Deficits, Dollars, and the Price of Energy

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"The quickest route back to $4 gasoline could run through Washington, DC, rather than Riyadh or Beijing. . ."

The latest revision to the forecasted federal deficit has implications beyond the sustainability of current government spending. Reading a pair of high-profile, skeptical assessments of Peak Oil in the context of a $9 trillion deficit projection for the next decade, it occurred to me that the most serious risk of higher oil prices in the near future might not be flagging production or surging demand but the further depreciation of the U.S. dollar. The quickest route back to $4 gasoline could run through Washington, DC, rather than Riyadh or Beijing, and that might not be as helpful for renewable energy as its advocates might guess.

The main concern about the size of the federal deficit has focused on the risk of inflation. However, high deficits carry another risk that could have a much more direct effect on energy prices, which in turn could help reignite inflation. The problem is acute because it goes well beyond the one-time impact of federal stimulus efforts, which have apparently ballooned this year's deficit to $1.6 trillion.

Fundamentally, there is a persistent and growing gap between government revenue and expenses, exacerbated by high unemployment and lower income—and thus lower tax collection—particularly from the top quintile of earners who have consistently been paying 86% of the federal income tax. Unless that gap can be brought back into line with recent history, the government will soon face a difficult choice. Financing a steady stream of trillion-dollar annual deficits will require either interest rates high enough to attract investment from all over the world—stifling a nascent recovery—or monetization of debt by means of the Fed printing even more money. The latter course would inevitably weaken the dollar and lead in fairly short order to higher energy prices.

We got a taste of this effect in 2007, when oil prices and the dollar moved in opposite directions in an oil-dollar price loop that looked more than merely coincidental. . .If only oil prices were moving, it might be helpful, but the only way to achieve that is through taxation, not inflation or currency depreciation.

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