If the price oil fell to $3 a barrel, and it stayed there for 10 years, that would be a good thing.
What if this led to massive unemployment in the oil industry? That would be a good thing.
But isn't the primary task of a free market economy to balance supply and demand? Yes, it is. Then isn't it important that employment stay high, so that output can remain high? That is Keynesianism's view. It is also mercantilism's view. But it is the wrong question. A firm does not employ lots of people in order that output can remain high. It employs lots of people so that output meets demand at a price that is profitable for the company. If a firm continues to produce large quantities of goods that cannot be sold at a profit, it is making a horrendous mistake. It is wasting resources. The important thing at this point is for the firm to shut down operations entirely. Close up shop. Go fishing. Stop the waste.
The free market economy, according to Adam Smith, and also according to Ludwig von Mises, is supposed to produce goods in order to meet demand of customers. The free market economy's task is not to see to it that lots of people are employed. It is not to see to it that investors receive a normal rate of return. The free market economy's task is to see to it that, when customers go to the store, they can find whatever it is they are looking for at a price they are willing and able to pay. That is called a market-clearing price. It is the central task of entrepreneurs to create output that will be sold profitably at a market-clearing price.
What is a market-clearing price? It is the price at which nobody is waiting to sell the item, and nobody is waiting to buy the item, unless the price changes. If an entrepreneur can forecast in advance what this price will be, and then organize productive capacity in order to meet this demand at a price that produces a profit, then he is well worth his money, and he will make a lot of it.
The entrepreneur's task is not to figure out how many people ought to be employed, except for one purpose: producing something that the market will buy. It is not the entrepreneur's task to serve the workers. It is the entrepreneur's task to serve the buyers. Any other view of the market is going to lead to some variation of mercantilism. Adam Smith refuted that position in 1776, but the world is filled with mercantilists who have not read Smith, or who do not understand Smith, or who find that it is not in their personal self-interest to admit that they believe Smith and they recommend what he says, because they want to clean up personally. That, as a matter of fact, is exactly what Adam Smith did. One year after he wrote The Wealth of Nations (1776), he went on the government's payroll as the head of the customs office of the Scottish branch of the British Empire. He made his money by collecting tariff payments that he believed were bad for the economy.
CHEAPER OIL
There is all kind of handwringing, wailing, and gnashing of teeth on the sidelines, because the price of oil is down, and oil producing companies will lose lots of money.
Some people really believe that the free market economy's number-one task is to provide high rates of return for investors. The secondary importance of the free market economy is supposedly to produce above-market wages for those people who are employed by favored industries. Only as a last resort do these people focus on the task of the entrepreneur, namely, to balance supply and demand at a price that keeps the entrepreneur in business.
The fall of the price of oil is bad for people who invested in junk bonds issued by lots of high-flying shale oil firms, whose stocks have fallen about 60%. Their bonds are doing almost as bad. What is good for the American customer, and every other customer, is low-cost oil that is sold at low, low prices. This enables customers to achieve their goals more effectively. The fact that it is going to bankrupt a lot of high-flying companies that borrowed way too much money is neither here nor there for consumers. "Not our problem."
If oil producers want to sell oil at a particular price, and this price is profitable for the producers in the short run as well as the long run (think Saudi Arabia), it is irrelevant that a lot of American oil companies that should never have started their projects now find that they are heading toward bankruptcy. They will have to sell their assets to entrepreneurs who were smart enough to stay out of the shale oil market until this week, or next week, or whenever the new owners take over. The oil will still be in the ground. But the investors who paid for the equipment to get it out of the ground made a big mistake. They did not see what was coming. They have lost their investment. That is their problem, but it is not the problem of the customers. It is not the problem, or should not be the problem, of the Federal Reserve System, the Treasury Department, or anybody else who is trying to extract blood money out of what are now entrepreneurial turnips.
Unemployment will undoubtedly go up in North Dakota. That's bad for North Dakota, but the rest of the country really doesn't care, nor should it. It may lead to unemployment in Texas. The same principle applies. Somebody made a mistake, and the fall in the price of oil has led to massive losses on the part of those people who made the mistake. This is what the free market pricing system is all about. This is what the profit-and-loss system is all about. It is all about conveying information to participants. The information that it is conveying to senior managers of companies that borrowed too much money is this: "You are going to go bankrupt. You have been weighed in the balance, and found wanting. You are going to be out of this line of work. Somebody else is going to replace you."
This is exactly the information that needs to be conveyed to these people. It is the information that needs to be conveyed to the people who will be able to come in and buy up these bad investments at a nice low price. Then they will be able to participate in the profits when the price of oil goes back up.
The price of oil will go back up. In February 2009, West Texas intermediate crude oil sold for $37.51 a barrel. By the end of December, it sold for just under $80 a barrel. But those people who invested on the assumption that it would not go to $37.51 a barrel lost their shirts. They paid too much for their investments. They should have waited to buy. That is what entrepreneurship is all about: losses as well as profits.
It is good for the economy to have lots of oil at a cheap price. It is indeed bad for shale oil entrepreneurs who were not very good at forecasting this market, but that is not the problem of customers. That is not the problem of the federal government. That should not be the problem of the Federal Reserve System.
KEYNESIAN MERCANTIISM
Unfortunately, Keynesianism is a form of mercantilism. Keynesianism teaches that what creates wealth is investing, especially investing by governments that are running deficits. Keynesianism believes that it is important that investing continue, whether or not the output of the investments are profitable. Keynesianism believes that government deficits and low interest rates pushed lower by central banks, when combined, will produce employment. They are correct; this will produce employment. Then, when customer demand does not confirm the decisions made by Keynesian entrepreneurs who have been subsidized by government policies, we find that their ventures go belly-up. This is a good thing. When a venture produces losses, it is supposed to be eliminated by the market process. That is what is going to happen to a lot of firms that have bet the farm on fracking, and which need $80 oil to make their ventures profitable.
We may get $80 oil. Nothing says that the price of oil has to remain at the present price, which is inflicting enormous losses on entrepreneurs who did not forecast what has happened. But that is not a threat to the American economy or the world economy. The fact that bad decisions made by entrepreneurs without sufficiently accurate information do produce losses for those entrepreneurs is altogether a good thing. It is good for the economy. It reduces waste. It reduces from the market those entrepreneurs who do not accurately forecast the market. This is the traditional justification of the free market system, and the logic of it has not changed just because the price of oil has fallen by 50% since June.
It never ceases to amaze me the extent to which people who believe themselves to be free market economists are Keynesians. They really do believe that is bad for the economy when bad investments made by poor entrepreneurs become visibly bad investments, and the market price of ownership of these investments falls like a stone. That is what is happening today in the oil patch. The customers should respond as follows: "Not our problem."
CONCLUSION
Output is not the great benefit of capitalism. Output that clears the market at a specific price is the great benefit of capitalism. The key concept here is market-clearing price. It is not aggregate output. It is not aggregate employment. It is not aggregate price stability. It is this, and this alone: output that clears the market at a price at which no one else wants to buy, and no one else wants to sell. That is the whole nine yards. That is the kit and caboodle. That is economics in one lesson.
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