"Kee" Points with Jim Kee, Ph.D.


  • Oil Prices
  • Impact of Technology
  • Say’s Law of Markets
  • A More Pragmatic View


Oil Prices

Oil prices have steadily increased since President Trump announced a pull-out of the Iran deal. Potential sanctions on Iran (limiting their oil exports) and the continued collapse (by half) in production from Venezuela are believed to be driving fears of tightening global supply (Barron’s). Last week West Texas Intermediate (WTI) – considered a “local” or US price – closed at over $71 dollars per barrel, while Brent Crude – considered a “global” price – closed above $77 dollars per barrel. OPEC and Russia, which have succeeded in curtailing production somewhat, meet again in June. Expectations are for an offsetting increase in supply by these parties, but expert opinion varies on whether or not the Saudis want prices higher (my sense) or lower (more market share). I personally think you can dispense with the “OPEC” here and just focus on Russia and Saudi Arabia.


 

Impact of Technology

Technology (fracking) has obviously resulted in increased global oil supply. This technology is also working to reduce the growth in global demand through increased efficiencies (less oil consumption per unit of output) and alternative energy sources. In a recent Barron’s interview, Citigroup’s Ed Morse asserted that it used to be that when global GDP growth grew by 1%, so did the demand for oil (at least). Now, Morse says, “it is more like for every 1% increase, there is a .2% or .3% increase in demand growth.” That’s why people tend to see oil prices as near-term higher (bullish for Texans) because of geopolitically induced supply disruptions, but long-term lower (bearish) because of technology-induced supply increases and demand decreases.


Which brings in the question of how higher or lower oil prices – and by extension gasoline prices – affect the economy. It is fairly conventional to assume that higher prices in any market (i.e. housing, mortgage rates, energy, etc.) “pinch” consumers, leading to reduced consumer spending. And since “the consumer is 70% of the economy,” that infers lower GDP growth. But keep in mind that when consumers have less money to spend because they have to pay more for something (e.g. gasoline), whoever is selling it to them (gasoline producers) have more money to spend. In the aggregate, a starting assumption would be that total spending in the economy is actually unchanged, it is just moving money from one pocket (gasoline buyers) to another pocket (gasoline producers).


Oil has always been considered somewhat of an exception to this, because so much of it is imported. That means that US consumers pay more for gasoline, but international oil producers get some of that, suggesting an international “leakage,” or moving money from one pocket to another person’s pocket overseas (so less overall US consumption spending). But economists would argue (this is the fun part!) that the more oil purchased globally, the greater is the supply of dollars on the world market, lowering the dollar’s value. That in-turn means less goods imported (because they are now more expensive) and more US-produced (i.e. “import competing”) goods consumed. So the leakage in consumption from dollars going overseas is offset somewhat by increased consumption of now cheaper US goods. I know, a little of that “global equilibrium thinking” goes a long way, making the analysis a lot more fuzzy or less sharp. But this added complexity is necessary, I think, in order to help understand why lower gasoline prices haven’t produced a consumption boom, and why higher prices haven’t produced a consumption collapse. It all looks good on the chalkboard, but in reality there are many factors working at the same time, and you could spend an academic career trying to statistically isolate the various impacts of technology shocks, geopolitical shocks, and exchange rate movements.


 

Say’s Law of Markets

So if higher or lower prices of things just shifts spending around between buyers and sellers without really affecting aggregate spending, what does change or increase aggregate spending? An answer can be found in “Say’s Law” of markets, which is often incorrectly interpreted as “supply creates its own demand,” as though merely producing or supplying goods creates the demand for them. If that were true no business would ever go under! No, Say’s Law really implies that the demand for goods and services must come from income earned by supply goods and services. In that sense, increasing aggregate demand or spending requires a focus on increasing production, so, production is primary, rather than demand.


That sets up the great divide among “macro” economists between those who emphasize stimulating demand versus those who emphasize stimulating production or supply. Proponents of Say’s Law argue that the Great Depression, which appeared to be a case of overproduction (i.e. not enough demand) was really a sequence of adverse interventions in an otherwise self-adjusting market. These include failures of the central bank to act as a lender of last resort and allowing the banking system to collapse; tax increases to “balance the budget,” and wage and price policies that prohibited market forces of supply, demand, and price to adjust. Those arguing against Say’s Law argued that it was consumption that was insufficient to purchase aggregate production, which led to an argument for government policies to stimulate aggregate demand.


 

A More Pragmatic View

I am no longer enamored with the somewhat rigid, doctrinaire positions of each side on this debate, preferring a more pragmatic view. When confidence collapses, like the Great Recession of 2007-09 for whatever reason government policies that stimulate consumption (aggregate demand) probably do more good than harm, restoring confidence. In more normal circumstances, like today, policies focusing on aggregate production (lighter taxes and regulation) are probably the right call. Most of the professional economists that I know share this more pragmatic view.