Wednesday, August 23, 2006

Back to the Future. No, Just Back to the 1970s

EUR/USD 1.2819 Hi1.2836 Low1.2783
USD/JPY 116.32 Hi116.57 Low116.07
AUD/USD 0.7650 Hi0.7668 Low0.7616
EUR/JPY 149.14 Hi149.31 Low148.76

Jack Guynn and Michael Moskow spooked the U.S. Stock market yesterday by suggesting (again) that the battle with inflation is not over and, more ominously, that allowing inflation to rise a little so that economic growth doesn't hit a brick wall IS NOT THE WAY TO GO. Suddenly the FED PAUSE is not a slam dunk.  And the markets didn't like it.  Mr Guynn would like us to consider what we have learnt over the past 40 years.  Indeed.

Let's start in the Middle East.  The establishment of the state of Israel and the shipping in of hundreds of thousands of foreign nationals into Palestine wasn't  welcomed by the people already in situ.  Not that it mattered much.  Supporting the establishment of the state of Israel suited the Americans and the British and it gave them a bullet-proof ally in the region, which was volatile and OIL RICH.  The OIL, of course, being the major attraction.  Naturally wars followed.  With the support of the U.S.A. Israel emerged victorious from war after war.  In 1967 the Israelis fought and won the 6 day war.  The Arab world was not happy. 

Then in 1969 the Nixon Administration came to power in the United States.  (Interestingly, both Rumsfeld and Cheney cut their political teeth in the Nixon Administration.)  Economic know-how wasn't the strong point of this Government.  Spending on the Vietnam War had made a big hole in the Federal Government's Finances.  Inflation had emerged as a problem.  Inflationary fiscal and monetary policy had seen a blow-out in the U.S. Balance of Payments.  Although still fixed to the price of GOLD, the USD was under threat. In 1971 Richard Nixon broke the USD's link to GOLD and the USD collapsed. 

On October 6 1973 Egypt and Syria launched an attack on Israel: the Yom Kippur war.  With American support the Israelis won, again.  On October 16 OPEC decided a 17% increase in the price of OIL, taking it all the way up to US$ 3.65 a barrel. Then, on October 17 the Arab members of OPEC announced an embargo on OIL sales to the United States.  This embargo was later extended to U.S. allies.  This was payback for the U.S. support of Israel during the Arab-Israeli wars. In response, it has since been reported, that the United States considered simply invading Saudi Arabia or Kuwait or Abu Dhabi and taking over the OIL fields.  The idea was that control over OIL would be a panacea for all the woes which were afflicting the U.S. economy. Doesn't this whole scenario sound terribly familiar?

By the end of this crisis the price of OIL had rocketed to US$12 a barrel.   The Arab world had discovered a powerful bargaining chip and the key to their economic prosperity.  From there it was a short step to remove the potentates who had been installed at the behest of the Anglo-American OIL conglomerates.  On January 16, 1979 the Shah of Iran fled the country. The price of OIL hit US$ 25 in 1979.  And the Anglo-Americans weren't happy.  

In January 1981 President Ronald Reagan was elected.
  And guess who should pop up: Cheney, Rumsfeld, and George Bush Snr. And so began the long sorry history of the Anglo-American support for another potentate in the Middle East: Saddam Hussein.  Not that that particular episode is getting a lot of air time at the moment.  Nevertheless with Saddam Hussein in power a war was launched against Iran.  And the OIL price pushed still higher. 

Then we had the relative calm of the Clinton Administration (1993-2001).  The U.S. Federal Government Deficit was brought under control, the stated policy of the Clinton Administration with regard to the USD was the "Strong Dollar Policy" and the price of OIL actually FELL. What's more, without a major conflict in the Middle East to galvanize OPEC, the organisation itself started to look shaky.  There were predictions that the price of OIL would languish for years. And then Al Gore lost the election. Oil was trading at around US$ 24 a barrel and the U.S. Federal Government was in surplus. In 2001 George W. Bush was elected President and things started to fall apart fairly rapidly after that. 

Cheney and Rumsfeld are back in the driving seat.  Iraq has been invaded.  There is talk that the U.S. actively goaded Israel to escalate hostilities with Lebanon and Iran is in the cross hairs of our dear friends, the "Neo-Cons".  The U.S. currenct account deficit is massive.  The U.S. Federal Government Deficit is similarly appalling.  The USD is under threat.  The price of OIL has more than trebled and the only solution on offer is more regional aggression in the Middle East.  Nothing like sticking to your game plan, even if it doesn't work.  Like a dog to its vomit, so returneth a fool to his foolishness.  What we do know about these people, if history is any guide, is that they simply have no idea of what effective economic management requires.  They prefer the allure of supposed quick fixes.  This does not bode well for the U.S. economy going forward, for the USD or for global Stock Markets.

One question for these guys: why can't you just buy OIL like the rest of us?

Oil 72.30
Gold 634.70

If what we should be watching is the 1970s then remember that GOLD moved from USD 35 to USD 125 in fairly short order.  GOLD bears beware.  

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