In a speech last week before the Stanford Institute for Economic
Policy Research, Fed Chairman Ben Bernanke questioned whether
increased worldwide economic integration has actually driven prices
lower. Though a strong advocate of globalization and free trade,
Bernanke said, “there seems to be little basis for concluding that
globalization overall has significantly reduced inflation,” and
that, “Indeed, the opposite may be true.”
Though inflation is traditionally viewed as a monetary
phenomenon, Bernanke pointed to demand from China and other
formerly dormant countries as major contributors to rising energy
and commodity prices in recent years. He also cited a study that
showed oil prices in 2005 would have been as much as 40 percent
lower absent demand from those economically resurgent
countries.
The question then is whether demand itself can be inflationary.
No doubt a shortage of oil met by stable or rising demand would
drive up its price, along with the prices of oil byproducts. Where
this theory breaks down is that if demand for certain products is
pushing prices up, demand in other areas must be falling, and in
the process, driving other prices down. The net effect of
demand-driven inflation is zero.
Looked at in reverse, the wonderful process that is
globalization certainly drives the prices of certain goods
downward. Where the idea that this could be disinflationary breaks
down is in assuming that capital saved lies dormant. More
realistically, consumers now have more money to demand other goods
(pushing prices up), or if they save money previously spent on
essentials, that capital will fund the buying power of new labor
entering the workforce. Taking nothing away from the life-enhancing
truth of free trade, its net inflationary or disinflationary effect
is by definition zero.
Returning to Bernanke’s point about oil, without a doubt rising
worldwide demand for it would in isolation bring up its price.
What’s left out of the equation is the impact of currencies on the
nominal price of commodities such as oil. Since the latter is
priced in the spot market, changes in the value of currencies tend
to have a near-instantaneous impact on its nominal price. In
comparing the price history of a commodity in two
currencies, it’s easier to judge whether its price is due to
demand, monetary error, or both.
Since June of 2001, oil has risen 41 percent in euros.
Conversely, the price of oil in dollars over the same timeframe has
risen 118 percent. While demand has certainly factored into more
expensive oil, the dollar’s role clearly cannot be discounted.
Importantly, Bernanke cannot be solely blamed for a weaker
dollar that began its descent nearly six years ago. Still, judging
by the value spread between oil in euros and dollars since 2001,
the Fed is not blameless when considering the price of oil
today.
Concluding on globalization, Bernanke noted that it “has not
materially affected the ability of the Federal Reserve to influence
financial conditions in the United States,” and indeed it
shouldn’t. The continuing integration of the world economy should
occur exclusive of Fed action, with the latter ideally only
inserting itself by providing a stable dollar to a world very much
reliant on one.
