Don’t Know Much About Economy…

John McCain has famously said he doesn’t know much about economics. A recent AP wire story by Glen Johnson illustrates as much:

The presumed Republican nominee on Monday proposed a $300 million government prize to whoever can develop an automobile battery that far surpasses existing technology. The bounty would equate to $1 for every man, woman and child in the country, “a small price to pay for helping to break the back of our oil dependency,”

The battery industry has been going through a grueling competition to improve capacity, usable life, size, weight, reliability, and cost for almost three decades, driven by the unlimited needs of laptop computers and mobile phones. Some of that technology has already helped make hybrid cars feasible.

With the hybrid industry heating up due to high gas prices, we can expect hybrid storage batteries to improve a lot as manufacturers compete to provide the best products to consumers. There’s already plenty of money to be made in this business, we don’t need government grants.

If the government actually held such a competition, I expect that most of the manufacturers would not pour their efforts into better technology but into lobbying congress to change the definition of the contest to favor their existing technology. We’re better off leaving it to the free market, which would pay engineers, not lobbyists.

The Arizona senator also proposed stiffer fines for automakers who skirt existing fuel-efficiency standards, as well as incentives to increase use of domestic and foreign alcohol-based fuels such as ethanol.

The market has already punished the automakers for building inefficient vehicles. Industry pundits are predicting the “end of the SUV” because fewer and fewer people are buying them due to high gas prices. With entire vehicle lines going out of business, does McCain really think that automakers need any more incentive to build fuel-efficient vehicles?

And the ethanol thing is just the usual tribute that all politicians pay to the farm lobby.

In addition, a so-called Clean Car Challenge would encourage U.S. automakers to develop zero-emission vehicles by offering consumers the incentive of a $5,000 tax credit when they purchase one.

By comparison, that’s a much better idea. Clean air is a legitimate public good, so government intervention in the market is more justifiable. But, as always, the devil’s in the details.

Of course, McCain is not alone in his ineconomeracy*:

On Sunday, Obama told a Washington audience he would strengthen government oversight of energy traders whose futures speculation he blames in large part for the skyrocketing price of oil.

McCain told a town-hall questioner on Monday that he was unsure of the extent of any oil speculation, but if it has boosted the price of a barrel by 50 percent — as he has heard from some analysts — or just 1 percent, “then it seems to me there should be a thorough and complete investigation.”

If speculators think the price of oil will go up in the future, they will invest in oil now (or in various oil derivatives). This will drive the price of oil up a bit right now. Then, when oil prices go up in the future, speculators will sell their oil stockpiles to make a profit. The extra oil they pump into the market will reduce oil prices.

In other words, speculators will raise the price of oil when it’s low and reduce the price of oil when it’s high. The net effect is to smooth out the highs and lows in oil prices. Both oil producers and oil consumers can operate their businesses better when prices are smooth, so speculators are providing a service. Like everyone else, they make money for their services.

Let’s suppose that McCain and Obama are right, and that speculators have dramatically overestimated the future prices of oil. That would mean that current high prices are due to speculation, not a fundamental increase in the cost of producing oil.

Now consider what happens next: If oil prices aren’t really going up, then speculators won’t be able to sell their oil at a profit. Eventually, they’ll realize this, at which point they will stop buying oil and start selling it to reduce their losses. The sudden glut of oil will depress prices even further.

This rollercoaster ride in oil prices will have been hard on consumers and oil companies alike, but the speculators will really take it in the neck. Their increasing losses will induce the sale of even more oil, which will further depress oil prices. The oil market will go into a death spiral. The oil price bubble will have burst, and all the speculators who bought oil at inflated prices will lose their shirts.

I’m not trying to say that speculators havn’t driven up oil prices—I haven’t a clue—but if they have, they certainly haven’t done it intentionally. And they will pay dearly for their error. No government intervention required.

*Note: I’m trying to come up with a coinage for economic ignorance, like illiteracy or innumeracy.