Sunday, July 27, 2008

The C-J's "Experts" on Oil Speculation Flunked Economics 101

The Courier-Journal's editorial writers come out today against the big bad oil speculators, and call Senate Republican Leader Mitch McConnell a "fraud" for not signing onto the Democrats' bill "to curb the rampant speculation that experts say is part of the reason gas prices are so high." The C-J's editors don't say who their "experts" are, but those "experts" appear to know more about dunking than principles of economics.

As Professor Craig Perron of the University of Houston wrote in The Wall Street Journal:

Commodity price shocks, like those currently rocking the oil market, inevitably lead to witch hunts. And speculators are typically among the first to be hunted down.
. . . .
The unprecedented run-up in oil prices is painful for consumers around the world. But the focus on speculation is misguided, and represents a convenient distraction from an understanding of the real, underlying causes of high oil prices -- most notably continuing demand growth in the face of stagnant production, supply disruptions and the weakening dollar.

More restrictions and regulations of energy markets, in the vain belief that such actions will bring price relief, are counterproductive. They will make the energy markets less efficient, rather than more so.

In other words, curbing speculation in oil won't lower the price of gasoline, but drilling for more oil (i.e., increasing supply) and conservation (i.e., decreasing demand) will. Oil speculation -- like speculation in any commodity -- is simply the mechanism through which an efficient market prices the commodity based upon anticipated supply and demand in the future. Oil speculators are, in a sense, the "messengers" of what the price of oil will be if more drilling and conservation do not occur.

Essentially the Democratic response to the reports of higher oil prices is to try to act in the counterproductive way that the Greeks handled bad news: by killing the messenger. Fortunately, we have leaders like McConnell who understand that the energy shortage can only be solved by addressing the root causes of the problem -- supply and demand for the commodity -- and not looking for imaginary scapegoats. As he writes today in a letter to C-J's editor: "The answer is simple: We need to find more energy and use less."

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