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Goldman Sachs last week stuck with its oil price prediction of $147 per barrel by the end of 2008. I pray for oil at $200.

$200 oil with its knock-on effects would drive the CPI up at least 20% initially from today’s levels, and would place the world into a recession bordering on depression. It would cause major upheavals in the financial markets. The Fed would be close to powerless to soften the impact of the impacts of this high oil price. There would be blood on the streets and it may be a good thing.

“For all practical purposes we are at currently at war.”

This was a quote from the Tom Clancy book, Debt of Honor. The USA has been at war for some time but few recognized it as war. Terrorism was not the real enemy – economics was. America is under attack from:

  1. The US government leaders with ever mounting debt servicing due to inefficiencies, lack of fiscal restraint, and using weapons which spill blood and cost a lot of money to fight wars;
  2. Certain trading partners who believe trade is a one way street;
  3. Europe with the Euro;
  4. Commodity rich countries; and
  5. US residents credit lifestyle and search for the fast and easy buck.

The US Economy is in Bad Shape

Within the last year, trillions of dollars of real and imagined wealth was destroyed. It is tough going now as this debt has damaged the US economic engine. It will take many years to work off the losses and recapitalize. Additional losses will continue to unfold as the dominos of the housing and commercial properties markets continue to fall. The government will be short revenue from tax base deterioration and this will exasperate the government debt.

The Differences between the Great Depression and Now

The Fed. The Fed today has mitigated the potential over reaction to the sub-prime mortgage crisis, and the ensuing credit crisis which will be unfolding for years to come. During the Great Depression, the government and the Fed stood around and let the market forces destroy the economy.

We are currently in the Great Indescribable. It is indescribable because there are issues of inflation, deflation, unemployment, debasement, expansion, contraction…… For sure there is a lot of bad debt and over valuation which cannot be absorbed in the short term. The Fed will continue to fight to ease the damage being done. It is defending economic valuations which will not be sustainable for years to come. The very effort of trying to create a soft landing may be working against a smooth recovery. Politically they have no choice, unless an event occurs which even the Fed is powerless to mitigate.

A Major Event to the Rescue - $200 Oil

Without a major event, it will take decades to work out the effects of the Great Indescribable. The Great Depression needed the Second World War to terminate its grip on the economy. The massive R & D and economic priming necessary during and shortly following this war supercharged the US economic engine while the rest of the world was in ruins.

$200 oil would hurt the US economy, but would destroy the economy of pretty much everyone else other than an oil exporting country, China and India. The situation in the US would be very bad for many years, but when viewed twenty years from today we would see:

  • Quantitative analysis of shipping costs favored local manufacturing. Mini factories were built all across the US. The cost of labor became a very small percentage of the retail price of industrial and consumer goods.
  • Massive R&D into alternative energy favored US technology base. New technologies will be born in the USA and exported.
  • Politically, there would have been no way to lessen the USA dependence on oil unless oil until it became so expensive that the middle class could not afford to drive their cars or heat their houses or watch TV.
  • This massive R&D investment, subsequent retooling, and then manufacturing & construction of non-oil using cars and power generation installations revitalized the economic engine.
  • The Treasury and the Fed were far more important than the Departments of Defense and Homeland Security. The US can only be safe if it is strong economically. All wars are economic.
  • It forced the US markets valuations to contract to a level that long term and sustainable growth could be achieved.
  • There were several constitutional amendments which included the line item veto to get the budgeting process under control, and political campaign regulations which outlawed any fundraising or political action groups.

In the long run $200 oil may be a very good thing.

Disclosure: It seems I will not be running for any political office after writing this article.

Source: Why $200 Oil Is Good for US Markets