While America’s left-leaning millennials weren’t around for the 1970s, some of the people who served in government during the 1970s are still around, and one of them is Philip Verleger, president of PKVerleger and an analyst who specializes in commodity markets. Over the years, Verleger has authored more than 100 articles and books about commodities. He also worked on energy policy during the Ford and Carter Administrations after getting his PhD in 1971.
It’s this first-hand experience that gives him special insight into why price controls don’t work, and also why it’s only a matter of time before the Biden Administration brain trust moves to bring them back.
The problem with price controls, as Verleger explained during a recent MacroVoices interview with Erik Townsend, is that they create “distortions” in the market which feed through and influence producers’ willingness to ramp up production, effectively exacerbating the underlying cause of high prices in the first place.
Here’s more on that in an excerpt from their interview:
Erik: Now, there are a lot of people that are beginning to talk about price controls. I personally have a pretty strong bias that that’s never the right way to solve a problem. But a lot of people think it is. Are price controls potentially a good idea and regardless of whether they’re a good idea, are they likely coming or not?
Philip: Oh, God. Oh, God. So when I had color in my hair. It is very gray now. I went to work in the Ford administration at the Council of Economic Advisers. And the focus and the reason I went there was to get us out of price controls. I stayed at the US Treasury in the Carter administration because I got asked by the Secretary of Treasury to help get rid of crude oil price controls and I managed to help lead the effort to get us out of price controls. The Energy Department’s didn’t. And as for getting us out of it, I was rewarded by being asked to draft and think of a windfall profit tax. These are not good ideas. Matter of fact, they’re terribly bad ideas. The distortions they caused if you go back and look at the World War Two experience and and I got into this business because my grandfather’s good friend had been a senior official in the Roosevelt administration had in fact run the price control programs for well had been ahead of the descent of St. Louis Federal Reserve.
And he, you know, told me all when I was in high school, all the problems with price controls. I cannot I can’t screen but I don’t, you don’t want them. Now, so that is a terrible idea. There are some controls that might help. One of the things and there’s the report I sent you. I sent for Notes at the Margin. I’ve been following very closely how hedging of call options on crude and on crude oil has exacerbated the volatility of oil prices. One of the steps that one could take is to require people who write calls on these say $300 call on oil be fully covered. That is if a firm writes a calls on 100 contracts, it must be long 100 contracts under all our modern derivatives models. If I write a call today on $300 oil for 100 contracts, I only have to have about a third of a contract. 1/3 of a contract I need to cover that to hedge it.
And if price goes up, I have to buy more. S, and Javier Blas wrote a great piece for Bloomberg in January 18 saying Wall Street was about to take the oil market on a wild ride. And it has because as I do the numbers, the number of calls out there are so large that every time somebody says well, oil prices might maybe should go up about 50 cents or something like that, it gets magnified to $5. So you don’t want price controls. The financial markets are out of control. And as Blas said, people are buying lottery tickets on oil. It’s you know, it’s the odds are better buying call options on oil right now or call options on natural gas in Europe than they are on betting on a sporting event. You know, you just look at the handle in the sporting events and how much it goes back to the better versus what oil is and oils earning much better returns. That needs to change. That could change. But you don’t want to tax and you don’t want just sudden taxes on oil and you don’t want price controls.
So, why are policy makers and academics still kicking around a revival of price controls? At the risk of sounding excessively cynical, Townsend and Verleger put it succinctly enough: It’s the policy corollary to Murphy’s Law. The best policy ideas are impossible to push through. And the worst ideas…will inevitably be put into practice.
Erik: I couldn’t possibly agree more Phil that we don’t want price controls. But the very fact that it’s such a bad idea almost tells my cynical mind that it’s more likely to happen if government’s in charge. You’ve been through this once before in the 1970s event for some of us that are a little bit younger than you are. Tell us a little bit more about maybe what people have forgotten about price controls. How that went and why it’s such a bad idea but also for fatalists like me who think it’s probably coming even though it’s a bad idea. What do we need to be thinking about as investors in terms of getting ready for it?
Philip: We agree 100%. You know, it’s an economic policy. If there’s a really great idea, it’s almost impossible to get it through and if it’s a bad idea, it almost always happens. That seems to be Murphy’s Law or move Murphy’s corollary. The problem with price controls essentially is that… Let me rephrase that the problem with price controls are… this is plural. The Myraid, of details that you have to get into to make them work. When we went into this in 1971 50 years ago. 50 years ago plus six months, they froze them for 90 days. For 90 days okay you can just freeze prices and most things will be fine. But if you go much further, then you start to say well we have a problem here. We’ve lost some capacity here or something else and we start having to make adjustments. And it means you have to start building a bureaucracy. And we built a bureaucracy called the Cost of Living Council in the 70s. And they were looking into everything, and everybody had to file all this information. And then you had to, you know, if you had a problem, then you can apply to get a special exemption. We had special courts, temporary court, emergency Court of Appeals which was not very temporary. You know, it’s a rabbit hole once you go down it. There’s so many details that you have to start looking at, that’s a problem.
Perhaps another clue lies in the analysis of Credit Suisse’s Zoltan Pozsar, who has in a series of notes published this year theorized about the birth of a new commodities-focused monetary regime which he has christened “Bretton Woods III”. While contemporary central bankers are accustomed to controlling the money supply via balance-sheet expansion and NIRP, they’re mostly powerless to counter soaring commodity prices (short of engineering a brutal recession that succeeds in crushing the ‘demand’ side of the supply vs. demand equation).
Once President Biden’s latest attempt at countering sky-high oil prices proves to be a failure, the only options left will be 1) gas stimmies, followed inexorably by 2) price controls.
Readers can listen to the full MacroVoices interview with Verleger below:
Sun, 04/03/2022 – 19:00
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Author: Tyler Durden