My wife and I just came back from a vacation in Europe, and experienced first-hand the cost of America’s inflationary policies. Traveling through Belgium, France and Italy, we were treated to opportunities to purchase amazing clothing, jewelry, perfume and foods. Unfortunately for my wife and I we come from the land of dollars and were now spending money in the land of Euros.
I planned to discuss the consumer price index this week, but after my European experience, I thought it might be more interesting to discuss how indications of inflation can be found in foreign exchange markets, or the global, decentralized financial market where over $4 trillion worth of currencies are traded every day. The supply and demand of various currencies in the Forex market determine the relative value of the different currencies over time, and the US Dollar has not fared well.
When the Euro was introduced in January of 1999, its value was about $1.18. In other words, something selling for €10 cost $11.80. When I was in Europe last week, the value of a euro was about $1.50 so something selling for €10 cost about $15, a 27% difference. This means that everything that I purchased in Europe was 27% more expensive than in the US simply due to the decline in the value of the dollar against the Euro. But this inflation does not stay locked inside the castle walls of Europe, it spreads to the United States initially in the price of commodity products that trade on a world market – products like steel, wheat and oil.
Consider a bushel of wheat. This is a fungible commodity in that each bushel is like every other one. Prices are set on a world market so a bushel of wheat in Paris France costs basically the same as a bushel in Paris Texas. But wait, didn’t we just say that prices in Europe are 27% higher due to the fall in the dollar’s value? Exactly! In 1999 when the euro launched, the price of a metric ton of wheat was $97. Today, that same wheat cost $344, an increase of 255% for the cupcake bakery in Paris Texas. But for the Patisserie in Paris France, the cost of that same metric ton of wheat rose from €82 to €229, an increase of 179%. Note that in both cases the price rose – reflecting the supply and demand of wheat on the world market, but the difference in the increase reflects higher prices in the US simply due to the falling value of the dollar relative to the Euro.
Over time, higher commodity prices are passed through to consumers stoking inflation, even when the economy is weak and wage increases are small. The CPI numbers came out today and inflation over the past 3 months is running at over 6% for the past three months – with commodity prices rising by 15%. While all of this inflation is not due to the falling international value of the dollar, one can expect continued high domestic inflation for some time simply as a result of the weak currency.