The headline is a sign of our time. Today, the world believes in money. In economics. In material progress. Everything else takes second, third, or fourth place. It is easier to see small changes in the price of oil than big changes in the way you look at the world. You can tell when the world changes; but when you change it goes unnoticed.

If this were August 1914, instead of August 2008, the headlines might read:

"French Bonds Fall on Invasion of Belgium." Or, if this were August of 1939, the headline might read: "Oil price jumps on threatened German invasion of Poland."

Or how would the modern press report the big event of 2000 years ago? "Miracle worker's earnings cut short by untimely crucifixion..."

But in years zero, '14 and '39, money was not the main issue. People believed in politics, nationalism, racism, religion...and reported the news otherwise.

Today, it is money that counts.

The price of oil fell heavily last week. It ended Friday at $115. But this morning, it is rising - on news of a political struggle in South Ossetia. And if this continues, we wouldn't count on the price to stay 'low' for long. The only good news is that when energy is under the gun, the soaring oil price itself opens you up to all kinds of soaring investments.

The region is between Russia and Georgia, on the Black Sea. Ossetians, whoever they are, have been there since the days when the ancient Greeks set up colonies around the Black Sea. In the 1930s, the Pontic Greeks were still there - until Stalin deported them to Kazakhstan. The Ossetians, too, disappeared into the maul of the Soviet Union. They were forgotten for most of the 20th century. Then, when the Soviet Union disbanded - there they were. But who then had the right to tell the Ossetians what to do? The Russians? Or the Georgians? The Russians expressed themselves on the issue over the weekend. According to one report, 2,000 people have died in the fighting.

U.S. Vice President, Dick Cheney, had Georgia on his mind over the weekend. He reportedly said that this violence "must not go unanswered." What sort of response he had in mind, we don't know. But inasmuch as the United States and Russia are the world's two most heavily armed nuclear powers, there may be more at stake than the price of oil.

Bill Bonner
The Daily Reckoning Australia

• Latin America Has Suddenly Become Very Interesting
• Russians Can Cut Off Natural Gas to Europe Anytime They Want
• Pirates of Private Equity Flying Colours Off Australia’s Shores
• The Rise in the Dollar Doesn’t Have Everyone Convinced
• The United States Matters Less and Less to the Oil Market

The U.S. stock market got smacked down yesterday - ending the day with a loss of 355 points on the Dow.

The proximate cause of this punishment, according to the papers, was yet more bad news from the oil market. The oil pot bubbled up Thursday. The price of crude rose more than $5 to close at its highest point ever - $139.

Hey, where's all that cheap oil the neo-cons promised when they invaded Iraq? We seem to recall three major routes to the war. First, of course, was the high road - we were going overthrow the wicked Saddam Hussein; the Iraqis would kiss our feet and become good democrats; the world would be a better place for it.

Second, there was the hard road - where the world's leading hegemon shouldered its imperial responsibility by dutifully eliminating weapons of mass destruction, establishing a base of freedom and military force in Mesopotamia; as a result, the world was supposed to a safer place, remember?

And then, there was the low road - where if we could knock off Iraq's legitimate leaders, we would have the country's oil to ourselves; we could pump up the world's supply of oil and lower its price; the world would surely be more prosperous as a consequence.

But all the roads led to Hell. (More below...) And today's news tells us that 75% of Americans blame George W. Bush for it.

Wait a minute. That's a lot of blame to lay on single man. It doesn't seem fair. Poor George W. is getting the highest DISapproval ratings of any president in history. He's dissed because he got us into the Iraq War...he's dissed because the price of oil has gone up 40% this year...he's dissed because houses are falling in price...and he's even dissed because inflation is increasing.

We hate to kick a man when he's down. But we like kicking George W. Bush so much, we'll make an exception. Better yet, we'll prop him up...just so we can have the pleasure of kicking him down again.

Let us make one thing perfectly clear; as another disgraceful ghost of the '70s would put it, all these problems are not the president's fault. Let's face it, invading Iraq seemed like a good idea at the time - at least to most right-thinking Americans. And as for the price of oil, who could have imagined that all those people in the East would start using so much of the stuff? And who could have imagined that the Iraqis would be such meatheads as to drag this war out so long...and make such a mess of their own most profitable industry? Well, anyone might have, but we're talking about George W. Bush.

Yes, poor George II lacked imagination. But is it his fault that houses are going down in price, or that Americans have too much debt, or that when the going was good, Wall Street went too far?

Meanwhile, our favourite metal seemed to take advantage of all the commotion yesterday to sneak up a full $32.

Before 1935, you could have bought a whole ounce and a half of gold for that money. Today, you get 1/27th of an ounce. Of course, you could have bought the whole Dow for the amount the Dow fell Thursday, too. And, not forgetting the black goo, you could have purchased a barrel of oil for Thursday's price increase.

As to the '30s, the ghost apparently spooked Wall Street...and then flew off to scare ordinary people coast to coast.

"More Pain Seen for US Banks," reported the International Herald Tribune.

"Low rated borrowers squeezed out of debt markets," the Financial Times followed up.

"Fears grow of a new stage of credit crisis," the FT went on.

Homeowners continue to get slapped around. From California, the latest report says the typical house is worth only about two-thirds as much as it was two years ago. Nationwide, houses are down for the first time since the Great Depression...with the go-go markets of Miami, Las Vegas and Washington, D.C. area, hit hardest.

With house prices falling so much, you'd think that fewer people would be left without roofs over their heads. Not so. USA Today tells us that the ranks of those with no roofs over their heads are swelling with "new faces" of those who hitherto had passed for normal, folks-next- door.

Among those most haunted by the spectre of the '30s are the people who were always closest to that era - old people. They're going broke faster than any other age group.

What is driving these fossils into the poor house? We can guess. They live on fixed incomes. While the ghost of the '30s lowers the price of their main asset - their houses - the ghost of '70s inflation is making their bare lives more and more expensive.

Everyone is driving less, as a consequence of higher fuel prices; but these graybeards didn't drive very much anyway.

Everyone is cutting back on air travel; but even before the price increases, these antiques didn't get into the air very often.

Everyone is trimming his budget, taking out the whimsical and witless spending; but old people often don't have much left in their budgets but the necessities.

They're in a classic '70s trap - hard against the rock of fixed income, crushed by the boulder of rising prices.

Last week the CRB commodity index rose to a new record high - at 595.

"Buffett says inflation is exploding," according to CNNMoney.

What can people do? A report in today's news tells us that many are "delaying health care." Probably a good move for the oldsters. If they put it off long enough, they won't need it at all.

You could hang George W. Bush for inflation too. It would be fine with us. He let government spending get out of control. "Deficits don't matter," said his #2, Dick Cheney. More new federal spending and US financial commitments were added in the Bush years than under all the rest of America's presidents put together; and more new money was created while George W. Bush was president than in all the years since the Declaration of Independence combined. Legally, we don't know if that charge is enough to hang a man. Besides, it seems extreme. In the middle ages, if the keeper of the mint allowed monetary inflation, the king had him castrated. That seems like punishment enough.

Buffett says he is supporting Obama.

*** Bill Gates retired.

*** Now it's the winemakers who are "on the rampage," says today's paper. In Montpelier, France, they burned cars and smashed up supermarkets.

What's their beef? Same as everybody's; they say they can't make any money. Their costs are rising faster than their incomes.

Well, at least they can't blame us. Last night, for example, we went to dinner at a restaurant in the Palais Royale. We had a black risotto (made from the squid ink) washed down by two bottles of Bordeaux.

What a lovely evening.

"This is the sort of night you wait for all year round," said a colleague. "It's almost 11 o'clock and it's still fairly light out...the temperature is perfect...and here, in the Palais Royale, it's as if we were in a painting."

We were dining outside, under the linden trees. The fading light reflected off the old stone walls of the Palais...children played in the park next to us...

...and we gave the wine industry our full support.

Bill Bonner
The Daily Reckoning Australia

• George W. Bush Presents Middle Easterners With a Lengthy ‘To-Do List’
• George Bush Speech Sounded Like an Edition of the Daily Reckoning
• The Bush Administration Has Been the Most Liberal Administration Since Franklin Roosevelt
• The Collapse of Gold and Commodities
• Feds’ Attempt to Bail Out Consumers with Tax Rebates

According to the Fed’s minutes of its April 29-30 monetary policy meeting, U.S. central bank policy makers have turned more pessimistic on the growth of the economy. The Fed is now forecasting that economic growth is likely to hover between 0.3% and 1.2% in 2008 – down from the 1.3% to 2% range, which was the Fed’s previous forecast.

The main reason for the lowering of the forecast is a sharp increase in commodity prices and in particular the price of oil, which Fed officials fear could ignite inflation expectations and lift the underlying rate of inflation. On Friday, May 23, the price of oil closed at around $132/barrel. The yearly rate of growth of the price of oil jumped to 106.3% from 72.9% in April. According to the University of Michigan’s consumer survey inflation expectations one year ahead jumped to 5.2% in May from 4.8% in April and 3.3% in May last year.

It is usually assumed that rising inflation undermines consumer’s real disposable income, which in turn weakens consumer spending. Since spending is the major component of real GDP, real economic growth is obviously going to come under pressure, so it is held. By this logic, if the price of oil were to continue to climb further, then at no time would Fed officials be forced to lower their forecast to negative growth.

Fed officials follow the Keynesian framework of thinking. In this framework, spending by one individual creates income for another individual. Hence the more people spend, the more income is generated. (What causes economic growth is consumer spending, so it is held.) Also, note that the source of a possible recession in this way of thinking is various shocks, such as an oil-price shock, that disrupts consumers’ ability to spend.

Most commentators are of the view that the presently observed sharp increases in the price of oil are on account of supply problems. Existing oil fields are becoming depleted as time goes by while not enough new oil fields are being discovered. Some other commentators blame the supply issue on US government restrictions on extracting oil from various areas in the United States for environmental reasons. Without diminishing the importance of the supply factors, we suggest that another factor that must be considered is the contribution of the U.S. central bank’s policies to the recent sharp increases in the price of oil.

What makes it possible to generate the goods and services that people require to support their lives and well being is the capital infrastructure of the economy and not spending by consumers as popular economics suggests. It is the enhancement and the expansion of the infrastructure that permits an increase in the production of goods and services.

An improvement in the infrastructure makes economic growth possible. The key factor that enables the improvement of the infrastructure is the flow of real savings that funds the enhancement of the infrastructure, i.e., enables the production of various tools and machinery also called capital goods. (With better tools and machinery, a better quality and a greater quantity of goods and services can be now produced.)

In a free unhampered market economy, the established infrastructure is in accordance with the tendency towards the harmony between various activities. On this Murray Rothbard, paraphrasing Ludwig Lachmann, wrote,

“Capital is an intricate, delicate, interweaving structure of capital goods. All of the delicate strands of this structure have to fit, and fit precisely, or else malinvestment occurs. The free market is almost an automatic mechanism for such fitting; ... the free market, with its price system and profit-and-loss criteria, adjusts the output and variety of the different strands of production, preventing any one from getting long out of alignment.”

This harmony gets disrupted by the monetary policies of the central bank. An artificial lowering of interest rates by the Fed and the subsequent increase in the rate of growth of money supply gives rise to various nonproductive activities – bubble activities.

We define a bubble as the outcome of activities that have emerged on the back of the loose monetary policy of the central bank. In the absence of monetary pumping, these activities would not have emerged.

As a result, the economy’s infrastructure gets distorted. Various projects are undertaken that, prior to the artificial lowering of interest rates and increased monetary pumping, would not be considered.

The increase in money supply, which supports various new projects, sets the foundation for additional demand for various commodities, including oil. More money is channeled toward commodities and oil. Since the price of a good is the amount of money paid per unit of the good, this means that the prices of commodities and oil are now going up.

Once the central bank tightens its monetary stance, the diminished flow of money weakens the expansion in the bubble activities – an economic bust is emerging.

Observe that bubble activities are supported by means of loose monetary policy, which diverts real funding to them from wealth-generating activities. Once the money rate of growth slows down, this slows the diversion of real wealth, i.e., slows down the support for nonproductive activities. As a result, the demand for various goods and services that emerged on the back of nonproductive activities comes under downward pressure. Consequently, the prices of these goods, such as various commodities and oil, follow suit.

Following this line of thinking, we can suggest that there is a high likelihood that the massive increase in the price of oil that we are currently observing is the manifestation of a severe misallocation of resources – a large increase in nonproductive activities. It is these activities that have laid the foundation for the oil-market bubble, which has become manifest in the explosive increase in the price of oil.

The root of the problem here is the Fed’s very loose monetary policy between January 2001 and June 2004. The federal funds rate target was lowered from 6.5% to 1%, while the money rate of growth had risen strongly. Between Q3 2001 to Q4 2004, the average yearly rate of growth of our monetary measure, TMS, stood at 7.5%. This should be contrasted with the rate of growth of 2% in Q2 2001 and 0.8% in Q4 2000. The easy monetary stance has given rise to various malinvestments, which we have labeled here as bubble activities.

From June 2004 to September 2007, the Fed had been pursuing a tighter monetary policy. The federal funds rate target was raised from 1% to 5.25%. In response to this, the yearly rate of growth of our monetary measure TMS fell from 7.1% in Q4 2004 to 0.4% in Q1 this year. Because of this sharp fall in the growth momentum of money supply, various nonproductive activities are currently coming under pressure. This in turn should start hurting the prices of various commodities, including oil.

Regrettably, the loose monetary stance that the Fed has adopted since September of last year (the federal funds rate was lowered from 5.25% to 2%), after a time lag, is likely to arrest the removal of various bubble activities and lay the foundation for the increased presence of these activities.

Obviously if the pool of real savings is shrinking – i.e., the flow of real savings is no longer sufficient to support various existing and new activities – economic growth will come to a halt and commodity prices will come under downward pressure, notwithstanding the Fed’s aggressive lowering of interest rates since September of last year.

Now, it is not only the Fed’s policies that must be blamed for sharp increases in the price of oil but also the policies of other countries such as China. Massive monetary pumping in China and the various structures that emerged on the back of monetary pumping there have contributed to the exaggerated increase in demand for various commodities, including oil.

For the time being, the pace of China’s nominal economic activity continues to push ahead. We have estimated that the yearly rate of growth of nominal economic activity stood at 38% in Q1 against 36% in the previous quarter. This, coupled with an upcoming effect of the loose Fed’s stance since September 2007, is likely to mitigate the downward pressure on the price of oil, all other things being equal.

We suggest that there is a high likelihood that the massive increase in the price of oil is the manifestation of a severe misallocation of resources. The loose monetary policy of the Fed from January 2001 to June 2004 is the likely key factor behind this misallocation. (The federal funds rate was lowered from 6% to 1%.) The tighter Fed stance from June 2004 to September 2007 should undermine the existence of various nonproductive activities and in turn reduce upward pressures on the price of oil.

Regrettably, the loose monetary stance that the Fed has adopted since September of last year, coupled with still very buoyant Chinese economic activity, is likely to counter any downward pressure on the price of oil. The Fed’s current policy of fighting an emerging economic slump is, in fact, a policy of deepening the misallocation of resources, thereby promoting higher prices for oil. If our thesis regarding the oil market bubble is valid, then it is the Fed’s policies that must be blamed for the erosion in consumers’ living standards and not the rising price of oil.

Frank Shostak
for The Daily Reckoning Australia

• What Lies in Wait for the Global Economy, Part II
• Fall in Commodity Prices Will Reduce Inflationary Forces
• Vietnam: The Next Bubble in the Emerging Markets
• Fed’s Inflation Would Go into New Bubbles – In Commodities, Oil, and Gold
• Crude Oil Could Hit $200/Barrel

The price of eggs has gone up 30% in the last 12 months. Why the big increase? Because the things that go into making an egg have gone way up – feed for the chickens, heat, light, and transportation.

As the egg goes, so goes the chicken...and the whole chain of consumer products that make up our cost of living. Everything is going up.

If we were looking for something to blame, we could turn to the price of oil. It was only $80 a barrel as recently as last summer. This morning, it is trading at $127 a barrel – near an all-time record, even in inflation-adjusted terms.

Modern economies run on petroleum products. As oil has gone up...so has everything connected to it. But as the oil price rises, it sets in motion a whole contraption of actions and reactions. As the price of a gallon of gas rolls up a penny, it tips over a little cup in which there is a steel ball. The little ball rolls down a track, trips a number of levers and switches, and runs into another ball attached to a string, which then swings over to the left and knocks over a glass of water, which falls down onto a tray of fast-growing ivy seeds, which send out shoots and vines and strangle the entire apparatus.

Well...you get the point: one thing leads to another...

And one thing that high oil prices lead to is higher prices for everything else. And higher prices lead to less purchasing power on the part of the average consumer, which leads to fewer sales, which leads to less output, which leads to lower earnings and slower growth...etc. etc.

This has put the airline industry is in “desperate” condition, reports the New York Times. Fuel is the airlines’ biggest expense. As it has gone up, airlines’ profit margins have gone down.

The latest report from the manufacturing sector show declining factory orders for four months in a row. And USA Today reports that many people are seeing declines in their incomes – in ways that don’t show up in the employment numbers. While the unemployment figures show little contraction, sales commissions, tips, and even Wall Street bonuses are going down fast.

Foreclosures are still rising nationwide, says the Wall Street Journal. The famous Foreclosure Bus Tours have now moved beyond hard-hit cities in Nevada and California; now there’s one touring the New York area!

Forbes has a word for all this: Stagflation. Of course, it’s not a very original word, but Forbes is not a very original magazine. But it’s not a new situation either, says the magazine. Stagflation is the devil’s child you get from the unnatural union of consumer price inflation and a stagnant economy. It’s also what the United States endured in the 1970s...the last time oil prices were so high. The price of gasoline rose during the late ’70s...and hit a record high, adjusted to today’s dollars, over $3 at the beginning of the ’80s. For all the whining about it, today’s gasoline is not much higher. But by 1981, the price of fuel was headed down. Over the next four years it fell in half...and stayed low until George W. Bush invaded Iraq.

Are we enjoying a re-run of a ’70s show? Is it time to get out the strobe lights and the leisure suits? Should we repaint the house in ’70s style slime green and dirty-carpet beige? Can we forget about trading in the SUV or putting in a wood stove? Won’t this whole thing blow over – the way it did in the ’70s?

George Soros says the bubble in commodity prices will burst. We believe him. So, can we stop worrying about high oil prices and rising inflation?

Not so fast, says Paul Krugman. This ain’t the ’70s because we don’t have the same kind of inflation, he points out. At the end of the ’70s, everyone was sure prices would continue to go up. In May of ’81, the United Mineworkers Union was able to negotiate a 33% pay raise spread over three years. The miners thought they needed the increase to make up for increases in the cost of living. And the mine owners thought they could afford it – because the price of coal had been going up for many years. They were both wrong.

But that was “wage-push” inflation, Krugman maintains, very different from what we have today.

Yes, he is right. This is a different kind of inflation...a different kind of stagflation...and, we predict, a story with a different kind of ending.

Stay tuned...

*** How will the story turn out?

Well, we repeat ourselves, what ultimately turned the situation around at the end of the ’70s was a change in regime at the Fed...the worst recession since the ’30s...and a whipsaw on Wall Street that whacked both the bond market and then the stock market, wiping out more than half the value of each of them.

At the end of the ’70s, the jig was up. When everyone had come to expect more inflation from the Fed, the central bank no longer saw any benefit in it. Its new money and credit was being anticipated and absorbed – in wage and price increases – even faster than they made it available. Inflation no longer worked, in other words. It no longer deceived businessmen into thinking they should expand production. It no longer deceived investors into believing their assets were going up in value. And even the lumpen householders had caught onto the game; as soon as they got a wage increase, they spent it quickly...and then demanded another one.

The feds didn’t have much choice. They could either inflate much more heavily than expected and wait for the disaster to catch up to them...or they could admit that the flimflam no longer worked, raise rates, and squeeze the “inflationary expectations” out of the system. Paul Volcker took the latter course. That, combined with the natural feedback look of the oil cycle – in which higher prices drew forth new supplies, as they always do – sent the price of oil back down. In today’s dollars, a gallon of gasoline sold for about $1.50 from 1986 until 2003.

Volcker’s anti-inflation Fed also knocked the price of gold down from over $800 in 1980 to around $275 in 1998.

(It was at this point that the then-chancellor, now-Prime Minister of England, Gordon Brown, decided to sell tons of Britain’s gold. It is why the low point in the gold market, set in the late ’90s, is still known as the “Brown bottom.”)

Of course, many people expect a repeat of the story. They see inflation rising...oil over $125...and gold over $900 (it closed yesterday at $897)...and it makes them feel 30 years younger; they think they see “Mary Hartman, Mary Hartman” on TV again and Jimmy Carter in the White House. Soon, they believe, the Fed will begin raising rates; oil will fall back to $70; gold will crash back below $500; and inflation will go back to sleep.

And maybe it will happen. But we’re a long way from it, in our opinion. We haven’t really had the run up in consumer price inflation yet. Forget the eggs, say the feds. According to their numbers, the CPI is only increasing at 4% per year. Not too bad. Nothing to get excited about. And certainly no reason to renegotiate a union contract.

Nor has there been a big sell-off in the bond market. Only very recently have yields on the 10 year note crept up over 4%. And yesterday, they sank back under the 4% mark. Wait until they’re over 8% – then, we’ll talk!

And as for the stock market – what’s the problem? Stocks got killed in the ’70s...they were down 75% to 90% in inflation-adjusted terms. But what has happened in the stock market recently? The Dow is still within 10% of its all time high. And over the last 10 years, in nominal terms, it is up 2.5%.

No, dear reader, we have a long way to go before we can have a genuine recovery. First, we need something to recover from. We need an egg. Then, we can have a chicken. More on this subject in today’s guest essay from Kevin Kerr.

*** Bad news is beginning to seep into the British press. Mortgage approvals just hit a record low. And the Guardian reports that more and more people have “negative equity” in their houses. The Financial Times says that the United Kingdom is “near recession,” and that foreign investors are “losing faith” in the island’s economy.

*** The simplest way to invest was to buy the indices. Don’t worry about chasing alpha (beating the market). Besides, says Warren Buffett, you probably won’t be able to do it very well anyway. So just buy the ETF. Especially when you’re entering a foreign market.

Then, along came a ‘better way’ to buy an ETF. Instead of just putting all the leading stocks into the ETF, the managers decided to run them through a few basic screens – eliminating or reducing exposure to those companies with poor measures on such things as growth, dividends, earnings, sales or book value. This was expected to give ETF investors a little taste of “alpha” – above market performance.

Well, don’t bother, says a new study. According to professors Richard Roll of UCLA and Moshe Levy of Hebrew University, so-called “fundamentally-weighted indexes” do no better than the traditional ones.

Just buy the ETF.

Bill Bonner
The Daily Reckoning Australia

• Lending Rates Will Go Up With Inflation
• Oil Was Down and the Banks Were Up
• Inflation Up… Gold Up… Oil up… Dollar up… Dollar down…
• RBA Leaves Rates Unchanged, Rio Wraps Up Negotiations
• House Prices Always Go Structurally Higher in Australia

You'll recall, dear reader, some time ago we guessed that the feds' efforts to keep consumers consuming were essentially inflationary...and that the inflation they caused would tend to go more into gold and oil than into economic growth or asset prices.

Since then, the price of oil has shot up over $100. Yesterday, it hit a new record at over $126, before falling back to $124. Gold, meanwhile, has traded above $1,000 - and now is correcting in the mid-800s.

This is already a major adjustment. It comes along with a major adjustment in the purchasing power of the dollar, generally. Americans' global purchasing power has been cut in half. The value of their assets - on the world market - are only half what they were during the Clinton years. And the value of their most precious asset - their time - has also been greatly reduced.

This is why you see so many Europeans in the United States...America is a cheap place to visit. It's also why U.S. export industries are reviving; the country has become a low-cost producer for many things; it is now a place where richer nations can consider outsource production.

All of this has gone almost 'according to plan' - that is, it is pretty much what we guessed would happen.

But now, we have to ask: are these adjustments enough?

You're expecting us to say 'no,' aren't you? Instead, our answer is 'maybe.'

In the case of America's 50% pay cut, (the U.S. dollar is only worth about half as much as it was compared to other major currencies) we think it should do the trick. Now comes a long period in which people come to realize it and begin living not quite as large as before. They lose their houses. They cut back on their spending. They relearn an old word - thrift - and find they like it. They downsize their lives - with smaller houses, smaller cars, and littler expectations. The economy goes into a long slump - as 70 million people, facing retirement, begin to save money.

In the case of gold, our guess is "probably not." Gold has still not come near the inflation-adjusted peak it set 28 years ago. Considering all that has happened during those years, we bet that there is another peak to come - even higher than the last. In 1980, the United States still had the residual financial integrity to stand up to inflation. Paul Volcker could push the yield on the 10-year Treasury note up to 16%; he caused a recession, but not a revolution. Most importantly, he protected the dollar. We don't see any Volcker around now...and we don't see how anyone - even Paul Volcker himself - could "pull a Volcker" now.

The country has twice as much debt per person. It has a hugely negative current account. It has the biggest government deficit ever (think what would happen to it in a real recession...the deficit would go to $1 trillion). No, we don't think gold is in danger of a sudden attack of monetary propriety. Instead, we think the gold bull market has much further to go - probably above $2,500 an ounce, before the dollar-based financial system collapses completely.

But it is oil we set out to reckon with today. And what we reckon is that oil is getting close to its near term peak. If we were holding major positions in oil, we would sell them.

Here's why. While gold is nowhere near its record high - oil is above it. In today's money, the top price ever paid for a barrel of oil, until recently, was only about $79. Today, oil seems to be headed to twice that level. And a few experts think it will go much higher. Goldman's oil expert predicts $200 oil.

But why should it go so high? For all the talk about China's insatiable demand, it is still true that prices and demand must worth themselves out. When the price goes up, people grumble...but they use less. We filled our tank in France last weekend. The total price came to more than $150. We had been thinking about driving down to the South of France next weekend. Instead, maybe we'll take the train...the trip would have cost us more than $300 in gasoline alone.

Everything happens at the margin, said a dead economist. Americans alone probably drive millions of marginal miles - to places they really don't really need to go...when they don't really have to be there. At over $3.50 - they'll drive less. Already, the Financial Times reports that U.S. demand is falling more than expected.

There's so much shifting sand in the oil market - usage, new discoveries, distilling capacity, storage facilities, OPEC policy, inflation, drilling technology, emerging market developments, the dollar, U.S. economic growth - its impossible to know how big the dunes will get. But oil demand - and prices - should generally stay in line with GDP. The more growth, the more oil. Plus, if you measure GDP and oil in dollars you eliminate both inflation and currency depreciation as variables. Well, at $100, reports Martin Wolf in the Financial Times , "the annual value of world oil output would be close to $3,000 bn. That is 5% of world gross product. The only previous years in which it was higher than that were 1979 to 1982."

Those were not good years to enter the oil business. The price subsequently collapsed.

Yes, you could make a lot of money in oil...many people already have. But sure as fleas come with stray cats, success leads to excess. As the price rises, more and more people imagine that it will keep going up. Some take measures to avoid using it. Some find substitutes. Some increase production. Markets still work, in other words. Every bubble eventually finds its pin. The day can't be too far off when the price of oil will fall back under $100.

Bill Bonner
The Daily Reckoning Australia

• Why the Bull Market in Commodities Isn’t Over
• No Spike in Oil Price Following IEA “Third Oil Shock” Announcement
• Has Oil Hit Its Peak Price?
• Bank’s Inflation Projections Will Not Return to the 2 Per Cent Target Figure Until Early 2010
• Fed’s Aggressive Attempts to Put More Money and Credit in Circulation and the Asset Bubbles

Source: www.bigcharts.com

It's the great question about oil right now that no one seems to know the answer to. Is the price of oil rise driven by good old fashioned supply and demand? Is it financial speculation? Is it a weak U.S. dollar? Is it a fear and geopolitical premium? Is petroleum exuberance?

It's probably all of these things. But saying that doesn't get us any closer to figuring where the price of oil is headed next. It could be $80. It could be $180. Sometimes charts will tell you something that the fundamentals miss. The chart is the language of the market: a picture of what's happening between buyers and sellers. The chart has no opinions. It is what it is.

We're going to depart from our normal inductive approach to finance today and do what human beings have done for thousands of years when confronted with the inexplicable: look to the stars (to explain the price of oil).

"As per financial astrology," reports Major Ajay (a financial astrologer) "the 17th week of year 2008 represents Saturn. Saturn will ensure that it brings highest volatility and profit booking in oil and metals in world futures market."

"During this week Sun is with Mercury and Venus, Jupiter is in his own sign, Mars will change Moon sign from Mithun to Karak and Rashi. All these combinations and conjunctions may show highest volatility in world stock market."

You can't really argue with that, even if you know what it means. However it is now the 18th week of 2008. Mars is now ascendant in the markets, not Saturn. Ajay reports on the new state of the stars, although his conclusion is more or less the same. "Mars is very famous to bring highest volatility, profit booking in Oil and Metals in world future market."

Mars is the God of War. He brings volatility to the commodity markets and a great deal of uncertainty. Buyers versus sellers...bulls versus bears...inflation versus deflation...this is a market that only Mars could love. But where will the price of oil go? What do the stars tell us?

We reckon not even Mars knows that. And that is precisely the problem. There are so many factors affecting the oil price it is impossible to predict which is ascendant. The guess of a financial astrologer is likely to be just as accurate (or more) than the guess of a professional energy analyst.

In fact, financial astrologers are probably more worth listening to. Their methods are more honest and they proceed empirically and inductively. They gather observations from the sky and then reach a general conclusion based on what they've seen. The quality of their conclusions is based on the accuracy of their observations.

You may think we're joking. And we are, just a bit. But what we're getting at is the value of modesty in making your investment forecasts. You have to acknowledge what you don't know.

Inductive reasoning is a lot more modest that deductive reasoning, but deductive reasoning (proceeding from some untried, unproven principle or axiom) is much more common in the financial industry.... stocks always go up...buy the dips...diversification works.)

When you trust your own experience and the evidence of your senses, you're basing your judgments only on what you really know (or think you know). Your information is always incomplete. But at least the probability of your conclusions is based on historic observations and not on unquestioned axioms or investment clichés.

The trouble with most energy analysts and all politicians is that they make their market forecasts deductively. That is, they already have some assumption about what the price of oil should be. This assumption influences everything else that comes out of their mouth.

Dan Denning
The Daily Reckoning Australia 

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