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Inflation Triangle Dilemma: Dollar / Oil / Euro

People are worrying needlessly over all this. The thing about markets is that they correct themselves. They do it better if pointy-headed bureaucrats stay out of the way, which isn't likely to happen.

When oil gets too expensive, the combination of increased production and reduced demand will bring it back out of the stratosphere. This will happen very quickly once the traders see that the upside potential is smaller than the downside. Ahmedinijad's grip in Iran is not terribly strong and once he is gone his yo-yo-like manipulation of oil prices will fade. Other crises will come and go but that has been the case in the Middle East for the better part of a century. There is talk of reducing government energy subsidies for consumers in Asia. Reduced consumption caused by even a modest slow-down in China/India would take significant wind from the speculator's sails.

Once the oil bubble breaks, it is likely to stay broken for some time. The high price now is stimulating oil exporters to spend lavishly. In other words, they are becoming accustomed to big incomes. When the price falls, they will have no choice but to pump more to maintain the spending levels to which they are becoming accustomed. OPEC members will bicker back and forth over who is over-pumping. We have seen this before.

Market forces will likewise find the appropriate value relationship of the Dollar/Euro. The long-term fundamentals underpinning the Euro are weak relative to those supporting the Dollar. The inherent strength of the U.S. system relative to that of continental Europe makes Euros a long-term loser, despite the near term support afforded by a weak dollar. Certain EU member nations are in no position to weather higher interest rates. Fissures will erupt, putting the unified currency and the member governments under pressure. The relative strength of the well-integrated U.S. economy will lend strength to the dollar, mitigating somewhat the effects of oil prices and interest rates.