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Reply to Baum on Higher Oil Prices

May 24, 2004

A response to Caroline Baum's column on Bloomberg, in which she argues that higher prices are neutral to the market:

True, higher prices are not the same as a tax, yes, the dollars do get spent somewhere else. But, no, this is not a neutral event. If if we suddenly all decided that we would walk everywhere tomorrow and not use our cars if possible, dollars would still be spent, yes - but, on shoes, socks and foot lotion--whosesuppliers may not of course be able to expand supply rapidly enough to cope, due to an intrinscic lack of resources, skills, plant, etc, no matter how great the incentive of now higher prices.

The whole industrial capital in the car plants, the toll bridges, the garages and gas stations and so forth would be thrown into chaos and relative disuse. Capital - real hard-won physical capital - would be in danger of being lost by becoming economically unviable under the new circumstances. This is a loss, a sudden change in any economic variable, especially one as important and all-pervasive as energy is potentially disruptive and inimical to entrepreneurial calculation.

If a marginal business now pays more for oil, it has less for investment first, then for the payroll. The fact that the price of Houston Texan executive boxes goes up, or Monaco casinos get more Arab punters through their doors is no consolation for non-oil patch tech and equipment makers or neighbourhood grass cutters.

As for 'cockamamie' and no basis in sound theory, the examples cited are facile, but otherwise this is another case where Austrian economics, not being blinded by trying to homogeonize all individual economic activity into dull aggregate quantities, shows its superior insights.

Of course, the other energy issue, which even the macromancers should grasp is that we also get the specious argument these days that, since oil is a 'supply-demand' problem and 'not a monetary one', the Fed is allowed to strip it out of the calcuations and carry on inflating to make sure the price of everything else goes up, too, instead of falling to make room for the extra oil spending. So the problem becomes not just that the dollars are still being spent, but that more of them get created to be spent, which is doubly damaging because it delaysthe necessary process of free market adjustment which the increased scarcity of energy is trying to signal through its higher price.(Incidentally, it also defrauds the oil producers. Hence, perhaps, why OPEC has decided to abandon the 'target' range, as measured in depreciated dollars, though crude is still in the same range as in the past four years, if we adjust for the dollar's world value or if we measure it against a braod basket of commodities such as the Journal of Commerce index.)

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