When the Oil Price Portends Recession

What a nuisance! Our laptop computer collapsed this morning. Hours were wasted trying to revive it. We were like a carpenter without a hammer…a clown without a red nose…an idiot without a village.

Meanwhile, the financial world seemed to be on the verge of collapse too. Stocks rose 161 points on the Dow yesterday…after a big drop the day before. Gold rose a bit too.

This is the kind of market nervousness that usually resolves itself – in a big drop. Yes, our “Crash Alert” flag – tattered, faded, and frayed – is out. Ignore it at your peril!

The Fed is still pumping $4 billion of new money into the system every day. And the federal government is putting in another $5 billion of deficit spending every day.

With this kind of support, you wouldn’t expect asset prices to fall. Instead, they should be soaring.

“Don’t fight the Fed,” the old timers warn.

But watch out. The Fed might have lost control.

The Great Correction isn’t going away. It’s intensifying.

As you know, it’s been war out there. The feds against the market. The market wants change. The feds fight to protect the status quo.

It’s an ancient struggle. But this phase of it has been going on for more than 10 years. The markets try to go down…to correct their mistakes…to reduce the amount of debt in the system. And the feds fight back with overwhelming firepower – forcing prices back up…adding more debt…preventing bankruptcies. And now the battle is heating up.

What to make of it? First, the feds can destroy wealth. They can prevent it. They can move it around. But it’s only the private sector – and market forces – that create it.

Second, the more the feds meddle in the markets, the more distorted and grotesque the outcome becomes. Regulation, rigged credit markets, bailouts and subsidies – all pervert the natural outcome of market forces.

Third, the feds’ current use of overwhelming force to block a market correction is creating overwhelming unforeseen and pernicious problems. They put money into the system to try to encourage spending and investment. The money pushes up stocks – giving investors more “wealth” to spend. But it also tempts speculators into risky trades…and pushes up oil prices…giving business and consumers higher energy prices…and less money to spend on other things.

Let’s look at what happens next.

No, the feds didn’t cause earthquakes in Japan or revolutions and civil wars in North Africa. But they created such a rickety financial structure…so top-heavy with debt…that almost any calamity can bring it down.

As it happens, political troubles in the Arab states…and Japan’s nuclear problems…both grip the world’s single most important market – oil – like the jaws of a vise.

The Arab world produces the stuff. Japan consumes it. Without its nuclear reactors, Japan will rely even more heavily on other forms of energy…leaving more people standing in line with gas cans in their hands.

And here’s where the feds come in – their funny money had already sent the price of oil from a low near $30 at the bottom of the ’09 crisis…to a high over $100 before the first coffee cup started to rattle in Japan.

Where the price will go next, we don’t know. But it’s being squeezed on both sides – supply and demand – simultaneously.

And here’s something you should know:

According to Nomura Securities, every time there is a big increase in the price of oil – 170% or more – there is also a recession.

We mean every time in the last 40 years – ’74, ’79, ’90, and ’00.

And don’t forget, it wasn’t just subprime debt in the US that spelled doom for the economy in ’08. It was also skyrocketing oil prices…that pinched household budgets all over the world.

And guess what? The price of oil has already risen more than 170%. It had hit the critical point even before the revolutions in North Africa or the earthquakes off the coast of Japan. Now, under even more pressure, we can expect a higher price of oil…until the bottom falls out again…

Bill Bonner
for The Daily Reckoning