Tuesday, February 21, 2012

Will Rising Oil Prices Burst the Money Printing Bubble?

The debt crisis has remained reasonably well contained over the last few months. The impact of planned austerity measures has not hit the northern tier of the Euro zone countries. Japan, the U.K., Canada, the U.S. and most of the world's other developed economies have blissfully proceeded along with continued profligate government spending. The reason that interest rates required to finance the burgeoning government debts has not gone through the roof is that central banks have been printing money by buying up the supply up government debt. Central banks have pumped nearly $7 trillion into buying government debt in the past 4 years.

So far, the gold bugs that have been warning that this money printing will lead to hyper inflation have been wrong. However, funding trillions of dollars in new debt simply by having central banks buy up the debt is unsustainable. There is a time limit on how many more years that U.S. can continue to add a trillion dollar to the national debt. Japan may already be at the edge of an economic abyss.

The inflationary effect of higher oil prices may hasten the bursting of the money printing bubble. If the opinion of some economists that proclaim that oil prices have a bigger impact on inflation than federal deficit spending is correct, then we may be in for a bout of inflation. The cost of oil impacts the price of almost every product sold in the U.S. in addition to its huge impact on food and transportation costs, as detailed in Do 2012 Economic Forecasts for U.S. Foolishly Discount High Cost of Oil?

There is a real danger that higher oil costs will function synergistically with the massive money printing to reignite inflation. And if interest rates go up due to inflation, government deficits will grow even larger as interest expense will grow. The whole process could turn into a vicious cycle of increasing inflation.

The irony of higher oil prices is that the effort of the U.S. to impose oil sanctions on Iran is backfiring. The higher prices of oil hurts the economies of the U.S. its oil importing allies, while increasing the compensation to Iran for their oil sales. The concept that an embargo on Iranian oil can be effective is incredibly foolish. Oil is too fungible to be effectively embargoed simply via economic sanctions.

The central bank money printing is creating a bubble that is sure to burst at some point during the next few years. Given the saber rattling by Iran, Israel, and the U.S., the price of oil seems unlikely to be headed anywhere but up. The higher price of oil could reignite an inflationary spiral and burst the money printing bubble before the November U.S. election. The rally in the price of gold over the past two days seems likely to continue. The gold bugs are starting to seem a lot smarter than they did when the price of WTI oil temporarily dropped below $100 a barrel.

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  1. Amazing that a certain set of economists do not see inflation coming out of increased oil prices. These "economists" treat oil as any other commodity so that they can continue to live in the la-la land of purely theoretical considerations. They consider any type of energy policy an invalidation of the Efficient Market Hypothesis and an invalidation of their worship of the Market itself.

  2. But since so called "core inflation" excludes items with volatile price movements, notably food and energy, why should economists worry about inflation. The BLS can continue to exclude from the calculation any input that is going up in price and inflation will stay moderate.

  3. And yet, when the price per barrel in US dollars was similar a few years back, the price of gasoline and other products were cheaper...in US dollars. So comparatively US dollars to US dollars, shouldn't the exchange be similar? Why is it that the products are now more expensive in ratio to the cost of oil then they have ever been previously?