Only if the “buck” stops here

Only if the “buck” stops here.

Craig Garbie

We have all noticed how the price of gasoline has risen over time. It certainly can be a source of pain when filling the tank. I know it is in vogue to blame the “evil” oil companies, but the fact of the matter is, prices of just about all commodities have had large price moves over the last several years. Just look around, virtually everything has gone up. Heck, wheat is at an all time high. Where are the people lambasting the “evil” farmers? That is an issue for another time. Demand has risen throughout the globe, so prices will rise. In the U.S., however, we are paying more than many other countries. Let’s get to the real problem, the dollar.

Simply, as our dollar continues to lose value against other currencies around the world prices for us will mostly rise. That is not to say there won’t be periods when prices will not fall, markets generally do not move in a strait line. After all, the dollar has come off its all time lows and wheat has pulled back from its all time highs. Just don’t expect this to continue, the direction of the dollar is lower the direction of commodities is higher.

Several key factors contributed to this unfortunate situation. Interest rates are too low.

We print too much money. Corporate taxes are too high. The government spends too much money. Government policy, for the most part, is the Culp rate. Sometimes the “evil” oil companies may affect prices in the very short time, but in reality they have very little power to do so and certainly have no power to affect the value of our dollars.

What do interest rates have to do with this? The world of interest rate differentials and currency movements is complex but also logical. Think for a moment, if you had you choice of holding in your bank account either euros or dollars how would you make your decision? You would likely make part of your choice based on what interest rate the bank was paying on each. All else being held equal you would take the higher interest rate would you not? So let’s say you originally held dollars and now chose to convert to euros. What happens is you buy euros with your dollars. Now more people want euros less people want dollars. As the demand for euros rises the price of euros rises as measured by dollars. Over time it will take more dollars to buy the same amount of euros. Likewise it will take more dollars to buy anything, oil for example. You see, as people view the dollar as being worth less they will demand you give them more and more of them for that barrel of oil, or anything else.

Printing money has the effect of increasing the supply. An increase in supply without an equal increase in demand will have what effect? Yes, the value will fall. This is an easy one, more and more dollars less and less value. Now we have inflation. Again, if I am selling oil for dollars and the value of dollars has gone down because there are just too many of them floating around, I am going to need you to give me a lot more of them.

Currencies are nothing more than a store of wealth and means of exchange. Another determinant of a currencies value is productivity of the issuing country. This one is a little more difficult to get your brain around. Let’s say there are two villages near one another on an island. One village has very good farmers and craftsmen we will call them the producers. The other just mostly forages for food and essentials; we will call them the foragers. Each village has its own currency, different rare stones found near each village. The village foragers comes to the producer’s village to buy goods. They try to exchange the rare stones of their village for these goods. Only the producers don’t want the stones. What would they do with them? If they went to the foragers village what would they buy since they produce nothing? See the producers stones are a better store of value because they are backed by the things the producers make. Now if the government of the producers decided to take some of the stones and start paying for non essential projects or even overpaying for essential projects, productivity would go down. Less will be produced. Let’s say the government pays for a park, what has been produced? I guess you could say recreation has been produced. Government is taking capital and possibly misallocating the use. The problem is when people aren’t making the choice of what goods and services are to be produced and at what price they are willing to pay, productivity will not be optimal. Hence currency valuation will not be optimal.

Lastly, excessive corporate taxation, plays nicely into our last point. Taxation inhibits the correct allocation and use of capital. I am not saying there should be no taxation because in fact there are necessities that need to be paid for; a common defense is an example. It is excessive taxation that undermines the ability of companies to compete with foreign producers.

We cannot keep capital in this country producing goods if profits are going to be squeezed by taxation issues. Taxes act as an unnatural force between supply and demand. I say unnatural because it is entirely outside the normal factors of production or the normal motivation driving demand. In the case of excessive taxation the corporation is having an impediment to profit put in its path. Now the officers of the corporation have to make a decision weather to produce here or in some other country or even if they will produce at all. Again, excessive taxation inhibits production. Inhibited production harms currency valuations.

Now, unless we can reverse the trend of the dollar, we will continue to pay more for just about everything. There are exceptions, some may benefit from a weaker dollar, but for most the situation is not advantageous. Reversing the dollars decline meaningfully would require interest rate hikes, easing of corporate taxes, and reduced government spending. Hmm, unlikely. Maybe the real problems are not the “evil” oil companies but our “friendly” government’s missteps.