The mortgage bubble, and subsequent meltdown, was caused largely by deviations from the market price of real estate (inflated prices), fueled largely by unreasonable price speculation beginning with the feds rate cuts in 2002-2003. Unsustainable access to money due to lower rates provided easy access to morgage loans (particularly ARMS), thus inflating the prices of real estate. As a result, when the Fed raised the rates again to combat inflation and restrengthen the dollar, mortgage prices collapsed…or rather they started a sharp period of price correction towards their fair market value.
The fed resorted to rate cuts again to fend off recession in the latter end of 2007, however, those rate cuts have been correlated with spikes in the price of oil in the commodities market. Are the rate cuts, and the subsequent devaluation of the dollar, creating unreasonable deviations in the price of oil in the commodities market? Will oil commodity prices and energy sector stocks enter their own period of sharp price correction once the fed once again takes positions to counter inflation?
I think oil is only going to “burst” when the economy really tanks. People always need oil, so I see a stronger real demand than for McMansions in the sun, which really was a bubble. The best you can hope for is a softer landing, maybe people will start to gradually cut back and it won’t be too big a shock.
My question is WILL the fed and other central banks take the needed steps to counter inflation or are we seeing a return to institutionalized inflation in the US?
Prices, particularly commodity prices, aren’t necessarily based soley on demand, they’re based upon speculation. Bubbles occur when speculative prices begin to deviate from their fair market values (which are based on real supply and demand), and eventually burst once prices start to self correct. ie the dot com bubble bursted because of miscalculated speculation about the value of the .com corporations… the mortgage bubble bursted once homeowners realized the speculation for growth in the values of their homes was unfounded, and subsequently started dumping their homes back on the market; causing prices to collapse.
I’m not denying the strong demand for oil, but when you have investors s purchasing oil as a hedge against a falling dollar, when you have oil inventories being tied up in the futures market, when you have sophisticated investors and hedge fund managers manipulating prices, the price of oil starts to become a function of much more than the fundamental rules of supply and demand. And bubbles occur when an assets price deviates from the normal rules of supply and demand.
In an overheated, inflation ridden economy, oil is speculatively priced at $130 a barrel. Our current demand for oil today is based upon economic conditions that allow for an overabundance of access to cash and credit. But what happens when the fed decides to combat inflation by raising rates once again? This will inevitably allow for a long overdue recession, a re-strengthening of the dollar, and less speculative growth for oil commodities.
That really is the million dollar question. Unfortunately fighting inflation has less popular short-term outcomes.
I hope that whatever administration comes into office this year takes steps to do what’s right for the economy, as opposed to what’s popular with voters. This involves paying back the war debt, raising taxes, and raising the rate…all of these steps will inevitably lead to a recession in an overheated economy…and while recessions are a normal part of the ebb and flow of the economic cycle, no politician wants a recession on their watch.
The real danger in todays economy with inflation in oil and food prices and a slowing economy is stagflation. Inflation in oil and food prices very quickly erase any economic benefit that the feds rate cuts might have created. Despite all the rate cuts, we’re still edging very close to a recession.
I basically concur with the above. I think one of the primary reasons the government is allowing the dollar to fall so much is to help pay for two wars - which is what we have done in the past during wartime. So in essence we are paying twice for Iraq and Afghanistan. Once in tax dollars and again at the pumps.
Your absolutely right sigma. I’ll disagree on the raising taxes, only because I think a shift in the tax burden from production to consumption is a better long term answer.
The focus of the fed and most of the world’s central banks has shifted from stablizing currency to stablizing economy. Economies are meant to be dynamic. That’s a hard thing to explain in a 30 second campaign ad.
We could’ve freed ourselves from the bondage of oil and have an unlimited energy supply long time ago. Inventors with genuine history altering technologies against all odds with “scientists”, suits, and governments.
In the Stan Meyer link there’s a nice show called “It runs on Water.” A must watch. A movie is actually coming out about him. If he wasn’t so conveniently poisoned I think we wouldn’t be having these sorts of discussions.
Definitely true. Say what you will about the war (I won’t go into discussions about the merits of the war itself), but whatever the case is, the war is eventually going to have to be financed. We haven’t even began to feel the full burden of paying for those two wars.
The world banks, politicians etc etc etc have been pretty effective at masking the effects of inflation that we’ve been suffering for the past decade. As such, the central banks have focused on trying to control the more immediately noticeable gyrations in the economy. They’ve been able to delay the full effects of the mortgage meltdown and credit crunch by (ironically) recreating the same economic conditions that caused the mortgage meltdown in the first place: they cut the rate. This effectively shiftied price inflations from the mortgage industry and financial sector over to the energy sector and oil commodities.
Inflation is definitely going to become the primary area of concern for the fed, policy-makers, and the every day joe, however. No matter how you fudge the numbers…no matter how many reports you put out that indicate that core inflation is within normal bounds, when people are paying 4 dollars for a gallon of gas, and 20 dollars for a bag of rice, its hard to deny that inflation is a serious issue.
As such, I expect the fed and the world’s central banks to focus on stabilizing inflation; very likely leading to a burst in the oil bubble.
I have absolutely no idea how I left and I posted the same message 30 minutes later, but I must say this is interesting.
The CEO of the company I’m working for once told me he met a man who carried two things in the trunk. A big suitcase full of money and a gun. He supposedly visited scientists working on projects the government wanted their hands on and offered them deals they couldn’t refuse. Apparently some of those scientists refused..
His dad was in the military and warned him never to get involved with any ‘conspiracies’ unless he was fully willing to forget any semblance of a ‘normal life’.
If you’re going to flood your basement with crude oil, then indeed you may be involved in the kind of hoarding that drives up the price of oil. OTOH if you invest in petroleum exploration and production companies, you are providing capital to help produce more oil. You, therefore, are part of the solution and deserve to profit. Invest accordingly.
In May of 2005 global oil production was higher than at any time before or since. We have reached peak oil and moved three years beyond it. Demand from developing countries will continue to increase even as the United States goes into recession. TPTB will continue to try to reassure us that everything is okay, so we’ll be good sheeple and work and vote for their boys. The Times article is interesting. It tells us that Chinese demand is decelerating. It is not decreasing. It is just increasing less quickly. In spite of wildly higher prices they continue to use more. Supply OTOH is not increasing. You cannot use oil that does not exist, and so prices continue to climb. Oil prices will fluctuate, but eventually (sooner than you think) they will double and double again. Increasing global demand. Decreasing supply. Either we get much higher prices or severe shortages.
If it is true there are tankers full of oil that cannot be sold, that would indeed be the sign of a bubble. I don’t believe it. Why are Bush and Cheyney both humiliating themselves begging the Saudies to increase production? If there are tankerfuls that aren’t being sold it is because the owners are waiting for higher prices. Pray we don’t get another hurricane this summer.
Again, I’m not denying the increasing demand and limited supply for oil…the whole point is that there’s a lot more going on with the price of oil in the commodities market (which is different from, but closely related to the stock prices of oil exploration and production companies) than the simple dynamics of supply and demand. My question is if the current price for oil in the commodities market truly reflects our current supply and demand, or if current prices have deviated from a fair market value due to other, unsustainable, economic conditions. The price of oil in the commodities market isn’t merely a function of supply and demand by end consumers, its a function of the attractiveness of the commodity as an investment vehicle. Under normal market conditions, speculative prices for commodities project realistic expectations about the real supply and demand by consumers. Bubbles occur when forces outside of real supply and demand begin to drive up the price of the asset/commodity.
The fed and federal government have resorted to throwing money in the economy (rate cuts and rebate checks) in an attempt to avert recession, consequently driving down the value of the dollar and creating inflation. Commodities are viewed as a hedge against a falling currency…it isn’t a coincidence that as the dollar drops and inflation inceases, the price of oil and other commodities will almost immediately increase (and vice versa). The result of these policies will inevitably lead to increased inflation, a devalued dollar, which, of course, creates more demand for oil and other commodities as an investment vehicle. It also isn’t a coincidence that major oil spikes in the past 6 months followed rate cuts from the fed.
Speculative prices for oil and other commodities in today’s economy reflect the demand for the commodity as an investment vehicle, not necessarily raw supply and demand for the commodity itself. Its in this discrepancy that bubbles occur. Unsophisticated investors will buy up oil commodities without considering the real supply and demand for these commodities simply because they provide safer returns in an inflation ridden economy. Sophisticated investors will recognize that although these assets are vastly overvalued, there is a great deal of opportunity for profit up until the moment when the prices for these assets begin to self-corrrect down to their fair market value. These forces inevitably drive up prices without regard to real supply and demand, creating economic bubbles.
Current prices and demand for oil today are based upon an overheated, inflation ridden economy. Eventually the federal government, the fed, and the central banks are going to have to take measures to control inflation. The effects of stagflation that are starting to sink in are too severe for them to ignore. Once the fed and the central banks take the appropriate measures to take money out of the economy, reduce inflation and re-strenghthen currencies, the attractiveness of oil and other commodities will decrease, and investors will start to dump these commodities; causing prices to fall until they reflect a fair market value (bubble burst). Also, when the fed and world banks result to rate hikes to restrengthen currencies, this will inevitibly lead to a long overdue recession. Growth in global economies (particularly in developing countries) will start to slow, driving the real demand/price for oil and other commmodities (which are vastly inflated in todays economy) downward. Keep in mind that the growth of developing countries are very strongly pegged to growth in the United States, as we’re the primary consumers of the goods and services they provide. ie Chinese and Indian economies were also suffering once the effects of the mortgage meltdown, which is localized to the United States, started to sink in.
The article was referring to oil inventories that are tied up in the futures market. These are essentially inventories of oil that are marked to be sold at a future date, at a set price, based upon the investors speculation of the movement of the price of the commodity. Again as inflation increases and the dollar weakens, oil futures begin to look more attractive as investment vehicles. Unfortunately, these oil futures tie up the amount of oil that is available for sale in the present. The more people take these speculative positions with oil commodities, the less we have available for use today (leading to higher prices). You can bet there are plenty of sophisticated investors out there waiting for oil prices to fall so they can make a killing short-selling the stuff.
There are always controversies brewing over whether futures markets are being used to manipulate the price of commodities. There is an especially fierce debate with reguards to gold and silver these days. In the metals, the question is whether governments are trying to suppress metals prices. I haven’t seen any evidence that commodities markets are pricing oil unrealistically. When you look at oil company stocks you still see relatively low P/E ratios. The market doesn’t seem to believe that oil will stay at these levels. If the same psychology is playing out in the futures makets it would seem oil, if anything, is being underpriced. There probably are large investors going short in the expectation of huge profits. Given the supply/demand fundamentals I don’t see any reason for them to win out.
There are very intelligent, sophisticated, successful investors who disagree on whether the US recession will drag down China and the rest of the world. Will that bring down oil prices – perhaps after the olympics? My take is that the rate of growth in China and India may well slow without a strong US consumer, but will likely stay positive as the US has become a relatively smaller part of the global economy. Upward pressure would remain on oil prices without some unforseeable increase in global production.
If you want to look for a conspiracy to keep oil prices high, consider that oil is priced in dollars. High oil prices increase demand for dollars and helps to support the value of the dollar. A weakening dollar has become a real problem. The current administration is unlikely to admit it, but high oil prices are saving their economic arse. Given the war effort and the bail out of financial institutions, money supply is increasing faster than in the Carter administration. High oil prices are the only thing keeping us out of hyperinflation.
Given “Helicopter” Ben’s view on avoiding deflation at all costs, I see no end to the printing of dollars and the accompanying price inflation. The Fed has no good choices.
If we really are in an economic bubble with oil prices, and deviated price speculations are reflecting current market conditions, given that oil company stocks are so highly dependent upon oil commodity prices, we should expect there to be deviations in the pricing of oil stocks as well. Low P/E ratios of oil stock companies may indicate that oil prices are expected to continue rising given current market conditions, but only because current market conditions are so conducive to inflation, and because of the effects inflation has on the price of oil commodities. Once current market conditions change (ie dollar strengthens), oil company stock prices will move to reflect expectations in the movement of oil commodity prices.
On that note, consider that as oil is priced in dollars, dollar depreciation makes oil less expensive in non-dollar economies… thus increasing the demand for oil in non-dollar economies.
Under this context, speculative pricing for oil during a period of dollar devaluation assumes that demand for oil will increase in non-dollar economies due to lower relative pricing in non-dollar currencies.
This is coupled with the fact a depreciated dollar also increases demand for oil in the US, causing speculative prices for oil to increase in periods of dollar devaluation.
Also consider that as oil is priced in dollars, devaluation of the dollar causes inflation in oil-producing nations. As such, dollar devaluation reduces the purchasing power of oil producing nations, thus reducing their ability to invest in drilling activities and production.
Oil production has historically slowed in periods of dollar devaluation. Oil production may be high as of today, but the oil futures market assumes that in periods of dollar devaluation, oil production/supply will decrease in the future. This, of course, drives speculative prices for oil in the futures market upwards.
Once the fed takes steps to re-strengthen the dollar you’ll likely see an unraveling of the forces that drove the relative price of oil upwards due to a devalued dollar. The fed will eventually have to take measures to re-strengthen the dollar (though I don’t expect it to happen any time soon), and the speculative price of oil will consequently drop. It isn’t a question of ‘IF’ it will happen…the question is how hard the drop will be when it does happen.
Lovely.