Wednesday, September 14, 2005

The power of markets

I've meant to address this for a few days but never really had the time. Last week I wrote on why rising oil costs are still nothing to worry about. Sadly, some still don't quite understand the power of markets, specifically the purpose of higher prices.

Last Friday, CNNMoney had a rather silly article:
Salvation in rising crude prices?

Slowing growth in world oil demand may help offset the impact of Hurricane Katrina and aid the West's efforts to prevent a global energy crisis, the International Energy Agency said Friday.

Even before Katrina pushed U.S. crude to a record $70.85 a barrel, high prices were beginning to damage global oil demand growth, the IEA said in a monthly report.

"There are clear signs at the moment that we are starting to see the impact of high oil prices on demand -- and that's being seen in many regions," said Lawrence Eagles, head of the IEA's oil market division....
The only response appropriate for this ignorance of basic economics would be a stereotypical Valley Girl saying, "Like, duh?" Perhaps the CNNMoney article just quoted them badly, but the IEA acts as if it's a miracle that higher prices are dampening demand for oil.

Again, higher prices are necessary when a resource is scarce and in demand. This develops from Austrian economics' subjective theory of value, versus the erroneous "labor theory of value" set forth by Adam Smith, David Ricardo and Karl Marx. Higher prices are the very thing that discourages people from using the resource unless they value it as much as someone else; higher prices also encourage entrepreneurs to develop and use substitutes, which spurs progress. With higher prices come accusations of "speculation" allegedly being the cause, but Capital Freedom recently explained why speculation reduces volatility.

What's been happening with oil and gasoline? On Tuesday, gasoline futures were up because of supply worries, but slightly. I've noted before what the real experts point out, that the bottleneck is refinery output, not crude supplies. Nevertheless, Labor Day is past, Americans are already cutting back on SUV purchases, and the market is cooling itself. As I write, crude futures on Wednesday are up slightly so far in Asian trading markets because of supply concerns (reports due out in the morning). Nonetheless, on Tuesday, October futures for light, sweet crude were down again, to almost $63 even, and futures for Brent crude were down again to $63.61. So $70 oil was only temporary, a combination of tapping into oil reserves and a tempering of supply fears.

Should those who paid $70 per barrel of crude feel like chumps, that they could have just waited a few days? No more than anyone like me who paid $3 per gallon for gasoline. We had a sufficiently great use for the resource then and there, we were willing and able to pay the asking price, and we calculated it was worth the price. There's nothing wrong with what we paid. Nothing.

I tried to explain to LLP member Anarchangel that it's still a perfectly rational decision for oil companies to pay the higher prices, regardless of what we think (again, subjective value). People do not make exchanges unless they believe they gain, and markets are simply representations of their expectations. An oil company will not buy crude at $70 per barrel unless they believe it's worth it to them. A family will not pay $3 per gallon of regular gasoline unless they believe they can afford it, nor will a shipping company spend $500 (instead of $300 before) to fill up a rig's diesel fuel tanks unless they believe it's worth transporting goods.

Getting back to Hayek's principle of knowledge being dispersed throughout society, you and I don't know another economic actor's particular knowledge of time and place. What pushes one person to start taking public transportation while another decides, "Gee, $3 per gallon of gas, but I need to drive to work, and I suppose I can afford it"? Specific circumstances, which are knowledge belonging to an individual, not society. Thus the price system comes into play.

Prices are not rich people's oppression of the poor, like Marx alleged, but the ultimate source of information about a resource's scarcity, and the ultimate determinant of a resource's best use. If car drivers can and will pay no more than $2.80 per gallon of gasoline, instead of $3, then an oil company will know it cannot buy crude at $x if that price means gas stations must charge at least $2.81 to stay in business. Crude suppliers, then, cannot charge above a certain price that causes a derivative product (even several levels later) to be too expensive for the final buyer. Who can deny that this flow of information across the free market is nothing short of amazing? The information itself, like the commerce, is completely unplanned and without direction, yet balanced. Chaotic, you could even say, yet it works (unlike failed government attempts at controlling prices). No coercion, no bureaucrats that effectively claim to have perfectly knowledge, and complete fairness. Someone will pay the agreed-upon price for a resource, no matter what we think is "overpriced," because he deems it worth paying.

I came across a blog -- update, I found it. The author learned too much Keynesianism and Marxist-like political economy, and he didn't really grasp his microeconomics. He alleges "robbery" just because oil companies and gas stations are "charging what the market will bear." This person said the government should absolutely enforce anti-gouging laws. This is false because people paying "what the market will bear" do so of their own free will. Besides, if it's a crime to sell at "gouging" prices, then people should also be prosecuted for having paid those prices. It doesn't matter how much they needed the resource, or how willing they were to pay. The latter is ridiculous, you say? Well, so is the former.

Suppose I'm selling my house for a certain amount, far above what I paid for it. Should the government now "regulate" prices because I'm asking too much, because I'm denying a family somewhere the chance to have their own home? No, because like any other person controlling a demanded resource, I can never charge more than what someone is willing and able to pay -- and the person offering the most, by definition, values my house the most and should get it. But how much is too much? Actually, there's no such thing. In a free market, no one forces a buyer into paying the asking price; if it's too high, the buyer moves on. If no one's buying, then the seller must lower his price. So prices will settle naturally at "what the market will bear," where the buyer's asking price and the seller's offer intersect.

The sole deciders of what is "fair" should be the only parties directly involved, not we bystanders, and certainly not government. When government intervenes into peaceful, voluntary commerce, it's not to "protect" the buyer or seller equally. It might help one party, but except in cases of force and/or fraud, ultimately its interference is just to please the rest of us with a false sense of social justice.



Blogger Scorpius said...

In a crisis price-gouging is necessary, I don't see why more people don't see that. The stores in a crisis usually have limited access to restock new supplies and gouging causes a more even distribution of the products when normally there would be a rush on stores of people over-buying, over-buying which would deny others critical supplies and irrational over-buying which would result in the overbought supplies probably being wasted.

Wednesday, September 14, 2005 4:06:00 AM  
Blogger Chris Byrne said...

Peery, this is about me saying you would be insufferable isnt it ;-)

Honestly, you were assigning entirely different thoughts and premises to my statements than were actually behind them. You kept talking basic economics, and I was talking about mob psychology.

Economically I AGREE WITH YOU. I jsut think that sometimes people dont do what makes economic sense. Economic systems depend on rational actors making rational decions in their self interest. When there is panic, those factors of rationality cannot be assumed. THAT was what I was suggesting when I said if we see $4.00 a gallon, we will have a recession.

Wednesday, September 14, 2005 5:59:00 AM  
Blogger Perry Eidelbus said...

But you don't really agree with me economically. Austrian economics, as the most developed school of economic thought, accounts for all the psychology you're talking about.

Mob psychology or not, the decisions are still rational. I don't know how many times, or in how many different ways, I can keep telling you this. THERE IS NOTHING TO WORRY ABOUT. Free market forces will carry things through. What's been happening to gasoline and crude prices? They've started to settle down. We're not going to hit $4 per gallon oil, not unless we have a severe supply shock. In all frankness, if we ever have $4 per gallon oil in the next few years, it will be because government screwed it up, not because of speculation.

The decisions don't make sense to YOU, but that doesn't mean they're not correct to the buyers. You do not have their specific knowledge of time and place, so you don't have enough information to determine what they need and whether it's too high. To the oil company buying crude at $70 per barrel, it WAS worth it to keep their business running. It WAS worth it to compete with other bidders. They knew it was worth it because a lot of people say gasoline IS still worth it at $3 per gallon.

Expectations can change, but people at the moment they make the transaction are certainly making a rational decision. I think your problem is believing that "panic" and "rational decision-making" are mutually exclusive. They're not. On the whole, people do make decisions rationally, perhaps not optimally once we have more information, perhaps not by our standards. Yet at the time they make the transaction, it seemed a trade that produced gain for them. I might be wrong about something I buy for $100. Perhaps later I'll realize it was only worth $75, but at the time of purchase my decision was a rational one.

Ask yourself this: why do people buy things from convenience stores? If nobody bought from convenience stores, they wouldn't be in business. Are they irrational for paying those high prices?

Wednesday, September 14, 2005 10:46:00 PM  

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