Economics of Oil, Hurricane Katrina, and the Real Estate Bubble

0:00Okay, Walter, can you hear me? I can. Outstanding. Okay, I just kind of did a setup, and I don't know if you saw my email earlier, but I wanted to set up this oil question, because oil's been hot in the news, and I thought, okay, what's the best way to set up a good question about root causes without getting into the technicals of it? Basically, I surveyed the news and you see root causes anywhere, you know, obviously the left is very hard over on saying that it's going to be, that it's the oil companies, especially the American oil companies because they're the near target and the target for their confiscations and taxes and on windfall profits and that's the Obama goal.

0:51but i also see even from from the right a lot of a lot of inconsistency of what they think root causes are and and i never see people get down to i mean i see things about the futures market and things about is it a natural supply demand curve or not i suspect it's kind of a mixed bag and i'll let you talk in a second what i'm what i'm smelling out though is that that that really the the oil cartel

1:51So, I don't know how deep you've done research on this, but it seems like it would be rather easy to collude as a government and to set prices, rather than being a private firm where you're accountable to shareholders. What's your sense of the anti-competitive behavior in the setting of the price of oil? Well, I agree with you and I think you're making some very good points. I would just add a few more. First of all, the price of oil is as high as it is partially because... hello? Yeah, I can hear you. Because there's some sort of echo.

2:38Oh, sorry about that. Let me move some phones around. That might help. I'm not hearing an echo, but hopefully... Okay, I guess I'll just have to deal with it. One of the reasons that the oil price is so high is because the dollar is so weak. One of the reasons that the dollar is so weak is because the U.S. government has been inflating the currency. But even in real terms, the oil prices are much higher now than they were 10, 20, 30 years ago, but part of it is because of inflation. Another but, as you aptly put, is due to governments. OPEC is 40 percent. You have other governmental agencies involved for another 40 percent. You know, it's a governmental problem. A lot of the critics say, well, this is free enterprise failing us again, but it seems that rather it's government failing us.

3:28Now, investment fails us, so far we've mentioned two ways. One near the inflator, two near the owners. A third way that they screw around with the prices or make the price of oil higher than it otherwise would be, is because they interfere with supply. They don't allow drilling in Alaska, they don't allow drilling offshore, they don't allow drilling here, they don't allow drilling there.

4:23and the oil prices would not be allowed to go as high as they are. So when you get down to it, government has got its mitts all over the problem and yet somehow the talking heads, the pundits, the people in Washington DC are talking about speculators. Now, the function of speculators has got nothing to do with high prices. Rather, speculators tend to even out prices. You know the joke about the old speculator who was teaching the young speculator how to speculate, and his advice was buy low and sell high. Well, if they buy low and sell high, when they buy low they raise the prices, and when prices are high and they sell, they're lower the prices.

5:10So what speculators do is not raise nor lower prices, but even them out. They dampen down the oscillations of prices so that the prices don't move around like on a rollercoaster, rather they move lower radiation.

5:45Is it true that if somebody was to invest in Exxon or Royal Dutch Petroleum or any of those companies as just a normal stock investment, would investing in the company in mass tend to drive oil prices up? Well, I would say, no, it would be the very opposite. The more investment you have, the greater the supply is, the lower the prices have been. You see, if we, a late government, and suppose we said that, I don't know what, rubber bands or chewing gum or something like that, some innocuous good, Market bars, the price was rising.

6:31Well, high prices or rising prices are a signal. It's sort of like when hikers get lost in the woods, what they try to do is they yell, help, help, and the louder they yell, the more likely they are to get help. Well, high prices are like a call to help. The markets went, hey, we need some more chocolate or toothbrushes, if those are the things that have the prices go up. And there are deep values for the effects of a higher price. One, on the demand side, people tend to ration the stuff. When the price of oil or gasoline goes up to $10 a gallon, if it does, people are going to start drinking it twice before getting in the old car, and they're going to get into a very small car instead of a big SUV.

7:19So, you have a tendency that people tend to ration it, and on the other hand, when prices rise, that is if you don't have government oil with a lot like you do in oil, but take chocolate or toothbrushes or paperclips, if the price rises, other things equal, that means the profits are higher, and if the profits are higher, this serves as like a red flag for the bull, namely more investments go in there and that pushes down the price. The price system is a very wondrous spectacle. We have this thing called the magic of the market. Well, part of the magic of the market is high prices. And high prices call forth new supplies, thus lowing prices. And they also call upon people to not use as much of the good at a higher price as they would use at a lower price.

8:09Oh, that's just perfect. And while you're talking about profit, the frequent attack on the oil companies is that they've made record profits. Just from my standpoint, if you're growing positively as a country, you better hope some of your companies are making record profits. They would have to be if you're going to have positive economic growth. Well, you know, high profits aren't really necessarily a signal of growth or of benefit. It's rather a signal that you need help here. It's sort of like if I were to stick a pin in someone, all the white blood corticals would come to that spot to fight off the pin or the poison or whatever. It's like profits are the white blood corticals of the body and they're fighting off the high scarcity.

9:00Let me give you another example. I'm from New Orleans. I'm a professor at Loyola University in New Orleans. And we had this storm called Katrina. I don't know if anyone's heard about it, but it was pretty famous a few years ago. And in New Orleans history, I think it'll never be forgotten. Well, what happened during Katrina is that the prices of things that people wanted catapulted. They went up into the atmosphere. For example, flashlight batteries and candles and gasoline and milk and orange juice and diapers and things like that, people with dire straits, they needed them, but the prices catapulted. Well, when the prices catapulted, if you're in the supermarket, instead of buying 20 gallons of milk, most of which is going to go bad, at the old prices you might have been tempted to do it, but when prices are ten times higher, you tend to be more judicious and more civilized And also, FEMA, which stopped the whole process, but that's government for you, if you had

10:03had high prices for these things, then there would have been profits for people to bring stuff in from Tennessee and Texas and Idaho and wherever else. In other words, the high prices were a cry for help on the part of New Orleanians. And what the governor of New The governor of New Orleans said he's going to put the price badges in jail. Well, that's interfering with the market signal, which is trying to help the people, in effect.

10:50Let's say, $10 a bottle. That's kind of the classic gouge. They say, well, no, look, here's the people in need. They need relief. They're suffering already. And here's a guy selling water for $10 a bottle. But isn't that where the relief efforts come in? Now I'm thinking, you know, markets work for almost everything. belief efforts are by and large believed to be whether it's fire or police or bringing provisions in to people who are somehow isolated and need immediate relief. That seems to be a government function.

11:35So I could see where they might be a little hostile toward a guy selling water for $10 for a small bottle. Well, I don't really see helping people as a government function. I'm from the government, I'm here to help you. That's nonsense. What happened in New Orleans is that FEMA not only didn't help people, but it prevented places like Walmart from bringing food in and bringing ice and water and stuff like that. No, I don't think government is the good guy. I think government is the bad guy. At least with regard to Katrina, the whole thing was caused initially by the Army Corps of Engineers screwing around with the levy. And in the case of oil, with which we started, again you see government's fingerprints all over the problem. The government is not the solution. The government is the problem, in my view.

12:31One large problem by one act, but certainly in a compounded fashion, they can raise risks as what happened in New Orleans to the point where you were very vulnerable to not even a full force hurricane, right? It was a Category 3 or something when it hit the coast and... Well, actually, the hurricane missed us. It just sort of hit us peripherally, mainly Mississippi. Yeah, it seems like, you're right, but I would point well taken, the government created the vulnerability more than it had the private sector been able to... If the government could contract certain things out, I mean, understand the competitive model for contracting, that certainly would have been an improvement.

13:21Well, I'm not sure about that because, you know, where did the government get a comparative edge in contracting out stuff? I mean, government is really naked forth. What government is, is a bayonet or a club or a gun. And they say, you know, you're going to be part of our club, government club, what they're like to do or not. So I don't really see, I'm not really much of a fan of government. I imagine if they take half the GDP, they've got to do some good. But the point is that with the money that they took, we could have done much better good for ourselves. Look, it's not that the government When it screws up, although it always does, it's rather that when it screws up, it stays in business. Katrina is another point that gave me a point. FEMA is still in business.

14:08One of my favorite bumper stickers, by the way, is FEMA happens. Well, they're still in business, the Army Corps of Engineers is still in business. Imagine if a private company screwed up in such a royal way and killed, I think, 1,100 people died or it was 1,500, something like that, they'd be out of business in a minute. So the point is that in the market when you have failure, and you know, to fail is to be human or to be human is to fail, you know, we all make mistakes. That's why they put erasers on the back of pencils. But in the market if you fail, you go broke and then you make way for somebody else who can do a little bit better of a job. But these are the people who brought us to post office. How good a job is the Motivation Bureau? Why would we expect them to rescue anyone?

14:56And as you're saying this, I'm looking through one of these articles, which kind of lays out a litany of government contributions to this oil price thing, including the higher operating costs due to regulations of the oil industry, the proliferations of grades The companies of gasoline that they're forced to create, the recovery from low and negative rates of return on investment in the 90s, which I don't know how that somehow would carry this historical burden. And maybe that's something that the companies themselves are doing, but they're implying I'm hearing here that the government is actually trying to do some recovery of their own.

15:53In other words, if you put on a gas tax, it goes into a general fund, usually. They'll talk about it going to this or that, but eventually it just goes into a general fund. It's just a revenue enhancer. Well, I think you're putting your thing on a very important point, and that's something that we've forgotten previously, that when you go to the pump and you pump in gas at what is it, $4, $4.50 now, an awful lot of that is tax. The government is taxing a lot of it, and if they're so concerned about high prices, they could forego their tax. And often, the government interferes with productivity in so many, many other ways, affirmative action, lowest productivity, regulations, red tape, you have to hire an army of tax lawyers to fill out your taxes, and I don't mean just personally, but as far as the corporation is concerned, those people, instead of filling out government forms and replicates, could have been producing stuff, and again, prices would be lower.

17:03The government has got its hands on every part of the pie or the oil barrel, and to say that it's the market's fault, or it's speculators, or greed, or capitalism, or profits, they're out for lunch.

17:28Well, the taxes are too high also, that's for sure. The true cost of producing a barrel of oil is only $30 and the price of the barrel of oil is $140.

18:27Let's just get to the point where you have a barrel of oil, like from what you said, the taxes on the corporation itself, the regulation, the labor, affirmative action, all those, and so on, many unquantifiable regulations and restrictions. Yes, you're quite right. Another cost that the lefties probably wouldn't count is advertising,

19:24Someone is going to pay that price for it. That's what the cost of a barrel of oil is, or a gallon of gasoline.

19:54in Hostile Territories, there's obviously, you know, increased pay and security that needs to be paid for, but also the transaction cost, if I can ask a general question, if security is lowered, does not that deter transactions in general, it would kind of make a smaller mid-size company shy away because of the increased risks, and so even if on paper they show If they could make a profit from a transaction, if there's some intangibles and unknowns and fears that they're going to have based on lack of security, they're not going to make the deal. Well, I think you've put your finger on a very, very important point. I don't see why you need me. You're doing a great job without me, but I'm glad that you're including me in this.

20:47Two magnificent points. One, the Iraq business. I mean, we're bombing people who have oil and we expect the price of oil to be lowest in the past. Obviously, if other people who have oil now see themselves as a U.S. target, then that'll put a kibosh on some supply, and the less supply the higher the price. So I think that the war in Iraq is debacle not only morally and in terms of our security but it also is a devastation in terms of the oil price. And this leads me to another pack of security especially in foreign countries, you know, and not just with oil but with any mineral, you know, gold, silver, cadmium, copper, whatever.

21:36You go into a country in South America or Africa or wherever, where their adherence to property rights is only theoretical, not practical, that is, that they don't respect private property rights, and they allow some U.S. or Western European company to come in there, and as soon as they find oil or gold or uranium or whatever it is that they're looking for, all of a sudden they try to nationalize it and take back a lot of the property that they had accorded to the private corporation. Well, that too is a lack of security, and when the government does that, that's another way of elevating the prices of reference.

22:29I think you're absolutely right.

22:36Now that we've talked a lot about oil and we know that energy in general, just to back out to energy and the infrastructure that runs on energy primarily, in other words a great, large cost of some of our infrastructure and a lot of our companies is an energy cost. It seems to be, I don't know, I know there's been some studies out there that try to show this kind of an exponential effect, but certainly that's something that, that much at the core of the infrastructure is going to, is going to inflate costs across all industries.

23:25And I don't know how much you've gotten into, into that kind of, I guess I'd call it, economists Let's call it a negative externality, right? Just bad? Well, that's not exactly a negative externality. That's rather an input. And the point is that oil or energy is an input into many, many industries. And if the price of oil rises, then the price of everything that uses oil or other types of energy also rises. Externalities are a little bit different. Negative Externality, for example, would be a case where I build a, I don't know, a fire, I'm a fire cop and I build fires, and out of my book sack comes thrust, and then it fades or gets on your property and in your lungs, and this is what's called the Negative Externality.

24:18A positive externality is supposedly education. If I become more educated, then I'm a better citizen and I'm less likely to be a criminal. And this benefits you even though you don't pay for it. So these are the classic market failures called beloved of leftist economists and other lefties. But I don't believe that these are market failures. I've never met a market failure. I only see government failures all over the place. Yeah, the market is going... As the two objections, having raised them, the supposed negative externality of pollution is not really an externality, it's rather a government that sets itself up as the judge and the judiciary, and it's supposed to uphold private property rights, and what pollution really gets is the trespass of fifth particles onto other people's property.

25:12So it's not an externality. Rather, the reason it's an externality is the government refuses to uphold the law of property rights. Now, with regard to positive externalities, education, they use it as an example, or soap might be another case. You know, if I take a shower, I benefit you because I don't smell bad or whatever. What they're saying is that the government should now subsidize education in soap, and this is silly. In terms of education, it's very subjective as to whether education has positive benefit or not a positive benefit. You know, one man's need is another man's poison. I am a professor in a university and I tell you most of what university education consists of is multiculturalism and feminism and black studies and sociology and other irrational fields.

26:06The political movements is what they are. The students who come out of there are more socialistic than they came in. It's no accident that rent control is most popular in the Old Republic of Santa Monica, or Ann Arbor, or Cambridge, Mass. You have many universities around there. So at least as good a case could be made that education is a negative externality as a positive externality. What we ought to do is tax it instead of subsidize it. Maybe the whole thing is silly. What the government should do, if it's going to do anything, is just uphold property rights, and it's too busy not upholding property rights and doing everything else under the sun. By the way, I thought of yet another cause of why oil is costly, and that is unions.

26:51Unions are involved in the energy business. And again and again we keep coming up with more and more examples of where government is raising prices and it's growing up the works. I keep looking for, just like when I learned about compound interest and how fascinating that was and how you could put a small amount of money and if you just kept putting in every The Theory of Money and Credit

28:01Taxing or regulating the energy industry, now you get a much more pronounced exponential impact, negative impact on growth. And just the numbers I looked at, the last five years, our productivity per person, our per capita productivity has gone up I think 3% each of the last five years. But our economic growth has, I think, struggled to make 2% in the United States. We're spending money like drunken sailors in Iraq and Afghanistan on all sorts of welfare systems.

28:46The government is taking almost half of the GDP and wasting it, pretty much. It's hard to see great growth in that way. The fastest growing countries in the last 10 years, I think, are India and China, and they're more free enterprise than we are in many ways. So this is almost a disgrace. George Bush is acting like a socialist, and the commies in China and the socialists in India are doing way better than we are. Yeah, it's troubling if your productivity, now maybe it's not a one-to-one, you've probably looked into this to some extent, but productivity seems to be a core factor in growth, and if our productivity is increasing at a faster rate than our growth is, something's wrong.

29:42It probably means that regulation is taking more money out of the economy at a faster rate than productivity can make up for it. I think you're putting your finger on a very important point yet again. Boy, if you were in my class, I'd give you an A in economics. You're doing very well. One of the key elements of productivity is capital, the amount of capital that labor If you ever have to work with them, if you're digging a foundation for building with your fingernails, you're not going to do too well. A teaspoon will be better, and a shovel and a pick and shovel will even be better, but a steam shovel will be even better than that. But in order to get a steam shovel you have to have a lot of capital, and the way you get capital is through savings.

30:31The way you get savings is through free enterprise. The more economic freedom we have, the more likely it is that people are to save and invest in our economy. And, fortunately, we're going in the wrong direction in so many ways under George Bush, and I fear that under Obama or McCain, we're not going to be getting back on the right track either. It's terrible. Isn't it kind of like, you know, if you're the father of a family and you're not really watching what's going on with what your kids are spending money on, and maybe dad's off making 10% raises every year, but maybe the wife and kids are spending at an increasingly higher

31:47Wasting it on all sorts of frivolities and very dangerous things. You know, we have 730 foreign military bases in 130 different countries. Now that costs trillions of dollars and we have a vast debt of paying off the debt. George Bush is like this woman who's a shopaholic, I agree, it seems like a train wreck waiting to happen, we've become so used to the rapid to Advance the Technology. It seems to be increasing exponentially, in a steady exponential rate.

32:51They talk about the Moore's Law, which is the doubling of computer power every 18 months, and that's certainly been true for the last 20 years, but there's nothing that's going to guarantee that those rates will continue. And even if they continue, if the politicians and the government grab it up at an even faster rate, as you say, that's the train wreck waiting to happen. Indeed, that's the train wreck that's sort of happening even now as we speak, what would the buzzer be, what do you call it, the real estate bubble and the high prices of gasoline and oil and all. We're not in very good times right now, so I wouldn't say it's a train wreck right now, but it's the prognostication that's supposed to be Good.

33:37Oh, yeah. Well, that's great. Well, while we have just a few minutes left, I do want to ask you, since you reminded me about the real estate bubble, here's where you're going to have to give me less than an A. I don't know exactly what the principle behind what the Fed is doing when the Fed The Fed drops the interest rate to like when Greenspan drops it to the prime rate to 2% or whatever he lowered it to, it would seem to have been below what the market rate would have produced, would have emerged in the market if the banks had been unregulated by the Fed.

34:24So does that have the effect of driving inflation up directly or is it a more complex kind of relationship? No, no, no. I think that there are two schools of thought on this, two supposed enterprise schools of thought. The Austrian School, which Amman is there, and the Chicago School, and both agree that when the government pumps excessive money into the system by lowering interest rates, The Chicagoites drop out and the Austrians continue and they say, not only is there inflation, but there's also a business cycle that's created, because the artificially lower rates of interest subsidize and encourage investments in the heavy orders, the higher orders of production, heavy industry, that is not sustainable based on the time preferences or the savings rates of the people. And what you have every once in a while is a The Austrian view is a way of cleansing the economy. If the government would allow it to occur, it would be short and sweet. What happened with the Keynesians in the 1930s was that they just exacerbated and strengthened the depression. They had the school holly tariff. We're getting a little bit of that now with the protectionism of Obama.

35:49Yes, I think that the Fed ought to be abolished and we ought to go back to gold money. We shouldn't have U.S. fiat currency. It's very easy for the government to inflate. You see, there are only three ways the government has to get money. One is taxes. You come with taxes. Everyone knows who's doing it. The other is borrowing. And again, everyone knows who's doing that. The third way is inflating. And here, people are not so strict. They think Inflation comes about from greed or people spending too much money. Now it occurs on the centralized bank and the Fed. So we'd be much better off getting rid of the Fed and going back to gold. Now let me just spend a minute on the housing bubble. What happens traditionally, if you want to borrow money to buy a house, get a mortgage, you have to have collateral.

36:42You have to show a good work record, you have to show that you've paid off debts in the past, you have to show that you have a job, that you're not drunk or whatever. Namely, you have to convince the banker that you're likely to repay the mortgage. Well, this is the way it was going for a long time, but then our friends on the left discovered that bank loans were not going equally to all races and all groups and all genders and all whatever other way that you want to break up society. Society, but rather some people or some groups had more collateral and therefore they got more loans than other groups. So they said, well, this is unfair, this is racism or sexism or some sort of ism, and we've got to stop that. And now what the banks are told to do under the very sphere of penalties is to give loans to people without collateral, to give loans to people who haven't got a record of repaying past loans, who don't have a steady

38:04I did not know that connection. I knew that there was some programs where they had to give high-risk loans. I don't know if the government, I had assumed the government somewhat would guarantee those loans, but I guess not. Well, these loans were packaged and served as the basis of borrowing and bonds and all. And when the people didn't repay their mortgages, the whole thing sort of burst. The crazy government, there was no racism, or sexism, or I don't know, ecstasyism, or whatever the word is. It was rather profit-making. Bankers wanted to loan money to people that they think will repay it. And if each group isn't equally represented in those who succeed in getting loans, well, you know, too bad. That's the way it could crumble.

39:01speculation, where like I saw some people sitting next to me who would go out and get one of these variable rate interest loans, get a house that they normally couldn't afford on a fixed rate 6% loan, and then flip it over after 12 or 18 months and make a big profit. So there was some of that speculation going on and they were obviously able to pay when The interest rate was still low, so the bank was happy in the meantime, and a lot of people did make money if they were able to flip the house like that. So was there a little bit of a Dutch tulip speculation going on there? Well, I don't think that that was really the problem when the housing prices are rising, anyone who's in the market starts to look good, but that goes with the regards to animal prices.

39:56You're right. The research thing is over-speculation, or rather I'd call it bad speculation. The point though is that if you speculate erroneously, and you don't buy low and sell high, well then you lose your shirt. In other words, the speculators who remain in the market are pretty good, but when the government speculates, well, you know, then we're off to the racers.

40:26The way they lower the interest rates is by buying up stuff, usually bonds but theoretically they could buy up anything. But what do they buy it with? They buy it with the checkbook money or the printing press? In other words, what they're doing when they're lowering interest rates, lowering interest rates and increasing the money stock, that's what they're doing.

41:16Okay, so they do have to go print money in order to make that... Yeah, in other words, the overall liquidity, if you could add it all up, is increasing whenever they drive those interest rates down. Wow. Okay, and that eventually ends up in inflation. What do you think, where are we going with this inflation? Is there a vector on there that you're, not that predicting the future is safe for anybody to do, but do you see a bad trend of continuation of this inflation? Yes, I mean, any paper hanger Bernanke is off to the races. He should be disqualified.

42:07They ought to take back his PhD and, I don't know, fire him and get rid of the Fed. I see no good prognostication here as long as he's just ahead of it, and I'm not a big fan of Alan Greenspan either. Nor am I ahead of any of the heads of the Fed. I think that they're all a bunch of bad guys. Yeah, it's a little bit too much power in one... If someone were to hand you the chair tomorrow, just for a fun last question... Hand you the Federal Reserve Chair. How would you determine how to set the rate? Would you just look out at a market survey and just try to peg it to what the market is doing?

42:52Well, if I were the head of the Fed, I would do the best I could to just stand it. But given that I couldn't just stand it, what I would do is not increase the money supply at all. Milton Friedman had this thing that we should increase the money supply by 3% One of the best things about going to the Fed is that you don't have to go to a movie

43:35That's it. Let them help us a little bit less. They help us too much.

44:05and where Bob Barr is looking like more of a factor all the time and perhaps maybe not as a contender for the actual win but certainly I think he's influencing the debate and I hope that some libertarian principles make it through on the economic front. That would be great. I'd love to interview you about that. It's a pleasure doing this with you and I hope we do it again. Thanks again, Walter. I'll be talking to you soon, and I'll send you a follow-up after the show. It'll be posted on the site, the recording, and hopefully we'll link it over there to Von Mises. That's wonderful. Thanks. Thanks again. Talk to you soon. Bye now.

44:51Alright, outstanding. That was Walter Block. Failed to give him a good introduction. I'll give him a post-introduction. He's a professor of economics at the University of Loyola at New Orleans.