Oil Hits Record Price: Can That Be Sustained?

Today, crude oil futures prices hit an intraday record price of $105.97 per barrel, continuing the climbing price trend of the past several weeks. Oil is now well established beyond the old 1980 inflation-adjusted price achieved during the Iranian hostage crisis. So what's behind this recent price surge and is it sustainable?

Crude oil has been rocketed into this new stratosphere of pricing as the growing U.S. economic and credit crises force governmental banking and economic agencies to take steps that debase the value of the dollar and convince Wall Street and Main Street that higher inflation is being baked into economic future. As investors sell stocks and bonds because of the economy and credit market turmoil, they are increasingly turning to commodities for a home for their funds.

Part of the rationale for this strategy is that the world's developing economies - in particular, China and India - will continue to grow as exceptionally high rates and thus will consume growing supplies of raw commodities. These countries are perceived as being immune from the economic malaise of the United States and Europe. Whether that decoupling theory will prove to hold water remains untested, and some monetary authorities and economists are already beginning to lower their 2008 growth forecasts for these formerly high growth economies.

China is the most important of these developing economies, and its government is currently huddled in its periodic convention at which policy and mandates are developed, or presented as the case may be. China is already beginning to reel from an accelerating inflation rate driven partly by the weather induced economic and social problems in late January and the government policies of controlling petroleum prices to the point it has created physical shortages of fuel.

Much of China's economic miracle of this decade has been driven by the government's desire to pretty-up the country for all the tourists expected for the Beijing Olympics later this year. The government knew that landing the Olympic Games would bring hordes of tourists, foreign government and business leaders to the country. After traveling so far to attend the games, it would be highly likely that they would want to see other parts of the country. Putting forth a positive image would help the country to secure international business and gain stature in the world. But what about after all these visitors go home?

We think it is quite likely that the social and economic issues that the Chinese government has been trying to keep under control could break out into public view. If the economic imbalances between the inland, rural and coastal, industrialized regions is not addressed, the country is at risk of labor unrest and economic problems due to a shortage of workers. How the government deals with these challenges remains to be seen, and as yet we have little feel for how the new generation of Chinese political leaders will deal with the challenge. Could the world witness another Tienneman Square spectical?

The big question is: Has China developed beyond the point where its politics cannot drive international business away from the country? Any questioning of the stability of China economically, and certainly politically, could undermine the economic miracle. If that happens, watch for a significant drop in energy and raw material consumption. That would produce a classic collapse in commodity prices, which would help stimulate Western economies and the non-energy and materials sectors of the world's stock markets. Another economic boom such as was experienced post 1982 could be in the offing. Betting on it today, however, would be a highly risky move. But ignoring its possibility would be just as foolish.