Prices are the street names of the economy and financial system. They define where you go, how you get around and where you are. Without them, you’d get lost and there would be chaos.
Think about it carefully. Based on one single number like the oil or gas price, entire global multinational corporations are built. Which economic activity is pursued and which is not depends on prices.
What you buy and don’t buy is determined by prices. Careers are chosen by the price of labour. What is imported and exported is controlled by prices. How things are built, manufactured and powered is set by prices.
Prices allow people who have no other ability to communicate to interact for mutual benefit all over the world, creating complex supply chains.
One simple number is the driver of how we live our lives.
My question to you is, what’d happen if we didn’t have any prices?
Well, in Japan, they don’t have street names. Which makes it extraordinarily difficult to find your way around. You can’t figure out where you are, where you’re going, or where you even want to go in the first place.
A chome, or district, is as specific as things get. But I have no idea how to tell someone where inside a little district I want to go once I get there. The house numbers are scattered.
The resulting chaos is much as you’d expect. Giving rise to this song about foreigners constantly asking for directions in Japan. Their map, after all, doesn’t help one bit.
Of course, asking for directions is also difficult given, for example, McDonald’s is pronounced Makudonarudo.
Perhaps my Japanese analogy is unnecessary given we have some experience of what happens when you abolish prices. But the starvation of millions under communism is a lot less enjoyable to recite than my misadventures living in Japan.
Still, it was the Socialist Calculation Debate that explained why communism would fail. The absence of market prices made economic calculation impossible. You couldn’t tell if the thing you produced was worth more than the inputs that went into it. And so the economic system descended into confused chaos.
According to economists, Soviet economic planners were constantly trying to get their hands on Western advertising to look up relative prices in order to make sense of their own economy. How else do you compare the value of a boot to a shoe or the value of a car to a boat? And if you don’t know those numbers, you don’t know how to produce what and how much of it where, using what. All those questions are answered using prices in a capitalist system. With profit signalling that you did something useful in the end – you created value.
Almost as bad as having no prices is, of course, having the wrong prices. Then things go haywire in the economy, just as they would if the street names were wrong.
Many years ago, on a school trip, we had an orienteering race. We were given maps with topography, buildings and fences marked out on them. I confidently led a party off towards our first marker, only to get lost within the first 50 paces.
We later discovered that the fences had been moved. Luckily, I wasn’t the only one fooled and the whole race had to be abandoned to try to find everyone.
Price controls are the equivalent policy. They shift the fences, leading groups of entrepreneurs, business managers and investors astray. Or, as journalists and economists would put it, they cause shortages.
The incentive to produce, distribute and sell an item with a capped price is reduced. And so less of it is produced, moved and sold, making it less available.
Ironically, of course, such a shortage drives the price of the good up on the grey market, where it is still available. The resulting effect is to make it more expensive.
It also misaligns the economy because the substitutes of that good are bid up in price, triggering investment decisions to produce more.
So, isn’t it great to hear that our government, having already made a mess of energy markets with price controls, is now floating price controls in the rest of the economy. The fact that it’s on essentials only, and voluntary, only makes me more worried.
But it’s not all bad news.
Going back to the Japanese street system for a moment, the lack of street names gives a mighty advantage to anyone who has lived in the local area for any length of time. Which is most people in Japan. But without local knowledge, you’re stuffed.
And it’s tough to squeeze the benefits of specialisation, economies of scale and comparative advantage if you’re relying on local knowledge to get things done. Immigrants can’t exactly get a job as a cab or delivery driver in Japan…
Local knowledge about the neighbourhood becomes incredibly valuable in such a situation. It gives you the advantage.
And it’s the same in mispriced markets, where government interference has created chaos and confusion. Suddenly, the price is not all you need to know in order to interact with others and create value. You need to know so much more.
My old friend James Allen, a true energy market insider, reckons we’re in such a situation right now in energy markets, just as we were in 2021. Back then, the realities of net zero hadn’t yet dawned on the stock market.
The trillions of investment needed to hit the market to drive the energy transition and comply with ESG was about to radically shift stock prices.
Over the subsequent months, I watched James’ followers bank extraordinary gains.
Now, James reckons the same opportunity is brewing for the opposite reason. The inability to deliver net zero hasn’t fully dawned on the market, yet. And the need for fossil fuels to be around for much longer than the market anticipates hasn’t yet been reflected in stock market prices. An entire industry is about to go from being phased out to phased back in.
That’ll move markets.
Until next time,
Nick Hubble
Editor, Fortune & Freedom
