“Oil has become the new interest rate, capping growth when central banks insist on flooding the system with liquidity,” says Sharma in his riveting diatribe against QE3 from Ben Bernanke‘s central bank. “Inflated prices for commodities like oil carry the seeds of their own destruction, because the higher they rise, the more likely they are to stall the economy,” Sharma adds. In other words, when the Fed increases the money supply it is similar to the past times when the Fed hiked interest rates in order to slow the economy down — even if it meant recession.
Lesson Number One: During QE1 in 2008 the price of crude oil soared to over $140 a barrel and economic activity fell about 8%, causing the major stock market average — the S&P 500 index to tumble from a peak of 1500 over 50% to 700. And in reaction to the recession that followed the price of oil tumbled from $140 a barrel to $40 a barrel — a tremendous 70% decline.
Sharma calls the the rising price of oil as a share of personal consumption “demand destruction for the US consumer; when oil hit $140 a barrel, people reduced their driving which reduced the demand for gasoline, which in turn reduced the price of crude oil.”
Lesson Number Two: QE 1 and QE 2 boosted the wealth of upper income groups because the stock market rose and the wealthiest benefited since 75% of all common stocks are held by 10% of the population. Thus, in 2009, the lowest income groups had to spend 41% of their after-tax income on gasoline and food — cutting off the ability have much discretionary income left over. The top income brackets only spent 2% of their incomes on gasoline alone — less than a quarter of the poorest segment.
Lesson Number Three: when the price of oil reached 10% of global gdp from 1976-80, America suffered enormously. But, when oil was only 2%-4% of gdp in the 1990s the Clinton economy created 23 million new jobs. Look at the chart for 1973-79 when the price of oil quadrupled and you will see that oil as a share of gdp rose to 9.5% from 6%. Enter double digit inflation.
What’s today’s lesson. Crude oil in the US is back up to $96 a barrel in the light of an extraordinary rise in the volume of trading in energy futures. The speculators are betting big time on QE3 damaging the dollar, driving up the price of oil– and putting us back in another recession in 2013. So far in 2012 futures trading is running at the shocking level of 25.2 times world demand for energy. This compares to 14.7 times in 2008 when crude oil hit $147 a barrel, and George Soros went short. Sharma is showing us what his hedge fund clients are doing and it is not beneficial for anyone below the wealthiest segment of the nation.
Hedge fund giant Ray Dalio of Bridgewater Associates warned today at a Council on Foreign Relations session that he was not bullish on oil going forward. He also warned in periods when deleveraging is a powerful factor, history can often repeat itself by means of another decline in stock prices that is not necessarily expected by investors who are not aware of past patterns of economic behavior. An example; higher oil prices shut off growth and lead to a worse economy and a weak stock market. Or, there can be events that are never expected until they occur, like a 9/11 or an attack on Iran by Israel.