Commodity based TIPS to stop futures speculation?

Discussion in 'Business & Economics' started by nirakar, Jul 25, 2008.

  1. nirakar ( i ^ i ) Registered Senior Member

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    Commodity based TIPS to stop futures speculation?

    The Airline Executives are blaming speculators in the oil futures market for the global increase in fuel prices. Other people blame the global increase in money supply for the global increase in commodities prices.

    On the supply and demand side population (potential demand) keeps rising, the capacity to extract raw materials from the earth keeps rising, while actual raw materials remain constant. In saying raw materials remain constant I am counting all products as recyclable and I am ignoring the issue of topsoil washed into the oceans.

    How are those of us who have money in the bank to preserve our buying power? The US Treasury introduced TIPS, Treasury Inflation-Protected Securities with the idea that these would be the most secure way to preserve purchasing power. Pension funds are increasingly investing in commodities rather than TIPS as the most secure way to preserve purchasing power. This may or may not be driving up commodity prices.

    There are 2 problems with TIPS. First, they are too USA based. If you want to preserve your global purchasing power TIPS won't protect you from a falling dollar. Second many of us increasingly don't feel the way the BLS calculates inflation is an accurate measure of how we experience inflation. I think that if the US government wants to pull the pension funds out of the commodities markets then the US treasury should start selling TIPS that take their inflation number from a commodities index rather than from the BLS numbers.

    I would definitely buy TIPS that measured inflation by a commodities index but I won't touch TIPS based on BLS inflation numbers.

    What do you think? Should the US Treasury issue Commodity Inflation based TIPS?
     
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  3. OilIsMastery Banned Banned

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    Are speculators to blame for oil's rapid decline from $147 to $123?
     
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  5. nirakar ( i ^ i ) Registered Senior Member

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    I think the role of the speculators is overrated by those who blame speculators for the rise in prices. If they blame speculators for the rise they should blame/credit them for the fall in prices.

    Still, a group of airline executives want tighter regulations on speculation in oil. They believe or pretend to believe that speculation in the futures markets somehow drove up the spot market oil prices.

    The volatility in oil prices just shows that the "correct" price of oil is unknown.
     
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  7. kmguru Staff Member

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    The airline executives are correct since they are the ones that buy large quantity of jet fuel. They also reckon that the oil price shot up too fast that did not account for steady growth in China for tha last 20 years. Supply and demand should be gradual and not abrupt barring oil field explosions etc. The normal expection was for the gas to rise a steady 5 to 6 cents per month for the foreseeable future.

    The other part is what do you do with US pension fund's 5 Trillion plus China's surplus of 2 Trillion (not counting their pension funds) plus sovereign funds of 8 Trillion. Where do you park the money that is safe and yet earns some interest?
     
  8. OilIsMastery Banned Banned

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    I think we need to define the term speculator. All human beings are speculators because of human stupidity, black swan theory, etc. Now these so-called speculators cut their bets as prices rose.

    http://www.bloomberg.com/apps/news?pid=20601087&sid=alYVlHUmKbF4&refer=home

    Markets are irrational because human beings are irrational. I can't explain markets and I don't trust anyone who attempts to.
     
  9. Billy T Use Sugar Cane Alcohol car Fuel Valued Senior Member

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    You show a lot of misunderstanding in two parts of your post.
    That is exactly what TIPs try to do by increasing the value of the principle to compensate for inflation. (TIPS also pay interest at a fixed rate, but the amount paid increases as the value of the principle increases.)

    For some the inflation correction is too great and for others the correction is too little. This because different people have different mixes of expenses and the inflation correction applied is an average value. For example, if your budget has a lot of medical or college expenses, not covered by some insurance plan or grants, then TIPs will probably under protect you as these costs have tended to increase more rapidly than the average inflation. If you buy a lot of high tech (IT digital cameras etc.), then TIPs have over protected you.

    As far as protection from non-dollar costs (your vacation in Europe, etc.): Again TIPs may protect or may not. This depends upon how the purchasing power of the dollar is changing wrt the purchasing power of the currency you will be spending. For example, recently, the dollar has been falling wrt the Euro (and almost all other currencies). So TIPs have lost purchasing power in Europe in recent years, but not as much as the dollar has.

    About a 1.5 year ago (or perhaps a little more) I recommended TIPs in a few posts here to those with no stomach for the more volatile ADRs. (India ADRs are more volatile than Brazilian ADRs, but in the long run both will gain as the dollar drops. I.e. ADRs (of these two* BRICs) will more than compensate for US inflation in the span of a few years.)

    I have some retirement assets that have accumulated over 40 years, on average. The profits are so huge that I could not cash out and invest all in ADRs without excessive transfer to the IRS, so about 1.5 years ago I moved them almost entirely into TIPs. (Actually TIAA/CREF's "TIP fund", which includes some corporate and foreign inflation protected bonds.) While the index funds these assets were in have dropped in dollar value about 20% (more in purchasing power terms) my TIAA-CREF "TIP fund" is up 14.7% in last 12 months (check me if you like at www.tiaa-cref.org) As I have average hold period of more than one year, I am up about 20% instead of down 20% as stocks are.

    I foresaw the drop in confidence in the dollar years ago and knew that the growing US debt cannot be repaid. Thus, I knew (and posted here long ago) that the printing presses will grid out dollars and produce inflation, just to finance the debt and its growing interest expense. (All this is in many posts several years old.) Now almost everyone fears the return of inflation, so many more are seeking the protection of TIPs. This increase in demand is why the interest rate on TIPs is even lower now than when I bought and why they are worth about 35% more in dollars than the stock index funds I sold to buy them with. - Once again you would have big profit by doing what I told you too. Buying TIPs now may not be so smart. I will not yet tell what is as I do not want others to drive up the price before I fully invest. (I am a very poor market timer in the short term, so I always take a few months, even a year, to adjust my holdings - sort of a dollar averaging idea.)
    Most pension plans and essentially all life insurance contract have fixed dollar obligations to pay in the future. Thus they buy regular US bonds, (which always pay higher interest rates than TIPs), not "commodities" to any significant extent. Neither they nor the government want to have volatile value assets and fixed dollar obligations. Most commodities have done very well recently but no asset class can forever do significantly better than the average. This is especially true of assets that man can make more of. For example, as I posted about 4 years ago in the OP of this thread (long before there was a housing / mortgage etc crisis) the fact that home prices had been increasing at more than twice the rate of other assets for more than a decade told me that they would soon collapse (to get back in line with the general inflation). Thus TIPs linked to commodities (Or any narrow assets class) is NOT a good idea, unless you buy only assets in that class. TIPs are, and should be, linked to a broad average measure of inflation, not any narrow asset class.
    ---------------
    *I avoid and do not recommend Chinese or Russian ADRs as I fear someday their underlying assets will just be confiscated. Russia has essentially already done this to some oil company investments (using "environment rule violations" to justify. Production is stopped, and then the government takes over, "nationalizes," paying a small fraction of the true value.)

    China probably will confiscate when foreign investment is not very important to them. They will destroy the dollar (if it has not already collapsed) then also. (To reduce demand for oil etc. with US and EU in deep depression after a dollar collapse.) This will drop the purchasing power of the US treasury bonds they still hold. Probably the confiscation will be "explained" as only "just compensation" for the losses China incurred on US Treasury bonds.
     
    Last edited by a moderator: Jul 27, 2008
  10. nirakar ( i ^ i ) Registered Senior Member

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    Older and poorer people have a hard time relating to the stable prices in ever more advanced techn.ology. The old technology worked just fine. The fabulous new technology is relatively unnecessary for security and happiness. I think the BLS has overvalued new technology in their CPI calculations.

    Bill Gross, the manager of the biggest bond fund also thinks the CPI is understating inflation. Many people in finance are beginning to doubt the CPI's accuracy.

    The BLS says this:
    Seasonally adjusted


    Expenditure Compound
    Category Changes from preceding month annual Un-
    rate adjusted
    3-mos. 12-mos.
    Dec. Jan. Feb. Mar. Apr. May June ended ended
    2007 2008 2008 2008 2008 2008 2008 June 2008 June 2008

    All items................... .4 .4 .0 .3 .2 .6 1.1 7.9 5.0
    Food and beverages .1 .7 .4 .2 .9 .3 .7 8.1 5.2
    Housing.................. .3 .2 .2 .4 .3 .5 .5 5.2 3.5
    Apparel................... .1 .4 -.3 -1.3 .5 -.3 .1 1.0 -.2
    Transportation........ 1.0 .5 -.7 .7 -.7 2.0 3.8 22.3 12.0
    Medical care........... .3 .5 .1 .1 .2 .2 .2 2.1 4.0
    Recreation............... .0 .2 .1 .3 -.1 .1 .1 .6 1.3
    Education and
    communication.... .3 .4 .1 .3 .4 .4 .5 5.1 3.4
    Other goods and
    services............... .3 .4 .2 .4 .5 .4 .4 5.2 3.8
    Special indexes:
    Energy.................... 1.7 .7 -.5 1.9 .0 4.4 6.6 53.6 24.7
    Food....................... .1 .7 .4 .2 .9 .3 .8 8.5 5.3
    All items less
    food and energy.. .2 .3 .0 .2 .1 .2 .3 2.5 2.4


    I doubt that you can find one American who would estimate the last years rise in their food budget at less than 10%.

    I looked into the CPI price for bread a few months ago and found that the only bread in my supermarket that matched their price for bread was a store brand loss leader that my supermarket keeps out of sight on the bottom shelf. Most bread cost 2 to 4 times what the BLS was saying bread cost.

    I am starting to join the conspiracy theorists who say the BLS is deliberately understating inflation to keep inflation indexed government spending down.



    I own FXE CurrencyShares Euro Trust. When I bought it last winter it was essentially paying 4% a year in Euros. The Euro also has inflation. This is a high inflation time for most currencies as compared to inflation a few years ago.

    I own my home so I tend to think of inflation minus the housing sector. I believe that my personal inflation minus the housing sector was at least 10 % last year.

    The 10 year TIPS issued this last July 15 that mature July 15 2018 pay 1 & 3/8 percent plus inflation. I believe the BLS will probably understate true inflation by more 1 1/3 percent annually for the next ten years which will make TIPS a financial instrument that will lose their owners money in true real dollars.

    The Ten year Treasury issued on July 15 pays 3.87%. I a sense the difference between the Treasury interest rate and the TIPS interest rate represents a prediction of the official CPI inflation numbers for the next ten years. But inflation is really going to be much higher than 2.5%.


    I owned the ADR RIO (Companhia Vale do Rio Doce) for a few years. Sold last Winter. I owned closed end funds invested in India. Sold them last winter. Wish I sold them earlier.

    I would put my mother in RIO now, but RIO is to adventurous for my mother who is risk adverse. That is why I wish TIPS existed that were tied to Commodities inflation rather than this very subjective CPI measured inflation. My moms money might eventually be spent on health care. I suppose ideally her money should be in TIPS that measure inflation in healthcare services.


    AS interest rates went down the value of the existing bonds go up. I think that accounts for your 14% gain. As interest rates go up you should have a 10% loss in the TIAA CREF TIPS fund if I guessed correctly at where the 14% gain came from.

    I was looking for a Farmland REIT. I have not found one yet that buys farmland in the USA. In my search for this farmland REIT I believe I saw that TIAA CREF was buying farm land. Pension Funds and Hedge Funds have been buying commodities futures as inflation hedges. I think that there is an increasing understanding that commodities inflation will drive general inflation higher for the 20 years.

    I think commodities will beat the Dow over the next 20 years. I care more about global inflation than USA inflation. I might eventually retire outside the USA. All that cheap good stuff from China should rise in price a lot if the Yuan ever gets unpegged from the dollar.

    Other forms of TIPS are as relevant sector funds are. Picking sectors can backfire. Picking the Market as a whole can also backfire.


    I think the general run up in Brazil against world currencies may be over. I have not yet identified which countries to look to now as a inflation/falling dollar hedge.

    I would gladly buy something that paid commodities inflation + 1/2 percent. But I do want that extra half percent and am reluctant to just buy and hold a commodities fund.

    If people buying commodity futures as Inflation Hedges or falling dollar Hedges really are pushing up commodity prices then The US government could reduce the demand for commodity futures by offering TIPS indexed to commodity prices rather than indexed to the CPI.
     
  11. nirakar ( i ^ i ) Registered Senior Member

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    Anybody buying something for the purpose of selling it at a profit rather than for the purpose of consuming it could be called a speculator. That definition would turn all retail stores into speculators.

    The Airline executives who complained about speculators pushing up the price of futures contracts seem to believe they would be getting better prices on fuel if people who did not intend to use fuel did not buy futures contracts.

    I don't think there is building boom in oil or Jet Fuel storage tanks. Without building storage tanks and taking delivery of the actual fuel it is hard to see how speculators in futures are affecting the spot prices. Some say rising oil prices leads to producers leaving oil in the ground while they wait for still yet higher prices. I doubt that. The traditional view that higher prices leads to more production makes more sense to me.

    For Irrationality in the futures markets to alter spot prices we would have to back off of the idea that supply and demand sets spot prices. Does supply and demand set the spot price for jet fuel?
     
  12. Billy T Use Sugar Cane Alcohol car Fuel Valued Senior Member

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    To NirKar:

    Only thing in your post 7 I disagree with significantly is:

    Nirkar: "AS interest rates went down the value of the existing bonds go up. I think that accounts for your 14% gain. As interest rates go up you should have a 10% loss in the TIAA CREF TIPS fund if I guessed correctly at where the 14% gain came from. "

    That 14.7% was TiaaCref 12 month data. Interest rates in the last 12 months have not been going down. Your logic is OK, but your facts are wrong in this case. Your 15July07 vs 08 data (significant increase in TIP interest rate) is mainly I think related to the percieved shift in expectations about the FED in last couple of weeks. - They do seem to be more serious about containing inflation with higher rates compared to a month or so more ago; as a result, the demand for the inflation protection of TIPs is probably down in last few weeks, making price down and interests up. - that would be my read on your data.

    I will extend that idea to predict that when the fact, even if well hidden, that the the saving of Fanny and Freddy will in some form "pump out dollars," the fear of inflation will grow again, and TIP rates will come back down as the demand drives the price up again.

    I do not take effort to fully understand all this, but the spread between TIP and regular bond rates with the same period is more important to full undersanding I am sure. The flow of money from /to stock vs bonds must also be considered. That is driven mainly by stock market price expectations, not bonds, which are ususally more stable (but at low interest rates bonds can be quite volitale too.)

    TIPs tend to be bid up in price and down in interest rate as inflation fears increase. That is what has happened in the last 12 months, although as just stated, in the last two or three weeks, the fear of inflation may/seems to have dropped at least the people investing seem to think that even though a slow down is coming and less oil will be needed, Fed is more likely to raise rates even with the slow down, etc.

    Honestly I have not looked at Cref's "TIP fund" recently but suspect it may have dropped a little if people now think the FED has the guts to fight inflation during a slow down in an election year. (I think they will, but not becuase they have the guts to follow the US's long term interests. I think it is because rates must go up to attract dollar rich governments to continue to buy Treasury bonds still. I.e. its not "guts" but "necessity."

    Specifically on your post, I agree more "experts" tend to think the correction to TIPs is not enough to compensate even for current inflation. Few think it does for probable future inflation, even with that postualted action by the FED. Also there will always be some lag in the adjustment applied as it is built on the past data, not the prevailing predictions. That said/ admitted/ none the less TIPs do offer some protection and interest, which I think for the multi-year investor is better than money in the bank. Perhaps even better than putting money in already inflated commodities now.

    One final comment: I think it is the "QUALITY CORRECTION" that is excessive in the compution of the CPI, not the data collected in stores that is in error. For example, a new tire for your car may be better that one of five years ago so part of the price increase is removed to adjust for the greater quality of the purchase, but that is nonsense, in most cases. That tire of five years ago was already "user perfect" and just as servicable as the new model for almost all users, except those that want to tke curves faster on wet roads etc. Likewise fact a new compter is twice as fast and has twice the menomy should not reduce the store price increase if I am limited by my typing and thinking speed with half the memory of the old machine still unused. etc.
     
    Last edited by a moderator: Jul 29, 2008
  13. nirakar ( i ^ i ) Registered Senior Member

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    I don't know if the info below is from your TIAA CREF TIPS fund
    http://72.14.205.104/search?q=cache...inflation protected"&hl=en&ct=clnk&cd=1&gl=us

    PERFORMANCE
    AVERAGE ANNUAL TOTAL RETURN
    TOTAL RETURN
    10 Years
    5 Years
    1 Year
    YTD
    3 Months
    7.96
    6.74
    14.54
    5.18
    5.18
    Lehman Brothers U.S. TIPS Index
    7.55%
    6.31%
    14.14%
    5.23%
    5.23%
    CREF Inflation-Linked Bond Account
    T

    MATURITY ALLOCATION
    Year(s) % Portfolio Investments

    1-10 Years TIIS 70.5%
    10-20 Years TIIS 29.0%
    Short-Term Investments 0.5%

    FUND FACTS
    Average Yield to Maturity 5.07%

    Number of Issues 24

    Average Quality AAA

    Option-Adjusted Duration 8.23 Years

    Average Coupon 2.42%

    Average Maturity 9.53 Years
    -----------------------------------------------------

    Ten year TIPS issued a year ago were paying 2 & 5/8%
    Ten year TIPS issued 2 weeks ago were paying 1 & 3/8%
    So interest rates on TIPs came down a lot.

    The ten year treasury issued a year and two weeks ago was paying 5.05%
    The Ten year Treasury issued two weeks ago was paying 3.87%
    MY choice to look at ten year maturities is rather arbitrary.
     
  14. kmguru Staff Member

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  15. Billy T Use Sugar Cane Alcohol car Fuel Valued Senior Member

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    I bet it is the same fund as when I looked about 2 or 3 weeks ago the 1 year return was 14. 7% (and I may have rounded to one decimal place) Your more recent look gave 14.54 for the one year return - either is quite nice compared to the double digit NEGATIVE returns of stocks - thanks for independently confirming my point, data and truthfulness.

    Yes the interest paid by TIPs came down a lot - that is very consistent with them being up a lot in value.

    TIPs always pay very significantly less interest that regular Treasury bonds as your are to large extent buy the inflation protection they offer, not trying to earn interest. Most of the ~14.6% one year gain in the TIAA-CREF "TIP fund" (actually more than just US treasury issue, but all with some inflation index) is the increasing demand for inflation protection, driving their prices higher, not that they pay interest.

    Also there is a "story" in the regular bond interest change (5.05 --> 3.87%). Their principle value has gone up as people lost money in stocks and moved to these bonds, making demand increase. Especially strong recently in part because in last few weeks the dollar has recovered some. - Gold as a "safe haven" IS NOT CURRENTLY working -(down to around 900/oz from 1000/oz, I think but do not follow.) What is a "stock Bear" to do? Buy Gold? No. Although I am not as bought my ADRS about 6 years ago, recent buyers especially in India are licking their wounds. - Not much else he can do NOW but "park dollars" in Treasury Issue.

    Althought I bet the FED does not have the balls to raise rate tomorrow as it should, I also bet that the longer term slide in the dollar will soon resume and then the 10, and especailly 30, year bonds will tank, driving interest rates up again even if the FED will not.
     
    Last edited by a moderator: Aug 4, 2008
  16. cosmictraveler Be kind to yourself always. Valued Senior Member

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    Here's a thought, only the oil companies can increase the price of oil not speculators. Speculation is just hoping that prices will rise in the future or fall. Another thought is that in America 32 BILLION less miles were traveled this year than last year meaning less gas was used so there was no "shortage" as was stated but only greedy assholes taking everything they can get.
     
  17. kmguru Staff Member

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    11,757
    From production to distribution, major oil companies control the entire supply chain. Therefore they control the price. Same for Natural Gas where I designed Cryogenic gas processing facilities for the companies that also distribute them. It is all about GREED!
     
  18. 2inquisitive The Devil is in the details Registered Senior Member

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    3,181
    False, that is the populist viewpoint of the uninformed masses. The exporting nations control supply and price to some extent. For instance, Saudi Arabia denies the oil companies access to much of their 262 billion barrels (known reserves) of crude. That is their right, as they have stated they want to save some crude for their children's future income. Much of the recent price increases in crude is from speculation of Hedge funds and other 'investors' as they put their money into oil futures and other commodities such as grain to stay out of falling stocks and the falling dollar. The dollar has recently exibited some strength (probably short-lived) and gained in value. That dollar strength, and the federal investigations into commodities manipulation, has caused many speculators to exit the oil market, lowering the price of a barrel. The oil companies have little to do with the retail price of gasoline. By keeping supply tight, OPEC has partial control on price, speculators most of the rest by inflating prices even more in a falling market.
     
  19. kmguru Staff Member

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    How many oil companies you have worked for - from production to refinery to distribution??
     
  20. 2inquisitive The Devil is in the details Registered Senior Member

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    You got me. Maybe I am really T. Boone Pickens. Maybe I got pissed off at the Saudies when they told me to develope our own offshore wells and ANWR before they would let me sink any more wells in their country.

    More seriously, a quick google search confirms what I say. From the US government's Federal Trade Commission:
     
  21. kmguru Staff Member

    Messages:
    11,757
    So, since over 60% oil comes from U.S. in US, who owns those productions, oil wells etc. in Louisiana, Texas and Oklahoma?

    What does this mean?

    "....are often referred to as “supermajors” – integrated firms that explore for, drill, produce, and ship crude oil and refine, distribute, and retail gasoline and other petroleum products."
     
  22. Billy T Use Sugar Cane Alcohol car Fuel Valued Senior Member

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    Want more proof (that 2Q has it correct)? Well Billy T, who seems to go out of his way to provoke 2Q, say 2Q is "right on" on this one.

    Also as the above ground storage is small compared to consumption there must be some way to keep the supply and use approximately in balance.

    Price, with no one able to set or control it, is the most simple and direct way. Given that there are many suppliers and millions of times more consumers, no one can set prices, but the suppliers (producers) could get to gether and and try to affect this price, which equlibrates supply and demand. - OPEC tries, but it controls too little of the supply and can not even stop some of its members from quota cheating. Russian is not, I think, part of OPEC and often now is the world's largest producer; (No longer needing to import oil as it did when Stalin's a-biotic oil idology was controlling the USSR oil industry)*

    Consummer nations can ration the consumption. In WWII, My MD father had a green sticker for his car window as he did make house calls. (Actually, back then, so I have read, the gasoline was rationed more to conserve rubber tires than gas as much of the natural rubber came from a region that the Japanese Navy controlled. - A big stimulous to the development of artifical rubber. If you have never even heard of a "blow-out"- thank the WWII chemists. US still had enough domestic gas production. Too bad "energy" is not "material" as substitution of materials is usually possible and some times even a "forced benefit" as the end of the natural rubber tire was.)
    ----------------
    *Stalin & CP idology was that USSR was making the new "Soviet Man," not be subject to capitalistic greed, and a new world order that would last forever. (Argueing that oil was finite or that genes could limit the reshaping of men or crop yields, were tickets to a labor camp in Siberia.) A-biotic oil & Lysenko's agriculture were manditory beliefs then.

    Facts do keep getting in the way of idology as oil is getting more costly to find and crops yield are growing with GM foods and fibers.
     
    Last edited by a moderator: Aug 5, 2008

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