When the head of the European Commission recently said that the European Union (EU) would break the link between natural gas prices and electricity prices, I was surprised her comments didn’t receive widespread media coverage. Natural gas is the source of 24 percent of electricity in the EU, so eliminating the effect of natural gas prices on electricity prices seems like a pretty significant feat.
If the EU shuts down its natural gas fuel electricity plants, that would certainly decouple natural gas and electricity prices, but I don’t think that’s the plan. Instead, it appears that European Commission President Ursula von der Leyen intends to control energy prices by imposing price caps on the rates various EU electric districts could charge end users. The Belgian Energy Minister warned that the next five-to-ten winters in Europe will be terrible unless the EU quickly imposes price caps on gas prices.
Not only can government not suspend the dynamics of supply and demand by simply passing a law, attempts to do so usually worsen the problem.
In 1971, Richard Nixon attempted to replace the laws of supply and demand with a 90-day freeze on wages, prices and rents, followed by the creation of something called the Cost of Living Council. This council administered and approved nation-wide pay and price increases for two years. During those two years, businesses sharply reduced investment in new production capacity, while at the same time, consumers attempted to increase their purchases of goods and services.
Increased demand, combined with stagnant and declining supply resulted in a predictable outcome: empty grocery store shelves and long gas lines. And as backward as it sounds, government price controls also resulted in ten percent annual inflation.
It’s difficult to effectively intervene when you don’t actually control the resources.
Price discovery is the process by which buyers and sellers decide the market value of a product. When prices freely adjust, it provides a constant signal to buyers and sellers about how much of a product to purchase or produce. Higher prices catalyze new supply.
When an entity with a cash printing press interferes in price discovery, it produces warped consumption and production patterns. For examples in the US, see health care, higher education and housing. It is no accident that the cost of Medicare-covered medical procedures has skyrocketed at the same time the prices of cash-pay health care services have declined. Or that the monetary value of a college education hasn’t kept pace with its cost. Or that new housing construction has fallen almost two million units behind demand.
If you think the price of a necessary commodity is expensive, just wait until the government puts a cap on its price.
David Moon is president of Moon Capital Management. A version of this piece originally appeared in the USA TODAY NETWORK.