September 2, 2005
The Fragile Façade of Confidence
You may not know this, but every banker and policy maker does. If every one of us got out of bed tomorrow morning, drove to our banks or financial institutions, and tried to withdraw our money, the system that seems so solid today would suffer a complete collapse. The same thing would happen to the electrical grid if every device that could draw power were switched on at once. In fact, if every one of us decided today to fill up our gas tanks we’d quickly run every station in America bone dry.
Depending on your point of view, that is either terrifying or inspiring. Either way, it illustrates a fundamental truth about modern economies like ours – namely, that they run on confidence as much as anything.
That confidence is so interwoven into our behavior that we don’t give it a second thought. We’re confident that the pieces of paper and plastic in our pockets and purses can be exchanged for food when we are hungry. We trust that lights will work when we flip the switch, that cars will stick to their side of the road, and that neighbors and strangers will not assault us on the street or in our homes.
Perhaps that is why events like those that have occurred in the wake of Hurricane Katrina are so unsettling. The scenes on television of what can only be called a complete breakdown of civil behavior in the city of New Orleans remind us of just how fragile the bonds of cooperation and tolerance between us are, and how much our well-being depends on them.
This single weather event will generate serious challenges in confidence for the entire economy as well. For energy markets, it has generated what has been perhaps our single greatest fear – a supply side disruption to the flow of energy products at a time when markets are already very tight. With worldwide demand pushing ever higher, there simply is no extra production capacity that can be brought quickly online to replace the 8 refineries knocked out by the storm and flooding, or the countless natural gas wells and offshore crude oil wells that have been indefinitely idled.
The result has already been a dramatic increase in prices, with promises of more to come. The attention of the media thus far has been focused on gasoline, but the problems go much deeper than that. Home heating oil production, which normally ramps up at this time of year to prepare for winter demand, has been dealt a serious blow. The supplies of natural gas, whose price has already doubled from last year, have likewise been seriously impacted.
Can the resulting price increases in energy goods bring about an economic recession? Of course they can. But of more immediate concern for policy makers is the potential for disruption of transportation and production should energy supplies become unavailable, at any price.
It’s easy to see how it could happen. With prices adjusting rapidly upward, should consumers alter their normal purchasing behavior and begin hoarding in anticipation of shortages or further price increases, their prophecies will be self-fulfilling. And if you think that a situation with $3.50 per gallon gasoline is bad, I can assure you that an economy with deliveries and transactions interrupted by dry tanks is much worse.
That’s why it is so important that governments and businesses alike spare no effort to restore a sense of normalcy to the marketplace. Without the confidence that the institutions that protect us and the businesses that provide for us will be able to do so tomorrow, there will almost certainly be chaos and misery today.
About the Author
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