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.

Posted by Jim Newton on May 22 2012. You can follow any responses to this entry through the RSS Feed. Comments can be made below.