Why Use Commodities To Measure The Dollars Purchasing Power?
Commodity markets have their ups and downs. Oil prices reached the nosebleed valuation of over $160 per barrel just before the 2008 financial crisis. Contrarily, the same barrel of oil only cost a few dollars in 2020. While these fluctuations might make commodities seem highly unstable on the surface, demand for essential commodities remains relatively inelastic. In other words, day-to-day demand for oil, corn, and other commodities rarely fluctuates by much. So why do these essential goods seem to experience wild price fluctuations?
This perceived instability primarily relates to how commodities are bought and sold. There are three major puzzle pieces that we’ll examine to illustrate how, despite this perceived instability, it is the underlying currencies that cause most of these price fluctuations. These pieces are: method of settlement, currency inflation, and commodity price over time.
Settlement: How Commodities are Bought and Sold
The purchasing power of many national currencies roughly correlates to the price of their most produced commodity. For example, when the price of oil fluctuates, the Canadian dollar often mirrors its movements. The same goes for the Australian dollar and gold — as a significant gold producer, the price of AUD is in part based on the price of gold. When it comes to commodities, however, no currency is more central than the US dollar.
The US dollar is used as the base currency in almost all commodity trading today. So much so that there exists an inverse relationship between the US dollar and commodity prices in general. This relationship is due to the dollar’s perceived stability on the world stage. As the world’s de facto reserve currency, a stronger dollar means your buck buys more, whereas a weaker dollar means you’ll need to pay higher prices for that barrel of oil. However, there’s a big problem with this approach.
Inflation: More Is Less
While the dollar may seem stable relative to other world currencies, it’s akin to the highest point on a sinking ship. The real purchasing power of the dollar has been declining since the early 1900s. $100 in 1913 is worth less than $4 today — representing a decline of over 97%.
This slow collapse of purchasing power has immense consequences for consumers. While advances in technology have, to some degree, offset the rising tide of inflation, the rate of monetary debasement has outpaced these innovations. New gadgets are great, but they only do so much to offset rising food and energy costs.
Manufacturers aren’t immune to inflation either. Given the US dollar’s dominant status as the medium of exchange in commodity transactions, producer goods have suffered from a steady increase in price over time.
Price: Very Slowly Or All At Once
All commodities have felt the effects of rising prices due to inflation. While some have trended steadily upward over time, others have experienced a sudden and rapid rise in cost. These events lead to significant headaches for produces and consumers alike, who are left to grapple with higher costs. Steel is an excellent example of a commodity that exploded in price. In the six years between 2002 and 2008, steel prices more than doubled.
Wheat, on the other hand, experienced a slow but steady increase in price due to inflation. While comparatively manageable, this trend is still a net negative to producers and the end consumer alike.
Putting It All Together
Recall our initial examples of commodity instability. While oil prices hit $160 a barrel just before the great financial crisis of 2008, its price fell by half to just $80 a barrel one year later. At the same time, investors worldwide were rushing to secure US dollars, as they were perceived as the most stable currency in the world in a tumultuous economic environment. Remember the inverse correlation: a stronger dollar means lower commodity prices.
Now let’s put these three puzzle pieces together. The US dollar’s purchasing power has been steadily declining for over 100 years. Commodity prices are inversely related to the US dollar. This negative correlation hurts commodity prices in the form of exasperated price movements — normal price fluctuations are amplified relative to how the US dollar is feeling on any given day. These amplified price movements hamper manufacturer’s access to clearly priced producer goods such as steel and wheat. In turn, the added costs flow downstream to the consumer resulting in even greater rates of inflation.
With the backdrop of persistent and often miscalculated inflation, we must invert existing inflation calculations to track the dollar’s purchasing power accurately. Rather than denominating commodities in dollars, which are theoretically infinite, we must denominate dollars in terms of commodities, which are finite.
By pegging Ramifi’s token to a basket of commodities, we can adequately adjust the dollar’s value for real-time inflation. Considerations regarding trading volumes, volatility, supply and demand elasticity, and CPI inflation can further help calibrate the real value of a dollar.
Ramifi accomplishes this task by leveraging the power of blockchain technology. By utilizing a dynamically weighted basket of commodities, rational actors can better understand the effects of inflation on the dollar and adjust their investment decisions accordingly. Commodities prices aren’t a byproduct of inflation — instead, they’re the solution to how we calculate inflation in the first place.
