The Third Oil Shock; Notes on Climate Change

The Third Oil Shock and the Dollar

Oil prices have jumped so high so fast, that we are arguably in the midst of the Third Oil Shock. But why is oil rising? Part of the answer is demand from India and China. But there's more to the story. It's not often that I find myself in agreement with the editorial page of the Wall Street Journal, but David King, a former Fed economist, makes an important point in an oped today, echoed in an editorial, that a large share of the current run-up in oil prices as well as prices of all commodities is due simply to the decline of the dollar.

According to King, in Euro terms, oil is up but far less than in dollar terms. Had the greenback not undergone its steep drop since 2002, oil would be selling for about $75 today instead of $135. The good news here is that managing the exchange rate--though not easy--is something the Treasury in concert with the Fed does every day. The bad news, of course, is that the dollar has not collapsed by accident. Arguably, it has long been overvalued and its high value allowed Americans to stock up on massive amounts of cheap goods from abroad--for which we incurred a trillion dollar debt, now held by the Bank of China in the form of US bonds--and also killed US exports.

The decline of the dollar in Euro terms but in Yuan terms as well (about 20% as opposed to 60%) will eventually lift US exports. But that will take time. In the meantime, we are importing inflation.

Finally, since so many countries peg their currencies to the dollar, the next shoe to drop in the surge of oil prices may be an inability of some developing countries to pay their oil bill as happend after the second oil shock, triggering the 1980s international banking crisis.

A Magic Bullet for Climate Change?

On a separate topic, climate change, Freeman Dyson asks an interesting question in the current New York Review of Books. Could there be a silver bullet to solve the climate change problem? In reviewing a new book by William Nordhaus, Dyson points out that CO2 levels vary seasonably by about 8%, with plants absorbing about 8% of the globe's CO2 every growing season and then disgorging it come winter. He hypothesizes that genetically engineered super trees could, in the future, be programmed to pull a lot more carbon out of the atmosphere. To do so, however, a great deal of science and technology development must happen first. That's why allocating money to R&D is likely to be such an important part of a climate change solution.

Senate to Debate Cap and Trade

In advance of consideration by the Senate of the Lieberman Warner bill to create a cap and trade system to combat climate change, currently scheduled for the first week in June, stakeholders are already beginning to float arguments. Legislation foes such as the Heritage Foundation are talking about the potential damage to the economy of higher energy prices that may result from putting a price on carbon--detailing the impact state by state. What they don't mention is that credits if auctioned off will provide revenues that offset higher prices. Nontheless, for climate change legislaton to move forward next year of not this year, these arguments are a necessary part of the process of calling out stakeholders. Before the legislation can pass, it's important to find out where the opposition lies and what the obstacles are in order to address them. Stay tuned.