Oil Price Increases Result of Terrorism in New York, not Middle East

Lately the fallacy has been spread that Libyan unrest combined with Egyptian and Tunisian uprisings have caused oil prices to spike up to over $104 per barrel as of the close of business on Friday March 4. Proponents of this theory declare that real concern exists that Saudi Arabia is also susceptible to such unrest leading to severe supply shortages in the future.

That said, there have been no substantial supply disruptions. In addition, US oil inventories remain at record levels. Further, OPEC has pledged that it will continue to meet its supply target regardless of disruptions in Libya, as Libya only represents less than two percent of the world's oil. Finally, Saudi Arabia has shown no sign of instabillity except for its proximity to the unrest, even though Southern Europe is far closer to Libya than the Middle East.

Since the last collapse in the price of oil in 2008, numerous OPEC leaders have said that $70/barrel is the requisite price for speculative oil exploration to remain profitable outside of the Middle East. This $70/barrel represents an apex in prices, where non producers find it profitable to become producers. Think of it as the wage necessary to make an engineer change professions to a carpenter. $70/barrel equals cost to remove + reasonable profit + premium to change behavior in a country that has made a decision oil drilling is not in their best interest economically.

So why are we at $104/barrel? Long positions by hedge funds and speculators has increased thirty percent since March 1, 2011. These individuals are unilaterally buying up oil contracts with the cover that the media will present the Middle East uprisings as dire. What is undesirable about these individuals behavior is that they are not end users of oil, such as refiners or power companies, they are merely adding as much money on margin as possible to exacerbate the oil increase. Why do they want to buy oil, simply to sell it to those end users at the end of the month's contract at a premium. Since the NYMEX crude oil market is relatively small in market cap compared to the NYSE or NASDAQ, relatively small amounts of money can create price changes. Also the availability of purchases on margin with little down payment reqyirements make the NYMEX an attractive place for market manipulators who desire to disrupt the purchase and sale transactions of drillers and end users.

The paramount issue is not supply, not producing countries and not the market.... it's simply American traders who want the price to move up at the expense of the entire country for their individual greed.

Three weeks ago, the market saw oil lose 3 percent in just under three hours when the CFTC and ICE raised speculators margin requirements 12 percent to purchase oil. This meant speculators had to put 6% down instead of the 5% that was previously mandated. Six Percent?????!!!!!!! Well, perhaps the inability of regulators to demand a reasonable hard money commitment is the issue in and of itself.

Aside from the common sense solutions of disallowing all participants except for end users to access auctions or the elimination of auctions all together, an effort to end price manipulation in oil markets should also include a commitment of over $6,300 to purchase $100,000 of oil contracts.

The Currency Seesaw

Picture two children on a Seesaw. One child elevated in the air feverishly jumping on his seat in an attempt to push himself back towards the ground. The other child sternly seated on his seat with his feet anchored under steal stirrups in the sand refusing to allow his seat to move up towards the sky. Can you picture it? Could you picture the balance difficulties of the child in the air as he pounces on his seat to push it down? Can you imagine the bruising of the crotch being experienced by the child who is attempting to anchor himself down? If you can, you now understand precisely the relationship of the US Fed vs. emerging markets' central banks.

If you ever wondered why the Federal Reserve Policies are failing to create the desired inflation in the United States, the answer would clearly be the trade deficit. If you then wondered why the rest of the world is struggling with food and commodity inflation, the answer would clearly be their resistance to currency appreciation.

Of course it is no secret that every country is better off as a net exporter. Collecting money instead of paying it is always the path to greater wealth. That said, the great equalizer is currency appreciation. Currency appreciation is the only way that the two children peaceably stay in balance on the seesaw. As one country purchases, or imports goods, from another it must purchase the exporting country's currency (a capital inflow) to complete the transaction. When this purchase occurs on a frequent basis the exporting country experiences currency appreciation which reduces the cost advantage it has in producing exports. With that appreciation, the population of the exporting country realizes greater purchasing power and higher standards of living for its population. The exporting country over time becomes better able to import at a more affordable rate and becomes progressively more stable as an economy due to purchasing power. Thus, the seesaw is able to balance the children according to their actual weight or on each country's production on the merits of the goods, rather than just input costs.

However, what does a net exporter do if they wish to protect their status as an "Exporter?" Well, you surely figured this one out. They manipulate their currency by making capital inflows less attractive and/or interfering in the currency exchanges. Sound familiar? Japan selling Yen for US Dollars, Brazil placing exorbitant taxes on capital inflows, China exchanging Yuan for US Dollars in a closed government controlled non-market based exchange and India raising interest rates (In India's case this certainly isn't going to work in battling currency inflation is it? But that is a topic for a different article. Higher interest rates=greater rates of return for foreign currencies).

What is the fallout of a country purposely holding its currency down? Items that are valued in US Dollars such as food, fuel and steel etc. get rather expensive for its population as they are being paid for their production in the currency that is being devalued by their government. Unable to provide comfortably for basic needs such populations may resort to civil unrest or similar types of behavior. Sound familiar?

The net result is exporters that refuse to accept currency appreciation disallow the seesaw to find balance. The country in the air (the US) will stay in the air unable to create substantial jobs due to its HIGH currency valuation and inability to compete with lower employment costs. Its population will be reduced to balancing deficits, both fiscal and trade, while confined to its space on the surface area of the seat well above the ground. Unable to expand, the US may attempt to print its currency at an alarming rate- effectively jumping up and down on that seat to become more competitive and create growth. Emerging markets may insist on anchoring into the stirrups on the ground and edure the great discomfort from the seat punding against their unmentionables to maintain their position. In such a scenario the worst of results occurs if one of the parties breaks the others resistance sending one into the tree and the other face down into the dirt.

So, the next time the US Treasury Secretary states that China, "Must allow its currency to appreciate to create balance," think of him saying, "Let us down you creeps." Conversely, when you hear China respond with "It is in both of our interests for our currency to appreciate but it must be gradual,"- remember it is better to take it groin than to be hopelessly stuck in the tree.