Crude Oil Price Hits All-Time High Due to Fed Interest Rate Cuts

See if you can figure out what’s wrong with this picture.

Crude oil for October delivery set an all-time record yesterday, hitting US$80.18 in intraday trading in the States. This comes right after the news that OPEC agreed to hike oil production by 500,000 barrels per day. Earlier in the week we learned that the world’s second-largest economy in Japan contracted by 1.2% in the second quarter. And yesterday, America’s National Association of Realtors said new home sales will decline by 24% in 2007.

To summarise: oil production is up, Japan may be in recession (after 17 years of fighting deflation), and the American economy is being slowly sucked in to a consumption-killing housing-led recession. And oil hit an all-time high. What gives?

The official line is that oil rose because US inventories fell by 7 million barrels, when the expectation was for a 2.7 million barrel fall. “Seven million barrels is an awful lot of oil to lose in one week…There's a feeling that OPEC waited too long to make this move,” Energy analyst Rick Mueller told Bloomberg. This variability in US oil inventories apparently trumps the prospect of recession in the world’s two largest economies. Surely there must be a better explanation.

There is, actually. We’ve found the inflationary leak in Federal Reserve policy. When Alan Greenspan cut rates like a madman starting in 2001, he couldn’t save the tech bubble. But he did create the housing bubble. The moral of the story is that you can flood the world with money, but you can’t control where it goes.

Central banks all over the world are trying to reflate the bubble that took all assets to soaring heights. But where will the money go? Back into stocks? Into real estate? What about commodities?

There are several good reasons why commodities could be the unintended recipient of the Fed’s interest rate cuts. For one, commodities are tangible assets. There is demand for those tangible assets (see below). And buying resource producers seems like a better bet than buying retail stocks (or anything that depends on consumer borrowing). Is this the beginning of much higher commodity prices?

Dan Denning
The Daily Reckoning Australia

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