Why the price of gas is going up while the economy is headed down

Why the price of gas is going up while the economy is headed down.

By Nick Sorrentino, 5-28-2009

So the economy is tanking. GM is bankrupt. Chrysler is also. House prices are still going down. Unemployment is approaching 10%, and using the numbers for unemployment that we used to use just 4 years ago unemployment is about 13%. Times are hard there is no doubt. But good news! The price of gasoline is going up! Oh…wait.

Used to be, before we entered the economic bizarro world we now live in, that rising gas prices indicated that trade and travel generally were increasing. Though it was generally bad news for the consumer, rising gas prices often indicated good things for the economy down the road, ahem. But it doesn’t look that way this time.

As of the writing of this article, oil is trading at about $66 a barrel. 4 months ago it was at $35. We’ve had almost a doubling of the oil price this spring. This is why the numbers at the gas station are inching higher again.

But wait. Didn’t we just enter into the worst economic downturn since the Great Depression? Wouldn’t that create downward pressure on oil prices?

It would, but there are 4 possible reasons why this is not the case right now.

The first is that there is indeed more demand for crude than anticipated back in the winter. Perhaps those “green shoots” Bernake and the mainstream financial press keep talking about are real. Perhaps China is pulling up out of the abyss ahead of the west. Perhaps India is right behind it.

I personally don’t buy this argument as I believe that China at least may be really tweaking its numbers. But that’s just a feeling. I may very well be wrong.

The second is that OPEC has reduced production to a level where inventory is pushing prices.

This has indeed happened. OPEC has ratcheted down production in recent months and has stated publicly that it would like to see $75 oil. Countries such as Iran and Venezuela would probably like it a good bit higher than that.

So a reduction in inventories is a factor in the oil run-up even with anemic world demand.

(A side note. There are rumors of full oil tankers floating on the high seas with excess oil to unload once prices go higher. Interesting.)

Third is that traders are looking beyond the recession to when oil demand will really increase fundamentally and they don’t want to miss out. When this economic storm passes, and it will, it’s hard to see that Chindia will demand less oil than it has in recent years. It likely will demand more, much more. Whereas the USA and Europe were the main customers of crude until very recently, the world may now be witness to a doubling or even tripling of demand for oil over the next decade and a half with the emergence of the East.

Since oil deposits look like they are declining in yield generally around the world this increased demand could wildly increase the cost of a barrel of crude. I think this is very likely to happen.

But it still seems a bit early for this play.

The fourth reason for the increase in the cost of oil is that oil is the antidollar. I believe that this is the main reason for the oil rally of the past few months.

Oil is denominated in US dollars. So when crude prices go up, the value of the dollar goes down and vice versa. There are times when oil is the dominant factor in the dollar/antidollar dance and there are times when the dollar takes the lead. Right now I believe the dollar is taking the lead.

The Federal Reserve is in the midst of a policy of “QE” or quantitative easing. QE is the wholesale printing of money. The goal is to head off deflationary trends in the economy by creating an inflationary draft. The logic is that deflation is worse than inflation and so if inflation is needed to head off deflation so be it. This is basically what “Helicopter Ben Bernake” said he would do in the event of a financial crisis.

The Fed is systematically weakening the dollar to inflate away the massive debt that the US has taken on. Unfortunately the weakening of the dollar means higher prices at the gas pump for you and me. This will further stress an already stressed economy and may further feed the negative economic feedback loop the world seems to have fallen into.

There are many weird things that become apparent once one understands the dollar/antidollar dynamic.

For instance:

Does that mean that OPEC, because it can manipulate the price of oil, has a powerful hand in American monetary policy? If they can make the dollar go down by restricting the flow of oil does this not put the USA in a very precarious position? Would that mean that Hugo Chavez, The Iranians, and the Saudis impact whether you have a job, can afford to go on vacation, or will have enough money for retirement?

The answer to these 3 questions is YES. I’ll explore these issues more fully in the next article.