Monday, April 5, 2010

Oil at $85 and likely going higher


By Nick Sorrentino

One of the main reasons for the the economic crisis that started in the fall of 2008 was the rise in oil prices earlier that summer.

As huge parts of the population used what little credit they had left to fill the tanks of their cars (or SUVs) to get to work the consumer economy went into a nose-dive. The consumer economy in the United States at the time represented roughly 70% of the entire economy.

But why did we have this run up in prices? Usually we would expect to see such a run up in the midst of an economic boom, not just before the world economy blows up.

There have been many theories put forward to explain what happened, but I think the most compelling one is that the dollar price of oil rose not because there was huge of new demand for petrol, even factoring in China's meteoric economic rise, but because the dollar was weakening.

To do business in oil, one must do business in dollars, and one has the choice of trading in New York or in London. (Though small amounts can be traded in other currencies and in other places. Iran in fact just opened an oil trading center that does not do business in USD.)

Because the dollar and oil are so closely linked, there is a strong inverse correlation between the two. In fact:

President (of OPEC) Chakib Khelil said in late April (2008 just before the huge run up in oil prices and the following crash in the US stock market.) He told investors that, "[Oil] prices are high due to the fact of the recession in the United States and the economic crisis which has touched several countries, a situation which has an effect on the devaluation of the dollar, and therefore each time the dollar falls one percent, the price of the barrel rises by $4, and of course vice versa."

Though this is not exactly right, it is generally right.

As oil prices go up, the real value of the dollar in your wallet goes down.

Why talk about summer of 2008 now? Well, during the last run up in oil prices we were still just heading into a recession, so there were still people with credit to buoy the system along. Now we may be seeing a new run up in oil prices in the midst of a near depression.

Right now the US is acting like a spoiled kid with an unlimited credit card. So what if we are hopelessly in debt, put that new Obamacare program on the card. We'll pay it off someday.

But the Chinese are not stupid. They can see the dollar train wreck coming and are looking to exit without killing themselves in the process. They know that as baby boomers retire there won't be enough money coming into the IRS to offset the expenditures.

What am I saying? Of course there won't be there hasn't been for 30 years! But like a good suburban American family we have done a good job of juggling the economic balls in the air. The Chinese likely see Obamacare as one ball too many. So they are quietly selling the dollars that they can without creating a panic. They've been doing this for the better aprt of a year in earnest, though not too ernestly.

The new medical program is by no means the only reason the world is selling dollars, but is a major one. It just shows that the US does not give a damn about anything approaching monetary responsibility.

So as you watch the price of oil continue to go up in coming months even as the economy continues to sputter (and folks I could always be wrong) remember that the value of your bank account is going down in real terms at the same time.
If you liked this post please become a fan in Facebook (see right margin) or encourage someone else to do so.

About Me

My photo
Nick Sorrentino is the Editor of The Liberty and Economics Review and CEO of Exelorix.com a social media management company.