TCS Daily

Matters of Mind and Matter

By John E. Tamny - September 29, 2004 12:00 AM

As oil nearly reached the $50/barrel milestone yesterday, the stock markets sold off in response. To explain the selloff, pundits cited oil's impact on corporate profits, along with expensive oil potentially crimping the buying habits of consumers. One potential factor left unmentioned involves capital flows, and the impact of flows on future investment.

In his Principles of Political Economy and Taxation, 19th century economist David Ricardo wrote, "high profits on capital employed in producing (a) commodity will naturally attract capital to that trade."

Worldwide capital chasing commodity profits is a sign that investment flows are moving from the metaphysical economy (what the late Warren Brookes called "the economy of the mind") to the physical. Though it's not spoken about much in the major media, this capital shift towards tangible resources would logically impact stocks negatively.

Canadian economist Reuven Brenner explains the above phenomenon best. In his 2001 book, The Force of Finance, Brenner opined that a saving grace for Hong Kong has to do with it having nothing in the way of natural resources. Because it lacks resources such as oil, copper, and gold, the government has no territorial claim (think taxation) on what makes it prosper.

If the government ever did try to redistribute wealth in Hong Kong, the skilled would simply disappear. Applying Brenner's logic to $40+ oil, investments on the margin are moving away from innovative (mind) assets like Cisco and Dell Computer to physical, taxable assets. Assets "of the earth" can more easily be taxed and regulated precisely because they're stationary, and can't flee in response to the greedy hands of legislators. In the extreme, stationary assets can be expropriated as evidenced by the Russian government's recent takeover of oil giant Rosneft.

The picture surprisingly gets even worse away from Russia. Expensive oil means that instead of funding the next Microsoft or Intel, capital will flow to state-owned oil companies such as Pedevesa (Hugo Chavez) and Pemex, not to mention economies most known for funding terror such as Libya, Saudi Arabia, and Iran.

One bright spot about oil profits is the potential for them to fund advances in drilling. While that's without a doubt a positive, the problem remains that the physical economy oil companies work within can more easily be brought under the thumb of big government.

On the other hand, Forbes publisher Rich Karlgaard has noted that Google's Web-search business is powered by "100,000 cheap servers." If California, or U.S. taxation/regulation ever becomes too onerous, Google can abandon its cheap physical assets, and take its mind innovations elsewhere. Dell Computer is not valued highly for its computers, but for the process by which it sells computers. That process can be taken anywhere, whereas oil cannot.

So, expensive oil is a problem for the economy and stocks, but not for the reasons most often cited in the major media. Those worried about a consumption crash need to be reminded that stimulating the consumer is as simple as devaluing the currency, or, raising tax and capital gains rates to confiscatory levels. In all instances consumers would spend more, but the markets would crater.

A supply-side response to the oil problem would be to address why oil has fluctuated so much over the years. It's controversial, but the oil price hardly moved at all from 1947 to 1967 when the dollar's value was tied to gold. Absent a return to the gold standard, it seems some sort of dollar stabilization program would be the cure for much of what ails us. If a stable dollar impacts oil the way it did from '47 to '67, capital flows will be normalized, and the result will likely be a more rational distribution of funds to all sectors of the economy.

John Tamny is based in Washington, DC and can be reached at


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