Let's Be Serious, Falling Oil Prices Are Not Causing the Oil Bust
In the 1960s IBM's first mainframe computer that filled a whole room would have set you back $1.5 million. Today, the cost of an exponentially more powerful and functional computer operated on your lap can be measured in the hundreds of dollars.
In the early ‘80s the very rich could access the first handheld cellphone, all for the princely sum of $3,995. Nearly four grand got you a heavy phone with battery life of ½ hour, roaming charges, and annoyingly bad sound. Today, the cost of a phone that fits in your pocket, plays movies and TV, sends messages, and that easily guides you to your desired destination is a two figure purchase.
Flat-screen televisions? Twelve years ago a 46 inch cost $25,000 and up, while today you can have one for less than $500. A year ago Ultra High Definition TVs set back the rare buyer over $25,000, but twelve months later they can be had for a few thousand dollars. Remember the Apple iPod? It used to be sold on a stand-alone basis for hundreds of dollars, but now iPod technology is so prosaic as to be included in the price of Apple iPhones that continue to decline in price.
My Forbes colleague Rich Karlgaard has described what's taking place in the technology sector as the "cheap revolution." As innovators in the technology space continue to find ways to get a great deal more to consumers for a great deal less, hotbeds of advanced thinking like Silicon Valley are attracting enormous amounts of intrepid investment meant to fund the entrepreneurial transformation of expensive luxuries into that which is ubiquitous, and cheap.
Simply stated, there's great wealth to be attained by those who relentlessly focus on lowering consumer prices, and this is nothing new. John D. Rockefeller became the world's richest man not because he gouged his customers, but precisely because his operational genius rendered cheap once hard to attain goods like kerosene and gasoline. Henry Ford achieved his great fortune for making the automobile inexpensive and common.
It's perhaps hard to figure given the media's demonization of it, but one of the many beautiful aspects of wealth inequality is that it signals a great shrinking of lifestyle inequality as business visionaries exuberantly deliver us the formerly obscure at prices that are always falling. Entrepreneurs not focused on price cutting are, contrary to popular belief, unattractive to investors simply because high prices of anything invariably attract imitators. The notion of "price gouging" in the private economy is very much a myth.
All of which brings us to the oil industry, and the gathering recessionary storm as $45 oil rewrites the sector's economics. It should be said up front that what's taking place is sick-inducing. These are real people in North Dakota and Texas. These are people with bills to pay, mortgages, and kids in school who work at Baker Hughes and Schlumberger; both oil service giants having announced major layoffs of late. Global oil giant Shell Oil recently signaled a $15 billion cut in spending over the next three years, and this will surely ripple throughout the oil economy, not to mention all the service industries reliant on it. It's terrible.
Still, the obvious question in search of an answer involves prices. Why has a "cheap revolution" marked by plummeting prices enriched so many tech entrepreneurs, while at the same time wiping out so many in the oil patch? Why did Rockefeller grow so rich for reducing oil prices, yet today a correction in the price of a barrel threatens to wipe out parts of Texas, Oklahoma, and North Dakota, along with commodity countries outside of the U.S. like Canada?
The answer to this seeming riddle is simple: oil was never expensive in the first place. Even at $100/barrel oil basically cost the same as it did in August of 1971 when a barrel set a buyer back roughly $2.30/barrel. How could that be? The answer is once again simple: money is a measure, the dollar is the most commonly accepted measure, and it's what's always been used to price commodities like oil. But with the dollar measure having shrunk substantially since 1971, the price of oil in greatly shrunken dollars has soared.
In the 1970s when President Nixon severed the dollar's link to gold, the greenback shrank. It was as though the foot was redefined as 1 inch. Assuming such a scenario, we'd all be 60-72 feet tall measured in the foot, but in real terms we wouldn't have grown at all. The price of oil revealed much the same. It didn't spike in the ‘70s, there weren't "oil shocks" in the malaise decade, rather the dollar in which oil is constantly priced in active markets for the commodity had shrunk such that oil became "expensive" in dollars.
Importantly, not all prices adjust at once. Commodities are unique in this sense simply because oil is literally traded all day, every day. Commodities like it are always the first to expose monetary error, and they were screaming it in the ‘70s. But with other prices slower to adjust, it suddenly became attractive and economic to extract oil that was much more expensive in diluted dollars. Indeed, the costs of extraction hadn't caught up with an oil price that fully reflected dollar shrinkage, and the oil patch boomed. Midland, TX in the ‘70s could famously claim one of the world's most profitable Rolls-Royce dealerships. In a preview of the ‘00s, jobseekers from around a recessed U.S. (devalued money is always horrid for the broad economy simply because it's anti-investment) flocked into Texas and other commodity locales.
Then the ‘80s happened with the clear thinking of Ronald Reagan, followed by the Bill Clinton ‘90s that were similarly marked by good economic policy. The Treasury departments under both presidents supported a stronger dollar, and with the greenback "elongated" as it were, oil plummeted. Its real price didn't change much, but its dollar price did on the way to a recessed commodity sector in the ‘80s and ‘90s. Sick-inducing layoffs were particularly the norm in the early ‘80s, but as a strong dollar is always good for overall economic growth (remember, investors whose capital authors the growth are buying future dollar income streams when they invest), the U.S. economy took off.
Sadly, Presidents Bush and Obama failed to learn the lessons of the ‘70s, ‘80s and ‘90s, so with the new millennium came a blast to our malaise-ridden ‘70s past as the dollar was shrunk again. Predictably the oil-patch once again boomed, but much like the ‘70s the boom was artificial. Commentators seemingly blind to history started to talk up the wonders of Williston, North Dakota. Even more comical, a right wing that had historically mocked Canada's economic policies suddenly decided that our oil-rich neighbor up north had learned how to grow just as we Americans not in Texas, North Dakota and Oklahoma were forgetting. It would have been funny had it not been so sad. One piece of commentary from a normally brilliant conservative commentator asserted that the "shale boom" had lured LeBron James back to Ohio.
Of course, there was one minor problem with this giddy narrative about North America morphing into Saudi Arabia: oil hadn't become expensive, rather the dollar had once again become cheap, or shorter as it were. Parts of Ohio and Pennsylvania were booming alongside traditional oil states like Texas not due to real economic fundamentals, but because a shrunken dollar had made extraction in forgotten oil locales attractive in dollar terms. It was all a mirage.
Happily for the U.S. economy, the dollar's shrinkage started to reverse itself in August of 2011, and then it took on greater speed in 2013. With the dollar once again "longer," oil's real, much cheaper price predictably revealed itself yet again. And it's brought us to where we are now. Members of the economic commentariat are now saying that oil extraction techniques were too successful, that they made supply too abundant on the way to lower prices. The obvious problem there is that there was never a supply problem in the first place, nor was there expensive oil, so the idea that fracking fixed that which wasn't in short supply as it was is quite the reach. A stronger dollar is what pushed the price of a barrel down, it has the broad U.S. economy on an upswing, but parts of the U.S. where energy extraction had been subsidized by debased money are suffering mightily. It's sickening. These are once again real people.
But let's not tie the problems in the oil patch to low prices. As economic history shows us very clearly, economic growth and wealth creation are most prevalent in places where entrepreneurs are relentlessly cutting the cost of goods. Falling prices are a sign of abundant economic health.
The oil patch isn't suffering cheap oil, rather it's being wiped out by an unstable dollar. We've seen this movie before as this column has been repeating in annoying fashion since 2005. Cheap oil isn't what's shaking the oil patch simply because the oil in the ground was never expensive to begin with. It's the unstable dollar that caused an artificial boom, and it's that same unstable dollar that's authoring the bust. Until the U.S. Treasury gets serious and gifts the U.S. economy with a dollar that is constant in value, the gut-wrenching reversal that's taking place now in economies reliant on commodities will be the tragic norm.
