Why Does Gasoline Cost So Much?

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This year, there aren’t any gas lines (though stay tuned), but the price seems outrageous; and in particular, its rate of increase recently has been amazing. Once again, establishment media offer no credible explanation; reports of gas prices often follow weather information, which seems quite appropriate since they have little idea what causes either. But this time, there’s a difference: I’ve not yet seen a fully credible explanation of what’s going on even in libertarian literature. That’s a first.

~ Jim Davies, "Gas Puzzler" from Strike-the-Root.com

According to a recent study, among the things about which the elusive "average American" worries the most, the economy is among the top. What? That anyone, and yes, I mean anyone spends any time worrying about the relative health of a measure so nebulous as the economy is testimony to the abilities of agents of the State to draw attention away from truly important matters and toward completely made-up, nearing bogus, statistics that no one can change. On the other hand, I bet everyone has an opinion, forged with the frustration of a rapidly emptying wallet, about the question that heads this essay.

Not surprisingly, having people worry about "the economy" is also the type of question framing by which agents of the State can obtain almost god-like power. Someone must do, well, something! There outta be a law! Certainly the average Joe knows he can't change the economy, but he still likely believes that "the government" or "the Fed" or Congress or the President can somehow directly affect these areas. Maybe they can affect them, but I remain convinced of one other truth: almost anything they do will have negative and unexpected consequences.

In fact, that is exactly the premise of this essay. As I read Jim Davies interesting piece on STR — quoted above — I wondered right along with him. Why does gasoline cost so much? I do disagree with him a little bit though. There has been no lack of Austrian-flavored scholarship on the matter. Sterling Terrell's basic primer on gasoline economics provided excellent context for the difference between the current price and the historical price. He also showed credible reasons why the typical boogey-men — price gouging and excessive oil company profits come to mind — are not viable alternatives.

One must also, I think, avoid being blinded by rather typical American paternalism. What many people are really asking is: Why does gasoline cost so much in the U.S. now, and why did the price go up so quickly? The simple fact of the matter is that gas has been over $4.00 a gallon outside the U.S., off and on, for years.

It seems to me that two factors are at work.  One is the actual price of the commodity.  The second is the rate with which the commodity has recently approached that price.  My working assumption, based upon the free market based scholarship I've been able to read, is that gas purchased in the U.S. now costs just about what it should, given inflation between now and 1971.  For instance, according to Steven Yates in a very recent piece for the New American:

How much of the rise in gas prices is attributable to the overall rise in prices caused by dollar inflation? One way of finding out is to measure the price of gasoline in terms of “constant” dollars instead of nominal dollars. For instance, in 1971 — the year is significant because that was when President Richard Nixon took us totally off the gold standard — a gallon of gasoline that cost 50 cents a gallon would cost $2.66 today in 1971 dollars, as calculated by the Consumer Price Index. In fact, this is a very conservative estimate of the devaluation of the dollar for the reason that the CPI increasingly underreports the actual overall increase in the cost of goods and services. (See “Dangers of an Underreported CPI” in our June 23 issue.) But even this conservative estimate shows that most of the increase in the price of gasoline from 50 cents in 1971 to $4.00 today is attributable to the dollar’s overall loss of purchasing power, a devastating consequence of inflation.

So (very) roughly, nearly $3.00 of a $4.00 per gallon gasoline price can be accounted for by inflation!  (I won't spend any time debating the CPI. I think we can all agree that it is very conservative.) Even if one tries to use other rubrics, the answer remains the same. As Doug French noted just the other day — comparing the cost of a gallon of gas to "real money" like silver — the value of a gallon of gas is relatively unchanged. The cost of a gallon of gas in terms of the fake, inflation-roasted dollars we all must use, well, that's another story.

The puzzlement – to use Davies' very appropriate term – is that the rate with which the price has approached $4.00 seems much too high for inflation to be the only factor.  (The price has doubled in the last nine months. Inflation, that ain't!) He's correct. He also provides an excellent clue to the answer as well, when he says, "The premise is that the rate of oil price increase proves that no free market is operating." Exactly.

If one was to plot the price of a gallon of gas now and the price of a gallon of gas in 1971 and draw a line between them, overlaying another plot of inflation between now and then, he'd see a gradual rise to the current price and it would all make sense.  Heck, he could probably change the slope of the line to match changing inflation rates in the intervening years and still get an excellent match. So why has the price changed so fast recently? The answer is the same as always: the State did it.

My guess: the controls placed on gasoline prices in the U.S. wore out. Those controls held the prices down, particularly relative to pricing of the same commodity worldwide. When those controls — whatever they were and I don't claim to know — stopped working, the price went up rapidly. When the State uses price-control schemes, and we already know that no truly free market exists in oil, unexpected and negative effects always result.

One quick note about inflation: people often fail to see it as it really is.  They tend to define inflation as a rise in consumer prices, when, in fact, it is growth in what is accepted as money.  In the U.S., the inflation first was directed toward the stock market, and then housing.  When those markets tanked, then it was directed towards commodities and, ultimately, oil. And here we are. In a capitalist economy, over time (provided money is relatively stable) prices tend to fall, which is what we have generally seen.  However, when you have a government that tries to penalize production and engage in the art of inflation, you are going to see commodity prices rise. I think some might refer to the current rapid change in price as a correction, but I'm just guessing. That some might now think the government should impose controls to keep U.S. prices levels at the unrealistic level they had maintained for so long, when the culprit is government intervention in the first place, particularly because of inflation, is truly ironic.

Conclusion

The U.S. almost always used more gasoline than it produced. The U.S. generally exceeded almost every other industrialized country in the relative amount of gasoline consumed, i.e., the demand in the U.S. always impinged greatly on the worldwide supply. The economic fact of the matter is this: gasoline should have cost more in the U.S. than it has long before now! As best I understand economics, the people who use more, i.e., demand more, of something, all things equal, generally pay more. For years, somehow, the U.S. has gorged itself on gasoline while Canada, Europe, and everyone else paid through the nose. Well, now that nations like China are vying for that gasoline, the demand is up even more. Even at that, I'm not sure that the cost has topped out, given the relative cheapness of gas in the U.S. (That's not a misprint.) Don't believe U.S. gas is a relative bargain? Think again. (This data is three years old and still shows a massive difference.) But wait, there's more. I realize that saying Americans still pay less than many people around the world won't make the frustration one feels at the pump go away. Just for yucks, here is a chart, created with a handy web-based tool I found, that compares U.S. and Canadian gas prices, with crude oil prices superimposed.

Notice how Canadians have been paying about $1.00 a gallon more than U.S. consumers for a long time. Notice also, how the recent rate of change for crude oil prices still has not been fully accounted for in the price of either Canadian or U.S. gasoline. Notice too, how the Canadian price shows almost the same shape, only with a different set-point than the U.S. price. (I wonder where that money went.) According to AirInc, a company that tracks the cost of living in various places around the world, "the main factor in [gasoline] price disparities between countries is government policy." No surprise there. Worse yet, the State cannot fix anything without causing another problem someplace else. The size of the proverbial pipeline in the U.S. has been getting smaller and smaller for years, due to crazy regulations, environmental mumbo-jumbo, and just plain irrationality.

Well, guess what? The chickens of inflationary economic policy, combined with extremely non-free-market energy policies, are coming home to roost. Repeat after me: The State is always the problem. I just hope people wake up and don't actually cry out for more of what already didn't work. Yes, I know. I'm dreaming.

Wilt Alston [send him mail] lives in Rochester, NY, with his wife and three children. When he's not training for a marathon or furthering his part-time study of libertarian philosophy, he works as a principal research scientist in transportation safety, focusing primarily on the safety of subway and freight train control systems.

Wilton D. Alston Archives

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