The Oil Trap

[Crewleader]

March 8, 2011

Bernanke's Version of Trickle Down

By Mike Whitney

Rising oil prices threaten to derail the recovery. Oil at $106 per barrel (Monday's price) is not a problem, but oil at $160 is. With fighting increasing in Libya and social unrest spreading across the Middle East, no one knows where prices will settle. That leaves Fed chairman Ben Bernanke with a tough decision. Should he call off QE2 prematurely and let the stock market drift sideways or go-til-June and hope for the best? If the Fed tightens too early, deflationary pressures will reemerge further straining bank balance sheets and consumer spending. Housing prices will fall sharply and foreclosures will mushroom. But if Bernanke holds-firm with his zero rates and bond buying program--especially when the ECB is raising rates--he could trigger a bond market rout and send the dollar into freefall.

Bernanke has shrugged off the inflationistas saying that core inflation is still hovering at a safe 1 percent. But if oil keeps climbing, consumers will have to cut back on spending just when Obama's fiscal stimulus is winding down and just as the states are trimming their budgets. That will be a drag on economic activity and slow growth. Business investment will shrink, hiring will sputter, stocks will retreat, and the economy will head back into negative territory. It all depends on the price of oil. Here's Gluskin Sheff's David Rosenberg providing a little context to the fact that oil has "doubled" in just two years:

"There have been only five times in the past 70 years when this has happened within a two-year time frame: January 1974, November 1979, September 1990, June 2000, and August 2005. And now, December 2010. . . .

Of the five instances cited above, all but one involved a recession for the U.S. economy and that was in 2005 during the height of the credit and housing boom, which acted as a huge offset. But oil prices did keep rising and managed to outlast the euphoria in credit and residential real estate, so the recession may have been delayed at the peak of the 'growth rate' in the oil price, but it was not derailed as history shows." (The Big Picture)

So spiking oil prices and recessions go hand-in-hand. Accordingly, bond yields have been trending lower anticipating deflation while the shriveling dollar has been steadily slipping for more than a month. All of this is adding to investor anxiety. Wall Street is on tenterhooks waiting to see whether Obama will tap the National Oil Reserve to stop the bleeding or just cross his fingers and hope that the violence subsides before the economy nosedives. And then there's Bernanke. What will Bernanke do?

http://www.counterpunch.org/whitney03082011.html

[DJ13]

1. Oil at $106 per barrel is not a problem

I hate to disagree with him since I always read his site, but oil at $106 IS a problem.

Theres a corrosive effect that oil at this price level has on other consumer prices that multiplies the damage to our economy.

Maybe in a healthy economy a spike to this level wouldnt be damaging, but this spike is occurring just as the economy had come off a bottom the likes of which we havent seen since the depression.