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Rudy in Wonderland

Mises Daily: Friday, March 17, 2000 by

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In an act reminiscent of King Canute’s attempt to keep the tides from rising, New York Mayor Rudy Guiliani garnered publicity for his U.S. senatorial campaign by paying a visit to a local gas station. With the press in tow, Guiliani found a place selling gasoline at more than $2 a gallon. Hizzonor climbed out of his sport utility vehicle and began to excoriate the owners for charging too much for gasoline.

One crew of reporters filled up its vehicle to emphasize the high cost of gas, the theme of the story being that greedy oil companies and gas station owners were victimizing consumers. The message coming from Guiliani was simple: "Elect me to the Senate, and I won’t permit this to happen again."

This is quite a year for politicians trying to expand their powers, real and imaginary. We have Al Gore, who has as one of his platform planks a promise to give us better weather (I am not making this up). On the other side, John McCain has been prattling on about honor when, in an attempt to gain some votes, he violated his oath of office by attempting to make the government decide what is proper Christian theology.

But just when one might have thought it safe to turn on the television, what with the primaries already having been decided, here comes Guiliani promising lower gasoline prices. What is ironic here is that U.S. politicians actually have it in their power to at least present an opportunity for lower gas prices, although Guiliani obviously would never care to use that power.

If the political classes were truly interested in lower gasoline prices, they would permit more oil drilling, not to mention mining for coal and other energy-related minerals. They would also stop trying to shut down existing oil refineries and end their jihad against the construction of new refineries with large capacities for holding oil inventories. Such sensible policies, however, would offend the environmentalists. Less violent price swings in oil would also mean that politicians would have to demonize someone other than oil executives.

The one way to guarantee lower oil prices is to allow for more oil to be pumped out of the ground and for that oil to be quickly processed into various products. Because they have chosen to ignore that option and, instead, to excoriate those in the oil business, one must assume that U.S. politicians have no interest in lower oil prices.

What is even more laughable is that Rudy Guiliani--who was the most vocal advocate of continuing New York’s ridiculous and harmful rent control scheme--has no intention of promoting economically sound policies on oil if he is elected to the U.S. Senate.

Guiliani’s "solution" to the present situation would be to slam down price controls, thus leading us back to the gas lines and utter chaos of the 1970s.

It is little wonder that Guiliani is ignorant of the damage done by the government’s price and allocation schemes of the Nixon, Ford, and Carter presidencies. If a documentary I recently saw on the History Channel about the oil industry is any indication of how the nation’s intelligentsia and news media view this industry, then those in power and influence are truly ignorant about this subject. According to these folks, OPEC cut back oil supplies and gasoline lines automatically appeared. Price controls not only had nothing to do with the mess, they didn’t even exist. It was only a supply problem.

What they don’t tell us is that during the 1970s, nations which did not practice price controls had no gas lines. In 1990, when the first troubles leading to the Gulf War of 1991 broke out, there were no gas lines in this country even though the markets immediately recognized that future supplies of Middle East oil might be severely curtailed. The difference, again, was the absence of price controls in 1990.

(The Wall Street Journal in the fall of 1990 declared that "experts" were predicting shortages and gas lines. Conversely, I told my economics students at the University of Tennessee-Chattanooga that I may not have been an "oil expert," but that no price and allocation controls translated into no gas lines, and I was correct.)

The latest tact taken by oil industry critics is that because it takes six weeks for crude oil from the Middle East to move from the ground to the gas pump, oil companies should also be prohibited from raising prices during that same period of time. Thus, one could expect large price spikes at the pump ever six weeks.

While such a scheme might sound good to those who espouse "social justice," it shows an appalling ignorance of economic analysis. First, and most important, the price of a final product is not simply the sum total of the costs of factors of production plus a "fair" profit. Pricing of the factors of production is actually the result of the market valuation of the final product that is created. In other words, the value of crude oil is ultimately determined by the value of gasoline and other products which are derived from crude oil, not the other way around.

Second, the present price of a product like gasoline is also dependent upon its perceived future price. For example, if news that a blight has destroyed half of the Brazilian coffee crop reaches the U.S. public, the price of coffee that is presently on store shelves also increases. The reason for this phenomenon (also called by the pejorative term "price gouging") is that if individuals believe the price of something will increase in the future, they will increase their demand to obtain that product at its present lower price. The very act of increasing present demand, however, serves to drive the present price higher--and also assures that the future price will be lower than it would have been otherwise.

On the other hand, if prices are forced to remain constant, bargain hunters quickly strip the store shelves. That is what happened in the United States in the 1970s whenever a supply crises occurred in the Middle East. Because the law did not allow gasoline prices to rise immediately, gas stations ran out of product quickly. Politicians, of course, also labeled that phenomenon as a "plot" by oil companies.

The "experts" have been predicting even higher prices of gasoline this summer, and, so far, their predictions seem to be credible. Given that evidence, it should be no surprise that the present value of gasoline continues to rise. What is ironic is that while consumers and their political allies are claiming that they are being "gouged" by oil producers, in truth, the reason for the present price increases is that consumers have escalated their own demand for gasoline.

It is ironic that Congress and President Bill Clinton actually have the power to create conditions that will result in lower energy prices. However, they choose instead to pursue a course of action that forces up prices while at the same time trying to "jawbone" prices down through sheer bluster and intimidation of energy producers. Their actions, of course, do not lower prices in the least, but, perhaps, that is not their intention in the first place. Rudy may be in Wonderland, but, then again, maybe the guy really does know what he is doing.

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William Anderson teaches economics at North Greenville College. Send him MAIL.