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There's some history that's weighing on my mind, these last couple of weeks. It's history that I'm not surprised that John McCain doesn't remember; he's famously not very bright. Nor am I terribly surprised that Barack Obama doesn't seem to know it; he was awfully young at the time, and going through a rough time in his personal life, so it's long before he started paying attention to economics or politics. I wish I were surprised that more of the American people don't remember it, since roughly half of us lived through it as young adults or adults, but the 1970s was a long time ago, I guess, and human beings, especially the Americans, tend to treat anything over three years old as "ancient history," not especially relevant to their lives unless someone shows them otherwise. I know that I remember it because it mattered to me personally at the time, and because it was only a couple of years after that that I embarked on my first serious studies of economics. But here's the part that really annoys me: George W. Bush doesn't seem to remember it. And that's pretty inexcusable, since important parts of it happened to him, personally.

Let's review. This will be long, please bear with me. You might care: it's about the history of oil prices. Let's start with an overview graph, inflation-adjusted to 2007 prices, from an extraordinarily good technical overview of the topic by James L. Williams, his 2007 "History and Analysis - Crude Oil Prices."

For all the right reasons, Williams' graph starts in 1947. Why 1947? Because in 1947, the USA inherited a really freaky bit of luck: we had very nearly the only oil refineries in the world that hadn't been bombed to smithereens. This meant that if anybody in the world wanted to buy gasoline, diesel fuel, jet fuel, kerosene, plastics, petrochemical fertilizers, or any other product derived from oil, there was only one place they could buy it: American companies. What's more, those companies were themselves busily converting back from war-material production to civilian production, so for quite a long time the demand was much higher than the refineries and chemical plants could supply, so forget competition. American companies could set the prices for petroleum products however high they wanted, and did. Furthermore, oil-exporting countries desperately needed to continue exporting oil in order to pay for food, and only the Americans were buying. So long as the Americans were paying even a few pennies more than it cost to pump the oil out of the ground, even if it meant they were paying no local taxes, no local mineral rights costs, and slave-labor wages to the oil workers, it was still worth more sold to the Americans than left in the ground.

Unsurprisingly, Americans remember the 25 years after that as a golden age of American purchasing power, and we set our national expectations as to how we can afford to live by that baseline. But a whole lot happened over that period of 25 years. The most important is that Europe and Asia rebuilt their bombed-out oil refineries. Another is that the American manufacturing sector got lazy and sloppy. But also importantly, the US spent the last several years of that time period, under both Democratic President Johnson and Republican President Nixon, engaged in a long, expensive, and futile land war in Asia, the Vietnam War, and by bipartisan consensus, neither one of them asked the American people to pay higher wartime taxes or even to buy war bonds to finance that war; they instead simply "ran the printing presses," inflating the national debt at a rate unheard of since the Revolutionary War, and thereby running the US dollar into the ground. And worse: they also lost the war those deficits financed, and lost it in a way that wrecked our military so badly it took us another 10 years to rebuild it.

A world-wide economic cartel of oil-exporting countries, OPEC, had been trying to gin up oil prices to the point where they could at least pay their people starvation-level wages since the mid 60s. With the 1973 collapse of the Vietnam War, they realized that the time was right, because they could do anything they wanted to the US and there wasn't a single thing the US could do about it. Nor did they even have to go without selling oil to do so, since once they broke their contracts with American firms, there were plenty of newly rebuilt European and Asian customers eager to buy that oil for their refineries. And the US's limited defense of Israel from unprovoked aggressive invasions by Egypt, Jordan, and Syria gave them the political cover they needed to do what they'd always wanted to do: raise the price of oil at the well-head from roughly $2-$3 up to $12-$15. US inflation, already troubling, went ballistic, reaching double-digit levels, and priced in US dollars, the prices kept going up way, way past the original $15 target price, up to $50 and more.

Economists and petroleum experts assured us that no end was in sight; the era of cheap oil was over. Pessimists insisted that the real reason for the price spike was that we were going to run out of oil completely, world-wide, by the end of the 20th century, but even the optimists were saying that $50 to $100 per barrel oil was a reality we were just going to have to get used to. But there were people to whom that was good news, after a fashion: American oil companies, their suppliers, and the financial institutions that desperately wanted to lend money to them. To explain why, I have to explain something about oil.

You see, it turns out that there are very few places on Earth where there isn't any oil. Wherever you're sitting now, if you were to dig down far enough, odds are that you'd hit oil. Some places, it's very near the surface, under a thin layer of dirt, or a shallow swamp, or even a thin layer of sand. Other places you might have to go down through hundreds of feet of solid granite rock. Nor are is the oil evenly distributed. The oil pocket under your feet might only be a couple of feet deep; other places might have a vast underground ocean of the stuff. Nor is oil always at the same temperature. Some places are atop thin spots in the earth's crust, closer to the molten magma, and therefore warmed to nearly the boiling point and under high pressure; others, not so much, leaving the oil cold, and sluggish. Nor is it all chemically identical; some oil is more glue-like, stickier, more sluggish even at the same temperature and pressure. All of which makes a difference.

So, imagine two extremes. Oil well #1 is in a place where there's a vast ocean of oil underneath it. The oil in question is thin, runny, and smooth. The earth's crust is thin underneath the oil, so it's hot and under high pressure. The soil on top of the oil is a thin layer of sand, maybe a couple of feet thick. Oh, and to make life even better: it's in a dirt-poor part of the world, the people around the oil well work for pennies an hour. Now imagine that oil well #2 is in a place where there's not so much oil at the bottom of that well. The oil that there is, is gluey, thick, and sluggish. Worse, it's cold. Worse than that, oil well #2 has to go very, very deep, through hundreds of feet of solid granite. And as if that weren't enough, oil well #2 is in a place where there's a comfortable middle class economy, with good jobs, so the owner of oil well #2 has to pay his workers a decent living wage, and because of how hard it is to get the oil out from under his land, he needs more of them, too. I take it you can see how it might cost even 100 times as much for oil well #2 to pump a barrel of oil as oil well #1?

If there's more demand than both of them can supply, them and everybody else, that's one thing. In olden days, wars would have been fought to get exclusive rights to oil well #1's output for your country, so you could produce oil products cheaper. Nowadays, with more open markets, what ends up happening is that the price gets set at about what it costs the guy who owns well #2 to get his oil out of the ground, and the guy who owns well #1 makes out like a bandit. But ... what happens to the guy who owns oil well #2, which happens to be in Texas in 1980, if supply goes up or demand goes down, and suddenly oil well #1, which happens to be in the Middle East, can supply all the oil the world needs? This isn't a theoretical question. It happened.

In 1979, the Iranian people overthrew their government. Neighboring Iraq, sensing a power vacuum (and assured of quiet US assistance) set out to conquer Iran. This turned out to be rather harder than they thought it would be; instead of the couple-day march to victory that Saddam Hussein had promised his people, the Iranian people fought tooth and nail for every inch of their new revolutionary state. Further, Saddam failed to anticipate that his own sizable Shiite Muslim population, emboldened by the Shiite revolution in Iran, might take their Shiite brethren's side over their own country's, and he and his army suffered terrible betrayals, including one very credible assassination attempt. So as the war slogged on for year after year, both Iran and Iraq said to heck with their OPEC quotas, to heck with supporting high oil prices by limiting supply, they needed the money to fund their war. (Which, I mention in passing, shows that both Saddam Hussein and the Ayatollah Khomeini were smarter than Lyndon Johnson, Richard Nixon, and George W. Bush combined.) Worse luck for Americans invested in domestic oil production, they did this just when the US was starting to get its inflation rate under control. Oil prices plummeted through $30 a barrel, and further down to $15 a barrel, and briefly even flirted with the $12 mark.

Good news? You wish.

Remember what I said about runaway inflation in the US, a few paragraphs back? Imagine that you're someone with a few thousand dollars (or more) in savings in the mid 1970s, when inflation is running around 10%, and the best interest rate you can get out of any bank account, or any form of investment at all, is around 6%. Unless you can find an investment that pays better than 10%, your money is dwindling away steadily every day, like water running out of a leaky bucket. That's the trap that every bank, every savings and loan, every brokerage firm, every pension fund, every bond underwriting firm, and every financial services firm found themselves in: they had nothing they could offer people that would pay an interest rate that was even half as high as the inflation rate. So how do you think they reacted when every expert told them that the optimistic estimate for the future was that even if everything else went right, there was no way in hell that oil could ever drop below $50 a barrel? What's so magical about that $50 (in 1976 dollars) price point? That was what it would cost to pump more oil out of Texas. So with $50 to $75 oil in the present, and every expert assuring them that the price of oil would never drop below $50 and might well be on the far side of $100 in a couple of years, everybody in America sank their money, all at once, into Texas oil exploration. Houston office real estate became more precious than gold, as company after company was funded to buy up mineral rights, or to scientifically survey for good places to drill, or to drill exploratory wells, or to build oil well machinery, or to service oil well machinery in place. Among those companies was a tiny little firm named Arbusto Energy Services. Its founder and CEO was the son of a US Senator and largely unsuccessful Republican Presidential candidate, happy to take his father's campaign contributors' money and eager to take advantage of the fact that oil would never be priced less than $50/bbl to earn his own "independent" fortune, to prove that he was more of a man than his father. That man was, of course, George Walker Bush, and when oil hit $15/bbl, he went completely bankrupt.

How does a guy forget his own multi-million-dollar bankruptcy?

But here's why this is weighing on me right now: for the last couple of weeks of the presidential campaign, every politician in America has been eager to take a stand on the subject of off-shore oil exploration and mining, particularly on the outer continental shelf just over the horizon from both the east coast and the west coast of the continental US. And it's taken me pretty nearly that whole time, up until a couple of days ago, to find the number that I wanted most to hear: how much is it going to cost to mine that oil? What is the cost per barrel that oil will have to be at, or above, for those companies to not go bankrupt? I finally got that number, or range of numbers actually, last Tuesday from Jacob Liebenluft's article on Slate.com, "What's the deal with offshore drilling? Will it do any good at all?" I say "range of prices" because the oil companies haven't decided yet just how much technology to throw at the problem. If they throw in the minimum investment, they can get a little bit of that oil, enough to reduce oil prices by about maybe 1% world-wide, and it will cost them $50/bbl to get that much oil. What they want to do is throw some higher-tech pumping solutions at it, get enough oil to make it "really worthwhile." In this context, "really worthwhile" means enough to lower the cost of oil by maybe 3%, reducing, say, gasoline from $3.50/gal to $3.40/gal. But the higher-tech pumping solutions mean that it will cost us $80 to $115 per barrel for that oil.

And there are a lot of American investors really, really eager to fund those offshore oil platforms. Inflation is edging up; by honest numbers, as opposed to the cooked books we've been getting out of every executive branch since the Reagan administration, it's already in the 10% to 12% range. The government is intervening to keep interest rates low, officially to "stimulate the economy" but even more than that in a desperate attempt to keep the interest payments on the national debt even close to manageable. (More on that in a later journal entry.) The collapses of the tech-stock bubble and of the securitized-mortgage bubble have left investors with no reliable way to earn more than the inflation rate, so everybody in America is watching the value of their savings, their pensions, and so forth dribble away. But fortunately, as long as the price of oil stays above $100 or $115 a barrel, there is a lot of oil we can mine right here in America, and with prices "only going up, from now on," there's a lot of money to be made in lending the oil companies the money to build those oil wells.

It's disturbing how many people don't remember that we have been told this before. Nor is there any more reason, this time, to doubt that by the time those offshore oil platforms become functional, oil could easily be back down to $30/bbl. And where will we be, if we invest every penny in every bank and in every pension fund in offshore drilling, when oil prices drop below what it costs to pay off the loans on those oil rigs? Rejoicing that our oil and gasoline prices have gone down? You wish; no, where we'll be is flat broke, as a nation, again.

Didn't they tell you better than this as a kid? "The Itsy Bitsy Spider went up the water-spout. Down came the rain, and washed the spider out. Out came the sun, and dried up all the rain. And the Itsy Bitsy Spider ..."? Well, you remember the rest. I hope. You do if you're smarter than George Bush. Or John McCain.


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Aug. 18th, 2008 09:42 pm (UTC)
Hhhhh. Hell, I remember this, and I was seven when the oil embargo started, 12 when gasoline price controls were cut in 1979, and just barely 20 when the price of oil went kablooie in 1986. A lot of places were hurting in '86, but North Texas was one of the worst places to be, because everything had been tied up with speculation in oil in one way or another.

Let's put it this way. An old friend's father was left bankrupt when his bank called in the loans necessary to keep building strip malls and apartment buildings, and the bank only called in his loans because several frat boys had been passing out lots and lots of handshake loans to his buddies for construction along the I-30 Corridor outside of Dallas. In my case, I wasn't doing as badly as most because I was already absolutely destitute, so I didn't have anything left to lose, but my apartment complex went through five owners in four months, as it was appropriated by one bank that promptly went under and was assimilated by another and so on. By the end of 1988, we thought it couldn't get any worse, and we just lucked out when defense contracting started to pick up in '88 and the beginning of 1989. Naturally, that imploded in 1990 with the first Bush recession.

I suspect that Shrub doesn't remember the joy of the oil bust for the same reason he doesn't remember a lot of other economic crunches: his mantra has been "Sucks to be you" for decades, because he personally never had to do without. Me, though, I remember the last oil bust all too well, and so does everyone else around here, and we're all squirrelling as much money away as we can because we know how this dance ends.
Aug. 19th, 2008 02:07 am (UTC)
I remember gas hitting .58¢ a gallon in '86, as I got my first car. Couldn't get any type of job so I ended up in the Air Force. By '89, was tracked for downsizing by Bush Sr. Luckily, made it in to the reserves just in time for Desert Storm. After the last 8 years, I think things have happened all just to move the price of oil around.
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(no subject) - litch - Aug. 20th, 2008 07:52 am (UTC) - Expand
(no subject) - bradhicks - Aug. 20th, 2008 09:24 am (UTC) - Expand
(no subject) - hairyfigment - Aug. 21st, 2008 07:35 pm (UTC) - Expand
Aug. 18th, 2008 09:43 pm (UTC)
"Sidebar" joke from the 1980s:
Two girls are walking along a path in the woods, when they hear a noise at their feet. They look down, and see a frog sitting there. The frog says, "Kiss me, I'm a Texas oilman." One of the girls reaches down, picks up the frog, brings it up to her face -- then changes her mind and drops it in her purse. The other girl says, "Aren't you going to kiss him?" The first girl says, "Naw, I figure that these days, a talking frog is worth more than a Texas oilman."
Aug. 18th, 2008 09:45 pm (UTC)
I had a vague idea of some of the elements of this, but I'd never seen it tied together coherently. Thank you for assuming the task of the historian again and again - not just telling what happened in the past, but making sense of the past.

In regards to the main point of your article, I'd like to point out that this illustrates something I remember hearing when I was getting introduced to economics. Part of the reason that the work of government is legitimate is that a good government provides stability and predictability in the business environment. When business can make and confidently execute 10-year plans, 50-year plans, and 90-year plans (as some still try to do), it's good for their bottom line. The world isn't, overall, stable or predictable, but creating some stability and predictability instead of, say, starting land wars in Asia, is a worthy task for governments - and it's good for business. The neoconservative obsession with turning government into a mechanism for organized looting is terrible for business because it destroys the stability and predictability that businesses need. In that situation, business too become looters, and matters worsen. I think that's what we've been seeing develop in the arc of events from Nixon to now.
Aug. 19th, 2008 04:29 pm (UTC)
Now if you could only convince the so-called "conservtives" of that...
Aug. 18th, 2008 09:50 pm (UTC)
I was only five years old in 1980, but I still remember this. I was a precocious kid. I remember 12% inflation and the idea that it made no sense to pay cash back then because any delayed payment would be worth less by the time you paid it. I remember Israel and a few other countries were going through a much worse version of the same thing.

I remember that gold was $800 per ounce in 1980. I remember it was back down to $300 by 1983. I remember that my parents bought a house in 1976 with a 20-year fixed mortgage of 8.67% and thinking that was an amazingly low rate by the time I was old enough to run the numbers (1984 -- did I mention I was precocious?)

Even though I've only lived a third of a century, I've been paying attention for much of that time. I plan accordingly. These cycles stop looking different and just get different decorative patterns. I remember all the same crazy "Kick Saddam's Ass" crap in 1990 and 1991, how it was suddenly gone by the middle of 1991 but nothing had really changed.

I also remember feeling alienated because I wasn't buying the rhetoric. I just saw the same people trade the word "Communist" for "Arab" for a year, then to "liberal politically correct types" and later to "terrorists" but it was always the same thing: they hated their lives and liked having an easy target that got the testosterone coursing.

It took us a long time to get out from the shadow of Vietnam. Now we're back under it, but that shadow is Iraq. We're scared, and that's when we make bad decisions.

I guess I'm just agreeing with you, synchronizing with you, happy to hear a deeper presentation of this than I had found myself. I like seeing those raw numbers. How can we sell the importance of this to the other 300 million before November?
Aug. 18th, 2008 10:07 pm (UTC)
Thanks for posting this, Brad. I wasn't too far out of diapers by the time the 80s oil price spike had calmed, so this is the first major gas crunch I've experienced. I wanted to believe that oil would drop once the economy stabilized, but the pessimist in me was afraid that oil companies who saw how much the populace would pay for gas would continue to charge that even after their costs dropped back down. This gives me more hope.
Aug. 18th, 2008 10:17 pm (UTC)
Thanks very much for the history lesson. The one thing that's unclear from your post is to what degree the current price spike is like the last - which you indicate was caused by an artificial scarcity that can be ended hastily at any time. Any information on that?

As for your question, How does a guy forget his own multi-million-dollar bankruptcy? - being strung out on coke and alcohol, and being part of a social circle where you never have to experience the consequences of your actions, I am sure.
Aug. 19th, 2008 04:24 am (UTC)
Tell me when America is no longer up to our necks in deficit-financed wars in major oil-producing regions, and I'll tell you when the oil shock will peak, and start reversing course. Assuming Obama wins, that's May, 2010.

Maybe I'm wrong. But to ask me to believe that I'm wrong is to tell me all of the exact same lines that we were told back 25 years ago, in 1973, with no more evidence than we were shown back in 1973, that turned out to be entirely false that time, and tell me, "no, really, trust me, this time will be totally different." Even before I started studying economics, I learned that any time a human being says, "no, really, this time will be different" that they're lying, that whether they really mean it or not, it won't be true.

(No later than the 3rd time, Charlie Brown should have his own faux "oops" moment and kicked the living crap out of Lucy.)
Isn't the current situation different? - jonathankorman - Aug. 19th, 2008 04:51 pm (UTC) - Expand
(no subject) - hairyfigment - Aug. 20th, 2008 01:42 am (UTC) - Expand
(no subject) - bradhicks - Aug. 20th, 2008 06:03 am (UTC) - Expand
Aug. 18th, 2008 10:31 pm (UTC)
As always, I find this post educational.
Aug. 19th, 2008 01:33 am (UTC)
I was asking my mom about this the other day, because I knew there had to be parallels between now and the 70s oil crunch, but she was too busy partying to really pay attention to such things (I wasn't born until 1979 so I don't have my own memories to call upon). Thank you for filling in the knowledge gaps.
Aug. 19th, 2008 04:11 am (UTC)
Question for you: What evidence, beyond "It happened before", do you have that a price crash like that is in the foreseeable future?
Aug. 19th, 2008 04:29 am (UTC)
Aside from the answer I just gave AtheneMiranda, above, I'll answer with a question. Can you show me even one reason to believe that the law of supply and demand has been repealed? Or even one reason that oil prices will go up for ever that isn't exactly identical to the same reasons I was given 25 years ago, or one bit of evidence for those reasons that is any better than the evidence I was shown 25 years ago?

I'm sorry, Chicken Littles, but the bump on your head that you're showing me now is the exact same size as the bump you showed me the last time, when it turned out to be a walnut, not the sky, that fell on your head. This time I'll need more evidence.
More evidence? - darksumomo - Aug. 19th, 2008 08:10 am (UTC) - Expand
Re: More evidence? - darksumomo - Aug. 19th, 2008 08:14 am (UTC) - Expand
(no subject) - pseydtonne - Aug. 19th, 2008 03:10 pm (UTC) - Expand
(no subject) - satyrblade - Aug. 19th, 2008 04:37 pm (UTC) - Expand
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(no subject) - kallisti - Aug. 19th, 2008 03:07 pm (UTC) - Expand
(no subject) - herbaliser - Aug. 28th, 2008 07:02 pm (UTC) - Expand
Aug. 19th, 2008 04:37 am (UTC)
Maybe asking the question of a later post, but if this investment is going to pan out and die thanks to the fluctuation of oil supply and demand, is there some other investment we should be making that will help us make progress toward a semistable gasoline or oil price that the majority of Americans will tolerate? Alternative energy sources? Highly-efficient vehicles? Not fighting two land wars in Asia and threatening a third? Or something else entirely?
Aug. 19th, 2008 05:27 am (UTC)
No matter how cheap or expensive oil gets, research and development into more energy-efficient ways to do the stuff we're already doing always pays dividends. Energy efficiency is the one energy investment that will always make money, eventually.
(no subject) - monkeyd - Aug. 19th, 2008 02:06 pm (UTC) - Expand
(no subject) - silveradept - Aug. 19th, 2008 04:31 pm (UTC) - Expand
(no subject) - monkeyd - Aug. 19th, 2008 05:38 pm (UTC) - Expand
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answering sadly but with humor - krinndnz - Aug. 19th, 2008 10:01 pm (UTC) - Expand
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Aug. 19th, 2008 06:25 am (UTC)
caveat: I was born in '77; I do not remember the 70's. I'm in FL and gas prices local to me range between 3.76 and 4.80 per gallon.

I don't dispute your analysis, but on an emotional level, it's difficult to agree with. I have never, ever, not a single time, seen gas prices drop by more than .15/$. It drops before elections, but I just cannot fathom that it'll go to 1998 prices again (when it was in that 30$/barrel range I believe; ~1.25-1.75/gal). Call me jaded and cynical, I just don't see the US consumer not getting fucked no matter WHAT the outcome.
Aug. 19th, 2008 08:35 am (UTC)
Graph here, from this blog post. Note the 1985-1986 price drop ($1.40 to $0.70) and 2000-2001 ($1.90 to $1.20), both for super unleaded.
Aug. 19th, 2008 06:30 am (UTC)
The generation of Americans which should remember, the Baby Boomers, is also the generation least interested in pragmatic results and the most concerned with ideology, so it's no surprise that history, for them, is merely a palimpsest upon which they can scrawl the most recent dogmas.
Aug. 19th, 2008 06:44 am (UTC)
Perhaps you'd care to weigh in on this recent story? http://uk.reuters.com/article/oilRpt/idUKN0325640920080703?pageNumber=1&virtualBrandChannel=10174

Seems well on topic and might even rise to the level of 'forbidden lore'? I can find open source material supporting the fact that we are exporting... just not an explanation as to the circumstances. One of the more frequent plaints is that we don't have enough refineries, but I can never find out just why.
Aug. 19th, 2008 08:25 am (UTC)
Yeah, I saw that. As weird as it sounds to the American public, it makes perfect sense. In the era of mostly-open markets for the oil itself (the exploration, drilling, and servicing markets not so much so, but the oil, yeah, mostly) it doesn't matter whose oil gets sold to whom. What matters is whether or not supply matches demand. And if US refineries are operating at or near capacity, and they are, then for US oil production to reduce the price of refined products, the oil has to be shipped overseas, refined, then shipped back as product. The theory is that this still ends up cheaper than if we hadn't pumped and then exported the oil, despite the transport costs, because otherwise those refineries would have to bid on the rest of the oil, and with less of it out there, they'd have to pay more.

Why not refine it here? Because the politics, and the economics, of building refineries are both insanely and stupidly complicated. A combination of really poorly structured financial subsystems for that kind of long-term investment and local NIMBY politics, to simplify it as far as I can.
Aug. 19th, 2008 09:30 am (UTC)
Brad, I've been reading your stuff for a few years now, and from my perspective, you always seem to just nail whatever it is you're talking about from a perspective I can't get anywhere else. You seem to be right most of the time, too. I know you have Asperger's, which, in my admittedly limited understanding, seems to be a less severe form of autism.

I don't intend this to be offensive, and I hope that you don't find this observation to be so, but from your essays at least, you seem to be kind of a political and social savant, albeit obviously a much higher functioning savant than the common perception of savants, as portrayed in flicks like Rain Man.

I'm just wondering if you think your Asperger's Syndrome is a factor in (what seems to me) your astuteness, or if it's unrelated. If I'm being an asshole asking you this, feel free to call me out on it, I know I'm treading on what may be highly questionable ground, but I simply ask the question out of curiosity, not any malicious intent.
Aug. 19th, 2008 02:31 pm (UTC)
How does a guy forget his own multi-million-dollar bankruptcy?

Lots of coke and alcohol?
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