Mark Zandi, chief economist of Economy.com, an economic-forecasting company in West Chester, Pa., says capacity utilization is clearly higher than the Fed figure suggests, and he points to rising prices as proof.

As recently as last November, Krugman's column celebrated the "export-led growth" in these and other developing nations as "an enormous, unexpected improvement in the human condition" -- and the only "upbeat" topic he could think of to write about. What could have possibly changed his mind?

One simple word: oil.

It seems that after all these years as an international economist, it has finally dawned on Krugman that when the third world joins the developed world, it will compete with us for oil.

According to Krugman, America is helpless in the face of this "threat to our prosperity." He wrote, "We can neither drill nor conquer our way out of the problem. Whatever we do, oil prices are going up." In a follow-up column a week later, Krugman added, "...it's hard to see where the oil will come from to meet the growing demand... So very, very high prices are what we'll get."

Krugman sternly warns, "An oil-driven recession does not look at all far-fetched." But don't worry. As you'll see, it's all based on silly economic errors, even though it sounds credible when it's solemnly intoned by someone with Krugman's reputation as an economist.

Krugman is putting that reputation at risk with this silliness, and it's all for the sake of politics. Oil prices -- and, consequently, gasoline prices -- have risen sharply over the last year. So stirring up fears about a new "oil crunch," as Krugman calls it, gives him an opportunity to take a swipe at George W. Bush about an economy that is otherwise booming in almost every respect. But it's nothing more than grasping at straws -- standard operating procedure for America's most dangerous liberal pundit.

A year ago Krugman issued warnings just as dire about another red menace -- SARS. He wrote in a Times column, "...experts fear it may be too late to prevent a global SARS pandemic...Even if SARS doesn't become widespread here — and that's not a safe bet — it can do a lot of damage to our own economy..." Since those words were written, SARS is all but forgotten, and GDP adjusted for inflation has grown 4.9%, the biggest jump in almost 20 years. So much for Krugman and his "experts."

Krugman's fears today about oil are silly for five reasons. First, the world is not running out of oil anytime soon. Citing those "experts" again, Krugman wrote, "...no major oil fields have been found since 1976, and experts suspect that there are no more to find." A week later Krugman himself had to contradict those "experts" when he wrote, "...I forgot about two large fields in Kazakhstan, one discovered in 1979, the second in 2000."

What Krugman has forgotten is history. The more oil the world has used over time, the more new oil we always seem to have found. According to OPEC statistics, world oil usage since 1982 has been 452 billion barrels. But proven world reserves have not been depleted, as Krugman's "experts" would have expected. Instead they have grown since 1982 from 696 billion barrels to over a trillion barrels. Yes, that means we've replaced oil faster than we've used it. Krugman finds himself in the unenviable position of defending the four most dangerous words in economics -- "this time it's different."

Second, equally unenviable is Krugman's argument that the law of supply and demand has been suspended in this case. He says oil-rich nations are in no position to pump more oil to take advantage of today's high prices, and thereby keep prices from going any higher. He says "the world's spare oil production capacity" is only "about 2.5 million barrels per day."

But just Friday Saudi Arabia's Oil Minister Al-Naimi announced his country would ask OPEC to increase production by "more than two million barrels per day." Krugman had cited the Paris-based International Energy Agency as his "expert" on capacity. The IEA's only reaction to Al-Naimi's statement was to carp that "it might not be enough to have a big impact on prices." Not even a mention of the supposed issue of limited capacity. Perhaps, like Krugman, the IEA "forgot." Or perhaps the law of supply and demand remains in force after all.

Third, Krugman is "forgetting" the fact that as energy-intensive manufacturing activity shifts from the developed world to the developing world, we won't need as much oil here in America. You can see it in the Department of Energy's statistics: energy use as a fraction of GDP has been falling since the late 1940's -- and American manufacturing jobs as a percentage of total employment have been falling at the same time.

Krugman points out that "...the U.S. consumes only about half as much oil per dollar of real G.D.P. as it did in 1973." But by cherry-picking 1973 as the point of comparison -- the year when the best-remembered "oil crunch" hit -- he makes it seem as though America's reduced energy use is solely the result of painful conservation in the face of soaring prices. The whole story is that it's also our long-term transition from a manufacturing economy to a services economy -- a transition that has been enabled in no small part by outsourcing formerly domestic manufacturing.

Fourth, Krugman has "forgotten" the single most important dynamic that motivates global trade: comparative advantage -- a principal so key to modern economics that Krugman's mentor Paul Samuelson has called it the "one proposition in all of the social sciences which is both true and non-trivial." It is that when nations specialize in what each does best -- and trade with each other -- they all come out on top: it's a win-win positive-sum game. So if increasing world-wide wealth means that world-wide oil demand goes up at the same time because everyone everywhere wants to drive an SUV, then bring it on: we'll all be able to happily afford it.

Finally, even if you accept all of Krugman's forgetful fallacies, that doesn't mean that today's high prices are going to soar straight from here to infinity, chasing that last drop of oil. Krugman, the great economist, has made the same dumb mistake that dotcom investors made at the top of the stock market bubble -- back when Krugman was arguing that technology stocks might be fairly priced with the NASDAQ nearing 5000, and singing the praises of companies like Enron (while acting as a paid member of their Advisory Board).

But this time it's not tech stock prices, it's oil prices. Krugman falsely concludes that because they've been rising recently they will continue to rise forever. If he really believed that malarkey, of course, he would buy some crude oil futures for his personal account -- but if he has done that, he "forgot" to mention it.

The reality is that prices won't just go up forever from here, because the oil market knows much more than Paul Krugman does. Today's oil prices already fully reflect the risk-adjusted value of all short-term and long-term supply and demand factors -- including ones Krugman doesn't know about, doesn't understand, can't predict, or "forgot." If anything, the kind of politicized panic that Krugman and other liberal pundits are mongering is likely to temporarily inflate prices. Look for prices to settle down when cooler -- and more intellectually honest -- heads prevail.

So don't worry too much about oil prices. And don't worry about China and India being a "threat to our prosperity." Think of it this way: the 2.3 billion people in China and India can help us look for new oil that Krugman can then "forget" about.

Posted by Donald L. Luskin at 11:12 PM | link  

Posted by Donald L. Luskin at 9:36 PM | link  

Posted by Donald L. Luskin at 7:49 PM | link  

Posted by Donald L. Luskin at 6:24 PM | link  

Posted by Donald L. Luskin at 6:20 PM | link  

Posted by Donald L. Luskin at 6:07 PM | link