There are many factors behind the sharp increase in the oil price, but one is usually overlooked: it’s a bubble. Where bubbles appear in the market (think of housing and tech stocks, to name two in recent memory), you will find the hidden hand of monetary policy at work. This is an underlying issue that helps explain the price. Recognizing this also helps us make a better judgment concerning the future of the oil price as it relates to overall economic well-being. FULL ARTICLE
Source link: http://archive.mises.org/8164/the-oil-price-bubble/
The Oil-Price Bubble
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Rod: “To what extent can our economies adjust to declining energy availability and very high prices; and how fast?”
That’s a very good question. I don’t think anyone knows. Best case scenario is that oil runs out gradually so that the price climbs steadily. In that case, the transition will be relatively easy. If we get a major shock, things will be very difficult for a long while.
An article in The Economist last month suggested that everyone find a piece of land that they could get to quickly to raise their own food on. At the time, I thought the author was a bit hysterical. I’m not so sure now.
As for the capital markets, I wouldn’t worry so much about what oil is doing to them as what the Feds are doing. The Feds seem intent on destroying the capital markets.
You may have noticed that oil took a plunge last month when it seemed clear that the Feds wouldn’t lower interest rates again but might raise them in order to fight inflation. Then, when the jump in unemployment was reported, oil took a huge jump again. Apparently, speculators think that the Feds are still playing Lone Ranger for the economy and will lower interest rates yet again. Let’s all pray they’re wrong.
Rod: “In practice in will never be allowed to because governments will take control and make a bad situation even worse.”
What do you think the screams for sustainable development and fair distribution of resources is all about? It’s a push for socialism. Today, something like 80% of all oil in the world is owned by states. I don’t think the time is far off when states attempt to take over the remaining 20%.
You (economists of the Austrian school) insist that money creation, not peak oil, is causing the price of oil to rise.
Maybe. Maybe not. We don’t know yet.
I have to say this, however: I am surprised at the tenor of your arguments. You (Austrian folk) convey the impression that you are trying to salvage a position, not understand what is going on.
My reading of the situation is that the direction of causation goes the other way, i.e., loose money is not leading to high oil prices but the other way around, scarce oil is leading to loose money.
To unpack my reading just a bit, it seems to me that we are living through a change of regime. The old regime was a centuries long decline in the marginal cost of energy. The new regime is one in which the marginal cost of energy is rising. The cause of the change is the peaking of the huge, old, oil fields and provinces (Ghawar, Cantarell, Daking, the North Sea, Samotlor, East Texas, etc etc). The process is slow, “macro†as heck, has been going on since the 1970s, and is now beginning to stress the system big-time.
In the USA, political authorities don’t have a clue what is happening except this: they sense fragility in the system. Their response is labor arbitrage and leverage, the path of least resistance. This has worked so far to keep the middle class more or less middle class, but isn’t, as they say, “sustainable.†Meanwhile, under the surface, what is really happening is the emergence among us of a standard third-world system, otherwise known as crony capitalism.
Money in this system is not an independent variable, so why put so much importance on it. Much more useful is the old Lenin dictum: who, whom. Who is doing what to whom?
Fundamenatlist: “What do you think the screams for sustainable development and fair distribution …..”
I am not sure socialism is back on the agenda. Even supposedly socialist parties such as Labour, now in power in the UK and Australia, cannot be labelled socialist in the 1960′s sense of the word (thank goodness). Globalisation has seen to that.
It is likely governmments will take control of oil, wherever it exists,but as you say 90% (not 80) is in the hands of government any way. Fields which are not in government control are likely in decline in any event.
On the other hand, maybe it is all just a bubble that will pop taking oil back down to $20. Then we can go back to the good old days, buy a Hummer, GM will be profitable again and we can enjoy cheap flights to crappy tourist holes for ever.
Rod: “I am not sure socialism is back on the agenda.”
As Mises wrote, there are two types of socialism, the Russian and German. Russian socialism nationalized all industry and made it state-owned. German socialism allowed owners to retain the paper title to ownership, but controlled every aspect of the business. The German kind is dishonest, but very popular. It makes people think they still have private property, but they lack any of the benefits.
Rod: “On the other hand, maybe it is all just a bubble that will pop taking oil back down to $20.”
It will never return to $20. The damage caused by Fed monetary pumping has been done. Even if it stopped today, which it won’t, the higher level of money has raised prices permanently. However, the part of the price increase that is due to speculation will go away when the Feds return to a sound mind. It mind go down to $100/bl. but not in the near future.
This is so puzzling–economics is deficient in understanding energy? Even mainstream economists understand the idea of supply and demand, and energy is something that people supply and demand, like any other good or service, even energy provided by oil. How much more ‘understanding’ does economics need?
More importantly, assuming, as fundamentalist did, a worst-case scenario, and we run out of oil (or at least drastically increases in price), then what? You’re still facing the same basic politico-socio-economic question that we face every day with every other resource that humans use: do we allocate it via voluntary exchange (the market place) or via command-and-control regulations and interventions (regardless of any specifice form such regulation takes)? Even Rod indicates that he thinks we are worse off with governments handling the situation, though he seems to think it’s inevitable.
The freedom of the marketplace provides the best incentives and best hope of improving energy efficiency and energy development, oil or no oil. Whether you believe oil is some magical and unique commodity or not. So just exactly WHAT are we arguing about here??
It seems we have two types of problems in the energy industry.
Technical problems such as we don’t know how to produce a sustainable break-even fusion reaction, or we don’t have the technology to use the methane or hydrogen from the moons of planets or the planets themselves in the outer solar systems.
Political/psychological problems. Even though we already have the technology, we don’t have a stable enough political structure in the US to build modern nuclear power plants to replace obsolete coal plants, or to build refineries to turn coal into diesel fuel.
My contention as to why the latter is so is due to a breakdown in the education system. In particular almost complete economic illiteracy. I would guess than less than 1 person in 10,000 understands the basic operation of the Federal Reserve System – something that is easily available on this site.
rod campbell-ross says:
“Even supposedly socialist parties such as Labour, now in power in the UK and Australia, cannot be labelled socialist in the 1960′s sense of the word”
i think fundamentalist is on the money here, the socialist parties have changed their rhetoric, but remain wedded to the central planning model. the really shocking change is way the conservative parties, too, have become increasingly socialistic, but with a tinge of khaki nationalism. i cannot even remember the last time a conservative government in the western world left office with fewer public servants on payroll. even thatcher and reagan failed on this criteria, howard in australia presided over a vast rise in public service numbers, grew the statute books enormously, and presided over one of the greatest centralizations of power in our federation’s history.
paul johnston says:
“Money in this system is not an independent variable, so why put so much importance on it.”
“Give me control of a nation’s money and I care not who makes it’s laws.”– Mayer Amschel Bauer Rothschild.
mind you, lenin, too, understood the critical importance of a state-run central bank in the socialist platform.
paul johnston: “Money in this system is not an independent variable, so why put so much importance on it.”
That’s the Keynesian view. Mises points out that even Keynesians who think money is not an independent variable (it’s endogenous in econ speak), admit that a rapidly growing money supply is absolutely necessary for price inflation to occur. So even Keynesians admit that monetary inflation is necessary to price inflation, but not the cause.
So what do they think the cause might be? Shocks! Or in laymen’s terms, acts of God. That sounds less like an explanation and more like a description. Thanks, but I’ll stick with the Austrian explanation.
Fundamentalist: “…..even Keynesians who think money is not an independent variable (it’s endogenous in econ speak), admit that a rapidly growing money supply is absolutely necessary for price inflation to occur.â€
Who said anything about price inflation not being linked to a rapidly growing money supply?
Not me.
My point is almost too simple. When it comes to inflation, ask one question: cui freaking bono? Who benefits? The people who want inflation get what they want. They get it because they have the power to get it. How they actually go about getting it is a mildly interesting question. Maybe they read von Mises, and come away with clear ideas about what happens when you hose the landscape with purchasing media.
Actually, my guess is that inflation for these crony capitalists is more or less a side issue, a not too difficult to handle result of lucrative manipulations in the realm of finance, government regulation and insider dealing.
Now, to be sure, stopping money creation would stop inflation. Big deal. This is a trueism. Money creation is not an economic problem. It is a political one, or worse. By this I mean: to break the power of the FED by instituting a money regime based on gold, or based on some variant of a gold standard (or based on any arrangement that would take power over money away from the center, i.e. from consolidated government and crony capitalists) would require an appeal to arms.
Economic talk might help in the formation of coalitions of outsiders against insiders, but as a general rule, it seems to me that economic talk is too unconnected to the human heat, too abstract, to get us to go out there and lay it on the line.
Shostak is right:
And so is Friedman: “inflation is always and everywhere a monetary phenomenon”.
Some people prefer the devil theory of inflation: “It’s peak oil’s fault.†This approach ignores the fact that the evidence of inflation is represented by “actual†prices in the marketplace. The “administered†prices of the world’s oil producing countries, would not be the “actual†market prices, were they not “validated†by (MVt), i.e., “validated†by the world’s monetary authorities.
Here’s a cool post that graphically shows how significantly less Buy Programs in the Crude pre-market can lift the market as much as when large amounts of Buy Programs enter Crude when the pits are open.
http://www.transactionlevelanalysis.com/2008/06/when-does-the-smart-money-make.html
Hope that you find this interesting.
to carl:
sure, there’s a lot of noise in trading markets, but ultimately fundamentals dictate price, not technicals (which may or may not be useful, depending on interpretation).
Does anyone know of any studies of the impact of monetary prices on inflation during the two oil shocks of the 1970s? Specifically, did countries with tight monetary policies experience lower inflation and fuel prices than others?
this from gerry jackson of brookesnews.com, 18 april 2005:
“If those who push this line were right about the 1973 oil price hike causing inflation then the biggest oil importers would have had the highest price hikes. They did not.
For example, Germany and Japan are wholly dependent on oil imports, but after the price hike German inflation was only 7 per cent but Japan’s was 25 per cent. Australia, which was 75 per cent self-sufficient in oil, had an inflation rate of 17 per cent; America, which imported about 50 per cent of its oil, suffered a 12 per cent inflation rate; Britain, which had become a large oil producer, laboured under a record 25 per cent inflation rate; Saudi Arabia, the world’s largest oil exporter, saw its inflation shoot up to 35 per cent.
The view that oil prices caused inflation can not stand against the facts, which brings us to more facts. Those countries with the lowest rates of monetary growth enjoyed the lowest inflation rates. Take Britain and Japan as examples:inflation in Britain rose to 24 per cent and the money supply ran at over 25 per cent; Japan’s 25 per cent inflation was preceded by a 25 per cent monetary expansion. ”
According to a large number of media types, it was all Bush’s fault that oil was $145 a barrel. If he was to blame for high oil prices, does he get cudos for $95 a barrel oil? Where are they now?
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According to a large number of media types, it was all Bush’s fault that oil was $145 a barrel. If he was to blame for high oil prices, does he get cudos for $95 a barrel oil? Where are they now?
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