Markets: Sometimes you just have to love them
One constant theme Americans have heard — and will no doubt continue to hear — during the on-going 2012 presidential cycle is the role of markets and government in economic decision making. In a nutshell, the basic problem every society faces is how scarce resources (land, labor, capital,and entrepreneurship) should be allocated so as to best satisfy unlimited wants and needs. Within this decision-making process, a “who-do-you-trust” choice must be made, that is, allow markets or government or some combination of the two to make such decisions. No matter which choice is made, some “opportunity costs” will be incurred.
For some, the answer is clear: Markets are superior and should be permitted to work. Others suggest that government must serve minimally as a regulator, and perhaps more comprehensively as a highly active allocator of resources in some sectors of the economy. In all of this there is no clear-cut answer, with opinions (aided by statistical analysis) guided by economic theory.
Regardless of precisely where one comes down between these theoretical camps — I fall decidedly in the pro-market group — one simply has to marvel at times at the incredible efficiency of market mechanisms. And in this efficiency, if market forces are permitted to operate fully, the pricing mechanism can take what seems to be an inevitable outcome and turn it on its head. Such is the case of oil markets in 2012.
As the year began, markets seemed to be tightening up and world prices were rising. On Jan. 3, West Texas intermediate crude prices settled at $102.96. That produced a gasoline price (all grades, U.S. average) of approximately $3.31 per gallon. With few exceptions, analysts believed that prices were on their way up, due in part to favorable world economic growth expectations and partly due to the uneasy Middle East situation where Israel was seen as possibly attacking Iranian nuclear facilities and igniting a wider conflict.
For the first few months of the year, it appeared analysts’ expectations would prove correct, with oil prices rising to just under $110 per barrel and gasoline topping out at just under $4 per gallon nationally. Even worse, oil industry experts were saying that gas prices could hit $5 per gallon by late spring.
Since that time, market forces have provided “experts” yet another reason to feel totally inadequate. The fear of the Middle East meltdown due to Israeli military action subsided, along with that portion of the price increase being driven by high growth expectations. Also causing prices of both oil and gasoline to recede has been the financial market turmoil in the euro-zone and the recession-like environment that developed. Without European growth, a major component of world oil demand subsided. And as their economic growth prospects fell, Europeans could afford to purchase fewer imports, thus slowing down economic growth prospects for other nations such as the U.S., China and Japan. As these economies slowed, oil and gas inventories accumulated beyond desired levels, with surpluses resulting. And as with any market, should a surplus develop, the only reasonable action to clear out the unwanted inventories is to cut price. As of early last week, this brought the price of oil below $93 per barrel and gasoline down to a national average of $3.71 per gallon. What’s more, the market has now, seemingly, turned direction so substantially that the “almost inevitable” gas prices of $4 to $5 this summer seem a distant and unpleasant memory.
And what brought about all of these changes? Not government price controls. Not a release of oil from the Strategic Petroleum Reserve (even though this is now being discussed for whatever reason). Market forces! It was simply the dynamic interaction of supply/demand factors among a number of different economic sectors across various nations that produced a drop in prices.
Of course, market forces will not always be to the liking of everyone. Later this year, as prices fall, consumers may have more discretionary income which may be used for desired purchases. More consumer spending could cause economic growth to reaccelerate and increase the demand for — and price of — oil. But then that’s what comes with a reliance on market forces. Sometimes market dynamics will seem to cut in favor of the consumer and sometimes not. In either case, left unimpeded by government, markets simply reflect the collective desires of society via supply/demand forces and the resulting prices.
Next week: Market forces and payback.
Dr. James Newton serves as chief economic advisor to Commerce National Bank and is an auxiliary faculty member in economics and statistics at OSU-Marion and OSU-Newark. Dr. Newton’s views do not necessarily reflect those of Commerce National Bank or OSU-Marion/Newark.