Ruminations, December 13, 2009

Blazing Cap and Trade

In the 1974 movie Blazing Saddles, Cleavon Little portrays Sheriff Bart, a black sheriff who has been given jurisdiction of the town of Rock Ridge. The townspeople definitely do not cotton to the idea of a black sheriff and draw their guns and point them at Bart. Sheriff Bart, thinking quickly, draws his own gun, points it at this own head and then says to the crowd: “Hold it! Next man makes a move, the sheriff gets it!” A voice in the crowd says, “Hold it, men. He's not bluffing.” As Bart continues to point his gun to his own head, he makes his escape.

The humor in the situation, as if it needed explanation, lies in the non sequitur; I don’t want you to kill me so I’ll kill myself if you don’t stop trying to kill me. I never thought that I would see such outlandish humor outside a Mel Brooks’ movie until last week.

Last week, an unidentified spokesman for the Obama Administration said to Congress: "If you don't pass this [Cap and Trade] legislation, then . . . the EPA is going to have to regulate in a command-and-control way [i.e., Soviet style]…”

Remember that President Obama is the leader of the Administration and the leader of the Democratic Party that controls Congress. So, in effect, the Administration pulled a gun, pointed it at its own head and said: “If I don’t pass legislation that will wreck the economy I will make the country a replica of the failed Soviet Union.”

In Blazing Saddles, after Sheriff Bart made his escape, he said to himself, “Oh, baby, you are so talented!” And then, thinking of the towns people, added, “And they are so dumb.” I wonder if, in the eyes of the Administration spokesman, we are just as dumb as the citizens of Rock Ridge.

Cap and trade, European style

Some, on the left, say that Cap and Trade will provide a market for speculators and not make a significant reduction in pollutants. Does their argument have any merit? Well, in Europe they’ve all ready started Cap and Trade, known as European Union Emission Trading System (EU ETS) – how’s that going?

Let’s take the case of Britain’s Redcar steel works. Redcar is a coastal town in northeast England of some 36,000 people. Two years ago, the Indian conglomerate Tata, acquired the 90-year-old works. (The purchase price for Corus, which owned Redcar, was some $12 billion and, considering Redcar’s proportional capacity and its age, Redcar’s value was maybe $750 million, tops.) This month, the Indian conglomerate announced that the Redcar plant would be closed in January and its 1,700 employees would lose their jobs.

Well, we all know how that goes. A company makes an investment in a plant and it doesn’t work out. Too bad for Tata, they made a bad investment. Or did they?

We’ve all seen the melodramatic movie where a tearful protagonist holds up an insurance policy and says, “I’m worth more dead than alive.” In this case, Redcar Steel Works is worth more to Tata dead than alive – and hold the tears.

You see, Redcar’s future was limited anyway. But it had the capacity to produce 3 million tons of steel per year. And, as a side product, Redcar also had the capacity to produce 6 million tons of carbon dioxide per year– and that’s where the real money is today, carbon dioxide.

By not producing carbon dioxide, Tata can sell its polluting rights in the ETS for over $130 million – and that’s just this year. The value of polluting rights is expected to rise making Tata’s non production benefit over $325 million – per year.

So, let’s evaluate. Britain loses 1,700 jobs (and a number of jobs that those 1,700 people supported), Britain loses up to 3 million tons of steel and Tata gains a sacred cash cow. But wait; there’s more.

The United Nations has created what is known as the Clean Development Mechanism (CDM). According to the UN, The CDM “allows a country with an emission-reduction or emission-limitation commitment … to implement an emission-reduction project in developing countries. Such projects can earn saleable certified emission reduction (CER) credits, each equivalent to one tonne of CO2.” So, if Tata implements a steel plant in India, they could pull in an additional $325 million per year courtesy of the UN until 2012.  

But, the Cap and Trade folks tell us, we eliminate up to 6 million tons of CO2 that Redcar could have produced and thus contribute to a healthier planet. Would that it were so, would that it were so.

With the acquisition of Redcar, Tata also acquired Redcar’s customer base. Do you think that Tata will ignore these customers’ needs? Hardly. Tata will satisfy customers by transferring the production of steel to India where, not only is labor cheaper and where there are no restrictions on CO2 production but where they can, in accordance with UN CDM regulations, “implement an emission-reduction project in [a] developing countr[y].”

So, to recap: leftist critics of Cap and Trade say it does little to reduce pollution and creates a market for speculators (including large conglomerates). Do you think that they have a point?

The carbon bank

In the Kyoto Protocols of 1997, the signatories were allowed to accumulate credits for CO2 as long as they met certain criteria. The credits were to expire in 2012.

The baseline for measurements was the pollution levels of 1990. In Russia, due to the breakup of the Soviet Union and the economic debacle that followed, Russia’s pollution levels dropped dramatically below 1990 levels. As a result, they have somewhere between $45 billion and $70 billion in pollution credits that will expire in 2012. Russia does not want them to expire and this is a contentious argument in Copenhagen this week.

Some fear that Russia will dump the credits on the market and drive the price for pollution credits down. Russia says that they have no intention of dumping their credits on the market; they just want to “bank” them.

Bank them? How do you bank carbon dioxide credits? Is carbon dioxide banking one of the new green industries we’ve been hearing about? Will there be derivatives for carbon dioxide banking? Would Russia be able to use its banked CO2 credits as collateral for loans? These may seem like facetious questions but go back and read them again and read them seriously.

If Russia is allowed to bank its credits, then it will always have leverage over the European Union Emission Trading System; Russia can always threaten, perhaps subtly, to dump its credits and cause havoc.

This is so cool: by running one of world history’s worst economic and most inhumane systems, the Soviet Union and its successor Russian state now get to exert great control over the European financial system and – if the United States decides to join – possibly the world economic system.

Есть ограничения выбросов и торговли больше, что ли?  (Translation: Is cap and trade great, or what?)

Our credit rating

Everyone knows that if your credit rating drops, you will pay more in interest if you need to borrow. It’s just common sense: if a lender is going to risk its capital with a risky borrower, it’s entitled to a higher premium. And, if you really need to borrow and have a low credit rating, the extra interest can really eat into your capital.

Well, guess what, folks — our interest rate may be headed up. By “our interest rate” I refer to the United States’ interest rate. Last week, the credit-rating agency, Moody's Investor Services, issued a warning to the U.S. government. Due to the precarious nature of the U.S. deficit, Moody’s may downgrade our credit rating from AAA. What? We’ve never had a lower rating than AAA.

Given our current credit rating, the interest we paid on our National Debt in 2008, according to the General Accounting Office, was $454 billion. The United States’ deficit to Gross Domestic Product (GDP) ratio is 6.8 percent. Certainly we’re not the worst in the world; Spain, at 11 percent has been downgraded from AAA to AA+ and Greece at almost 13 percent has been downgraded to BBB+.

On the other hand, for a country like the United States that has long considered itself one of the most financially stable countries in the world, a country whose dollar is not only a reserve currency for other countries but is used to price international goods, it is galling to find that other countries are looking as better bets to lenders. Other countries with better deficit to GDP ratios are, for example:

            China 3.0

Hungary 3.2

India 5.3

Italy 5.5

            France 5.6

Italy and France are better models of fiscal probity than the United States? Times sure have changed.

But all is not lost. All President Obama needs to do is to cut the deficit and can do so by returning unspent Troubled Asset Relief Program (TARP) money to the treasury, eliminating big spending programs like health care and foregoing programs that will put brakes on national income, such as Cap and Trade. Obama has the tools and the ability. All he needs is the will.

Quote without comment

Paul Volcker, former Federal Reserve Chairman and currently Chairman of President Obama’s Economic Recovery Advisory Board, at Copenhagen on December 8, 2009: “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence.”