Thursday, September 18, 2008

Inflation myths

Myth # 1: "Dependence on Foreign Oil"
This myth basically suggests that the problem with oil prices is due to America's "dependence" on foreign oil. One of the worst economic myths, it plays on economic nationalism and on xenophobic feelings that are sometimes pervasive in the United States.

The high price of oil has nothing to do with its origin; the price of oil is determined in international markets. Even if the United States were to produce 100% of the oil it consumes, the price would be the same if the worldwide supply and demand of oil were to remain the same. Oil is a commodity, so the price of a barrel produced in the United States is basically the same as the price of a barrel of oil produced in any other country, but the costs of labor, land, and regulatory compliance are usually higher in the United States than in third-world countries. Lowering these costs would help increase supply. Increasing supply, whether in the United States or elsewhere, will push prices lower.

Importing a product does not mean you "depend" on it. This is like saying that when we "import" food from our local supermarket we "depend" on that supermarket. The opposite is usually true; exporters depend on us, since we are the customers. Also, importing a product usually means buying at lower prices, whereas producing in the United States often means consuming at higher prices. This point is proven when we see the cheap imports we can purchase from China and the higher prices of many of these same products manufactured in the United States. The amazing thing is that the protectionists claim, on the one hand, that America should be "protected" from cheap imports, but when it comes to oil, they say we should be "protected" from "expensive imported" oil.

Most, if not all, of the higher price of oil can be explained by the expansion of the money supply or the debasement of the dollar. The foreign producers are not at fault; our national central bank is the culprit.

Myth # 2: "Inflation is caused by rising oil prices."
False. If the money supply were to remain constant, then an increase in the price of one good, such as oil, would cause a decrease in the price of other goods. If more money is spent on oil, then less money will be available to spend on other goods. This will in turn cause a drop in the demand for other goods, which will subsequently cause a drop in the prices of these goods. The reality is that inflation is always a monetary matter, caused by the increase in the money supply due to the interest-rate-easing policies of central banks.

Myth # 3: "Current inflation is being caused by the increased demand of millions of new consumers in China and India."
At first this myth might seem true. Millions of new Asian consumers have entered the market, thus, there is higher demand for most goods, which would apparently cause higher prices. What is being overlooked is that these new consumers are also new producers. In general, most people produce far more than they consume, because most workers have to produce more than what they earn in wages (if not, they lose their jobs). While it is true that demand has risen due to these new consumers, supply has increased even more, due to their increased production. This can clearly be seen by the frequent drop in prices of most goods being manufactured in China. On the other hand, the only way these new workers can increase their consumption beyond what they produce is through credit. Thus we return to the real culprit behind inflation: credit expansion due to central banks' intervention in the financial markets.

David Saied


At 8:19 PM, Anonymous Anonymous said...

No, the problem with foreign oil is that it means billions a year pumped to the saudis who fund terrorism.

At 7:01 AM, Blogger Mutton Chops said...

There are so many problems with your logic in this post but I'll just attack this one...

"What is being overlooked is that these new consumers are also new producers. In general, most people produce far more than they consume, because most workers have to produce more than what they earn in wages (if not, they lose their jobs)."

What is constant (for the most part) is natural resources. It is the rise in natural resource prices which have a limited supply (boosting supply usually involves higher costs since marginal finds are more expensive). You only talk about labor and the production of goods. The problem with China is their demand for raw materials (which are finite).

At 7:35 AM, Blogger angryroughneck said...

Mutton chops: If money levels remain constant then an increase in price in one are ultimately has to mean a decrease in value of something else.

The main point is that inflation is a monetary issue not a natural resource issue.

Rising commodity prices are a symptom of inflation not the cause of inflation. Commodoties have real value, so when money value is dilluted through inflation their relative value rises almost instantly.


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