Oil prices finally hit $100 a barrel this week, albeit
briefly, but breaking through that symbolic barrier is ominous and
higher gasoline prices are sure to follow. Supply disruptions in
various places and surging demand in China and India are part of the
explanation for this decade's upward trend in oil prices. But perhaps
the biggest factor has been largely overlooked: the decline in the
value of the dollar.
Since 2001 the dollar price of oil and gold have run
in almost perfect tandem (see nearby chart). The gold price has risen
239% since 2001, while the oil price has risen 267%. This means that if
the dollar had remained "as good as gold" since 2001, oil today would
be selling at about $30 a barrel, not $99. Gold has traditionally been
a rough proxy for the price level, so the decline of the dollar against
gold and oil suggests a U.S. monetary that is supplying too many
dollars.
We would add that the dollar price of nearly all
commodities -- from wheat to corn to copper to silver -- are also
surging, a further sign of a weakening currency. On Wednesday alone the
price of wheat and soybeans increased 3.4% and 2.8%, respectively. That
follows a 75% increase in their price in 2007 -- which ran ahead of the
oil price, which gained a mere 57% for the year. Neither OPEC nor China
caused food commodity prices to rise like this. The main culprit here
is a global loss of confidence in Federal Reserve policy and the dollar.
This state of affairs is all too similar to what
happened in the commodity markets in the 1970s -- particularly the
energy markets. Oil price spikes in that stagflationary decade were
driven less by OPEC than by the weak-dollar policies pursued by the
Fed. Gold in that decade broke from its traditional $35 an ounce
mooring and climbed as high as $850 in 1980, before Paul Volcker began
to restore the Fed's credibility.
Another way to consider the impact of the weak dollar
is to examine what would have happened if the dollar had simply kept
pace with the euro in this decade. What would oil cost today? Not $100,
but closer to $57 a barrel. The nearby chart gives a sense of the
comparative trend since 2000.
A weak dollar has been trumpeted in the business media
and especially among manufacturers as a strategy to lower the trade
deficit. But this strategy makes imported oil a lot more expensive. The
trade figures reveal that a major contributor to the rising trade
deficit over this decade has been the high cost of oil imports. We
don't worry about the trade deficit -- except in so far as it inspires
protectionism -- but those who do might want to consider that the weak
dollar policy they are cheering is making fuel very expensive.
We aren't saying that supply problems and an increase
in relative demand haven't played a role in oil's rise. Cambridge
Energy Research Associates estimates that "aggregate supply
disruptions" reduced oil supply by almost two million barrels a day in
late 2007, which isn't helping prices. But the high price of oil is not
a vindication of theorists who say we are confronting "peak oil."
A report issued this summer by the National Petroleum
Council and energy experts across the spectrum concluded that "the
world is not running out of energy resources," though it conceded that
"there are accumulating risks to continuing expansion of oil and
natural gas production from the conventional sources." Daniel Yergin of
Cambridge Energy notes that in the energy markets "most of these risks
are above ground, not below ground." By that he's referring to the
tendency of politicians to intervene in the energy markets in any
number of harmful ways. We'd offer barriers to drilling in Alaska and
on the Continental Shelf as Exhibit A and B in this country.
Rising oil prices act like a tax on American
consumers. With the economy slowing, the Fed is now under intense
pressure to cut interest rates to stimulate the economy and provide
liquidity to the banking industry. But if this causes the dollar to
continue to weaken, the tax of higher commodity prices will offset much
of the "stimulus" from looser money. The Fed will get a lot less bang
for its easier buck.
The larger danger here, as we've been warning for some
time, is that the U.S. seems to be returning to the Carter-era economic
policy mix of tight fiscal policy (tax increases) and easy money. Add
barriers to oil and natural gas production and you have a recipe for
higher oil prices and slower growth. In a word, for stagflation. The
Reagan-Volcker policy mix of the 1980s changed all that, but maybe we
have to relearn the hard way every generation or so what works -- and
what produces $100 oil.
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