Cap and Trade: Unintended consequences

We have just published a White Paper on the cap and trade issue. The intent was two fold: first, develop a simple analytical model to understand how it works and what are its consequences. It appears that no one has present such an approach. Second, to consider the unintended consequences of this proposal. We have found that it is essential to study these otherwise you find yourself back in the same mess we have in the financial markets. The Administration is so hell bent to institute this that they are totally neglecting the downside risks! We summarize a few here.

The law of unintended consequences plays an ongoing role in all Government programs. Whenever the Government acts there are reactions to avoid the actions. The unintended consequences are critical to understand and hopefully anticipate and if necessary avoid. It is akin to flying an F‐16 having had one lesson in a WW‐I bi‐plane. If you enter a dog fight you best have some skills.

Leakage from Mexico and Canada

Why not just set up coal power along the Mexican border. It would employ hundreds of thousands of Mexicans, and then send it across the border. Likewise Canada could use shale oil and do the same on the North. Then watch the trade deficit sky‐rocket. The cap and trade proposal is a national first mover approach. Yet Canada and other nations have already moved. Thus what the US does is not followed by other countries.

Inherent Instabilities in Deployment of Alternatives by Environmentalists

As we have seen in so many prior cases, the environmental lobby, for reasons often known to only themselves, oppose anything. The use of wind has seen objection after objection. The deployment of large wind turbines across the mid country would be in the path of many migrating birds. Thus they cannot go there. Or the environmental impact statements would go on forever. Delay is often the deadliest form of denial. Delay can occur at the Federal, State, and local level, and the delay adds costs directly and derivatively.

Failure to Deploy Grid; Environmental and Other Delays

You cannot get wind and solar or even nuclear unless you have a national grid. This is in and of itself a major task. What is an intelligent grid? It is an evolving and learned process just as was the Internet. The Internet did not spring forth fully formed. It began in the late 1960s and slowly evolved assisted by thousands of highly intelligent and collaborative systems and development engineers. The power industry has been a backwater for the past fifty years. Thus the competence set is just not there. IBM had developed SNA, something that one may now find in history books. A handful of very smart people developed TCP/IP and its progeny. GE will not develop the smart grid. It will take the same group. However the problem is that they just do not exist. Thus the essential first step is at best problematic. Ironically many of those who could do this have H1B visas and are soon to be shipped out of the US! Who is forcing this? The
Unions. They want all Americans. The H1Bs want to become Americans and yet we throw them away. The system seems to devour itself in an endless fashion.

Stability Problems and Cycles

As I recalled about my involvement of the Black‐Scholes model, my parting comment was beware of the instabilities. They seemed to have forgotten that admonition in Long Term Capital Management. This is not a static system, year upon year. It is a random dynamic process with nonlinearities. By definition they become unstable and they oscillate. However we can model and monitor them. They may be controllable and than can be observable. It just means that you fully understand this and have people looking at it as a system. Economists are poor at this since economists never have to design something that works. They are not engineers, scientists, or physicians. They are at best abstract conjurers.

Massive Job Loss and Displacement

Coal is the livelihood for hundreds of thousands in the United States. Wheeling, WV is a lynch pin in this world, and in the hollers of that region mining of coal has been centuries of existence. We will drive them totally into the stone age. The technological solution is a clean coal which seems to be dismissed out of hand by the Administration. Technologically ignorant people assume if it has not been done it cannot be accomplished. Roosevelt was not a luddite; the atomic bomb was a glimmer in the eye as late as 1943. It took really just over two years to deploy. The same effort could be applied to coal. But for some almost religious reason it has been defaulted. Add to this the industrial collapse because of dislocations of Industries and we would expect massive unemployment. The recovery would take generations. It would be costly beyond any trillion dollar Stimulus we have yet to see.

Massive Industrial Movement from the US

The Industrial sector is a major user of energy in the United States. One approach of controlling the CO2 emissions at the source would be to have the Industrial sector be controlled like the electricity sector. If we look at the Table below the sector relies heavily on oil, gas and even coal. Coal is used for aluminum and concrete, it is a cheap energy source for creating these and also concrete as a chemical process also produces CO2. Thus is we were to apply the same restriction here we would inevitably drive these industries from the US totally. The IT industry is a heavy user of electricity and it too would find itself drive elsewhere. Thus one of the unintended and totally un‐thought about consequences is this driving of industrial entities, the residual one at that, from the US to countries which have available and affordable power.

Dramatic Inflation and Inflationary Pressure

The problem of inflation is pandemic in this approach. Taxes will drive up demand which drive up costs of the energy sources which drive up energy which drives up costs and on and on. The cap and trade proposal may very well set in motion a whole cycle of such inflationary pressure. Also like Gresham's Law, it may drive out "good fuels" and leave bad. For example as coal becomes non‐existent in electric power plants, there may be created a "Black market" for coal and wood may replace coal in certain markets. It will be akin to prohibition, the demand will be intensified because of the inflationary pressures. As one begins to know this Administration, the home still will be replaced by the home coal burning stove and a new massive Federal police force will likely be formed to strike down the down trodden pollution violators.

Destruction of Entrepreneurial Innovation

One of the things which seems to be coming out of this Administration is a total lack of understanding of the entrepreneur. As we have written before the entrepreneur is the engine of innovation and commerce in the US since the Dutch settled in Manhattan.