Oxstones Investment Club™By Charles Kadlec, Forbes,
Dollar debasement, not OPEC or the Chinese, is the driver of ”expensive oil.”
The stage has been set for a surge in the price of oil to more than $100 a barrel. The culprit is not the Organization of Petroleum Exporting Countries, nor China and the developing world’s growing demand for energy–though they will surely be blamed.
Oil prices are not headed higher because we are running out of oil, nor for the lack of green energy alternatives.
The real agent behind higher oil prices is the Federal Reserve, which my research shows has more power than all the sheiks of Arabia when it comes to increasing the price of oil.
The notion that oil prices are controlled by the sheiks of Arabia and their counterparts in the other OPEC countries was seared into our brains by the oil embargo and the near tripling of the price of oil in the last half of 1973 when the average price per barrel of West Texas intermediate crude oil jumped to $10.11 in January 1974 from $3.56 in six short months. This belief was reinforced at the end of that decade, when the price of oil nearly tripled again to $39.50.
Whether or not you were around in the 1970s, you probably have heard of these oil “shocks.” The reason: Until 1968 oil prices had been stable. The annual per barrel price of oil ranged from a low of $2.57 in 1948 to a high of $3.06 in 1958, and averaged just $2.79. A tripling in the price of oil was simply unimaginable until it happened.
The view that OPEC was all powerful happily fell into disrepute during the 1980s along with long held beliefs that removing government price controls would lead to much higher prices. In 1981 oil price controls were lifted and oil prices began to fall, declining to less than $13 a barrel in the spring of 1986.
For the next 14 years–until 2000–the price of oil remained relatively stable. The annual price–with the exception of 1991, the year of the first gulf war–ranged between $16 and $22 a barrel, though by December 1999, the price was back up to $26 a barrel.
But, for the past 10 years, oil prices have been back on the rise, surpassing their old highs in 2004. They hit a monthly high of $134 during the oil bubble of 2008 and then fell below $40 a barrel in early 2009 as the world was engulfed in a recession and a financial crisis that threatened deflation. But, with a modest world economic recovery underway, oil prices have rebounded to above $80 a barrel.
One way to see the role of the Federal Open Market Committee (FOMC), which runs U.S. monetary policy, in this 40 year saga of gyrating oil prices is to track what the price of oil would have been had $1 remained worth 1/35 of an ounce of gold, the value that had been guaranteed by the U.S. government during the 20-years prior to 1968.
Let’s call this the gold-dollar. Although this approach is imprecise, it does provide important perspective on the power of the sheiks of Arabia over the price of oil relative to the members of the FOMC.
The first surprise is that in terms of the gold-dollar, there were actually two oil shocks in the first half of the 1970s. The first shock was to oil producers. The rapid depreciation of the dollar relative to gold dropped the gold-dollar price of oil from $3 in August of 1971–the month that President Nixon broke the dollar’s link to gold–to only $1.01 in June 1973. The second shock–to oil consumers–was when OPEC tripled oil prices. But the gold-dollar price was back to only $2.66, approximately its average price for the 20-year period ending 1967.
The second surprise is that in June 1980, when the paper-dollar price of oil hit a then record of $39.50, the gold-dollar price of oil had actually declined further to only $2.12! It seems that for all of its supposed market power, the sheiks of Arabia could not even keep up with the declining value of the dollar.
What happened in the first half of the 1980s, when the paper-dollar price was falling to under $13 a barrel? This period coincided with a strong dollar policy under President Reagan and Federal Reserve Chairman Paul Volcker. Between June 1980 and spring 1986, the dollar nearly doubled in value, rising from 1/653rd to 1/338th of an ounce of gold. And the gold-dollar price of oil averaged $2.58 per barrel.
During the remainder of the 1980s and the decade of the 90s, the value of the dollar, like the price of oil, was relatively stable. And, over those 14 years, the gold-dollar price of oil averaged only $1.87.
It should no longer be a surprise that the four-fold increase in the price of oil since 1999 has coincided with the dollar falling to one-fourth of its value relative to gold. As a result, the gold-dollar price of oil this year is about where it was in 1999.
Second, the FOMC’s commitment to lowering the value of the dollar and achieving a higher rate of inflation through its second round of quantitative easing will lead directly to higher oil prices. A return of the gold-dollar oil price to its average since 1971 alone implies a 20% gain of the paper-dollar price of West Texas Intermediate crude to $98 per barrel. Any cyclical recovery in the world economy could easily push both the gold-dollar and paper-dollar price even higher over the shorter term.
Third, the paper-dollar price of oil will eventually rise to offset any additional decline in the dollar’s value relative to gold. If the price of oil hits $100 a barrel, don’t blame the rise in the price of gasoline, heating oil, electricity and other energy sources on the sheiks of Arabia, OPEC, the Chinese, “greedy” oil companies or the “profligate” American consumer. Blame the sheiks–that is the members–of the FOMC.
Charles W. Kadlec is a member of the Economic Advisory Board of the American Principles Project, an author and the founder of the Community of Liberty. He can be reached at charles.kadlec@communityofliberty.org.
Tags: big picture, Dollar debasement, Dollar-Gold Ratio, Dollar-Oil Ratio, food for thought, Middle East Oil, Oil prices, Oil Sheiks, Oil Shocks, Oil-Gold Ratio, OPEC, The Fed