Energy, the Economy, and Thomas Piketty

by | published July 11th, 2014

No one would have ever thought that a 700-page book on economics would hit the bestseller lists and become a lightning rod for political controversy.

Then again, 10 years ago, all of the experts were saying that the price of oil (then $30 a barrel) was unsustainably high.

Clearly, with oil at $100+ per barrel, the energy experts were wrong. And, as it turns out, the classical economists were wrong about how energy affects the economy.

What does Piketty’s Capital in the Twenty-First Century have to do with making money in energy? A lot more than you might think.

You can’t make big money in energy without understanding how it works…

Energy and Thomas Piketty

I first met Thomas Piketty over a cup of coffee. It was a particularly disagreeable cold February morning in 2001. Back then he was an up-and-coming visiting professor at MIT who was starting to look at income inequality, one of the most divisive issues in economics, in what he hoped was a more objective way.

I, on the other hand, had already begun the journey to map out a better way of looking at how energy operates in a modern market.

Turns out we had a lot to talk (and disagree) about.

We still do.

I may have retired from my university professor days, but I haven’t left those academic debates. Sometimes those debates spill over into broader conversations. And that’s certainly true in Thomas’ case.

It seems like all of the pundits on both ends of the political spectrum have opinions on Piketty’s book and ideas.

By my count, this isn’t the first time that economics has become the subject of global debate.

In 1867, Karl Marx published the first volume of Das Kapital, Kritik der politischen Ökonomie (“Capital: Critique of Political Economy”). Most thought the work would never be equaled as a magnet for political, intellectual, and opinion discord… a debate that continues today.

Yet filling that bill these days as a contemporary lightning rod is Piketty’s Capital in the Twenty-First Century. Now a professor at the prestigious Paris School of Economics, Thomas has unleashed the latest firestorm in the still unresolved debate over global wealth and inequality.

Rarely has an academic book had such an impact.

And make no mistake: this is a 685-page tome with a thesis that doesn’t make for easy reading, even in the comic book version being bandied about by pundits

And boy, has it ever become the center of a ballooning public controversy. Most of the conversation has been driven by narrow partisan and self-serving assumptions. When complex issues become public discussion, that’s usually the case.

So what does all of that have to do with investing in energy?

First, please understand that Piketty has renewed the entire debate over global income, capital inequality, and the concentration of wealth. This guarantees that the book will be sitting on coffee tables all over the literate world, whether the owners actually open it or not.

These are issues that Thomas and I have been discussing off and on for over 15 years, starting with that cup of coffee in Cambridge.

His approach, based on the most extensive international databases ever developed, should revise how investment capital, return, and risk are viewed.

And that includes investing in energy.

But first, we have to finally put to rest one of the primary assumptions underlying “classical economics.”

Don’t be thrown off by the word classical. The classical period of economics has nothing to do with ancient Greeks or Romans. In this case, the classical age refers to the end of the 1700s and into the 1800s, when the basic principles of economic study were developed.

This is the age of figures like Adam Smith, Thomas Malthus, Jean-Baptise Say, David Ricardo, and John Stuart Mill. (By the way, their contribution is usually called neoliberal economics these days, although that has nothing to do with a political persuasion. After all, Adam Smith is a darling of contemporary conservatives, even though he called his approach economic liberalism.)

These giants defined the core of what we think of as economics and investment: the relationship between supply and demand, scarcity, comparative advantage, and the impact of things like wages, price, disposable income, and a range of other essential concepts.

They got many things right, but one thing wrong.

And that one thing was energy.

In their defense, the world they lived in was, in many ways, fundamentally different from the one we deal with today.

To simplify a complex discussion, the “founding fathers” of modern economics held that energy serves no function in the determination of value creation. That was because energy was regarded as one of two elements (technology being the other) that did not act as a “factor of production.”

In classical economic thinking, production (and therefore the creation of value) resulted from the application of three things – capital, labor, and land. All of these were regarded as elements which could not be exported.

As a result, what determined value was regarded as domestic, and under the control of local law and politics. The farm and factory were both local.

Energy and technology? Those were available to everyone virtually everywhere. Classical economists considered them to be part of the background.

Today, of course, we know better.

This idea might have made sense 200 years ago, but it’s flat out wrong today.

We wouldn’t invest in energy if it was “in the background” and equally available to all.

Nonetheless, the position of energy in most economic thinking remains an afterthought.

That’s wrong.

As I explained in my book The Vega Factor, there has never been a coherent theory of energy as it affects economies. But energy is critically important in the modern world, and pricing swings in energy can have a significant impact on a whole lot of other economic matters.

In fact, as I’ve emphasized over the past four years of OEI, energy is a pivotal and central focus for economies. It has developed its own risk and threat signals, provided opportunities for return well beyond other investments, and is one of the few almost direct bridges between geopolitics and wealth.

As you might imagine, this thinking has led to many lively discussions between Thomas and me.

Anyway, this view of energy as a market given had always, at least to me, appeared to be quite wrong. After the oil pricing debacle (in both directions) that began five years ago this month, it no longer makes sense to discount the effect energy has on the economy.

We know now that the price and availability of energy can make an economy take off or sputter to a halt.

Which brings us back to the current book. Later in OEI,I’ll discuss some of the main elements in Capital in the Twenty-First Century. Because there is one interesting result once we strip away the ideological and political overtones.

The relationship between global capital and income is at the very core of the energy market.

It points to another element the investor can use to make money.

In later issues of OEI, I’ll explore this issue further. I’ll also soon be talking about a new project I will shortly unveil here at Money Map Press.

But for now, if you choose to read Thomas’ book, try to leave your politics and ideology at the door.

There are some important lessons on investing in there.

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