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To pick up from where we left off yesterday, there are at least two factors to consider that will push the price of oil higher, and possibly gold as well.
The first of these factors is already in: the Federal Reserve will pump more cash into the system. And by ‘system’ I mean the financial system, which really means the banking system and the stock market…
The economy as a whole, as we have seen since quantitative easing began, is only temporarily helped by the Fed’s actions, and not by that much, either. The take away there is that with more dollars on their way, the dollar-denominated price of oil should rise on the world market.
How much of a price jump will we see?
That’s hard to say, because demand for oil has fallen due to economic slowdown and larger inventories.
But the second factor may well have a longer term affect the price of oil, with possibly a much greater impact than Fed easing.
What’s the second factor?
It’s the rising Mideast tensions.
War games are no game
The announcement of war games between Russia, China, Iran, and Syria next month may well have a bigger, long-term impact on oil prices than anything the Fed does going forward.
What are the reasons for the war games, and how could they affect oil prices?
The war games are a demonstration of power; they are a show of force by Russia and China, with the Iranians tagging along and the Syrians not having a lot of say in the matter except that the Assad regime is happy to have the support.
The games themselves are meant to intimidate the US into retreat, and to stop backing the Syrian rebels. If the US does not retreat, there is the real possibility of escalation. Both Russia and China are betting that the US will not have the spine to call their bluff.
But the US may not have any good or easy choices left.
Because even if the US backs off from the Syria civil war, which looks likely to be the outcome, Russia and China may well use that opportunity to deepen their position in the Mideast, with Iran as their regional proxy.
Remember, Russia has long sought a way to kick the US out of the region. Today, with the rise of the Muslim Brotherhood to power, the Egypt-US alliance is on the rocks. Also, with Russia backing Iran and playing hardball in Syria, a US retreat in the Mideast seems much more of a possibility than before.
And of course, an emboldened Iran, backed by the firepower of both Russia and China, would be a driver of higher oil prices almost immediately, helping both Russia and Iran, with China sure to get a sweetheart oil deal for their cooperation.
Think this scenario is unlikely?
Or does it makes sense that a rising China and a resurgent Russia both view the US as a war-weary nation with a weak leader and a military that is stretched thin and worn down by two very long wars in the region?
But why, you may wonder, is it so important to Russia and China that US influence be reduced or even eliminated from the Mideast?
At its core, it has to do with the American dollar’s monopoly on the world’s oil trade. Russia and China view the petro dollar scheme as an obstacle to their growth and power in the world…
And they are entirely correct.
The petro dollar is the key
Without the petro dollar, the dollar as a currency would be finished. The deal the US struck with the Saudis back in 1975 priced oil in US dollars in exchange for US military protection of Saudi Arabia. And to further guarantee a consistent demand for US dollars, Saudi Arabia agreed to invest their vast oil revenues in US T-bills.
That is why the US presence in the Mideast is so crucial. At its essence, US dominance in the region ensures that it will maintain its ability to live up to its end of the petro dollar bargain of providing a real and credible defense of Saudi Arabia, which ultimately means defending the dollar.
So the US involvement in the Syrian civil war is not out of concern for another strong-armed military dictator slaughtering his people. If that were the case, there are plenty of other places we could be as well, but are not.
No, the underlying meaning of the war games scheduled for next month is huge and potentially world-changing: The US is being directly challenged by a Russia/Chinese/Iranian axis of power, and it is nothing less than a frontal assault on the US dollar and the petro dollar arrangement.
A worthwhile question is “who is the target audience for these theatrics?”
Russia and China are certainly not out to impress the Syrians. The Syrians have been allied with the Russians for decades; nothing new there.
What about the Iranians?
Both Russia and China have strategic interests with Iran. Iran and Russia both share borders on the Caspian Sea, and Russia has been massing troops in the south in anticipation of an attack on Iran by as soon as this summer.
Such an event would also make war games in June a very useful way of making Israel balk at attacking Iran.
China’s interest in Iran is much less involved. China’s interest in Iran is for its oil, for which it already has long-term contracts.
Fueling Saudi Arabia’s doubts
But if the target audience isn’t Syria or Iran, then who is it?
Israel, as just noted, is a possibility; but the greater probability is Saudi Arabia.
Why would that be?
Imagine if the Saudis think that American power is no longer willing or able to defend them?
The petro dollar deal would die a quick death…and so would the US dollar and the US Treasury market. The US currency and its entire financial system would collapse, as would the dollar-denominated global financial system.
That is the endgame that the Russians and the Chinese have in mind. They will be ready to step in and offer a replacement currency, backed by both their economies and possibly gold, to the world as a replacement for the dollar.
These are the games nations play, and the stakes are very high indeed. So, even though Fed easing may well drive an oil price spike in the short term, the elephant in the room is the challenge I have just described.
Regarding gold, prices do correlate to the Fed easing pretty closely, but have also been offset by the gold market’s lack of liquidity. So when things go south in the Eurozone, for example, the dollar has rallied more than gold because of the Treasury market’s size and liquidity, which the gold market cannot match.
If, however, the war games drama plays out in a fashion that diminishes the dollar of the petro dollar, then gold, of course, would spike in value overnight.
How far will the US go to defend the dollar and the status quo? It would appear that in the summer of 2012, the Russians, the Chinese, and the Iranians are willing to find out.
And those are…The Gorrie Details.