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SPECIAL TOPICS!  The RISING costs of ObamaCare. Health care "insurance."  Why the economy is NOT a bottomless pit.  And did the "stimulus" work?


Update on ObamaCare (February 2014):


The CBO's study on the long-run employment impacts from ObamaCare was nothing short of a stunning revelation.  As you will see, this does not spring from a discovery of some previously unknown economics, but from a uncharacteristic and unexpected political admission. The CBO redo of previous estimates (800k estimated in 2010) now has labor input into the economy shrinking the full-time equivalent of 2.5 million jobs by 2024.  (Much, to most of this employment reduction will come from reduced workweek hours, as opposed to a loss of a whole job.) 

I have rarely, if ever, heard so much garbage from politicians over the interpretation of this new analysis.  It literally had me hollering at the TV screen (and my wife fearing my ballooning blood pressure would result in a heart attack).  Probably all youngsters have some notion that the steering wheel affects the car's direction, and its gas pedal affects its motion.  But you would not put a young child in the driver's seat and say, "Have at it."  Yet we have a bunch of similarly uneducated and inexperienced politicians "playing economics." The essence of the analysis revolves around a beautiful example of supply-side economics.  (Funny, I have yet to hear any commentary specifically making this observation.)  Supply-side economics goes much deeper than "the Laffer-Curve," although that is a good example.  Broadly speaking, supply-side economics says that peoples' behaviors are shaped by incentives AND disincentives.  These decisions are made on the margin (as opposed to averages), so marginal tax rates exert significant impacts on workers' willingness to labor longer and harder and take more risks OR substitute leisure for work, and take fewer risks. Very simply, if your next hour of work were to be taxed at a 99% tax rate, the chances are high most persons would decide not to work that hour, and enjoy an hour of leisure, instead.

Now you know that we have a very progressive system for personal taxes.  Almost one-half of tax filers pay zero personal income taxes.

A central, defining feature of ObamaCare, however, is that the insurance premiums are highly subsidized.  For the truly poor, the subsidy is 100%!  The subsidies are progressively diminished as family incomes increase, but some level of subsidy extends well beyond average family income levels.  The reason for the subsidy is to encourage insurance coverage, because a lack of health insurance coverage was deemed major social, financial, and health care wellness problems in America.

The problem with this scheme is that the diminution of insurance premium subsidies as income increases can create enormously high marginal tax rates for the poor and middle class income earners.  In principle, you can find a "dividing line" income area where earning $1 extra of income could come with the loss of thousands of dollars of subsidized insurance costs (premiums and deductibles).   Of course, that is a rare case, but there might be plenty of cases where earning an extra $1000 might reduce subsidies $500  -- a 50% marginal tax rate.  That is a very real loss.  That's a higher tax rate than millionaires pay, as the federal marginal rate on personal income maxes out at about 40%.

Note that this is strictly an issue for the poor and middle class, as the rich receive no subsidy for health insurance premiums (so there is no greater out-of-pocket insurance costs as income increases further).  Note further that there is no new economics here: it's been known for decades that some welfare programs create the same disincentive to work harder to lift recipients out of their poverty as a result of the very high implicit marginal tax rates incorporated into the structure of benefits.

There may be plenty of people that lack higher education, but people by-and-large are not stupid.  They can and will figure this out.  So it is silly to simply say that ObamaCare "frees up people to enjoy more leisure," to the tune of 2.5 million full-time equivalent jobs.  No, ObamaCare creates a powerful disincentive to work harder to raise incomes, and given that disincentive, people will act rationally.

Furthermore, this is a "general equilibrium" result, not a "partial equilibrium" result.  To laypersons, that sounds like economics mumbo-jumbo.  But it is a critical point.  Why?  Because you hear politicians says, "Well, the loss of THOSE 2.5 million-equivalent positions will just create an opportunity for THESE 2.5 million workers to find and fill jobs.  After all, don't we have an employment crisis in this country?"

This silly statement springs from an incorrect understanding that the CBO's finding is a partial equilibrium conclusion.  No it is not!  It is a general equilibrium finding.  The wealth of a nation is based on how many goods and services it produces.  (Everything else is a market-based or arbitrary distribution issue.)  What this means is that if 2.5 million fewer persons are working, then there is the production equivalent of 2.5 million less goods and services being produced.  OR stated another way, if the economy's income is reduced by the loss of 2.5 million workers, then the labor demands of producers/suppliers will similarly be reduced by roughly 2.5 million workers because there is less income available to buy their products.  This "circular flow of income and production" is a core concept of ECON101-macroeconomics.  It's illustrated on page 171 of my 7th Edition of Paul Samuelson's Economics (1967).

A few more thoughts. 

1. Since the lower income workers work less, and the higher income workers work the same, ObamaCare will increase income inequality.  (But this illustrates that equality should be viewed from the standpoint of what is consumed, including payments in-kind, as opposed to normal income earned.) 2.  Who is paying those subsidies?  They do not come out of thin air! 3.  And what are the chances that with a 2.5 million worker smaller economy that Govmint will be correspondingly smaller?  Are you kidding me?  It would probably be larger!  Even if the size of the Govmint is totally unaffected, with fewer persons working and earning income, tax collections will be correspondingly lower.  Thus, the deficit will be larger-even beyond the extra subsidy costs from persons not living up to their earnings potential. My bet is that down the road, if the roll-out of ObamaCare continues unhindered, that future estimates of withheld labor will be revised even higher than this 2.5 million job impact.

University of Chicago professor Casey Mulligan has published scholarly articles with the National Bureau of Economic Research last year on the jobs and other macro effects of  the Affordable Care Act.  Apparently, the research had some impact on the CBO.  Says Mulligan (WSJ, 2/8/14), "I knew eventually it would be acknowledged that when you pay people for being low income you are going to have more low-income people."  More from the WSJ:

[L]iberals have turned to claiming that ObamaCare's missing workers will be a gift to society. Since employers aren't cutting jobs per se through layoffs or hourly take-backs, people are merely choosing rationally to supply less labor. Thanks to ObamaCare, we're told, Americans can finally quit the salt mines and blacking factories and retire early, or spend more time with the children, or become artists. 

Mr. Mulligan reserves particular scorn for the economists making this "eliminated from the drudgery of labor market" argument, which he views as a form of trahison des clercs. "I don't know what their intentions are," he says, choosing his words carefully, "but it looks like they're trying to leverage the lack of economic education in their audience by making these sorts of points."

He adds: "I can understand something like cigarettes and people believe that there's too much smoking, so we put a tax on cigarettes, so people smoke less, and we say that's a good thing.  OK.  But are we saying we were working too much before?  Is that the new argument?  I mean make up your mind.  We've been complaining for six years now that there's not enough work being done. . . . Even before the recession there was too little work in the economy.  Now all of a sudden we wake up and say we're glad that people are working less?   We're pursuing our dreams?"

The larger betrayal, Mr. Mulligan argues, is that the same economists now praising the great shrinking workforce used to claim that ObamaCare would expand the labor market.

He points to a 2011 letter organized by Harvard's David Cutler and the University of Chicago's Harold Pollack, signed by dozens of left-leaning economists including Nobel laureates, stating "our strong conclusion" that ObamaCare will strengthen the economy and create 250,000 to 400,000 jobs annually. (Mr. Cutler has since qualified and walked back some of his claims.)

"Why didn't they say, no, we didn't mean the labor market's going to get bigger. We mean it's going to get smaller in a good way," Mr. Mulligan wonders. "I'm unhappy with that, to be honest, as an American, as an economist. Those kind of conclusions are tarnishing the field of economics, which is a great, maybe the greatest, field. They're sure not making it look good by doing stuff like that."  [Emphasis added.]

Professor Mulligan is my new hero.

Health Care Insurance (from Late-September 2009):

The passing of Labor Day has brought on the reconvening of Congress.  The top agenda item: universal health care insurance, and thus, universal access to health care.  

One of the most vexing problems in making health care affordable for all revolves around the issue of “pre-existing conditions.”  We are all aware of sad cases where someone with insurance develops some malady (let’s say “cancer”), and then loses his job and thus his health care insurance with one provider.  But when applying for insurance on his own, the application asks about “pre-existing conditions.”  The item “cancer” is a red flag for another insurance provider, evoking either a rejection OR a terribly expensive (and often unaffordable) premium.  Or there is an alternative path: the worker is rehired, with insurance coverage except for the cancer condition, which is carved out because it is a pre-existing condition.  Cancer treatments paid for by the individual can impoverish his family.

So that’s the problem.  It sounds down-right unfair, in fact, cruel.  But look at it from an insurance company’s point of view.  Insurance is all about “risk,”  which is uncertainty about some future event or condition.  Not knowing anything else, an actuary can make statistical estimates about the chances for someone to suffer from a range of costly conditions, versus the chance that someone may need no significant health care attention at all.  Based on these chances and associated costs, a premium can be determined.  The premium includes some expected value of future costs PLUS a fee for providing the service of insurance.  In principle, a person can self-insure—put money aside to cover future medical care costs—but this requires sophisticated knowledge (what are the possible outcomes and their costs?) and discipline (regularly reserving to cover potential future needs, versus buying that big-screen LCD TV this month).  Furthermore, the risks begin Day 1, but it takes time for an individual to build reserves to cover the contingencies.  So most individuals opt to purchase insurance from a provider.  The provider can pool risks—cover many individuals—which reduces risk for the provider by averaging individual outcomes, making them more predictable, so it can charge a lower premium.  The provider can also identify differences in risks to tailor a premium to a specific group with specific risk characteristics.  For instance, a pool of young group participants would carry (and justify) a lower premium than a group of older participants because on average young people need less medical care than older people.

The problem with a pre-existing condition is that there is considerably less risk because  an outcome is known with substantial certainty!  So a buyer with a pre-existing condition is basically charged a premium that pre-pays for a probable course of treatment.  Hence, the premium is extremely expensive because the medical care can be extremely expensive.  This is something fundamentally different from charging a premium that allows for the possibility of someone developing cancer.

There is no easy fix to this situation.  One possibility: the original insurance provider in fact enjoyed a windfall and got off the hook for being responsible to cover the costs of the malady when the worker lost (of otherwise left) his job.  Why not require them to make a lump-sum payment to cover future costs that they would have otherwise incurred, or have them assume for some period any incremental costs between a normal insurance premium and the premium given the pre-existing condition?  Yeah, that will go over big in the insurance industry!!!

The public wants a solution regardless of what the definition of “insurance” is.  The public does not want health care insurance, per se.  What the public really wants is some variant of taking a national health care bill and dividing it by its 307 million population.   (But if this scheme proves too costly for some, let’s just soak the rich.)  In insurance thinking, this is blatantly unfair!  Such a system would provide a windfall for some and unfairly high cost to others.  Like Social Security and Medicare, it will extend the generational transfer of wealth from young people to old people.  I am no expert on the history of our Constitution, but I strongly suspect our nation’s founders would be aghast that their remarkable invention has come to this.

This is the best, succinct statement of the health care problem I’ve seen (from the WSJ, 6/20/09):

Contrary to what we might think, comparative studies show us that the US when compared to other advanced countries, does not have a sicker population: we actually use fewer prescription drugs and we have shorter hospital stays (though we manage to do a lot more imaging in those short stays—got to feed the MRI machines). The bottom line is that our health care is costly because it is costly, not because we deliver more care, better care or special care. Alas, a solution that does not address the cost of care, and negotiate new prices for the services offered will not work; a solution that does not put caps on spending and that instead projects cost-savings here and there also won’t cut it. Leaders have to make tough and unpopular decisions, and if he is to be the first President to successfully accomplish reform there does not seem to be much choice: cut costs. 

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The economy is NOT a bottomless pit!  (From Late-March 2009)

One reason for the considerable gloom brings up what I believe to be a common forecasting mistake—to believe the economy is spiraling down a bottomless pit.  I think that is the wrong way to think about the economy.  The reasons: sectors have floors and behaviors have limits.  Once they are hit, the downward spiral ceases.  The better way of thinking about the economy: demands are transitioning from one equilibrium to a lower one.  The reductions in retail sales, industrial production, employment, factory orders, and so on, represent the dynamics of getting from one place to another.  But once you get there, then the economy’s nosedive flattens out. 

Let me create an example to demonstrate the point.  Consumer spending has fallen because persons, for various reasons, have lifted their personal saving rate (= lowered the personal spending rate out of disposable income).  But there is a limit to this behavior, and once the new equilibrium is reached, the drag on the economy stops.  In the simplified table below, as consumers raise their personal saving rate from 0% to 6%, spending declines.  But once that saving rate stabilizes, as it inevitably will, then consumer spending stops falling (Year 2:Q1).  And once consumer confidence returns and they decide to lower their personal saving rate somewhat, then the dynamics works in the other (positive) direction.  [In this simple example, without loss of generality, the feedback loop between consumer spending and income is omitted.]

                  Year 1:                           Year 2:
                   Q1    Q2    Q3    Q4    Q1   Q2
Income        100   100   100  100    100   100
Saving rate   0%    2%   4%   6%    6%     5%
Spending     100    98    96    94      94     95
--Growth rate      -2%  -2%  -2%    0%   +1%

 I expect over the next weeks and months you will hear more talk of the “second derivative” of the economy.  This is the rate of change of the rate of change.  In physics, if “X” marks a position, the first derivative of X gives you the rate of change of position, or velocity, and the second derivative of X gives you the rate of change of velocity, or acceleration.  If the economy is receding, then its first derivative is negative.  But if its rate of decline is lessening (e.g., from -6% growth to -4% growth to 0% growth…) then its second derivative is positiveThe second derivative turning positive is a necessary precursor to the economy flattening out and forming a bottom, a bottom from which an economic rebound can be staged.

What economic indicators are issuing a second derivative reading?  Weekly initial claims for unemployment insurance have stopped increasing (around 650k) for now.  Housing starts stopped falling and increased in February.  Retail sales fared better in January and February than they did in November and December.  And durable goods orders increased in February.  Indeed, as a result of these indicators, my projection for the economy’s Q1 decline is less than the 6.3% (AR) fall-off actually suffered in Q4, and my Q2 estimated decline is less than I am expecting for Q1.

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Did the "stimulus" work?  (From Late-July 2009):

I, quite frankly, am getting tired and somewhat annoyed over talk that the stimulus packages of 2008 and now in 2009 are ineffective.  (It troubles me to say it, but the repubs and conservatives are mostly at fault.)  Put aside whether I (or you) like the shape of them, or not.  Don’t the goofs know that they are trashing EVERY macroeconomic textbook on the market?  Have they submitted peer-review papers statistically backing their positions? I can PROVE that they did and are having impact.

The first (Bush-Pelosi) stimulus package exerted most of its effects in Q2 and Q3 of last year.  Mind you, the U.S. was in a now-officially declared recession since December 2007.  All the major economies of the world were succumbing to the enormous rise of oil prices from mid-2007 through mid-2008 PLUS the slow-boil credit difficulties.  Compare U.S. GDP growth in Q2 versus other major economies:

Inflation-adjusted GDP Growth (Q/Q, Annualized):

Country:     Q2     Q3
U.S.            2.8   -0.4
U.K.             0     -2.8
France       -1.6   -0.8
Germany     -2.0   -2.0
Italy          -2.4   -3.6
Japan         -3.6   -2.4

In a recession, why was Q2 GDP growth in the U.S. so good?  Why for both quarters did the U.S. greatly outperform other economies subject to the same energy and credit drags?    Hmmm.  Do you think the stimulus package had something to do with it??? 

The $800B stimulus package this year (2009) did not begin to take effect until April—and keep in mind, it is a lengthy and slow roll-out.  Look how the Blue Chip consensus forecasts for Q2 and Q3 real GDP growth have changed over the last several months:

Month:    Q2      Q3
March    -2.0%  0.5%
April      -2.1%  0.4%
May      -1.7%  0.5%
June      -1.8%  0.6%
July       -1.8%  1.0%

What’s changed over this period?  Hmmm.  Maybe the stimulus plan beginning to take effect and influencing expectations?  (I suspect that these numbers may continue to prove too low.)

And lest we forget, although President Bush passed his first stimulus package in early 2001, it did not prevent a recession from occurring (although no doubt made it milder), and he followed up with additional packages over the next two years, but the U.S. economy did not really gain a head of steam until 2003.

Q.E.D.

With increasing talk about an impending “recovery,” some discussion of semantics is in order.  To economists, “recovery” simply means that the economy is expanding again.  To many in the public and business worlds, “recovery” is synonymous with “recovered”—a full return to better times.  Given the extremely high jobless rate and low factory operating rates, it will take a long time to regain the lost ground.  Also, keep in mind that some industries lead a recovery process but others (especially those that relate to capital spending) follow.

There is considerable focus—and worry—re the consumer, today.  Will they spend?  The macro numbers are weak (but even I was surprised with the finding displayed in last month’s issue of “ClearView…” that total quarterly consumer spending since the economic peak is down an inflation-adjusted 1.2%).  But one of my contentions is that one aspect of the weak spending issue is that they have little to excite them to spend.  Cell phones and I-pods are ubiquitous.  We are already on third and fourth generation big-screen LCD and plasma TVs.  In the auto world, there is not much “gee-wow” product.

But what if there were new, compelling product?  I think we have a clue from the movies.  The much-anticipated Transformers movie ran up a $339M box office after just 19 days and the unheralded but very funny and entertaining  “The Hangover” movie scored $222M in a couple of weeks  And Harry Potter’s new movie enjoyed a $104M box office on its first day.  The lesson: you give consumers a compelling reason to spend, and they WILL spend. 

 

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The windfall profits tax...

The Winds Blow in BOTH Directions
An Examination of Oil Industry Windfall Profits and Taxes

If you live and work long enough, you are bound to see things come full circle.  When the OPEC cartel unexpectedly tripled oil prices late in 1973, it produced “windfall” gains for the oil industry.  A part of the policy for coping with the increased economic burdens of higher energy prices included imposing a windfall profits tax on the industry to redistribute away from the industry and its shareholders the extraordinarily high profits associated with the surprisingly high oil prices.  Another spike in oil prices came from the cartel in 1979.  Supply from new exploration and production did not overpower demands until 1986, when the price of oil per barrel plunged $18/barrel, yielding more than 50% year-over-year declines.

Flash forward a generation.  A number of factors beyond industry and policy control have combined to produce another spike in oil prices.  From mid-2003 to present, the market price of West Texas Intermediate oil exploded from below $30 per barrel to above $60 per barrel.  Throughout the oil sector—from explorers, to drillers, to providers of oil field services, to refiners—profits have zoomed.  The increases in energy costs will prove quite burdensome for most American families.  Once again, there’s a din in Washington (democrats AND republicans!) fishing around for a way to get at and redistribute the oil industry’s windfall gains. 

The dictionary defines windfall as “a sudden, unexpected piece of good fortune or personal gain.”  What is the nature of this good fortune and gain for the oil industry?

There are two main elements that can produce windfall profits or losses for the oil industry.  The first element is the nature of energy demands.  We don’t want energy so much as we need it.  This is the opposite of ice cream: I don’t need it for dessert, but I want it.  But I need energy.  I need gasoline from the pump to fuel my car to get to work.  I need natural gas to heat my home in the winter.  But I need only so much, and I want no more.  

This is not double talk.  What this means is that if there is a little excess supply, prices will plunge, because I don’t want any more.  It takes a BIG price cut to encourage me to use a little more.  The opposite situation: if there is a little supply shortfall, then prices will rise sharply.  I still need to drive to work and heat my home; it takes a BIG price increase to alter basic behaviors to force me to need less, such as resorting to carpooling and the lowering of thermostats.  (Economists call this property of demand “price inelasticity.”)[1]

The other element of the windfall story concerns the costs and time issues associated with generating oil supplies.  The costs are massive and the time lags are quite long.  Producing oil is not a simple matter of opening up the spigots and letting it flow.  The geology must be performed; the acreage acquired or leased; the platforms constructed; the drilling done; the pipeline infrastructure put in place; and the refining capacity manufactured.  This takes time, depending on the resource to be tapped, perhaps years.  Producers must weigh the substantial costs of this process, also figuring in the time value of money, against the expected price of oil.  

Energy producers need not make any excuses here: they are profit maximizers just like virtually every other business and industry in the economy.  Capitalism and the efficient use of the economy’s scarce resources demand this.  The calculus of costs versus potential future revenues must produce profits.

Oil industry executives, like economists, are not especially prescient in anticipating future oil prices in the time frame associated with the investment-production process.  Many perhaps choose to make what economists call the “naïve” assumption: that tomorrow prices will be at or near today’s prices.[2]  Regardless of how the price assumptions are arrived at, “you pay your money and you take your chances.”

In the end, today’s production is the result of long-past investments.  The costs of production are therefore largely fixed.  Today’s prices, however, are associated with today’s economic factors.[3]  The profits drop out of this.  Oil prices will be higher or lower than expected.  So profits will be higher or lower than planned for.  Voila!  There is a windfall gain or loss.

Let’s get one thing straight here.  It has been said that in the current situation that the oil industry “did nothing” to earn today’s windfall profits.  This is blatantly false!  Years ago, the industry took the risks—the whole production process—in an uncertain price environment in order to produce the supplies that currently come to market.  

Profits and prices do not go in only one direction.  As previously mentioned, oil prices plunged in 1986.  The industry and its shareholders were clobbered.  Investors were punished again in 1998, in the wake of the Asia economic debacle, and in 2002, a feeble and halting recovery that was frozen by the upcoming conflict with Iraq.  None of these price and profit dampening events was generally anticipated.

Profits ARE booming in the energy industry.  Tax revenues ARE swelling (a windfall!) along with these profits.  And capital spending in the industry IS growing by leaps and bounds.  But high energy prices in the industry are NOT a sure thing.  It is not just me saying this.  The price-earnings (P/E) ratio of major producers falls into a 8 to 11 range, well short of the Market P/E ratio of around 19 (through Q2, based on trailing year’s earnings).  The best investment minds in the business are essentially saying that these profits are not sustainable, presumably because current energy prices are not sustainable.  (For what it is worth: my bet is that the Market is wrong.)

Are the profits a “windfall?”  Yes.  But tax them?  The industry DID assume huge open-ended risks.  Is the government prepared to compensate the industry for windfall losses?  You can’t have it both ways.  How is this windfall different from other windfalls?  Last year when Florida experienced a deep freeze, the price of tomatoes soared.  Those with tomato inventories enjoyed a windfall gain.  Those producing tomatoes from other parts of the country or world saw windfall profits, too.  Did the huge price increases constitute gouging?  No, this is just a market with a similar set of characteristics “clearing.”[4] 

And what about all the windfall profits associated with the huge run-ups in home prices?  We’re talking trillions of dollars of capital gains, here!  Some people say energy is a “special” category because we can’t do without it.  Did you ever try doing without a home?  Don’t you feel sorry for the young workers just starting out in life facing the challenge of buying a home at these prices?  Residential real estate is just as “special.”  But no one is talking about slapping a windfall profits tax on home sales.  I think if they did, they would be ridden out of town on the proverbial rail!

No, this is more the case of a grab for easy money from a relatively concentrated segment of the economy (as opposed to a large, vocal segment, such as “homeowners”).  In other words, don’t tax you, don’t tax me, tax the guy behind the tree.

What should beleaguered families do?  Don’t just drive slower and turn down your home thermostats.  Create a “natural hedge” by owning some energy stocks!  What is lost out-of-pocket from higher energy prices can be offset by portfolio appreciation.  The capital appreciation and dividends on 100 shares of Exxon Mobil would have gone a long way this year in covering the incremental cost increase of gasoline purchases.  Another 100 shares would have paid for much of the higher home heating bills for an average family.  My expectation—though it is only an informed guess—is that continued growth in demands pressing against constrained supplies, will cause energy prices to trend higher over upcoming years.  But just remember, like any hedged position, prices can go either way (and do your securities homework!).

Oh, one more thing, in terms of “biblical” tithes.  The industry is already contributing multiple tithes—in the form of the corporate income tax, which the government is free to flitter away for rain forest museums and bridges to nowhere.

Dr. Kenneth T. Mayland

President

ClearView Economics, LLC


[1] This is why one of the objections to drilling in ANWR is so wrongheaded.  Opponents suggest that the incremental increase in U.S. production would be a small fraction of total U.S. (or world) production.  But pricing does not work based on averages, it works on the margin.  Given the logic expressed above, even small additions to production capacity could exert major, welcomed downward pressure on prices, or at least work against seeing big oil price increases.

[2] Oil executives can hedge their energy investment bets by “locking in” a financial result utilizing the energy futures markets.  But even here, the “expert” speculators have proven to be wildly off the mark.

[3] This is literal, as the market price of energy will react to the daily path of a hurricane or the Wednesday morning report of oil inventories.

[4] Clearing means finding a price where demand equals supply; in this case, prices jumped higher to ration demand to meet reduced supplies.


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