Saturday, April 26, 2008

More coins in the fuse box

Even as the signs of a growing oil crisis gather around us, there are those who prefer to put coins in the fuse box. I am referring, of course, to the very dangerous practice of putting a coin in a fuse box where the fuse ought to go.

Sometimes foolish homeowners whose electrical systems are prone to burn out fuses do this out of frustration or as a temporary expedient until they can get to the hardware store. In doing so, they deny themselves the feedback that keeps electrical fires from starting. (I have used this analogy previously and couldn't resist trotting it out again given recent developments.)

Perhaps the most visible current coin-in-the-fuse-box proposal is John McCain's gas tax holiday. Its irresistible political appeal in a campaign year means it is likely to be enacted. By lowering gasoline prices his proposal would, of course, send a price signal to people to use more gasoline. That's hardly the message they ought to be receiving when the peak in world oil production is growing ever closer. McCain and many others have also called on the U. S. government to cease its oil purchases for the country's Strategic Petroleum Reserve. The move would eliminate one sizeable source of demand from the oil market. (Never mind that such a reserve might be especially important now when a major oil supply disruption could cripple the weakened U. S. economy.)

The result of suspending gas taxes and oil purchases for the Strategic Petroleum Reserve would probably be a brief period of lower prices followed by another runup set off by increased demand. So, instead of the money going into the federal highway trust fund, it would then go into the coffers of oil producers. (Perhaps the failure to repair roads and bridges would reduce incentives to drive more. But that hardly seems like an efficient and proper way to encourage less driving.)

Coins in the fuse box make for an addictive habit. As long as things continue along smoothly, the temporary fix feels great. That's why it is almost certain that as the date for resuming collection of the gas tax approaches, there will be a call to extend the tax holiday. And, if gasoline prices don't decline sufficiently by the time that extension lapses, there could be further calls to extend it.

In other important areas we are also being deprived of necessary feedback. The recent bailout of Wall Street investment banker Bear Stearns by the U. S. Federal Reserve tells Wall Street once again that the Fed will always come to the rescue if things get bad enough. Such actions create what in financial circles is called "moral hazard." It is the hazard that financial institutions will engage in ever more risky behavior to seek higher returns, secure in the knowledge that the government will rescue the financial system if it becomes vulnerable to systemic collapse.

This is not a new development, but one that has been growing in proportion for many years as I explained in a previous piece entitled, "When Socialists Take Wall Street." The fact is that as such bailouts become more certain over time, they become more necessary to avoid catastrophic financial collapse. That's because risk taking expands with each cycle of crisis and government rescue. As a result of decades of indulgent U. S. policy toward financial institutions, such risk taking has now expanded to the point where it would have been too risky for the Federal Reserve not to bail out Bear Stearns. Removing the coin from the financial fuse box--that is, letting Bear Stearns go down--would not simply have cut power to Wall Street; it might have made the entire world economy go dark.

But perhaps the most insidious of the current coins in the fuse box is the one that is in the mind of most Americans and perhaps many others across the globe. It is the idea that the high oil prices of the last few years are simply a cyclical phenomenon and that lower prices are sure to follow as the market brings forth new supply. While the market is indeed bringing forth new supply, the question now is whether that supply can keep up with depletion. The evidence increasingly is that it will not and that high prices will become a permanent state of affairs.

The public is aided and abetted in this belief by the soothing pronouncements of the great majority of economists that the operations of the market eventually cure all high prices. It is a message that the public wants to hear and wants to believe is true. And, while it has turned out to be true on many occasions, neoclassical economics is not physics. There are exceptions to its precepts and this exception, if that's what it turns out to be, could be highly destabilizing to our global society.

Waiting for the market to resolve the oil problem on its own may have financial consequences just as severe as regulators feared would have occurred had Bear Stearns gone bankrupt. Imagine for a moment what $200- or $300-a-barrel oil might do to the economy. (In saying this, I am not advocating government actions that would lower prices. Rather I support deep subsidies for a rapid transition to renewable energy funded perhaps by higher taxes on nonrenewable energy.)

Because they are in power for a limited time, it is the habit of politicians and policymakers to temporize. They are simply trying to make it through to the next election. I do not expect any of them to take the coins out of the fuse box. If we want that to happen, we are going to have to do it ourselves, community by community.

1 comment:

Rice Farmer said...

A fine metaphor. And of course politicians -- and now the presidential candidates -- are going to pander to the electorate instead of taking the necessary painful steps to remedy the situation (as we say in the Orient, "Good medicine is bitter").

In reference to the gas tax, it is perhaps instructive to see what is happening here in Japan in that regard. On March 31 the gas tax expired due to political disagreement over its renewal, and gasoline prices plummeted. Everyone was overjoyed. Just one catch: most road maintenance projects were suspended. Since roads, especially if heavily traveled, can deteriorate quickly, this is a serious matter, and it was duly recognized as such.

Now that the reinstatement of the tax on May 1 is virtually assured, Japan's refiners have announced that on that day they'll be jacking up wholesale fuel prices by a whopping 30 yen/liter to cover the tax and recent increases in crude procurement costs. So we have (very dangerous) gasoline hoarding.

The kicker, of course, is the Catch-22 relationship between fuel cost and road maintenance. The Japanese economy is already strained by high fuel prices. But if the gas tax is lowered or eliminated in the future to help people stay on the roads, those roads start falling into disrepair (and road construction costs are high in this mountainous country). It will be interesting to see how this plays out.