The Real Reasons For Your Pain At The Pump | Business Week

U.S. policies have caused the dollar to fall, leading OPEC to hike prices - Robert Kuttner

<BW>...... 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.

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.

Is it fair to blame the cheap dollar on the Administration? It is, and here's how the dots connect. 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....... </BW>

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