IRAQ WAR FUELS OIL RALLY, DOLLAR FLOUNDERS, CHINA TAKES OVER (2002 TO PRESENT)
The 2001–2002 economic slowdown proved only temporary. The 2003 Iraq war was more of a burden on U.S. fiscal affairs than on the rest of the global economy. By the outbreak of war in March 2003, oil prices had doubled to $35 per barrel from their December 2001 lows. Concerted in-terest rate cuts in major industrialized economies, along with broad tax cuts in the United States, reenergized aggregate demand and spurred corporate spending. Global unemployment started heading lower, while rallying stock markets and improved balance sheets spurred household confidence and spending.
In January 2002, the U.S. dollar index peaked at 120.51, just short of its 15-year highs attained six months earlier. The peak marked the end of a seven-year bull cycle from 1995 to 2001 and ushered in the beginning of a new bear market, currently in its seventh year. It was no coincidence that the dollar’s peak of spring 2002 coincided with President Bush’s trade war action of slapping foreign steel producers with tariffs in order to secure the Republican Party victory in key states ahead of the Congressional elec-tions later that year. Escalating protests by U.S. manufacturers calling the administration to weaken the strong dollar were heeded by Washington. The message was also loud enough for currency traders to begin selling the dollar against all major currencies, including the euro, which had be-come an obligatory legal tender in the Eurozone that year.
Neither the swelling budget deficit resulting from soaring war costs in Iraq nor escalating geopolitical risks helped the U.S. currency. More is dis-cussed on the geopolitical dynamics of the currency market in Chapter 9. The Federal Reserve’s slashing of interest rates by 550 basis points (bps) in the Fed funds between 2001 and 2003 weighed heavily on the U.S. currency as investors sought higher yields in other currencies. With the Fed funds rate reaching a 45-year low of 1 percent in June 2003, U.S. short-term rates were the lowest in the industrialized world with the exception of Japan and Switzerland. From 2002 to the end of 2004, the U.S. dollar dropped 53 percent against the euro and the Australian dollar, 32 percent against the British pound, 22 percent against the yen, and 25 percent against the Canadian dollar. The Fed’s rate hikes of 2004–2005 gave the U.S. dollar a prolonged reprieve in 2005, before renewed selling eroded the currency’s value in 2006 and 2007.
Figure 2.15 shows the clear inverse relationship between the U.S. dol-lar (bottom graph) and oil and gold prices (top graph) between 2002 and 2007. The U.S. dollar index lost nearly 40 percent of its value from its 2002 high to a new all-time low in November 2007, while oil prices surged five-fold from their 2002 lows to an all-time high in late 2007. Gold surged 290 percent from its 2002 low to breach the $800 per ounce mark in later 2007.
As the dollar tumbled in world markets, commodities soared across the board. Metals, fuels, and agricultural commodities woke up from their 1990s slump as their currency of exchange, the dollar, began its secular bear market. From 2002 to 2004, crude oil soared 200 percent to $55 per barrel, reaching its highest level since 1981, while gold gained 65 percent to break above $450 per ounce for the first time in 14 years.
China’s energy appetite was also a major factor in escalating commod-ity demand. Its weak currency and ultralow labor and costs helped lift the trade surplus by more than 300 percent from 2000 to 2005. The resulting
In January 2002, the U.S. dollar index peaked at 120.51, just short of its 15-year highs attained six months earlier. The peak marked the end of a seven-year bull cycle from 1995 to 2001 and ushered in the beginning of a new bear market, currently in its seventh year. It was no coincidence that the dollar’s peak of spring 2002 coincided with President Bush’s trade war action of slapping foreign steel producers with tariffs in order to secure the Republican Party victory in key states ahead of the Congressional elec-tions later that year. Escalating protests by U.S. manufacturers calling the administration to weaken the strong dollar were heeded by Washington. The message was also loud enough for currency traders to begin selling the dollar against all major currencies, including the euro, which had be-come an obligatory legal tender in the Eurozone that year.
Neither the swelling budget deficit resulting from soaring war costs in Iraq nor escalating geopolitical risks helped the U.S. currency. More is dis-cussed on the geopolitical dynamics of the currency market in Chapter 9. The Federal Reserve’s slashing of interest rates by 550 basis points (bps) in the Fed funds between 2001 and 2003 weighed heavily on the U.S. currency as investors sought higher yields in other currencies. With the Fed funds rate reaching a 45-year low of 1 percent in June 2003, U.S. short-term rates were the lowest in the industrialized world with the exception of Japan and Switzerland. From 2002 to the end of 2004, the U.S. dollar dropped 53 percent against the euro and the Australian dollar, 32 percent against the British pound, 22 percent against the yen, and 25 percent against the Canadian dollar. The Fed’s rate hikes of 2004–2005 gave the U.S. dollar a prolonged reprieve in 2005, before renewed selling eroded the currency’s value in 2006 and 2007.
Figure 2.15 shows the clear inverse relationship between the U.S. dol-lar (bottom graph) and oil and gold prices (top graph) between 2002 and 2007. The U.S. dollar index lost nearly 40 percent of its value from its 2002 high to a new all-time low in November 2007, while oil prices surged five-fold from their 2002 lows to an all-time high in late 2007. Gold surged 290 percent from its 2002 low to breach the $800 per ounce mark in later 2007.
As the dollar tumbled in world markets, commodities soared across the board. Metals, fuels, and agricultural commodities woke up from their 1990s slump as their currency of exchange, the dollar, began its secular bear market. From 2002 to 2004, crude oil soared 200 percent to $55 per barrel, reaching its highest level since 1981, while gold gained 65 percent to break above $450 per ounce for the first time in 14 years.
China’s energy appetite was also a major factor in escalating commod-ity demand. Its weak currency and ultralow labor and costs helped lift the trade surplus by more than 300 percent from 2000 to 2005. The resulting
FIGURE 2.15 The 40 percent decline in the U.S. dollar index during 2002–2007 was closely correlated with the surging prices of oil and gold.
increase of more than $120 billion in China’s current account surplus gave China the newly acquired status of world’s leading consumer of coal, cop-per, and iron ore.
China’s growth rate has become synonymous with global demand for commodities. Figure 2.16 shows that China’s oil demand stood at
increase of more than $120 billion in China’s current account surplus gave China the newly acquired status of world’s leading consumer of coal, cop-per, and iron ore.
China’s growth rate has become synonymous with global demand for commodities. Figure 2.16 shows that China’s oil demand stood at
FIGURE 2.16 China’s oil consumption grew from less than 6 percent of the world’s total in 2002 to 9 percent in 2006.
4.80 billion barrels per day in 2002, or 5.8 percent of the world’s total. Two years later, China’s share of global demand rose to 7.8 percent in 2004, beating Japan to second place behind the United States. The correlation between China’s strengthening oil demand and oil prices remained robust throughout. With GDP growth topping 11 percent in 2007, elusive signs of an economic slowdown have yet to weigh on commodities. Until then, China’s accumulation of the biggest armory in currency reserves at $1.5 trillion should maintain the country’s support for commodities prices.
SUMMARY
We have seen in this chapter how strong global growth can be instrumen-tal in boosting oil prices. The years 1976–1979, 1994–1997, 1999–2000, and 2003–2006 were all periods of steady import demand sustained by robust growth in both the developed and developing world. While Saudi Arabia’s status as the world’s largest oil producer has enabled it to act as the swing producer during supply uncertainty, China has assumed an increasingly similar role on the demand side.
4.80 billion barrels per day in 2002, or 5.8 percent of the world’s total. Two years later, China’s share of global demand rose to 7.8 percent in 2004, beating Japan to second place behind the United States. The correlation between China’s strengthening oil demand and oil prices remained robust throughout. With GDP growth topping 11 percent in 2007, elusive signs of an economic slowdown have yet to weigh on commodities. Until then, China’s accumulation of the biggest armory in currency reserves at $1.5 trillion should maintain the country’s support for commodities prices.
SUMMARY
We have seen in this chapter how strong global growth can be instrumen-tal in boosting oil prices. The years 1976–1979, 1994–1997, 1999–2000, and 2003–2006 were all periods of steady import demand sustained by robust growth in both the developed and developing world. While Saudi Arabia’s status as the world’s largest oil producer has enabled it to act as the swing producer during supply uncertainty, China has assumed an increasingly similar role on the demand side.
PLEASE READ ALSO : WHEN THE DOLLAR WAS KING (1999–2001)
The United States remains the world’s biggest economy as well as the world’s biggest oil consumer. But this also means that 5 percent of the global population is consuming 25 percent of the world’s energy supplies. Given that the United States imports 58 percent of the oil it consumes, the cost implications are considerable, especially given that dependence on foreign oil has risen from about 36 percent in the first and second oil crises, and is expected to reach 68 percent in 2025. At what cost? The dol-lar amount of total U.S. petroleum products pyramided from $103 billion in 2002 to $302 billion in 2006, doubling its share of total imports to 14 percent over the same period. As a share of the trade deficit, petroleum imports surged from 25 percent to 40 percent of the U.S. trade imbalance. With world oil supply struggling to catch up with soaring demand, and the world’s biggest consumer continuing to grow at subpar rates, conditions remain ripe for a prolonged bear market in the U.S. dollar and an extended bull market in oil.
The United States remains the world’s biggest economy as well as the world’s biggest oil consumer. But this also means that 5 percent of the global population is consuming 25 percent of the world’s energy supplies. Given that the United States imports 58 percent of the oil it consumes, the cost implications are considerable, especially given that dependence on foreign oil has risen from about 36 percent in the first and second oil crises, and is expected to reach 68 percent in 2025. At what cost? The dol-lar amount of total U.S. petroleum products pyramided from $103 billion in 2002 to $302 billion in 2006, doubling its share of total imports to 14 percent over the same period. As a share of the trade deficit, petroleum imports surged from 25 percent to 40 percent of the U.S. trade imbalance. With world oil supply struggling to catch up with soaring demand, and the world’s biggest consumer continuing to grow at subpar rates, conditions remain ripe for a prolonged bear market in the U.S. dollar and an extended bull market in oil.
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