Meet Cap 'n Trade

Cap and Trade is the linchpin of the government's effort to curb carbon emissions. Senior Editor Paddy Hirsch explains how the cap and trade model works.

Credit default swaps? They're complicated -- and scary! The receipt you get when you pre-order your Thanksgiving turkey? Not so much. But they have a lot in common: They're both derivatives. Senior Editor Paddy Hirsch explains.

Bonds, notes and bills

So much government debt! But what's the difference between the Treasury's bills, notes and bonds? Senior Editor Paddy Hirsch explains.

Inflation

Most economists agree that inflation of about 2% or 3% annually is a natural function of a growing economy. But people are worried government stimulus measures could spark much higher inflation. Senior Editor Paddy Hirsch explains

High-frequency trading

High-frequency trading is creating a ruckus on Wall Street. Marketplace Senior Editor Paddy Hirsch explains what high-frequency trading is and why some people are up in arms about it.

Factoring

Many small businesses get the cash they need to operate and expand from so-called factors. One of the biggest factors in the business is CIT, and with CIT on the ropes, small businesses are worried. Senior Editor Paddy Hirsch explains what factoring is, and how it works.

Comments

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By Rod Herdman

From West Chester, OH, 08/07/2009

If I wanted to devise a way to slowly squeeze the life out of the worlds economy and create absolute poverty, I would enact a cap and trade policy. It should be renamed " anaconda", the deliverer of death and destruction.

By Mark Beaver

From Atlanta, GA, 06/17/2009

Wasn't this the idea the enron guys came up with?

I'm not saying I have all the answers but I can say definitavely that Cap and Trade is a horrible idea. This only hurts consumers by jacking up prices. If a company wants to say "go green" then all of their money is tied up in buying carbon credits so that they can function today. If all of their money is tied up doing that, where does the money come from? From the consumers.

Implementing something like this will increase the cost of doing business, which will increase consumer prices for bare essentials. The truly horrible piece of it is that it increases exponentially, not just doubling.

Consider that if my electric bill doubles that most likely means that all of them doubled, including businesses. Businesses now have to charge more for goods because the cost of doing business went up, it's a ripple effect that has no end.

At this point in time a doubling or more of energy prices when we're just starting to get out of an economic down turn would be a nail in the coffin of our entire economy. If we're not spending now, just wait until more of our hard earned dollars are being funnelled away.

By david gonzalez

From palm city, FL, 06/16/2009

wow you just proved that Cap and Trade in the US will totally kill our economy. Since we don't produce anything now let's put a cap on it!

By George McPherson

From DC, 06/15/2009

This is interesting but clearly a "consumption" tax would be more straightforward and would minimize sketchy behavior by corporations and individuals. If Cap'n trade offered the boys a percentage of the profits of the pies that are sold instead of eaten, he'd realize a similar result and would have a better alignment of interests with all of the stakeholders....just my humble opinion (JMHO)...

By to sad

06/15/2009

milton friedman would be sad at this.

By Judy Trautwein

From Columbus, NE, 06/10/2009

Great illustration. However, you need to illustrate part 2 that shows the costs to the industries and people.

I work for an electric utility in Nebraska. 60% of the electricity in the United States is generated by coal.

Everyone wants clean air. Wind is great for producing electricity if the wind blows. The central US is windy, but wind does not blow all the time. We need to have back up (produced by coal) electricity unless you want to flick the switch and experience darkness when it is not windy.

Electricity produced with a nuclear plant is the cleanest. However, a nuclear plant has not been built in the US for 25 years. A new one would cost billions of dollars. The nuclear technology and equipment has gone to other countrys because we have not built one for so long. The regulations are very stringent and no one wants the waste.

If cap and trade goes into effect, our electric rates in Nebraska would go up 150%!! I think of the industries in Columbus, Nebraska. The production would go to Mexico. I think of our customers who cannot afford to have their electric bills go up 150%.

The solution to cleaner air is to go slowly on this so there is an opportunity for clean coal technology to be developed.

By Peggy Sutherland

From Holbrook, NY, 06/09/2009

Thanks, for another excellent white board. Wonderful series!

By Karl T

From PA, 05/31/2009

Although I think reduction of CO2 is a noble pursuit, cap and trade is not the answer.

First, this system essentially puts the government in charge of our economy--probably not the best idea, given the government's track record of waste and corruption.

Second, C&Trade is essentially a huge tax upon industry and consumers.

Third, if it will cost businesses more to operate in the United States they will move elsewhere, e.g., the decline in IPOs since the enactment of Sarbanes Oxley.

Neither China or India have such schemes in place, once again our politicians are putting the U.S. at a disadvantage. If you really want to curb CO2, the entire planet needs to be involved.

By Jay Taylor

From San Antonio, TX, 05/28/2009

Trying to watch the cap and trade segment May 28, 2009, but no video. :( Just audio, and broken up at that. What gives?

By Pipin Aripin

From Bekasi, 05/26/2009

Thank's paddy for your explain...

By Bill S

From Indianapolis, IN, 05/23/2009

Paddy Hirsch does a great job explaining concepts, but normally in his presentations he includes some mention of how a concept might go awry. As Paddy describes it, cap and trade involves substantial governmental "hands on" involvement--dictating who falls under cap and trade, dictating the types and amounts of pollution allowed to each, dictating periodic changes to the caps and periodically grading how each participant performed. Could such power in the hands of politicians and government officials go awry? Would this not invite attempts at backroom politicking and payoffs? Any system can be "gamed," but why not instead merely establish one-time clear and transparent tax rates for pollution, collected by the IRS, and minimize opportunities for underhanded manipulation?

By Dan Riedinger

From Washington, DC, 05/22/2009

This is a very engaging (and sorely needed) explanation of "cap and trade.” It describes fairly well the way legislation just passed by the U.S. House Energy and Commerce Committee would work - setting legally binding emissions caps that reduce over time, and distributing emissions allowances that can be bought and sold, the number of which gradually is reduced as the caps are lowered.

The only major factual error comes at the very end, with your assertion that without the caps, companies can emit whatever they want. CO2 and other greenhouse gases aren't yet capped, but other pollutants are, so there are limits (which soon will be further tightened) on the amount of pollution related to soot and smog, for example, that can be emitted.

Dan Riedinger
Edison Electric Institute
Washington, DC

By K. Sparks

From Denver, CO, 05/21/2009

Clever explaination which expains the economic incentive for the politically correct process redefining "polution" as CO2. People and countries that pour sewage into rivers and smoke into the air have no money, so let's blow off real polution to focus on something that "pays"....CO2

By Mike Spike

05/20/2009

How are the individual polluters' waste calculated and tracked?

By Aaron W

05/19/2009

Cap and Trade, as this guy describes it, ultimately puts money in the hands of those that are already clean, which means that the pollution step down will go that much slower. I say this because the resources spent on acquiring the surplus cap credits from other companies can no longer be invested in acquiring cleaner methods of production for those who need it. Once you're clean, there's little more that you can do to reduce your pollution output.

Those that sell their cap credits may (read: will) profit by doing so, and thus will produce less of their product, which is generally bad news for everybody. Let us remember that wealth is not paper or electronic dollars: wealth is stuff; wealth is production.

By Mary P

From Denver, CO, 05/17/2009

This is very educational and leads to may pondering questions as raised by other comments. Will Cap.n.Trade be regulated and enforced in all countries by all companies without politcal interference? I think Not, and would suggest yet another way to encourage business, and production to leave the cap.n.trade nations. Secondly, once this type of logic is imposed on "pollutants" lets say, then where is the end to the reach of government to regulate all production and consumption, down to the individual? This is clearly a politically motivated assumption, but raises some serious questions as to why people think government has the answers to our social problems. They are clearly only looking, in my humble opinion, at the newly created tax base and the enourmous growth potential to exploit the real problems. Guess we shall learn from this financial mess how well the Government out performs private industry, and judging by actions, statements and policy, they are clearly power grabbing for authority and wrecking the integrity of the entire market system...did i mention "Free Market" system....yes, applied literally! Wake up America, cap.n.trade will NOT solve our problems, it will only proliferate them and drive more jobs out of America. But then again, Globalization has already whipped out most American production, so what will be left? WE ARE SHEEPLE BEING LEAD TO THE STEEPLE!

By Mike Hopkins

From tulsa, OK, 05/16/2009

the pie analogy works, but perhaps you should talk about the impacts of this.
- Gus, what, he isn't going to Grow, eat more, produce more?
- you used the oil company as an expample, but what if there is not "new technology" or that "technology cost more" would not he price rise and be passed on to all the pies sold to customers?

By greg Crannell

From WWU, WA, 05/15/2009

Additionally,

the economy can still grow by adapting to higher prices with more efficient practices, technological innovations and use of alternatives (hopefully less pollutant ones).

By Greg Crannell

From WWU, WA, 05/15/2009

@ Jerry Trancik

Actually in the video Paddy states the boys are fat, so the assumption is that they're over-consuming the resource (i.e- pie). So not only do they need to consume less anyway, but it's better for everyone if less is consumed.

"As the businesses increase in size your analogy does not allow for them to get more credits. It seems to work fine in a stagnate market but not a vibrant economy."

This analogy extends to each boy representing size and relative age of firms. It actually works quite well if you've studied cap and trade and can see the beauty in it.

The real point of cap and trade is not so much growth, but a reduction in negative behavior/effects that are not taken into consideration of the cost/benefit analysis of the market that currently exists. If those costs were taken into consideration (i.e- perfect or at least better information was available) the prices would reflect these costs and cap and trade wouldn't be necessary.

Why wouldn't it be necessary? Because with perfect information you'd be able to assess the sustainable threshold of resources and not pollute/extract beyond that point. Sadly this isn't possible in most cases and many things just aren't easily quantified, like the damage of pollution to the biodiversity and resilience of local forestry and wildlife.

By Jerry Trancik

From Ada, MI, 05/15/2009

Good to see that you are branching out beyond financial topics. These whiteboards are great.

On your cap and trade analogy.
Your analogy works fine if each of the boys stayed the same age. But as the younger boys age and grow and assuming they are fit and trim they will need more pies to keep their strength up and function properly. The same with the economy. As the businesses increase in size your analogy does not allow for them to get more credits. It seems to work fine in a stagnate market but not a vibrant economy.

By Greg Crannell

From WWU, WA, 05/14/2009

@ vikram parekh

Most of the arbitrary lines set to limit pollution are still far below our current levels. So pollution overall is supposed to reduce, so influencing government policy would only come into play as to how much it's incrementally reduced.

Also there are different ideas as to how the credits are originally allocated, in this video it was done upon age, which is the traditional operating procedure for cap and trade. However there are plenty of other options such as letting market mechanisms determine the price of credits.

By Greg Crannell

From WWU, WA, 05/14/2009

Good basic analysis of Cap and Trade, personally in the case of air I'm a fan of the 'Sky Trust' model cap and trade system.

I wish you had mentioned the basics of how credits are originally allocated and why this is so important to what incentives are provided/how they're effected.

Also, one big problem w/ cap and trade systems worth noting is the concentration of pollutants which can result from people like 'gus' selling their credits to higher polluters.

The higher polluters do pay a higher price for their pollution, and that's great. However the area within which they operate continues to suffer and does not see enough of a reduction to limit externalities upon local--or in the case of air even regional-- constituencies.

By vikram parekh

From mundelein, IL, 05/14/2009

Thanks Paddy for such a wonderful series. One question i have w.r.t. cap-n-trade is how can we all be sure that the caps are fair? what if one of the boys is favored over the other (depending on the political climate)....wont that create issues with confidence in the system and ultimately result in everyone trying to influence the govt policy rather than genuinly invest in polution resulting techonology?

By Jeannie Cat

From New York, NY, 05/14/2009

Hi, I love the series! I prefer it to the news and the explanations are tops.

I have a few questions:
What are rating agencies and how do they work?

After learning more about Madoff I wondered:

-How front-running works (is it essentially working off an inside tip?)

-How split strike conversions work.

Thanks much!
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