With oil at $140 a barrel, can you still love Julian Simon?

Remember Julian Simon, the guy who argued that resource prices would fall, fall, fall in real terms?  I loved spending time with him and to this day he remains an underrated economist.  (By the way, the very first piece I ever wrote was a guide to using Julian Simon for high school debaters.)  But can we still advocate his major thesis?

The possible belief space includes the following:

1. There is still a good chance that future resource and oil prices will fall dramatically, so Simon should not be dismissed.  Still, the single best estimate today can be inferred from the current market price, which implies a good chance that resources will get more expensive.

2. Simon is right and futures markets currently indicate that the price of oil is expected to fall dramatically.

3. Simon is still right, the rest of the world is wrong, and betting on this is how I will get rich.

4. Simon is right but current markets don’t allow us to bet on his major claims.  Futures markets extend for only a few years’ time, not for say the twenty years or so that are needed to validate his prediction.

4b. The deliverance of plenty is truly far away and no one is willing to take those margin calls for the next 187 years; in this scenario the present expected value of the future improvement is pretty low.

5. Simon is right but nominal interest rates will soon fall so low that successive short selling of oil in the futures market won’t yield supernormal returns.  (This can mean, for instance, that you’d rather lock up all your money today at the higher rates, rather than short selling.)

No way does #2 work, though there is often slight backwardation in the futures price.  I’ve never heard anyone argue #5 and indeed most people haven’t even thought of it as an escape hatch.  My belief is closest to #1.  Bryan Caplan argues for #4 but Arnold Kling shows that doesn’t fly.  If you’re always rolling over a successively renewed short position in the futures market, sooner or later the price decline for oil will yield you supernormal profits; in the meantime your margin deposit is earning the rate of return on T-Bills, noting that you must buy into the new contract cycle before your old contract expires so as not to miss the window of opportunity.  OK there is margin call risk, etc. but if Simon is right that is small relative to your potential gains.

(Alternatively you might argue that if you are in contract cycle #3, the good news will arrive to affect the pricing of cycle #4 before you can buy in, adding on that even after the future good news is announced the MC curve is so steep that you don’t gain much on contract cycle #3.  That’s possible but a) ex ante you still have supernormal returns since it may not work out that way, and b) the reality is that huge good supply news, whether for oil or some other energy source, would lead to lots of pumping today and a plummeting oil price right away.)

I invite Alex to accept #1 or otherwise indicate his stance.

It’s amazing how much, on this issue, some people resort to what can only be called technical analysis — inferring future price movements from past trends — when they would scoff at that approach in almost any other context.  It’s OK to argue that belief #3 held for most of world history –before we all read Simon and perhaps before there were futures markets in oil — but I want to know if you are betting on #3 today and if not why not and also what other ways there are to get very rich that you can tell me about (does only the oil market malfunction so?).

I’ll also note that current oil prices hardly suggest (do click on that link) a level of bone-crunching, civilization-ending scarcity, so you can believe in #1 and still be an optimist overall, as indeed I am.  I’m just not nearly as much of an optimist as I was when oil was $10-$20 a barrel, wasn’t it even $8 a barrel for domestic oil less than ten years ago?

Also on belief #4 note that: forward contracts allow for longer bets than do futures contracts, contract length is endogenous to important events (though synthetic contract positions mean we don’t need all of the possible longer term contracts), and it is odd for libertarians — combinatorial prediction market fans at that — to suddenly cite missing markets to defend their broader position.

Addendum: Oh, yes, there is one more option.  I call it "#3 is correct but my wife won’t let us get rich."  I’ll say this in response: for all the virtues marriage has for men, when you look around and study it more closely, you’ll find the institution has even more virtues than you had thought.

Second addendum: Here is Jeffrey Sachs on this topic.


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