One of the pressing issues of the day is the rising price of oil, and huge profits flowing to the oil companies.  To offer some relief to consumers, several politicians have proposed a “windfall profits tax” on those companies.  Others have suggested that we suspend the 18 cents per gallon federal tax on gasoline for the summer.  Still others have suggested that the oil companies are not producing as much as their refineries can handle, while encouraging that we drill more in the waters off our coasts and in the tundra of Alaska. 

There are a small number of “radicals” who have had the temerity to suggest there could be a link between oil profits, the Iraq War, and those who benefit most from the interconnections.  These connections are nebulous, at best, so I thought it would be worthwhile to call upon economist Adam Smith, himself, to bring some clarity to this festering problem.

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Question:  Mr. Smith, suppose you have just been elected President of the United States.  Many of your wealthy friends and contributors helped get you elected, especially those from the oil industry.  You want to pay them back.  How would you go about doing that?

Smith:  For starters, I would run up a large budget deficit. 

Response:  Why? 

Smith:  Budget deficits tend to cause the dollar to lose value in international trade.

Response:  I don’t follow you.

Smith:  The foreign exchange market adjusts the value of currencies based on how much of that country’s budget is on credit.  For example, if we must borrow 10% of our budget to get it into balance, and Europeans must borrow only 3%, then the dollar would fall about 7% against the Euro. 

Response:  OK.  That is almost exactly what has happened to the dollar every year since 2001.

Smith:  That’s right.  In 2000, 1 Euro was worth just 96 cents.  Today, 1 Euro is worth $1.56.

Response:  But how would that do anything for your wealthy oil friends?

Smith:  Well, OPEC demands to be paid in dollars.  So as the dollar loses more and more value in international trade, OPEC raises the price of oil to offset that difference. 

Response:  That is exactly what has happened.  But oil has gone up even more than 7 percent per year.  In fact, it has risen from $25/barrel to $125/barrel.  That is 400%. 

Smith:  You are right.  So, there are at least 2 more ways to jack up the price of oil.  First, I would stir up a lot of turmoil in the Middle East.  International markets don’t like strife and conflict.  It’s reflected in the value of futures contracts for oil.  I might even invade one of the oil producing countries.

Response:  Do you mean you would invade a country like Iraq?

Smith:  Exactly.  In addition to causing uncertainty, it would be costly to carry out, and that cost would run up the budget deficit even more. 

Response:  But wouldn’t you need a really good reason to do that?

Smith:  Either that, or I would have to fake a good reason. 

Response:  Do you mean like accusing them of having weapons of mass destruction?

Smith:  That would probably do it.  I might also try to link Iraq to al-Qaeda or to 9/11.

Response:  You said there were 2 more reasons.  What’s the second one?

Smith:  I would help other countries to drive up the demand for oil.

Response:  I don’t understand.  How would you do that?

Smith:  Well, since OPEC demands to be paid in U.S. dollars, I would see to it that all of our trading partners had lots of dollars, especially those countries that need to import lots of oil.

Response:  Do you means countries like Japan, China, India, Korea, and all of Europe?

Smith:  Exactly.

Response:  OK.  I’m beginning to follow you.  But how would you make certain that they get their hands of lots of U.S. dollars?

Smith:  Actually, they would see to it by acting in their own interests.

Response:  Now you’ve lost me again.

Smith:  It’s really quite simple.  When we buy their products we pay them in U.S. dollars.  So they would all have lots of dollars in their foreign exchange accounts with which to pay OPEC for their oil imports.

Response:  So you mean that instead of buying our products with those dollars, they would buy oil and that would increase world demand and drive up the price of oil?

Smith:  Exactly.

Response:  Now I’m beginning to see things a little clearer.  We buy their products, but instead of them buying our products, they buy oil and drive up the price of oil even more.  But that would be very costly to U.S. consumers in higher prices for gasoline, airline tickets, and heating costs.

Smith:  Exactly.  It would also cause the price of plastics to rise as well as transportation costs to all businesses, thus the general price level for everything.

Response:  But that would mean U.S. consumers would be getting the “double whammy.”  They would be providing the dollars to pay for the world’s oil imports, and then they would pay again at the pump and in the rising costs of all goods and services.

Smith:  You’re only partly right.  They would be getting the triple, the quadruple, the quintuple, and the sextuple whammy.  We would also need to borrow some of those same dollars to pay for our budget deficits.  In return U.S. taxpayers would have to pay interest on that debt to the same countries whose oil imports they would be subsidizing.

Response:  Wow!  You’re right.  But what about all those other “whammies?”

Smith:    When we run a trade deficit, that also subtracts from our GDP.  It’s right there in your
Econ 101 textbook:  GDP = consumer spending + government spending + investment + net exports.  By importing more than we export, our GDP falls and we will have fewer jobs.  So U.S. workers would pay for that deficit by losing jobs to our trade countries.

Response:  I see.  Our job losses would mean job gains to those countries that would be exactly equal to the trade deficit we have with them.  What else?

Smith:  You’re catching on.  But we still would need to bring as many of those “excess” dollars back home as possible, so we would have to sell them our stocks, real estate, and even our own companies.

Response:  Holy Enlightenment!  That would explain why China, for example, might want to buy up our companies, or why Anheuser-Busch might be offered $46 billion by Belgium and Brazil.  In fact, it would explain why foreigners now hold more than $3 trillion dollars worth of our companies.   But wouldn’t we be getting equal value for our money, that is, by importing lots of really cheap products from China wouldn’t the savings consumers receive from those products offset the negative effects of our trade deficit?

Smith:  If only that were true .  But no.  You forgot the old business axiom “if it goes up in price, buy it” and “if it goes down in price, rent it.”  At the end of the year all those cheap imports like toys, towels, beach sandals, toothpaste, etc. would be worth nothing.  But our stocks and bonds, our real estate, and our companies would be worth a lot more.  So they would win, and we would lose.   

Response:  Holy Ponzi Schemes!  Let me see if I’ve got it.  First you would start a war in the Middle East that would create uncertainty about oil deliveries…and that drives up oil prices.  Then you would create huge budget deficits at home to drive down the dollar in international trade.  That would also drive up oil prices because OPEC would raise prices to offset the falling dollar.  Then you would “look the other way” as our trading countries refused to buy an equal amount of our products, but instead bought oil with our dollars.  That would cost us jobs while it drove up the price of oil even more.  Then we would borrow some those dollars to pay for our budget deficit, and we would have to pay them lots of interest.  That would be costly to all taxpayers.  Then we would again look the other way as they bought up our land, our real estate, our stocks and bonds, and our companies instead of our products. 

Smith:  That’s a good summary.

Response:  But there is only one price for oil—a world price.  All that would mean huge profits to the oil companies.

Smith:  Exactly.  And that is what you asked me to do:  Pay off my friends.

Response:  But all those dollar flows would be very costly to American consumers and they would result in both huge budget deficits, huge trade deficits, and a mounting national debt that would be passed on to our children and our grandchildren.  Soon we would not be able to pay for things like Social Security and Medicare.  That would be unconscionable!  You’re talking about the health care and the retirement funds for millions of Americans.

Smith:  Those are the remaining whammies.  But remember:  You didn’t ask me to be Mr. Nice Guy.  You asked me how I would pay off my wealthy friends for putting me into the Presidency. 

Response:  What about for the long run?  What would you do with respect to our trade imbalance and our need for a National Energy Policy?

Smith:  I would instruct our chief trade negotiator and our energy czar to do absolutely nothing to upset my plan.  In order to preserve all the steps that produced higher oil prices, I would instruct them to preserve the status quo and do nothing at all about our huge trade deficits or our need for imported oil.  I might go further and instruct our trade negotiators to retain a fixed exchange rate with China, and also tell our energy czar to insist on more offshore drilling as a bogus solution and a diversion away from the oil import discussion.

Response:  Hmmm.  Our chief trade negotiator is the Secretary of the Treasury who has not reduced our trade deficit.  And I think our energy czar is the Vice President.  He won’t show his records about anyone he has spoken to on the subject of energy, and the Supreme Court has upheld his “right” to keep us in the dark.  Well, thank you, Mr. Smith.  Please go back to your place in history.  We would not be able to survive for very long if we followed your advice.  I’m sure glad this was just a discussion about hypotheticals.  But the American people are smart.  They would be able to see through your scheme like a sheet of clear plastic.