News reports have some analysts now predicting that gasoline will hit $10 a gallon over the next few years. Will it reach $10? No one knows – but the idea alone has the American people asking questions: How will I afford to drive? Will we be able to take that vacation? Should I buy a smaller car, maybe a motorcycle? What will happen to the economy? What will the government do about this? What is the cause of all of this?

They’ll turn on the evening news and read the newspaper – and they’ll be presented with myriad explanations for what is going wrong – but most of it will be misplaced cause and effect analysis at best, blatant deception at worst. I’d like to keep it simple, to provide a lens through which to see and filter what we hear. This will be a two-part post, the first will stay at a higher level, based on two straightforward premises:

  1. This is not a failure of the free market.

  2. Governments are culpable.

The only reason prices rise in a true free market with sound money is when demand exceeds supply, and we will hear a number of analysts giving supply and demand reasons for the price increases:

China’s growing appetite for energy, decline in worldwide oil reserves, lack of refineries in the US, OPEC production restrictions, our insistence on driving big SUVs, labor actions overseas threatening crude supplies, slowing of production by refiners due to low margins – have I started to confuse you yet?

It is axiomatic that these and many other aspects of supply and demand have an effect on prices, but if you view them with the perspective of my second premise, that governments are culpable in this mess, you will see that supply and demand are manipulated by governments. Absent government, the only variables that exist are consumer demand and the ability of the market to deliver what consumers want – and as long as there is demand, free market enterprise is eager to fill it. The only thing that can keep the entrepreneurial spirit from meeting demand would be a true shortage of oil, or the ability to access it and deliver it to the market place.

If there is a true market shortage in supply, consumer demand will change as prices rise. They’ll reduce their consumption, alternatives will arise through innovation on the free market, and supply and demand will move closer to one another again. Price is the signal that provides everyone in the market with the information they need to make decisions.

Let us turn our attention to the second premise: Governments are a major part of the problem. We’ll begin our analysis with a few sub-premises:

  1. Governments are anti- free market because they are based on central planning and control
  2. Governments seek to seize wealth and control resources to their benefit

In a true free market, supply would be limited only by reserves and the ability of enterprise to access them. When government is involved, supply is manipulated and controlled in the interests of bureaucrats, dictators, and central planners. There isn’t anything close to a free market in the major oil producing countries, because the governments have seized control of the oil to the detriment of the people. The reader may quickly point the finger at other governments, but the fact is that many of these regimes were formed by, and are manipulated by, external governments. It was only in the early part of the 20th century that oil in the Middle East was known to be in vast supply, and that oil itself was recognized as holding great strategic value. From that moment forward, empire-seeking governments such as Germany, Great Britain, and the United States have fought wars, divided the region into countries to their benefit, and installed regimes that will bow to their interests. In oil-rich countries where the government resists the empire, they have nonetheless seized the wealth of the oil to the detriment of the people. They are socialist countries, with government controlling their only real source of wealth and distributing just enough pottage to the people to keep them pacified.

War is devastating to supply. Governments launch wars over oil to control its supply, in the sinister belief that they will be assured of a cheap flow of oil if they can wield enough military force over the oil producing countries. One of the primary objectives of the US Government’s invasion and occupation of Iraq was to gain control over the vast resources of that region, to diminish the strength of the Saudi Government and its attempts to wield power by manipulating supply. Iraqi oil production, once at 3.5 million barrels per day, plummeted due to war, sanctions, and more war, and has been less than half its previous average for most of the time since. Reduced supply has increased prices. Another factor is the cost of insuring shipments in a war zone, costs that will be passed on to the consumer. All told, remember when we were told that Iraq would pay for this war with oil, and we’d all see an improved supply of oil and cheap prices at the pump? It doesn’t appear to have worked out. Oil has rocketed from less than $30 per barrel to $120 at the time of this writing. The forecasters, predicting $10 per gallon gasoline, are talking about $200 a barrel.

The reader may ask, absent US Government intervention, won’t we be at the mercy of oil producing countries? The first response is that the producers have an incentive to sell their oil. It is their source of wealth. The second response is that it is their oil, their property. If your neighbor has something you want, you don’t have the right to steal it from him, nor beat him up to make him sell it to you – and you can’t use your government to do it for you either. It is not “our oil.” Again, they have an incentive to sell it, and the US market is their biggest customer. Even Osama Bin Laden understands this when he says that it’s not like they’re going to drink it – they want to sell their product.

At home, the US Government takes on its role as central planner and attempts to manipulate demand, directing resources to the production of alternative energy sources. Taxpayer funds are diverted to favored special interests and immense profits are made on non-viable solutions. Profits, in a free market, are the result of efficient production of goods and services that can be sold at a price higher than the costs of production, because the consumer places value on the good or service that exceeds the cost to produce it. In government subsidized production of non-viable solutions, profits are privatized while the losses are socialized – that is, a chosen few benefit from government contracts and subsidies, receiving money that could not have been earned on the free market, while consumers are forced to make up the difference with their tax dollars. A belief in government and central planning is the culprit – innovation does not occur by specially appointed “experts” (and government officials are experts at nothing) picking the winners and losers, innovation is the result of hundreds or thousands of individuals exercising intellectual curiosity – you cannot know where it will come from. When oil prices signal opportunity, the market will respond. Government planning has resulted in wasteful, inefficient boondoggles like ethanol, subsidized with tax dollars to the point that corn is sold cheaper than it can be produced. This government intervention is a form of tampering with the free market, redirecting resources and causing ill side effects.

We’ve shown how intervention disrupts supply and increases cost, and how attempts to manipulate demand by forcing economically infeasible solutions costs the taxpayer, but there is a much more subtle, more hidden means by which the US government, predominately, is at fault for our pain at the pump.

The biggest hammers in the government’s interventionist tool box – war and subsidies – must be financed with inflation, destroying the value of the dollar and decreasing its purchasing power. A devalued dollar, of course, will purchase less gasoline with each dollar. Many economists have pointed to the falling dollar and the rising cost of oil. This is a good start, although, if we compare the prewar price of oil to the postwar price, we see more than a 400% increase. The dollar, while sliding precipitously, has not lost that much value over the same time frame. What has happened? This will be the topic of my next entry.

Next entry:  Inflation and Gas Prices