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Wednesday September 27, 2006 - 10:39:15 GMT
Black Swan Capital - www.blackswantrading.com

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Oil isn't inflationary alone...

Key News
• Asian stocks had their biggest jump in two months after U.S. consumer confidence rebounded. (Bloomberg)
• The UK's current account deficit fell to £7bn ($13.2bn) in the second quarter of 2006, offical figures show. (BBC)
• Key Reports (WSJ):
8:30a.m. Aug Durable Goods Orders. Previous: -2.5%.
10:00a.m. Aug New Home Sales. Previous: -4.3%.

Quotable

“Those are my principles: if you don't like them, I've got others."

Groucho Marx

FX Trading – Crude isn’t inflationary alone

What could change the dynamic?

The European Central Bank decides crude oil isn’t a problem, when it comes to inflation and decides not to hike, while the Fed decides crude oil isn’t the problem and decides not to cut.

We are told over and over again by pundits and gurus and analysts and central bankers (and we plead guilty to using crude in the same sloppy logic) that rising crude oil prices lead to inflation. But only if our central banks acquiesce in the process is this true; otherwise crude oil prices shift the composition of consumer spending, but are not inflationary in isolation.

“If the stock of money rises while all other things remain intact, this must lead to more money being spent on the unchanged stock of goods — which means an increase in the average price of goods. (The term "average" is used here in conceptual form. We are well aware that such average cannot be computed).

“If the price of oil goes up and if people continue to use the same amount of oil as before, people are now forced to allocate more money for oil. If people's money stock remains unchanged, less money is available for other goods and services, all other things being equal. This of course implies that the average price of other goods and services must come down.

“Note that the overall money spent on goods doesn't change; only the composition of spending has altered here, with more on oil and less on other goods. Hence the average price of goods or money per unit of good remains unchanged. Likewise, the rate of increase in the prices of goods and services in general is going to be constrained by the rate of growth of money supply, all other things being equal, and not by the rate of growth of the price of oil.

“In other words, it is not possible for rises in the price of oil to set in motion a general increase in the prices of goods and services without the corresponding support from money supply,” writes Frank Shostak, of the Mises Institute.


CRUDE CHART


There is a growing chorus of belief the Fed will cut to avoid a “pending” recession. Maybe! But we can create a very plausible scenario that says no cut is needed—in fact it’s time to play wait and see as the lags of past monetary policy play out.

If, and these are the usual big if’s of markets, stocks continue to rally, bonds continue to rally, and crude oil prices continue to fall (we still believe it’s a supply and demand thing, not the Peak Oil thing), it would provide plenty of collateral support for the US consumer. In this scenario, any cut might push the “inflation,” already in the system, higher.

So, we could once again see another shift in expectations about the Fed. And if the ECB doesn’t do the deed, the dollar dynamic might change once again. And all those major banks that have penciled in EURUSD at $1.30 by year end may have to get out their erasers.

Jack Crooks, Black Swan Capital Black Swan Subscription-based Service

 

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