Thursday, January 22, 2009

How We Solved the Gas Price Problem

American memories are apparently becoming shorter and shorter. Various misguided references to the alleged causes and cures of The Great Depression aside, people don't remember that we once upon a time, less than 100 years ago, didn't have a Federal Income Tax, that drugs were legal (and then alcohol prohibited), and that inflation and interest rates were double-digits less than 30 full years ago.

Among the most recent things to be completely forgotten are the high gas prices, peaking in July 2008 with nationwide averages over $4 per gallon and people in California paying $5 on occasion. Politicians and pundits blamed this on "speculators" and called for the government to "do something." Toyota (TM) Priuses were selling at MSRP or higher.

Less than six months thereafter, gas prices had fallen by over 50%, and Toyota Priuses now come with $750 rebates to make them move. Never before did gasoline prices fall so far, so fast. Not even close.

What was the government program that fixed this economic problem? The answer is none at all. The government didn't lift a finger to solve this problem. It let the market do its magic, curing the issue with its own natural self-healing mechanism first described in Adam Smith's The Wealth of Nations [1776]. Sure, there was a lot of huffing and puffing about what people suggested the government should do, but in the end the government did nothing. The problem just went away. No government intervention solved the problem.

Think about it: The one recent problem which the government left to the free market to solve, got solved in record-short time. Contrast this to the ever-ballooning demands for the government to "do something" about the financial and economic crisis. The demands from almost all ends of the political spectra suggest that we drop all economic common sense and instead spend money we don't have.

Think about it again: We got into this mess by borrowing too much, spending too much, and making too many loans. What's being proposed? Let's spend even more, borrow much more, and make even more loans. It's like an alcoholic trying to cure a whiskey bottle's hangover by drinking a whole case worth of whiskey the next morning. If there ever were a more self-evident disaster outcome guaranteed, I can't think of one.

The free market cured the high gas problem in less than six months without the government lifting a finger or spending a dollar. Likewise, the free market would cure the imprudent debt bubble by allowing it to be pierced, seeing prices falling, wages falling and allowing bankruptcies and foreclosures to clean up the imprudent investments into orderly liquidation. Adjusting wages to demand, would guarantee full employment as with any other market price.

In a free market, the current recession would probably be cured within a year or two, and it would allow the government to cut expenses instead of increasing them. Only by dramatically cutting the size of our government, so that we can eliminate the deficit and start paying back the debt, can we restore sanity to our financial and monetary equation, which includes saving the value of the dollar.

As it stands, we are on a path that will put us in Germany's World War I surrender rail car and its 1918-20 aftermath. We will be left with a debt burden so great that the only way out will be massive inflation, as we essentially default on government bonds. Germany was left with a huge war debt after World War I, but because the debt was not denominated in British Pounds or French Francs, Germany simply inflated itself out of its obligations, causing dramatic mis-allocation of resources, societal chaos, the rise of Hitler and the bloodiest war (World War II) in its wake.

In our case today, the debt-explosion path that we will apparently be pursuing, will most likely also mean a massive inflation when we eventually print the money to pay off the bond buyers (read: The Chinese). China has one of the soundest economies in the world today, with low or nonexistent public and private debt, and high growth, but it has invested its surpluses largely in U.S. government bonds. Whoops! All that the Chinese worked for during the last decade, will go up in smoke. And in the wake of the Chinese losing their savings invested in U.S. government debt – another war? We are clearly playing with fire, taking on all this debt to finance unprecedented levels of government spending.