Tuesday, June 01, 2004

Which comes first: rising oil prices or faster inflation?

Rising oil prices contribute to higher inflation. No doubt about it. After all they form part of the inflation rate as measured by the Consumer Price Index.

What is easy to forget is that the inflation rate is determined by a lot more than just oil prices.

More importantly, the inflation rate itself chips away at the value of oil and the earnings of oil producers.

Charting oil prices that are adjusted for the inflation rate next to the rate of inflation might lead you to conclude that oil prices have pretty much determined the U.S. inflation rate since the first oil price shock of the 1970s.

What I see when I look at that chart is the oil industry (essentialy OPEC, a group of oil producers who stabilize the price of oil) attempting to keep track with inflation.

If oil prices were to rise FASTER than the rate of inflation then I would be convinced that it is higher oil prices that cause higher inflation, and that will probably only come with the next REAL oil price shock.

To see why we aren't even close to this type of shock at the moment, read on...

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