Interesting Thoughts on Oil

from a blogger and FinServ analyst:

Some nuggets, but read it all. This is what real-world, rubber-meets-road financial services economics looks like.

Another chestnut is that "oil is doing the Federal Reserve's job for it", which I heard yesterday on a business news show---the implication being that Alan Greenspan and the Fed don't need to raise interest rates since higher oil acts to slow the economy just as higher rates do. More nonsense. Oil does not do the Fed's job; it reflects the job the Fed is doing. All else being equal, the more money the government prints, the higher oil goes. And indeed, over the past year all else has been equal. Despite the constant media hype about Chinese demand, last week Morgan Stanley analyst Andy Xie noted that oil's demand-supply relationship has not changed this year---but oil prices are up about 70%.

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This leads to yet another oft-spoken absurdity about oil: even though it is near an all-time high, "it's still well below its inflation-adjusted high" of the 1970's. In other words, the price of oil is rising due to inflation, but we've printed so much money over the past 25 years that we've made oil cheap! So goes that line of reasoning, which is cognitive dissonance, denial, and circular logic all wrapped into one. Want a good prediction on where oil will be trading a year from now? Tell me exactly what the Fed's monetary policy will be and how much liquidity will be created or drained over the next twelve months, and I'll give you a pretty good guess on where oil will be trading.

Here's a good example of non-Guassian events causing market indices to temporarily uncouple from the market itself. In much the same way a weather vein will point the true direction of the wind most of the time, but become randomized in a storm, market indices have boundaries in which they are valid.

But parts of German society did quite well during this chaos, particularly those with access to the river of money creation. This included the staid banker class, as well as leveraged stock and real estate speculators---in other words, today's investment bankers, hedge fund managers, corporate insiders, and real estate flippers. At the height of its inflation during the early 1920's, Germany's stock market began a stunning climb that masked and defied the underlying economic chaos. This happened because people were desperate for any type of return on their money in order to meet their ever-increasing daily living expenses. Twenty-five year old stock traders got rich, while prudent savers and middle class pensioners lost everything to inflation. It is impossible to overstate the impact this had on traditionally conservative and ordered German society. The nation was turned upside down, and people were both fascinated with and enraged by the chaos that defined their daily lives. The public's reaction to this paved the way for the rise of Hitler, who railed against the "greedy money changers" who had benefited from the economic insanity. Importantly, Hitler's appeal increased exponentially after the great credit collapse of the early 1930's, when the inflation and debt creation of the previous decade unwound quickly. We know what happened after that.
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If you knew the government would pay for your temporary relocation, rebuild your house, give you a job, and send you a nice check after a natural disaster, would you buy insurance? Would you live in a place less vulnerable to a natural disaster? Would you evaluate your overall risk profile rationally and take appropriate measures to protect yourself? And importantly, what incentive does government have to live up to its own responsibility to prepare for disasters if the printing press is always available as a salve when something happens?

A point I've been harping on for about a year now:

Since oil is currently priced globally in dollars, using a different currency for both pricing and transactions would remove the only way outside of direct military action the U.S. exerts control over a critical natural resource it does not own. This poses a direct threat to dollar hegemony and thus the system of debt creation upon which we rely.

There is, unfortunately a long section of reasoning-by-analogy in this, but I think it's more pedagogical and he isn't relying on the answer for anything more than an illustration of the larger principle of dollar-inflation.

The comments and critques are good as well. I don't agree with all of it, but it does reflect some of what I and others who work in the industry have been thinking.