In 2005, oil was $65 a barrel. Gold was $513 an ounce. Thus, a barrel of oil could be bought for 0.127 ounces of gold.
Today, with oil at $127 a barrel and gold at $887 an ounce, a barrel of oil can be bought for 0.143 ounces of gold.
So, in nominal dollars, oil has gone up from $65 to $127 a barrel—a 95% increase. But when measured in gold, the price of oil has gone up a comparatively scant 13%. If we paid for our oil and gas with gold instead of with unbacked paper dollars, the price at the pump might be $2.20 instead of $4.20 and rising.
But is this a sensible comparison? Why should we compare the price of oil to gold rather than wheat or pork bellies or comic books? The reason: before August 15, 1971, the U.S. dollar was backed by gold. Since that time, the dollar has lost 81% of its purchasing power, according to the government’s Consumer Price Index, or 96% of its value when measured in gold.
When the U.S. dollar was backed by gold, there was a limit to how many paper dollars could be created. After all, the Treasury Department had to exchange an ounce of gold for every $35 on demand. Thus, the government and its central bank could only create dollars for which there was sufficient gold to make future exchanges. But with President Nixon’s closing of the “gold window,” the government and banks had no more restraints—they could create as many paper dollars as they wished. And they have.
When the Federal Reserve creates more money, it diminishes the purchasing power of all outstanding dollars. There are more dollars competing for the same amount of goods thereby causing prices to rise. While increased demand for oil from China, India, and the rest of the world have caused a real price increase of 13%, the remaining 82 percentage points of increase are directly attributable to the expansion of the money supply.
I was at an Easter party earlier this year, and my aunt told me she was going to use President Bush’s “stimulus package” to fund a cross-country road trip. She said the stimulus would help with the price of gas. I said, “The day those checks start arriving, the price of gas is going to soar.” It did. And yet the news media rarely, if ever, point their fingers at the real culprits: the federal government and its central bank, the Federal Reserve.
Much of the world faces slower economic growth this year, initiated by the U.S. subprime mortgage crisis which has sliced assets and balance sheets of commercial banks throughout the world to the tune of at least $387 billion. The International Monetary Fund, which monitors economic conditions throughout the world, predicted in their latest outlook (April 2008) that world economic growth would slow to 3.7% this year from 4.9% in 2007. Although their forecast isn’t proving crystal ball accuracy (first quarter 2008 growth in the U.S. came in at 0.9% as opposed to the IMF assessment of 0.5% for the entire year), such a drop in global economic expectations is sobering at best.
Central banks would normally fight such risks to their nation’s gross domestic product by lowering interest rates to encourage demand, as the Federal Reserve, the Bank of Canada and the Bank of England have all demonstrated recently. The Fed has lowered the U.S. interbank lending rate by 3.25% since September, ferociously fighting the specter of recession, followed by the BoC (1.5%) and the BoE (0.5%) beginning in December as the slowdown snuck across their borders.
Because foreign currency exchange terms are heavily influenced by interest rates, when a nation’s official rate is lowered, the value of the currency declines as well. The weakening U.S. dollar (USD in forex cant), which has been sliding in value since April 2002, raised the cost of imports, including crude oil, and therefore discouraged hauling goods into the country. At the same time, the record low exchange rate reduced the cost of U.S. exports, which was good for the U.S. economy but not for its trading partners who increasingly find their own domestic production competing with goods made in the U.S.A. in an international role reversal.
Weakening Dollar and Soaring Prices
This global slowdown is being fueled by soaring inflation biting into consumer and corporate spending, lowering the level of discretionary funds in countries ranging from China to Germany. In Germany, producers’ prices rose 8.1% from May 2007 to May 2008, while in China, retail prices shot up 7.7% in one month. Pork alone rose 48%.
Most of these higher prices can be traced back to higher commodities prices with crude and fuel oils being the major culprits because they affect production costs. The reasons for crude oil doubling in price within the last twelve months is an article in itself, but the boost given by USD weakness against other major currencies—and remember, most commodities are priced in U.S. dollars—is estimated at around $25 per barrel.
So let’s put this in perspective. Global inflation is high because commodities prices are high. High commodities prices are caused in part by USD weakness. Ergo, strengthen the USD and watch commodities prices fall and inflation recede worldwide.
If only it were that simple.
The value of any nation’s currency, relative to those of other nations, is based on many factors—economic growth and prospects, interest rates, balance of trade, governmental accounting ledgers and so on—all of which take time to make their influence felt. Although U.S. exports contributed 0.34% to first quarter economic growth in 2008, nobody knew that until May 29 when the U.S. Department of Commerce released the data, and the resulting shift between the USD and the euro, for example, although monumental in forex terms, only strengthened the dollar by two cents.
Speaking to the Economy
So the USD isn’t going to become Popeye overnight, and the original global dilemma remains. Central bankers can’t raise interest rates to fight inflation because they’ll cut into GDP growth which is already balanced on a razor’s edge between creeping progress and outright recession. They can’t lower interest rates to encourage growth because inflation will balloon out of control. What, then, can they do?
They can talk.
Around the globe, politicians and central bankers are rattling verbal sabers. Most practiced at this art is the European Central Bank’s president, Jean-Claude Trichet, who has a series of “code phrases” that are inserted in his speeches when he and his multinational banking cadre are considering changing rates. Let the financial district hear him mention “heightened alertness” regarding inflation, a phrase signaling an interest rate hike, and the euro zooms up like a rocket.
So when France’s Finance Minister, Christine Lagarde, commented that the USD’s gains against the euro were “very satisfying” and when Russia’s Finance Minister spoke of the need for a stronger dollar, they’re fighting against currency exchange rates for their citizens’ purchasing power.
Let’s hope the global economy pays attention.
It’s undisputed that the nonprofit arts industry has a large fiscal impact on the nation’s economy. According to Americans for the Arts, a nonprofit organization dedicated to advancing the arts in America, the arts and culture industry generates over $166 billion in “economic activity.” This activity includes both spending by arts organizations and event-related spending by audiences.
What is not so clear, however, is the reverse; how does the state of the economy impact the fiscal health of the arts organizations? While there are many arts organizations around the country that are for-profit enterprises, the vast majority of regional theaters, operas, symphonies, museums, dance companies, fine arts organizations and more are designated 501(c)(3). This is an IRS status that relieves the organization of most federal income taxes and generally offers tax deductions for qualified donations as well. These not for profit groups depend heavily on donations and grant monies from individuals and other entities including municipalities like state arts programs, city arts programs, community foundations, private foundations, etc.; but many arts organizations also depend heavily on private donations to stay afloat as well. How these nonprofits are faring in today’s shaky economic times is, for now, a mixed bag.
Economic downturns often have long-term effects as well as immediate pain. The lack of funding resulting from a slowdown can take years to recover. Many nonprofits and the organizations dedicated to advancing philanthropy are taking steps to help organizations brace and prepare for the potential pain that may follow an ever-softening economy. MassNonprofit.org, an organization that shares news and information on nonprofits in Massachusetts, has recently published an article especially geared to arts and social service organizations to help them respond to a potential recession. The article includes pointers such as how to handle donor relations, contingency plans and revenue.
“Keep ‘Em Comin’!”
Marc Solomon, the interim chairman of the Palm Beach Opera board of directors, recently submitted a plea via the Palm Beach Daily News to supporters requesting they not let the slumping economy deter them from making donations. Attempting to head the problem off at the pass, he points out the need to step forward in support despite tough financial times.
Alex Aldrich, the Vermont Arts Council head, says in the Rutland Herald, “The severity of this economic downturn may prove particularly challenging for the nonprofits. We’re low on the discretionary spending totem pole.” The Northeast Florida Jazz Association has revamped its approach to sponsorship based on economic realities – the title sponsorship has gone up for auction on Ebay! According to Muriel McCoy, president of NEFJA, “This year, because of the economic downturn in the economy, getting sponsorships for the festival in the traditional manner is not working.” A press release by NEFJA says, “McCoy attributes the slumping economy and limited business resources as the primary catalyst for NEFJA’s innovative approach to raising funds for the festival.”
Amid the cautionary tales, however, are several bright spots. Surprisingly, foundation monies represent one of the more stable sources of income for nonprofits. Foundations include community foundations, corporate foundations and family foundations. The Foundation Center, whose mission is “to strengthen the nonprofit sector by advancing knowledge about U.S. philanthropy,” released the May 2008 Foundation Growth and Giving Estimates: Current Outlook report which is reporting a 10% gain in foundation giving in 2007, following on the heels of a 7.1% gain from 2006. Additionally, the report says over half of the nation’s 72,000 foundations expect additional increases in giving in 2008.
A Parable for Proper Planning
The biggest reason for this stability in giving is a direct result of proper planning by foundations. Sara Engelhardt, president of the Foundation Center, says, “Foundations — especially the larger, endowed grantmakers — often engage in long-range planning to ensure that they can maintain relatively stable levels of support for their grantees regardless of periodic dips in their assets.” This type of forward thinking helps arts organizations weather the storm during economic periods of downturn or instability which may affect individual donations.
Yet another beacon to arts organization and a reason for continued hope and confidence is the National Endowment for the Arts. The NEA, a governmental agency, is the largest funder of the arts in the U.S. each year. While funding has not yet resumed the peak funding level of $176 million back in 1992, the funding appropriates for 2008 were $144 million, a $20 million increase over 2007. And for 2009, the House Appropriations Interior subcommittee has, as of June 16, set 2009 funding for $160 million.
Arts organizations are, like other nonprofits, particularly sensitive to fluctuations in the economy, especially those that hinder the average citizen’s discretionary income like increases in taxes, a widely fluctuating stock market, gasoline that costs over $4 per gallon and widespread housing problems. However, at least so far, the pinch is not too tight for many arts groups. Those that rely most heavily on individual donations will likely feel the pinch first while those whose primary source of funding comes from a bigger machine, such as foundation grants and governmental entities, will likely weather the economic storm better.
The rise of the United States to economic prominence can be attributed to the presence of the highly skilled workforce. But in the last 30 years or so, the skill level of the American workforce has stagnated. The U.S. is no longer a skill abundant country.
To produce a more highly skilled workforce among Americans, new educational policies must be implemented. But this will take a long term before the effects can be seen. In the short to medium term, the U.S. will increasingly need foreign high-skilled workers and will therefore have to reform its high-skilled immigration policies and procedures not only to welcome the best and the brightest but also to make it easier for them to stay.
The H1B visa program was introduced to allow businesses to bring in skilled workforce from abroad to cope with the shortage of skilled workforce and for the U.S. to retain it economic prominence.
The major beneficiary of the H-1B visa program has been the IT industry. Major IT companies have over the years lobbied with lawmakers to increase the number of H-1B visas issued every year.
The large IT corporations need skilled workforce in order to remain competitive. But with the short supply of skilled workforce in the U.S., these companies have to bring in skilled workforce from abroad. The existing immigration rules made it difficult for these companies to bring in skilled workforce from abroad. However the introduction of the H-1B visa program changed all that.
Critics of the H-1B visa program point out that the H1B employees are a new type of indentured servant. In a new, unfamiliar country, they are docile and focus on working hard. The average salary of an employee on an H1B visa is lower than that of an American employee doing the same job. The H-1B sponsorship provisions make it very difficult for H-1B foreign workers to change jobs. The other major criticism of the H-1B visa program is that it takes away American jobs and gives them to foreign workers.
From a broader economic perspective, H-1B workforce has saved the U.S. economy millions of dollars in human resources and R&D costs, boosting the value of their employers’ stock.
It is just a myth that the use of foreign workforces by American companies using the H-1B program has cost Americans jobs. Instead of taking away jobs, the H-1B visa program has contributed positively to the economy by creating more jobs. The reasoning behind this is simple economics. The availability of skilled workforce enables American companies to retain their competitiveness and grow bigger. As the companies grow, they tend to help the economy grow. Then when the economy grows, it requires even more workers. A recent study found that for each H-1B visa issued by larger IT companies, five additional hires were made as well. With smaller companies, it was even more drastic, showing seven new hires.
Till the U.S. manages to overcome the shortage of skilled workforce in the long term, the H-1B visa program is the only way the United States can overcome the shortage in the short to medium term is to bring in skilled workforce from abroad. If the shortage is not overcome, the U.S. will loose its economic prominence.
One of the neatest developments in economics is the formulation of game theory. Even though its strategies and recommendations have been known to people throughout history, game theory puts these strategies on a theoretical structure. One of the situations thrown up by game theory is a Nash equilibrium.
Assume that there are competing players in a situation (call it a game). Each player has to choose which strategy to adopt. The outcome of that strategy is going to depend on what other people choose. In such a situation, a Nash equilibrium is formed when each player knows what strategies the other player is going to adopt and will gain nothing by changing his/her choice.
Let us take an example of chess. If you watch a Grandmaster play chess against someone who is well beneath him or her in playing stature, you will probably be surprised that the Grandmaster will take longer to beat the novice than an expert would take, although the expert is still much superior to the novice but far inferior to the Grandmaster.
Grandmaster Chess. Photo by Kryten. Taken from Everystockphoto.com
The reason for this is that when you try and finish off an opponent quickly, you leave gaps in your own defenses. These gaps are not easy to spot, but Grandmasters are in a position to take advantage of them. Therefore, it is in the interests of anyone who is playing a Grandmaster to take their time and not rush. So if there are two Grandmasters playing each other, each knows that the other will adopt the strategy of non-rush and will therefore play non-rush themselves. Because of this, Grandmasters are in the habit of taking their time, securing their defenses, and playing slowly.
However, when the expert plays the novice, he has no problems about tearing the poor novice apart because he knows that the novice can’t take advantage of the weaknesses that he leaves behind while attacking. If the expert were to play the Grandmaster, however, he would be a fool to rush into the attack.
In the case of the two Grandmasters, the Nash equilibrium consists of both players choosing the strategy of non-rush because they know that their opponent will do the same. It would be foolish to attack a Grandmaster hastily because they would be building their own defenses, and if you don’t do the same, you will be left in an untenable position. Therefore, the strategies of two Grandmasters playing each other are stable. Each will not change their own strategy if the other continues to maintain theirs.
In a cartel, a group of players who control the supply of a certain product get together and agree to keep the price of that particular product high. There are two strategies here – high prices and not so high prices. It’s easy to see why all the cartel members benefit in the long run if each follows the strategy of high prices. However, it is unstable because it is not a Nash equilibrium.
This is because of the fact that if one of the cartel members changes their strategy to not so high prices, that person will get all the customers who will no longer buy from the other players since they are following the high prices strategy. This will lead to a dramatic gain of business for the player who changes his strategy to not so high prices. Naturally, this situation can’t last. The moment the other players find out that one of them has changed their strategy, it is no longer in their best interests to adhere to the strategy of high prices. Thus, they change their strategy to not so high prices as well, and the cartel breaks.
OPEC Headquarters in Vienna
Cartels are so unstable precisely because of the threat of betrayal. And the more people that make up the cartel, the more unstable it becomes since there are more chances of any one person changing their strategy.
Cartels like OPEC have stood the test of time because, firstly, there are not too many players. And secondly, they all recognize that they’re here for the long term and that if one of them breaks the cartel by adopting not so high prices, then all others will follow suit, and they will be back to square one with lower prices.
Indeed, the only real reason for any cartel to stay together is if they are in the long run together and realize that united they stand and divided they fall.
Editor’s note: Last year a German watch magazine did an interview with John Nash. Read more about it at Amateur Economist. Thanks to Chris Meisenzahl for the link!