Blame the Arabs?

Week after week I spend more and more money on transportation. With oil prices soaring, millions of people around the world pray that the political tensions in North Africa and the Middle East would soon come to a peaceful resolution. The unrest within the Arab nations gives a financial boost to different authoritarian regimes, strengthening the positions of religious nuts in Iran and power-hungry socialists in Venezuela, but it may also do a lot of damage domestically. The media is already starting to talk how higher energy costs can slow down the global economic recovery in oil importing countries such as ours. And a question arises: Is inflation around the corner?

Consider the case of Sam, an iPod-maker, who buys oil from Prince Ali. Sam gives Ali cash but he pays ultimately with his exports. Sam's demand for oil is born not in the process of printing money but in his supply of iPods to Kim whose power to purchase those electronic gadgets arises in Kim's ability to produce and sell rice to Ali, etc., etc. (Say's Law). If oil becomes more desirable or less available (and thus more expensive), the new terms of trade will decrease Sam's living standard. To buy the same amount of oil, he will have to work harder and export more iPods. Sam will have fewer resources to enjoy other goods and services, the prices of which will adjust downward domestically. In other words, Prince Ali has no control over the general price level in Sam's house. Inflation will creep in and settle only when someone unleashes the destructive forces of monetary expansion at home.

In case we start losing jobs again later this year, short-run unemployment fears will likely eclipse the long-term concerns for our fiscal health. Close to the next elections, our consequentialist president could flip again and try to push another "stimulus" through Congress while the Fed may engage in one more of their "quantitative easings," turning government promises to "pay later" into "cash now." If we allow this to happen and see prices rising left and right, we may be tempted to scapegoat the Arabs for our inflation. It happened under Presidents Nixon, Ford, and Carter and it will happen again and again unless we understand what Milton Friedman meant during the 1970s when he said: "Inflation is always and everywhere a monetary phenomenon." (Watch the episode "How to Cure Inflation" here.)