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A Strong Ruble is Economic Window Dressing; from Michael Frank (John Eipper, USA, 06/13/22 3:22 am)Michael Frank writes:
The Russians have taken some aggressive steps to prop up the official ruble exchange rate. One of the most important of these measures is requiring ruble payment for oil. In an ironic twist, the West's sanctions result in few rubles escaping Russian borders. (Contrary to Tor Guimaraes's theory, nobody is buying Russian stuff.) These two factors unexpectedly account for a massively favorable balance of trade, and a strong ruble. The Russian central bank has also made it next to impossible for capital to be transferred out of Russia: the companies that bravely shuttered their Russian operations simply flipped the keys to the new owners and went home. Kleptocracy in action. So once again, currency itself is a commodity subject to supply and demand. International ruble demand has been artificially propped up while supply has been restricted.
The situation with global exchange rates isn't reflected in Russia's internal situation. A favorable exchange rate under these circumstances is window dressing. The exchange rate obfuscates a crumbling economy. Current projections are that the Russian economy will contract by 10% for the full year 2022, comparable to the US in 1932. Inflation is above 17%, which isn't what you would expect with a strong currency. With the borders closed, there's no place for the rubles to go.
https://tradingeconomics.com/russia/inflation-cpi
JE comments: The Brave New World of Russian economics under wartime sanctions. One would never associate a strong currency and favorable balance of trade with inflation and a shrinking economy. Michael, what can you tell us about Chinese exports to Russia? Most reports say they are declining, due to the fear among Chinese companies of losing their Western markets in retaliation. Is this an accurate assessment?
If even the Chinese are reluctant to sell to Russia, then it is absolutely true: the rubles have nowhere to go. You can eat at Vkusno & Tochka only so many times...
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Why the "Strong" Ruble? From Ric Mauricio
(John Eipper, USA
06/14/22 3:35 AM)
Ric Mauricio writes:
As a consultant to high tech and venture capital firms here in Silicon Valley, I have had projects opening offices in many parts of the world, many in Asia and Australia, and a few in Central and Latin America, as well as the EMEA (Europe, Middle East, Africa) region. The challenge in opening these offices was the coordination of the movement of FOREX (taxes are a big part of this challenge, as is the timing of repatriation).
In terms of currencies, I find that the word "strong" is an absolute that cannot be utilized. The ebb and flow of currency valuation more aptly requires the comparative words "stronger" or "weaker." As for the Russian ruble (funny that in a previous post, John E revised my tongue-in-cheek spelling of rubble to ruble), yes, it is stronger than its previous low. But I would not say that it is "strong." In fact, much of that previous low was caused by short selling from forex traders, so an artificial pricing. But it certainly is not "strong" when comparing it to other currencies. Incidentally, these same forex traders had to cover their "shorts" when the sanctions started to take hold, thus causing the price to increase. Couple this with purchases of Russian oil resources from China and India, requiring movement from the renminbi and rupee (ah, interesting that all these currencies begin with "R") to the ruble and yes, the ruble will strengthen against itself. I also read that there is quite a movement of finished petroleum products out of India (to the US?), thus circumventing the sanctions.
When valuing currencies, it is important to look at its Purchasing Power Parity.
The relative worth of one holder's currency pegged to another's in consideration of the purchase of the same basket of goods and services is referred to among economists as the purchasing power parity (PPP). The parity is a theory that suggests "exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries."
In order to better understand the purchasing power parity and how it adversely affects the Russian middle class, the following example will better illustrate its practicality:
Consider the two countries, Russia and the US. A Big Mac (probably called a Big V now) costs approximately 420 ₽ or an American equivalent of $6.00; however, in the US, an identical product costs $4.00. The PPP between Russian and the USA for a Big V is the price paid in Russia in US dollars ($6.00) divided by the price paid in the United States in US dollars ($4.00).
Simple arithmetic leads to the conclusion that for this item, the PPP between Russia and the US is approximately 1.50, which means the consumers pay $1.50 to make a purchase in Russia that would cost $1.00 in the United States. Alternatively, Russian consumers are using their weaker national currency to pay a 50 percent premium on a Big V. Apply this to the purchase of an apartment, college education or vehicle, and the numbers and basic economic principle alone illustrates how worse-off the Russian middle class is than that of its western counterpart.
I read somewhere where an economist computed the inflation rate in Russia is 61%, rather than the 8% that the government is reporting. That's quite a disparity.
One can think of a 98-pound "weakling." One can get this person to a gym and train them with weight resistance exercises. Thus they will get stronger, but one cannot say they are "strong," especially if one compares them to someone who has been training for a longer period of time.
Another subject I'd like to address is "inflation." Such a benign word: inflation. It conjures up an image of getting bigger, like bigger muscles. Bigger is better, right? Well, no, not in this case. Inflation really means that the consumer is losing purchasing power. It'll cost them more to acquire whatever it is they're buying. Or the new word: shrinkflation. What you are buying is getting smaller. Same price, less goods. I wonder how the economic powers-that-be are taking shrinkflation into account.
But why is there inflation? First of all, the blame is the creation of fiat money. Every country does this, not only the US. This is one reason inflation is global, not just in the US. Then there are tariffs and sanctions (economic warfare). Who do the governments think this affects? Manufacturers and shippers will pretty much pass these tax costs to the consumers. Ah, inflation. But wait, here in California, our gas prices have increased to $6.50 to $9.60 per gallon, a 98% increase. Chevron's first quarter net income increased 355% in the last year. As a former controller of a fuel distribution company, I know how this works. When oil prices increases, we raised our prices in line with our cost of goods going up. But when oil prices decrease, we hold our prices, thus increasing our margins. And now oil prices have again once increased to previous highs, and again, prices are being increased at the rate of increase of this latest increase. You gotta love it if you own the oil companies.
Then, of course, now that the pandemic has increased utilization of offices and cars once again hit the road, demand has increased, thus the oil companies are not only increasing their margins, but increasing the volume of gas sold. And this fuel cost, of course, feeds into the delivery of goods and services, so inflation is compounding upon itself.
All this leads to a possible recession or stagflation. Wait, is that why the markets are selling off? Despite many companies recording good earnings growth (to be sure, there are many who are not exhibiting such growth), you have a selloff that is waiting for its final capitulation. As I have often been asked lately, "Are we there yet?" Sounds like the kids on a car trip, right?
Almost there, guys. I hope.
JE comments: There's nothing like driving with impatient kids to the bottom of a market. The trip itself is nightmarish, but the destination is not exactly Disney World (or around here, Cedar Point).
Short-selling the ruble after February 24th sounded like a clever move. Oops for those folks. But how, I wonder, can you even "cover" your shorts when the ruble is no longer available on the open market?
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Accountancy Primer: LIFO, FIFO, and Windfall Oil Profits (from Michael Frank)
(John Eipper, USA
06/14/22 3:04 PM)
Ric Mauricio wrote on June 14th: "When oil prices increase, we raised our prices in line with our cost of goods going up. But when oil prices decrease, we hold our prices, thus increasing our margins. And now oil prices have again once increased to previous highs, and again, prices are being increased at the rate of increase of this latest increase. You gotta love it if you own the oil companies."
Michael Frank replies:
The tax police would like to know the name of that company. An oil company, any company, can account for its inventory on a LIFO, last-in-first-out, basis. Or it can report on a FIFO, first-in-first-out-basis, or it can use average cost. It has to use the same inventory method for tax purposes as for financial reporting, and it has to be consistent. What it can't do is report on a rapacious mixed LIFO-FIFO basis.
When costs rise, the price of the finished product increases immediately under LIFO, and the difference between current cost and true inventory cost appears on the balance sheet as a reserve. When prices fall, the reserve is reduced, with the effect that the "windfall" on the way up is reversed on the way down (no doubt resulting in calls for tax relief). To illustrate the LIFO effect, here's a chart comparing the prices of gasoline and crude oil over the last five years. You can judge for yourself how well they track:
JE comments: It's a little hard to decipher the above, but RB=F (dark blue) is the gasoline price, and BZ=F (light blue) is the crude oil price (Brent crude). Michael, for us laypeople, could you explain what RB=F stands for? Is it simply the wholesale price for a gallon of gasoline? I suspect this, because the current RB=F is $4.16, which seems more or less to line up with our current $5+ retail.
It certainly feels like gasoline prices spike immediately when crude increases, and a corresponding decrease is very slow to arrive at the pump. But the chart above suggests otherwise.
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What is RB=F? Michael Frank Explains
(John Eipper, USA
06/16/22 4:10 AM)
Michael Frank writes:
JE inquired about the meaning of RB=F.
In Yahoo world, RB=F is the month-ahead future for gasoline. BZ=F is the comparable quote for Brent crude. Either quote assumes the wholesale purchase of 1000 barrels (42,000 gallons). There can be a disconnect between the wholesale price and what you pay at the pump, based on when retailers fill their tanks. Also, the LIFO method is a choice, not mandatory. An independent retailer can use average pricing or FIFO, and in these cases, the wholesale price will take time to impact the pump price. Or they can simply be price gouging.
Gasoline retailing is a low-margin business, so if an opportunity to score a few pennies comes along, a retailer may just bend the rules. The major oil companies aren't blameless, but sometimes the problem lives just down the block.
LIFO is a controversial practice, and generally isn't permitted in jurisdictions other than the US. The reason is that during periods of rising prices, LIFO effectively understates profits, reducing tax liability. And during periods of weak performance, LIFO reserves can be drawn down to engineer the illusion of profitability. There are periodic calls for eliminating it from the accounting standards. The holdup is that many important companies have large LIFO reserves on their balance sheets, and a conversion to less aggressive accounting methods would result in a massive tax hit. I'm not sure where repeal efforts are at the moment, I think the effort died out during the Trump years.
JE comments: Michael, this is very informative. Accounting is famously dismissed as a boring profession, but is there any other field that allows for more creativity? A skillful accountant can generate profits (or losses, as needed) with a flick of the keyboard.
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- How to Gouge: Futures Prices and Spot Prices (from Ric Mauricio) (John Eipper, USA 06/17/22 6:44 AM)
Ric Mauricio responds to Michael Frank (June 14th):
Ah, mystery solved. The chart is a chart of futures pricing, not spot pricing. The chart is of COMEX (Commodity Exchange) trading of futures contracts, not of spot prices. Futures prices are bets placed by commodity traders, be they speculators or those who hold actual inventories, so not a true picture of what the consumer will pay at the pump.
Now look closely at the chart you posted. It shows that fuel distribution companies were selling their gas at prices lower than the Brent crude for two years; from mid 2018 to mid 2020. By the way, Brent crude is the oil from the North Sea and thus mostly supplies European markets. Here in the US, the most often quote per barrel of oil is WTI, or West Texas Intermediate. Raise your hand if you believe that your local gas station was losing money for two years.
Michael Frank further wrote: "The tax police would like to know the name of that company" in his prior post. Then he launches into accounting practices of inventory accounting, hinting that the company is performing aggressive non-compliant accounting practices by the random utilization of FIFO or LIFO. The consistent utilization of either FIFO or LIFO is the generally accepted accounting principle. But yes, in a rising cost environment, LIFO would result in more advantageous profit reporting (less profit). But in practice, in the fuel distribution industry, it is a moot point due to the rapid flow of product through the pipeline. And also keep in mind, that in a downward cost environment, LIFO would exacerbate the profit picture. Regular gasoline gets replenished at the most every two days. Other grades a little longer, but not by much. So whether one utilizes FIFO or LIFO, or aggressively tries to finesse it, results in wasted time and energy. Either way, you will pay the normal tax on your profits. The fact is: fuel distribution companies make the most (their margin increases) when oil prices retreat because they hold their prices aloft longer than the price of oil.
But let's take a look at actual spot prices. Keep in mind that these numbers are the national average and do not include FET (federal excise tax), SET (state excise tax), and sales taxes. I've always had an issue of why the sales tax is computed not only on the price of the product but the FET and SET here in California. There was an idea floated in the California legislature to waive the sales or SET tax to help drivers, but it was voted down (I am non partisan, but the Democrats voted it down). Instead, Governor Newsom wanted to send every car owner a flat $400 per car. Wouldn't it cost the state more money to generate and mail those checks? OK, that really doesn't help the person who has to commute every day to work because Elon Musk insists on a minimum 40-hour week at the office. Just ranting, sorry.
OK, here are the spot prices at particular times of this year.
March 8, 2022: Oil WTI spot is at $119.65. Gas priced at an average $3.6392 (again, no tax).
March 16, 2022: Oil WTI spot is at $91.59 (down 23.4%); Gas priced at an average $2.9520 (down 19%; raise your hand if you saw the gas price at your local gas station fall this much in mid March). Here in Silicon Valley, the gas stations did not change the price from March 8th to March 16th. It stayed at $5.89 per gallon for regular, so we did not benefit from falling WTI.
June 9, 2022: Oil spot is at $122.11 (up 33.3%); Gas is at $4.2752 (up 45%).
As you can see, your local gas station is not only making more margin (profit) on the upside but also on the downside (especially here in California where they did not change the price from March 8th to March 16th).
This has nothing to do with inventory accounting. It is just plain and simple gouging. Unfortunately, if the government mandated price controls, it would result in chaos not unlike the long lines and mandated filling according to your license plate that we had in years past.
This is why profits at Chevron were up 355% in the first quarter. Can't wait for the 2nd quarter earnings.
JE comments: My "oilmen" family members have confirmed to me what we already know: life is very good at present in their business. Yet they are also cautious: burned by the hard times of just two years ago, they are investing almost nothing in new development. It's not a viable long-term strategy, but it does have the added benefit (for them) of keeping the prices high.
Ric, what are your thoughts on combating price gouging? During the depths of Covid there were a few symbolic prosecutions of hand-sanitizer and PPE speculators, but what about an industry as huge as the oil business? Price controls are famously disastrous, but what are the other options?
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How Do You Combat Price Gouging? From Ric Mauricio
(John Eipper, USA
06/23/22 3:58 AM)
Ric Mauricio writes:
Economics has a lot of moving parts, so controlling the numbers is at best an inexact science. Indeed, it may be more art than science.
If one were to strip away manipulations by corporations and/or government, pricing the cost of goods (inflation/deflation), would come down to basically a supply and demand equation.
More supply and less demand should eventually lead to lower prices. Vice versa, less supply and more demand should lead to higher prices. Currently, limited supplies and more demand due to more employees commuting back to the office, there is the opportunity for fuel distributors to charge what the market will bear. People ask me if the gas stations raising their prices in lockstep proves collusion amongst the fuel distributors and thus an anti-trust situation. Well, the government will have to have definitive proof that fuel distributors talk to each other and agreed to increase their prices in lockstep. Good luck with that. No, our guy doesn't talk to any other fuel distributor when he sets the prices. He has an algorithm that takes into account the cost of goods (fuel) and determines whether to raise or lower the retail price. He was the highest-paid employee on the payroll. He also has to determine what the market will bear in specific areas. It's complicated, which is why he gets paid the big bucks.
John E asks what options we have to combat this? Taking the above supply/demand equation, one would simply (simply in this case is not easy) increase supply or decrease demand or both. At this point, it would be easier to decrease demand by allowing more companies to allow more work-from-home employees. Again, easier said than done. Musk requires his employees to come into the office. On the supply side, increased importing of fuel from Canada would help supply. The shutdown on the Keystone XL pipeline inhibits the import of oil. It has been said that the pipeline is environmentally unsafe, but that is not true. In fact, transporting the fuel by truck is not only inefficient, using more fuel that goes into the air, but is inherently more dangerous on the roads.
Personally, I have taken steps to combat inflation. I refuse to pay the higher grocery prices that some products are now priced at. I am driving less and planning trips more efficiently, oftentimes bundling many stopovers to avoid the mileage. I am in the midst of xeriscaping my front yard (already did the backyard) to save water. I time my showers and utilize an on/off switch at the shower head to soap up. I noticed my personal gas/electric bill is half of what my neighbors are quoting. Yes, all my lighting is LED, but I am conscious of turning off the lights when I am not in the room.
I would like to figure out how to harness the wind (we have a good strong breeze coming in from the Bay) to generate electrical power. In fact, I noticed that between houses, the wind is the strongest, so it seems like a good location for a wind turbine.
If every person in the US were to personally combat their personal inflation, I am optimistic that we can overcome the headwinds. But it would take a concerted effort, which I am not sure the American people are up to. We are just too comfortable as things are.
But let's talk about comfortable music. "The best female voice in the world: melodic, tuneful and distinctive" (Paul McCartney). He was describing Karen Carpenter. Yes, to answer John E's query, I did set up the sound system at the San Francisco Civic Auditorium in July 1971. The Carpenters were the headliners with Mac Davis. I really never got to interact with Karen or her brother, Richard. We were just too busy. But I tell you, she made our sound system sound like a million dollars. What a voice. I totally agree with Paul McCartney. I did get to talk with Mac Davis. Really nice guy. His biggest hit was, "Baby, Don't Get Hooked on Me." What impressed me more was his composing talent. He composed songs that were performed by Elvis that I count as my favorite Elvis hits: "In the Ghetto," "Memories," "Don't Cry Daddy." If there was anyone that I would have loved to have the voice and looks, it would be Elvis, the svelte Elvis. OK, ok, I'll settle for the voice of Englebert Humperdinck or Roy Orbison. But Karen Carpenter's tragic story is sad. The story was she was abused by her husband which led to anorexia nervosa, which eventually killed her.
JE comments: Amen, Sir Paul. Karen Carpenter's greatest strength was her low range. Flashy sopranos get all the attention, but a powerful alto touches the depths of your soul. (I don't know if this image makes sense, but I really like the voice of Karen Carpenter. She was also a first-rate drummer.)
Reducing demand is the best antidote to price gouging, and Ric, you've lowered your carbon (and water) footprint admirably. What are other WAISers doing? We're driving less, to be sure, and also thinking of installing solar panels at WAIS HQ. Does anyone have advice? It's very windy here too, but I don't think our Home Association allows windmills. Possibly it's for the best; I'll have to do my tilting elsewhere.
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- How to Gouge: Futures Prices and Spot Prices (from Ric Mauricio) (John Eipper, USA 06/17/22 6:44 AM)
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What is RB=F? Michael Frank Explains
(John Eipper, USA
06/16/22 4:10 AM)
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Accountancy Primer: LIFO, FIFO, and Windfall Oil Profits (from Michael Frank)
(John Eipper, USA
06/14/22 3:04 PM)