Oil prices have reached a 29-month high, reflecting a variety of factors including the prospects for war, expectations of lower supply, strikes and other unrest in Venezuela and Nigeria, and inflationary pressures. At the same time, the Producer Price Index recorded a 1.6 percent jump in January, the biggest across-the-board increase since January 1990.
Just as the script dictates, cries of "gouging" are now heard across the land.
"I think a lot of it is pure greed," a consumer told the New York Times. Another said, "If there's a chance of the oil companies' driving up the prices, they'll do that." Another: "I don't blame the government, I blame the gas companies." Still another: "They are going to get all the money they can out of us."
In covering economic issues, journalists have a way of quoting the most ignorant possible statements by consumers. And you watch: these statements will, in turn, be followed by statements from officials warning gas stations and oil companies against raising prices too much. A poor station owner will be singled out by a local newspaper and might eventually face some sort of federal charges for economic crimes.
Of course gas station owners and oil companies want to make a buck. So does everyone else, in good times and bad. They want to charge the highest price possible, consistent with the highest profit. At the same time, consumers want to pay the lowest price possible. It is in the marketplace that these differences are sorted out in the glorious and peaceful institution of voluntary exchange, where a meeting of minds takes place and society's needs are met.
For hundreds of years, thanks to the insights of economic science, we've known a lot about the forces that push prices in a range of different directions. We know that producers will offer more supply at a higher price than a lower price, and we know that more consumers will buy more at a lower price than a higher price. We know that all of this happens without the guiding hand of government. Students are taught this in Economics 101 (whether they remember it is another matter).
What we do not know are the precise weighting of factors that go into why prices increase at any particular time. The bits of information that are built into the price of anything are too diffuse and vast. For the same reason that no price on the market can be completely unpacked and dissected, it is also impossible for any outsider to know what the price of anything "should" be. That is why the market price exists in the first place: to provide an evaluation of the value of resources relative to their availability, their desirability, and the costs associated with delivering them.
Ah, prices! How we take them for granted! In fact, they are guides to the conduct of life itself. What should you have for dinner? Should you take that vacation or not? Should you buy or rent? Should you supplement your wardrobe or not? Should you heat your house till it's warm and cozy or just wear a sweater indoors? All these decisions are made based on the price of things. They are what make rational daily living possible. Without them, all would be chaos.
But somehow, in a time of crisis when prices leap around in various directions, doing their job to coordinate supply and demand and conserve resources to overcome the uncertainty of the future, all this wisdom is forgotten. Consumers suddenly look at their retailer as the enemy and the government starts taking names. The worst part is that it is precisely during times of market uncertainty and change that prices are needed more than ever to coordinate resources.
When the oil price rises, it suggests more supply is needed. More precisely, it sends two signals: to consumers it says conserve, and to producers it says invest. If nothing else changes, and people follow the price signals, the price will end up falling as consumers cut back purchases and producers bring more product to market. Putting a price ceiling on oil will short circuit this mechanism, causing producers to offer no more than is currently available (or even less), and consumers to continue buying as much as they always have. Again, if nothing else changes, the result will be shortages, which the government will attempt to rectify through ever more stupid policies.
In the case of the oil price, there is an additional complication. Many people in powerful position are dead-set against a lower oil price. The environmentalists are nervous about lower prices because they fear it will lead to more gas consumption and SUV purchases. This is one reason, and not love of caribou, that they oppose opening up more public lands for drilling.
In government, we've had sanctions against Iraq that have artificially kept supplies off the market, driving up the price. This is something the Bush administration, closely connected with the oil industry, approves. David Frum reports in his account of his time with the Bush administration that Bush himself is a passionate opponent of lower oil prices. Frum once suggested that Bush call for lower prices to help consumers. Bush looked at him like he was nuts, and pointed out that lower prices are the source of all the problems.
Max Boot, current fellow at the Council on Foreign Relations and former editor of the Wall Street Journal opinion page, provides further evidence that this is the case. "For that matter, would our government really want a steep drop in prices? The domestic oil patch—including President Bush's home state, Texas—was devastated in the 1980's when prices fell as low as $10 a barrel. Washington is generally happy with a range of $18 to $25 a barrel."
Even as far back as the 2000 presidential race, Richard Cheney told "Meet the Press" that "we need a national energy policy." He explained that prices can be too high but that they can also be too low ("no one will invest"). He was asked, "what is the correct price of oil," and Cheney mumbled on about the need for price stability.
These are very dangerous attitudes based on remarkable ignorance of the forces of economics. No one can know in advance what the correct price of anything should be. If prices fall, it would indeed signal producers to offer less. Some producers, maybe even most, would go out of business. This is precisely what should happen.
There is no way for government to plan better than the market, especially for unusual market disturbances, which is why Soviet-style programs like the Ford administration’s "Strategic Petroleum Reserve" are so ridiculous. They work as subsidies to the oil industry even as they keep supplies on the market artificially low. Knowing that the government may, at any time, unleash all this pent-up supply on the market, producers face a diminished incentive to drill and process oil for consumption.
But to the average consumer, none of this matters. They see only the price meter on the gas pump, and get mad at the poor fellow behind the counter that processes their credit cards. Then they go running to the government for help. This is the worst possible outcome. Remember that fellow who said "I don't blame the government"? Well, he should. And if the government intervenes to force the price down and shortages result, he will have even more reason to do so.
