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Dollar, oil prices hint of inflation

Rising energy costs and the declining dollar pose trouble.

By Staff writer of The Christian Science Monitor / November 8, 2007

Two runaway trends – record oil prices and a plunging dollar – are hitting consumers just in time for the biggest retail spending season of the year.

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Americans will be paying more at the gas pump and in their home-heating bills. Meanwhile, a falling dollar means that imported goods are more expensive. That includes all the toys, gadgets, and clothing people buy during the holiday shopping season.

The dollar is down for several reasons, but all reflect a more negative view of the United States relative to the rest of the global economy. Investors are selling greenbacks because of concern that inflation will rebound, uncertainty about the health of US banks, and a higher risk of recession – plus some longer-term rethinking about where to hold currency reserves.

What's going on with oil is partly the flip side of that same financial coin. Since oil is priced globally in dollars, it's typical for any big markdown in the dollar to be mirrored in a big markup in oil prices. For foreign buyers, that keeps the price of oil fairly stable. But US consumers take that adjustment on the chin.

"The terms of trade have worsened" for Americans, says Ken Mayland, who heads ClearView Economics, a Cleveland research firm. "The amount that the dollars in our pocket can buy has diminished."

A key question is whether the dollar's decline, in the long term, will be a healthy thing.

Some economists say that an overvalued dollar in recent years has made the global economy imbalanced – and that some retrenchment by US consumers is the price to pay for a return to normal.

Others say that the dollar's recent drop – and the record highs set almost daily by the rival euro – is the marketplace's warning signal that the Federal Reserve is failing to keep inflation pressures at bay. An inflating currency is generally a declining currency.

Whoever is right, the short-run fact is volatility in financial markets and a squeeze on consumers. The rising energy costs and declining dollar add a new measure of uncertainty to an economy that already faces significant challenges tied to a deep housing slump.

The directions of the dollar and oil may not persist, but in recent days they have shown considerable momentum:

•The dollar fell Wednesday to another record low against the euro, with the 13-nation European currency nearing $1.47 in value. The dollar also hit a 26-year low against the British pound.

•Gold, another barometer that investors use to gauge the dollar, is also at quarter-century highs, pushing above $840 per ounce during trading Wednesday. Gold is up more than 10 percent in the past month alone.

•Oil edged above $98 per barrel Wednesday morning, and many analysts expect the price to rise past $100 in coming weeks. After adjusting for inflation, oil is now at or near the record set in 1980 (at a nominal price then of $38 a barrel), according to the Associated Press.

•US oil and gasoline inventories fell last week, according to an Energy Department report Wednesday. Stockpiles of oil are now 8 percent below the levels of a year ago. Falling inventories have been an important factor – along with the dollar and oil-production concerns – pushing petroleum prices higher in recent weeks.

"What's happening to the dollar and gold and oil is that there is an expectation … that the Federal Reserve is going to inflate and devalue [the dollar] in order to offset the turbulence that's going on in residential real estate and mortgage finance," says Michael Darda, an economist at MKM Partners, an investment firm in Greenwich, Conn.