Robert Murphy

With food and energy prices soaring, housing prices collapsing, and the economy sinking into what could be a deep recession, the government has been searching around for villains. The latest scapegoats are speculators, OPEC, and of course, the big bad oil companies. As usual, our government ignores its own role in our current economic mess. To add insult to injury, most of the politicians’ proposed “solutions” would only make things worse.

Whenever there are large moves in prices, people naturally become suspicious of the mysterious speculators. These shadowy figures lurk behind every financial market, and apparently have the power to move prices up or down at will, earning fat profits for themselves. (If this were true, why do the speculators only appear at certain times? Why not make guaranteed money constantly?) The politicians promise to crack down on this antisocial behavior, and let prices return to the levels set by supply and demand.

There are two problems with this view. First, the huge run-up in oil prices over the last few years is due to the “fundamentals”: Demand is soaring among developing countries, while global output has been flat since 2005. Second, even if it were true that speculators were manipulating prices, that would be a good thing. Speculators buy low and sell high. When they buy at the low prices, the speculators push prices up. And then when they unload at the high prices, they push those prices back down. Over the entire cycle, the speculators actually dampen the price volatility, making it easier for producers and consumers to plan for the future. Punishing speculators in the oil market will only make oil price swings more exaggerated.

The next government scapegoats are the countries forming OPEC. It is true, fans of the free market should have little respect for a cartel among governments that ignores market signals. Despite the skyrocketing price for oil on the world market, OPEC has been cutting output, with its 2007 output down over 1% from the prior year.

The obvious response of the rest of the world should be to increase their own output and take market share from OPEC producers. Yet rather than this sensible strategy, the U.S. government instead continues with its prohibitions on ANWR and offshore drilling, and chooses to threaten OPEC countries with antitrust lawsuits and other punishments, such as a held-up arms deal with Saudi Arabia. The Congress doesn’t seem to see the irony involved when it accuses other governments of restricting oil output and thereby harming consumers.

Finally we come to the easiest scapegoat, domestic oil companies. Politicians have been threatening to impose a windfall profits tax, and Maxine Waters infamously suggested outright nationalization at a recent hearing. As with speculators, the theory here is that oil companies can set whatever price they want, and the hapless motorist has no choice but to pony up at the pump. Only by taking away those excess profits can justice be restored, say our politicians and pundits.

Even on its face, this strategy is absurd. If the oil companies really can decide, “Well, we’d like to make $45 billion in profits this year, so let’s set the price of a barrel at $130,” then the last thing the government should do is tax away a large percentage of those profits. Why wouldn’t the fat cat companies respond by jacking up prices even more to recover their profit objective?

In reality, the price of oil is set on the world market. Even though U.S. oil companies are huge, they can’t unilaterally set prices. If the federal government slaps on a windfall profits tax, it will only apply to domestic producers. Their after-tax returns will drop, and they will cut back on investment in future output. With reduced supplies, the world oil price will go up, not down. What’s even crazier, Americans would become more reliant on foreign oil producers, as these state-run companies would have a competitive advantage once U.S.-based firms are slapped with a new tax.

Americans are understandably upset over a faltering economy and in particular over record-breaking gasoline prices. The only solution is to find ways to bring down the price of crude oil. There are definitely steps the federal government can take, such as opening up domestic sources for development. Unfortunately, virtually every proposal put forth in recent months would make our energy situation worse. Picking scapegoats might sell at the ballot box, but it won’t bring relief to consumers.

Robert Murphy

Robert Murphy has a Ph.D. in economics and is the author of The Politically Incorrect Guide to Capitalism (Regnery 2007).

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