Things in the Sky

We’ve been hearing about how the rise in oil prices can potentially be due to the devaluation of the dollar. And I think it’s a convincing case, at least for some of the increase.

Oil is priced in terms of dollars. So let’s say the dollar depreciates against other currencies – to compensate for that, the price of oil goes up. The dollar did strengthen against other currencies at the end of last year, mainly due to the horrific events in the financial markets. One reason for this is that people fled to some form of financial safety in the United States. That increases the demand for dollars, which increases their price in the form of the exchange rate. This urge to find safe investments is the same reason why we briefly saw negative treasury yields.

But, while currencies like the euro are nowhere near their highs, they have been gaining some ground. The Euro, for example, hit a low period in late February and early March, but is now essentially flat for 2009.

So, basically, if the devaluation argument holds, then any increase in oil prices should be less in currencies like the Euro that it is in the dollar. I decided to graph these prices from February 12, since this was the lowest spot price I found for oil in the EIA data I obtained.

And, if my calculations are right – in dollars, oil has increased 107.08% from February 12 to June 16, while it has increased 91.32% in euros. That’s still a big increase, but it’s a difference of 15.72 percentage points, which is pretty significant, I think.

Meanwhile, I saw a graph like this on a Financial Times blog, and decided to make my own graphing the price of oil and the value of the euro in dollars.

It’s actually a pretty decent fit. For the statisticians out there, I got an r-squared value of 0.83, which isn’t too shabby.

This suggests to me that indeed the devaluation of the dollar has an effect on the price of oil, whether it be current moves in currency markets or future inflation expected by traders.

And while we’re on the topic of the dollar and inflation, I once again present the scary graph of the monetary base. But this only tells half the story. The other half is the velocity of money, and you can see a graph of that here. Basically, once that picks up, well, it cold get messy, depending on what the Fed does

Anyway, more on oil later.