Inflation to Follow Oil's Direction

Oil is down $4.25 from Friday's highs. Hurricane relief? I didn't really see much built in to the Friday run-up. Iran concerns? Seems to be ignored by the markets. Supply disruptions? Maybe the world economies are demanding less and world supply is catching up. Regardless, there are more than the fair share of pundits out there that made a switch from $100.00 a barrel to $50.00 a barrel. Personally, I see no reason why we can't get all the way down to $35.00 a barrel. We were there before, and there's no real reason to not go there again.

Regardless, these are the "secondary" concerns that a few Fed members have been concerned with. Any relief in the price of oil is going to provide relief in inflation. And that spells a pause, or lower.

Also keep this in mind when considering FX trading: Oil has the same affect on inflation overseas, and thereby the same easing in inflation worries with, oh, say the ECB... BoJ... BoC... RBA... BoE.... to name a few.

There's still a long way to go, but no moves higher means no moves higher in inflation.

Comments

[J P:]

The price of oil doesn't change the money supply in any significant way. Thus, the price of oil has little effect on the rate of inflation. The rate of inflation is controlled solely by the federal reserve (at least inflation in US dollars) and they do so, not by changing interest rates, but by deciding or not deciding to create dollars to underwrite US federal debt.

I'm not quite sure why oil is down now, it should be well above $80 due to the Iran trainwreck that seems inevitable. But I'm certain oil will never see $35 a barrel prices in the US, at least not in a situation you would like.

The reasons are twofold:
1. The dollars used to measure a barrel of oil have been inflated massively for the past 30 years, thus only an increasing supply of very cheap oil acquired at ever greater political cost has been able to keep the price of oil down when measured in rapidly devaluing dollars.
2. The supply of easy to get cheap oil has peaked and is now in decline.

The only possible way we could have $35 oil again would be for the federal reserve to raise interest rates to around %20, stop underwriting federal debt, and start sopping up all those dollars in circulation with gold. But I am certain they don't have enough gold to do it.

If we'd kept to the gold standard, we'd already have $35 a barrel oil, even with its increasing rarity.

2006 Aug 30 12:48 PM

[David Taylor:]

J.P.

Getting off the gold standard was one of the best things this country has ever done. Bernanke outlined and argued for in his book, The Great Depression, how countries that did get off the gold standard faired much better and got out of their economic woes much faster than countries like ours that did not. If we were still on the gold standard, this country would be in an economic trainwreck of its own.

2006 Aug 30 03:03 PM