New Polity

The latest installment of Lou Dobbs Tonight saw a longwinded panel on energy, with all the customary clichés at the forefront of the discussion. The group’s explanations for rising prices in the energy market ranged from the president’s environmentalist agenda to evil speculators rigging the market. There is much truth to the first claim—while the president claims this country has never produced more oil, almost all of the increases in oil production have occurred on non-federal lands, while Mr. Obama’s efforts have focused on pushing “green” alternatives and actively curtailing the exploitation of traditional energy resources. The second claim—that speculators are responsible for high and volatile oil and gas prices—has been utterly discredited by empirical evidence. Contrary to the popular wisdom, speculation makes commodity prices more stable over time, not less (for a theoretical perspective on the topic of speculation, I would refer readers to this article by the always-illuminating Robert P. Murphy). Moreover, as financial authority Christopher Mayer pointed out in this 1999 article, speculators provide valuable services by assuming risks, speeding market adjustments, and providing liquidity. None of these activities leads to chronically overpriced commodities. So if the Obama green agenda isn’t the whole story, and speculators aren’t the big bad wolves of the energy market, what does account for skyrocketing energy prices?

The real culprit is inflation. Over the past several years the Federal Reserve’s actions in buying up bad debt—both from private institutions and the government—and keeping interest rates low have introduced massive amounts of new money into the economy. Inflation, which is the increase in the quantity of money, inevitably leads to higher prices, as a simple matter of supply and demand.

But the Fed’s been engaging in money-creating shenanigans for years. So why the delay between the increase in the supply of money and the increase in commodity prices? Why does the price-increasing effect of inflation accelerate as time goes on?

There are two reasons.

First, depending on where the government directs newly printed money first, prices will rise in those sectors before they rise generally. The politically connected often benefit from this, reaping the rewards of their insider status by staying ahead of the curve of rising prices.

Secondly, it takes time for inflation to result in increased prices because, in the words of the legendary Henry Hazlitt, “the value of a unit of money is determined, like the value of a unit of a commodity, primarily by psychological factors”. As with any commodity, an increase in the quantity of money devalues the individual monetary unit, but the story doesn’t end there. People’s expectations regarding the future quantity and quality of money also affect its value, and at the beginning of an inflationary period they generally retain confidence in the purchasing power of the currency. As inflation continues—in other words, as money continues to be printed—this confidence erodes and “fears for the future are reflected in the present. There is a flight from money and a flight into goods”[1], Hazlitt explains. The flight from money into goods eventually causes prices to rise even faster than the quantity of money is increased.

We are watching just such a flight right now, and its effects are especially evident at gas stations all across America.

Now, the sixty-four thousand dollar question is why Lou Dobbs and other pundits who purport to be in favor of free markets naturally drift to blaming the bogeyman speculator for rising energy prices, when the real answer is staring them right in the face. Why accept any explanation for rising energy prices except inflation? These are the same people, incidentally, who rightfully lambast many of the flawed policies that led to stagflation some decades ago. Have they now arrived at the conclusion that inflation is no longer an issue, or that the energy market is somehow immune to it? Of course inflation is not the only reason for rising energy prices, but one cannot reasonably deny it is playing a major role.

So why join the left in making speculators the punching bags of choice, when speculators help find the real market worth of a commodity more quickly, and since their beneficial activities cannot be curtailed but by violating property rights? Why not blame inflation, inflation caused by a flawed monetary policy and the appetite for big government that necessitates it?  Doing so would certainly be more consistent for the aforementioned “free market” pundits, but more importantly, it would be accurate.

It seems too many fair-weather friends of economic freedom have little interest in being either.