Friday, August 26, 2005

Adjusted for Inflation

George Will takes us back to Economics 101, and reminds us of the difference between "real" and "nominal" prices. Is oil expensive? At $68/barrel, it's more than it's ever been; but adjusted for inflation, it should be more like $86, based on its 1981 price. In other words, it's "real" price is still cheap.

But who says the 1981 price is the one we should use as the standard? That appears rather arbitrary, and makes the current picture rosier than it could be. Will also mentions that oil looks cheap, adjusted for inflation to the 1935 price, though he admits it looks expensive based on the $1.80 price/barrel from 1970, which would make it $9.80 in today's dollars. Why not use the 1970 price as the standard, however? Will doesn't say. Oil is a commodity, after all, without any ability by itself to control demand, and other "commodity" products like computers do nothing but decline in price. (This is why some investors avoid energy companies, which don't control prices as much as they are subject to them.) So shouldn't oil prices decline in "real" terms over time?

One could argue that oil is a finite resource, whereas computers aren't. That's debatable, however. Some scientists argue that the earth is constantly producing more oil. In any case, Will's point would be more believable if he would tell us what the known reserves were in 1981 and what they are now. We need to know about the supply side as much as the demand side. Additionally, technology is getting awfully good at extracting oil from previously hard-to-reach areas. One can hardly look at the business section of a newspaper today without reading about "Canadian oil sands," for example, and how oil above $40/barrel makes it cost-effective to drill Canadian fields, from which it was previously difficult and prohibitively expensive to extract oil. One could argue that improved technology should be keeping prices lower -- at least lower than $68/barel. And perhaps it will over time, but it certainly hasn't yet.

Also, even if oil has been underpriced or not moving with inflation since 1981, when you go from $30/barrel to $68/barrel in a few years, that can't be easy for an economy to absorb. There must be a fancy economic way to express that thought, but I don't know it. It doesn't matter though, because a conservative like Will should appreciate that it might be difficult for a people and an economy to acclimate to jarring change. No normal person going to the gas pump these days soothes himself by saying, "I know that gas is still cheap in real terms going back to 1981, no matter if I was paying less than half of what I am now just a couple of years ago to fill up."

So, should we be worried about rising oil prices, even if it's not as expensive as it was in 1981 in "real" terms? Probably. Will's points that the press is overblowing the situation and that the economy is in good shape are strong. It's true that the press is more interested in bad news (and also that this administration is rhetorically challenged when it comes to trumpeting good news). It's also true, as Will points out, that people don't seem disturbed yet about gas prices, and that they are driving more than ever. Nevertheless, despite these points, there's little question that cheaper oil would be better for the economy. In fact, I wouldn't be surprised if WalMart executives prayed every night for cheaper oil to give their customers more disposable income. Irwin Stelzer seems to have it right when he worries about the specter of "stagflation."


Blogger ALH ipinions said...

An interesting lesson to be sure but it's rather like lecturing starving people on drought patterns when all they want to know is why they have no food... Perhaps George can also explain the counterintuitive phenomenon of President Bush's special relationship with his oil producing friends and his promise to "talk down" the price of oil actually resulting in the price trending defiantly upwards....

1:32 PM  

Post a Comment

<< Home