What Higher Oil Prices Are Directly Related To

I’ve written extensively about how the stock market can only go down as oil prices rise. In the end, higher oil prices mean less consumer spending, higher interest rates and a lower stock market. The government has done nothing to help consumers deal with oil at $145.00 a barrel, while American oil producers are posting collective profits of about $50.0 billion a quarter.

It’s my belief that the excess from the Greenspan-created real estate boom that ended in 2005 and the credit crisis is close to bottoming out. The stock market, and in particular the Dow Jones Industrial Average, might have been 20%-40% higher than it is today if it were not for higher oil prices, as the stock market has a strong distaste for oil over $125.00 a barrel.

While analysts continue to argue about whether the rise in oil prices is tied to real supply/demand imbalance or simply to traders bidding up the price of crude, I continue to believe higher oil prices are directly related to the falling value of the U.S. dollar.

President Bush will soon travel to his last G-8 summit and I’m sure much of the talk will be about oil prices. Since our President took office, the value of the U.S. dollar has fallen 40% against the euro, and I think we have that single factor to blame for the rise in oil prices.

Advertisement

Imagine if you were a foreign oil producer. Would you take American dollars for the oil you make when that currency is down 40% and continues to decline? Any sane businessperson would either increase the price of the commodity he/she produces or ask for payment in different currency. So far, the price of the commodity has increased.

If we actually look at oil measured in gold, the price of oil has not changed. About 10 years ago, an ounce of gold would have bought seven to eight barrels of oil. Today, an ounce of gold still buys eight barrels of oil. Hence, my message it that the price of oil has not risen when measured in real dollars (gold), but has risen against the U.S. dollar, because the U.S. dollar has fallen so much against other world currencies.

And until Fed Chief Ben Bernanke takes the dreaded step of raising interest rates, the U.S. dollar will continue to be a weak currency and oil prices will remain high. This morning, the European Central Bank raised its key interest rate by 25 basis points to 4.25% — this can only add more selling pressure to the already fragile U.S. Dollar.