Re: Wall Street Journal Editorials — The Fed Caused the Rise in Food and Oil Prices?

In numerous unsigned editorials, The Wall Street Journal has argued that cutting the federal funds rate to 2% from 5 1/4% last September has been the main reason prices of crude oil and food commodities have soared in recent months. Such commodities are priced in dollars and the dollar was generally falling through February, though not in the past two months (even though the funds rate was reduced by one percentage point).

An April 28 editorial, “The Fed’s Bender,” notes that “since 2003 the dollar price of oil has climbed far more rapidly than the euro price — 273% in dollars, compared to 146% in euros.” It is not likely that the whole 2003-2008 picture reflects “the European Central Bank’s sounder monetary management,” as the editorial implies. The euro had dropped to below parity with dollar until late 2002. And the fed funds rate was repeatedly increased from 1% in 2003 to 5 ¼% in mid-2006 (well above the ECB’s equivalent 4% rate). The euro rose partly because it had first fallen, but also for reasons other than central bank interest rates (economists have no reliable model for forecasting floating exchange rates).

The editorial boldly concludes that “had the dollar merely retained the same purchasing power as the euro, today’s price of oil would be below $70 a barrel.” That is a counterfactual exercise that makes little sense.

Even if we accept the half-true premise that the dollar-euro exchange rate is sensitive to relative short-term interest rates, the dollar might have “retained the same purchasing power as the euro” by having the ECB lower interest rates to 3% and the Fed to keep ours at 3%. Or the Fed might have kept the funds rate at 5% and the ECB at 4%. Although either option might have stabilized that particular exchange rate, they would not have had the same effect on global economic growth and therefore on the world demand for oil.

If oil had been priced in dollars and the euro had not appreciated against the dollar, then the euro area would not have been as insulated as it was against the rising cost of oil. Because demand is responsive to price (particularly business demand), Europe would have bought less oil than it did. Or, to use the editorial version, if the U.S. still faced $70 oil then we would try to buy more. Either way, the price in dollars would not have remained the same.

The Economist index covers the prices of 25 commodities, excluding oil and gold, with food accounting for 56% of the index. By April 22 it was up 31% for the year and 3.7% for the month, when measured in dollars.

That was mostly because of food. Industrial commodities were up only 1.6% for the year.

If we are going to blame the rising price of oil and food commodities on the dollar, do we need a different theory to explain why industrial commodities have barely risen?

Here’s another anomaly: Measured in British pounds, the commodity index was up about the same as it was in dollars—31.6% for the year and 4% for the month. That can’t be because Britain has a weak currency—the pound buys 8.9% more dollars than it did a year ago. It can’t be because the Bank of England cut interest rates too much, since 3-month interest rates are 5.86% in Britain, compared with 1.97% in the U.S.

I happen to agree that the Fed (and ECB) have paid too little attention to the impact of exchange rates on prices of internationally traded commodities. And I suspect the Fed has already gone too far with rate cuts and will have to put rates back up shortly after the election. But to single-out a few sensitive commodity prices that have risen the most (in dollars or pounds) and blame just those prices on the Fed is going too far.

I Have a Dream …

… that one day, corporate executives will tire of being bullied by demagogic politicians. I was reminded of that dream by a press release issued yesterday by Sen. Pete Domenici, ranking member of the Senate Energy and Natural Resources Committee and long-time Republican major-domo on energy policy. Sen. Domenici asked the heads of the five largest oil and gas companies in America (BP America, Chevron, ConocoPhillips, ExxonMobil, and Shell America) to promptly send reports to his office “explaining” their individual corporate investment strategies with particular attention to their work in the “clean energy” sector.

In my dream, Senator Domenici would get a reply like this:

Dear Sen. Domenici:

We appreciate your interest in our corporate operations, but we are too busy at the moment to expedite your request as outlined in your letter dated April 30. You write in that letter that you are interested in a compilation of all previously released, publicly available data on this matter. Accordingly, we suggest that you put some staffers on the job and compile those reports for yourself. To help you on your way, you will find enclosed our 2007 Annual Report.

That having been said, Senator, we answer to our stockholders, not to you. Our investment strategy is our business, not yours. While we are happy to discuss our perspective on the energy market and the merits of existing and proposed public policy, we are not interested in encouraging the idea that our investment strategy is a legitimate matter of interest to the United States Senate.

Big Oil CEO

Alas, it is only a dream.

Doublespeak in Health Policy Reporting

By all accounts, U.S. spending on health care has been growing much more rapidly than national output. Health statistics–health spending as a share of national output or per person, compared across developed nations–routinely ranks the United States at the top of the list, and statistics on effective health care delivered per dollar spent routinely ranks the United States near the bottom. So news reporters could not miss the clear implication that Americans need to cut health care spending growth and make their health care sector more efficient. If we could reduce spending on unnecessary and low-value health care services, it would go a long way in achieving both objectives.

Now for the doublespeak: Many proponents of Health Savings Accounts (HSA) that can only be accessed under a high-deductible health plan tout the increased role of health care consumers. With larger out-of-pocket spending initially, consumers have greater incentives to eliminate unneeded and costly health services. But success on this count is routinely dismissed in the media as having undesirable side effects–as in today’s Wall Street Journal (HSA Users Find Hassles Amid Savings, May 1, 2008, Personal Journal, page D1):

…average health-insurance costs rose 3.6% in the past two years for employers who offered high-deductible plans, compared with a rise of 7% for employers without such plans.

That’s followed by

Some analysts say much of those employer savings come because many HSA participants tend to forgo care.

Excuse me, but isn’t this exactly how it’s supposed to work?! The language in all such instances usually hints (as does this WSJ report) that the forgone care is valuable and people with HSAs are therefore suffering unduly. Such implied criticism is unjustified unless accompanied with the qualification that the rejected health care services may not be valuable or cost effective.

Indeed, the article later cites a patient with an HSA “fighting” with a doctor about routine physicals and cardiac exams. The doctor wants these exams to be taken regularly, whereas the patient does not because the high-deductible HSA implies larger out-of-pocket payments. In my personal experience, both types of health checkups are most often a waste of time–all they do is separate the patients from their money, which goes to the doctors.

But if many more consumers were to obtain HSAs and economize their health care spending, it would clearly be a problem for the medical profession. And news reporters usually accept, without further questioning, analysts’ comments about unneeded patient suffering because of forgone care. Clearly, wider use of HSAs and better management of consumers’ health care dollars face tremendous hurdles–the medical profession’s self-interest being the biggest one of all. (And I hope my doctor doesn’t read this.)

Upcoming Event: See South Carolina Governor Mark Sanford Make Sense of the REAL ID Act

Last week, Minnesota Governor Tim Pawlenty (R) vetoed a transportation bill that included a provision objecting to the federal REAL ID Act. The bill would have required the federal government to pay 95 percent of the cost of issuing national IDs before Minnesota would participate. Claiming political machinations were afoot, Pawlenty said that he preferred “something more reasonable like 50 or 60 percent.” One wonders what principle of federalism, liberty, or privacy could possibly support his willingness to accept a 50% unfunded surveillance mandate.

A much clearer vision will be on display next week when Governor Mark Sanford (R-SC) joins Senator Jon Tester (D-MT) here at the Cato Institute to discuss the REAL ID Act. South Carolina has barred itself from participating in the national ID system created by the Act, and Governor Sanford defiantly refused to ask the Department of Homeland Security for an extension of the compliance deadline earlier this year.

Senator Tester represents a state that has been similarly defiant. He is an original cosponsor of legislation that would repeal the REAL ID Act and restore the identification security provisions of the Intelligence Reform and Terrorism Protection Act, which REAL ID repealed.

The event is called The REAL ID Rebellion: Whither the National ID Law?, next Wednesday, May 7th, at noon, and it will be Webcast.

Uncle Sam Wants You

USA Today ran an article about the ever-expanding band of bureaucrats on all levels of government. Citing Bureau of Labor Statistics data, the author points to a new 76,800 bureaucrats added to payroll from January-March this year;

That’s the biggest jump in first-quarter hiring since a boom in 2002 that followed the 9/11 terrorist attacks. By contrast, private companies collectively shed 286,000 workers in the first three months of 2008.

For the most part, when a public employee is hired the full cost of their labor – including generous government pensions and health care coverage – is not accounted for upfront.  With the baby boomers starting to retire, the costs of maintaining the army of bureaucrats will only rise.  Tack on the large unfunded liabilities in government-provided defined benefit plans and retiree health plans, and you easily have a trillion-dollar problem

Most governors in “fiscal crisis” states will call for temporary hiring freezes that fail to address the core issue of reckless government expansion.  But watch for some states, like Tennessee, to take steps to cut costs by culling a small number of their taxpayer-funded workers.


Arizona’s law requiring employers to use the federal government’s “E-Verify” system to check workers’ immigration status has employers there “confused by the law’s requirements and ‘terrified’ at the prospect of losing their business licenses if they run afoul of its provisions,” according to a local chamber of commerce official.

My recent paper on electronic employment verification calls it “Franz Kafka’s solution to illegal immigration.”

Wishful Thinking on Cellulosic Ethanol

Supporters of ethanol, stung by the backlash over its unintended but foreseeable consequences (see, e.g., here and here), namely, increasing hunger due to a run-up in global food prices and increased threats to biodiversity, now tell us that cellulosic ethanol will come to the rescue. The theory is that cellulosic ethanol, which is still in the research and development phase, would be produced from non-edible plant material, e.g., switchgrasses, crop residue and other biomass that is not currently grown or used as edible crops. Thus, it is implied, it would have no effect on food prices.

But this is wishful thinking.

If cellulosic ethanol is indeed proven to be viable (with or without subsidies), what do people think farmers will do?

Farmers will do what they’ve always done: they’ll produce the necessary biomass that would be converted to ethanol more efficiently. In fact, they’ll start cultivating the cellulose as a crop (or crops). They have had 10,000 years of practice perfecting their techniques. They’ll use their usual bag of tricks to enhance the yields of the biomass in question: they’ll divert land and water to grow these brand new crops. They’ll fertilize with nitrogen and use pesticides. The Monsantos of the world – or their competitors, the start-ups – will develop new and genetically modified but improved seeds that will increase the farmer’s productivity and profits. And if cellulosic ethanol proves to be as profitable as its backers hope, farmers will divert even more land and water to producing the cellulose instead of food. All this means we’ll be more or less back to where we were. Food will once again be competing with fuel. And land and water will be diverted from the rest of nature to meet the human demand for fuel.

Does this mean that biomass – and farmers – should play no role in helping us meet our energy needs? Not necessarily. If farmers can profitably grow fuel rather than food through their own efforts, so be it. But we shouldn’t favor growing one over the other either through subsidies or indirectly through government mandates for so-called renewable fuels. And if anything should be subsidized or mandated, it shouldn’t be growing fuels. That would inevitably compete with food.