Thursday, December 20, 2007

Megan McArdle versus the Ronulans

Apparently the best way to draw attention to your blog is to badmouth the gold standard, thus tempting the Ronulans to attack in force (some people just cannot escape those pesky orbital mind control lasers). A textbook example on how to enrage these idiots comes from Megan McArdle where she discusses an exchange between congressman Ron Paul and Fed Chair Ben Bernanke:
What Congressman Dr. Paul is saying doesn't make any particular sense; American consumers are not particularly suffering because of the decline of the dollar, the dollar is not declining because of Fed policy, and the Federal Reserve has nothing to do with a relative scarcity of oil and food, which is what is driving the CPI increases he complains about. If we were on the gold standard, oil and food would still be getting more expensive, and people on fixed incomes would still be feeling the pinch.
I think this all makes sense; making a sympathetic reading of her posts instead of blowing your top about them tends to help the reasoning sink in faster. Here's my analysis (admittedly a physicist's point of view) on the subject.
  • At any point in American history, there is a certain amount of suffering experienced by American consumers. I believe her point is that American consumers are not particularly suffering because of the decline of the dollar.

  • The dollar isn't declining because of Fed policy. The dollar is declining because of a decrease in the demand for dollars. Think of the case of China and the United States as an example. For years, China has been exporting anything that wasn't nailed down to the United States in exchange for dollars. China then loaned those dollars back to the United States in exchange for repayment with interest (i.e. more dollars). The United States was getting lots of cheap consumer goods, China was slowly dollarizing its economy, and life was good.

    Then the housing bubble burst. If we assume that Chinese investors with spare dollars formed the impression of greater risk associated with American investments, this would serve to deter them from investing their dollars in American investments. So what do they do with their spare dollars to make a profit? They buy American-made goods and resell them in China! So the supply of dollars is the same, but the demand for dollars has partially switched to a demand for American-made products. Thus, the dollar weakens without the Fed having been involved.

  • The Federal Reserve doesn't have anything to do with the relative scarcity of food and oil, unless you suspect that Ben Bernanke has a secret reservoir of oil wells and corn fields that nobody else knows about. You might want to double-check the magnetic permeability of your metallic head covering, just in case.

Megan McArdle reiterates this last point (my boldface):
How much of the higher price of gasoline is the Fed's fault?

To a first approximation, zero. Oil is priced in dollars in the international market. The falling dollar has no effect on the price of oil. And inflation is a tiny contributor to the huge increase in gasoline prices. The huge increase is due to the fact that a lot of people want to consume oil, but producers have been slow to supply additional quantities. When demand goes up and supply doesn't, prices rise.
You can read a dissenting view here.


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