Sunday, June 08, 2008
Don't discount inflation's role
From the RoundTable blog
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Norb Weckstein
Weckstein, of Roanoke, is a retired engineer and manager from GE, and has an MBA from Virginia Tech.
Recent letters to The Roanoke Times have been pointing fingers for the current high gas prices at the limits on supply from the Saudis and restrictions on drilling in the Arctic. They could have also noted the costs from our having limited refining capacity for converting oil to gasoline, and the pricing-to-achieve-maximum-profit approach of the industry leaders. These all have a partial effect, but the primary reason seems very different.
The international price for a barrel of oil has been traditionally stated in U.S. dollars, but a dollar isn't worth what it used to be. So it takes more of them to purchase any product -- be it oil or baby food. The U.S. dollar index is a measure of the value of the dollar compared to a specified market basket of other established currencies. Seven years ago, the index was about 119; today it is close to 72. So today's dollar is worth about 60.5 cents compared with its value in 2001.
If the dollar were still valued at the 2001 level, a gallon of gas would cost $2.42. In 2001, the price per gallon actually was about $2, so it appears that if the value of the buck had been held at the 2001 level, that extra 42 cents could be due to the scarcity factors noted above. The rest, about $1.58 per gallon, or 39.5 percent of the $4 price, is due to the lower value of the dollar.
Why is the dollar valued so low? The answer is complex, but it is only a slight oversimplification to say that it is primarily because the Federal Reserve has wanted it to be.
Actually, the dollar is regarded by the international market as a commodity. Speculators (big banks) buy dollars when they think it is a good investment, and they sell them when it is not. This market sets the international value of the dollar.
The Fed affects this in two ways. First, it sets the target interest rate that the holders of dollars will earn when they loan money. The Fed has been lowering this Federal Funds Rate, from 6 percent in 2001 to 2 percent currently. Obviously, international investors will be looking to buy and use currencies that can pay them higher rates, and several stable foreign currencies do just that.
Second, since we went off the old gold standard many years ago, the dollar is not backed by any tangible reserve. The Fed can just run the printing presses and issue as many dollars as it wants. And it recently did this by making billions of dollars in low-interest loans of "new money" to the large banks that were suffering under the mortgage crisis. Currency investors downgrade the value of the dollar in proportion to the increase in the total dollars in circulation.
Why would the Fed want to cheapen the value of the dollar? There are several reasons. One, even though the stated dollar price of the goods we produce is higher, the real value of those goods (in index adjusted dollars) is lower. This makes the cost of U.S. exports cheaper to countries with stronger currencies, and this can improve our balance of trade with those nations. Second, it makes the pain of repaying our national debt easier. Any dollars we borrowed in 2001 can be repaid at dollars worth only 60.5 cents. And, the lower interest rate makes new borrowing less expensive, making it easier for entrepreneurs to invest in expansions or new ventures And third, even if we produce no more goods, stating their value in terms of the inflated dollar makes it seem as if our economy is growing (when it really is not). But, most important, it makes borrowing money less expensive and makes it easier for entrepreneurs to invest in expansions or new ventures.
But, while these actions may improve the national statistics, they negatively impact the citizenry.
Putting more dollars out there, chasing a fixed bag of commodities, ramps up the price for each item to accommodate the larger number of dollars in circulation. This is called inflation and is demonstrated by the rise in prices for gas and for all raw materials.
While debtors are helped by the cheaper dollar, savers are doubly penalized. Their dollar savings are now worth less in real value than when they deposited them, and the interest that the banks are paying on those savings has been reduced to a level that is less than the level of inflation. So they are really losing money on those savings.
Further, the government intentionally understates the level of inflation so employers or other entities with pay rates indexed to inflation do not have to pay increases that match the real inflation levels. Since salaries seem to be staying pretty stagnant, the lower cost of exports is largely attained by paying the workers in cheaper dollars -- effectively, paying them with a smaller basket of commodities. And, of course, this also applies to Medicare payments to doctors, Social Security payments to retirees, etc.
Consequently, while it may be satisfying to blame things on outside interests, we cannot ignore the fact that a very big reason that we are suffering at the gas pump, and in other areas, is largely the result of intentional fiscal actions by agencies of our own government.
