135 Dollars a Barrel: Are You Falling for the Great Oil Illusion?

Saturday, July 19, 2008 by: Tk Maine
Tags: oil prices, health news, Natural News

(NewsTarget) Headlines around the world are highlighting the fact that oil has reached a new peak in price as U.S. oil reserves unexpectedly declined. Many mainstream media articles and television shows -- the essence of news reports these days -- blame this problem on OPEC and increased demand from developing nations such as China and India. While these factors do play a part in the pricing of oil, they shadow the truth that the price is more reflective of other things occurring in the global economy.

Consider the lowering of the interest rates and the injection of capital by the Federal Reserve into the U.S. economy. These actions by the Federal Reserve are intended to solve the credit crisis by placing more money into the financial system. As this "new money" is injected into the system at a faster pace than advances in productivity, there ends up being more money relative to assets. Assets thus appreciate in relation to current price levels. Uninformed individuals would believe that the increase in prices of different goods is attributable to those items having an increased demand or decrease in supply. However, if you take the inflationary actions of the Federal Reserve into account and calculate prices today versus those during the 1990's, it is quite apparent that products aren't more expensive, but rather the price has increased as inflation increased.

In order to make the facts more transparent, consider the price of oil relative to the price of gold. If these prices are placed on a chart alongside one another and a standard deviation is used in order to cancel out seasonal swings and non-reoccurring large transactions, it becomes quite apparent that the ratio between the two has been equal since the 1970's. Let me break it down for you... If you had an ounce of gold in the '70s and used it to purchase a certain amount of oil –- in other words, barter -- then that same ounce of gold today would buy the same amount of oil!

During the past two to three decades individuals have not paid a significant amount of attention to rising prices since salaries rose alongside with them. I always remember hearing my parents complain about how cars were a couple thousand dollars back in the day, while today a decent new car can cost at least 10 to 20 thousand dollars. Certain interests understood that by inflating prices and inflating salaries a double effect was being created: one, making individuals believe they were better off than the previous generation in terms of monetary compensation since they earned more than their parents; second, it gave the false illusion that through monetary control, we can continue a perpetual advance in economic growth.

An essential part of having a free-market is to allow the market to correct itself every so often -- such as a recession -- in order for the market to revalue its prices. As soon as any politicians get involved, they realize that if the economy doesn't perform strong, they don't get re-elected. This drives them to become more involved in the economy in order to maintain their position, yet this artificial stimulation ultimately destroys the free-market, which always seems to be the case when politicians get too involved. No economy can sustain growth forever without eventually overheating and crashing. The ideal environment for our economy would involve long periods of growth, followed by short periods of recession, in order to correct any inaccuracies in price levels. If we sustain growth periods for too long, such as through political meddling, it delays any recession and increases the likelihood of depressions –- or worse, long periods of economic decline. For further reading I would suggest individuals look into Ludwig Von Mises' concepts along with the Austrian School of Economics.

I like to imagine the economy as a fire we all use to keep warm. If we add enough wood to the fire we will maintain it at a rational level and keep everyone warm, even though those farther away might be a little cold. Playing with the free market as politicians always do is akin to throwing gas on the fire, which might burn those who sit too close or even start a forest fire. Through basic free market economics, untouched by politicians and government control, the fire will slowly build itself up as productivity and innovation dictates pace. I would hope that most would agree to build a fire slowly and carefully, ensuring that everyone is kept warm, rather than rushing carelessly and losing control of the fire, only to have it consume us all.

About the author

Single male American-Arab residing in the Middle East, while being a financial analyst for one of the regions leading asset management firms. Involved in daily emerging markets and global economic data in relation to investments. Continously pushing to think outside the box.