Follow The Money

The price of Brent crude has collapsed from $115 to $70 dollars a barrel. US light crude to $66 a barrel, all in a very short time. The US dollar has risen by 10-15% against most currencies. The US has ended QE (Quantitave Easing = money creation) and has now been replaced by zero growth Japan, soon to be joined QE in zero growth Europe. After many years of high interest rates in China, they have now initiated lower rates resulting in a 40% jump in the Shanghai Index. And what of Russia and Putin? Goodness, so much is happening...how to make sense of all this?

Economics and political power go hand in hand, though by watching news media, one would probably not notice this (Ferguson and the racist colour of Black Friday seem to be the rage). What are the consequences of the collapse in energy prices? logically most oil producing nations will find themselves in a spot of bother. OPEC are no longer the political or economic power they were in the previous decades. The interesting part of this conundrum  is that both Saudi Arabia and the Emirates voted against reducing supply to shore up prices and the question is why? Texas, Colorado and North Dakota shale-drilling has increased U.S. production by nearly three million barrels a day since 2011. arguably, the break even for shale is around $70 a barrel. The conclusion is that the Saudis are fighting for market share.

Importantly, the Saudis have foreign currency reserves of $800 billion which gives them breathing room to take it easy for a year. Who does not have that breathing room? Iran, the venomous Saudi rival is in big trouble from this turn of events which could be termed as a crushing blow to Iran's oil exports and therefore, to its budget. Another victim of this crisis is Russia. The majority of Russia's income is from energy exports. The Russian budget next year is based on $100 a barrel oil, creating quite the income shortfall. The obvious way for Putin to to avert attention from the economic malaise, is to focus on military undertakings like the Ukraine, Crimea and Afkhazia (in Georgia), and then blame the West.

World economic policy, since 2008 is to create inflation. The opposite of inflation, being deflation (another word for recession or depression). Imagine economies who have close to zero inflation and positive interest rates, of say 1%. With the fall of oil prices, many country's inflation rates will fall into negative territory. With positive, or even zero interest rates, the real interest rates will rise, making expansion more difficult. Japan is one of those countries, and thus announced a QE program and allowed its currency to fall.

The US dollar strength is also creating anxiety everywhere. The USD is the world's reserve currency, so nearly all international debt is in USD. A rise of 10-15% in the USD has automatically increased all international debt (except for the US) by that amount. Which countries are best placed to handle this situation? China and India. Both have cash in the bank and both benefit tremendously from the fall in oil prices. Further, with their manufacturing and export capacity, they can take advantage of the US dollar strength to increase income.

Are we seeing a change in world order, with China and India beginning to flex their economic muscles? Is a desperate Russia flexing its military muscle? Interesting world. How will the markets react to these developments....any ideas?