March 8th I predicted that oil prices would drop during 2008. They proceeded to march up for a time, but they’re now doing what I expected would happen for the reason I expected: collapsing demand. This is going to continue. Price target for oil is $50 to $70 a barrel. Probably it will swing below $70, then the oilarchies will cut production to boost it back up.
This sounds like good news and it is. It will be part of a general drop in prices, as inflation gets clubbed over the head as the economy stops thrashing around in the bathtub and just lies there, slowly rotting. If you were to include housing prices in inflation indices, the US is already in deflation. Within about 6 months, unless the Fed or Treasury does something really stupid (always a possibility) the general press will be full of talks of the danger of deflation.
The good news on this is that that will get banks lending again. The main reason banks aren’t lending isn’t fear of counterparty risk, it’s because inflation is much higher than they are expected to lend at. When inflation crashes, lending will become profitable for them again, and they will do a lot more of it.
Meanwhile, over the next couple months, the US Treasury needs to issue somewhere between 1.5 trillion and 2 trillion dollars of bonds. These will probably almost all be short term treasuries, very likely 3 months. This means the US dollar will continue, paradoxically, to rise, even as the economy craters, because much of that money is going to have to come from overseas. Foreign central banks and normal banks will lend the money because they know if they don’t, the US will crash out and take the rest of the world with it. The dollar rising will also help moderate inflation, since it will make imports cheaper, and the US imports, well, most things.
The danger point, ironically, will come when the US stops borrowing so fast and so much…
…either because the new Congress and Administration can’t stomach it anymore, or because foreign governments decide they’ve had enough and would like to use their money to bail out their own economies and banks. At that point, the natural influx will start to be "out". Other countries will be repatriating their reserves, investors will be looking at the fundamentals of the economy, which will still be awful, and getting out. That won’t be new, all through the dollar’s rise, investors will be getting out of everything but Treasuries and securities which they believe are government backed, but it will be overwhelmed by the huge sucking sound coming from the Treasury building.
So, once the US stops borrowing as much, the dollar will begin to collapse again. The bottom line is that the US economy basically did nothing for the last 7 years. During that time the Europeans, Japanese and Chinese actually did try and improve their domestic economies. Fundamentally, they’re better bets. So, the money will start to go to them.
Don’t expect all of this to feel as good as you might think. Yes, the price of gas and heating oil will drop, but the recession will make it feel like gas is still $4 a gallon. And the dollar increasing may make things cheaper, but American workers are going to have absolutely no pricing power and neither is American industry, so wages will stagnate at best, for those who are still employed.