Economists Don't Understand High Oil Prices

A story in today's Washington Post centers around what seems to be a growing consensus that economists and industry "experts" don't understand exactly why oil prices are rising as rapidly as they are.

The Saudis refused Bush's entreaty to boost production because they didn't want to get caught holding the bag when the prices inevitably drop. They stated that supply and demand are currently balanced and that they didn't want to disrupt the equilibrium.

Some people are blaming speculators, citing some $90 billion of investment money being pumped through the markets in the last two years.

Everybody points the finger (at least partially) at China, which has become the flagship for the rapidly developing world. Certainly China, India, Brazil, and other rapidly developing countries are putting stress on demand, but then, at least according to the Saudis, supply is in balance with demand. Many of those same developing countries are heavily subsidizing oil and China particularly has been cited for hoarding oil in preparation for the Olympics.

Congress seems to think that OPEC is the problem in that they are keeping prices artificially high. The problem with that thesis is that it seems more likely that the weak dollar is to blame for OPEC's high prices. After all, can we really expect the OPEC countries to continue accepting $20 per barrel that is worth about half as much internationally as it was just a couple of years ago?

Further circumstantial evidence that it is actually our own fault that oil prices are rising so rapidly in this country is that, if you'll notice, every time that crude prices hit a new high the Dow drops about 200 points or so (270 yesterday). My theory in the correlation between oil price spikes and stock market tumbles is that all that money being leeched from the stock market is being pumped into the commodities markets which have seen exponential price growth, not just for oil, but also for corn, rice, and natural gas. As the demand for commodities futures rises, so does the price.

Ultimately, I think that high oil prices are a function of a confluence of factors: irresponsible financial policies on our part, both at the macro- and micro-levels (e.g. the credit markets and hyper-consumption); rising demand around the world as former 3rd world countries begin to industrialize and compete; different rules for different players (e.g. China buys its oil through state-negotiated contracts and does not pay market price); and over investing in commodities market as the boom and bust cycle that has plagued Wall Street over the past 20 years creeps into new territory.

The US solution is probably not going to lie in a business as usual approach, but rather we will need to innovate. We will need to move past the oil economy and into a new age. The problem is that no one really knows what resource will fuel the next era. Interestingly, this seems to be the first time (at least that I can think of) that humans have needed to transition from the fundamental mover of the economy (e.g. stone, bronze, copper, iron, etc.) due to pressures on the resource pool instead of simply using the technological gains of one age to bring about another.

The clock is ticking on the oil age. Global warming threatens the relative environmental stasis we have enjoyed throughout most of human history. Oil supplies are dwindling as new sources become more and more scarce. The question is whether or not we can transition from the oil age before it happens on its own.