I still remember my first lesson in economics at Island School in Hong Kong with Mr Abrahall. I had no idea of my future career, but I had fortunately dumped chemistry at the last moment. A very wise choice, if I may say so; the stock market has enough bangs and smells without bringing more in from chemistry.
Nobel Prize winner in economics Paul Samuelson’s great and physically heavy tome, Foundations in Economic Analysis, was used in class. I probably still have mine somewhere. Lesson 101 talked about supply and demand curves and the light bulb went off inside my head.
The demand curve goes down from top left to bottom right; a high price means low quantity is demanded; a low price, high quantity. The supply curve is the opposite: no one is going to supply anything at a low price, everyone wants to sell to you at a high price. At the point the lines meet, a price is struck – at which point the good (or service) is traded. Simple, basic and understandable even at a high school.
The supply and demand curves were so important that they brought down communism, because if you ignore the price mechanism, you end up with too much stuff that no one wants, or too little of the stuff that everyone wants. That’s why you pay more for face masks at the beginning of an epidemic; the supply curve stays the same while the demand curve moves right.
Of course, governments, cartels, suppliers and buyers all try to play around with supply and demand to make the price more advantageous for themselves.
That is why, if you let things go unchecked, it is possible to get a Circle K or a 7-Eleven mini-market right next to each other, selling the same items at the same price (and somewhat higher than at discount stores like Best Mart 360, 759 Store or U Select).
Don’t get me started on the ongoing uselessness of our Competition Commission to break up the many cartels that gouge poor people in Hong Kong.
What Samuelson didn’t figure out was that you can actually get negative prices in a world of (nearly) free market economics. This means that the supply curve can move so far to the right that the intersection point between the two curves – the price – becomes less than zero. And who wants to do business if you are losing money?
There is no storage. Many people trade in oil, but few want the black gold in kind as you can’t do much with it without a US$2 billion oil cracker. Hopefully, this is a temporary phenomenon that will ease when the threat of oversupply fades and the supply curve moves back to the left.
Wholesale electricity prices also went negative across continental Europe last month on the back of collapsed demand and great weather for wind and solar generation. The base supply had to be maintained because generation capacity has a “must run” minimum capacity, so again there was too much supply.
At least our economic models can handle negative supply and demand. What could not were the calculations for options pricing when the oil prices went negative. When prices go negative, the logarithmic function in the option models crashes and oil traders can’t price their asset. The CME Group returned to a century-old formula to price its options. Perhaps it shows how approximate these calculations are, anyway.
The biggest threat to our economic understanding is something that has been going on for quite a while: negative interest rates. Jim Grant, editor of the Grant’s Interest Rate Observer investment newsletter, notes that negative nominal bond yields are a 4,000-year first.
If so, how did we mess up the global economy so badly? By printing money to try to prevent a recession that would “clean up” the economy, first in 2008 then much more in 2020. We now have so much money sloshing around the world that it has no price, or indeed a negative price.
Surely it means that if you are willing to put 100 dollars/euros/francs in a bank, with the deliberate intention of getting, say, 99 dollars/euros/francs back in a year’s time, you expect any other investment to yield you even less than 99 dollars/euros/francs. No wonder the equity market is going up. At least companies can put their prices up.
How will that value be destroyed? By inflation, by sequestration and by debasing the value of money. So many zombie businesses, and household budgets and pensioners are at risk if we devalue paper money. The financial narrative that low interest rates are a good thing has permeated the US, European, Japanese, and many other central banks so deeply that we are sleepwalking into a monetary black hole.
Negative interest rates are the most dangerous economic phenomena of our times. Today, Samuelson would be horrified at how dismal his science has become and Mr Abrahall might be teaching something very different.
Culled from South China Morning Post