Sunday, May 23, 2010

Oil confusion.

On Sunday's Meet the Press, New York Times columnist Tom Friedman said America's addiction to oil played a role in reducing the dollar's value.

This is a troubling error from the country's most important foreign policy analyst and extends the life of a canard that has distorted American policy for more than three decades.

In 1971, President Nixon, desiring to spur economic growth, closed the London gold window so he could increase the money supply.

This decision, along with an earlier decision to raise taxes, reflected the era's ascendant economic policy framework -- loose money and high taxes -- as proposed by Keynesians James Tobin and Paul Samuelson. The supply-side policy mix formulated by Robert Mundell -- sound money and lower tax rates -- was a direct repudiation of Tobin/Samuelson, which explains the Keynesian establishment's hostility towards it ever since.

Any how, with the dollar delinked from gold, the greenback fell, losing half its value against gold within a year and half again the next year. By 1973, the gold price had increased from $35 to $140.

Realizing they were being paid in dollars worth a quarter of their prior value, the oil producing nations quadrupled the price per barrel from $2.50 to $10, shocking the American economy and angering the public.

Rather than own up to its weak-dollar error, the establishment blamed OPEC for raising prices. As the dollar's decline became evident in the rising general price level, cause and effect were reversed; the argument emerged that higher oil prices had trickled through the economy, causing inflation.

This theory stuck. To this day, American policy is built on the premise that the oil producing nations can arbitrarily raise the oil price, thereby increasing the inflation rate.

See here, here and here for more.

1 comment:

  1. Tom Friedman's remarks are most likely largely based on the implications of the oil spill in the Gulf. The great big elephant in the room which is starting to appear like it's going to have some effects on offshore drilling operations. If the damage is as large as it is contemplated by some to be then all bets are off. It's interesting to note that the USD slipped on Friday against most currencies, not just the Euro. If it continues to slip on Monday this will begin to be confirmed.

    All the beaches of the Gulf states could become polluted stinking wastelands for decades to come. Yes, that is the extreme but not entirely unlikely.

    If drilling offshore is curtailed, America has no oil!