We like to think that when we deposit a dollar at the bank, it goes into a big vault and we can pull out that same dollar at any time. But that¿s not how the U.S. banking system works. Banks take that money and invest it to make money themselves, so cash gets spread around. This, naturally, leads to a big risk: What happens if those investments go sour? Well, you¿d be out of luck. You can¿t get your dollar back.

The Federal Reserve doesn¿t like that scenario, so it prohibits banks from putting all the cash it has on deposit on the line. In fact, the Fed forces banks to keep a portion of their assets at the Federal Reserve itself, to make sure that some of your assets won¿t get squandered if the bank¿s bets go south. These are called ¿reserves,¿ (hence, Federal Reserve. Got it? Good), and usually amount to 10% of the total cash kept in checking accounts.

These reserves are never exactly 10%, and banks like to keep a little extra in reserve ¿ not, as you might think, to make you more comfortable that they¿re in good financial shape, but rather so they can take that excess and lend it to other banks and make money off it. (They¿re banks, they can¿t help themselves.) The rate at which they make these loans is called the Federal Funds rate, which is set by the Federal Reserve¿s Federal Open Market Committee.

When you hear people chattering about how the Fed cut or hiked interest rates, this is what they¿re talking about: the interest rate banks can charge for lending money from their reserves. This begs the question: If these are essentially loans between banks, why is the Fed Funds rate so important for the rest of the economy?

Well, simply put, because loans make the financial world go round. Bank A lends Bank B $10,000 at a Fed Funds rate of 5%. Bank B then lends out $10,000 to a small business at 7%. The small business then takes that money and expands the business and hires new workers. Now someone is employed, Bank B has made interest off the loan, and Bank A is the richer for making it all happen. It¿s perhaps overly simplistic, but you get the idea. When you want the economy to thrive, you make lending cheaper.

Of course, sometimes you don¿t want the economy to thrive. In fact, you might want it to cool down, mostly to avoid money flooding the system and causing inflation. In that case, the Fed raises interest rates, making it difficult to lend or borrow.

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Wednesday, July 23, 2008

Oil Continues to Decline as Hurricane Fears Wane

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Associated Press

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Oil prices fell further Wednesday after tumbling more than $3 a barrel in the previous day's session as a hurricane looked likely to spare key oil installations in the U.S. Gulf of Mexico.

Feeding bearish sentiment were expectations that U.S. oil supply data to be released later in the day would show a rise in gasoline stocks amid weakening demand in the world's largest energy consumer.

Light, sweet crude for September delivery fell $2.11 to $126.31 a barrel in electronic trading on the New York Mercantile Exchange by noon in Europe. The contract fell $3.40 to settle at $128.42 in the previous session.

The August contract fell $3.09 to settle at $127.95 a barrel as it expired at the end of floor trade.

The overnight sell-off dragged oil prices to their lowest level since early June and was crude's fifth decline in the last six sessions.

The drop offered further evidence that investors are now quickly pulling money out of the market, after driving prices to a record above $147 only a week and a half ago. It was also a reminder that, with traders for the moment turning bearish, the absence of major news can push the market down -- just as incremental supply concerns previously drove prices sharply higher.

Prices fell as Dolly -- a tropical storm that spun into a hurricane on Tuesday -- headed toward the U.S.-Mexico border but grew increasingly unlikely to threaten key oil supply in the Gulf.

"This partly eased concerns and lent a bearish hue to the market," said Vienna's JBC Energy in a research note. A strengthening dollar also helped keep prices in check.

"Clearly, there's not a lot of price-supporting news in the market, and what was there has been diminished now with Hurricane Dolly," said Mark Pervan, a senior commodities strategist with ANZ Bank in Melbourne.

"This market's still fundamentally quite strong -- it's just that we've seen prices coming off from over-inflated levels. The market's letting steam out," Pervan said. "There's genuine reason to be taking profits in this market with the weak U.S demand numbers."

Crude oil inventories were expected to drop by 1.9 million barrels in the U.S. Energy Information Administration's weekly petroleum supply report, according to the average of analysts' estimates in a survey by energy research firm Platts.

The survey also showed that analysts projected gasoline stocks to rise by 500,000 barrels.

"I suspect we'll see another rise in gasoline stocks, highlighting again that demand is certainly weak," Pervan said.

In its weekly pump spending survey, MasterCard found U.S. gasoline demand dropped last week for the thirteenth week in a row. Demand fell 3.3% compared with the same week a year earlier, according to the survey. Since the start of 2008, gasoline demand is down 2.2%.

In other Nymex trading, heating oil futures lost more than 5 cents to trade at $3.6206 a gallon while gasoline prices shed over 6 pennies to fetch $3.0835 a gallon. Natural gas prices fell more than 6 cents to $10 per 1,000 cubic feet.

September Brent crude fell $2.24 to $127.31 a barrel on the ICE Futures exchange in London.