Wednesday, October 31, 2007

A Case in Point Against Price Controls

One death so far in China, where price controls have created a volatile situation in gas lines. Lest we ever forget, we must read this Reuters article about the latest example of what happens when markets are not allowed to function freely.

[Thanks to for the photo of a past US price control situation.]

For those who are still upset at the oil companies, please look at this example closely. You will see the workings of a shortage caused by price controls close up and personal.

Even the Chinese themselves are aware of the cause of the problem:

" 'The crux of the problem is the state-owned enterprises... you see the remaining contradictions of the state sector in the market economy,' said Joseph Yu-shek Cheng, political science professor at the City University of Hong Kong.... Underlining the key role of pricing in the shortage, shipping companies in badly hit Zhejiang province said they had no problem securing supplies if they were willing to pay above-market prices to independent traders.... With current retail prices most plants only break even when crude is around $65 a barrel or lower, so soaring markets have forced many independents out of the market.... But a Sinopec official told Reuters on Tuesday that its largest refinery will switch off a crude unit in November and process 3 percent less crude than the previous month, sending a signal to Beijing in a move that could worsen the shortage." [Why should they continue to lose money?]

It looks for now like the US population gets it and is not crying out very loudly for price controls here. But even if the price at the pumps goes above $4.00, we should simply look here in China to see why this is not price gouging.

What is the cause of the rise in price? Turmoil in oil-producing countries and exploding demand from developing nations. Both are temporary situations, and as supplies catch up to demand, prices would be expected to return to their normal level just as they have in the past. Another factor is the devaluation of the dollar, otherwise stated as the excessive increase of the American money supply over its usefulness in the marketplace, due to central bank intervention in the credit markets.

This last is where we should direct our anger, if my suspicion of such mismanagement is borne out by the evidence. But this is a subject for a separate post.

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Anonymous Anonymous said...

Both are temporary situations, and as supplies catch up to demand, prices would be expected to return to their normal level just as they have in the past.

Except for that Peak Oil problem....

11:37 AM  
Blogger Katy said...

I call "that Peak Oil problem" a myth. Read this fellow who pretty much states my position.

In sum, I believe the market takes care of this kind of problem, and here's how.

As prices for petroleum rise, producers are encouraged to find more oil, produce more oil, refine more oil. Simultaneously, other types of energy producers--solar, bio, hydrogen, nuclear, whatever--are spurred by the price increases to renew their efforts to improve their technology so as to make it affordable at these new prices (whereas before it was too expensive).

In the past, studies show that prices are only a signal and an incentive to the marketplace. They communicate what the public wants and how much they're willing to pay for it, and they direct producers to produce what the public wants at the best possible price.

Another economic rule is that, as more supply comes on line, prices will fall. This is an absolute rule, absent other outside influences (like price controls, for example).

In 1974, oil cost over $100 in today's dollar. Subsequently, it fell all the way back to $10 a barrel by 1998. I'm not suggesting this will happen again; but I see no reason why the tendency isn't there for it to do so, with time and with a change in geopolitical climate and with an increase in supply of oil and of alternative energy solutions.

Chart source.

12:45 PM  

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