Oil prices

The Collapse of Oil IS the Economic Boom

Don't listen to the pundits


"We fail to remember, for instance, that it was the internal combustion engine that gave oil its present value, and not the other way around."—Warren Brookes, The Economy In Mind, p. 30

Back in the late 1970s when a weak dollar last authored an illusory commodity boom, Zaire was one of the world's richest countries in the resource (commodities) sense. At the same time poliitical economist Warren Brookes described Japan as "144,000 square miles of some of the lowest-resource territory in the world."

Despite the massive distance between the two countries in terms of commodity wealth, Japan was exponentially wealthier than Zaire. There were and are many reasons for the massive wealth gap between them, but the biggest by far per Brookes was that "a nation's wealth has far more to do with people than with territory."

19th century economist Carl Menger, realistically the creator of Austrian School economics (Ludwig von Mises said Menger's Principles of Economics turned him into an economist), arguably would have agreed with Brookes's analysis. A major focus for Menger was the difference between "high order" goods and "first order" goods.

Applied to commodities, while essential to economic progress they're nowhere close to first order goods in economic importance. Oil is a crucial high order input, but per Brookes again "it was the internal combustion engine that gave oil its present value, and not the other way around." The world would be awful without oil, but it's first order products like automobiles and planes that gave oil value in the first place.

This is of course why it's not important that rich countries (think Japan, Switzerland, Singapore, etc.) be resource abundant. Figure commodities are easily importable at the market price, and as plentiful oil exports from economically backward countries like Venezuela, Iran and Equatorial Guinea constantly reveal, commodities in a normal world free of currency distortions would largely be exported by less developed countries to developed ones full of entrepreneurs creating the first order advances that give the prosaic (commodities) life.

Let's also not forget the tax implications of wealth that is essentially of the earth, as opposed to metaphysical wealth. Brookes called the metaphysical the wealth of the mind. Human beings are the greatest source of economic advance (nothing else comes close), and humans are mobile. Hong Kong has long been one of the richest locales in the world precisely because the wealth on this resource-bereft island was and is human. In that case, any attempt by its political class to overtax its citizens would have led to an outflow of the "barren rock's" source of abundance. Conversely oil, or wealth that springs from the earth, is easy to tax. It's not mobile. Bakken, Eagle Ford and Prudhoe Bay are places, not mobile people. That oil companies are nearly always the most heavily taxed companies in the U.S. shouldn't surprise us. 

We also can't leave currency devaluation out of the commodity discussion. Commodities like oil have never been expensive in modern times; rather during periods of dollar devaluation they've become dear in the way that one's height would 'soar' if the length of the foot were cut in half. If the latter weren't true then there wouldn't have been mass layoffs in the oil patch in the '80s and '90s when the price of a barrel plummeted, nor would sick-inducing layoffs in the oil patch be taking place now. Industries that relieve scarcity are always and everywhere rewarded. That "cheap" oil in dollar terms is occurring alongside a bloodbath in the sector is a certain signal that a lack of oil supply was never a problem to begin with.

If readers are still not convinced, consider how U.S. oil production alone rose to record levels from 2009-2015. Despite a U.S. surge that saw daily oil output increase by 4 million barrels, the price of oil tripled from 2009-2014. For analysts to then say that the oil industry solved a supply problem is for those same analysts to say that the oil industry is the only one in the history of mankind that is rendered much worse off when it's fulfilling a market need.

All of the above is important in light of all the commentary suggesting that oil's collapse is the source of U.S. economic malaise. Leaving aside the unsung good of natural downturns (more on them in a bit), the downcast talk about oil's weakness infecting the broader economy defies basic economics. Readers should ignore the pundits.

To see why, readers need to first remember that an economy is not a blob. It's just a collection of individuals. As individuals are we made better off when a market good is cheaper? Are we hurt when the gasoline we purchase costs less? The answers to the two questions are fairly easy. Taking it one step further, were Americans better off when the dollars they were earning were in freefall alongside gasoline prices that reached nosebleed levels? 

Some will point out that the plunge has led to mass layoffs in the energy space. While true, a recession for an energy sector whose profit margins rank 112th among U.S. industry sectors is hardly a negative for the rest of the U.S. economy. Investment that once flowed to what is globally plentiful and not terribly profitable in a relative sense will now flow to more promising economic ideas. Figure oil plummeted in the '80s and '90s, yet the U.S. economy boomed. So did the stock markets. Compare this to the health of the U.S. economy and stock markets in the 1970s and 2003-2014 when oil surged.

Furthermore, even if readers choose to ignore the historical correlation between stock-market/economic booms and falling oil, they can't ignore the basic truth that says even if falling oil is helping author the correction/downturn, this is healthy. Just as recessions lead to lousy companies being relieved of capital so that well-run firms can access more of it, so do stock-market corrections gift us with the same outcome. Applied to oil, assuming what's unlikely (that oil's collapse is pushing markets down), the present market correction is the happy signal of a looming bull as market forces starve the bad to the betterment of the good.

Away from oil, arguably a better explanation for the gimpy markets is that political uncertainty of the Donald Trump and Bernie Sanders variety has investors scared. I made this argument as early as last September, and also last week.

Some worry that the falling oil price is not transmitting to the "consumer." This may be the dopiest (but least surprising) argument of all from an economics profession and pundit class almost uniformly informed by the teachings of John Maynard Keynes. But back in the real world no serious economic thinker would ever consider or worry about consumption. Indeed, as individuals we're wired to consume things. We have infinite wants. Consumption is the easy part.

What's important here is that if we're producing we're as a rule consuming. Even better is that the more we produce, the more we consume.  That's true even if the productive individual is saving every dollar earned from production. Short of the individual stuffing dollars earned under a mattress, money saved is lent to those who have near-term consumptive needs. Money saved is also lent to or invested in business and entrepreneurial concepts, thus boosting production even more.

Most important of all for the purposes of the U.S. economy is the notion of high order versus first order goods talked about by Menger. Oil is once again an essential economic input, but it's ably provided by some of the least economically and culturally developed countries in the world. Figure even Saudi Arabia brings abundant oil to the marketplace.

The beauty of cheap oil is that it will make it more likely that U.S. economic actors import it, and at the same time more and more U.S. investment will migrate toward the Mengerian first order goods that give oil and all manner of other commodities life. Back to Brookes, this is once again what he meant by an economy of the mind. Predicting a broad economic boom amid a "commodity recession" in 1981, Brookes was arguing that falling commodity prices would be brilliant for a country like the U.S. populated by the greatest minds on earth in need of cheap inputs to drive true innovation. From a consumption standpoint, it will surge thanks to cheap oil simply because our production will surge as fewer Americans extract already plentiful oil, and more focus on creating the first order goods that render oil marketable to begin with.

What worked for Menger in the 19th century, and for Brookes in the 20th, will also work to the betterment of the U.S. economy in the 21st. Without dismissing the impressive engineering feat that is fracking, it has been an advance that led to enhanced extraction of what was already well supplied. The oil boom authored by a weak dollar signaled not even a stationery U.S. economy, but instead one moving backward as the most advanced nation in the world pursued a commodity capably provided by the third world. Rich countries import the prosaic as opposed to extracting it.

While the world would be bleak without oil, it can't be stressed enough that per Brookes, oil's value springs from the much more advanced first order goods like cars and planes that gave it value in the first place. Oil's weakness will free up abundant U.S. investment that will flow back into the creation of first order goods that very few advanced minds can make. In short, oil's recession signals the liftoff point for an impressive U.S. economic boom.