It’s not just about $100 oil

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Headlines blared today: Oil Hits $100 a Barrel for the First Time. But perhaps it is not so much that oil has gone up as it is that the dollar has been in decline (though not that badly by some historical standards), as the price of a commodity of limited usefulness, gold, illustrates rather well. (Gold “closed at a record $857 an ounce…though it was still considerably shy of the mark $2,287 in 1980 when adjusted for inflation.) Here’s the take from the FT:

Crude oil prices briefly hit the $100-a-barrel mark and gold prices jumped to an all-time high as investors poured money into commodities on Wednesday amid deepening fears about the weakness of the US dollar. The dollar fell against the euro and the yen after a report that showed the US manufacturing sector slumping to its lowest levels in five years during December.

Investors bet that the Federal Reserve would be forced to lower interest rates in response to economic weakness, potentially increasing the downward pressure on the dollar. The $100-a-barrel level was reached as the result of a single trade by two independent traders – known as locals – at the Nymex floor, industry sources said…

Investors sought the safety of government bonds, sending the yield on the policy-sensitive two-year Treasury down to 2.88 per cent from 3.02 per cent. Interest rate futures fully priced in a quarter-percentage point rate cut to 4.0 per cent by the Fed by the end of this month. The dollar fell to $1.4750 against the euro.

The Wall Street Journal, whose writers has become sensationalists of late, calls one story on the subject, Oil’s Surge Reshapes the World. Asset and commodity bubbles sometimes, but rarely, “reshape the world.” More often they end with unpleasant consequences for many of the previously complacent.

Various forces think they will profit from the slide of the dollar, and no doubt seek to do what they can to exaggerate it. (We are not unaware of the sound logic about the US economy and Fed policy that traders and speculators have built their strategies on, by the way.) But the thing about magical price rises that somehow have “caught economists, Wall Street commodity traders and seasoned energy executives off guard” (WSJ) is they often to end rather abruptly and rather badly. Just ask the oil men in 1983 Texas, or the Hunt Brothers for that matter.

UPDATE

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The WSJ explains the chart above:

Since 2001 the dollar price of oil and gold have run in almost perfect tandem. The gold price has risen 239% since 2001, while the oil price has risen 267%. This means that if the dollar had remained “as good as gold” since 2001, oil today would be selling at about $30 a barrel, not $99. Gold has traditionally been a rough proxy for the price level, so the decline of the dollar against gold and oil suggests a U.S. monetary that is supplying too many dollars.

We would add that the dollar price of nearly all commodities — from wheat to corn to copper to silver — are also surging, a further sign of a weakening currency. On Wednesday alone the price of wheat and soybeans increased 3.4% and 2.8%, respectively. That follows a 75% increase in their price in 2007 — which ran ahead of the oil price, which gained a mere 57% for the year. Neither OPEC nor China caused food commodity prices to rise like this. The main culprit here is a global loss of confidence in Federal Reserve policy and the dollar.

We don’t know the arithmetic necessary to do the appropriate calculation, but we have the feeling that reported money supply statistics have been distorted by the huge build up of unrecycled dollars in China and the oil exporting countries. We recall that the M3 series of money supply figures, which included some large offshore Eurodollar deposits, among other things, was discontinued by the Fed in 2005. We have a notion that M3 would show a level of expansion in recent years that appeared significantly higher than the 5-6% that the Fed reports as the M2 rate of growth over the past year. Alas, we do not have the statistical tools to do the appropriate analysis, or even to assess the precise significance of high M3 growth. But it doesn’t feel right.

2 Responses to “It’s not just about $100 oil”

  1. JMB Says:

    Investment is difficult when it relies, not on a particular businesses practices, but on what some bureaucrat somewhere is going to decide is sound economic policy–for the next five minutes.

  2. gs Says:

    Key commodity prices may well be in a speculative bubble, but, like many bubbles, this one apparently began with a legitimate rationale.

    From the WSJ (subscription required):

    Since 2001 the dollar price of oil and gold have run in almost perfect tandem (see nearby chart). The gold price has risen 239% since 2001, while the oil price has risen 267%. This means that if the dollar had remained “as good as gold” since 2001, oil today would be selling at about $30 a barrel, not $99. Gold has traditionally been a rough proxy for the price level, so the decline of the dollar against gold and oil suggests a U.S. monetary that is supplying too many dollars.

    We would add that the dollar price of nearly all commodities — from wheat to corn to copper to silver — are also surging, a further sign of a weakening currency. On Wednesday alone the price of wheat and soybeans increased 3.4% and 2.8%, respectively. That follows a 75% increase in their price in 2007 — which ran ahead of the oil price, which gained a mere 57% for the year. Neither OPEC nor China caused food commodity prices to rise like this. The main culprit here is a global loss of confidence in Federal Reserve policy and the dollar.

    The graph from the article is shockingly self-explanatory; accessing it does not require a subscription.

    Drudge links to

    LIVING standards in Britain are set to rise above those in America for the first time since the 19th century, according to a report by the respected Oxford Economics consultancy.

    Whether or not this conclusion is valid, today I do not dismiss it out of hand; in previous decades, I would have.

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