Sunday, January 2, 2011

Get ready for $4.00 and then likely $5.00 gas.

By Nick Sorrentino

July 11th, 2008 is a very important date in American history. It is the date that crude oil hit an all time high of $147.27 a barrel. Nationally gasoline toped $4 a gallon.

Suddenly one need not be a tree hugger to drive a Prius. SUVs began disappearing from America’s highways. Where was it all going to end?

Housing prices had begun to fall across the board in 2008 but for most people the gasoline run up was the first shake of the economic earthquake to come. For many this was the first time the reality of broader economic issues had made their way into people’s otherwise insulated worlds in a very long time. Suddenly the prospect of loading the kids up in the SUV and heading down to Disneyworld seemed less appealing. That’s to say nothing of the fact that one’s daily 50 mile commute suddenly increased in cost by 20, to 25%.

The run up in oil prices had many causes. To be sure some of it was momentum building on momentum in the markets. This was a factor. But it was by no means the most important factor.

The real issue was the fact that the dollar in 2008 had started to decline in value at a pace that was significantly more than average.

Why would this affect the price of oil?

Simply, oil, like most commodities is priced in dollars. As the dollar declines, the “price” of oil goes up.

Sure there are always supply issues. momentum issues, broader economic issues, and these we are told are what drives the cost of a barrel of oil. They often do in more stable times. But 2008 (really 2007) was the beginning of the end of stable economic times.

As the housing crisis began to take hold in the United States and around the world the dollar looked increasingly ugly. Dollar denominated debt gave little return which made the Greenback less attractive generally and as such the dollar was increasingly questioned as the core component of the world economy for the fist time in 35 years. As the dollar declined, oil, denominated in dollars moved up into the stratosphere.

It came crashing back of course as the pressure of high oil prices accelerated the recession and pushed America over the brink. As the stock market melted down along with other markets around the world there was a rush back to the dollar, as bad as it was, because it was the only perceived safe-haven in the midst of calamity. The price of oil crashed down as the dollar “strengthened" in the Fall of 2008.

This phenomenon is not always one to one. But the dollar crude “mirror effect” is often very close as is exhibited by the comparison chart of the dollar index and crude oil prices in 2010 seen here. The dollar goes up, oil goes down and vice versa.

OK so why are we again looking at the possibility of $4 (or higher) gasoline?

The Federal Reserve is now engaged in a money printing policy, often called “quantitative easing.” What it means is that the Treasury is issuing debt, and because China and Japan and pretty much no one else wants it, the Federal Reserve itself is buying up the debt. The Fed is creating money out of nothing to buy debt that is used to finance the American economy (not forever though.) This pushes more dollars into the world system and as such weakens the dollars currently in the system.

With each passing day this QE policy reduces the value of America’s savings. It makes it more difficult for the poor (and everyone else) to buy food as oil is not the only commodity priced in dollars- corn, sugar, etc are also. Bread, juice, cheese, rice, all become more expensive for the average person.

In other words, because the Fed is seeking to force inflation into the system (by weakening the dollar deliberately) to save a tenuous economic system built to benefit those who have first access to the newly printed money (read the large banks) life for most people is likely to get more difficult in the relatively short term.

The middle class is now presented with a double whammy. The prices of their homes are in decline, and are likely to remain in decline for a good while more. However, at the same time the price of everyday staples is on the incline. The only thing that the middle class can cling to is the fact that at least their 401ks have turned around.

Yet the “flash crash” of last May 6th where 10% was lost on the Dow in minutes can’t give anyone who is paying attention too much confidence even as the market continues a march upward.

In July of 2008 things had not hit the wall yet. People didn’t like $4 gasoline, but they made due. They got to work by putting gas on credit cards to be paid off when things weren’t quite as tight. But as we know, for most people, things only got tighter.

Now after almost 2 years of full blown recession we are again presented with rising oil prices, and much higher gasoline bills, yet this time many people no longer have the credit card to put the fuel on. It was maxed out the last time gas was at $4 a gallon. They are still paying for that gas bought 2 years ago, and the bank that issued the card is likely insisting on a higher rate of interest than they did originally. (Despite the fact that the bank charging this rate of interest was privy to bailout money given at nearly no interest to them.) But many consumers, many who made up the core of the middle class, now have few options in the face of a huge “tax increase” on fuel created largely by the Federal Reserve.

$4 gas was one of the triggers of the Great Recession, now we are revisiting it as much of America is already bruised and battered by the economy. All of those people who have hung on through the past 2 years in neighborhoods built on the far outskirts of major metropolitan areas with long commutes are going to be pushed even further toward fundamental economic hardship. Some will be pushed too far.

What’s worse is that there is now little perception of the dollar as “safe haven” as it was during the first oil run up. Yes, the dollar is still by far the world’s most important currency, and yes the Euro looks terrible, but China is rising. Much of the East is rising. There is a perception that there is a fundamental shift in power happening from America and Europe to China.

China has huge structural problems that may keep it from achieving the success that most of the world thinks it will achieve, but the fact remains that in 2 years China will likely eclipse the USA as the worlds largest economy.

What this means is that a general strengthening of the dollar due to the world being scared out of it’s wits by another rumble in the world economy is much less likely. (Though even now by no means impossible.) As such another downdraft in the cost of oil, and more importantly for most people in the cost of gasoline, is far less likely this time around.

This time, as the Federal Reserve continues to print money to sure up the banks for another quarter, there will be a very tangible result in the lives of everyday people- it will be harder to make ends meet. As Christmas bonuses are handed out at record levels for those who have direct access to the Federal Reserve, most of us will watch the totals at the gas pump creep higher and higher as the weather gets warmer.

That ought to be good for the economy. Thanks Mr. Bernanke.

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About Me

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