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March 6, 2012, 12:01 a.m. EST
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By Joseph R. Mason
BATON ROUGE, La. (MarketWatch) "” Any motorist on the road can see our domestic energy policy isn't working. It's posted on the prices at the pump, and it continues to rise.
Consumers are rightfully worrying while politicians scramble to point the finger. Certainly there is no shortage of factors to blame "” precarious international markets, political gridlock, poor consumer confidence "” and the list goes on. But a not-so-obvious culprit is causing some of the biggest and longest-lasting impact: misdirected U.S. monetary policy.
Intrinsically, oil prices and the value of the U.S. dollar are inversely correlated "” that is, when the value of the dollar falls, the price of oil increases. Traded in the global marketplace, prices are determined by international supply and demand. When the value of the dollar decreases, oil becomes comparatively cheaper for other countries, who buy more, driving up demand and the price. In turn, higher energy costs at home increase operating costs and diminish productivity, which makes America less competitive globally.
Taking a look at rising oil prices and increased pressure from Congress to regulate oil speculators. Photo: AP.
The Federal Reserve has pursued a strikingly soft monetary policy. Shaped in part by efforts to revive the downturned housing markets, the White House has supported the Fed's commitment to near-zero interest rates. Such low rates incentivize consumers here at home to purchase more, but it also makes the dollar less lucrative to outside investors, thereby decreasing its value.
In 2009, the central bank completed its first round of "quantitative easing," a process in which it injected funds into markets to deflate interest rates to these low rates. It completed a second round, or QE2, in 2011. Oil prices surged in tandem with each. Recently, the Fed signaled again its commitment to zero interest rates through 2014, and already oil and other commodity prices have begun to swell.
Unfortunately, the situation is oddly self-compounding. Low interest rates diminish the value of the dollar, which in turn drive up oil prices. Higher energy costs then increase operating costs and prices for domestic goods, putting the U.S. at a competitive disadvantage to other countries and causing the value of the dollar to suffer even more. As a result, America faces the very real threat of stagflation, a situation in which the value of the dollar is falling as prices increase.
The Fed already knows the economy is susceptible to considerable upset, but has no ammo left in its belt after fighting to bail out banks following the financial crisis. A slower economy on the back of a further rise in oil prices would probably lead to another round of quantitative easing from the Federal Reserve. But lowering interest rates further in QE3 would exacerbate the problem of high oil prices as the Fed bets that monetary stimulus will expand growth to a greater magnitude than higher oil prices hinder growth.
Since rates are already approaching zero, achieving a QE3 on the back of what is already extremely creative monetary policy implementation is very risky. Thus, the Fed is left scraping the bottom of its monetary policy toolbox searching for massively complex solutions to increasingly complicated economic problems.
For consumers here at home, the consequences are tangible. Motorists have watched prices at the pump climb 95% under President Barack Obama to reach a 10-year high, and the zero interest rate extension through 2014 will likely ensure they continue to move in the same direction. Striking the right balance among interest rates is a complex calculation, and it will require making difficult trade-offs. But it's clear pursuing the same tired policy will continue to sap U.S. competitiveness and hurt consumers.
In his State of the Union Address, the president called for an "all of the above" approach to U.S. energy development, and indeed exploring the resources available to us is a practical, and much less complex, way to counter stagflation. Sadly, despite its rhetoric, the administration has delayed, overregulated, and simply killed oil and natural gas projects that would help stabilize markets, cut costs, and increase energy security.
In recent years, the share of domestically produced U.S. oil has increased rapidly, but the trend is the result of previously implemented policy. Under the Obama administration, the permitting rate for offshore drilling has been cut to about a third of its previous level, and the average review process now takes nearly three times as long. Earlier this year, the president very publicly killed the Keystone XL pipeline, which would have created jobs and increased oil delivery from Canada and North Dakota, curbing reliance on supplies from volatile regions of the world.
America last faced the devastating reality of a weak dollar, high unemployment, and increasing prices in the 1970s. The recovery wasn't easy. No one would argue there are numerous factors affecting those figures and the country's economic health, many of which are outside of the president's control. But there are options available, many of which have been poorly utilized or altogether ignored. We need to reconsider our energy and economic policies, and priorities, and create a path forward that will re-establish the U.S. a global leader and innovator.
Joseph R. Mason is the Moyse/LBA Chair of Banking at the Ourso School of Business at Louisiana State University and senior fellow at the Wharton School.
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