Surging prices for oil and other commodities are linked to an equal and opposite reaction in the valuation of the U.S. dollar, the common currency of commodity trading. Not enough thought is being given to the full range of implications in these relationships, the extent to which they may limit fiscal and monetary policies for the U.S., or what they might mean for energy policy and for energy producers and consumers worldwide.

Oil has long been priced in dollars for global trade. Dollar pricing contributed to oil’s emergence as a liquid, fungible commodity.

The search for a sustainable oil price is an old one. In the days when Humble Oil Co. co-founder William Farish sought to convince the Texas Railroad Commission to rein in a production free-for-all, the danger was that the nascent oil industry might not survive. During the peak of the battle to discipline East Texas producers, one operator complained, “Hell, I sell a barrel of oil at 10 cents and a bowl of chili costs me 15.”

(For other colorful quotes and a pictorial history of the Texas Railroad Commission, see the Texas State Library & Archives Commission’s online history, Hazardous Business: Industry, Regulation and the Texas Railroad Commission.)

Paul Frankel in his 1969 classic, Essentials of Petroleum: A Key to Oil Economics, argued that surplus was the bane of the business. Frankel knew full well that, even though production coordination had long been sought, a devilish dance between oil prices and global economic health would ensue as OPEC hung out its shingle.

And so, at press time, oil prices have finally made a long, painful trajectory beyond the inflation-adjusted 1980 peak to above $100—with a dollar that has, so far, sunk to a modern low relative to major currencies. Talk now centers on a $200 “super peak.”

As the accompanying charts show, there are varying degrees of inverse correlation in the petrodollar linkage. Correlation is much stronger since 2002 than across the previous timeframe, but correlation during periods like the late 1990s is even stronger.

The visible effects are clear, if insidious. Petrodollar-based “petro-econ­omies” face a double-edged sword of managing production to stay ahead of the eroding currency, thus preserving their real revenue targets, while not sinking in a flood of inflationary dollars.

U.S. customers, who already pay dearly for oil, are now paying a premium for imported oil in cheaper dollars. Countries that hold large dollar reserves in their treasuries have seen their wealth diminished by almost 40% since the dollar’s peak in 2002. The competitiveness of American exports has been given a boost, but our balance of payments, including dollar leakages for purchases of imported oil, remains firmly in negative territory.

The invisible effects are perhaps more pernicious. In the current climate of roiling credit markets and uncertain economic prospects, a low dollar and the inflationary push of higher prices for oil and other commodities leave no wiggle room for either monetary or fiscal action. The Federal Reserve Bank can lower its targeted bank-borrowing rates only at the risk of further dollar declines and increased inflationary pressure. An overextended federal budget means more deficit spending will induce even less confidence in our economy and currency. In spite of a perceived competitive edge from a relatively lower dollar for U.S. exports, the balance of payments account remains firmly in negative territory.

How the dollar is valued against other currencies is a relative thing. There is no right answer, no prescribed equilibrium. But beyond U.S. and global economic considerations, the petrodollar linkage is seldom discussed with respect to how domestic producers, who sell only to the home market, might be affected should the dollar strengthen and oil prices fall accordingly.

Likewise, “energy independence” is debatable as a strategic intent for U.S. energy policy actions. Shifting toward a more diverse mix of domestic energy resources might, under the circumstances, seem like a good idea—but mandated substitutes (i.e., ethanol) are equally inflationary.

A most-effective petrodollar realpolitik strategy could be to open new domestic terrain for oil and gas exploration and production, coupled with more efficient use of hydrocarbons. Not only would this contribute to an improved balance of payments, lower oil prices and less pressure on the dollar, it might also make some exporting countries think twice before bullying the neighborhood.

—Michelle Michot Foss, chief energy economist and head of the Center for Energy Economics, a Houston-based unit of the Bureau of Economic Geology at the University of Texas at Austin