Oil (and gasoline) has been on the rise lately, up 29% over the past year according to the NYTimes. Why the rise? A recovering economy and unrest in northern Africa are commonly-cited reasons. Prices are ruffling enough feathers that Obama has publicly considered releasing supply from the Strategic Petroleum Reserve. Seriously? Shouldn't the SPR be reserved for true emergencies or for at least after other policy "weapons" have been exhausted? What I want to know is this: why isn't anyone looking to the Federal Reserve? The "Fed" is buying Treasuries and keeping the discount rate about as low as possible. Yet, the recession ended in June 2009, employment is recovering and signs of inflation are popping-up.
But, what does all this have to do with gas prices, you ask? Well, currency investments are often not made into raw cash, but rather bonds of the currency-issuing country. Cash doesn't pay interest; bonds do. So, if interest rates increase in a particular country, that country's currency looks more attractive to investors due to the guaranteed interest income. In other words, if the Fed can effect interest rate increases on Treasuries, then the US Dollar will become more valuable in the eyes of currency investors. This, in turn, will increase the value of the Dollar relative to other currencies and decrease the price of gas in terms of US Dollars. Of course, raising interest rates can also have the effect of slowing an economy. That was a serious concern 1-2 years ago when the prospects of a recovery were unclear. That's not the case any more. In fact, the Fed's discount rate needs to rise soon so that it can be used to soften the blow of the next crisis. Hopefully, the Fed will realize the benefits of increased rates before its too late.