Oil, the Dollar and the Election

Last week, this “twist action” was extended. Operation Twist doesn’t flood the market with dollars simply because they are using the proceeds from the sale of the short-term securities to buy longer-term bonds. Therefore, the dollar has been strengthening, contributing to the fall in commodity prices.

If the Fed were to introduce QE3, the money supply would be further expanded, and we would see oil and other commodities rise. However, this assumes global demand remained somewhat constant. Demand is the other side of the coin. With Europe in a recession, America’s economy slowing, and the BRIC countries, most notably China, slowing, the global economy is getting weaker. This slowdown in global economic activity and the stronger dollar should keep commodity prices, and specifically oil, lower. Of course, a conflict in the Middle East could change all that.

If economic growth does continue to slow to the point where deflation becomes a threat, then the Fed would certainly entertain the idea of another round of QE. In Bernanke’s mind, anything is better than deflation, especially since he is such a student of the 20-year Japanese deflation trap. However, if deflation does not appear to be a threat, then QE3 would not see the light of day.

The drop in oil is just in time for the November election. I expect the dollar will continue to strengthen for a little while longer. Rest assured, its movement is not strictly dependent upon market forces. There’s another force at work, which is especially true in an election year. One can only hope that change takes on a new meaning in November.