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Energy and Macroeconomics

Professor Ferdinand E. Banks
ferdinand.banks@telia.com
May 23rd, 2013

Many years ago, one of my international finance students at Uppsala University (Sweden) - who is a gifted musician - wrote a song called 'MACROECONOMICS IS A WAY OF HAVING FUN'. It was dedicated to yours truly, and occasionally played on the radio in the Stockholm-Uppsala region of Sweden, as well as at some of the brilliant parties organized by my students. I can begin by saying a few words about what the “fun” in the title of that delightful melody means by comparing macroeconomics with physics, since many physicists believe that economists often suffer from 'physics envy'.

If you read an excellent introductory textbook in macroeconomics, and learn what you read perfectly, you can tell academics, business persons, journalists, break dancers and rappers that you are a brilliant and highly educated macroeconomist, and generally get away with this bluff. Try the same routine with an introductory physics book, and you will likely be called a fool - or worse. I have taught macroeconomics in many countries, enormously enjoyed teaching the elementary and intermediate courses, and eventually learned everything I wanted or needed to know about that subject. But of late I make a point of avoiding advanced macroeconomic presentations - especially mathematical macroeconomics - and keep my distance from the elegant models that fill the so-called scholarly journals, because most of them are useless, and in reality are an insult to students and teachers, although the latter are often unaware of this sad fact.

The last time I stood in front of a macroeconomics class was at the University of Technology in Sydney Australia, and since then I have adopted a very special approach to the topic. For me macroeconomics involves everything that has to do with the aggregate standard of living, and thus includes items like energy, population, education, and even elementary conventional macroeconomics. Excluded are crank lectures of the type presented in Sweden by some of the recent Nobel laureates in economics, and even more pitiful, junk science discourses on energy economics that are often delivered to graduate students at various universities, and sometimes to readers of the best known and more renowned business press. Let's put that another way: it's better to try to learn everything about the few things in energy economics that matter, than a lot about the trivia and bunkum that is sometimes unloaded on unsuspecting economics students in our institutions of higher learning.

THE OIL PRICE AND MACROECONOMICS

In the silence of my lonely room, and sometimes in crowded seminars, I like to call myself an accomplished energy economist, and among other things I feel that this gives me the right to describe Professor James Hamilton as the leading academic oil economist in the United States (U.S.). I want to make it clear though that I don't know that scholar, nor do I want to know him, because although we share the same outlook on the past and future of oil, he has never mentioned me in his publications, despite my citing and alluding to his work whenever I get the opportunity.

Hamilton has carefully examined the relationship between increases in the oil price and the negative effect they have on the U.S. macroeconomy, beginning at the end of the second world war (WW2), until the early years of the last decade of the 20^th century. His results are similar to those of Professor Andrew Oswald of Warwick University and myself, but much more thorough, and covering a longer period. The thing that my future energy economics students will kindly be asked to remember is Hamilton's claim that “all but one of the recessions in the United States since WW2 were preceded - typically by about 9 months - by a dramatic increase in the price of oil.”

This is the kind of contention that you can take to the bank and draw interest on, although in later articles and conference papers, and of course on the blogosphere, his research likely goes as far as the present day. I might as well confess however, that for the period 1991 to the present, my own work on oil economics ranks with any that has been done anywhere in the world, and as a result I will use this opportunity to give readers a taste of exactly what has happened on the global oil market.

From the formation of OPEC in 1961, until the beginning of the twenty-first century, it was the intention of that organization to manage not only the oil in their countries, but also to eventually obtain a controlling interest in the global oil price. In order to do this efficiently, complete (or nearly complete) unanimity among the directors of that cartel was required, and as far as I can tell they did not obtain that like-mindedness until the price of oil fell below ten dollar a barrel (= $10/b), and the amateur energy experts - or 'know-nothings' and charlatans as I usually call them - in the oil importing world, began talking foolishness about it reaching $5/b. That was when even the 'independent thinkers' in the OPEC executive suite in Vienna saw the light, and fell into line with OPEC's main men.

Econometrics is a topic that I taught for a few years in Stockholm and Uppsala, but eventually abandoned, however some simple calculations that I made about 2004 indicated that the oil price had started to accelerate upwards. A few years later, while I was giving a long talk on oil at the Ecole Normale Superieure (Paris), that price was on its way into orbit, and eventually it reached $147/b, which provided OPEC with the income they had been dreaming of since the formation of that organization. Fortunately, a high degree of intelligence and rationality prevailed in the OPEC executive suite, and so there was no attempt to over-exploit a good thing. Unfortunately however, according to myself and Professor Hamilton, the macroeconomic damage had been done. As much as I hate to say it, the machinations of speculators, and the clumsiness of bank directors and politicians had very little to do with the bad economic news that began in 2008, which is best described as the most serious economic downturn since the great depression (that began in l929).

Future students of mine will have to understand the above perfectly if they prefer a passing to a failing grade. They will also have to understand the power of OPEC. The recession triggered by the oil price escalation cut the ground out from under the global macroeconomy, and as a result the demand for oil fell in such a way that the oil price bottomed out at about $32/b. OPEC simply reduced production by a small amount and the oil price quickly climbed to $72/b. Shortly after - with the global macroeconomic apparatus still in disarray - the oil price kept moving up, until finally the aggregate oil price exceeded $100/b, although the demand for oil was not increasing rapidly.

It is also useful to cite what happened when the war in Libya began - a war, incidentally, that was about oil and not protecting civilians, as the ignorant NATO president claimed. Oil production in Libya almost ceased, which meant that about 1.7% of the global oil output disappeared. That loss was enough to cause the oil price to increase by 17%. Even students at the store-front university in Chicago from which I obtained my economics degree should be able to calculate and interpret the short-run elasticity of the oil price from those numbers, and if they are hooked on nonsense about speculation, also realize that OPEC receives all the help it needs from large oil producers who, surprisingly, prefer high to low oil prices, and understand how to make the moves that are necessary to obtain them. PLEASE REMEMBER THIS!

Much more will be said about oil in my forthcoming textbook (2013), but right now I want to mention some thoughts of the billionaire Canadian investor Stephen Jarislowsky, which are especially appropriate when dealing with energy economics. “We're living in just about the most dishonest time in the history of mankind. It's theft from A to Z”. Well Steve, it's also lies and misunderstandings, where by the latter I constantly refer to President Obama's belief about natural gas, and where the former is concerned the persons who have provided the commander-in-chief with his counter-productive opinions about energy, since I am certain that some of them know as much or more about that issue than my good self.

REFERENCES

Banks, Ferdinand E. (2013). Energy and Economic Theory. Singapore, London and New York: World Scientific.

Hamilton, James (2012). 'World oil production is not going to increase forever'. Working paper, University of California (San Diego).

Professor Ferdinand E. Banks
ferdinand.banks@telia.com
May 23rd, 2013