Tracing the Post-WWII Economic History: Its Effects to Oil Price Instability - Essay Example

? Tracing the Post-WWII Economic History: Its Effects to Oil Price Instability First and of Tracing the Post-WWII EconomicHistory: Its Effects to Oil Price Instability Introduction Oil price is very sensitive to events that rocked the global community; because of these events, oil price has become more of a roller coaster ride. It goes up most of the times and goes down at some points. The changes in the oil price from time to time do not only affect one product’s price but also affect most prices of the basic commodities that are considered vital to living. This is true to all countries all over the world; even United States is not an exception. America has been a major player in the international market. Most of the commodities, like oil, are traded in terms of dollar. There is a direct relation between US dollar and oil price. Following the World War II, the prices of oil increased to $3/barrel in 1960s from $2.50/barrel in 1948 (Reisdorf, 2008). The current oil price is around $83 per barrel as of June 18, 2012 (Fox, 2012). Although it has been constantly decreasing since April of this year, the price is already twenty-seven times the price of that in 1960s. This issue may not be interesting to some since they are only up to what is really happening now. Though the global situation in the previous decades, specifically after the World War II had been stable, there are these events that turned the tables and rocked the value of oil barrel. The purpose of this paper is to discuss some international economic events after the World War II that are relevant to the abrupt change in oil price. These events have contributed a lot to the present global oil price hike, as what everybody knows that prices have skyrocketed since the post World War II period. Moreover, this will also tackle the probable causes of the current high price and its effects to the global economy. There may be numbers of identified causes and consequences, however, this paper will only cover those which are of remarkable contribution and worldwide effects brought about by this oil crisis. Bretton Woods System According to Dammasch (2007), there were 44 countries that joined the conference held in Bretton Woods, New Hampshire in 1944 with the purpose of establishing a basis in international monetary exchange among countries and ensuring their financial stability, as well. Developing the Bretton Woods system was lead by John Maynard Keynes, a well-known British economist and Harry Dexter White, a US Treasury official. Under this system, all the member nations set their currencies to US dollar, which pegged itself to gold at fixed rate. It established two international financial institutions: the International Bank for Reconstruction and Development (also referred as the World Bank) and the International Monetary Fund (IMF). IBRD or the World Bank is responsible in providing loan assistance to developing countries to reduce poverty and to boost their economic status (Carbaugh, 2010). On the other hand, the IMF, as attested by Stephey (2008), was created to oversee the exchange rates and to help its member countries with negative trade balance. In addition, it is also capable of lending financial assistance to members with problems in “balance-of-payments.” However, there was still a limited access to fund resources (Mason & Asher, 1973). For a country to be a member of IMF, subscription should be made in 75% in its own currency while the remaining 25% in gold (Coffey & Riley, 2006). Member countries pegged their currencies at fixed rates but can be changed when there is a “fundamental disequilibrium” with the approval of the Fund. These currencies were set in terms of US dollar, which was also set in terms of gold. Gold standard, in the context of Butcher (2011), was considered as a widespread monetary policy all over the world wherein currencies are associated to the gold price ensuring the value of one currency against the other. According to Bordo (1999), England was the first to formally put it into effect and other countries followed its steps. Gold was said to be set as the “common denominator for all currencies” in the world and for a country to buy back its currency in gold for a stable rate, it needs to maintain reserves of gold (Peng, 2008). Peng (2010) further argued that the Bretton Woods system was focused on making US dollar “the official reserve currency” which, by that time, was pegged to the price gold at $35/oz. The money supply of a country adopting the gold standard is directly related to the supply of gold maintained (Butcher, 2011). In an article by Amadeo (n.d.), she said that countries exporting oil should peg their currencies to dollar since they are selling oil in terms of dollars. The reason is to establish a stable exchange rate among countries in the international market. So, when dollar rises the currencies pegged also increase and when it falls, the same happen to these currencies. The real issue is that oil price rose in US dollars but not in other currencies because the dollar value depreciated. The real culprit is not OPEC that controls the oil price, rather the causes of destroying dollar. Alhajji (2008) discussed the short term and long term effects of depreciating dollar value. Dollar devaluation , in the short run, does not influence any change in the demand and supply, but, in the long term, weakening of the dollar value does affect the supply curve by “reducing production” and the demand by “increasing consumption” (Alhajji, 2008). When there is an increase in demand while the supply falls, the prices of goods will surely be higher. Alhajji (2008) also added that the devaluation also led to a reduction in the purchasing power of dollar causing the country to buy less. The Collapse of Bretton Woods System During the Vietnam War in 1970, US domestic spending had increased and country experienced a recession accompanied with inflation during 1971 (Butcher, 2011). United States also had “trade deficit” and “payment deficit” that resulted to excessive printing of dollar. Its reserves of gold become depleted that they ran out of gold to cover up with their massive money printing. On August 15, to address the inflation, President Richard Nixon temporarily suspended the gold-dollar ties allowing currencies to freely float (Bildirici, Alp, & Bakirtas, 2011). On the same time, he imposed a 10% surcharge on the imports and price and wage were freezed for ninety days. This move was known to be the Nixon shock. It paved way to the end of Bretton Woods system. Exchange rates were not set by the government but by the free market; thus, government was not able to control their currency exchange rate. According to Kyle (2011), exchange market became volatile that convertibility rapidly changed every now and then. In Lewis’ (2011) article, he said that during this time, the dollar was not anymore pegged to gold, and other currencies could no longer peg to dollar at “fixed exchange rates.” Nixon’s ultimate goal to increase the GDP was successful but resulted to long term inflation (Lewis, 2011). A floating currency then is a currency whose value changes in a constant manner depending on its demand and supply. It is said to be “economically efficient” but it has volatile exchange rates. The 1973 Oil Embargo In October, 1973, the Organization of Petroleum Exporting Countries (OPEC), which were dominated by countries in middle-east, supported Syria and Egypt in the war against Israel by imposing an oil embargo on United States and other western countries (Kemp, 2004). By definition, embargo is any restriction or limitation on foreign trades, for example, the restriction of exports to be sold in other country. The move was a response to US supporting Israel in the Yom Kippum War by re-supplying the Israeli military. By this time, America was already importing 35% of its oil consumption because of its diminishing oil reserves according to Trumbore (n.d.). The embargo led to a shortage in oil supply in United States while the oil price changed drastically (Khan, 2003). Countries found to support Israel were also included in the said embargo. OPEC established an oil embargo to the Western Europe and raised the price by seventy percent (Trumbore, n.d.). Some producing countries had reduced five million barrels of production per day while others raised their production by one million barrels. As a result, there was a loss of four million barrels per day until March, 1974 (Williams, n.d.). The price rose from $3 to $5.11 per barrel to these countries and even reached $11.65 per barrel during the first month of the next year (Trumbore, n.d.). After the Bretton Woods’ collapse in 1971, the international market became unstable. The value of US dollar decreased dramatically by 25 percent against Western currencies (Hammes & Wills, n.d.). Even prior to the embargo, OPEC countries already raised the prices of oil to maintain the purchasing power. Because of inflation, the suspension of gold window and the fall of monetary system, there was a crash of stock market in 1973 to 1974. The oil price increased constantly although the embargo had been already lifted. However, Simmons (2005) pointed out that the real reason of the steady increase in the oil price is the diminishing oil reserves when the world demand for oil is obviously increasing. Oil is considered to be non-renewable natural resource, and putting up additional reserves required higher costs. The 2008 Oil Crisis On July, 2008, the oil price was US$147 per barrel. It was the highest price of oil recorded in the market. Young (2008) discussed the possible reasons why oil crisis happened. First, world demand for oil is apparently increasing due to rising motor vehicle users. Second, there is a limitation in resources and capacity by the countries producing oil; one example is that developing facilities requires higher costs. Third, political and geographical conflicts between nations are still occurring every now and then causing the oil price to rise. Fourth, unpredictable weather conditions and accidents also contribute to the oil crisis. One very good example is Hurricane Katrina which affected the oil production in America. Next, the US dollar value has been decreasing, which is an effect of its economy’s “overall downturn.” Lastly, investors have been taking the initiative to buy commodities, oil in particular, as a result of the dollar’s weak value. Buying contracts that specify future supply of oil is blamed to be the primary reason why the oil price skyrocketed (Young, 2008). Cleveland (2009), to simply put, stated that the main cause of oil crisis is that the supply was not able to sustain the rising demand of oil during the period. Impacts of oil crisis on the global economy, according to Young (2008), are as follows: with rising oil price, consumer behavior, in the demand perspective, is affected which can be manifested in cutting back their spending; and viewing on the supply issue, production by some industries was reduced resulting to increasing jobless individuals. Following the 2008 oil crisis, prices of other goods, like food, also increased as oil played a major role in the global economy. It has been the primary concern of every nation because of its domino effect on other goods’ price. Conclusion Due to the instability of the oil price, United States exerted extra effort on minimizing its fluctuations. The establishment of Bretton Woods system had brought up the creation of International Bank for Reconstruction and Development or World Bank and International Monetary Fund (IMF) to build an international monetary standard of exchange between nations. It has its flaws that it only lasted for more than two decades. Bretton Woods’ collapse in 1971 caused some currencies to float in the world market. Subsequently, two years after, an embargo had been imposed to the West. Oil-producing countries raised the oil price several times higher affecting the US oil consumption. Recently, oil crises shocked the world during 2008. The price rose to $147 per barrel, which was the highest price recorded ever. Probable causes of this oil crisis would be increasing demand, limited resources and reserves, geo-political conflicts, unforeseeable interruptions like weather conditions and accidents, dollar devaluation, and speculative buying of commodities and oil future contracts. The above-mentioned events during and after the post WWII economic expansion era affected the US economy and the whole global economy, as well. These are some of the determinants of oil price trends in the international market in which United States of America is a major participant. Although inflation is inevitable, certain measures were applied to minimize its rate, but there are events in history that greatly contributed to the increase in the oil price, more than the normal rate of inflation. References Alhajji, A.F. (2008). How does the weak dollar affect the oil prices? Project Syndicate. Retrieved from http://www.project-syndicate.org/commentary/how-does-the-weak- dollar-affect-oil-prices- Amadeo, K. (n.d.). What is a peg to the dollar? About.com. Retrieved from http://useconomy.about.com/od/glossary/g/dollar-peg.htm Bildirici, M., Alp, E. A., & Bakirtas, T. (2011). The great recession of 2008 and oil prices. The Journal of Energy and Development, 35(1), 1-31. Bordo, M. (1999). The gold standard & related regimes: Collected essays. Cambridge, UK: Cambridge University Press. Butcher, K. (2011). Forex made Simple: A beginner’s guide to foreign exchange success. Milton: Wrightbooks. Cleveland, C. J. (2009). Concise encyclopedia of history of energy. San Diego, CA: Elsevier Inc. Carbaugh, R. (2010). International Economics. Mason, OH: South-Western Cengage Learning. Coffey, P., & Riley, R. J. (2006). Reform of the international institutions: The IMF, World Bank, and the Wto. Cheltenham: Edward Elgar Publishing Limited. Dammasch, S. (2007). 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