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Forgetting The Fundamentals In Regard To Oil And Afghanistan.

By       Message Lawrence Velvel     Permalink
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July 21, 2008

 Re:  Forgetting The Fundamentals In Regard To Oil And Afghanistan.    

            Forty plus years ago, when friends and I were young, recently graduated government lawyers doing tax or antitrust work in Washington, D.C., five of us used to carpool to and from work every day.  There occasionally would be a subtraction from and consequent new addition to the cast, but it was always limited to five as I remember.  How many men, after all, some of them pretty sizable, could you squeeze into a VW bug, which is what I had. 


            The other members of the group were very bright fellows who went on to prominent professional careers in law firms.  One, whom I will call Jacques, had graduated first in his class at the Harvard Law School, gone to work for a prominent Midwestern-based law firm, and, around 1964 or 1965 (I don’t remember exactly), had come to Washington temporarily to write briefs in and argue Supreme Court tax cases for the Solicitor General, who was then Archibald Cox, I believe.  In later years Jacques became the highly regarded managing partner of his prominent law firm, which grew into one of today’s behemoths.

            Jacques had an unforgettable way of arguing.  When a question was being debated, he would start at square one.  To take a hypothetical, non legalistic example, if the debate were over the merits of two different kinds of chairs, Jacques would begin by saying, “To create a chair, you must first take a piece of wood.”  (Or metal or plastic.)


            This type of argument -- beginning at square one -- could be very frustrating because most arguments assume the basic premises.  We all know what the hell a chair is, after all.  When debating which of two chairs is better, we don’t have to be told that to have a chair you must first start with a piece of wood (or metal or plastic).


            Yet, there can be real value in Jacques’ style of argument because too often we ignore the basics, the fundamentals.  Too often we argue and reach conclusions on the basis of assumptions which are false and which cause our conclusions to be wrong.  So there can be real value in going back to basics, as they say.  It sure didn’t hurt Jacques, who was an immense success. 

            Two especially prominent examples of ignoring the basics are in the news these days.  One deals with the price of oil.  It was pointed out here a long time ago -- a couple of years ago, I think -- that the price of oil was rising because of speculation on the oil futures markets, that the oil industry had existed without futures markets for its first 100 years or so, and, if memory serves, that the oil companies had welcomed the creation of futures market because they knew they could peg their prices to the price on those markets and the markets’ prices would likely be higher because of speculation.  This information was obtained from a Naderite expert whom I interviewed on television and who approved the accuracy of the written work that was set forth here and was based on what he said.


            At the time, however, you simply could not get anyone in the mass media to mention even the possibility that the futures markets were responsible in whole or in part for rising oil prices.  Caught, as ever, in the eternal mediocrity of the prevailing conventional wisdom of the moment, the MSM would not get near the idea that speculation on the futures markets could be responsible for the price rise.  I had the unforgettable experience of listening to Tom Ashbrook conducting a one hour discussion of rising oil prices on his national radio show “On Point” without Ashbrook or any panelist so much as mentioning the possibility that the futures market could be contributing to the rise in oil prices.  Amazingly, the very Naderite whom I had interviewed, and who had approved the accuracy of written work posted here, was one of the panelists, and he too completely failed to mention speculation in the futures markets.

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            I phoned Ashbrook’s (call-in) program before it was over to ask on the air why they were ignoring the futures markets.  But naturally they would not put me on the air to ask the question.  (Such a question might interrupt the otherwise conventional wisdom they were purveying, right?)  So, in high dudgeon as the saying goes, I wrote an email or a letter strongly criticizing their failure to so much as mention speculation on the futures markets as a possible cause of the increases in the price of oil. 


To my shock, a young woman who had done the research for and, I think, written the questions for, Ashbrook’s program replied to me.  When we spoke she seemed to feel guilty in a way that they had ignored the effect of the futures markets.  She told me that they had not been able to get anybody (aside from the Naderite, I guess) to agree that the futures markets might have anything to do with the price of oil.  So they felt they could not have the question discussed on the air.  She told me to find material agreeing that the futures market had an effect (material she inadequately had been unable to find) and explicitly said, or plainly implied, that if I did they would use it on the air.  I did (in Senate reports).  They didn’t.


            So in thrall to the conventional wisdom and the views of big shots is the MSM, including NPR and people like Ashbrook, that they wouldn’t even allow the effect of the futures market to be discussed on the air.  Wow.  No wonder so many millions of us despise the MSM. 


Today, of course, the conventional wisdom has somehow changed 180 degrees.  Today people are saying right and left that speculation on the futures markets is the cause of the run up in the price of oil.  Some are even saying it is the whole story.  One expert told Congress that, but for the speculation, the price of oil would be about $60 per barrel.  Now the oil industry shills, and the Wall Street type investment shills and economic shills, find themselves in the position of desperately trying to persuade Congress that the futures markets are good things, desirable things, things that are useful to legitimate hedgers and so on (though we didn’t have or need oil futures markets for about 100 years, until financial types figured out they could make a killing from them, no doubt).  The shills are trying to once again get people to believe the price of oil is governed solely by legitimate supply and demand, insufficient exploration, and so forth.


            But in all the sturm and drang of the new conventional wisdom and its continuing opponents (who’ve made fortunes from bovine defecation about oil in the past), people are ignoring Jacques’ point that, to have a chair, you must first start with a piece of wood.  Here is what I mean:

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            It is a basic principle of economics, -- perhaps the basic principle of economics at least since Alfred Marshall if not long before him -- that price is supposed to consist of the cost of producing a good or service plus a reasonable profit.  (Profit is actually considered a cost in economics, but this is no never mind here.)  But nobody -- I mean nobody -- is claiming that the price of oil these days is based on its cost -- including production and transportation, plus refining cost when you’re discussing fuel.  The great thing, so to speak, about the futures markets is that they have enabled price to be totally divorced from cost -- the price goes up because speculators think there will be future panics that will drive price even higher, etc. etc., and the question of cost plus reasonable profit doesn’t come into it, doesn’t get within a thousand miles of it, even though the concept of price being based on cost plus a reasonable profit is a fundamental basis of the capitalist system.


            Basing price on cost plus profit is the way most businesses are forced to operate, of course.  Yet there have been many prior cases in history in which companies obtained the power to set prices far higher than cost plus profit.  Often, even usually, these were in industries that were monopolies or oligopolies.  The problem was met by imposing regulation, or breaking up companies, or opening markets to new competitors -- often foreign ones.  And maybe I am just ignorant, but I have never heard of the problem being solved by the use of futures markets.


            It seems to me that in considering what to do about the price of oil, our legislators should consider the question of how you bring prices back down to where they represent costs plus a reasonable profit (with due account being taken of exploration costs, which are a cost of doing business in the oil industry).  Maybe you have to do away with the speculating financer’s friend, the futures markets.  Maybe you need a law forbidding oil companies from pegging their sales prices to prices on the futures markets.  Maybe you need to have regulation of prices.  But whatever you have to do, it seems to me that the politicians and the ignorant media should start focusing on the piece of wood which you need to build a chair -- should start focusing, that is, on the basic economic principle of what is the cost plus a reasonable profit to produce oil and gasoline, and what do you need to do to ensure that the price is at that level, not at some artificially high level set by a speculative futures market on which some financers make killings while hundreds of millions of ordinary people get screwed at the gas pump.

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Lawrence R. Velvel is a cofounder and the Dean of the Massachusetts School of Law, and is the founder of the American College of History and Legal Studies.

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