Friday, August 9, 2013

Synthetic Solutions

In the past three or four years, I've been increasingly enamored of what I will call synthetic solutions, for lack of a better phrase; the collapsing of seemingly opposing arguments into a singular position or solution. It's important to note that what I mean by that isn't just a compromised middle-ground of some sort, but rather recognizing that sometimes the cores of two juxtaposing arguments need not be mutually exclusive. In other words, some things that appear to be dichotomies may just prove to be limitations of our language and bias.

I've seen this phenomenon repeatedly since I first noticed it. It can be applied to arguments about concepts as lofty as theism, consciousness, and/or materialism. But it can also be applied to arguments we're far more likely to have in our daily lives.

Take markets and basic economics for instance. I ran across a thread of arguments on Twitter last night regarding regulation on oil-drilling and pipeline excavations. Taking note of the stubbornly high gas prices under the current administration, one group of individuals slam Obama for keeping us dependent on foreign oil. Another group claims that oil is a commodity on the world market and that more drilling will have no affect on prices. The former group responds that basic supply and demand dictates that more oil will bring lower prices. The latter group rebuts by pointing to the fact that oil production is always going up and yet prices continue to rise regardless. Another party chimes in and makes the claim that both are wrong; that oil prices have nothing to do with supply and demand, but rather it is controlled by speculators.

Who are we to believe here?

My answer is "all of them." All of them have a reasonable claim (or at least some part of one) that has a bit of truth to it. Where they have gone wrong, in my opinion, is in not completely fleshing out their points. Instead what remains are almost caricatures of proper points. All these contentions seem true, on their face - is it possible to synthesize them?

I'll give it a try.

Price is most certainly a function of supply and demand. Ceteris paribus, when supply rises prices fall. And even with all the intricate factors at play regarding various market mechanisms, it's not unreasonable to assume this would be true of crude oil (or anything else for that matter). So, yes, it would seem that increasing the production of oil should bring down the price.

So what about the claim that price hasn't dropped concordantly with increased production over the years? Well, this claim is also true - depending on exactly what is meant by it. Unfortunately, and to the bane of many self-proclaimed macroeconomists, the world as it exists is never ceteris paribus. With markets, things are always in flux...which is actually a good thing in that it lets entrepreneurs and consumers redirect the allocation of resources in real time (but that is a subject for another day).

For instance, an observer who isn't particularly discerning could be looking at a nominal (as opposed to real/adjusted) price history. Looking at prices without adjusting for the steady monetary inflation can be very misleading in matters like this.

Another point worth considering, by the same token, is that crude oil is not (as of yet) a practically replenishable resource. Therefore production is never static. We consume the resources that are most easily accessible first and then, over time, move to extract resources that are more difficult to obtain. So, even though technological progress may or may have not offset it, production costs for such resources (ceteris paribus) will rise over time. You can't gauge how supply and demand is affecting the price of a commodity by looking at production alone.

A third point, which I believe to be the most obvious one in this case, is that demand for crude-oil has not remained static over time. As more and more of the world industrializes (especially with regards to India and China), demand for oil has skyrocketed. Production has had to increase by leaps and bounds just to obtain any sense of tethered pricing given the increased demand over the last twenty or thirty years.

And to the lone voice in the wilderness who cries out, "Speculators!" - well, of course speculation plays a role in the real-time price of commodities. But it does not usurp the role of supply and demand - it is part of that role. Speculation is just a betting market on future supply and demand. Nothing more and nothing less. And, interestingly, although people decry it, it actually serves an important market function.

Many people don't understand how this could be true, so let's look at an example:

Let's say there are ten people in a relatively small city that have chosen to stock up on sheet metal. There's a relatively steady flow of sheet metal to the city every week. These ten people buy a considerable amount of it but they don't use it for current projects, they simply begin to store it in a warehouse to sell at some later point. Although it's not enough of the total market cause too much of a fluctuation  it's undoubted that they contribute to an overall increased demand and subsequently somewhat higher prices for the customers.

One of the country's major metal foundries has gone under. The national supply of metals of various types has been tightened. Prices go through the roof. The people who have stored metal (or bids on it in the case of actual speculators) see the tightening supply and decide to start selling their stocks of metal to make money off the currently increased prices. Speculators selling off their goods will, in turn, increase the market supply and put downward pressure on current prices.

In this way, we can see that speculators actually do perform a market function by acting to further stabilize economies for shifts in demand and/or supply in the future. Speculators certainly affect the price of commodities, but it is because they are a part of the temporal supply and demand chain.

The oil-market argument is just a small example of something that I think is far more prominent. I think we have an unfortunate habit of taking one little piece of the truth and just running with it. I'm sure a lot of it is the result of our biases and predispositions. Maybe we simply don't consider other aspects of the argument because we feel it threatens our own beliefs on the matter. You'd certainly get that impression from witnessing any standard political debate. But it would probably be healthy, at least once in a while, to stop being quite so defensive - to step back and allow for the possibility that another point should be considered, and that we might not have to give up all of our beliefs about those arguments to embrace it.

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