Don’t Let Populists Set Prices

(Original Caption) Washington, DC. President Richard Nixon makes victory speech at a rally shortly after being elected to serve a second term by a landslide in the November 7th Presidential election.

Bettmann Archive

Economic literacy amongst politicians has never been high but it lately seems to be taking a big hit from populists on both left and right. Whether Hungary’s Viktor Orban declaring “Prices don’t rise, they are raised,” Viktor Orban Is a Conservative Lodestar. Now He Wants to Fix the Price of Eggs. – The New York Times or New York mayoral candidate Zohram Mandani suggesting he “will immediately freeze the rent for all stabilized tenants” Platform — Zohran for NYC there is a near conspiratorial perception of price-setting and the need for political intervention. Shades of the 1960s.

I used to talk about how oil markets had become less politicized in the 1990s, remarking that price controls on energy had come to be considered far outside mainstream thinking. That was a significant change: oil price controls were established in 1970 by Republican Richard Nixon as part of his more general fight against inflation, for example. When his broader wage and price controls proved unworkable, he nonetheless maintained controls on wellhead oil prices, keeping them well below international prices and thus undermining his own drive for energy independence.

Conservatives have long argued that markets should set prices, but this was often misunderstood as meaning that the resulting prices would behave as they wanted. Twice at the International Energy Forum, U.S. Secretaries of Energy insisted that free markets would stabilize oil prices and I had to point out that commodity prices were inherently unstable. In my experience, they and many others were using the phrase ‘stable prices’ as a substitute for ‘lower prices.’ A free market generates prices that balance supply and demand, which doesn’t necessarily translate into either lower or higher prices.

Producers also call for stable prices by which they mean higher prices. Whether farmers, miners or oil companies, it is typical to hear that prices are not adequate to support new investments, and low prices now will mean a supply squeeze later. The late economist Richard Gordon, listening to various consultants lament that prices were too low to allow investment in tankers, oil drilling rigs and refiners, remarked that ‘As economists, if we have learned one thing it is that markets clear and they usually clear faster and at lower prices than we expect.’ (That is a paraphrase.)

The deregulation movement championed by Alfred Kahn, Margaret Thatcher and Ronald Reagan was largely intended to reduce regulatory capture, by which industries managed to turn regulations to their benefit, protecting them from competition. But this also extended to deregulating oil and gas prices in the United States and removing British Gas’ monopsony power over North Sea natural gas supply. The resulting prices in both countries were more volatile and mostly lower.

To many like Viktor Orban, prices are set by ‘someone,’ and rising prices bring calls for investigations and action, whether it be oil prices, food prices, rents or interest rates. But markets are like the tides and they do not respond to modern-day King Canutes ordering them to recede any more than the tide responded to his importuning. (Opinions are split on whether he thought he could control the tide or was demonstrating to his supporters the limits to his power.)

In effect, Adam Smith’s ‘invisible hand’ should have been ‘invisible hands’ because the market represents decisions made by countless participants. In the short run, prices can vary enormously but in the long run, the fundamentals of supply and demand win out. Various efforts to circumvent market forces have always come at a cost and usually failed, whether it has been the U.S. government’s efforts to set or influence agricultural prices or mineral producers attempts at cartelization, including commodity price stabilization agreements between producers and consumers. Any number of politicians have complained that speculators were influencing currency values, interest rates and/or commodity prices, but their interventions have almost always failed, sometimes spectacularly.

The point is that no one person knows the ‘correct’ price of anything, that is, the price which will enable supply and demand to balance. Economists and experts on exchange rates, oil prices, and so forth regularly admit to making bad calls (that includes me) and most would be loathe to suggest that they should be empowered to arbitrarily set them. Worse, most individuals who want to set prices have biases that will guarantee resulting errors, creating shortages (think apartments in New York City) or surpluses (think U.S. government warehouses of cheese in the 1980s).

Which takes us back to Adam Smith’s invisible hands or, to use the current pop culture term, crowd sourcing. Any given trader or speculator can be wrong, and the consensus about the equilibrium price can be wildly off-base, but with the constant iteration of thousands of buyers and sellers judging the market balance, over the long run, they manage to stumble towards equilibrium.

Which is reminiscent of the Soviet-era joke. Stalin wakes up in a hospital surrounded by Communist Party officials. Welcome back, comrade! They exclaim, the miracle of socialist medicine has allowed us to bring you back to life. It is now the year 2050 and all the world is Communist except for New Zealand. Why not New Zealand? Stalin asks. Well, shrug the apparatchiks, someone has to tell us what prices are.