Why The Price of Oil has Fallen

There is a lot of debate among economists about what causes what and what does it mean, but at my pay grade, I am retired, economics is not all that complicated.

For example, the relationship between the price of a barrel of oil and the value of the U.S. dollar in relationship to the other major world currencies that are traded in the currency markets is not that complicated. If you have been paying any attention to either the price of gasoline at the pump or the price at which a barrel of crude oil is trading in the commodity markets lately, you know that the price of a barrel of oil has been coming down over the last several weeks. The price today in some markets is below $113 a barrel.

At the same time that the price of oil has been coming down, the value of the U.S. dollar has been going up in relationship to other major world currencies. What is this all about?

Some writers attribute this simply to the fact that investors are no longer seeking to hedge themselves in the commodity oil. But why are investors not continuing to hedge themselves in the commodity of oil? My opinion, and let me remind you that I am not an economist nor have I a Ph.D. in economics, is that we, these United States, are importing less goods and less of the commodity oil. The price of gasoline has sucked a vast quantity of money out of our domestic economy. T. Boone Pickens in his commercials says that it is the greatest transfer of wealth in the history of the world, and places the amount at around $700 billion dollars a year. Where is this money going? The money is going to oil companies that refine the oil into gasoline, but the bulk of the money is going to oil producing countries around the world. When U.S. dollars are removed from our domestic economy, there is less buying power because there are fewer U.S. dollars in circulation. Add to this that the Federal Government is running a budget deficit and has to borrow money and issue I.O.U.s, known as U.S. Government Notes and Bonds, and you have a situation that makes investors around the world less eager to hold U.S. dollars.

When investors think that a government is monetizing their debt by printing more paper money, investors fear losing the purchasing power of their money and look to trade U.S. dollars for other major world currencies, or invest (hedge) their money by buying commodity futures of oil. Monetizing the debt also leads to inflating the economy which leads to a loss of purchasing power of the dollar also known as inflation.

As a result of all of the above, the United State’s domestic economy has slowed down. Since people have less money to spend, economists refer to this as less disposable income, because they are spending more money to fill their car’s tank with gas, other goods and services that would normally be purchased are not purchased or the amounts of them are reduced. Gasoline’s price at the pump finally got to a level where the demand for an additional gallon of gas became elastic. When gas was selling for under $2 per gallon and its price bounced around during the week like a rubber ball, most of us could deal with that and continue to afford the products and services we were used to buying. But, once the price of gasoline reached $3 a gallon and then continued to climb to $4 a gallon, more people began to feel the pinch that the price of gas was having on their budget and thus their disposable income.

So, here we are at the end of August, 2008, and the price of oil and gas have had their run and now like any product or service that gets out of the reach of most people, the price starts to come down because the demand for the product or service has come down. As a result of Americans buying less foreign made products and gas, the amount of imports is less and as the imports are less, the number of dollars leaving the United States is less and therefore investors become less concerned with hedging themselves against the U.S. dollar and more interested in holding U.S. dollars rather than oil futures in the commodity markets.

Now I will tell you one more thing that gets little play in the media. The president of the United States could have taken action to have prevented this from happening, or, at the very least from hitting the American consumer as hard as it did. Had the president even hinted that he would have sold oil on the open market from the government’s oil reserves, those teeing off on the bet that the president would not sell oil from the government’s oil reserves would have been more cautious in their hedging activities. But knowing that President Bush and Cheney would do nothing to help the American family with the price of gas, the speculators drove up the price of oil in the commodity markets with no fear. Bottom line, the president could have taken action to thwart the greed of speculators and he did not do it. Look at it this way, if you are a base runner and you know that the catcher will not even try to throw you out at second or third base, there is then no reason why you should not run and steal a few bases. Those playing the commodity markets in oil had the sign that they could steal all the bases they wanted to steal because this “catcher” was not going to throw them out. Eventually, when the domestic economy slowed down as a result of $4 a gallon gas, the price of oil came down.

The Federal government can make a difference as a player in the commodity markets as a buyer or as a seller, but, this administration saw fit to do neither. This November Americans have an opportunity to elect a new president. I plan to vote and I plan to vote for a ticket that cares about the American family by their actions. I am voting for Obama-Biden for president and vice-president. I ask you to join me and vote.