Oil, the Dollar, and the Global Economic End Game
More than any other commodity, the crude oil market has been the focus of the investment world this year. More investors are oil-conscious today than probably anytime since the 1970s. The lesson the market has taught investors this year is an old one, but until now, had been largely forgotten: "What's good for oil is generally bad for stocks."
This summer we saw a soaring oil price, which in turn put pressure on equity prices for a time. But since peaking at around $56 in October, the crude oil price has come well off its high for the year and has essentially returned to trend line around the $40 area. This represents roughly a 62% retracement of the longer-term bull market advance in crude in just a matter of weeks.
The aforementioned lesson the crude oil market has taught investors obviously then has a flip side: "What's bad for oil is generally beneficial for stocks." It took a sharp drop in the price of crude to help stimulate the long-awaited fall rally in the stock market just as the 10-year cycle was bottoming in October. Indeed, the inverse correlation between stocks and oil has been uncanny, and I think the tracks that the oil market has laid provides us with a road map as to what we can expect in the next couple of years ahead.
Oil has once again become a major regulatory keystone of the global economy and the financial controllers have made their intentions clear that they will use the oil price to keep the global economy on course. They showed us in 1998 that they weren't afraid to let the crude oil price to levels unseen since the mid-1980s. And in converse fashion they showed that they aren't afraid to let the oil price soar to never-before-seen prices when they feel the action is warranted and for as long as they deem essential.
I've said it before and I'll say it again -- the crude oil price will not be allowed to spiral out of control, either on the upside or the downside. Earlier this summer we were barraged from all sides with prognostications of doom and gloom concerning oil. I personally received mail solicitations from newsletter publishers with the following foreboding headlines: "Sit back and collect tollbooth profits on $4-a-gallon gas," "Get rich as oil prices soar," "Unnatural profit potential in oil and gas."
Such extreme pessimism is the emotional reaction of a trend carried to an extreme and on the brink of reversal, and the reversal is often carried along (in contrarian fashion) by the hyper-emotional sentiment expressed by investors and analysts as seen in the above headlines. Now that the oil super bulls have been temporarily shaken out of the tree, oil will likely confirm its bottom in the immediate-term and retrace at least part of its losses as we head into early 2005. This is needed to work out the excesses and put the financial markets back into the proper balance.
So how will the oil price be regulated to keep the financial markets in check and allow for the total integration of the global economy? Petroleum, the backbone of the world economy, will be tightly guarded by the regulators and will most likely be allowed to progress in a slow, controlled fashion along its long-term uptrend, but not in as pronounced fashion as it did in 2004. Whenever the world's dominant engine of economic growth -- the United States -- needs an economic stimulus the oil price will be allowed to drop as it has in recent weeks.
The stimulus of falling oil prices was needed in the late 1990s when the Federal Reserve was fighting the final battle with lingering inflation pressures from the mid-'90s. But now that the dominant longer-term economic trend is toward deflation, the oil price will be used to keep the deflationary pressure coming from overseas manufacturing in check. The primary concern for the regulators of the global economy now being integrated is to keep the U.S. on a relatively even keel until the global economy is fully completed and "sustainable."
This also means the U.S. dollar will not be allowed to crash just yet (at least not until the global economy is completely integrated, a process that will take a few more years). This is another economic scare story being propagated at the present time. Just as the oil price has soared to vertiginous heights this year, so the dollar has been allowed to drop to levels not seen since the early-to-mid '90s. And while there is no question that a sustained decline in the dollar's value would cause tremendous damage long-term, for a while the weak dollar will aid U.S. multinationals with exports.
The strong dollar policy of the Robert Rubin/Bill Clinton Administration of the mid-to-late '90s was deemed necessary by the regulators of the global economic to assist foreign manufacturers and China in particular, but now it's time for the U.S. manufacturing economy to get a needed lift. This is in keeping with the Rule of Alternation and is really a form of global economic "sector rotation." This is the means by which the global economy is put into place -- a game of "musical chairs" if you will.
How long will the "weak dollar" policy of the Bush Administration continue? As long as the regulators deem it necessary to recovery the U.S. economy, the chief engine in the global economic endgame. To this end an editorial appearing recently in the Financial Times by Henry Kaufman, entitled "Why there can be no alternative to the U.S. dollar" has hit the nail on the head.
In the article Mr. Kaufman asks, "Will the dollar maintain its key currency status? Or will the euro or the yen take over until some later date when China has become a formidable economic and financial colossus?" He answers this question by stating that the dollar "will continue to be the dominant currency" for several reasons, first and foremost because the U.S. "is, and will remain for some time to come, the world's only superpower," adding that such status is normally accompanied by currency supremacy.
Mr. Kaufman also points out that a dramatic 1970s-stye outburst in the U.S. inflation rate is unlikely. "The increasing globalization of economic activity will not allow it," a point worth pondering. Whether we agree with the coming integrated global economy or not (and I personally do not), Mr. Kaufman is correct in making this statement.
He also observes that a key reserve currency "needs the backing of large, open credit markets, strong, diversified financial institutions and a central bank cognizant of its global responsibility." No other nation comes closer to meeting these criteria than the U.S. at the present time.
Moreover, Kaufman adds, "the incentives to invest in the U.S. remain quite strong" with the yield on two-year government bonds now at 3 percent in the U.S., compared with 2.37 percent in German and 1.15 percent in Japan. And with an emerging upward trend in U.S. interest rates a good possibility, a firming monetary policy will attract even more investors. He also points out that the U.S. has a "cohesive political system and tends to be ruled from the center." Meanwhile, "Europe does not have a centralized government with fiscal and monetary powers over the entire region and lacks a leader who would speed up centralization."
Mr. Kaufman's conclusions are worth repeating: "For the foreseeable future, even though the U.S. has a very large budget and current account deficit, there really is no alternative to the dollar as the key reserve currency." Thus, the U.S. economy will not be allowed to falter in the foreseeable future as the world's leading engine of growth and the central component to the global economy now being integrated.