You Can Only Choose One: Cheap Oil Or A Weak Dollar

Authored by Charles Hugh Smith via OfTwoMinds blog,

When the price of oil rises to the point of pain, just remember the handy-dandy discount mechanism: a much stronger US dollar.

Glance at this chart of the trade-weighted U.S. dollar, and note the swing highs and lows in the price of oil per barrel around each peak and trough. You can look up historical inflation-adjusted prices of oil in USD on this handy chart: Crude Oil Prices - 70 Year Historical Chart (

The correlation isn't perfect, of course. Oil was relatively cheap between 1986 and 2003, due to a relative abundance of supply as Saudi Arabia and new fields ramped up production, with two periods of extreme price action: a brief spike higher in 1990 preceding the First Gulf War, and a collapse to $17 in the 1998 Asian Contagion financial crisis.

Geopolitical crises, wars and supply shocks will move oil prices regardless of the value of the USD. That said, it's clear that absent such shocks, there is a strong correlation between a stronger USD and lower oil prices (in USD of course) and a weaker dollar and higher oil prices.

The reason why is straightforward: if the dollar gains purchasing power against other currencies, it buys more oil for each dollar.

Conversely, when the USD weakens, its purchasing power declines and it takes more USD to buy an imported barrel of oil.

(Note that the price of domestically produced oil is largely set on the global marketplace. West Texas crude oil may be a few dollars less per barrel than Brent crude oil, but if the global price skyrockets, so does the price of US-produced crude.)

Since oil and gas are the essential resources of the industrial economy, the price paid by consumers and commercial users matter.

The one way the US can get an across-the-board global discount on oil is to push the purchasing power of the USD higher. That is an enormous benefit that few commentators ever mention. Instead, pundits talk about the benefits of a weaker dollar, which boil down to lower priced exports.

Which matters most to households and enterprises? A tiny blip higher in exports (a relatively modest slice of the U.S. economy) or lower energy prices at the pump?

If a recession were to pressure household budgets, the one sure way to lower household spending on oil/gasoline would be to strengthen the USD.

There are two basic mechanisms that strengthen the USD: raise interest rates, so global capital flows to USD-denominated debt to earn the higher yield, or a global financial crisis which causes global capital to seek the relative safe haven of the USD.

In a global crisis, liquidity and credit will dry up, and all those non-US debtors holding the $11 trillion in USD-denominated debt I mentioned on Friday will be scrambling for USD to service their debts. This will also increase demand for USD, pushing the USD higher.

The Federal Reserve insists that yields must remain near-zero or the economy will collapse. Americans paying 15% to 23% interest on their credit cards haven't seen any benefit from near-zero rates, nor have student-loan debtors. The real beneficiaries of low yields are financiers, banks and corporations which borrow immense sums for next to nothing. (Try finding a credit card with a 1% or 2% interest rate.)

At some point, the price of oil might start mattering to households and businesses. Note that the discoveries of oil are now a thin slice of annual consumption. As the cheap oil is depleted, what's left is the costlier-to-extract stuff.

Even more alarming, the global supply of oil might fall well below global demand, and stay there.

When the price of oil rises to the point of pain, just remember the handy-dandy discount mechanism: a much stronger US dollar.

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Blue Dog sickavme Mon, 09/25/2017 - 14:57 Permalink

Expect Saudi Arabia to start accepting yuan in payment for oil. The Saudi king is visiting Russia in October. Expect a big announcement. Then other countries will want to buy oil in yuan and others will start selling oil in yuan. Then yuan based trade will sweep the globe. It won't be long and the dollar will be dead.

In reply to by sickavme

Yog Soggoth GoldHermit Mon, 09/25/2017 - 21:44 Permalink

Umm, yeah. All this data is based on current system while not recognizing what has been in planning for many decades, if not a hundred years. The recent drop in exploration has nothing at all to do with the world running out of oil, anymore than to do with running out of money. Oil price goes down, exploration becomes more expensive. Why would anyone spend money on things when they cost more for a short duration? The two biggest sources are under attack by the USA right now, and they are VEN an IRAQ. That is the denominator. China is heavily invested in both as are many other countries. My only question is will it be a new Yen, or will the old Yuan still be exchangeable? The first currency to go gold backed, That's it, I am going full on, until I see the next.

In reply to by GoldHermit

DjangoCat Mon, 09/25/2017 - 12:56 Permalink

The way to a stronger dollar is higher interest rates.  QE and lower rates depress the dollar.Higher rates will kill the economy and lead to defaults in the junk bond markets.  Defaults cascade.  Collapse follows.So oil prices should rise, since the US is not capable of raising rates.  The latest threats by the Fed to reduce the balance sheet were greeted with buying in the bond market.  Mr. Market does not believe rates will climb, obviously.

Justin Case DjangoCat Mon, 09/25/2017 - 13:11 Permalink

There’s too much debt and not enough growth in the world. The only way to get growth now is by stealing it from your trading partners through currency devaluation. Not everyone can devalue their currency at the same time. Someone's has to be weak and somebody strong. Bernanke came up with a plan back in 2012 he calls pass the canteen. Countries are taking turns cheapening their currencies. Now it’s the USD turn to weaken to strengthen the US economy.Economic recovery remains a mirage.

In reply to by DjangoCat

sinbad2 DjangoCat Mon, 09/25/2017 - 16:12 Permalink

QE depresses the dollar because it is debasing the currency, even the Romans did it, by putting lead in their gold coins.The US is following the same path as most failing empires do.Interest rates, well that's a bit different. In a debt based economy like the US, low rates mean people can borrow more, which raises asset prices, and creates inflation. I know the official figures say that there isn't much inflation, but that's a fantasy.

In reply to by DjangoCat

Justin Case Mon, 09/25/2017 - 13:13 Permalink

It is the dying days of the dollar but you are confusing “price” with “velocity”. Velocity is drying up, this is the evidence of a dying dollar as it’s global use is dropping. This symptom of low oil “prices” alone would be saying the opposite as it is taking fewer dollars per barrel…thus making the dollar more valuable in terms of oil. I believe what we are seeing rather is a weakness in global economic activity and trade at a time China (and the U.S.) have largely full storage facilities. “Where” to put the oil seems to be the problem so Mother Nature lowers the price to increase consumption and lower incentives to produce. I do believe there has been “cartel support” in price over the last year but that story has been torn apart by lower demand and full storage facilities. Debt saturation and slower (negative?) debt creation is taking it’s toll on economic activity, it may currently be viewed as deflationary winds blowing…until debt actually starts to blow up. Then, we will see currencies themselves rapidly fail as financial institutions fail…at that point central bank reactions will be considered hyperinflationary. You see, fiat currencies will not survive , whether you call it inflation or deflation is a moot point as “wealth” will end up accumulating in gold and silver. It is in terms of precious metals where everything will deflate, because at current “prices”…there is simply not enough gold and silver to go around. Think this one through thoroughly, the very last line is the key!

LawsofPhysics Mon, 09/25/2017 - 13:34 Permalink

WRONG.Stop thinking in terms of bullshit fiat.Start thinking in terms of consumable calories...Some will have access to the consumable calories required to maintain a decent standard of living, most will not.In the meatime, arguing over the price of anything in the absence of a mechanism for true price discovery is moronic."Full Faith and Credit"

slightlyskeptical Mon, 09/25/2017 - 14:34 Permalink

I don't think you have the relationship right. A stong dollar in pure currency conversion basis means lower cost oil. A weak dollar means oil prices go up. Supply and demand can interupt that relationship but eventually the strength or weakness of the dollar means the opposite of what this article states.Doublespeak already sneaking into the consicience of society. Not great.

sinbad2 Silver Savior Mon, 09/25/2017 - 16:02 Permalink

The banks have a problem with a weak dollar, most of the worlds loans are written in US dollars, and a weak dollar would mean the banks would not get as much money in real terms.The strong dollar has gutted American industry and cost millions of American jobs to move to places where wages are cheaper.However look at how so many underpaid Americans demand a strong dollar, like it's a status symbol, and so they can buy cheap foreign junk.You can lead a horse to water, but you can't make it drink.

In reply to by Silver Savior

Ink Pusher Tue, 09/26/2017 - 06:07 Permalink

 "You Can Only Choose One: Cheap Oil Or A Weak Dollar"In that case. Fuck You Charles Hugh Smith for only giving us this single choice.I choose the death of the dollar and cheap oil until the merciful nukes rain down.