Agora Financial’s Rude Awakening

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Laguna Beach, California

• Hypocrisy as usual – Congress lines up Big Oil for a talking to,
• How crude stacks up measured against non-dollar pricings,
• Where to from here? The trouble with rewarding shareholders and plenty more…

Eric Fry, reporting from Laguna Beach, California…

When share prices soar, we call it a “bull market.” When home values soar, we call it “healthy price appreciation.” But when oil prices soar, we call it “speculation” and “manipulation”…and then we gaze around for someone to blame.

The members of Congress recently convened a special hearing to berate, rebuke and ridicule executives from five major oil companies. Each Congressional inquisitor took a turn excoriating the oil companies for daring to earn a profit, especially when so many Americans have so little money. It just isn’t fair.

A few months earlier, you may recall, Congress invited the heads of America’s leading financial institutions to a little tête-à-tête. During that encounter, the Congressional inquisitors took turns admonishing the finance CEOs for feathering their nests a bit too lavishly. But none of the execs in attendance drew much criticism for frittering away billions of dollars of shareholder wealth.

Therefore, the essential message from the nation’s top lawmakers is clear: Losing billions of dollars of shareholder wealth is a bad thing, but not nearly as bad a thing as adding billions of dollars to shareholder wealth. In fact, earning billions for shareholders is such a bad thing that it must legislated away or taxed into extinction.

Where were the nation’s top legislator-inquisitors when the Nasdaq bull market of 1999 and 2000 was powering higher? Where was the outrage over the “speculation” that produced obscene “windfall profits” for the Wall Street firms?

And where were the Congressional hearings during the housing boom of 2004 to 2006? Where were all the sanctimonious, finger-wagging Senators who might have berated the National Association of Realtors (NAR) for making too much money? And why didn’t Congress drag members of the NAR into a hearing and accuse them of colluding with mortgage lenders to manipulate homes prices?

We possess no answers, dear investor, just a long list of impolite questions.

But from the looks of things, some bubbles are “good” and others are “bad.” A good bubble is one that makes the things we OWN go up in value. A bad bubble is one that makes the things we USE go up in value. Profiting from a good bubble is perfectly respectable in the eyes of most folks. It is honorable. But woe to the individual who profits from a bad bubble. A porn star enjoys greater respect and public approbation.

The funny thing is; good bubbles and bad bubbles are not so very different from one another. In fact, they are genetically identical. Monetary inflation sires them both. As dollars flood into the global monetary system, prices rise…somewhere. The prices of all goods and services do not always rise at the same time. Instead, the prices of some items will rise for a bit, while the prices of other items will remain the same.

But over time, a surging supply of U.S. dollars will cause the prices of almost all goods and services to rise. Back in the late 1990s, when share prices were rising and the oil price was falling, the headline inflation rate was delightfully quiescent. But that’s only because the stock market alone was “inflating,” and we called that a “bull market.”

A few years later, the housing market began “inflating.” No one complained. No one griped that home prices were soaring, even though the dollar was losing value at the same time. Throughout the last years of the Great Housing Boom here in the U.S. home prices actually FELL in terms of the euro and gold, even though home prices were rising in dollar terms.

Today, oil is rallying. In fact, it is skyrocketing. This fact does not make very many people happy (except perhaps, for all of the Rude faithful who have loaded their portfolios with energy investments). Almost no one cheers the oil bull market or celebrates its “healthy advance.” No. The soaring oil price is a plague. It is the demonic offspring of speculation and oil-company greed, if we are to believe the folks on Capital Hill.

But your editors do not believe them. The rallying oil price may be a demon-child, but speculation did not sire it. That ignominy belongs to the Federal Reserve, as Paul Van Eeden explains in the column below…

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The Road to $200 Oil
By Paul Van Eeden of www.paulvaneeden.com

When the crash dummies up on Capitol Hill see crude oil at $130 a barrel, they cry “Manipulation!” and start looking around for someone to blame. The funny thing is; they’re right. Manipulation is causing the oil price to soar…manipulation of the U.S. dollar. As for finding someone to blame, well, taking a stroll over to the Federal Reserve building might be a good place to start.

By increasing the supply of dollars the government devalues every dollar in existence by an equivalent amount. The impact of this inflation is not uniform through the economy or markets but, with time, it does filter through to everything. If we look at the price of oil in US dollars and simultaneously look at the inflation of the dollar we can see that oil has in fact not gone up in value at all - it is the dollar that has declined in value. So the manipulation is clearly evident, but it is not the supply of oil that is being manipulated, but the supply of dollars, to decrease the dollar’s value on the assumption that that would stimulate spending and economic activity. That is the cause of the rise in the oil price.

If we look at the exchange rate of the US dollar against the euro, and the twelve currencies that comprise the euro before its launch, we see that in January 1970 it took 1.151 “euros” to buy a dollar. Today it takes 0.644 euros to buy a dollar. For the sake of simplicity let’s use the euro-dollar exchange rate as a benchmark for the dollar’s devaluation on foreign exchange markets. From this exchange rate we can see that the oil price would have been 44% lower today were it not for the decline of the US dollar exchange rate. That would make the oil price, not $120 a barrel, but only $67 a barrel. In other words, the oil price is approximately 80% higher today than it would have been if the government was not so hell-bent on destroying the dollar.

For those who cannot fathom that it’s as simple as this, or that inflation of the money supply directly affects the value of the dollar, consider these words from Ben Bernanke, the current Chairman of the Board of Governors of the Federal Reserve Bank of the United States, in a speech he made on November 21, 2002 before the National Economists Club in Washington, D.C.: “Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services.”

Aside from the fact that the assumption that inflation can create economic activity is entirely false, the idea that OPEC is somehow to blame for the rise in the oil price is absurd. Look at the chart below that shows the oil price in US dollars and the increase in the supply of dollars as measured by M3. We see that the oil price is trying desperately to catch up with the dollar’s inflation. In fact, if anything, oil companies and oil producers have been subsidizing American gasoline consumers for the past 22 years!

The manipulation is clearly in the dollar. By rapidly increasing the money supply and thereby decreasing the value of the dollar, the government is directly and solely responsible for the increase in the oil price.

On another front, a proposal was tabled in the Senate this week to mandate higher cash collateral for energy futures trading. The thought is that since energy speculators must be responsible for driving up the price of oil, the government should increase the cost of such trading, thereby making it harder for energy speculators to engage in futures transactions.

This proposal again demonstrates the complete lack of any fundamental understanding of how a market works, and will have exactly the opposite effect to what its proponents have in mind. Professional speculators are seldom the cause of unjustified price increases or decreases (although they can be). Quite the contrary — if speculators deem prices too low they will buy a commodity thereby preventing prices from falling further. Similarly, if they deem prices too high they will engage in short sales thereby mitigating price spikes. The end result is less volatility, not more volatility.

Now, I am not going to try and argue that speculators as a group are always right, or that they do not sometimes get carried away and drive prices too high or too low — they are still human. But when speculators make such serious mistakes they typically lose their own capital, or the capital entrusted to them, and so the market eliminates them or, at least, “educates” them to make better decisions in the future. However, taken over a longer period of time and across a spectrum of commodities, speculators as a group undoubtedly reduce volatility in prices. In the rare instances when speculators do drive prices far too high, or too low, it is usually the result of unsophisticated “retail” gamblers trying to get rich quick at the end of a market cycle.

In the case of oil, the incredible inflation rate of the US dollar, as measured by M3, is clearly devaluing the currency and causing the oil price, and many other commodity prices, to soar. By making it more expensive and difficult for speculators to participate in the market, legislators will achieve only an increase in price volatility and the loss of market share to foreign exchanges that do not impede speculators from doing their work.

Notwithstanding anything said thus far, the oil price had a good run and so in the short term a pull back in the price of oil should be expected. But this would merely be normal market volatility, as we are currently seeing in the gold price. Over the long term the price of oil is going up. The days of $50 or $55 oil are gone forever.

Blame the manipulators!…the ones with reserved parking spaces at the Federal Reserve.

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Rude Endnote: A short while back we asked the Rude populace where they thought oil was headed in the future. Most said “higher”. Okay. No surprises there.

Today, let’s dig a little deeper. We’d like to hear WHY you think oil will track your chartered course. Will it be a glut of “Bernanke Bucks”? Will China kick into overdrive? Or is your editor’s backyard here in the Middle East about to erupt in a dazzling display of political fireworks?

We look forward to your response…

Cheers,

Joel Bowman
aussiejoel@the-rude-awakening.com