News reports have been sounding a lot like “chicken little” recently. To be fair, news reports are just that, they are mostly reports of statements made by politicians and occasionally by those who claim to be financial experts. If the report is sensational and full of sound bites, all the better.
For example, the Presidential candidates have attributed every foreign or domestic situation as either the fault of a President Obama policy or the lack of one. Financial gurus are unable to explain the large drop in the markets and alternate between “China is not growing fast enough” to “oil prices have dropped too far and too fast”. Between the politicians and the financial experts, what is one to do?
Let’s begin with China. China’s growth has been spectacular to be sure. But it is useful to note that China did not build a better mouse trap and the world beat a path to its door. Rather, China managed to build an export economy by converting uneducated and untrained peasants into productive workers making everything from dresses to gym shoes to furniture etc., items already being produced somewhere else in the world.
China’s growth resulted from producing goods at a low cost and selling it to other nations whose citizens wanted those items. For many of China’s customers, it was good products at lower prices. For others it was products they could finally afford. China’s growth rate averaged about 10% per year, a growth rate which is mathematically unsustainable for extended periods. No one should be surprised that these heady days had to end.
News reports indicate that China is shuttering many of its factories. This can only mean that world demand for more Chinese produced products in not there. While some other low wage countries are probably taking some of China’s share, the main factor is the world is just not buying as much as it did before. In other words, the slow down is not a producer problem but instead a consumer problem. So forget about blaming China and start asking why aren’t consumers outside the US buying more?
But what about oil, isn’t low price good news? No, we are told. Oil has dropped to much and too fast. Hmmm. Of course the price of oil is mainly the result of supply and demand, and right now the world’s oil producers are bent on pumping and selling at what ever price prevails. Hmmm.
OPEC has had life quite comfortable for oh so many years, raising price when ever the urge seemed right. Oil sales were the primary engine for growth in the quality of life for their citizens. Then along came fracking and the Canadian Tar Sands, spurred on by the high price of oil. Hmmm.
Suddenly the supply side was tilted above the prevailing demand. And as any capitalist knows, when there is more of something than what consumers want, the price goes down. The Saudis, for reason of their own, chose to keep pumping and not reduce their output. The Saudis said they did not want to lose “market share”. Hmmm.
The good thing about capitalism is while a supplier can act irrationally, for example lowering the selling price below the cost to produce, there are consequences. One the Saudis have found is that maintaining market share has not prevented oil revenues from falling. Revenues have fallen so much that their national budget has a deficit now. Hmmm.
While it might seem appealing to gloat at the Saudi misfortune, one might be wise to hope that they are able to adjust their national budget (which means reducing entitlements for their citizens) and avoid popular unrest.
Just imagine that another Sunni group replaces the royal family and what chaos might ensue (like when Saddam Hussein was toppled in Iraq). Imagine if the new rulers were called ISIS (they are Sunnis too).
There could be other unanticipated consequences of prolonged low oil price. Those companies and countries that have invested in new capacity have done so by borrowing. With income far lower than expected, the chance of default is high. Hmmm.
I wonder whether these lending banks are too big to fail? Hmmm. And who looks demon-like now over the XL Pipeline?
Adam Smith’s “invisible hand” predicts that natural events will correct supply-demand imbalances, and argues governments should not intervene. Keynes, on the other hand, recommends government spending to restart a sluggish or stalled economy. For the past 6 years, by default, the US has followed more the invisible hand approach. In effect the Country accepted higher unemployment for a longer period in exchange for unremarkable but steady growth. Said differently, there is no “bubble” in the US economy to burst now.
In comparison to the rest of the world, except China, the US economy is performing the best. Hmmm. I wonder what the GOP Presidential candidates will say about the economy?