Ever had to read something five times to make sure you didn’t imagine it?
That seemingly happened to half the UK press Tuesday evening as they perused the transcript of opposition Labour Party leader Ed Miliband’s party conference speech. Said Ed: “If we win the election in 2015 the next Labour government will freeze gas and electricity prices until the start of 2017.”
On the surface, it’s easy to see the appeal—energy is expensive! What consumer wouldn’t want two years without price hikes?! Problem is, price freezes never work—they mess with normal market forces, creating shortages and ultimately fueling inflation. It’s happening today! Argentina, Brazil and India all have various price controls, and all are struggling to contain inflation—inflation that has worsened with price caps in place—and maintain economic growth. Price ceilings are historically bearish for stocks, too—not to say the UK has a bear market if Labour wins in 2015, but equity investors should keep this possibility in the back of their minds.
Specifically, they should think about the early 1970s—the era of the three-peat Oakland A’s, David Bowie’s greatest hits and The Bob Newhart Show. It’s also when President Nixon uttered the following on live TV: “I am today ordering a freeze on all prices and wages throughout the United States for a period of 90 days. In addition, I call upon corporations to extend the wage-price freeze to all dividends. I have today appointed a Cost of Living Council within the Government. I have directed this council to work with leaders of labor and business to set up the proper mechanism for achieving continued price and wage stability after the 90-day freeze is over.”
Like Miliband, Nixon was gunning for votes. It was August 15, 1971—the eve of the 1972 campaign—and the plan was extraordinarily popular. Inflation wasn’t abnormally high, but the fear was there. Price freezes seemed like a safety blanket.
But they aren’t. Ever. Prices are how we allocate scarce resources. Without flexible prices, the only choice is rationing—which means supply shortages. Even if governments don’t resort to official rationing policies, firms will do it on their own. When prices are fixed at a certain level, producers tend to fix output—without the ability to raise revenues, they have to reduce costs to protect margins. And when potential margins are tiny, there isn’t much incentive to sell at a high volume—they’ll just sit tight and bide their time until controls are gone. And, once that happens, prices shoot up—supply is still limited; plus, businesses have lost ground to make up.
That’s what happened in the 1970s—price controls bred shortages and rationing, some of which took years to sort out. Nixon’s decision to end post-Bretton Woods currency controls—effectively taking the US off the gold standard—is often blamed for the era’s high inflation. Yet the imposition—and eventual abolition—of price controls is the real culprit. What was only intended as a 90-day freeze turned into nearly three years of attempts to artificially force prices down. Sure, it seemed to work at first—CPI moderated from 4.4% y/y in August 1971 to 2.9% a year later. But then—with price controls (including controls on interest rates) still in effect—it crept up as shortages arose. By the time the scheme was abandoned in April 1974, CPI was at 10.1%—and then it rose further still, peaking at 12.2% in November. US stocks suffered. A bear market began in January 1973 and lasted 20 months, with stocks falling 48% peak to trough. Recession took hold in November 1973 and lasted through February 1975.
Now, Miliband isn’t proposing economy-wide price controls—only on gasoline (petrol to the Brits) and home energy. But the impact likely proves similar to what the US experienced in the 1970s. For one, with a good two-year warning, firms have ample time to hike prices in advance of the freeze—and might very well hike them above what the market would have otherwise determined. Once the controls take effect, suppliers will cut back wherever they can, likely rationing power and slashing investment. In 2017, when the freeze ends, they’ll probably ratchet up prices. And then, prices could keep rising as the lack of investment comes home to roost—if firms don’t invest preemptively to build new plants to replace aging ones as they go offline, supply stays pressured. We’re seeing that now as a lack of investment in North Sea oil in recent years has brought declining production (and higher prices) as facilities and technology age.
The timing is especially suboptimal when you consider all the UK stands to gain from shale developments. Regulators greenlit hydraulic fracturing last December, and analysts estimate shale gas could power the UK for decades—and power it much cheaper than today. With time and investment, market forces could well tame energy prices far greater (and more sustainably) than price controls could. But investment results from profits. If price controls whack Energy firms’ margins, this progress won’t happen. Heck, with Labour currently polling eight points ahead of the Conservative Party, firms could very well start pulling back in the near term, just in case, robbing the UK of an important economic lifeline.
It’s tough to envision sometimes, but even one misguided policy can throw an economy (and markets) off track—unintended consequences are viral, no matter how well-intended the legislation. Make no mistake, helping folks withstand higher costs of living is a very benign—even noble—goal. But often, the best way to reach this and similar goals is to remove the barriers preventing capital from flowing efficiently. The UK removed two big ones last year, when quantitative easing and the fracking ban ended. And a third looks set to evaporate at year end, once banks are done adopting Basel III capital requirements and have more flexibility to lend. What will likely benefit the UK—its economy, markets and, most importantly, people—most is simply time for things to play out amid much freer markets.
Show me a price control, though, and I’ll show you failure. Should they become likely in the UK, investors will have a big risk to consider.