Sliding Oil Prices – Good or Bad?

Greetings all!

I was tuned into Larry Kudlow’s radio show on Saturday night, and of course he and his guests got around to the topic of why the current stock market selloff is happening. One of the culprits that pundits like to cite is the accompanying slide (no pun intended) in the price of oil.

While the skid (no, seriously, I’m not trying to make oil jokes here) in the oil market does have some direct effects on stocks, I think the declines in both markets are sister symptoms caused by the slowdown in China. There are a few other causes too, but I’ll go into that a bit more in a future post.

Anyway…back to Larry and the gang. Kudlow likes to say that he’s a free market capitalist, but I often wonder if that’s really just more of an empty slogan. He really seems to just be in favor of whatever makes the market go up. If that means, for instance, siding with establishment Republicans on raising the debt ceiling instead of only allowing the government to operate within the limits of it’s cash receipts, well that’s just fine with him. Quantitative easing that piles up mountains of potentially inflationary cash while fueling a market bubble? He’s in. By all means, let’s not let a few laissez-faire principles rock the boat and threaten our hefty market returns.

So it’s no surprise that Larry was quite flummoxed by this idea that low oil prices are killing stocks. This must mean that falling oil prices are bad! But how can this be, he wondered, when he’s been taught by professional economists throughout his career that low gas prices are like a stimulating tax cut for the economy?

So which is it? Are falling oil prices good or bad? Larry, let a real capitalist explain. Are you sitting comfortably? Good. Then I’ll begin.

First of all, whatever the price of oil is, or the price of any commodity in a free market for that matter, there’s one thing of which we can be sure. The price isn’t too high or too low; it’s exactly right. If it were too high or too low, then the forces of supply and demand would move it back to the correct level, courtesy of Adam Smith’s invisible hand. This is free market economics 101, so I was disappointed but not surprised to hear Larry’s guests talking about what the correct price “should be.”

Secondly, what is this nonsense about whether falling prices are “good” or “bad” for the economy? We ran into this same silliness during the last financial crisis. Everyone was freaking out because housing prices were falling, and by golly that can’t be “good for the economy!”

Well guess what? There’s no such thing as the economy. “The economy” is a useful concept for organizing our knowledge about the process by which we humans apply labor to our environment in order to create value for ourselves. But there’s no actual entity called “the economy” sitting out there saying, “Oh, I love that price,” and “Ouch, that price hurts! Oooh, that fed stimulus tickles…” The idea that some things are good or bad for “the economy” is a dangerous Platonic collectivist fiction. So stand back, because I’m ’bout to get all Aristotelian on yo’ ass.

Go outside and point to the economy. You can’t. What you can point to are individual people and the things they value, like resources and goods. The economy, in essence, is people. People like you and me. I’m a person. And you know what? I don’t have a house. So when I hear about falling house prices, I’m in! Let them fall through the floor, I say! Houses, two for a buck! Gas? A penny and a half a gallon I say! Let oil drop to a buck a barrel! Yay!

Wait, but you say you own three houses as investment properties? And you have stock in oil companies? Or you work for a driller or a homebuilder, so your job depends on revenues from those things? So you want prices for houses and oil to rise, right? Of course you do! And by the way, screw me! Yeah!

Get the picture? Whether rising or falling prices are good or bad depends on what side of the transaction you’re on. The owners of things want prices to rise, while people that are looking to buy those things want prices to fall. “The economy” of which you often speak is composed of a set of markets, which bring buyers and sellers together. But buyers and sellers are always at odds with each other. No matter which way prices move, the move will always favor one and hurt the other.

But hold on. Isn’t there an objective measure of what’s “good for the economy,” namely the rate of economic growth (one of Larry’s favorite talking points)? Sure. but prices don’t affect the rate of growth. Prices simply tell us how much of one commodity can be exchanged for some other commodity. They don’t control the rate at which those commodities are produced or consumed.

Price movements in either direction are a double edged sword. High prices for some good may reduce the demand for that good, causing inventory to rot or rust on the shelves. But if demand stays strong instead, then high prices can attract more production of that good as suppliers see dollar signs dancing in their heads. This leads to investment, jobs, etc. Conversely, low prices can discourage suppliers, and lead to wells being capped and factories to close. But low prices can also increase demand, leading to more consumption, dropping inventories, requiring more production and jobs, etc.

So please guys, stop talking about whether rising or falling prices for such and such a thing is good or bad for the economy. That’s meaningless. Price movements are good or bad for individual people, not collective constructs like “the economy as a whole.”

That’s my rant for tonight. As always…keep pipping up!

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