Oil

The most important thing is this (oil price collapse) is a massive tax cut for the world. This is really good stuff for the world.

Larry Fink

CEO Blackrock

December 11, 2014

Lower oil prices are like a tax cut to the economy, so in terms of macroeconomic impact, it’s a positive.

Jacob Lew

U.S. Treasury Secretary

December 11, 2014

Despite the impressive recent gains in natural gas and crude oil production, the U.S. is still a net importer of energy. As a result, falling energy prices are beneficial for our economy.

Over the near term, this will lead to a significant rise in real income growth for households and should be a strong spur to consumer spending. Since energy expenditures represent a higher proportion of outlays for lower income households, falling energy prices disproportionately raise their real incomes. Also, because such households are more liquidity constrained, with budgets that often bind paycheck to paycheck, they have a higher tendency to spend any additional real income.

As a result, much of the boost to real household income from falling energy prices is likely to be spent, not saved.

Bill Dudley

President New York Federal Reserve Bank

December 1, 2014

Here we have the head of the world’s largest asset manager, the CFO of the U.S. government and the globe’s chief money printer and regulator of the world’s most important banks all telling us that crashing oil prices are a good thing. Consumption will go up and savings will fall as a result of lower oil prices and these are, allegedly, good things.

Personally, I have never seen an issue that more starkly contrasts the Keynesian view of the world, as referenced above, with that of the Austrians.   

Keynesians focus on GDP, aggregate demand and animal spirits. Austrians focus on savings and capital creation, the entrepreneur’s focus on wealth creation and the avoidance of the malinvestment that comes from money and credit creation from thin air.

Keynesians want to boost consumption and penalize savings following a bust by artificially pushing interest rates lower. Austrians want to point to rates being too low during the bubble phase as being the cause of the subsequent crash and economic hangover and they argue that lower rates for longer will only create bigger problems in the future.

Oil’s collapse gives us a perfect perch from which to compare these contrasting economic views.

As we saw above, the typical Keynesian view is that the oil price collapse should increase consumer demand and decrease savings. These are thought to be good things.

Austrians view the oil price collapse with horror. Savings (real capital) was wasted on a truly epic scale as malinvestment ran amok throughout one the world’s biggest and most important industries. This is an industry that has seen annual upstream capital expenditures increase by about 75% to nearly $700 billion in the past five years. Pretty much all of that spending appears to have been wasted.

How could this happen?

Keynesians, it seems, don’t really care about the cause of all of this wasted capital. In the U.S. and Europe the only concern seems to be with whether or not the oil price collapse will lead to increased consumption and decreased savings. Both of these effects are cheered on by the Keynesians.

Austrians point to artificially low interest rates as having impacted the structure of production and consumption. Artificially low rates appear to have been a prime mover in China’s titanic infrastructure build-out of the past five years. This created a nearly insatiable demand for energy on the part of China, the major incremental driver of nearly everything on the planet for much of the recent past. This demand drove oil prices relentlessly higher over the past few years.

Alas, the Chinese real estate miracle appears to have crested and, with real estate prices starting to fall, the infrastructure build-out has stalled. Energy demand is, therefore, falling relative to previous expectations.

Oil production, especially in the U.S., boomed with the rise in capital spending that came from artificially low interest rates and strong, but artificial, oil demand. Despite the overall fall in savings in the U.S. over the past decade, whatever remained of the pool of savings was made available for oil production. In fact, oil production in the U.S. is up about 80% from its low point and the high yield market has come to be dominated by borrowers from the oil patch.

To the Austrians, looking back at the oil boom, it was lots of money and credit from thin air that drove the malinvestment that is now being revealed. They question whether pushing the savings rate lower from the current miniscule levels, a move that the Keynesians cheer, will allow for adequate capital spending in the future to drive any wealth creation in the U.S. They also worry about why anyone would ever want to create and deploy capital (savings) any longer if it always seems to be wasted. Malinvestment is simply a reduction in the already paltry rate of interest that is currently being paid on savings and it does not bode well for future capital creation or future real GDP growth.

Until recently, everyone thought that increased U.S. oil production would lead to American energy independence and that this was a good thing. Now, it seems like the Keynesians are telling us that wasting a few trillion dollars in the oil patch while blowing up the junk bond market was also a good thing. Who knew?

I’ll stick with the Austrian line: The crash in oil prices is exposing malinvestment that was driven by central bank fostered easy money policies which destroyed wealth, deters future savings and wealth creation and, as a result, destroys future growth opportunities.

Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.