Friday, February 29, 2008

How the Dollar Affects the Price of Oil

There was a chart in the WSJ yesterday and it’s important that you understand it.

People will blame cartels and “Big Oil” for the rise
in oil prices. Somehow thinking that evil
corporations are conspiring against them. In the same
line, people will also wonder how is it the price of
oil keeps going up when the world’s largest economy
has stalled in terms of economic growth, which logic
would dictate would cause oil prices to go down. The
two are not unrelated.

The key thing is that in terms of the US dollar the
price of oil has skyrockete
d. Compared to other
currencies the price of oil has not (and compared to
gold – remember that currency – oil has not even
changed in price in the past 4 years) This is proof
that the price of oil is going up not because of evil
oil companies or even OPEC is cartelling against us,
but rather the value of the dollar has been dropping,
losing its purchasing power and thus buying less oil.

The question of who to blame for high oil prices is
not “who is controlling the oil” but “who is
destroying the dollar.” And the answer is three;

1. Greedy, dumb, spoiled Americans that spent
themselves into oblivion by taking out home equity
loans with no ability to pay it back. If people don’t
pay back their debts, the currency will suffer. Just
like the debt defaults of Argentina, Mexico, Brazil,
Russia and so forth, when the people of these
countries (actually their governments) defaulted on
their debts, what was the value then of their
currency? The same applies here. You don’t pay back
your debts, nobody wants to invest in your country,
and so the value of your currency will plummet
relative to countries where people have more fiscal

2.The specter of recession directly affects the value
of the dollar in that the only thing that gives a
dollar value is the stuff you can buy with it. An
economy is not about how much money you make (the
government can print off money all it wants). An
economy is about how much stuff it can produce. Cars,
food, movies, cake, video games, planes, etc. In a
recession an economy “contracts” meaning it produces
less stuff. So with less stuff, but the same amount
of money (more when you consider the monetary moves
the Fed is making) your money becomes worth less.

3. And the final culprit to blame are those that blame
big oil, namely leftists ;P For what do they produce?
They protest. They campaign. They “bring awareness”
to the issues, but what do hard core activists really
produce? The answer is nothing. This wasted labor
does nothing to produce any goods or services that
have value. Taylor the American protesting Big Oil
(or CAFTA, or what have you) majoring in “peace
studies” is not going to produce anywhere near the
amount that Punjab or Khan is going to produce
programming code or developing a new computer. And in
doing so, does nothing to help contribute to the
purchasing power of the dollar.

So if you’re sick of high oil prices, how about you do
the following;

1. Pay off your debts. I had an ingenious idea about
making extra principal payments tax deductible.

2. Find a job and produce something of worth.
3. Quit protesting stuff you don't understand, drop
your major in philosophy, and get a degree in
accounting and start producing something of worth.

See? This economics stuff ain’t so hard.


Anonymous said...

This is rather interesting. I never looked at it his way. The us dollar is losing power which is why the price of oil goes up, at least for the Americans.

Anonymous said...

Hey Cappy-

Which one of those do you give credit to for having the 6 mo treasury yield be almost the same as the 30 year treasury for multiple years in a row (June 05- Oct 07)?

How many of the crappy financial products (Mortgages/CDO/Junk Bonds etc) that are blowing up now were created in that time period because of this incentive?

Who has ruined the reputation of investing in American financial products as a safe harbor?

Anonymous said...

Wow, I guess this economics stuff is hard. What you said is just plain wrong: oil prices have shot up in real terms. Look at the price of oil in Euros or pounds. It's more dramatic in dollars because the dollar is depreciating but it's happening everywhere. And it's terrible in Renminbi - which're pegged to the dollar. You are just making it up.

Most people who make "real" stuff the way you seem to define it are - guess what? - in unionized industries. Leftists. Surprise!

What you've cooked up is an argument for protectionism, and it's stupid on its face.

Making principal payments tax deductible is also a hell of a bad idea which has to do with this economics stuff being not so hard. Part of the housing bubble came about because some bright dude had exactly the same idea about mortgages. Incentives matter. Why do you want to incentivize people to hold debt?

Anonymous said...

I always thought that oil companies would increase production because the price of oil has quadrupled in the last few years. Economically, that makes it profitable to drill new holes at sites which have been to costly to explore yet. Thereby supply would be increased and prices would be reduced in the long run.

However, last week I read that OPEC wants to DECREASE production. There you have "Big Oil"! It's just not in the US or Europe, but in the Middle East.

Anonymous said...

Interesting post.

I have done my part in your drive to improving the value of the dollar.

1) The only debt I have is a small mortgage - less than 40K and four years left.

2) My wife and I live on much less than our means.

3) We are both gainfully employed in businesses that actually makes things and offers services which improve people's lives. Both of us have invested in ourselves by getting advanced degrees in our chosen fields and so are our adult children.

4) We do not vote for morons that take away tax deductions of the 5 largest oil companies. We recognize that corporations do not pay taxes - their customers pay the taxes levied against corporations.

5) We do out best to spread the message that there is no free lunch - that you work hard, you invest in yourself, you make sacrifices in the short term to improve your situation for the long term and you earn your way to prosperity by offering a service of value or building things that matter.

6) We recognize that life is not fair - it never is and sitting around having pity-parties because life isn't fair is worthless. Picking yourself up after life throws you a bad deal, then renewing your efforts is a necessary skill for success. Success is a choice - so is failure.

Now repeat after me...

"I hereby promise to never use a font smaller than 10 characters per inch."


Anonymous said...

Does anyone think this temporary, and the dollar will rebound? I keep seeing people say that the Euro is going to replace the dollar, but from my understanding, a currency is based on the strength of its economy, and, well, the European economies are a lot weaker than the American economy. They have lower economic growth overall, higher inflation, high unemployment, a large national debt (the U.S. national debt to national income ratio is rather normal-sized I believe), etc...I think the Euro is over-valued, and the dollar will rebound. If I was an investor, I'd be thinking about how to short the Euro.

Anyone else think this or am I off...?

Anonymous said...

Man I hate blogspot. Write a 150 word essay on how the Euro price of oil increased 15% from Sept 5 of 2005 to March 3 of 2008, while the Dollar price of oil increased 46%... Hit backspace once, and poof, all that comment gone.

Opec sure hasn't increased production in that time. Sept 2005 they were pumping 32million barrels a day, whereas in 2007 November (last data available) it was still 32 million. It sure isn't increased demand in the OECD countries... 48mil vs 49mil.

What frightens me is that the Government-schooled populace doesn't understand Supply and Demand curves. China started consuming more oil than it produced in 1994 (a great chart idea; chart price of oil vs chinese oil imports) and India's oil consumption continues to grow fairly linearly.

China's definitely caught in the middle here. The purchasing power of that trillion or so dollars has dropped drastically over the last 3 years. By pegging to the dollar (weak or strong, the yuan/rmb is virtually pegged), those dollars they earn buy less and less oil.

The Euro-zone is also in a squeeze; no longer can they even come close to competing on price for exports versus China into the US. And the Yen appreciation against the dollar is going to be very unsettling for the Japanese export crowd this year. Sony's already cut it's earnings outlook due to the weak dollar.

Seems like we're heading towards a global downturn; the US consumer has blown their entire entire wad now that the housing market can't make people 100% equity returns in a year.

Anonymous said...

Pig, I'd take that bet. I think the dollar should rebound some -- but the Euro ain't overvalued. Conservative websites are full of people predicting he collapse of Europe's economy, but good luck finding a published, reputable economist - left or right - who says it. If you think the Euro is going to go way south, lets set up a nice, big bet!

I like the American system. I'd rather live here than Europe. For some reason people who don't have enough faith in why the American system is so good, have to invent reasons why the Euro area is going to collapse any year now. BS. Europe's worked out a different system, and it works, and it'll last. Some things will have to be modified but that's true here too and no less dramatic. Europe has some advantages over us, too , like MUCH better involvement with emerging markets.

So? Put your money where your mouth is, Pig -- and anyone else who wants in. Let's pick a good basket of currencies, and see if the Euro's adjusted value falls to half what it is now or less averaged over any six month period, in the next, what, ten years? Here's your chance.

Anonymous said...

You missed two important elements. First, the massive US trade and current account deficits have flooded the world with US dollars. Make too much of something and the price goes down. This is the fault of Congress and the President together; I didn't see Congress vetoing any of the Bush budgets.

But the second element is the true culprit - the Federal Reserve under "Easy Al" Greenspan and "Helicopter Ben" Bernanke has been so - what's the nice word they like to use? - oh, accomodating that they have effectively reduced the entire US standard of living. When Bubba visited Toronto a few months ago, he joked that he might need to take out a mortgage just to pay for his hotel room.

Bernanke is apparently deathly afraid that the US is going to slide into a decade-long period of little growth, such as Japan has been going through. The rumours now are that he is going to cut rates by another 75 basis points to help reliquify banks and bond insurers which are reeling from the sub-prime mess.

To steal from Archie Bunker, mister, we could use a man like Paul Volcker again.

Anonymous said...

Mmm...sorry not betting anything yet, as I am not an economist officially, so I could be way, way off. However, you say the European system is different...what exactly is different about it? An economy needs to remain strong for the currency to remain strong from my understanding; what is there to keep the Euro afloat? The European economies have a far higher national debt to national income ratio than the U.S., higher inflation, high unemployment, low GDP growth, will their economies be strong enough overall...?

I sort of think of it like the stock market, the value of a company's stock doesn't really matter as long as the underlying fundamentals of the company are very solid; the stock will eventually adjust, one just has to be patient.

Economies kind of seem the same way; as long as the underlying fundamentals of the economy are solid, I'd think the currency will adjust accordingly, given proper time.

And I think the U.S. economy, in addition to having better figures than the European economies, has shown some incredible resiliency with being able to withstand a weak dollar, high oil prices, threat of terrorism, war in Iraq, 9/11, Katrina, sub-prime disaster, credit crunch, etc...yet still maintain fairly good figures. To me, that is a testament to the U.S. economy's underlying strength.

With the recent housing bubble, all the experts said that there was no way the housing market would crash, that it had never done so before, and anyone going to short it was crazy.

So while I am, again, not qualified to judge the European economy yet, the experts could be wrong, there's always that possibility.

Anonymous said...

Take the bet, then, Pig. I must be a rube. I thought you said you'd be trying to short the Euro, man, here's your chance.

But it seems odd to say Europe's inflation is worse than ours benetah a post about how much our currency has lost value relative to theirs. EU unemployment is what - 7, 8%? But to be unemployed in EUrope is a lot nicer than to be unemployed here, it's not obvious those numbers are easily compared. GDP growth in Europe has been better than ours for a while and I actually would bet on them there too (although I still prefer living here) because as I said they are much better globalized with emerging markets. And they don't run our big current-account deficits, and they aren't likely to anytime soon. Comparing public debt to GDP in systems where the public sector simply owns that much more of the economy doesn't seem worthwhile to me. So, I'm in for a few grand if you want to walk the walk.

I don't know where this meme I keep hearing, only on this site, about experts and the housing market comes from. I get Business Week, Fortune, The Economist, and the Wall Street Journal and read the Financial Times a lot. All of them have been angsting about a housing bubble for years. Like since '98-'00. It is very very like the tech bubble - the business press saw it coming for years. But everyone keeps thinking, maybe it'll just hold on a couple more years before popping - and most of 'em were right! If you want to think you saw it and nobody else did, well, keep thinking it, it'll make ya feel good. But stay away from LEXIS-NEXIS cause it'll prove you wrong.

Anonymous said...

balloonist, I'm not an investor right now; as I become better-educated about investing and actually start doing it, I will consider shorting the Euro.

However, why do you think it isn't worthwhile to compare public debt to GDP in economies where the government owns that much more of the economy? If they have a The national debt to national income ratio in 2003 was 118% in Italy, 155% in Japan, and 70% in France, and averaged 77% in the European Community countries. In the U.S., it was 63%.

I would think a larger government requires more debt, but also a larger national income to fund such debt. More debt with less national income only shows the government-owned portions of the economy are not producing wealth the way the same the privately-owned portions are in the U.S.

Anonymous said...

Its to bad the WSJ chart did not go back for 5 or 10 years so we could get a better historical perspective. Also I wish the graphs were on the same set of axes so you could easily spot the interaction. Finally I agree with the comment about 10 point font.

Anonymous said...

How About really pushing into green energy and wind power / fuel cells etc and the like and stop complaining about price of oil - it is running out , and will keep going up & up & up...get used to it...! Maybe also drive a 1.5 l engine car like we do in europe rather than driving 5 litre guzzler....!!!

Anonymous said...

Explain this captain capitalism the dollar has and oil prices are the 10% margin on oil future prices give wall street an big oil the ability to pick main streets pockets any time they want, Raise the margin to 50% an watch oil plummet

Captain Capitalism said...


Try English.

God, make a freaking clear question will you?