Mover Mike

Joel at No Pundit Intended and I had a conversation about oil. Was the price increase of Oil due to inflation as I contended in Larry and Carol and Bernie or as Joel contends to demand. Joel said

Our high gas prices are not due to inflation. They are due to the grossly higher demand for fuel in developing nations, as well as our continuing rise in the US. While the US demand for fuel has risen about 20% in the past several years, it has nearly quadrupalled (double check my numbers, but you will get the idea) in China, as they reap the technological benefits of capitalism.

Mover Mike said

GCC countries are dollar dependent. Their currencies are pegged to the dollar, their main source of income (oil) is factored in dollars and the majority of their investments abroad are held in dollars. While after World War II, the US dollar was still backed by gold and current account surpluses, it has turned into an empty paper promise since the 1970s. That spells potential disaster for GCC countries and calls for a stronger diversification of their currency reserves.

I just learned of the International Relations and Security Network (ISN). Based in Zurich, Switzerland,

the ISN is a free public service that provides a wide range of high-quality and comprehensive products and resources to encourage the exchange of information among international relations and security professionals worldwide. The ISN works to promote a better understanding of the strategic challenges we face in today’s changed security environment.

Here's their take on the reason for higher oil prices:

One of the most important reasons for higher oil prices is the US trade and budget deficit. The trade deficit, which stood at around US$500 billion in 2004, served to devalue the dollar, and as the price of oil is set in US dollars, the cost has gone up to maintain its value. As energy imports make up 30 per cent of the trade deficit, an increase in the price of oil is reflected in the trade deficit. February’s deficit stood at an all-time high of US$61 billion and is projected to amount to a staggering US$700 billion for 2005. David Rewcastle, an analyst on energy and the Middle East, sees three financial reasons behind the rise in oil prices. First, he says, “oil is being used as a hedge against the falling dollar; secondly, a lack of good investment opportunities makes oil a good alternative for hedge fund and institutional investment; and thirdly, with the subsequent price rise, and high futures curves, everybody in the market is buying in the expectation that some event will cause a catastrophic oil crunch, which would reap huge returns for those who bought oil futures.

In one sense Joel is right, demand is the culprit, demand based on economic growth. However, demand is also based on the "fraud" I posted about.

Bootstrap the system with leverage to inflate asset valuations, to inject easy money into the economy, to convince everyone that we are prosperous.

So investors and speculators are buying oil to hedge against a falling dollar and some disaster they think may happen. A government that cheapens its currency, like we do and most of the world governments do, is inflating and that inflation causes mixed signals. Ultimately, down through history, NO fiat currency has ever survived. Which would you rather do, buy something that is going to be worthless over time or an asset that is in demand.