Seeking to shift blame away from the Federal Reserve and the Nixon White House for the oil shocks of the early 1970s, the late Herbert Stein said, “My devotion to the old-time religion is not so great as to make me believe that M1 or the full-employment budget deficit determines the amount of rainfall in the Russian wheat lands, the location of Peruvian anchovies or the decisions of the oil cartel.”
Seeking to shift blame today, politicians in Washington have brought oil executives before Congress twice to explain their profits, and just recently voted 389-34 to fine oil refiners and wholesalers up to $150 million if they’re caught “gouging.” Just last week, the Republican congressional leadership proposed a $100 rebate check to supposedly compensate U.S. motorists for the high price of fuel.
Alternatively, various economists and pundits cite the growing economies of China and India as the main reasons for expensive fuel today. These rising economies without a doubt are major factors, as is our own expanding economy. Importantly, the demand-driven price signals that result from economic growth will lead to more oil exploration and arguably lower prices for all commodities in the future. And while supply and demand inarguably play a role in setting the oil price, the dollar’s role is largely unsung today, just as it was in the 1970s when expensive oil first became a political issue.
The consensus view of the 1973 oil shocks is that the U.S. was the victim of an Arab oil embargo that resulted from its support of Israel in the Yom Kippur War. That oil prices rose over 300 percent during the timeframe in question certainly bolsters this view. Leaving aside the fact that Iran and Iraq did not participate in the embargo, what’s easily forgotten is that commodities not impacted by OPEC machinations were booming too.
Indeed, meat prices were rising at a 75 percent annual rate in 1973. From 1972 to 1973 the cost of a bushel of wheat rose 240 percent. Soybeans rose from $3.50 a bushel in 1972 to $12.00 in 1973. Since commodities are priced in dollars, a change in the dollar’s value has an instantaneous impact on the spot price of those commodities. The greenback’s fall in the aftermath of Bretton Woods in a sense made a broad commodity rally inevitable. Looked at in this light, while the Arab factor coupled with regulations and price-caps on fuels in the U.S. were largely to blame for the 1970s energy crisis, Fed policy unhinged from the disciplines of Bretton Woods must take part of the blame.
Moving to the late 1970s, the consensus view is that OPEC’s failure to boost output amidst the Iranian revolution explains the oil shock that closed the decade. The facts suggest otherwise. The price of a barrel of oil did increase, but it was largely a United States phenomenon relating to the falling dollar. While the dollar price of oil rose 43 percent from 1975 to 1979, the price of oil in Japanese yen rose just 7 percent, and in German marks it rose just 1 percent. In Swiss francs the price of oil actually fell 7 percent.
With oil presently trading in the $70 range, today we hear that greedy oil executives, historically high demand in China and India, political uncertainty in Iran, excessive consumerism, and restraints on domestic drilling and refining have combined to bring on the 164 percent rise of oil since the summer of 2001. That list is pretty good if you leave out the greedy CEOs and the gluttonous consumers — the Herbert Steinesque exogenous factors that have nothing to do with expensive oil. What is inappropriately left off that list, however, is that over the same period of time the dollar price of gold has risen 169 percent while copper has risen 373 percent.
All of the above could be attributed to demand, but as commodities are priced in world markets, it’s notable that over the same timeframe the price of oil in euros has risen only 66 percent, and in copper, 200 percent. That the euro price of gold has risen 70 percent is evidence that as opposed to a pure supply/demand phenomenon, part of today’s commodity boom is attributable to central banks printing too much money relative to demand.
The years since we left the relative currency stability of the Bretton Woods era have shown how movements in the value of the dollar and other currencies greatly impact the value of commodities, including and most notably oil. Numerous explanations have been offered up about today’s oil price, but the dollar’s considerable role has not often been mentioned.
As a recent Wall Street Journal op-ed by Marc Sumerlin noted, “Domestic oil producers, venture capitalists and entrepreneurs don’t know whether the price of oil in the next decade will justify the costs of investments they must make today.” Sumerlin’s point described the secondary effect of currency instability on supply, and the resulting oil price. The falling and unstable dollar is having a large impact on the nominal price of oil today. And so long as the dollar’s value is uncertain, so too will be investment in and exploration for oil.
– John Tamny is a writer in Washington, D.C. He can be reached at jtamny@yahoo.com.