fbpx
July 18, 2022 Reading Time: 7 minutes

In the rush to allay the public outcry over rising gasoline prices (which have since fallen), President Biden is adopting the standard ploy of politicians who think that the solution for every problem is the coercive power of the state.

Government has only one fundamental tool at its disposal, and that is coercion. It can (or at least attempt to) make people do things under threat of physical punishment, fines, jail, or scourging-by-regulation. (The latter approach is becoming increasingly common as government agencies are directed, by presidential “phone and pen,” to punish disliked corporations and industries with a tsunami of regulations.)

But coercion is not the same thing as production. Production is a positive, not a negative. It is the creation of values, and it can only be done at the scale and low prices that power a rising standard of living through the positive motivation of profits. To achieve prosperity, you need the profit-motive. Put in a different light, it is motivation by love and not punishment that creates prosperity.

In contrast, coercion can only destroy. A society based on coercion – such as any dictatorship or a slave society such as the agrarian South before the Civil War, or a Lilliputian world where its great producers are ensnared in an impenetrable web of regulations – is, as a rule, much poorer than societies that are more free, such as today’s more capitalist countries and the pre-war North.

The human mind does not function creatively at its best under compulsion. Slaves and tormented rule-followers don’t innovate. They don’t develop great new industries at ever declining costs through economies of scale, such as those achieved by Jeff Bezos at Amazon, or by John Rockefeller, the father of the modern oil industry.

So what is Biden’s answer to the problem of high gas prices? Compulsion. After initially thwarting the oil industry by banning pipelines and new oil and gas leases shortly after his inauguration, his recent proposals are, in essence, watered-down varieties of the failed policies that created the multiple gas crises that rocked the nation in the 1970s. Biden complains that prices are too high and that the oil companies, refiners, and gas stations should – somehow – reduce their prices to a “fair” price that exists only in Biden’s mind.

In the 1970s, this notion of a “fair” price – which is always below the market price – led to the 1973/74 and 1979 gas shortages. Oil prices in the United States were held down by government price controls below the global market price, which had sharply risen due to the Arab Oil Embargo. The embargo was a response by the Arab oil producing states to America’s support for Israel during the 1973 Arab-Israeli War. The later 1979 crisis emerged when the U.S. embargoed Iranian oil following the takeover of the U.S. Embassy and the taking of diplomatic hostages.

America’s price controls, originally implemented by President Nixon in 1971, undercut the financial motive – the profit-motive – for producing oil in the United States. And because prices were held to a government-set below-market “fair” price, consumers never reduced their demand to match available supplies.

This resulted in the epic 1970s shortages. Lines at gas stations grew so long that drivers ran out of gas while waiting for gas. Ambulances couldn’t get gas. Delivery vehicles couldn’t get gas. In response, President Jimmy Carter exhorted Americans to wear sweaters while they turned their heat down in winter to conserve fuel. He implemented such harebrained schemes as gasoline rationing on alternate days based on the last digit on drivers’ license plates. Needless to say, his dour exhortations and schemes to persuade Americans to live more poorly and frugally neither succeeded in resolving the gas crisis, nor in getting him re-elected. He was a one-term President.

Coercion had reached its dead end in the 1970s, yet Carter, to his partial redemption in a policy completed by President Ronald Reagan, lifted the oil price controls. This restored the profit motive and, over the subsequent decades, powered an explosion of exploration, drilling, and domestic production. Ultimately, it motivated the development of innovative hydraulic fracturing (“fracking”) technology that greatly enhanced production in once-moribund shale oil formations. By 2019, powered by profits and the market prices that drive them, the U.S. had once again become the world’s largest oil producer and imports had fallen to their lowest level since 1957.

What was the “fair” price during this period? It was the market price. The only true, fair price is the market price, which is the price that results from the voluntary bargaining of all market participants. And there are an awful lot of those participants in the oil industry, one of the most complex and logistically demanding industries on our planet. Reflected in the market price are the decisions of millions of individual car drivers, homeowners adjusting their thermostats, manufacturers who decide whether to burn natural gas or oil, oil producers figuring out how to squeeze more production out of existing oil fields, refiners deciding which products to create out of crude oil, speculators deciding how much oil to store for future demand, researchers developing incredible new technologies, such as deepwater drilling, horizontal drilling, satellite reconnaissance, and fracking, the decisions of transoceanic crude oil shippers, who operate the largest vessels in the world, wildcat drillers who make money only by finding oil in new locations, and countless other individuals.

The market price results from all of their interactions, and it also incorporates the effect of “exogenous shocks” such as the Ukrainian War, which has curtailed supply, the decisions of regulators who may shut in production or prevent exploration due to environmental or political concerns as the Biden Administration has done, and the actions of sundry dictators and authoritarians who use oil money to prop up their regimes.

In other words, market prices reflect reality. They reflect the actual conditions of production and the actual desires of consumers. Economists understand this and use terms such as the “invisible hand” (Adam Smith) and analogies such as the famous “I, Pencil” essay and video (Leonard Read) to explain how market prices perform the almost miraculous task of coordinating and motivating. Market prices coordinate and motivate the actions of millions of market participants. In an industry as complex as the oil industry, market prices are especially important. The solving of production and logistical challenges, and the matching of supply and demand happen only because of the coordinating role provided by these unhindered prices.

The recent increase in oil prices has provided important new logistical and supply/demand information to the market. It is telling market participants that the supply has fallen – due to consequences of the Ukrainian War, including sanctions on Russia – and it is also informing the market that the risks to future production are now greater (for example, if the war widens). So, what does this higher market price signal? It signals consumers of oil to conserve oil today so that there will be more oil available in what may be a more supply-constrained future. Higher prices encourage people to take one less weekend ride in their cars, and to figure out how to manufacture products using less oil or natural gas. Everywhere markets encourage people to adjust, conserve, and adapt to the reduced current supply and a potentially lower future supply.

That same elevated market price is telling producers to drill, drill, drill. Produce more oil, ship more oil cheaply on pipelines (except when President Biden bans their construction and cancels new drilling leases), and store more oil for the future.

All of this human life-sustaining activity depends on one thing: market freedom. Prices only work when they reflect the voluntary assessments of each market participant. When that happens, the market price properly summarizes all of that information that is held in the individual minds of each participant. Each of us, in turn, can access that dispersed information just by looking at the price.

Nobel Prize-winning and Austrian-school economist Friedrich Hayek explained this in one of his most famous essays, “The Use of Knowledge in Society.” When prices rise or fall, we almost don’t need to know why. It can reflect sundry and millions of factors, or one big factor, like the Ukrainian War, but at all times the price reflects reality. It reflects actual supply and demand conditions, as perceived by all of the participants in the market.

The market price is the best price and the only “fair” price. This is why societies that allow markets to function, flourish, and those that stifle the market with price controls and rationing, suffer. This is why free market economies (to the extent they permit markets to function) are far wealthier than authoritarian societies. This is why the United States suffered during the 1970s price controls, but flourished during the significantly freer 1980s.

In their actual effect, President Biden’s proposals could be viewed as just the ramblings of a very old man. He has not yet rolled out the government’s police powers – the governmental gun – to force oil companies to charge less. His plan is more like Carter’s exhortation for Americans to wear sweaters,and it is likely to have the same electoral effect as Carter’s exhortations. So far, he is just exhorting gas stations, refiners, and producers to lower their prices. Commentators and industry experts have pointed out the inanity of his concepts, such as telling refiners to eliminate their margins (“refining spreads”) or gas station retailers to lower their prices.

So there is probably not much to fear from Biden’s blusterings. We are not headed for a repeat of the 1970s gas lines any time soon.

But the longer-range and more fundamental threat is Biden’s moral condemnation of oil companies and contention that their prices are “unfair.” This presidential “jawboning” paves the way for a future administration – maybe even Biden’s – to go down the disastrous path of price controls that brought our country to its knees in the 1970s.

And then there is inflation. The other significant reason for the nominal rise in oil prices is simply that the value of the dollar is plummeting. Inflation now runs at 9.1 percent, a more than 40-year high. In real (inflation-adjusted) terms, gasoline prices are high, but they are still slightly below their last peak in 2012. Inflation is a Trump and Biden-created problem, when the government “printed” trillions of dollars in new money for pandemic relief. Those $1,200 checks that nearly every American got, and the “PPP” largesse that most businesses got, and the trillions of dollars that local and state governments got came with a price. That price was inflation. All that new money simply reduced the purchasing power of the dollar and pushed up the nominal price of gasoline.

President Biden has an unusually low 37 percent approval rating. This undoubtedly has many causes. One commentator attributes this to the hopelessness he conveys in regard to issues such as inflation and high gas prices. In this sense he is like former President Carter, who also presided over a period of high inflation and gas prices in the 1970s. But at least Carter eventually realized the error of his ways and began to deregulate. He did not just deregulate oil, but also the airlines, railroads, and trucking industries, ushering in tremendous growth in each. By deregulating oil, he and President Reagan ended the 1970s oil crisis.

Let’s hope that President Biden learns from Carter and Reagan. It is time to stop demanding “fair” prices. He should support market prices, even if he doesn’t like them and they are politically unpopular. And he should stop standing in the way of new drilling and the construction of energy infrastructure like pipelines. It is time to unleash the market to produce more, rather than excoriate the oil producers. Try some motivation by love, President Biden, not motivation by fear.

Raymond C. Niles

Raymond C. Niles is a Senior Fellow of the American Institute for Economic Research. He holds a PhD in Economics from George Mason University and an MBA in Finance & Economics from the Leonard N. Stern School of Business at New York University. Prior to embarking on his academic career, Niles worked for more than 15 years on Wall Street as a senior equity research analyst at Citigroup, Schroders, and Goldman Sachs, and as managing partner of a hedge fund investing in energy securities. Niles has published a book chapter and numerous articles in scholarly and popular publications.

Get notified of new articles from Raymond C. Niles and AIER.

Related Articles – Crisis, Economic History, Energy, Free Markets