Sunday, October 10, 2010

Gas prices getting you down? Want to know why it is increasing? Glad you asked....

    The price of gasoline has increased lately, if you have not noticed. There are several reasons for this, from refining problems, oil supply interruptions, price manipulation, and, well, the oil "man" is greedy.  All may be true in some capacity, but I want to focus on an actual contributor: The Depreciating US Dollar in the foreign exchange market. 
    Almost all major commodities (oil, wheat, cotton, copper, gold, etc) are bought and sold with dollars, regardless of the nationality of the buyers and sellers. In other words, if India wants to buy oil from Venezuela, or Canada wants to buy rice from Thailand, they must conduct the transaction using US dollars. The dollar is the currency of record for international business. I am going to use a very simple example to illustrate the problem of the dollars depreciation on the price of internationally traded commodities, specifically oil.
   I am the dictator of an oil producing nation and I depend on the revenues from MY oil to keep me in power.  My currency is known as "The Hayward, or the "TH"".  Right now in the foreign exchange market the exchange rate for the US Dollar to TH's is at parity, or $1.00 = 1.00TH (the reciprocal is also true, 1.00TH =$1.00).
    Assume currently the market price of a barrel of oil (about 42 gallons) is $50.00US.  So, when I sell a barrel of oil on the international market I get $50.00US. When I take that back home I can exchange it for 50.00TH and buy a new gun to protect myself for 50TH.  I am happy!
    What happens if the dollar DEPRECIATES relative to my currency?  If this were to happen then it means that it now takes MORE dollars to buy the same number of my currency, the TH.  Assume the new exchange rate is now $2.00 = 1TH. This means it now takes $2.00US to buy 1.00TH.  If I sell my barrel of oil for $50.00US on the open market and then exchange it back into TH's, then I will ONLY receive 25TH's! Not enough to buy another gun! Well, this is not acceptable.  The purchasing power of my currency has decreased. I am going to have to do something about it...
   I must raise the US dollar price of my oil to $100.00US just to get the same 50.00TH I got before ($2.00US fetches 1.00TH-- $100.00 divided by $2.00 equals 50TH).  I obviously cannot do this on my own. I don't have enough market power world-wide to do so.  The market forces of supply and demand (or market manipulation, if that is your perspective) will increase the dollar price of oil for me.  Other oil producers will face the same problem too.  The world price of oil increases, oil is a major input into making gasoline, hence the price of gasoline increases at the pump...Stuff rolls downhill...
   Most people don't link the value of the dollar to the price of gasoline.  Again, it is not necessarily the main cause, but it is contributor.  Feel smarter? You should--you now know something 99% of Americans don't know....
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