As a kid growing up in the frigid northern states, I eagerly awaited April and May when the days of shivering mornings, glove-covered hands, and general misery would be over. But these days, I dread the arrival of the warmer months. Spring and summer are when people take to the roads en masse, which means the price of gas is bound to skyrocket even higher than its current record rates. The average price of unleaded is above $5.00 a gallon and it’s not even May yet. June and July could mean higher prices than we have seen in decades.
The President and both parties of Congress have ratcheted up the rhetoric to explain why prices are so high and what needs to be done. But are they pitching the truth?
World Demand of Oil
Oil executives and Republican politicians would have us believe that the problem with rising gas prices is due to a rise in world demand. The countries of India and China are growing their economies and so have an increased need for energy. It’s easy to blame an increase in world demand because there legitimately is one. China, India, and other countries have increased energy needs, and their purchases of oil have risen to compensate. In fact, China alone has increased its oil consumption 350% above what it used in the 1980s.
To make matters worse, America is not exploiting its oil resources fully. The President likes to say production has risen under his term, but that is deceiving. Production is up, but not from drilling and not from new permits on public land. Private land used for fracking, the process of liquefying rock and extracting natural gas, is the cause. Oil drilling permits have not been issued, and there has not been a new oil refinery built since the 1980s. So those who blame the high price of gas on a demand/supply issue have it right…right?
Wrong, they are incorrect. The problem with this assertion is that the same thing was occurring back in 2008 when prices spiked and “Drill, Baby, Drill” became a campaign mantra for John McCain. Demand was high back then too. But after the election and before Obama took office, gas prices dropped below $2.00 a gallon. If robust world demand increases the price of gas, it would not have dropped in late 2008.
Evil Oil Speculators
Others, including many politicians on the left and television pundits like Bill O’Reilly, have found their target in oil and gas speculators. These are people, or companies, that trade oil futures for profits. In layman’s terms, they “bet” on what the future price of oil will be, and if correct, they make a boatload of money.
Speculators are being blamed for the high price of gas because people believe they are running up the price in order to make a profit. This idea is so strong and persistent, in fact, that Congressman Bernie Sanders of Vermont has written a bill that is designed to stop oil speculation. He is not the only one to call for an end to speculation either. Columnists, pundits, and even the President have called for its halt. The only problem is that speculators are not the reason behind high gas prices.
One of the problems faced by politicians and TV pundits is that often they are called on to speak or fix things they know nothing about. Naturally, and with a public clamoring for quick solutions, this can lead to ineffective or even destructive measures that get signed into law.
In order for a group of people to control the price of anything – oil, stocks, currency, gold – they must be able to move the market. To move the market, they need enough buying power (money) to control demand for the item in question. But the oil marketplace is a multi trillion-dollar market. To control the price long-term, speculators would need at least a third of the market’s size in investment dollars – easily a trillion dollars. But as a group, they do not have that amount of investment dollars. There simply are not enough speculators in total numbers or in combined investment dollars to control the world oil market long-term.
Think of this analogy. Imagine you have a backyard pool. But instead of water it is filled with cherry flavored Kool-Aid. You decide you want to lighten the deep red color, so you pour one gallon of clear water into the pool. But does the color of the pool change? No, because you have not poured enough water into the pool to dilute the Kool-Aid. This is the same principle. There are simply not enough oil speculators to have any significant effect on the large size of the oil market.
The other issue is that most people do not understand what speculators do or how they think. Oil speculators are securities traders. They trade securities, they don’t hold them. In fact, they don’t even care if the market is going up or down. They just care that it’s moving; they can make money in either direction. So, sure, the oil speculators are profiting off the up-trend, but they’re not responsible for it. So the question is: What is causing the move up, if it is not the oil speculators?
The Guilty Party Is the U.S. Dollar
The answer to this conundrum is in your wallet. Take out your wallet, pull out a dollar bill, cut it in half, and you have the answer. The U.S. dollar is not worth what it used to be. This is not a revelation to most people. However, most do not realize how a weak dollar affects the prices of all the things we buy, especially gas. Look at the chart below. It shows the value of the dollar versus the price of oil over much of the last decade.
As the chart shows, whenever the value of the dollar goes up, the price of oil goes down. When the value of the dollar declines, the price of oil goes up. The reason for this is simple. The oil market is priced in dollars, so everyone buys and sells in dollars. The oil sheiks get paid in U.S. dollars, so if the dollar does down in value, they require more dollars to receive the same value. The chart is the simplest way to see adjustments in the price of oil relative to the strength of the U.S. dollar.
The dollar has been in a downward spiral for the last 10 years. It started its downward move under President Bush because he adopted a weak dollar policy to spur the export of U.S. goods. And when President Obama came into office, he accelerated governmental debt spending, and the Federal Reserve began printing money to help the economy. But neither spending nor the printing of more money has helped the economy. Printing more money has led to a diluted dollar and governmental debt also weakens it. The result? Higher gas prices.
As a citizen, it is crucial to know the true reasons behind the problems we face. When you do not, you may create or accept solutions, but discover later that the problem has not been solved. Unfortunately, our recent history is rife with such examples.
In the wake of the Enron scandal, the Sarbanes-Oxley Act was signed into law. It was supposed to stop fraud regarding financial records. But years later, Bernie Madoff was jailed after defrauding billions in large part owed to fraudulent financial records. Sarbanes did not stop it. In 2008, the financial market crashed because of the mortgage market, derivatives, and a financial sickness created by Fannie Mae and Freddie Mac.
Now, we have the Dodd-Frank Act, written by the guys who were in charge of the recently collapsed mortgage market. Though the Act intends to prevent another banking crisis, it does not in any way affect, include, or deal with Fannie Mae or Freddie Mac. A prediction that it will not prevent another banking crisis is easy to make.
Both examples illustrate responses that did not address the real issues behind the events they were supposed to prevent. Congress could make every single oil speculator in the world disappear tomorrow, and yet gas prices would not come down. A Republican controlled Congress and President could order drilling off every single oil hole in America, and in the long-term it would do nothing to decrease gas prices.
Though an increase in supply could lower prices in the short-term, we would still be faced with the issue of a declining dollar. If that is not addressed, gas prices could go even higher. This is especially true since it is unlikely the U.S. will become independent of foreign oil given our current and projected rates of consumption. If, however, we enact policies that lead to a strong dollar and the value of the dollar goes up, the price of gas would come down – even without additional drilling.
Our monetary policy is the most effective means we have to control the price of gas and positively affect the lives of everyday Americans. Your wallet is getting thinner, so to speak, because the dollars bills in it are worth less. That is why gas will be so expensive this summer, in the fall and winter, and in the foreseeable future – unless, of course, the value of the dollar goes up.