Oil and gas
prices are high now for a very simple reason: the U.S. Federal Reserve
has gone on an unapologetic campaign to push up inflation and push
down the value of the U.S. dollar. Just last week on CNBC James
Bullard, the President of the Federal Reserve Bank of St. Louis,
stated this unequivocally. What is somewhat overlooked is the degree
to which an inflationary policy at home creates inflation abroad.
Many countries who peg their currencies to the U.S. dollar need
to follow suit with the Fed. As China, for example, prints yuan
to keep it from appreciating against the dollar, prices rise in
China. This is especially true for commodities like crude oil.
Many critics,
such as Mr. O'Reilly, have relied on a limited understanding of
the supply/demand dynamic to question why gas prices are currently
so high at home. With domestic gasoline production at a multi-year
high and domestic demand at a multi-year low, he logically expects
low prices. But he fails to grasp the fact that the price of gasoline
is set internationally and that U.S. factors are only a component.
O'Reilly's
loudly proclaimed solution is to limit the ability of U.S. refiners
(and drillers) to export production abroad. If the energy stays
at home, he argues, the increased supply would push down prices.
Although O'Reilly professes to be a believer in free markets he
argues that oil (and gasoline by extension) is really a natural
resource that doesn't belong to the energy companies, but to the
"folks" on Main Street. What good would "drill baby
drill" do for us, he argues, if all the production is simply
shipped to China?
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First off,
the U.S. government has no authority whatsoever to determine to
whom a company may or may not sell. This concept should be absolutely
clear to anyone with at least a casual allegiance to free markets.
In particular, the U.S. Constitution makes it explicit that export
duties are prohibited. Furthermore, energy extracted from the ground,
and produced by a private enterprise, is no more a public good than
a chest of drawers that has been manufactured from a tree that grows
on U.S soil. Frankly, this point from Mr. O'Reilly comes straight
out of the Marxist handbook and in many ways mirrors the sentiments
that have been championed by the Occupy Wall Street movement. When
such ideas come from the supposed "right," we should be
very concerned.
But apart from
the Constitutional and ideological concerns, the idea simply makes
no economic sense.
In 2011 the
United States ran a trade deficit of $558 billion. For now at least
America has been able to reap huge benefits from the willingness
of foreign producers to export to the U.S. without equal amounts
of imports. China supplies us with low priced consumer goods and
Saudi Arabia sells us vast quantities of oil. In return they take
U.S. IOUs. Without their largesse, domestic prices for consumers
would be much higher. How long they will continue to extend credit
is anybody's guess, but shutting off the spigots of one of our most
valuable exports won't help.
In recent years
petroleum has become an increasingly large component of U.S. exports,
partially filling the void left by our manufacturing output. According
to the IMF, the U.S. exported $10.3 billion of oil products in 2001.
By 2011, this figure had jumped nearly seven fold to more than $70
billion. How would our trading partners respond if we decided to
deny them our gasoline?
Keeping more
gasoline at home could hold down prices temporarily, but how much
better off would the "folks" be if all the prices of Chinese
made goods at Wal-Mart suddenly went up, or if such products completely
disappeared from our shelves because the Chinese government decided
to ban exports that they declared "belonged to the Chinese
people?" What would happen to the price of energy here if Saudi
Arabia made a similar decision with respect to their oil?
But most importantly,
limiting the ability of U.S. energy companies to export abroad will
do absolutely nothing to improve the American economy. As a result
of our diminished purchasing power, American demand for oil has
declined in relation to the growing demand abroad. Consequently,
we are buying a continually lower percentage of the world's energy
output. Consumers in emerging markets can now afford to buy some
of the production that used to be snapped up by Americans. If U.S.
suppliers were limited to domestic customers, then prices could
drop temporarily. But what would happen then?
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With the U.S.
adopting a protectionist stance, and with gasoline prices in the
U.S. lower than in other parts of the world, less overseas crude
would be sent to American refineries. At the same time lower prices
at home would constrict profits for domestic suppliers who would
then scale back production (and lay off workers). The resulting
decrease in supply would send prices right back up, potentially
higher than before. The only change would be that we would have
hamstrung one of our few viable industrial sectors. (For more about
how diminishing supplies could exert upward pressures on a variety
of energy products, please
see the article in the latest edition of my Global Investor newsletter).
Mr. O'Reilly
can spin this any way he wants it, but he is dead wrong on this
point. It is surprising to me that such comments have not sparked
greater outrage from the usual mainstream defenders of the free
market. To an extent that very few appreciate, America derives a
great deal of benefits from the current globalization of trade.
Sparking a trade war now would severely reduce our already falling
living standards. And given our weak position with respect to our
trading partners, such a provocation may be the ultimate example
of bringing a knife to a gun fight.
Rather than
bashing oil companies, O'Reilly, as well as other frustrated American
motorists, should direct their anger at Washington. That is because
higher gasoline prices are really a Federal tax in disguise. The
government's enormous deficit is financed largely by bonds that
are sold to the Federal Reserve, which pays for them with newly
printed money. Those excess dollars are sent abroad where they help
to bid oil prices higher.
For years,
mainstream economists argued that as long as unemployment remained
high, the Fed could print as much money as it wanted without worrying
about inflation. The argument was that the reduction in demand that
results from unemployment would limit the ability of business to
raise prices. However, what those economists overlooked was the
simultaneous reduction in domestic supply that results from a weaker
dollar (the consequence of printing money).
I have long
argued that neither recession nor high unemployment would protect
us from inflation. If demand falls, but supply falls faster, prices
will rise. That is exactly what is happening with gas. The same
dynamic is already evident in the airline industry. Fewer people
are flying, but prices keep rising because airlines have responded
to declining demand by reducing capacity. Since seats are disappearing
faster than passengers, airlines can raise prices. At some point
Americans will be complaining about soaring food prices as much
more of what American farmers produce ends up on Chinese dinner
tables. Because the Fed is likely to continue monetizing huge budget
deficits, Americans are going to be consuming a lot less of everything,
and paying a lot more for those few things they can still afford.
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