Greenspan & Those High Oil Prices Jude Wanniski October 15, 2004

Memo To: Alan Greenspan
From: Jude Wanniski
Re: Record Oil Prices

Just a few minutes ago, Alan, I caught your talk in Washington on the record oil prices that are discouraging the financial markets. There is plenty of wisdom in your comments, as I especially agree with your debunking the idea that the world is running out of oil. We have discussed this issue several times over the last 30 years, from the time I was writing the energy editorials for the Wall Street Journal in the 1970s. You know that the fourfold jump in the price of a barrel of oil in 1973, from $2.50 to $10 a barrel, was not because the world was running out of oil, but because President Nixon had "floated the dollar" in August 1971. In other words, the dollar price of gold had floated up fourfold, to $140 from $35, and the Arab oil producers simply followed suit in order to maintain the real price of their oil.

Where I take issue with you is where you blame the high dollar price of oil today on factors other than the monetary policy of the U.S. You say, for example:

These heightened worries about the reliability of supply have led to a pronounced increase in the demand to hold larger precautionary inventories of oil. In addition to the ongoing endeavors of the oil industry to build inventories, demand from investors who have accumulated large net long positions in distant oil futures and options is expanding once again. Such speculative positions are claims against future oil holdings of oil firms. Currently, strained capacity has limited the ability of oil producers to quickly satisfy this markedly increased demand for inventory.

Adding to the difficulties is the rising consumption of oil, especially in China and India, both of which are expanding economically in ways that are relatively energy intensive. Even the recent notable pickup in OPEC output, by exhausting most of its remaining excess capacity, has only modestly satisfied overall demand. Output from producers outside OPEC has also increased materially, but investment in new producing wells has lagged, limiting growth of production in the near term.

The fact is, Alan, that these are all minor factors relative to the wide fluctuations in the dollar price of gold over the last dozen years -- swings which of course could not have occurred had the U.S. still been on the Bretton Woods gold standard. Remember I tried to warn you in early 1997 that unless you persuaded your Fed colleagues to switch from targeting the economy to targeting the gold price, that gold's decline would soon lead to a decline in the price of oil and all other commodities? As I made that argument to you repeatedly, even face-to-face, you surely remember.

In retrospect, you might admit that I knew what I was talking about. Oil fell from $25 bbl to below $10 in January 1999 and all other commodity prices collapsed as well. And it all happened because you decided "the gold signal" that you had been following all your adult life was no longer an indication of anything important. The press corps and political establishment feted you as "the maestro" because you had brought inflation down to almost nothing, but in the process the world energy industry shut down. It could not invest in infrastructure with costs of $15 a barrel when it could only sell oil for $10 bbl. I can't blame you completely, Alan, because everyone and his brother disagreed with me and agree with you. Still, you should have learned from the experience. Here you said today:

Although OPEC production quotas have been a significant factor in price determination for a third of a century, the story since 1973 has been as much about the power of markets as it has been about power over markets. The signals provided by market prices have eventually resolved even the most seemingly insurmountable difficulties of inadequate domestic supply in the United States. The gap projected between supply and demand in the immediate post-1973 period was feared by many to be so large that rationing would be the only practical solution.

Ah, the power of markets! Eventually, you note, markets have adjusted to supply and demand conditions in the world energy market. How nice that markets still work that way, but I'm afraid that "eventually" is not good enough, which is why we and the rest of mankind are burdened with $50+ oil when the price should be closer to $28 bbl.

For goodness sakes, Alan, you were a gold guy for almost your entire life, appreciating that its signal was instantaneous, not "eventual." Big difference, no? People make mistakes. President Bush made a biggie when he warred against Iraq and he may not be re-elected because of it. You made a biggie when you disavowed the gold signal. You don't have to bare your breast in public and ask forgiveness, or anything like that. Just make an adjustment in your public posture and bring the gold signal back into business. Every day you do not causes some unnecessary misery to someone in the world as you are one of the two or three most powerful men on the planet.