Now I finally understand the concept of how cap and trade is supposed to fight global warming and the way the politics are playing out in Congress. The best explanation I found has come from the Financial Times editorial
“Cap and trade or coach and horses.”
President Obama’s original idea was to auction permits granting a finite allowance to emit greenhouse gasses to the highest bidders. The supply of permits or allowances would be capped at the level of pollution the government wants to allow. The purchasers of the allowances could then sell them in the open market, thus the trade component.
The Administration should more aptly call the program cap and tax, since the President’s real objective was to pay for his middle class tax cut, healthcare reform, and other social and economic programs. The President’s hands-off policy towards Congress is allowing the real horse trading to take over, and plenty of companies will be able to generate their manure for free.
Just like Bernanke’s Fed is printing money with reckless abandon, the current House proposal will give away 85% of the allowances for free. The idea is to assist consumer friendly electric utilities and punish big bad oil. The beneficiaries would theoretically pass the savings on to consumers.
With 85% of the allowances generating no revenue for the federal government, the temptation to inflate the supply of allowances will be too difficult to resist. If the market does not trust that the supply will be limited, their value will be questionable. Traders will not want to keep any allowances in inventory. Brokers only act as agents and the market would be held back by a lot of friction.
Without an auction and the belief that the supply of allowance will truly be managed, neither the revenue nor the global warming goals of the President will be realized. Inflating the allowance supply will destroy its currency, a lesson neither Bernanke nor Greenspan seemed to grasp.
