Memo To: Professor Thomas DiLorenzo
From: Jude Wanniski
Re: Oil Standard, or Gold?
As a professor of economics at Loyola College in Maryland, you have become known to me as a staunch supply-sider of the Austrian school, if you don’t mind me putting it that way. That is why I was interested to read, on the Mises Institute website, that you were critical of Dick Cheney’s comments on Meet the Press last Sunday. I actually was impressed with Cheney’s defense of his argument two years ago that OPEC’s decision to cut oil production to raise the price of a barrel from its lows of $10 was a good one. From his vantage point as CEO of Halliburton, a major Texas oil-service corporation, Cheney then saw the impact that low price would have on the availability of capital investment -- and that the disruption would lead to the shortages that now have driven up prices of oil and oil products. On the Sunday show, Cheney criticized the Clinton/Gore administration for not having a national energy policy, one which would keep the energy price from being too high or too low, which is what led you to entitle your column “Cheney's Energy Socialism.” When I then e-mailed you that Cheney was “groping his way to a gold standard,” I'm afraid I did not make myself clear, Professor, which is why you replied with puzzlement, noting that Cheney had said nothing about a gold standard. As you put it: “Calling for a ‘national energy policy’ to stop oil price fluctuations is an appalling statement for a Republican (or anyone) to make and a far, far cry from Ronald Reagan's principled advocacy to abolish the Department of Energy and put an end once and for all to ‘national energy policies.’ Such policies can only be viewed as watered-down central planning. I'm unaware that Cheney has ever said anything about a gold standard.”
I apologize for not being clearer and will try again. Here is what I meant:
As CEO of Halliburton, Cheney noted what I would call a "convulsion" in the energy industry during the five years of his tenure. In a brief period in the middle of those years, the world price of oil dropped from $23 a barrel to $10 a barrel, an astonishing collapse. It meant, temporarily, a windfall for consumers of oil and gas, and here at home at the gas pump the price of a gallon of gasoline fell as low as 90 cents.
In that environment, as Cheney has pointed out, the world oil industry stopped investing in new exploration and production. There is, we know, more than a trillion barrels of proven reserves in the world, a supply that is projected to last more than 40 years even if no new oil fields are discovered. Private enterprise will not invest in the process of getting that oil out of the ground and to the markets where it is used unless the return on that investment is commensurate with the risk. With oil at $10 or below, a dollar of such investment could not possibly recover the cost, let alone produce a profit, so the oil industry stopped in its tracks. The risks shifted to the consumers of energy, who now, taking it for granted that supplies were in surplus, paid no attention to the fact that the world oil industry was in mothballs, waiting for a recovery in prices. Neither President Clinton nor Vice President Gore had a clue to what was going on. The Secretary of Energy, Hazel O’Leary, interested only in globetrotting, sharing nuclear know-how with the Chinese, and keeping her friends at Greenpeace happy, knew less than nothing of the gathering crisis about which Cheney was warning.
OPEC, at this point in 1998, met to limit production of oil from existing infrastructure in order to increase the price to a point where profits could be made. Cheney spoke favorably of those measures, which is why now he is being excoriated by those who blame OPEC for the price of gas at our pumps, in some cases exceeding $2 a gallon. Cheney's retort is that the volatility of prices in the free market is the cause of this distress, which would have been alleviated if in 1997 the price of oil had not fallen as far as it did and which now would not have to rise as high as it has to invite production.
You of course are correct that an "energy policy" designed to smooth out these swings would necessarily have to be accomplished by government and properly would be considered “socialistic.” When the capitalist market does not serve the needs of the masses of people, the masses of people become biased in favor of socialist ideas. I say the "masses," because the elites are quite content to pay $1 a gallon or $2 a gallon, and lecture the masses on how the market is a self-correcting mechanism; if allowed to work through the law of supply and demand, it will in time get the price of gasoline back to its correct equilibrium point in the galaxy of prices. The "left-wingers" in society do everything they can, of course, to incite the masses to attack the oil industry and insist that it be taxed and regulated to make it behave. They do so whether the price is “too low,” and thus devastating the environment by spewing greenhouse gases into the environment, or “too high,” which results in a “rip-off” of poor people.
You and I both favor a gold standard, Professor, but do not consider it to be “socialistic” to have the government absolutely fix the dollar/gold price. When I said that Cheney was "groping his way to a gold standard," this was the case as he tried to figure out why the price of oil jumped around so much. He knows it is not good for the industry to have oil move from $25 to $10 then to $30. Oil is a major part of the daily lives of the world's producers and consumers of all goods and services, which means such volatility disrupts those lives. Planning becomes difficult for all, impossible for many -- those who get wiped out in the swings, as a good part of our independent oil industry did in 1998-99.
As an admirer of the work of Ludwig von Mises, I used his teachings on monetary deflation to see how the Federal Reserve policies of Alan Greenspan were inviting these swings in the dollar oil price. I saw before others did that the decline in the price of GOLD that began in November 1996 was the result of Fed errors in managing the floating “greenback” dollar -- and that unless the Fed took action to arrest the decline in the gold price, the price of oil would fall and so too would prices of other commodities that come from the earth. In other words, if our central bank had not made a series of inflationary, then deflationary, mistakes in managing the world’s most important unit of account -- the dollar -- the price of oil would have remained stable and so too would the prices of all other commodities. Notice I said “stable,” not fixed. Only the gold price need be fixed to the dollar, providing one precise unit of measure around which all other prices can fluctuate in relatively narrow bands to account for real -- not monetary -- changes in supply and demand.
It was Canadian economist Robert Mundell, 1999's Nobel Laureate, who first noted this close connection to gold and oil. When President Nixon cut the dollar link to gold in 1971, Mundell predicted there would soon be “a dramatic rise in the price of oil, and thence all other commodities.” Conversely, when the price of gold fell, it seemed reasonable to me that there would soon be a dramatic decline in the price of oil -- and thence all other commodities. I tried to persuade Fed Chairman Alan Greenspan then that by starving the banking system of liquidity in late 1996 and 1997, the gold price would fall, precipitating a monetary deflation. When he dismissed my warnings, I then explained the problem to Sen. Bob Torricelli [D-NJ] and asked him if he could get me a meeting with President Clinton. He called President Clinton’s chief-of-staff, Erskine Bowles, who in turn asked then Deputy Treasury Secretary Lawrence Summers to meet with me, to hear my concerns. I did so in his office, in April 1997, and while he dismissed my concerns about the declining gold price, did say he would be happy to have me stay in touch. I’d done my best, Professor, but you know it is not easy being taken seriously when you bring the yellow metal into the equation. If he were asked today about all this, Alan Greenspan would acknowledge my warnings well in advance of the collapse of commodity prices in general, oil in particular. So would my clients, particularly those at the Independent Petroleum Association of America and the American Farm Bureau Federation. They tell me now they wish they had paid more attention to my warnings.