Zero Hedge got it Wrong on Oil Price Analysis

Written By Geoffrey Pike

Posted January 5, 2015

There are a lot of misunderstandings when it comes to economics, and the recent fall in energy prices is no exception. There are a lot of discussions about the economic impacts from falling oil prices and the other energy prices linked to oil.

As with anything, there are winners and losers. In the case of falling oil prices, it is easy to see some of the obvious winners and losers. We won’t get into the geopolitical effects in terms of what governments and what countries benefit the most or are hurt the most.

The obvious winners are the consumers. While the price of oil affects the price of several different things, such as heating a home, the most obvious and widespread benefit is the significant reduction in gasoline prices. Most Americans drive, so this is a direct benefit.

The obvious losers are those invested in energy companies. There will also be some ancillary effects, such as those who are employed in regions where oil is the main business.

But one question is what the net effect is on the whole economy and whether falling energy prices are good overall.

There was an interesting piece on Zero Hedge where it was stated that “the economy is a ZERO-SUM game and gasoline prices are an excellent example of the mainstream fallacy of lower oil prices.”

They offer an example that gas prices fall by $1 per gallon. The consumer fills up a 16-gallon tank, saving $16. The gas station revenue also falls by $16 for the transaction, resulting in a net economic effect of zero.

They use another example of Big John who has $100 to spend each week on retail purchases. He fills up his truck for $60, but it used to cost him $80. He spends his normal $20 on beer. With the additional $20 he now has from his gas savings, he buys roses for his wife for $20.

A Zero-Sum Game?

The folks over at Zero Hedge make an important point, yet they are wrong on their overall point because they don’t thoroughly examine their own examples.

It is true that it is zero-sum only in the sense that money is changing hands and no additional money enters or leaves the economy. But we can’t just examine the money in circulation. We have to look at the wealth.

Zero Hedge needs to look at the broken window fallacy that was used by French economist Frederic Bastiat in the mid 19th century. In this example, a boy breaks a window and it is celebrated as economically beneficial because the man with the broken window will have to pay for a new window. The window glazier will get extra business and use his new money to buy something, until the money comes full circle.

As Bastiat pointed out, the problem is the unseen. The man with the broken window would have bought something else if he didn’t have to fix the window. He could have bought a new pair of shoes and he would have been richer with a non-broken window and a new pair of shoes.

Can you spot Zero Hedge’s error in his example? Big John was able to fill up his car and get his beer as he previously did. But this time he was also able to buy roses for his wife. So he and his wife are happier for it. They have more wealth.

Of course, most people won’t buy roses with their extra $20 each week. They may pay off debt. They may save it or invest it. They may go to the movies. They may go out to eat. The point is, consumers are better off for it.

If you have any doubt, just ask yourself whether it would be beneficial if oil prices went to $1 per barrel. Just think if it were almost free to fill up your car each week. Almost all of us would be far better off in the long run.

In the short run, those in the oil business would suffer. There would be a reallocation of resources. Zero Hedge also makes this error on falling energy prices, pointing out that jobs in the energy sector are some of the highest paying jobs and that they also lead to a ripple effect of creating other jobs.

But they misunderstand the economy and purpose of jobs.

We should never want to create jobs just for the sake of job creation. We have jobs for production. If energy prices are falling and fewer workers are needed to extract energy for consumption, then this is a long run benefit. It just means that some workers will have to redirect their talents into other areas that are more in line with consumer demand. Would we want to continue to pay workers to dig ditches and fill them in, even if they were high-wage jobs? Of course we wouldn’t, because those jobs are not necessary and are not meeting any demands for consumers.

In conclusion, falling energy prices will hurt some people in the short run. But overall, it is a huge benefit to consumers, and as a whole it would be beneficial to the economy if energy prices stay down in the long run.

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