariffs, taxes, the deficit, interest rates, employment, or economic growth.

          He’s not being clear, but his opponents do not have good criticisms of what Trump has said, and their proposals are even much less detailed and impressive than Trump’s.

          Trump would never sign a development contract nearly as loose and unspecific as what he is asking the US voters to sign with him.

          So, maybe Trump is the best candidate because among all the candidates running he is the least bad candidate.

          It looks like Trump will win the White House without being more clear. It’s as if he is asking us just to trust him, that he will do for the US economy what he did for the Wollman Skating Rink, find some good people and let them do a good job.

          On foreign exchange, you reminded me of an old idea: Look at the entries in that matrix you mentioned, set up a directed graph with one node for each currency and a directed arc from each currency to each other currency. Except for the main diagonal of the matrix, each component in the matrix gives the ‘cost’ of shipping ‘one unit of flow’ on that arc.

          Then have two more nodes, a ‘source’ node and a ‘sink’ node.

          From the source node there is an arc to each currency node, and from each currency node there is an arc to the sink node.

          The arcs can have capacities, say, positive integers.

          So, the problem is to say how to run one unit of flow from the source node to the destination node to minimize the cost or maximize the profit.

          This problem is linear programming. The classic simplex algorithm solves it nicely. With integer arc capacities, the algorithm, at no extra effort, solves the integer linear programming version — and is one of the main sources of integer linear programming problems where we know how to get a solution efficiently.

          What the simplex algorithm does on such a network is special: Each basic solution corresponds to a spanning tree of arcs on the network. A simplex iteration consists of evaluating arcs not in the spanning tree, and there is a fast way to do that, picking an arc that will make money, adding that arc to the tree so that there is now a circuit, and running flow around that circuit to make money until the flow on some arc hits zero. The arc with flow hitting zero is removed leaving a spanning tree again.

          With a modification due to W. Cunningham, one of my grad school profs, later chair at the important Department of Combinatorics and Optimization at Waterloo, the simplex algorithm has some good guaranteed properties.

          E.g., if have a spanning tree and see no way to make money by adding an arc to the tree, then, with a Cunningham result there will be no way to make money with any other spanning tree or any arbitrage. Nice result.

          If someone, say, swaps a lot of dollars for Yen and, thus, the two corresponding components of the matrix change, then there may be arbitrage opportunities.

          Maybe there is a theorem that, if there is such an arbitrage opportunity, then there must also be one involving no more than three currencies, e.g., trade dollars for Yen, trade Yen for Euros, and trade Euros for dollars. But no such result is in the usual theory of the simplex algorithm on networks.

          The simplex algorithm on a network of only 100 or so nodes and 10,000 or so arcs is blindingly fast and in an obvious way can be made much faster with quite a lot of parallelism.

          I hate to say knowing so little, but it sounds like need to pull down the values of all 10,000 or so components of that matrix each few milliseconds, run the algorithm, find a trade, and execute it right away — maybe.

          That is, if swap a lot of dollars for Yen, then for, say, a second or so, should change the two corresponding components of the matrix. If that is all that is changed, then maybe there are arbitrage opportunities until some, many, most, or all the matrix components change. That change stands to be from an ‘iterative’ process in the market that also needs to make use of all the elasticities.

          Begins to smell a little like a Dirichlet problem. So, if knew the elasticities, maybe could calculate the new arbitrage-free matrix and take a position that yields the best ROI as the market tends to that new matrix. Maybe.

          But that dollar-Yen trade is not the only one; that is, there are other trades causing other ‘perturbations’ of the values of the matrix components. Since there is no coordinated, central, global adjustment of the matrix, tough for me to believe that there are never any arbitrage opportunities.

          I can’t believe I’m the first person to think of this.

          What are people actually doing?