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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Thursday, August 28, 2008

Oil Tumbles to $115 Despite Storm Concerns

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Associated Press

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Oil prices fluctuated sharply Thursday as Tropical Storm Gustav spun toward the Gulf of Mexico, with some traders fearing a disruption in supplies and others betting that the government would tap the Strategic Petroleum Reserve if needed. Either way, consumers were likely to see a hike in gas prices for Labor Day weekend.

Gustav, approaching Jamaica with winds near 70 mph, could regain hurricane strength later Thursday and possibly enter the Gulf as a dangerous Category 3 storm early next week, forecasters said.

Light, sweet crude for October delivery jumped as high as $120.50 a barrel on the New York Mercantile Exchange before pulling back to $115.05, down $3.05. Light trading heading into holiday weekend exacerbated the volatile trading.

Oil rose $1.88 on Wednesday to settle at $118.15 a barrel.

Atmospheric models showed Gustav heading toward Louisiana and areas devastated by Hurricanes Katrina three years ago Friday, though it was too early to pinpoint where it would strike.

The storm not only threatens the more than 4,000 oil and gas rigs scattered throughout the Gulf, but also the dozens of oil refineries dotting the vulnerable coastline from Texas to Louisiana.

"If it goes anywhere near refineries, that's going to knock out production for about a week," said Tom Kloza, publisher and chief analyst at the Oil Price Information Service in Wall, N.J.

Oil's retreat in the face of a possibly dangerous storm surprised some oil market watchers, who attributed the move to speculation that the government could release supplies from the Strategic Petroleum Reserve to counter any drop in production from Gustav.

"I think that's taking some of the steam out of this rally," said Jim Ritterbusch, president of energy consultancy Ritterbusch and Associates in Galena, Ill.

Regardless of where Gustav hits, analysts said pump prices are still going to rise at least some, probably in time for Labor Day weekend.

Fears of disruption in energy production have already sent wholesale gas prices soaring by up to 40% in recent days, meaning filling stations will have little choice but to pass on those costs to consumers.

"Prices are going to go up pretty soon. You're going to see increases by 5, 10, 15 cents a gallon," said Kloza. "If we have a Katrina-type event, you're talking about gas prices going up another 30%."

That would send retail prices back above $4 a gallon, a level first reached in July.

Meanwhile, the exodus from the Gulf by oil workers accelerated.

Royal Dutch Shell PLC has evacuated nearly 400 people and said it will bring in another 270 Thursday.

The company said production will be impacted. BP PLC was also removing personnel from the region that's home to about a quarter of U.S. crude production and much of its natural gas.

Transocean, the world's biggest offshore drilling contractor, is suspending operations at all of its rigs and pulling nearly 1,600 people out of the Gulf.

Weather research firm Planalytics predicted as much as 80% of the Gulf's oil and gas production could be shut down as a precaution if Gustav enters the region as a major storm.

Gustav formed Monday and roared ashore Haiti Tuesday as a Category 1 hurricane. The storm triggered flooding and landslides that killed 23 people in the Caribbean. It weakened into a tropical storm, though it is likely to grow stronger in the coming days by drawing energy from warm open water.

The tropical storm was centered about 80 miles east-northeast of Kingston, Jamaica, and moving toward the west-southwest near 8 mph.

Forecasters said Gustav might slip between Mexico's Yucatan Peninsula and the western tip of Cuba on Sunday, then march toward a Tuesday collision with the U.S. Gulf Coast -- anywhere from south Texas to the Florida panhandle.

"We know it's going to head into the Gulf. After that, we're not sure," said meteorologist Rebecca Waddington at the National Hurricane Center. "For that reason, everyone in the Gulf needs to be monitoring the storm."

Gustav is the first storm of the 2008 Atlantic hurricane season to pose a serious threat to the more than 4,000 oil and gas installations in the Gulf. In 2005, Katrina and Rita destroyed 109 oil platforms and five drilling rigs.

In other Nymex trading, heating oil futures rose less than half a penny to $3.2645 a gallon, while gasoline prices gained 0.01 cent to $3.0697 a gallon. Natural gas futures fell 39.5 cents to $8.211 per 1,000 cubic feet.