MARKET CONFUSION:

Market forces have met their match in oil prices (Charles Stein, April 10, 2005, Boston Globe)

In the late 1970s, oil prices soared to unprecedented heights, which set in motion a series of events that ultimately brought prices back down to earth.

By buying smaller cars and insulating their homes, Americans learned to be more energy efficient. Inspired by those same high prices, energy producers looked for new sources of oil and found it in far-flung parts of the world.

The result: Supply rose, demand fell, and prices dropped -- an outcome straight out of Economics 101.

With gasoline prices averaging $2.22 a gallon nationwide, the question to ask is: Could the same thing happen again? Alan Greenspan apparently thinks so. In an upbeat speech last week, the Federal Reserve chairman said, ''History shows that market forces play the key role in conserving scarce energy resources." Greenspan's faith in markets is justified. They do work, especially when it comes to energy.

But Greenspan should have added a caveat. Something like: Energy markets work, but they work pretty slowly, and this time around, there are reasons to think they may work more slowly than in the past.

In other words, don't hold your breath waiting for prices to fall dramatically. [...]

Energy prices are not high enough. In 1981 gasoline prices reached $1.40 a gallon. Adjusted for inflation, the equivalent price today would be $3.20. ''We are not hurting enough yet to provoke a big reaction," said Nariman Behravesh, chief economist with Global Insight in Waltham.

If prices are too low then the market forces that are pushing them up would be working, no? However, given that supplies are adequate there's no reason to believe these prices aren't too high instead and driven by speculation rather than reality.

MORE:
Message to investors: Lose the oil obsession (DAVID ROEDER, 4/10/05, Chicago Sun-Times)

To many people, it's not much of a leap from commodities to inflation, a bane of market performance. But will higher energy prices force families to cut trips to Wal-Mart and their favorite restaurants?

For an answer, I sought out two of the more level-headed thinkers I know: Carl Tannenbaum, chief economist at LaSalle Bank, and Phil Flynn, equities analyst at Alaron Trading. Starting from different perspectives, they come to a similar conclusion: that inflation is tame outside commodities and that the economy isn't as energy-sensitive as it used to be.

Tannenbaum said labor remains the biggest cost driver. The international labor market is plentiful and companies continue to find ways to boost productivity, he noted.

Flynn said commodities merely are reverting to historical growth names after a decade of deflation. People adjust and they save money elsewhere, he said, such as on long-term interest rates that remain low. The energy situation could actually keep the economy out of inflationary overdrive, Flynn said.

"We're in an era where $2-a-gallon gas will be more the norm. People will get used to it, just like they adjusted to paying for bottled water,'' Flynn said.

That reasoning won't alleviate buyers' regret for owners of monster SUVs. But it suggests how Wall Street will work itself out of a funk based more on psychology than business outlooks.

Posted by Orrin Judd at April 10, 2005 10:06 AM