Oil Watchdog

Back in the days when Lawrence Welk was still banging out polkas on
the accordion in Escondido, an off-stage bubble machine would add some
effervescence to his "champagne music."

These days, of course, Welk wouldn’t need the machine. All he’d
have to do is hire the Federal Reserve and he’d be able to produce the
biggest, costliest bubbles his waltzing fans could ever hope to see.

Over the past decade, the U.S. economy has lurched from one
bubble to another, ranging from the hedge fund investments that
imploded in 1997 and 1998 to the dot-com stocks that crashed in 2000 to
the housing prices that are continuing to fall at this moment.

After each implosion, the Federal Reserve has faithfully stood
by to slash interest rates and print fresh reams of crisp cash,
inadvertently laying the groundwork for the next bubble.

"Going from bubble to bubble has become part of our economic
lifestyle," said Tapan Munroe, a director of the Law and Economics
Consulting Group in Emeryville.

Now, it seems, the bubble machine is adding a bit of froth to
the worldwide petroleum market. With the price of oil hovering near
$100, it seems likely that we’re heading for another bubble — this
time in commodities. And even if this bubble is short-lived, which
hopefully it will be, it’s still going to cause a bit more pain as we
fill up our gas tanks.

Over the past year, the price of gasoline has jumped 36 percent
from $2.42 to $3.30 per gallon in San Diego County. In the meantime,
other potential bubbles are developing as well, ranging from gold,
currently selling at nearly $835 per ounce, to building materials,
which will add to the expense of people rebuilding their homes after
the recent wildfires.

"As the dollar slides, it encourages people to hold real assets
of all sorts: gold, platinum, oil, metals," said Stephen Leeb,
president of Leeb Capital Management and author of "The Oil Factor."

There are plenty of reasons that oil prices are rising: growing
demand for fuel in China and India, fluctuating oil reserves in the
United States, the threat of open conflict with Iran, and so on.

Each of those factors has added a few dollars to the price of
oil over the past couple years. But they still don’t explain why oil is
around the $100 mark.

Part of the blame for the run-up lies with the Fed.

Let’s go back to 2003, a year not so far away. After the stock
market crashed in 2000, then-Fed Chairman Alan Greenspan pulled out all
stops to keep the economy from going into recession. In the period from
Jan. 3 to Dec. 11, 2001, he slashed the federal funds rate from 6.50
percent to 1.75 percent.

By 2003, it was down to 1 percent, well below the rate of
inflation. Greenspan was, in effect, paying people to take money off
his hands. And he had plenty of takers. The financial industry lined up
at the trough, turning the money into risky new mortgage vehicles that
fueled an unprecedented housing boom.

Home buyers were so happy with their purchases that they failed
to notice that their dollars were getting cheaper by the minute. As
Greenspan pumped in more and more money, the value of the dollar
declined, which in turn meant it made commodities and most foreign
currencies more expensive.

The euro was worth as little as 95 cents when Greenspan began
slashing rates and pumping more money into the economy in 2001. By
mid-2003, it was at $1.15. Today, it’s at an all-time high of nearly
$1.50.

Similarly, oil rose from $28 a barrel in 2001 to $29 in 2003 to
$98.62 at its highest point Wednesday, before sliding down a couple of
bucks later in the week.

Oil was undoubtedly fated to rise anyway, especially with
increasing demand from China and unrest in the Middle East. But without
the easy money from the Fed, it would probably not have risen at that
rate.

"Oil prices and the value of the dollar are definitely
connected," said Keitaro Matsuda, senior economist with Union Bank in
San Francisco. "Oil prices are growing for Americans because our dollar
buys less and less goods."

In addition, the Fed’s loose monetary policies mean there’s plenty of money on the market for speculators to play with.

As they did with the run-up in the stock market in the late
1990s and the housing market in the early 2000s, speculators are
pumping money into the investment vehicle with the greatest growth
potential. And for the time being, that appears to be oil.

"Of course it’s a bubble," said Judy Dugan, a specialist on oil
issues at the Foundation for Taxpayer and Consumer Rights in Santa
Monica. "Of course it’s driven by speculators. It’s insane for an
economy our size to be held hostage by unregulated speculation."

Although some analysts have tied oil-price rises to negative
headlines from the Middle East and the North Sea oil fields, Dugan says
there is little difference between the fundamentals of the market today
and two years ago, when oil prices were about $60 per barrel.

She assumes that prices can’t get much higher, but she’s been wrong before.

"People thought it might bust at $85 and then $90 per barrel, but it’s kept going," Dugan said.

The bright side of that is that the soaring price of oil may
turn out to be a bubble, too. There’s a good possibility that the price
could pop after the speculators pump it up and then dump their
holdings.

But judging from past experience, if the oil bubble pops, we
will likely see yet another price spike form in another area of the
economy, as the Fed dips its bubble wand into its bottle of soap mix
and blows some fresh froth into the market.