I recently visited with an old farmer in a nursing home. At ninety-five, his body was beaten up from years of hard work, but his mind was still sharp as a tack. I took a look at his gnarled old hands and noticed both thumbs were missing. Thinking it might be a good conversation starter, I asked him what happened. With a faraway look in his eye, he settled into his story. As a young farm boy of only ten, he not only had to drive the tractor, he had to fix it as well. When the tractor was up on the jack for him to work on, the jack slipped. When the tractor came down on the block of wood beneath it, his unfortunate thumbs were in the way. “Yep, I was a farmer all my life.” he said.
I had to be patient, as he would stop talking and drift back into his memories. “Who does that at ten years old”? he asked rhetorically. “Back then, we had to work.” he exclaimed before going silent again. Unsure if he was falling asleep, or just reminiscing, I sat back patiently and waited.
Finally, his eyes cleared, and he started again. “It was an old International tractor,” he said with a tone of longing.
“Diesel”? I asked.
“Yup, and diesel was only 20 cents a gallon back then!” he declared with a touch of annoyance in his tone. “I just don’t know how farmers today can do it—there is no way they can afford $3 a gallon! We are going to lose our farmers!”
“Well,” I stammered, my mind racing as he touched on a topic I know well, but most people misunderstand, “I think you are referring to the old definition of a dollar, you know, before Nixon changed it?” He seemed not to hear me (or maybe he ignored me) as he declared with real anger now, “It’s pure greed! That’s what it is! The Middle East is screwing us! They shouldn’t get away with charging so much!”
Not wanting to delve into the subject explaining how fuel prices are actually lower today than in the 30s, I decided to ask him more about his old tractor. With that, he drifted back to the good old days, and the anger left him. When I left, he was still wandering through the farming memories in his mind.
When we think of all the technological innovations in the past few decades, we have to agree that we live in exciting times. Advancement in technology has improved our efficiency of extracting oil to the point where we are practically drowning in it. OPEC is forced to cut back on oil production in a feeble attempt to get the price higher, but their cutbacks are offset by record output in the US. At the same time, advancements in engine technology have helped vehicles travel more miles on less gas. With supply growing faster than demand, prices should fall, right? The law of supply and demand says so!
If that’s true, then why is diesel $3.00 a gallon today, when it was only 20 cents a gallon in the good old days? Was it really greed? Perhaps, but by who? While our leaders would love for everyone to think as the farmer did—that it’s the greedy oil companies in the Middle East taking advantage of us–let’s take a look at it from their perspective.
Let’s imagine you are an oil producer in Saudi Arabia, and you are selling everything you produce to the United States. In turn, you are paid in US dollars that you can exchange for gold at a rate of $35 per ounce. Life is good for you. Business is brisk, and you have a great system of checks and balances to assure that you are paid with real money. If you suspect the US is running its printing press a little too hot, you can always exchange your greenbacks for something the US can’t print—gold. But then one day, everything changes when you turn on your television and see President Nixon give his famous speech.
You hear him explaining that the dollar will no longer be convertible into gold, at any price. But not to worry, the dollar is still good for…
Well, okay so you, as a Saudi, can’t redeem it for anything—but still, you should take the pieces of paper anyway, and give the US your oil. Are you going just to shrug your shoulders, and continue as before? Or, are you going to recognize that a dollar that is just a piece of paper today can’t possibly be as valuable as one that could have been exchanged for actual gold yesterday? What would be the most logical thing for you to do? Either refuse to sell your oil (like an oil embargo perhaps?) Or, demand a lot more of those pieces of paper? In this scenario, did your oil price go up, or did the quality of what you were paid with go down?
We remember the farmer pining about the good old days when diesel was only 20 cents a gallon. We also know that the law of supply and demand dictates that with all of the improvements in the supply chain, fuel prices should be lower, instead of higher. So what’s wrong? Well, first, let’s see if we are using the same unit of measure (the same dollar) to see what’s high and what’s low. For that, let’s see what 20 cents back then really meant. If the official exchange rate promised by the United States was $35 per ounce of gold, then 20 cents represented .006 ounces of gold. Will .006 ounces of gold still buy a gallon of diesel? Recently, gold has been selling for approximately $1250/ounce, which makes 20 cents worth $7.14. Voila! Those same twenty cents will now buy a little over two gallons of diesel! It turns out the law of supply and demand is valid after all, as long as we stick with the same unit of measurement.
The old farmer was quick to call the oil companies greedy, but do you think he will thank them for their generosity in cutting the realprice to less than half? Not likely. Debasing the purchasing power of a currency is not something the general public thinks about, and that is what makes it so attractive to governments the world over. In previous articles, we’ve mentioned that in addition to the obvious taxes we are all familiar with, there is also a hidden tax. This is the tax we’ve referred to, and a great example of it is my new farming friend and the price of diesel fuel throughout his lifetime.
Currency debasement is a blight on our financial health. It hurts at the pump, but it absolutely mutilates savers. Let’s say my reminiscing farmer had a bumper crop one season back in the “good old days” and thought he would put $1000 in an envelope for a future season when the weather wouldn’t be so kind to his crops. At .20 gallon, he was putting the ability to purchase 5000 gallons of diesel in that envelope. That’s enough to keep his tractor running for an entire season, he assures himself, as he tucks the money safely away secretly hoping he’ll never need it.
Being a savvy farmer, and blessed with good weather, years go by without a need to access that envelope. Finally, the old farmer decides it’s time to take it easy in his golden years, so he passes his beloved farm on to his son. As he goes through his belongings, he sees that old envelope and remembers the season of bounty that allowed him to store a whole season of fuel for the future. “Son,” he says, “I hope you never need it, but should you have a rough year, here is one season worth of fuel to keep this farm operating.” Now, that farmer knows for sure he put a full season of fuel in that envelope, but if his son needs it today, it will only buy 333 gallons of diesel! Who took the other 4666 gallons?
To answer that, we need to look at the change in the US money supply. Take a look at this chart of the total M2 money supply of the United States (i.e. how many dollars there actually are). There are different definitions of what money is, and therefore different ways to measure its supply, but we will use M2, which includes savings accounts, checking accounts, cash, and money market funds. This chart shows an increase of about 14x the total supply since Nixon unshackled the US from the constraints of a gold standard. Who benefits from all this newly printed money? Is it the farmer? Is it the pensioner? How about someone who worked hard and put their money in the bank for when they are old? Nope, none of them benefit.