The decline of the Russian economy didn’t start with the
imposition of Western sanctions or the tumble oh oil prices. Stagnation was
evident already in 2013, when oil prices were still averaging well above $100
per barrel.
The collapse of oil prices turned a structural economic
downturn into a recession. Now, after two years of declines, the Russian
economy has started to stabilize, and oil prices are rallying. Crude prices are
up by more than 50 percent from their January lows, even though OPEC failed to
agree on production curbs, US oil supplies have risen and the International
Monetary Fund became the latest international agency to lower its forecast for
global economic growth – all factors that should have a negative impact on the
price of oil.
Analysts are pointing the jump in oil imports from China in
March, as the government in Beijing added to its strategic oil reserves, and
weaker oil output in the United States as reasons for the latest increase in
oil prices. However, while supply and demand do impact trends in the oil market
over the longer term, oil prices are set by other factors Futures contracts for oil are first and
foremost financial instruments. The
value of futures contracts traded in London and New York far exceeds the amount
of physical commodity produced around the world. In this respect, the main
factor in setting oil prices is not how much is pumped out of the ground or burned
by power plants and internal combustion engines, but how the U.S. dollar is
valued on foreign exchange markets.
The dollar exchange rate and oil prices are closely correlated
because oil is traded in dollars and oil futures represent a readily available,
very deep and liquid store of value for dollar-denominated liquidity. A
stronger dollar means the lower oil prices, and vice versa.
As in other financial markets, the dominant influence on oil
markets over the past decade and a half has been the massive expansion of
liquidity in the global financial system. In other words, oil prices have been
set by the printing of money by global central banks, notably, by the U.S.
Federal Reserve since the 2008 financial crisis.
The Fed printed over $3 trillion worth of dollars in the
ensuing six years. That liquidity had to be invested, and a major portion of it
went into speculation in oil futures. Between early 2011 and mid-2014 oil
prices stood solidly above $100 per barrel. That was happening despite the fact
that oil traders knew perfectly well that oil supply was consistently
outstripping demand and, moreover, expanding rapidly.
The fact that oil prices tumbled so quickly and definitively
has been the best indication that the oil market had been in a bubble stage.
The timing of the oil price decline was also significant. The
Fed tapered off its quantitative easing program starting in 2013 and ended it
in October 2014. The nearly unlimited printing of money by the Fed ceased. You
would expect oil prices to rise – since the end of quantitative easing meant
that the U.S. economy was finding its legs – but they actually dropped
precipitously starting in mid-2014.
On the other hand, as oil prices tumbled, the trade-weighted
exchange rate of the US dollar began to rise. In other words, the dollar
strengthened against most other currencies. In gained, on average, a quarter of
its value against other currencies by early January.
However, after the Fed raised its interest rates for the first
time in nearly a decade in December, substantially weaker economic data
suggested that U.S. interest rates will not be going up quite as fast as
previously thought. The dollar has been weakening since then, softening by
about 5 percent.
Once again, you would expect oil prices to fall in this
environment if they had been driven by supply and demand considerations. Yet,
the weakness of the dollar helped push oil prices much higher.
Interest rate movements and the printing of paper dollars are
not the only forces that determine the value of the dollar. It is also
influenced by political considerations. Note that periods when the dollar is
weak – and, by extension, international oil prices are high – have tended to
correspond to the overall weakness of the West and the ascendancy of its
enemies.
In the 1970s, the United States was grappling with the
post-Vietnam syndrome, triggering social turmoil at home and major reverses in
foreign policy. Communism was advancing in Asia, Africa and Latin America.
The same happened after the September 11, 2001 terrorist
attacks and the subsequent U.S. entanglement in Iraq and Afghanistan.
Today we may be witnessing the start of a new period of Western
weakness, manifested in the highly unusual presidential campaign in the United
States and the potentially fatal loosening of the European Union.
Wall Street has been on an upswing since January, oblivious of
the election. But foreign exchange markets have been showing signs of growing
nervousness.
It’s not even so much the fact that out of the five remaining
candidates for U.S. presidency one is an anti-establishment socialist, another
a Canadian-born Christian fundamentalists and a third a buffoonish carnival
barker with a fuehrer complex – with the latter being the most likely nominee
of the grand old party of Lincoln. Rather, it is the disintegration of
America’s political consensus and massive dissatisfaction with the status quo
on the part of the most engaged American electorate that bodes ill for
America’s continued leadership in the world.
On the macroeconomic level, the long-term supply-demand
relationship in the oil market points to continued overhang of the former and
price weakness. The oil market, which for decades was dominated by oil
exporting countries, is now governed by technology – new, more efficient
production and exploration methods allowing to tap previously uneconomical
deposits such as shale, shale sands and the ocean floor, energy efficiency and
alternative and renewable energy.
But over the medium term oil prices may be pushed higher thanks
to the weakness of the greenback. Regardless of who is elected its president in
November, America is in for a period of political turmoil and divisiveness.
President Hillary Clinton will face obstruction that could make the gridlock
years of Barack Obama seem like the golden age of across-the-aisle
bipartisanship. President Donald Trump may not have much interest in
implementing any of his anti-constitutional and outright illegal agenda, but
his electorate is unlikely to settle for the same old politics, having been
riled up by extremist rhetoric.
The result is likely to be, as in the 1970s, a weakened dollar
and higher oil prices. A side effect of this would be a strong ruble – at least
for a while. This will no doubt confirm for those in Russia who have overdosed
on their mind-numbing propaganda that their country is indeed in a hybrid war
with the United States, and that their side is winning.
