Why Are Oil Prices So High? Gold Solves the Riddle

As the price of a barrel of crude oil continues to rise past $140 a barrel, one begins to wonder, is the price of oil primarily rising due to the strong global demand for oil, or due to the U.S. dollar [USD] falling so much in value?

One way to solve this riddle is to travel back in time to the 20th Century when after World War II the USD was considered 'as good as gold' because the exchange rate between the USD and gold was fixed by U.S. federal law at 1 USD = 1/35th of an ounce of gold; that is, until President Richard M. Nixon shocked the world by unexpectedly yanking the USD off the gold standard on August 15, 1971. Or, travel even further back to a time centuries ago when men and women the world over used gold as a medium of exchange, a store of value, and a unit of account. Back then, prices of almost all goods and services were quoted in units of gold. Looking at the price of oil from this historical perspective, a new question arises: Would the price of crude oil be rising so much if the world were paying for a barrel of oil with ounces of gold instead of the currently 'goldless' USD?

Thankfully, we can use readily available historical data on gold, oil, and the U.S. dollar to answer that question. The key is to transform the data -- and our thinking -- such that a single ounce of gold becomes the currency (or, unit of exchange) that anyone could use to buy and sell a barrel of crude oil or to buy and sell the currently 'goldless' U.S. dollar. Applying this data transformation and then using 1991 as a normalized index point (January 1, 1991 = 100) for both oil and the USD, the logarithmic graph below uncovers a hidden truth: starting in late 2001 (around the time of the September 11 terrorist attacks on the U.S.) through today, anyone could use a single ounce of gold to buy an ever-increasing number of U.S. dollars (the red line), or anyone could use a single ounce of gold to buy an ever-decreasing number of barrels of crude oil (the blue line).

Normalized Index for Gold Ounce Price of Barrels of Oil and U.S. Dollars (January 1, 1991 = 100)

Graph © 2008 by Prof. Werner Antweiler, University of British Columbia, Vancouver BC, Canada. Used with permission. Time period shown in diagram: 1/Jan/1991 - 14/Jul/2008.

Looking at the graph another way, the red line reveals that an American today is having to spend almost 2.7 times the number of U.S. dollars he had to spend back in 1991 to buy a single ounce of gold (July 14, 2008 = 268). This is confirmed by comparing the USD prices of one ounce of gold in 1991 and today: $362 and $971, respectively.

Similarly, the blue line reveals that anyone today using an ounce of gold as currency can only buy 40% as much crude oil per ounce of gold as he could in 1991 (July 14, 2008 = 40). In other words, anyone must now use 2.5 times as much gold as he could in 1991 to buy one barrel of oil. This is confirmed by comparing the gold ounce prices of one barrel of oil in 1991 and today: 0.06 ounces of gold per barrel and 0.15 ounces of gold per barrel, respectively.

So, a barrel of oil has increased in price by 150% in terms of gold ounces since 1991 and, at the same time, an ounce of gold has increased in price by 168% in terms of 'goldless' U.S. dollars. Thus, gold solves the riddle: the price of crude oil is high and rising primarily due to the 'goldless' USD losing its purchasing power, and secondarily due to the strong global demand for oil. That is why the same single barrel of oil that cost only $23 in January 1991 costs over $140 in July 2008.

In short, as the U.S. dollar in his pocket becomes increasingly worthless, the average American is being forced to cough up more 'goldless' U.S. dollars to convince a seller of a barrel of oil to make a fair trade. Who can blame the oil seller if she believes "fair" requires ever more increasingly worthless U.S. dollars to complete the sale of an increasingly demanded barrel of oil?

Perhaps the riddle that the average American should be trying to solve has less to do with the price of oil going up and more to do with the purchasing power of the USD going down. The real questions that Americans should be asking are:

• Why is the USD losing so much purchasing power?
• Why are our elected representatives in Washington, D.C. failing so badly in their constitutional mandate (Article 1, Section 8, “The Congress shall have power…to coin money, regulate the value thereof, and of foreign coin, and fix the standard of weights and measures…”) to provide We the People with a stable currency -- a currency 'as good as gold', or at least a currency the supply of which is actively managed by the Fed to maintain the currency’s value within a narrow range of gold ounce prices?
• Why do We the People continue to elect representatives who think nothing of devaluing our currency through profligate printing and spending, rendering us all poorer and poorer as time goes by?
• When will "We the People" say 'enough is enough' and finally elect representatives who will honor their constitutional mandate to provide all Americans with a stable U.S. dollar?

Until "We the People" take action and demand real change in our federal government -- especially its monetary policy (stable dollar) and fiscal policy (balanced budget, lower debt) -- we will continue to watch in dismay as the price of oil climbs higher and higher on the world market.

Copyright 2008 PowerWealth.com.

 

Comments

[john s. gordon:]

there was @ one time a fellow named w.j.bryan who made a cross of gold speech.....
> jack

2008 Jul 15 08:20 AM

[FeverBuster:]

The fall of the dollar value is a catalyst for over investment in oil futures. Just as all of the propaganda from the Middle East or the latest round of "fear" tactics coming from Brazil and their oil strike which only represents 64,000 barrels of oil a day in actual physical loss. This is not even in the same ballpark as to how much demand destruction has occurred from the high prices, yet the considerable fall in demand does nothing to offset the price.

Physical Supply and demand are not at play now. Just oil futures determining the price curve.

Your essay only proves that there is more at play than the fall of the dollar if even gold can not buy the same amount of oil as is did in the past. As I stated before, the over investment of oil futures on the scale of 2X futures than actual supply is where the high price is coming from.

2008 Jul 15 08:28 AM

[xsuddensam:]

It's too late. Responsible and intelligent people don't want the job. Americans have settled for mediocrity from our offiicials and that's exactly what we got.

I'm afraid that it's too late to fix the financial system--too much debt, too much corruption, too much ambivalance and most importantly, too much fiat money. It's laughable, if it weren't so dire, that the only short term solution for the financial markets is to print more money!

I may be a pessimist, but owning paper assets, including stocks, bonds and cash is foolhardy at best. The only question is when will the house of cards will fall.

2008 Jul 15 08:39 AM

[Kunst:]

The underlying cause of the decline of the dollar is decade after decade of government deficit spending. By refusing to pay the full cost of government services we use, we overconsume with the money we borrow instead. We are going to have to live within our means whether we want to or not.

2008 Jul 15 08:41 AM

[ferguson:]

The American economic system has always been a magic show. Value is created and destroyed every minute, right before our eyes, even, as in the case of the mortgage securitization business, if there was more than a little wool pulled over those eyes. In the short term, a minority made outlandish profits. In the long term we will all pay. The gold standard is not sufficient to restore honesty to the system. A little moral fibre in the backbone of our so-called representatives in Washington would help.

2008 Jul 15 08:42 AM

[Mathman Pro...:]

Good article. Instead of blaming oil companies for price hikes, the public should hold the government responsible for a weaker dollar. Unfortunately, the concept of inflation doesn't seem to register with the general public -- nor with the Fed.

2008 Jul 15 09:38 AM

[GMiki1:]

FeverBust, Demand destruction? Not really. Demand increases. Just not here.

The federal government for sure is at fault for allowing a private institution--the Federal Reserve--to dictate dollar policy--as well as for the degree of deficit spending.

2008 Jul 15 10:10 AM

[JohnE:]

Thanks for a good article. Politicians in administration after administration, democrat and republican have been destroying the nations financial security even as they pander "free" programs to the citizens and shill for their big business "contributers" and political pals so they can stay in power for ever. The nation is doomed, unless we change.

2008 Jul 15 10:19 AM

[Larry House:]

So many problems in the U.S. could be solved if voters would insist on certain things from their elected representatives, but I don't see it happening. For seventy years the government has been nursing more and more citizens, and many, many people will not do anything that would wean them from the Federal bottle. As long as people look to Washington to take care of them, the hard and correct choices will never be made. I am a hopeful person, but I see this great country on a continual decline. I have seen events in this country since the 1950s, and I don't see us moving in a better direction. We are in an economic, moral, and political decline. The pillars of this country are cracked and crumbling. We can turn it around, but I just don't see it happening anytime soon. The people do not have the resolve to do it.

2008 Jul 15 10:23 AM

[ICouldBeWrong:]

Good article. Good comments.

2008 Jul 15 10:47 AM

[Kelly Liebe...:]

GLD, SLV, now not later. Do yourself a favor. This morning. while you're at it buy some for your kids and grandchildren - whether you have them now or not....

2008 Jul 15 11:11 AM

[sandspider:]

And all the Feds men and all the Feds horses could not put poor Humpty Dumpty back together again. With the white knight walking backwards and the black queen off her head..... is that "Rome" I smell burning or is it because the Fed has no clothes and just farted??
How good will it be when the UK unravels as it has started?
And how much better will it get once the Golf Cooperation Council
(Saudi, Kuwait, Bahrin, Omar, Qatar and the UAE) get their new currency off the ground. Watch out Euro and sad for the $$.... And who else is going to dump the powerful $$ out there? hmmmm
The real CPI (pre Carter admin) yesterday was 11.5% and forget U-3, how about U-6 of 9.7% and include the long term unemployed (> one year) which Clinton's admin dropped and it is 13.7%... How I love the smell of fiat currency burning in the morning....May the lying Fed rot in hell. Smoke and mirrors....Smoke and mirrors....
Remember what the Dolman said..."Feed your head" READ!! And be awakened.

2008 Jul 15 12:12 PM

[sbennett1:]

JohnE writes that "Politicians in administration after administration, democrat and republican have been destroying the nations financial security..." he seems to echo the point of the author -- Washington is doomed, no one has ever tried to fix our deficit, etc.

But don't you remember back to the Clinton administration eliminating the annual Federal deficit -- by (God-forbid!) raising taxes and controlling spending? It was part of a larger deal with Greenspan to make more investment dollars available for productive businesses without wild inflation by... limiting, and in fact eliminating, the federal deficit. Passed in 1993 without a single Republican vote? Anyone? Anyone? It was in all the newspapers? No?

See graph above for effect on value of dollar, see history books for number of jobs created over the next 8 years...I think it was 22 million...

Am I the only one who remembers this?

I know the author cites the 9/11 attack as the turning point -- but maybe we could more accurately say that when Bush's tax cuts, along with no reduction in federal spending became apparent, then the value of the dollar fell off the table.

If this is not what happened, please someone tell me what did?

My figures show the (deficit) or surplus in Billion of $ during the Clinton Years as:
1993 (255.1)
1994 (203.2)
1995 (164.0)
1996 (107.4)
1997 (21.9)
1998 69.3
1999 125.6
2000 236.2
2001 128.2

I think we could do it again...let's start with higher taxes on folks who earn millions from investments that depend on our national infrastructure; couldn't they help pay their fair share for its improvement?

I know the right-wing will yell "income re-distribution" but really who will benefit more from new bridges, new research at Universities, and new military adventures around the world -- the owner of the trucking company or one of its drivers?

Sure it is fun to say democrats or republicans govern the same way in Washingon -- and I'm sure they both extend favors/deals to corrupt friends etc -- but have budget numbers lost their meaning?

2008 Jul 15 12:24 PM

[faststock123:]

Right on....I hope this message is heard!

2008 Jul 15 02:39 PM

[User 30121:]

Sonofabitch! What a TERRIFIC article! THANK YOU!...and the comments???? Jesus help us. When folks like you all can sit there and punch out SIMPLY ACCURATE PORTRAYALS of what is WRONG with our country (economic, political, and MORAL) and those PINHEADS in Washington don't have a clue (because they are CROOKS) is enough to make me cry! Love yas all!

2008 Jul 15 03:26 PM

[sherrikrn:]

sbennet1,
I remember, and agree. (I also remember when the US Constitution was interpreted to embrace and defend the individual over business and lobbyists. I am probably older than you, but I remember when we had three co-equal branches of government, not a unitary government).
Talk about "income re-distribution", we have witnessed the biggest redistribution in history, over the past seven years....

2008 Jul 15 03:28 PM

[fireball:]

LOGAN FLATT your questions, (1) we keep the presses rolling and now at a frantic pace trying to save institutions and debtors who do not deserve saving, but bad government has allowed such foolish lending and borrowing. spending more will never be an answer except very short term. (2) because to them money and foolish policy is the way to buy voters or big money political support. cling to power no matter the cost to the nation. (3) because we have devolved from a representative republic into a democracy and the masses want largesse. the majority are ignorant of the constitution, history, and economic consequenses. give us our beer(soma) every night and we will not think. because they cannot see that the difference in candidates is the lies they tell their constituants. because we have grown fat stupid and lazy. because the mainstream media support the wwf like contest. i do not know if the talking heads are stupid or if it is more sinister. because the very few industrious intelligent citizens left waste their energies defending socialist partyA or socialist partyB. if they would turn around and look at what putrid scum they are defending they would be sick. because only a room full of lawyers could twist and defile a document so simply written(for the common man). i certainly do not need a lawyer to tell me or interpret for me what was written for me. because judges think it is their courtroom instead of our courtroom (and think they are worthy of this power). they regard themselves as masters(politicians too) rather than servants. because government schools are teaching less and less anything that matters and are focused on green-red philosophies and politically correct garbage. therefore ignorance grows. because we no longer deserve what the founding fathers gave us at great cost to themselves. because most are ignorant of the warnings they gave us. example no national bank. (4) when soldiers and tanks are rolling through the streets and because of weakness and sickness from starvation we are to weak to fight we have become slaves in the land of the frightened and home of the cowardly................. get the leaders we deserve.....because we are divided and think it is o.k. to steal from one to give to another. because we are stupid enough to think government can fix anything. because a fiat currency is doomed to fail. government the largest debtor, spender, employer, land owner(illegal by the constitution) etcetera is so far beyond the legal boundaries......... gold is buying less oil because whether real or fabricated the demand is greater than the supply. gold is behaving as real money should. the people have forgotten that the final most powerful check and balance comes back to them in the form of a jury of 12 being able and duty bound to order any law struck from the books if it is bad law, and the largest problem is they have forgotten that lawyers are not to be allowed to hold public office. the highly restrictive voting laws have been nullified. no one who recieves government stipend(look it up) no debtor and non property owners were allowed to vote. (we have corrected any thought of race or sex being excluded) because they have a conflict of interest, this is a simplified set of answers.............JO... S GORDON my friend i hope you got a chance to examine gbrc. it is interesting from a potential profit point of view.

2008 Jul 15 03:42 PM

[fireball:]

LOGAN FLATT i have been thinking more. history is my pet subject. now we have government of the lawyers by the lawyers for the lawyers, because we forgot. we should not allow career politicians. they should after a term be forced by the voters not term limits to come home and try to live and work in the environment they have designed. we should not stand for any law to be for us and not them. example they wish to force our children into the government schools yet their children attend the finest private schools. example they wish to destroy the second ammendment for us yet they go armed and have armed bodyguards. the second amendment was never about fighting indians, home protection, hunting or target shooting. it was to keep government afraid of the people instead of the people fearing the government. only a slimy lawyer would not see the obvious. for years i traveled this country working. most of the time i kept a loaded revolver handy. i never needed a permit because i understand SHALL NOT BE INFRINGED.i only pulled it four times and never had to pull the trigger. criminals only want to prey on the defenseless. they ran like rabbits. only once was i tempted to shoot anyway when 5 punks thought i should be intimidated. i did not want them to victimize another person but i did not shoot because i really do not wish to harm anyone ever. should we not tar and feather a judge who says do not mention the constitution in my (it is ours) courtroom or who dares to instruct the jury? why do we allow lobbyists to bribe the people we voted for to go against us? lobbying is bribery that lawyers made legal for themselves. a man who represents himself has a fool for an attorney. it was never meant to be that way. an innocent man should be able to walk into a courtroom by himself without fear or expense. that is what was intended. now no matter what we do a lawyer makes money. i fear the constitution is so buried in crap (illegal unconstitutional law) that it is irretrievable. these simple beautiful documents are to good for us. as my father would often say a free state can only exist with a moral civil people. now every plank of the communist manifesto is in place here except they have only partially disarmed us. i challenge anyone (unless you are a puss filled lawyer) to do the research and prove me wrong. if you are a lawyer and insulted good. go to hell. if you support obama or mccain you are an idiot. they are not for you. they are for continueing their political career, period. yes include hillary, bush, gore ad naseum. the grandfathers of gore and bush both got in trouble for doing business with the nazis. only two this century have tried to help this country. kennedy came out of the missle crises a changed man. he took our currency out of the hands of the federal reserve (which is a private organization not federal) and issued united states notes (30 days before the assassination). johnsons first act was to give it back to the fed. ten days before he was killed he gave a speech at colombia university in which he said , i must use the office of the presidency to inform the american people of their betrayel by their own government. yell conspiracy all you want but i ask that you look for yourself. two weeks after the asassination before the warren report post magazine ran an interview with the doctor who tried to save jfk in which the doctor compares the rifle wound in the head to the pistol wound in his throat. the other decent man was regean but he lost his nerve after the attempt on his life. sometimes i get so disgusted i think about expatriating, then i say no my ancestors died, and died and died in the revolutionary war for us, all of us. can i just leave and hope it works out o.k.. a man who seeks power is not fit to weild it. a good leader is servant to those he leads.

2008 Jul 15 06:02 PM

[JeffDB:]

sbennett1, It does seem to me like much of Clinton's deficit reduction was due to some smoke and mirrors magic tricks. IIR they they paid off some bond with funds from Social Security reserves and did not count the IOUs they left as debt on their balance sheet. Ta da! The deficit was magically reduced.

I believe they also rolled over long term debt ie. 30 year bonds as short term debt, such as 1 year and 90 T-Bills etc. and dropped the interest expense quite a bit, and hence the deficit. Unfortunately, that also increased our risk as that debt needs to be rolled much more frequently and if interest rates jump, those lower short term interest rates will have to be renewed at much higher ones. Possibly much much higher ones.

I think he was also the beneficiary of the major drop in trade restrictions via NAFTA and of the big gains in productivity via computer upgrades (many due to companies upgrading because of the Y2K scare) and of companies and individuals taking advantage of the internet on a much grander scale.

Certainly the war isn't helping things, but I'm not sure if downsizing the military as he did was the best thing to do either. It was ramped up again after he left and many were complaining that the military had been way underfunded with the shortfall having to be made up later to get parts for equipment etc.

2008 Jul 15 07:50 PM

[Kunst:]

"But don't you remember back to the Clinton administration eliminating the annual Federal deficit -- by (God-forbid!) raising taxes and controlling spending? It was part of a larger deal with Greenspan to make more investment dollars available for productive businesses without wild inflation by... limiting, and in fact eliminating, the federal deficit. Passed in 1993 without a single Republican vote? Anyone? Anyone? It was in all the newspapers? No?"

Yes, and I remember how the Republicans warned that the economy would collapse. Not exactly.

But keep in mind that Clinton's "surpluses" weren't quite kosher either, because they still counted the positive cash flow from Social Security and Medicare as revenue even though they were really debt. So even though we had some "surpluses" there, the national debt went up each of those years.

Still, a lot better than Bush's insane tax cuts, which will nearly double the national debt by the time his two terms are over.

One more note: of the $10 trillion (will be by the end of this year) national debt, $1 trillion is from before 1980, $1 trillion is from Clinton's terms, and $8 trillion is from Reagan and the two Bushes. Bush I was right the first time: "voodoo economics".

And who has to take the ultimate blame? The American voter, who for decades has reelected politicians who tell us we don't have to pay for government, we can just borrow from our children and grandchildren.

2008 Jul 16 02:22 AM

[AEB:]

I don't understand why smart people spend so much effort trying to make the high price of oil seem complicated. Worldwide demand has expanded as the benefits of the global economy have spread. Supply, while not an immediate problem for the short-term, is not expanding. Punto!

The idea that a weak U.S. dollar somehow controls the worldwide price of oil is parochial, at best. It does make oil more expensive for countries whose currency is tied to the U.S. dollar. It also encourages investment in commodities, like oil, that are relatively more attractive than investments in treasury bonds and elsewhere in the U.S. economy. Push the Fed to raise interest rates if you want to fix this.

Finally, the mindless litany about speculators pushing up the price of oil by futures trading needs needs a moment of ground truth. There is no correlation between the percent of speculation on the NYMEX and the annual price change of oil over the past 10 years. Look at the data rather than repeat the uninformed statements of others. Speculation has increased as it always does in any market that has a lot of mobility. That doesn't mean that speculation is increasing the price. Remember, just because you buy a contract (whether speculative or not) doesn't mean anything unless someone will buy it.

Let's stop bantering about secondary or tertiary factors regarding the high price of oil and look at the fundamentals. Don't forget about price elasticity: it takes time to change momentum (price increase). Whenever future price expectation is different than spot price, spot price must adjust until the two are again in equilibrium. That is happening with oil price. U.S. demand is down 1 MMbopd since January. The price will fall.

Keep it simple.

2008 Jul 16 11:28 AM