Tuesday, April 19, 2016

GOLD Thought #2

This post follows up on my last post, in which I explained the economic theory as to why increases in the supply of oil and natural gas due to new fracking technology ended the Great Recession in circa December 2014. A GOLD economic postulate is that the value of a dollar equals the total pool of value in the economy divided by the total number of dollars in the economy. Thus, with newly created wealth (namely, newly created oil and gas) (and by the way, when I say "wealth" I refer to value, not to money) the difference between the old amount of wealth and the new amount of wealth is like a gift given to all dollar owners who buy gas and oil and automotive gasoline. Their dollar now buys more relative to the previous equilibrium between supply and demand. This is why, from a policy point of view, the supply side policies that create new wealth are always better than the demand side policies of taxing and spending, which focuses on wealth redistribution instead of new wealth creation. When new wealth is created, it usually makes prices cheaper, which very obviously inures to the benefit of the poor and lower middle class, since it is in essence giving them a gift. In contrast, a policy that makes things more expensive while claiming to help the poor is almost always going to hurt people with scare dollar holdings who just can't afford it, and does not actually create any new wealth to give more to the people than what they had already--hence the naive and ironically self-defeating nature of many liberal platform planks.
Of course, gas won't stay cheap forever, nor would GOLD theory hold such. The decrease in the price of oil relative to other prices will redirect profit-seeking resources away from the production of oil. Thus, in turn, will decrease the supply of oil until oil finds a price where it clears the market, in other words, where its profit justifies the precise amount of resources spent to produce it. This then becomes a new equilibrium point, the price point where supply clears demand, which is the most efficient use of resources in the context of consumer decisions to buy it and the supply of and demand for that commodity, the resources used to create it, and everything else that competes with them. When people choose to buy more, price goes up, which draws in more resources to produce it until it reaches an efficient price, and when supply goes up, price goes down, which takes resources to produce it away until supply goes down to the price that clears the market. Price summarizes and results from an incredibly sophisticated machinery of the economy that measures everything relative to everything else and coordinates the economic behavior of all the disparate individuals in the world--the miracle of Adam Smith's Invisible Hand. This is not complicated, really, it is basic supply and demand from Economics 101, yet both the Keynesians and Austrians frequently just don't get it.
Lastly, while on the topic of the price of oil and supply and demand, this is a perfect opportunity to flay a pet peeve of mine, namely, the theory of marginal utility. The Austrians say that water is cheap despite being vital to humans survival because every unit of water is priced at the value of its lowest use, in other words, for washing your car or something even less important, not for drinking when dehydrated. I think there is no need to say this, since water is valued at the value of the use it is bought for, obviously. Instead, the theory of supply and demand explains it adequately. Water is cheap, despite being a vital necessity, because there is a high supply relative to demand. If there wasn't--and on the Moon and Mars, there won't be--it would be quite expensive. Oil is fundamentally like water, a vital essential commodity, and its recent collapse in price due to supply and demand supports my argument. Why does it matter? Well, why does it ever matter to believe a true theory instead of an incorrect theory? Because, if you apply it, and you are wrong, the results will be worse than applying a theory that is actually true.

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