Storytelling In The News: #118

Getting the straight story on rising US energy prices

April 13, 2004

When bad things happen to us, there is tendency to tell stories assigning blame to some external agency, preferably someone a long way way away from us, and to absolve ourselves from our own responsibility for our problems.

The sad lament of John Snow

Such is the case of US Treasury secretary John Snow who spelled out the growing US concern about rising energy prices on Monday April 12, describing production cuts by the Organization of Petroleum Exporting Countries as "most unwelcome".

Prices are already high, but more bad news is also on the way. According to the Financial Times, gasoline futures hit an all-time high in New York after the International Energy Agency raised its forecast for global oil demand for the sixth month in a row.

Asked on radio about rising petrol prices, Mr Snow said: "We are very concerned and the actions by Opec in reducing its quota are most unwelcome. We have let Opec know that we don't think well of these actions. The situation is a serious one."

Other foreign factors can also be pointed as contributing to the problem. Increased supply has been far outstripped by surging demand, especially in China. A report by the official Chinese news agency showed that imports rose 35.7 per cent year-on-year in the first quarter. Meanwhile, concerns about instability in key oil-producing nations such as Iraq and Venezuela are boosting prices.

The specter of surging prices at the petrol pumps is obviously causing Snow worry about the the effect on the US economy in an election year.

The real reasons for the pain at the pump

Snow might however do better than complaining about OPEC by reading Robert Kuttner's article in BusinessWeek on "the real reasons for your pain at the pump."

The culprit isn't so much OPEC as it is U.S. financial policies that have caused the dollar to fall, leading OPEC to hike prices. Kuttner notes that hardly anyone is talking about what is probably the most important reason behind the current runup in oil prices -- the weak dollar.

Kuttner points that those who recall the first OPEC oil shock in 1973 will remember the central role played by the weak greenback. In the period from 1971-73, the U.S. ceased being able to maintain the Bretton Woods system of fixed exchange rates, with a dollar pegged to gold at $35 an ounce. Dollar devaluation ensued, followed by floating exchange rates. For OPEC, this reduction equaled a huge cut in revenue, because oil is priced in dollars. Since OPEC is a cartel, it has a fair amount of pricing power. Dismayed by the lost income and irritated at Western support for Israel in the 1973 Arab-Israeli war, the OPEC nations decided, for the first time, to use that power to extract a large oil price increase. The U.S. economy suffered accordingly.

Now fast forward 30 years. The dollar has again lost a large part of its value (over 40% against the euro since 2002, and more than 20% against the yen). For oil-producing countries, this equals another enormous revenue loss, and they are raising prices to make it up. Indeed, if oil were priced in euros, OPEC's revenue per barrel would not have taken a hit. In addition, as in 1973, Arab nations are less than thrilled with Washington's Middle East policies. Once again, gasoline prices are soaring.

Who's responsible for the dollar's decline?

Is it fair to blame the cheap dollar on the Administration? Kuttner says it is, and here's how he connects the dots.

First, the Administration's tax and budget program hasn't produced enough purchasing power for ordinary people. Despite one month of good job growth, median wages have not kept pace with inflation. Consumer and business debt are high, and the economy is not generating enough jobs and consumer buying power. The economy also suffers from a chronic trade imbalance that is increasingly structural. With fiscal policy exhausted, the Federal Reserve has had to come to the rescue with very cheap money. Extremely low interest rates, of course, yield a weaker dollar.

That can be laid at the Administration's door for another reason.

Countries with irresponsible fiscal policies find that their currencies lose respect in global currency markets. As budget deficits have gone skyward, confidence in the dollar has gone down. Some foreign exporters, Toyota Motor Corp. (TM ) for instance, choose to absorb the exchange-rate loss and take an earnings hit rather than lose U.S. market share. Others, such as purveyors of fine French wines, have raised dollar prices. But the oil cartel is a special case that is able to engineer its prices -- indeed, that's the definition of a cartel. Gasoline, unlike French wine, is a necessity with no near substitute. Most consumers just absorb the increase because they have to.

Some observers have contended that the high price reflects refining bottlenecks or increased global demand. Despite increasing demand from China, overall oil consumption is projected to go up only about 2% this year. The main culprit is OPEC's manipulation of the price of crude, most recently with a 4% production reduction, which in turn reflects the cheap dollar. March and April are months when home heating costs decline and the expenses of summer air conditioning and vacation travel have not kicked in yet. Other things being equal, energy prices should be enjoying a seasonal decline.

How will this story play out politically? The connection of soaring prices at the pumps to the cheap dollar, the Bush tax reductions, and climbing budget deficits may be obscure to the average voter. But it doesn't matter if most voters miss it, since they tend to judge incumbent Presidents by a visceral response: Is the economy good or bad for me? High gas prices are one more reflection of an economy that still feels bad for millions of Americans.

Bottom line

Rather than rail at OPEC, it would be more helpful for Snow to consider revising his story to include the contribution of his own policies that have led to a weaker dollar, and so to higher gas prices.

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