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Daily Speculations The Web Site of Victor Niederhoffer & Laurel Kenner Dedicated to the scientific method, free markets, deflating ballyhoo, creating value, and laughter; a forum for us to use our meager abilities to make the world of specinvestments a better place. |
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05/31/2004
What Everyone Should Know About Economics and
Prosperity,
by James D. Gwartney
Reviewed by Victor Niederhoffer
One of the best introductions to economics I have read, a worthy supplement to Heyne and Pashigian. The first of the 10 key elements of economics that everyone should know is that incentives matter: "Markets work because both buyers and sellers alter their behavior in response to changes in incentives." I would add that "everything has substitutes " is a close second. The two come together whenever the price of a single commodity rises. Consumers ration, and substitute less costly goods, while suppliers increase production and stop producing so much of other less profitable goods. Workers move to where their marginal product is more valued. The higher price thus discourages consumption and encourages production, bringing supply and demand into balance.
The authors writing in 1993, then give an excellent summary of how this relates to higher oil prices of the 79's. Less costly trips, more carpooling, smaller cars on demand side; more drilling, more sophisticated oil recovery techniques, and more searching on supply side. A discussion of the numerous times that governments have predicted that we will run out of oil starting with a 1905 government report is salutary. "In 1914, the Bureau of Mines reported that the total supply of oil would last 20 months. In 1926, the Federal Oil Conservation Board predicted that oil would run out in seven years. A couple of decades later the Secretary of the Interior (the most important person in government) said we'd run out in a few more years. The club of Rome made similar predictions in 1970. ... Doomsday forecasters fail to recognize that private ownership provides people with a strong incentive to conserve a valuable resource and search for substitutes when there is an increase in the relative scarcity of the resource." (A beautiful discussion of selfishness too good not to memorialize in part follows on p.37: "Private ownership both provides protection against selfish people who would take what does not belong.... and forces resource users to fully bear the cost of their actions." References are given to the work of Barnett and Morris, Scarcity and Growth, 1963,and to Simon and Stephen Moore, So Much for Scarce Resources, Public Interest, Winter 1992.
The subject of incentives and substitutes must be considered in relation to the power of competition, which protects the consumer against scarcities. The interaction between these three principles are well covered in the text mentioned above. Together, the three principles constitute the backdrop around which the total growth in commodity prices over the past 100 years is some 1/10 to 1/100 the growth of equities.
To me, the three principles together constitute a reason never to hold a commodity that has had a big rise in the previous year more than a nanosecond, and a great and terrible backdrop to the recent 20% declines in the grains, and the inevitable ultimate comparable decline in the spot price of oil.
5/31/04
Comment from Professor
Elroy Dimson, London Business
School:
I like this analysis. All sorts of cases were made over the years for investing in commodities on the grounds that resources are finite and usage infinite.