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« Carnival of the Capitalists | Main | What Karl Told James »

Economic Illiteracy Spreads to Salazar

Which Salazar? Take your pick. But in this case, it's Ken's brother John, the first-termer from Colorado's Third District. Evidently, he and Diana DeGette have been attending the same economics classes. The Congressman is in high dudgeon over Rep. Joe Barton's bill to promote new refining capacity. Aside from the usual blather about how increased supply won't affect prices, the Pueblo Chieftain carried this remarkable statement:

Salazar said the measure also requires the government to make $3 billion in oil available to oil companies from the Strategic Petroleum Reserve, but does not set any limits on what oil companies can charge customers for that fuel at the gas pump.

Aside from the fact that oil companies don't (usually) charge consumers for gas at the pump, this statement reveals a mind-boggling (if such a thing is still possible) ignorance of how inventory works. Look at any income statement, and you'll see a line like "Cost of Goods Sold." This is, roughly, the base cost of the inventory that was sold. It doesn't include operating costs, so it's a good measure of the company's efficiency in turning inventory into sales.

Companies use one of three methods for valuing their inventory. FIFO, or First-In-First-Out; LIFO, or Last-In-First-Out, and Weighted Average Cost of Goods. The classic classroom example for FIFO is milk. It's got a short shelf-life, so most of the milk that comes in early gets sold early. The classic LIFO example is televisions, or hardware. Since these don't decay, you just put new widgets at the front of the shelf. The older widgets stay there, unless there's a run on widgets.

The classic classroom example for Weighted Average Cost of Goods is - heh - gasoline in a storage tank. The gas truck pulls up, pumps in 1500 gallons to top off your 3000-gallon inventory, and all the gas mixes together. When the time comes to report your COGS, you just divide the gallons sold by the price you paid for it. It lets you smooth out your pricing, simplifies your accounting, and accurately reflects your business processes. The same is true for refineries, which have multiple lines feeding multiple barrels of oil into the maw at the front end, with the back end releasing gasoline, nicely blended from all of them, into multiple trucks. If I even wanted to try to keep track of what oil ended up in which consumers' cars, I couldn't do it.

Let's go back to the simpler case of the gas station alone. In fact, LIFO (which is what Salazar is really proposing here) simply can't be calculated. Since I never fully empty out that underground tank, every gallon I pump out is a mixture of every delivery ever emptied into it. Sure, I could pretend that it works on a LIFO basis, but to what end? To provide a fictional paper-trail for some publicity-hungry Champion-of-the-People DA or AG who's got nothing better to do than to calculate my gross profit margin on a daily basis?

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