Friday, June 06, 2008

Woe is us (NOT)

There is much hand wringing about the high cost of gasoline these days. I’m sure that the effects are painful for those who have to fill up the tank each day for a long commute. Still, why did Americans buy so many SUVs, instead of the smaller, fuel-efficient cars Europeans drive? After all, gas was bound to go up in response to world demand.

Hardly anyone points out that gas spiked once before--as a result of the 1973 oil embargo imposed by the Arabs. In a remarkably short time gasoline went from 29 cents a gallon to over a dollar. In 2008 dollars that is not much different from what gas costs now at $4 a gallon. In real terms the price of gas gradually declined since the mid seventies. Now it has gone up again.

For those who may be incredulous about the ravages of the steady march of inflation, please recall the following benchmarks. At the end of the sixties a ride on the subway in NYC cost 15 cents; a regular slice of pizza was the same. Now they cost $2.00 and $2.50 respectively.

There is also much hand wringing about the supposedly disastrous fall of the dollar. Well, I have curtailed my purchases of French and German books. There are more of those lurking around the apartment than I could possibly read. Good stuff to drink? There are plenty of fine wines from California, Argentina, Chile and other non-Euro locales.

The Euro has climbed to new heights, but not so most other currencies. For Mexico and most other third-world countries the exchange rates remain stable. China is our principal trading partner, not Europe. The Yuan has been revalued, but not by very much, as the Chinese are wary of disturbing the market conditions that have been so profitable for them.

Moreover, these matters need to be considered in a larger time frame. A short history of the modern British pound will be instructive.

In 1940 an agreement with the USA pegged the pound sterling to the American dollar at a rate of £1 = $4.03. This rate was maintained through World War II and became part of the Bretton Woods system, which governed post-war exchange rates. Under continuing economic pressure, and despite months of denials that it would do so, in 1948 British government the devalued the pound by 30.5% to $2.80. The move prompted several other currencies to be devalued against the dollar. This rate, $2,80, was what we got during my Fulbright years in London in the early sixties. We were happy to get it.

In the mid-1960s, the pound came under renewed pressure since the exchange rate against the dollar was considered too high. In the summer of 1966, with the value of the pound falling in the currency markets, exchange controls were tightened by Harold Wilson’s government. Among the measures adopted, British tourists were barred from taking more than £50 out of the country, until the restriction was lifted in 1979. Eventually, the pound was devalued by 14.3% to $2.40 in November 1967.

With the breakdown of Bretton Woods--not least because mainly British currency dealers had created a substantial Eurodollar market which made the U.S. dollar's gold standard harder for its government to maintain--the pound was allowed to float in the early 1970s and so became subject to a market appreciation. The Sterling Area effectively ended at this time when the majority of its members also chose to float freely against the pound and the dollar.

A further crisis followed in 1976, when it was apparently leaked that the IMF thought that the pound should be set at $1.50, and as a result the pound fell to $1.57, and the British government decided it had to borrow £2.3 billion from the IMF. In the early 1980s the pound moved above the $2 level as interest rates rose in response to the monetarist policy of targeting money supply. A high exchange rate was widely blamed for the deep recession of 1981. In the mid-eighties the Pound fell again, before regaining the US$2 level in the early 1990s. This is where it stands today.

The long-term picture is that British pound has lost half its value relative to the dollar since 1940. Half its value. In their current prosperity, the British public does not concern itself about the matter. Nor should they.

In this country, however, the media have found that they can churn these stories of economic distress over and over again. They rarely discuss the countless items, from electronics to cutlery, that have become cheaper.

Others find the contemplation of apocalyptic change exciting. Yet the apocalypse is not in the offing.

Currency fluctuations are part of the overall pattern of Josef Schumpeter’s Creative Destruction--the Kali principle that is central to capitalism. Adjustments will occur periodically. In this context alarmist complaints about loss of value are otiose. Such things happen, and a good thing too.

PS I note a NY Times story of June 9, 2008. In the middle of a typically alarmist account of high gas prices, the following words are embedded: "Economists say that despite widespread concern about gasoline prices, the nationwide impact of the oil crisis has so far been gentler than during the oil crises of the 1970s and 1980s, when shortages caused long lines at the pump, set off inflation, and drove the economy into recession."

Moreover, "Americans on average spend about 4 percent of their after-tax income on fuels . . , That compares with 4.5 percent in early 1981, the highest point since World War II. At its lowest point, in 1998, that share dropped to 1.9 percent."



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