Blaming the Buck

The lead editorial in today's Wall Street Journal (subscription required) attributes much of the recent increase in oil prices to the weakness of the dollar, and to the monetary policies of the Federal Reserve. As evidence for this argument, they present a chart of the relative value of oil in dollars, Euros, and gold for the last eight years. Although the editors make the obligatory nod to the growth of demand and problems of supply, they contribute to the general sense that our energy problems can be blamed on some unaccountable party: OPEC, oil companies, or now the Fed. This absolves us from the contribution of our personal consumption habits, while failing to differentiate cause from effect.

The Journal is hardly the first to notice the inconvenient relationship between a depreciating dollar and higher commodity prices. Among others, I suggested a few months ago that this might constitute a worrying feedback loop, with higher oil prices further weakening the dollar, a weaker dollar driving up oil prices, and so on. A closer look at the relative value chart in the editorial provides a sense of the relative importance of this factor among the many affecting global energy prices. Using gold as the measure of price stability ignores its status as an important industrial commodity, participating in the same global commodity trends affecting steel, copper, grains, and other goods affected by the sustained rapid growth of China, India and other developing countries. If instead we choose the Euro as our proxy for stable value, we see that the real price of oil has at least doubled since 2000, reflecting the 11% increase in global oil demand that consumed the surplus production capacity that had been left after the collapse of oil prices in the late 1990s, along with virtually every barrel of new capacity put into service since then. A weak dollar exaggerates but did not create this trend.

The other implication raised by the editorial is that Federal Reserve policy might offer a mechanism for pushing oil prices back to more comfortable levels. There's something to this, though the cure might be worse than the disease. A couple of interest rate hikes could pull the dollar out of its current slump, and lower oil prices would likely follow, not just because the dollar would be more valuable, but because the US economy would be pushed into recession, thereby reducing estimates of future US demand and easing speculative pressure on oil. That's hardly an appealing scenario, however.

What we're left with, then, is an interesting observation about another consequence of US policies that have generally promoted consumption but not production--and not just for oil--but one that offers no real help in addressing the problem. That lies with the fundamentals of supply and demand, more sensible energy policies, and the creation of a public consciousness that connects the results of policy and personal choices with the price at the pump--whether denominated in dollars, Euros, or ounces of gold.