Category Archives: Shortage

Price Controls: Political Gut Reaction, Gut Punch To Public

06 Thursday Jan 2022

Posted by in Price Controls, Shortage

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In a gross failure of education or perhaps memory, politicians, policymakers, and certain academics seem blithely ignorant of things we’ve learned repeatedly. And of all the dumb ideas floated regarding our current bout with inflation, the notion of invoking price controls is near the top. But watch out, because the Biden Administration has already shifted from “inflation is transitory” to “it only hurts the rich” to “it’s fine because people just want to buy things”, and now “greedy businessmen are the culprits”. The latter falsehood is indeed the rationale for price controls put forward by a very confused economist at the University of Massachusetts-Amherst named Isabella Weber. (See this for an excerpt and a few immediate reactions.) She makes me grieve for my profession… even the frequently ditzy Paul Krugman called her out, though he softened his words after realizing he might have offended some of his partisan allies. Of course, the idea of price controls is just bad enough to gain favor with the lefty goofballs pulling Biden’s strings.

To understand the inflation process, it’s helpful to distinguish between two different dynamics:

1. When prices change we usually look for explanations in supply and demand conditions. We have supply constraints across a range of markets at the moment. There’s also a great deal to say about the ways in which government policy is hampering supplies of labor and energy, which are key inputs for just about everything. It’s fair to note here that, rather than price controls, we just might do better to ask government to get out of the way! In addition, however, consumer demand rebounded as the pandemic waned and waxed, and the federal government has been spending hand over fist, with generous distributions of cash with no strings attached. Thus, supply shortfalls and strong demand have combined to create price pressures across many markets.

2. Economy-wide, all dollar prices cannot rise continuously without an excess supply of a monetary asset. The Federal Reserve has discussed tapering its bond purchases in 2022 and its intention to raise overnight interest rates starting in the spring. It’s about time! The U.S. money supply ballooned during 2020 and its growth remains at a gallop. This has enabled the inflation we are experiencing today, and only recently have the markets begun to react as if the Fed means business.

Weber, our would-be price controller, exhibits a marked ignorance with respect to both aspects of price pressure: how markets work in the first instance, and how monetary profligacy lies at the root of broader inflation. Instead, she insists that prices are rising today because industrialists have simply decided to extract more profit! Poof! It’s as simple as that! Well what was holding those greedy bastards back all this time?

Everyone competes for scarce resources, so prices are bid upward when supplies are short, inputs more costly, or demand is outpacing supply for other reasons. Sure, sellers may earn a greater margin on sales under these circumstances. But the higher price accomplishes two important social objectives: efficient rationing of available quantities, and greater incentives to bring additional supplies to market.

So consider the outcome when government takes the advice of a Weber: producers are prohibited from adjusting price in response to excess demand. Shortages develop. Consumers might want more, but that’s either impossible or it simply costs more. Yet producers are prohibited from pricing commensurate with that cost. Other adjustments soon follow, such as changes in discounts, seller credit arrangements, and product quality. Furthermore, absent price adjustment, transaction costs become much more significant. Other resources are consumed in the mere process of allocating available quantities: time spent in queues, administering quotas, lotteries or other schemes, costly barter, and ultimately unsatisfied needs and wants, not to mention lots of anger and frustration. Lest anyone think this process is “fair”, keep in mind that it’s natural for these allocations to take a character that is worse than arbitrary. “Important people” will always have an advantage under these circumstances.

Regulatory and financial burdens are imposed on those who play by the rules, but not everyone does. Black market mechanisms come into play, including opportunities for illegal side payments, rewards for underworld activity, along with a general degradation in the rule of law.

Price controls also impose rigidity in relative prices that can be very costly for society. “Freezing” the value of one good in terms of others distorts the signals upon which efficient resource allocation depends. Tastes, circumstances, and production technology change, and flexible relative prices enable a smoother transitions between these states. And even while demand and/or input scarcity might increase in all markets, these dynamics are never uniform. Over time, imbalances always become much larger in some markets than others. Frozen relative prices allow these imbalances to persist.

For example, the true value of good A at the imposition of price controls might be two units of good B. Over time, the true value of A might grow to four units of good B, but the government insists that A must be traded for no more than the original two units of B. Good B thus becomes overvalued on account of government intervention. The market for good A, which should attract disproportionate investment and jobs, will instead languish under a freeze of relative prices. Good B will continue to absorb resources under the artificial tradeoff imposed by price controls. Society must then sacrifice the gains otherwise afforded by market dynamism.

The history of price controls is dismal (also see here). They artificially suppress measured inflation and impose great efficiency costs on the public. Meanwhile, price controls fail to address the underlying monetary excess.

Price controls are destructive when applied economy-wide, but also when governments attempt to apply them to markets selectively. Posturing about “strategic” use of price controls reveals the naïveté of those who believe government planners can resolve market dislocations better than market participants themselves. Indeed, the planners would do better to discover, and undo, the damage caused by so many ongoing regulatory interventions.

So beware Joe Biden’s bluster about “greedy producers” in certain markets, whether they be in “Big Meat”, or “Big Oil”. Price interventions in these markets are sure to bring you less meat, less oil, and quite possibly less of everything else. The unintended consequences of such government interventions aren’t difficult to foresee unless one is blinded with the scientism of central planning.

Texas Cold Snap Scarcity: Don’t Blame Markets!

18 Thursday Mar 2021

Posted by in Electric Power, Price Mechanism, Renewable Energy, Shortage

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People say the darnedest things about markets, even people who seem to think markets are good, as I do. For example, when is a market “too efficient”? In the real world we tend to see markets that lack perfect efficiency for a variety of reasons: natural frictions, imperfect information, taxes, subsidies, regulations, and too few sellers or buyers. In such cases, we know that market prices don’t properly reflect the true scarcity of a good, as they would under the competitive ideal. Nevertheless, we are usually best-off allowing market forces to approximate true conditions in guiding the allocation of resources. But what does it mean when someone asserts that a market is “too efficient”.

Not long ago I posted about the failure of Texas utility planners to maintain surge capacity. Instead, they plowed resources into renewable energy, which is intermittent and unable to provide for reliable baseline power loads. That spelled disaster when temperatures plunged in February. Wind and solar output plunged while demand spiked. Even gas- and coal-fired power generation hit a pause due to a lack of adequate winterization of generators. The result was blackouts and a huge jump in wholesale power prices, which are typically passed on to customers. The price to some consumers rose to the ceiling of $9/kwh for a time, compared to an average winter rate of 12c/kwh. A bill in the Texas Senate would reverse those charges retroactively.

I cross-linked my post on a few platforms, and a friendly commenter opined that the jump in prices occurred because “markets were too efficient”. For a moment I’ll set aside the fact that what we have here is a monopoly grid operator: “market efficiency” is not a real possibility, despite elements of competition at the retail level. There is, however, a price mechanism in play at the wholesale level and for retail customers on variable rate plans. Prices are supposed to respond to scarcity, and there is no question that power became scarce during the Texas cold snap. Higher prices are both an incentive to curtail consumption and to increase production or attract product from elsewhere. So, rather than saying the “market was too efficient”, the commenter should have said “power was too scarce”! Well duh…

If anything, the episode underscores how un-market-like were the conditions created by the Texas grid operator, the ironically-named Electric Reliability Council of Texas (ERCOT): it allowed massive resources to be diverted to unreliable power sources; it skimped on winterization; it failed to arrange interconnection agreements with power grids outside of Texas; and it charged customers on fixed-rate plans too little to provide for adequate surge capacity, while giving them no incentive to conserve under a stress scenario. ERCOT can be said to have created a situation in which power supply was highly inelastic, which means that a normal market force was short-circuited at a time when it was most needed.

ERCOT‘s mismanagement of power resources is partly a result of incentives created by the federal government. The installation of wind and solar power generation came with huge federal subsidies, which distort the cost of the energy they produce. Thus, not only were incentives in place to invest in unreliable power sources, but ERCOT forced electricity produced by fossil fuels to compete at unrealistically low prices. This predatory pricing forced several power producers into bankruptcy, compromising the state’s baseline and surge capacity.

There are plenty of distortions plaguing the “market” for electric power in Texas, all of which worsened the consequences of the cold snap. This was far from a case of “market efficiency”, as the comment on my original post asserted.

The very idea that markets and the price mechanism are “ruthlessly efficient” is a concession to those who say high prices are always “unfair” in times of crises and shortages. We hear about “price-gougers”, and the media and politicians are almost always willing to join in this narrative. Higher prices help to ease shortages, and they do so far more quickly and effectively than governments or charities can provide emergency supplies (unless, of course, a monopoly grid operator leaves the state more vulnerable to stress conditions than necessary). Conversely, price ceilings only serve to exacerbate shortages and the suffering they cause. So let’s not blame markets, which are never “too efficient”; sometimes the things we trade are just too scarce, and sometimes they are made more scarce by inept planners.

Everything’s Big In Texas Except Surge Capacity

01 Monday Mar 2021

Posted by in Electric Power, Price Mechanism, Shortage

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The February cold snap left millions of Texas utility customers without power. I provide a bit of a timeline at the bottom of this post. What happened? Well, first, don’t waste your time arguing with alarmists about whether “climate change” caused the plunge in temperatures. Whether it was climate change (it wasn’t) or anything else, the power shortage had very nuts-and-bolts causes and was avoidable.

Texas has transitioned to producing a significant share of its power with renewables: primarily wind and solar, which is fine across a range of weather conditions, though almost certainly uneconomic in a strict sense. The problem in February was that the state lacks adequate capacity to meet surges under extreme weather conditions. But it wasn’t just that the demand for power surged during the cold snap: renewables were not able to maintain output due to frozen wind turbines and snow-covered solar panels, and even some of the gas- and coal-fired generators had mechanical issues. The reliability problem is typical of many renewables, however, which is why counting on it to provide base loads is extremely risky.

Judith Curry’s web site featured an informative article by a planning engineer this week: “Assigning Blame for the Blackouts in Texas”. The Electric Reliability Council of Texas (ERCOT) is the independent, non-profit operator of the state’s electric grid, with membership that includes utilities, electric cooperatives, other sellers, and consumers. Apparently ERCOT failed to prepare for such an extreme weather event and the power demand it engendered:

“… unlike utilities under traditional models, they don’t ensure that the resources can deliver power under adverse conditions, they don’t require that generators have secured firm fuel supplies, and they don’t make sure the resources will be ready and available to operate.”

ERCOT’s emphasis on renewables was costly, draining resources that otherwise might have been used to provide an adequate level of peak capacity and winterization of existing capacity. Moreover, it was paired with a desire to keep the price of power low. ERCOT has essentially “devalued capacity”:

“Texas has stacked the deck to make wind and solar more competitive than they could be in a system that better recognizes the value of dependable resources which can supply capacity benefits. … capacity value is a real value. Ignoring that, as Texas did, comes with real perils. … In Texas now we are seeing the extreme shortages and market price spikes that can result from devaluing capacity. “

Lest there be any doubt about the reliance on renewables in Texas, the Heartland Institutes’s H. Sterling Burnett notes that ERCOT data:

“… shows that five days before the first snowflake fell, wind and solar provided 58% of the electric power in Texas. But clouds formed, temperatures dropped and winds temporarily stalled, resulting in more than half the wind and solar power going offline in three days never to return during the storm, when the problems got worse and turbines froze and snow and ice covered solar panels.”

Power prices must cover the cost of meeting “normal” energy needs as well as the cost of providing for peak loads. That means investment in contracts that guarantee fuel supplies as well as peak generating units. It also means inter-connectivity to other power grids. Instead, ERCOT sought to subsidize costly renewable power in part by skimping on risk-mitigating assets.

Retail pricing can also help avert crises of this kind. Texas customers on fixed-rate plans had no incentive to conserve as temperatures fell. Consumers can be induced to lower their thermostats with variable-rate plans, and turning it down by even a degree can have a significant impact on usage under extreme conditions. The huge spike in bills for variable-rate customers during the crisis has much to do with the fact that too few customers are on these plans to begin with. Among other things, Lynne Kiesling and Vernon L. Smith discuss the use of digital devices to exchange information on scarcity with customers or their heating systems in real time, allowing quick adjustment to changing incentives. And if a customer demands a fixed-rate plan, the rate must be high enough to pay the customer’s share of the cost of peak capacity.

Price incentives make a big difference, but there are other technological advances that might one day allow renewables to provide more reliable power, as discussed in Tyler Cowen’s post on the “energy optimism” of Austin Vernon”. I find Vernon far too optimistic about the near-term prospects for battery technology. I am also skeptical of wind and solar due to drawbacks like land use and other (often ignored) environmental costs, especially given the advantages of nuclear power to provide “green energy” (if only our governments would catch on). The main thing is that sufficient capacity must be maintained to meet surges in demand under adverse conditions, and economic efficiency dictates that that it is a risk against which ratepayers cannot be shielded.

Note: For context on the chart at the top of this post, temperatures in much of Texas fell on the 9th of February, and then really took a dive on the 14th before recovering on the 19th. Wind generation fell immediately, and solar power diminished a day or two later. Gas and coal helped to offset the early reductions, but it took several days for gas to ramp up. Even then there were shortages. Then, on the 16th, there were problems maintaining gas and coal generation. Gas was still carrying a higher than normal load, but not enough to meet demand.

Heal, You Dogs!

26 Tuesday May 2015

Posted by in Obamacare, Shortage, The Road To Serfdom

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Doctor-shortage

In bondage to the State: The Classical Values blog has this interesting quote from Dr. Rand Paul:

“With regard to the idea of whether or not you have a right to healthcare, you have to realize what that implies….I’m a physician, that means you have a right to come to my house and conscript me, it means you believe in slavery. It means you’re going to enslave not only me, but the janitor at my hospital, the assistants, the nurses…There’s an implied threat of force, do you have a right to beat down my door with the police, escort me away, and force me to take care of you? That’s is ultimately what the right to free healthcare would be.”

It would be “free” only in nominal terms to the patient, and greatly degraded. The gap between the need for health care and the available supply cannot be solved via “conscription” of providers. And caring for the sick is one thing, but granting a “right” to well-care or health maintenance makes the gap much larger. Inadequate compensation to providers is an important subtext here, and it goes to the heart of the conflict. Basic economics tells us that the gap in access will expand if buyers are subsidized and providers are penalized by artificially low prices. The expanded eligibility for Medicaid in many states under Obamacare only exacerbates shortages, as physician reimbursements remain generally low.

Obamacare may have improved access to health care for a small minority of individuals, but only at the expense of penalizing many others, including providers. The program has fallen far short of its goal of covering the uninsured and has failed to “bend the cost curve” (despite false claims to the contrary, which attempt to take credit away from the Great Recession for slowing costs). Obamacare still looks to be unsustainable, as many have predicted. Insurers are now seeking large rate increases in many states, and going forward, they will not have the cushion of government-funded “risk corridors” when premiums fail to cover claims.

A Supreme Court ruling in the King v. Burwell case is due next month. The case has been discussed on this blog twice this spring. The plaintiffs have challenged federal subsidies in states relying on federal insurance exchanges in direct contradiction to the “plain language of the law”. The subsidies were intended to be an inducement to states to set up their own exchanges, but a number of states chose not to do so. A ruling for the plaintiffs would severely damage the Obamacare program, since the subsidies are key to making the relatively extravagant mandated coverage affordable to low-income individuals. However, Joel Zinberg insists that ending federal subsidies will not cause a death spiral.

Still, such a ruling would seem to give Congress and the Republicans an opportunity to craft legislation to replace Obamacare with a more viable program. Republicans seem have been unable to craft a strategy for dealing with this contingency, but their best strategy might be to wait, pass an extension of subsidies until 2017, and dare Obama not to sign it into law.

Can Water Markets Drive the Nuts From California?

14 Tuesday Apr 2015

Posted by in Price Mechanism, Secondary Markets, Shortage

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Water Use CA

Leaders in California seem determined to deal with the state’s water shortage in the least effective and most intrusive ways possible. Governor Jerry Brown has ordered such “bold”, yet ultimately weak, actions as restricting urban water usage, fines on “water wasters”, and xeriscaping of public property. The plan includes additional state intrusions such as rebates for high-efficiency appliances, bans on certain types of faucets, toilets and residential lawn irrigation systems, and more rigorous monitoring of water use, which could ultimately include shower time. A $1 billion state investment in wastewater recycling and desalinization plants is also planned, and pundits advocate other huge projects such as new reservoirs. These efforts are costly, but they are also beguiling to politicians seeking the appearance of positive action.

Overlooked is a straightforward and relatively costless way to achieve effective conservation and relief from the shortage: use the price mechanism! This simple approach encourages conservation in many large and small ways that are beyond the  discernment of government planners. Obviously, it can also address the profligacy of certain agricultural uses. A market mechanism is the one sure way to find the most rational price for water, and it is sorely needed in the face of such a significant shortage.

The misallocation of water rights in California is truly staggering, as demonstrated by the graphic at the top of this post, which is from a post at Marginal Revolution (originally from Mother Jones):

“… as farmers are watering their almonds, San Diego is investing in an energy-intensive billion-dollar desalination plant which will produce water at a much higher cost than the price the farmer are paying. That is a massive and costly misallocation of water. … In short, we are spending thousands of dollars worth of water to grow hundreds of dollars worth of almonds and that is truly nuts.”

The Mises Daily blog makes the same point in an article entitled, “Drought and the Failure of Big Government in California“.

“When crops like pecans, which are native to Louisiana where it rains over fifty inches per year, are being grown in central California, we will have to ask ourselves if there is true comparative advantage at work here, or if the industry is really sitting upon a shaky foundation of government-subsidized and -allocated resources.

The rhetoric that’s coming out of the growers, of course, is that California growers are essential to the American food supply. Some will even suggest that it’s a national security issue. Without California growers, we’re told, we’ll all starve in case of foreign embargo. … But let’s not kid ourselves. North America is in approximately zero danger of having too little farmland for staple crops.” [Emphasis added.]

Last month, my post “Scarcity, Scarcity Everywhere, And Water Pricing Stinks” addressed the mispricing of water and the promise of marketable use permits for water conservation. Details may vary, but in this sort of arrangement, residential, industrial and agricultural users would receive a base assignment of water rights at a relatively low, uniform price. The base assignment can be a function of historical usage. A secondary market then allows consumers and other users to purchase additional use permits or to sell permits exceeding their own usage:

“The price of water on the secondary market will rise to the point at which users no longer perceive a benefit to marginal flows of water above cost. A higher price encourages voluntary conservation in two ways: it is a direct cash cost of use above one’s base water rights, and it is an opportunity cost of foregoing the sale of permits on water use up to the base assignment. Those best-prepared to conserve can sell excess rights to those least prepared to conserve.”

Price incentives and their power for conservation are discussed in this post at Marginal Revolution. Market pricing is the single-most effective method of fostering sustainable patterns of resource use. Increasingly scarce conditions naturally lead to higher prices, which both discourage excessive use and create incentives for investments in reuse and other efficiencies. Yet politicians are highly averse to the idea of pricing resources rationally via the market. Instead, as exemplified by Governor Brown’s restrictions, they promulgate a seemingly endless series of measures that play on “green guilt” without adequate consideration of alternatives.

A colorful example of this misguided philosophy is the low-flow toilet, as described in this post entitled “Americans Destroyed Indoor Plumbing“. Mandatory recycling presents a classic case of conflicting policy goals: another sacred cow of environmental dogma, it increases water use in California because containers must be washed before they go to the curb. And there are other conflicting environmental goals, such as an effort to protect the Delta Smelt in San Francisco Bay by diverting over 300 billion gallons of water away from the Central Valley.

Meanwhile, big government Republicans are thumping their chests over their self-described success in planning for water needs in Arizona. This consists of infrastructure projects that capture runoff and store water in underground reservoirs, which are fine as far as they go (and, if available, better than above-ground storage subject to evaporation). However, these projects involve considerable public expense, and they have not prevented the imposition of mandatory conservation requirements. It should also be mentioned that current drought conditions in Arizona are mild compared to California. The point here is that market-oriented pricing and conservation reduces the need for such costly projects and intrusions. Administered water prices are expected to rise in Arizona, and they probably should. But it’s noteworthy that the last link, a summary of what is purported to be a careful study of water pricing issues, makes no mention of trade in water use permits and market pricing. As Glenn Reynolds might say, unlike big infrastructure and intrusive regulations, market-oriented policies and efficient pricing may not entice politicians with sufficient opportunities for graft.

Risk Takers and Ingrates

31 Friday Oct 2014

Posted by in Cafe Hayek, Carpe Diem, Don Boudreaux, Mark Perry, Markets, Oil Prices, Price Mechanism, Short Position, Shortage, Speculation, Surplus

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Jack Beanstalk Commodity

Just a few months ago, reactionary leftists were eager to blame “evil speculators” for driving up oil prices. Mark Perry asks: why don’t leftists give any credit to speculators when oil prices fall?

In the spring, there were concerns about Iraqi and Libyan oil supplies, as well as the usual seasonal increase in gasoline demand. In fact, under such conditions, it is never in any speculator’s interest to bid oil prices upward to “excessive” levels, above what is justified by underlying conditions. That would be a losing bet for the speculator. But when they bid prices upward in anticipation of tightening market conditions, speculators and market prices are broadcasting a forecast, providing information upon which other interested parties can act. In particular, the upward price movement encourages reduced consumption and conservation, and it creates incentives that bring forth additional supplies. Thus, by taking risks, the speculators play a valuable social role. Don Boudreaux of Cafe Hayek posted a letter he sent to Senator Ben Cardin on this topic back in June. It’s a fun read, but I doubt that it had any influence on Cardin.

As it happened, oil prices peaked in June. The increase in U.S. production from the shale boom has helped to ease conditions, as has strong Saudi production. Speculators can profit under such conditions by taking short positions in oil. In so doing, they encourage prices to fall, sending a signal to the market that production is too strong and that costly conservation measures have less value. The upshot is that such price adjustments prevent a surplus of oil and wasteful use of resources. Again, speculators take significant risks in the hope of earning an adequate return, and in so doing they fulfill a valuable social function. If anything, they should be lauded, not vilified.