Making Economic Sense
Making
Economic Sense
by Murray Rothbard
(Contents
by Publication Date)
Chapter 92
Oil Prices Again
Sometimes it seems that our entire apparatus of
economic education: countless courses,
students, professors, textbooks, backed up--in the case of oil
pricing--by a decade of experience
in the 1970s, is a gigantic waste of time. Certainly it seems that way
when we ponder the
near-universal reaction to the Kuwait crisis.
When Iraq invaded Kuwait on August 2, 1990, and the
Bush administration quickly
organized an oil embargo and military action to try to restore the
hereditary emirate, gasoline
prices, wholesale and retail, began going up immediately. In two days,
gasoline price rises
throughout the country ranged from four to 17 cents a gallon.
Immediately, hysteria hit.
Wherever one turned--media pundits, the financial
press, professional consumerists,
politicians of all parties, the general public, even parts of the oil
industry itself--the reaction was
unanimous. The price increases were unacceptable, a "ripoff by Big
Oil," they constituted evil
"price gouging," and the cause was all too clear: "unconscionable
greed."
Not content with "desecrating" pristine beaches and
blue water by wantonly dumping oil
upon them, Big Oil, in the words of Edwin Rothschild (all over TV as
energy policy director of
the Naderite Citizen Action), had launched a "preemptive strike: they
are doing to American
consumers what Saddam Hussein did to Kuwait." Federal, state, and local
governments hastily
began investigations of the "gouging." Senator Stevens (R-Alaska)
ominously predicted "gas
lines by Christmas," and Senator Lieberman (D-Conn), leading the
anti-oil hawks in the Senate,
declared "there is absolutely no reason consumers should already be
paying more for oil and gas .
. . it must be stopped."
Under this bludgeoning, ARCO quickly announced a
one-week freeze of gasoline prices,
and there was general talk of "voluntary" freezes by other oil
companies.
We are mired, once again, in a farrago of economic
fallacies. Let us start with "greed."
There is absolutely no evidence that Big Oil is any greedier than small
oil, or that oil businesses
are any greedier than any other firms. It is even less likely that oil
businessmen, whether big or
small, were suddenly seized by a monumental intensification of greed on
August 2.
In fact, pricing on the market is not an act of
will by sellers. Businessmen do not
determine their selling prices on the basis of whether they feel greedy
or "responsible" that
morning. The entire apparatus of economic theory, built up over
centuries, is devoted to
demonstrating a great truth: that prices are set only by the demand of
purchasers (how much of a
good or service purchasers will buy at any given price), and by the
supply or stock of the good.
Prices are set so as to "clear the market" by
equating supply and demand; at the market
price the supply of a good will exactly equal the amount of the good
that people are willing to
buy or hold. If the demand for the good increases, purchases will bid
the price up; if the supply
increases, the price will fall. Demanders consist
of consumers, whose purchases are
determined by the values they place on the goods, and various producers
or businessmen, whose
demands are determined by how much they expect consumers to pay for the
final product.
Current production, and therefore future supply, will be determined by
how much businessmen
expect that consumers will be paying in the future for the final
product.
When Iraq invaded Kuwait, knowledgeable people in
the oil market immediately and
understandably forecast a future drop in the supply of oil. (In fact,
as soon as Iraq began to mass
troops on the Kuwait border a few weeks before the invasion, crude
prices began to rise sharply,
in expectation of a possible invasion.) Actions on the market, e.g.,
demands for the purchase or
accumulation of oil, are not at all mechanistic: they are a function of
what knowledgeable people
on the market anticipate will happen.
Far from being disruptive or "unconscionable," this
sort of speculative demand performs
an important economic function. If people were mechanistic and did not
anticipate the future, a
cutoff of Middle Eastern oil would disrupt the economy by causing a
sudden drop in supply and a
huge jump in prices. Speculative anticipation eases this volatility by
raising prices more
gradually; then, if supply is sharply cut off, speculators can unload
their oil or gasoline stocks at a
profit and lower prices from what they would have been. In short,
speculators, by anticipating the
future, help to smooth fluctuations and to allocate oil or any other
commodity to its most-valued
uses, over time.
The general public, media pundits, politicians, and
even some businessmen, seem to have
a mechanistic, cost-plus model of "just" pricing in their heads. It is
all right, they concede, for
each businessman to pay his costs of production and then add on some
"reasonable" markup; but
any price beyond that is morally condemned as excessive "greed." But
cost of production has no
direct influence on price; prices are only determined by supply and
demand.
Assume, for example, that manna from heaven, an
extremely valuable product, falls on
some piece of land in New Jersey. The manna (extremely scarce and
useful) will command a
high price even though its "cost" to the landowner was zero (or is
limited to the costs of
advertising and marketing his find). There is no guaranteed
profit margin on the free
market. A businessman may find that he can only sell his product below
his costs, and thereby
suffer losses; or that he can sell above costs, and enjoy a profit. The
better he forecasts, the more
profit he makes. That, in fact, is what entrepreneurship and our
profit-and-loss system is all
about.
Ideas have consequences; and the danger is that we
will repeat the calamaties of the early
and late 1970s. Then, too, suddenly higher prices (caused by current
and anticipated supply
cutoffs) were treated as moral failures on the part of oil men and
combatted by maximum price
controls imposed by government.
Imposing controls to stop a price increase is like
trying to cure a fever by pushing down
the mercury on a thermometer. They work on the symptoms instead of the
causes. As a result,
controls do not stop price increases; they create consumer shortages,
misallocations, and drive
the price increases underground into black markets. The consumers wind
up far worse off than
before. The consumer gas lines and shortages of both the early and late
1970s were caused by
price controls; these gas lines (including the shooting of drivers who
tried to muscle through the
line) disappeared as if by magic as soon as gas prices were allowed to
rise to clear the market and
equate demand and supply.
If the politicians and pundits have their way,
there may well be gas lines by Christmas;
but the cause will be they themselves, and not small or Big Oil.
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