Gas Price Worries - Are Policy Changes Necessary?

The continued increases in gas prices has sparked a considerate amount of political talk because of its widespread impact on almost every single American. This article by Nelson Schwartz from the NY times looks at reasons why the oil prices continue to hit record highs.

Schwartz believes that the basics of demand and supply cannot account for the steady climbing of prices by citing adequate supply of oil available. He finds that the answer lies in the falling dollar. The depreciation of the dollar is causing investors and traders to move their investments into crude commodities such as oil to hedge their portfolio risks. Since the oil market is a global market that is not being affected by domestic currency devaluation, investments in these goods are more stable in comparison to the dollar. The same story goes for gold prices. Since the dollar depreciation, gold prices have continued to raise, also hitting record highs. The institutional shifts of investments, by large investment institutions, into oil has caused informal investors and less informed traders to also move in this commodity. This signaling has only exacerbated the problem of inflated gas prices.

The blame for this exacerbation has been placed on these informal "speculative" traders. Therefore, the potential political response to these bad traders is to raise margin requirements for these trades. Higher requirements would force traders to take less risk because they would be forced to back up their positions with more equity. Schwartz doesn't seem convinced that these traders are the fundamental reasons why prices are so high; however, he believes that it is still worth trying.

Personally, I don't believe that speculative trading is the core reason for the price hikes in oil prices. It does, however, provide a convincing scrape goat and a easy solution. Seeing how politicians are more adverse to inaction than to actual efficacy, this seems that this policy response is adequate to keep them happy - even if it doesn't actually solve the problem. Yet, I remain skeptical that there is even a pricing mismatch problem in the case of oil as Schwartz outlines.

My gut feeling is that current oil prices are anticipating higher costs in the future due to more regulation on carbon emission. The internalization of these externalities is necessary and universally understood in economics as the best way to move towards better efficiency. However, no one said it would be an easy, painless process. These high prices will be born by everyone in the economy and are just the beginning of what is necessary to move the nation, and eventually the world, to a more efficient frontier.

Quick solutions now might cause politicians and their constituents to feel better about themselves. But, in the end, I believe that higher prices of goods are just what we should expect in the horizon because we are in the painful process of internalization of previously unaccounted externalities.