Mar. 10 2011 - 2:59 pm |
By BILL FLAX
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To understand whether our recovery is in jeopardy, we must first grasp what prospers us, why economies recede and then what rejuvenates them.
There is a natural symphony to the market. Everyone seeks the best available outcome. Our unlimited desires are tempered by scarcity, yet we all strive to get what we can while wanting still more. Price signals orchestrate this perpetual friction between buyers and sellers into a concert of mutual satisfaction.
Wealth creation emanates from the value sellers add for which buyers are willing to pay, but buyers ensure efficient utilization of resources by insisting on lower prices. The more freely prices may move and the more certain the scale, the better the invisible hand can conduct a harmonious improvement in living standards for all.
A recession occurs when our aggregate output veers off tempo from society’s wants. GDP represents a basket of goods and services. If our demands shift dramatically or discord renders existing production unprofitable, the economy must correct. A recession is the process by which producers are redirected back into concert with what consumers now request, as can be produced profitably.
The freer the economy is left to transition toward fulfilling the demands of the new era, the faster recovery hums back into tune. When politicians prop up failing firms or resurrect dying industries, they trap precious resources in arrangements focused to the old market realities. Bailing out the failures of the past prevents the successes of the future.
Neither does deficit spending stimulate the instruments of wealth generation. Politicized spending rudely interrupts the market’s performance by intercepting scarce resources and parking them in uneconomic overtures to favored sections of the audience.
Conversely, Schumpeterian creative destruction transfers capital and resources into bands playing fresh numbers while composing innovative products ready for the challenges of the new paradigm. We cannot continue building houses in Las Vegas or other locales where a plethora of homes sit vacant. Nor should we manufacture goods rendered obsolete by technological advances or shifting tastes.
Investors grasp this quickly. Homebuilders in overbuilt areas and firms producing what consumers no longer value are accordingly deprived of capital. This inflicts pain on those workers, suppliers, and investors, but the market adjusts except where recovery gets drowned under the din of interventionist clatter.
Capital chases the choicest ideas in pursuit of profit. Where capital flows, jobs follow and growth renews. The market allows the finest instruments and best artists to achieve profits, which trickle into goods, jobs and amusements for the rest of us.
Growth continues chiming along until some large scale change triggers numerous firms across varied industries to suffer simultaneously. Rarely could one firm’s folly or another’s brilliance alter the market’s rhythm.
Oil shocks have frequently instigated such large scale dissonance. Many industries and nearly everyone personally gets hurt by rising gas prices. If this happens gradually, we adjust, but a rapid increase creates chaos. Heretofore profitable firms get squeezed as rising transportation costs overwhelm thin margins. If energy remains expensive for an extended period, the entire economy suffers as the number of failed firms mounts.
Recessions in the mid Seventies, after the first Gulf War and even the Great Recession of late were all attributed to rising fuel costs. Hence the renewed concern that the current spike could knock recovery off key.
What causes oil to spike?
The price of anything has three components: supply, demand and the scale used for measurement. As we demand more of something buyers bid its price higher. If the available supply increases faster, the price falls.
An infinite array of factors can shift either supply or demand. Demand for oil increased over recent decades as previously moribund economies such as the former Soviet Union, India and China joined the chorus. They consume far more energy. Demand also fluctuates as the world economy goes through cyclical gyrations.
Supply can be curtailed by OPEC, though not as drastically as people assume. Or it can be hindered by environmentalists extorting politicians into refusing to let us drill. Supply has recently been threatened by the internal unrest in several large oil producing nations. This invited speculators to bet on rising prices.
But the ebbs and flows of international commerce cannot entirely account for the roller coaster ride of oil. Speculators may accelerate these turns, but when they bet rightly this actually smoothes the spike by moving the increase forward. It thus becomes more gradual. When wrong, the speculators lose dearly as prices fall.
There must be more here than normal cyclical movements or speculation. Thomas Carlyle said, “Teach a parrot to say ‘supply and demand’ and you have an economist.” Most currencies were then defined in terms of gold or silver. No more.
Now supply and demand dance on a wobbly scale, which corrupts price signals and misdirects capital and resources. Even successful firms generating value for customers can be knocked off balance. As the dollar slips prices leap for anything denominated in dollars. Fluctuations in the dollar will always appear first in international commodities such as gold, oil or food ingredients.
Were the dollar still defined in terms of gold, or at least defended by our monetary masters, fuel’s cost would be purely derived from changes in supply relative to demand. But everything from foreign currencies (the Canadian, Australian and New Zealand dollars all test record highs) to precious metals (setting new records almost daily) and crop futures (corn and wheat have nearly doubled this year). None of this can be blamed on North Africa’s discord.
Turmoil abroad has certainly lifted oil prices, but they were rising rapidly long before Tunisia, Egypt and Libya revolted. As investors around the world fled to the safety of the dollar in late 2008, oil cost $35 a barrel. It had already crested $80 and trended towards the century mark long before the Arab world rattled.
Producers, whose cost structures include any of these commodities, which to some degree include everyone, will stumble badly. During the Bretton Woods era, with the dollar pegged to gold – at least tentatively – oil prices remained remarkably steady. After the dollar began to float in 1971, both oil and gold soared. Now they soar again. Or do they?
Perhaps oil doesn’t soar, but the dollar plummets. Will it take our recovery down too.
blogs.forbes.com/billflax/2011/03/10/oil-spikes-double-dips-and-dilapidated-dollars/