Is It Gas Prices, Or The Dollar, Stupid?

It’s fun watching the Obama Administration’s insincere contortions over gasoline pump prices, since Obama’s claims that he wants lower pump prices so palpably fly in the face of his latent “energy-prices-will-necessarily-skyrocket” philosophy, not to mention discrete decisions like blocking Keystone.  But perhaps Obama’s economic advisers are telling him (assuming that he listens to them—there is much evidence that he doesn’t) that gasoline prices could well abort the fragile recovery and send the U.S. economy back into a recession.

That at least is the warning that you get from the work of James Hamilton, an energy economist at the University of California at San Diego, who has published several compelling papers showing the link between oil price shocks and recessions going back to 1950.  In one recent paper he states:

All but one of the 11 postwar recessions were associated with an increase in the price of oil, the single exception being the recession of 1960. . .  The correlation between oil shocks and economic recessions appears to be too strong to be just a coincidence.

Among other things, Hamilton’s work suggests our domestic auto industry, barely back on its feet, may slump again: “[O]ne of the key responses seen following an increase in oil prices is a decline in automobile spending, particularly the larger vehicles manufactured in the United States.”

Meanwhile, Larry Kudlow and other literate observers have long argued that a weak dollar is often a leading culprit in higher global oil prices, since oil is priced and traded in dollars.  Brian Domitrovic, an economic historian you’re going to be hearing a lot more from in the years to come, writes at this week that it was the weakness of the dollar that was the trigger for the bursting of the housing bubble and subsequent great recession starting in 2007:

The most obvious problem with the economy during its mild boom from 2003 to 2007 was sectoral. There was way too much investment in things like housing, energy, and commodities.

Here are the stats. The Case-Shiller housing index blew past its usual secular peak of a 15% increase and went up by 90%. Oil did even more, retracing the upward march to $35 a barrel it had made in the 1990s, this time not stopping till it crashed through $100. And gold, which had been parked at about $300 an ounce for two decades, kept lifting its head up after 2003 such that it was brushing $1,000 by crisis time.

Given this lay of the land, you want to ask one question. Why the mad dash on the part of capital for housing, energy, and commodities?

Traditionally, activity of this sort will mean one thing: people aren’t trusting the dollar. Housing (which is to say land), energy, and commodities are all classic hedges against superfluous dollar production.

The implications of this are important, for it suggests the dominant narrative of the economic crisis is wrong, and as such that much of the policy response (especially Dodd-Frank) is equally wrongheaded:

To mistake credit default swaps, subprime mortgages, easy loan approvals, and all the rest with the fundaments of the crisis is to fail to ask why markets for these things suddenly materialized out of nowhere from 2003 to 2008. It would be news if these things had developed outside of major dollar devaluation. But since they in fact developed in the face of major dollar devaluation, the real story cannot be the financial sector’s accommodation of the new dollar weakness, but rather the fact and origins of that weakness itself. . .

Real leadership requires calling things as they are and taking responsibility for past actions. In this election year, and as our great economy still only pokes along, it is time to get serious and admit that the major economic arms of the federal government, the Federal Reserve and the Treasury, mismanaged the currency. . .

Read the whole thing, as the saying goes.

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