Governor Perry, The Dollar and His Energy Policy

Addressing the alleged 1970s energy crisis in his classic book, The Seven Fat Years, the late Robert Bartley ably discredited the claim made to this day by economists, commentators and politicians that the oil shocks were in fact supply shocks. Instead, Bartley did his readers a great service in putting “shocks” as they applied to ’70s oil prices in quotes.

In truth, commodities across the board, from wheat to meat to soybeans to oil (NYSE:USO) all spiked in the ‘70s thanks to President Nixon’s disastrous decision to de-link the dollar from gold (NYSE:GLD). Lacking any definition after August of 1971, the dollar collapsed and commodities shot upward. The commodity “shocks” of the ‘70s were in fact dollar shocks, as the unit of account that commodities were priced in fell in concert with the nominal rise in the prices of commodities themselves.Advertisement

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Bartley’s essential point was that “money illusion” had captivated far too many. Indeed, in terms of gold, the most constant measure of value known to mankind, the price of oil didn’t change much in the ‘70s, nor did it in the ‘80s and ‘90s. When gold fell in the ‘80s and ‘90s thanks to a strong dollar, oil fell with it; usually reverting to its 15/1 oil/gold ratio. Just as an ounce of gold at $35 bought 15 barrels of oil in 1971, so did it buy 15 barrels in 1981 at $480/ounce.

In more modern times that same ratio has regularly revealed itself, and with oil at $86 versus gold at $1,680, the price of crude is set to rise if the historical relationship predictably holds. The broader point here is we don’t now, nor have we ever had an oil supply problem; rather in the ‘70s and the most recent decade we’ve had a weak dollar problem that has driven up the price of crude in nominal terms.

All of this is important in light of Republican presidential candidate Rick Perry’s recent utterances on energy. To quote the Texas governor, “Getting the energy industry back to work is the quickest way to spark 1.2 million good, well-paid American jobs, and at the same time reduce our dependence on energy from nations that are all too often hostile to the United States.”

Perry’s suggestion that energy exploration is our path to economic salvation shows in high resolution that he’s but the latest political type to be captivated by “money illusion”, and for falling for this most basic of monetary falsehoods, it’s apparent that he lacks the economic bona fides to be president. Though he’s certainly correct that barriers to drilling anywhere and everywhere in the U.S. should be reduced, the simple truth is that we don’t have an oil supply problem now, nor have we ever.

Perry seeks to bring the Texas economic model to the rest of the country, and while he would be correct that the U.S. would benefit from Texas’s low taxes and relatively light regulations, it’s apparent that he’s wanting when it comes to understanding that to some not insignificant degree, today’s Texas boom is merely a repeat of the 1970s when a cheap dollar money illusion similarly reared its ugly head.

Much like today there was a rush among Americans to Texas in the ‘70s as a nominally high price of oil turned the commodity state into a boomtown relative to other parts of the U.S. wilting under those same weak dollar policies that invariably retard investment in growth initiatives. Of course what Perry doesn’t remember is that with Ronald Reagan’s strong dollar ascendance in the ‘80s, the price of oil collapsed. And with the collapse of crude, so did the Texas economy decline such that its unemployment rate in the ‘80s was two percentage points higher than the national average. That U.S. taxpayers were forced to bail out so many bankrupt Texas S&Ls in the ‘80s was clearly a function of the money illusion luring lots of energy investment that logically went bust once dollar policy returned to a more credible course.

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Looking at the present, if it’s true that reduced energy regulations might foster a great deal of job creation nationally, ignored is the history that says we’ll eventually correct a decade-long bout with cheap dollar policies authored by the Bush and Obama administrations, and when we do, many of those “jobs” created will no longer be economically viable. Perry has disqualified himself because from his bold statements about making the U.S. an energy economy, he’s looking to foist a boom/bust economic model on the rest of the United States. Better it would have been had he simply given a speech correctly drawing a correlation between powerful economic growth and light taxation/regulation, the ability to trade freely irrespective of country border, and a strong, stable dollar.

Where the Texas governor is quite simply dishonest is in his suggestion that we’re dependent on hostile countries for our energy. In truth, if we ignore that U.S. interests are the third biggest oil producers in the world, it’s notable that Canada and Mexico are the two largest providers of “foreign oil” to the United States. Of course “foreign oil” is a misnomer when we consider that once the crude is shipped to market, there’s no accounting for its final destination. So while wailing about dependence on “foreign oil” might be good politics, in pure economic terms it speaks to illiteracy.Advertisement

Most disappointing about Perry’s energy policy, not to mention that of so many on the right similarly blinded by the money illusion, is the near total dismissal of arguably the most powerful economic concept ever conceived: comparative advantage. But to put it in basic terms, profit margins for the energy sector rank 112th among U.S. industries; meaning it doesn’t accrue to the U.S. to bet its economic farm on oil. In short, for the U.S. to mobilize in the direction of an “energy economy” as so many who should know better want us to, is for the U.S. to commit a slow form of economic suicide as we remove human, physical and financial capital from far more profitable pursuits in favor of relatively prosaic ones in the name of “jobs” and “energy independence.” Better to source our oil from locales comparatively better off finding it.

Thinking about the above, if the U.S. economy struggles now, just wait to see how difficult life will be if we naively chase nominally high oil prices driven by a cheap dollar. Lest we forget, imports are the reward for our own productivity; thriving economies by definition major importers by virtue of their productivity. For us to run after this most monetary of mirages will not only lead to a major bust once dollar policy is corrected (this will be true even if it isn’t), but it will also signal our descent into the prosaic ideas of the past, rather than a rush into the future. In a world awash in crude, oil is so yesterday, but that doesn’t stop Republican presidential candidates and their enablers on cable television from endorsing our economic lurch to the past.

Most disappointing of all about the right’s continued worship at the energy altar is how very much it contradicts the ideology’s correct articulations about the horrors of big government. Indeed, lost in all this nonsensical talk about the U.S. economy attempting to emulate Equatorial Guinea, Nigeria and Saudi Arabia (a lot of good “energy independence did the citizenry of those three) is that today, thanks to nationalization, the bulk of oil around the world is controlled by governments.

The above should surprise no one. Oil “wealth” is wealth from the earth, as such is immovable, so the greedy hand of government is rarely far from where energy is sourced. Conversely, and particularly in the modern U.S. economy, much of our wealth is “intellectual”, or of the mind. If California seeks to expropriate Google (NASDAQ:GOOG) and its billions, it will get its hands on very little due to the simple truth that Google’s (NASDAQ:GOOG) wealth is the individuals arriving to work each day. If California ever becomes too overbearing, Google (NASDAQ:GOOG) will simply move its wealth elsewhere; maybe to Texas.

For policy to move in the direction of the U.S. morphing into an energy economy is for our economy to become far more taxable by a political class that knows no limits. No thanks to that. The reality is that Switzerland, South Korea and Hong Kong thrive despite being totally “energy dependent”, and one major reason they do is that tax authorities in each could never become too greedy else the source of those three countries’ wealth would simply move elsewhere. This will be harder for our vital few to do if we seek to become the Norway of North America.

Much the same is said about every election, but the 2012 presidential elections are arguably the most important in modern times. President Obama has been a total failure, and his resounding rebuke is necessary so that investors feel more comfortable about committing capital to what was once the most dynamic economy on earth. Obama needs to go, but if all the Republicans can offer is illiterate rhetoric about “energy independence” without mention of a stronger dollar that would expose the latter as incredibly false, they’ll fail too.

Governor Perry has shown his hand in this regard, and in doing so has disqualified himself. It’s time now for other Republicans vying for the nomination to make clear their position on the energy issue, and more importantly, that they show a very real understanding of the dollar problem that is animating the hopeless policy proposals of the Texas governor.

John Tamny is editor of RealClearMarkets and Forbes Opinions, a senior economic adviser to H.C. Wainwright Economics, and a senior economic adviser to Toreador Research and Trading.

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