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.