According to Bloomberg, oil is back @ $80 per barrel US. It’s been here before.
What usually happens is the oil price rises along with US stock prices. It reaches a peak a little above $80 and then falters. Why? Who knows?
Could be the Saudis are selling a few hundred thousand ‘virtual barrels’ on the Brent exchange in order to push the price down. Why would they do this, rather than simply letting the price follow the market?
One reason is the demand is not as robust as the $80 would suggest. China’s economy is a lovely fake and the developed world is cutting back on driving. Supply matches consumption pretty closely, enough to allow demand to bid the price of available crude to a high level without having to constrain output. It doesn’t appear that a lot of oil is required to move the market.
The better reason is that Saudia and the rest of the producers like receiving something of value for their oil. The calculate having a relatively more valuable dollar will allow them to trade them for more productive assets – in the USA and elsewhere – at a later date. The Saudis are creating deflation by simply holding the price of crude within a limited range. That is what establishing value is and does. It’s a simple binary relationship. Crude oil has real value because of its productive potential. Fixing its price to dollars explicitly makes a sum of dollars traded for it equal in value to the crude. One is a proxy for the other.
People want to gather dollars so they can be assured of a supply of crude. What the Saudis and other producers have noticed is a shortage of dollars. Shortages of anything are self- reinforcing. Available dollars are being bought up. People who hold dollars are not spending them. This causes nominal prices to decline, increasing apparent purchasing power. I say apparent because what is being expressed is decreasing spending itself. Purchasing power is an abstraction that increases with the decline in spending! This is Keynes’s ‘Paradox of Thrift’.
Right now economic policy makers don’t recognize the new, hard, crude- swapping dollar. Most economists don’t consider energy, it is to them simply another input, a commodity. What they don’t realize is that economists can disappear tomorrow and no one will miss them, but oil disappearing tomorrow and the entire world comes to a screeching halt.
You can see the relationship between the crude prices and equities. The decline in crude price @ the end of 2008 and the beginning of 2009 marked the ‘Green Shoots’ era. Low oil prices favored embracing risk. Stock plungers returned to the exchanges … with a vengeance. Traders could hope that crude prices would hover below $40, propel more commerce and provide company profits and a return on stock investment. However, the rest of the economy was reacting to the spike of earlier in 2008. Demand had been destroyed and producers were reeling.
The current trading range for crude is reflected in a stock rally that is losing steam. A dollar that is worth something is better held for purchasing all important fuel rather than gambling on companies that cannot earn profits by means other than firing all their help.
As the more astute traders begin to see the dynamic in action – the rise to $80 then retreat, then stock market retreat – they will realize as I do that the dollar is now a hard currency. A dollar that is worth something is not a candidate for carry- trading or shorting against. Hoarding dollars will become an obsession. Who knows when anyone will see another dollar? If one appears, some oil- hungry trader will snatch it!
Each dollar worth something real; one- half gallon of crude oil. Since oil is the one thing that industrial economies cannot function without, pegging the dollar – a proxy for crude – becomes the second thing that industrial economies cannot function without.
If the Saudis – or other swing producers – were to let the price of oil rise above $85 a couple of things would happen. One is that the crude price would reflect against a dollar falling worthless. While this would please stock traders in the US, the Treasury Department and other borrowers of dollars – as well as US exporters – the value of savings and outstanding credit would decline as well.
Another is that the resulting high nominal crude price would cause a shock to the guzzling public. $80 oil represents Approximately 4% of US GDP. Any higher price is a threat to both the economy and to the oil producers downstream. The consequence of very high price is demand destruction leading to plunging oil prices.
This is why the dollar/oil peg cannot be broken by flooding the economy with dollars. The oil price in dollars will rise then crash. After demand is destroyed, the price will stabilize then rise again … until the peg is reestablished. There is no escaping the peg. The peg makes the dollar king and all the other currencies vassals.
Let’s see what happens now that oil is @ $80 a barrel. If the past is prologue, the price will retreat shortly, followed in a few days by stocks.