Like all commodities, the price of oil has taken some hits recently. It may even go down a bit further from its current $100 a barrel level in the next few months. Or, it may go up a bit. But whether it goes up or down from $100 a barrel isn’t that important relative to another potentially more important issue — inflation.
Whatever price it is at, it is likely to remain high and if the price stays above $90 a barrel, such sustained high oil prices have the power to kick-start inflation.
Much like high oil prices in the 1970s served as a match to help light inflation from an increased money supply, high oil prices have the potential to do the same today.
Clearly, the fuel for inflation fires is there with the Fed’s recent massive increase in the money supply via QE1 and QE2. All it needs is a good match to get inflation going.
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The length of time between printing money and when that money becomes inflation can vary depending on a variety of circumstances.
One of those circumstances is how fast commodity prices are rising.
Commodities are often the first component of the economy to react to inflation since they are heavily traded on a daily basis. And oil is one of the most important commodities since it is part of the price of almost everything we buy. A large increase in oil prices can be one important factor in kicking off an inflationary spiral that turns that increase in the money supply into inflation, as we saw in the 1970s.
Consumers are already feeling the inflationary pinch but it is also beginning to show up in economic indicators as well. For example, in the Richmond Federal Reserve manufacturing Index that came out on May 24, 2011 raw materials prices increase at a rate of 6.12 percent in May, the highest reading since the inception of the survey in December 1993. That number is a big increase over April which saw an increase of 4.81 percent.
Other indicators are showing higher inflation as well. With commodity prices falling, some of that increase will slow down, but the key is that commodities serve more as an igniter of inflation than the creator of inflation. Inflation is created by printing money. A massive increase in the money supply relative to true economic growth will become inflation at some point; the only question is how soon.
As in the 1970s high commodities prices, especially for oil, can be the key to making that sooner rather than later.
About the Author: Robert Wiedemer
Robert Wiedemer is a managing director of Absolute Investment Management, an investment-advisory firm for individuals with more than $80 million under management. He is a regular contributor to Financial Intelligence Report, the flagship investment newsletter of Newsmax Media. Click Here
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