Oil at $40 or $200?

May 7th, 2008

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Yesterday, Goldman Sachs analysts predicted that oil can hit US$200. As this news article, New ‘super-spike’ might mean $200 a barrel oil, reported,

With $100-a-barrel here for now, Goldman Sachs says $200 a barrel could be a reality in the not-too-distant future in the case of a “major disruption.”

Goldman on Friday also boosted by $10 the low end of its 2008-2012 projected range for crude to $60 a barrel — significantly lower than current prices, to be sure, but a possible mark for oil if “normalized” trends return to the marketplace.

Mind you, those Goldman Sachs guys predicted US$100 a couple of years ago and no one believed them. This time round, people take their forecasts more seriously.

At the same time, Citigroup analysts predicted that oil will hit US$40 within 2 years.

Why is there such a vast difference in the price forecast of oil?

Is it possible for oil to fall in demand so drastically that its price falls to US$40? Can its demand surge so hight till its price hits US$200? If one asks such questions, it shows a fundamental error in thinking. You see, the underlying assumption behind these questions is that the US dollars is an immovable yardstick of measurement. The truth is, the US dollar is as elastic and twang as rubber band. With deflation, the US dollar shrinks, and with inflation, the US dollar stretches (see What is inflation and deflation?). As we said before in How is inflation sabotaging our ability to measure the value of things?,

If you want to measure the length of a box, you may use the ruler to do it. The reason why a ruler can do such a job is because its length is reasonably consistent for the foreseeable future. Now, imagine that ruler is as elastic as a rubber band. Do you think it is still a useful tool to measure the length of the box? An elastic ruler is useless because you can always make up the measurement of the box to whatever you please just by stretching the ruler such that the edge of the box is aligned to any intended measurement markings in the ruler.

Now, let come back to measuring the value of oil. Since oil is priced in US dollars and if the supply of US dollars can be expanded and contracted at will by the Federal Reserve, how useful do you think it is as a calibration for measuring the value of oil?

Can oil fall to US$40? Yes, it will take an acute deflation of money and credit in the global financial system to result in that. If you wonder how such a deflation will look like, the Great Depression is the best template. Can oil surge to US$200? Sure, other than Chinese and Indian demand (see The Problem that can throw us back into the age of horse-drawn carriages), monetary inflation can lubricate the upward slide of oil prices.

If you notice, the mainstream media is catching on to this understanding too. They are starting to blame rising oil prices on the weak US dollar. Speculators and ‘investors’ are also blamed. But there are a couple of things they do not see. What are they? Keep in tune!

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