Want Lower Oil Prices? Fix the Dollar!

Most folks hail the low dollar vs foreign currencies as making our exports cheaper for foreign buyers, thus helping our economy. True, but it also has a very real negative effect that currently is doing far more damage.

The price of oil (USO) from Saudi Arabia, Iran an the rest of the world is priced in dollars. Why does this matter? When the value of the dollar falls, as it has precipitously done the past several years, it costs more dollars to buy things from other nations. The largest of those purchases we make? Oil.

In fact, had the dollar simple kept pace with the Euro this decade, the price of oil today would be sitting at a very comfortable $57 a barrel. Had it been pegged to gold, the per barrel price would be in the $30 range. Makes you think.

The result? Companies like Dow Chemical (DOW) are moving production overseas where "inputs" (read:oil) are cheaper. One cannot fault Dow for this, its survival depends on these actions. Companies like Coca-Cola (KO) has enjoyed profit runs as the goods they sell in foreign nations are now bringing them increased profits as those overseas currencies are converted into increasingly more dollars.

While a cheap dollar may make some exports more appealing to other countries, with the increased cost to the average consumer here at home from heating oil, gas prices, and all the products derived from oil, it is a losing game.

Here is the real danger. We are entering a political season with the following scenario developing. Higher taxes and lower interest rates. What this effectively does is provide consumers with less of an asset that itself is decreasing in value. That is a VERY bad scenario. Think of the late 70's and Carter.

If we have to raise taxes (we don't, politicos just think we do), then in order to offset the effect of consumers having less money, we have to make that money more valuable by keeping interest rates at least where they are now or raising them to the crush inflation. Inflation matters, as Berkshire Hathaway's (BRK.A) Warren Buffett likes to say "It does not matter how many dollars I have, it matters how many hamburgers I can buy with those dollars". That is the effect of inflation.

So, what to do? Stop the dollars decline and stop the decreasing of interest rates. The fall in the the dollar must be stopped. Any benefits we get from the increase in exports, is crushed by the added cost of products and losses in jobs as energy prices force firms to move to other nations.

Here is the good thing: Oil trades in the futures markets. Simply put, it trades based on where people "think" prices will be. With the dollar constantly falling, that thought process is always to the upside. If market participants actually believed the dollar would strengthen and that trend was going to become the prevailing one, there would be an immediate reversal in the current upward march in the price of oil.

The bad thing is that in order for this to happen, Bernanke & Co. at the Fed must not only disappoint the market, he must pull the rug out from under it. He must allow the excess liquidity to evaporate and must hold rates (higher than now eventually) to crush inflation. Both of those actions would exacerbate the housing situation and cause the market to tank.

It would be the best thing in the long run though...



Disclosure: Long Dow