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The Real Price of Oil: Dollars, Gold, and the Price of Tea in China

Posted in Fuel, Gas Prices, Newsworthy, Oil Industry, Politics by Vito Rispo | August 16th, 2008 | 38 Responses |

Oil, it’s the lifeblood of our society. It’s given us the freedom and wealth we have today. It’s given us automobiles and machinery and greased the wheels of the industrial revolution. It made old Jed a millionaire. But oil’s in trouble, the price is up and everyone thinks they understand it. But what if the price of oil wasn’t really up? What if it were just an illusion?

“The price of oil is skyrocketing, and that means gas prices are up…”
That’s about the limit of what most Americans know and understand about the whole oil situation. But there are more complex issues at work, and they involve more than just Middle East politics and China.

The American Geological Institute (AGI) recently released a report looking at the price of crude oil in relation to the U.S. dollar and the price per ounce of gold. It highlights a fact that probably makes some folks at the Federal Reserve very nervous.

This graph makes it easier to understand:

The bottom purple line is the price of a barrel of crude oil per ounce of gold (if you wanted to use gold to pay for a barrel of oil). As you can see, that line is stable, and has been for the entirety of the graph, which is about 7 years.
The top two lines are the price of oil in relation to currency (blue is the Dollar and the red is the Euro). Those lines show that the cost of oil has been going up in relation to currency only. What this chart makes obvious is that the value of oil has not been increasing in real terms, currency has just been decreasing in value.

To put it another way, if the US Dollar were still based on gold (as it was until Nixon eliminated the Bretton Woods system in 1971), then the price of oil would be just as stable as that purple line in the chart is.

So oil is worth the same, and the US dollar is just worth less. Maybe we need to shift our focus away from war and drilling; and towards a better economic policy at home.

Here is the AGI data report

And here’s the summary from the AGI report:

The steep increase in the price of crude oil in the United States remains a headline issue, along with the falling US dollar. The drop in the dollar has caused concern in oil-producing countries which use it as the economic basis for the commodity, and often their currency. The chart below shows the spot market price of crude oil per barrel (BBL) in US dollars and in euros from 2001 to today. The price of oil has grown faster relative to the dollar than to the euro. Yet, a portion of the rise in oil prices is due to the fall of the value of the dollar. The graph also shows the number of barrels of crude oil per cost of an ounce of gold, demonstrating the parallel growth in commodity pricing.
If the US dollar had remained strong in the global economy, oil might, in theory, be around $65 per barrel. However, oil is priced in dollars, and oil prices continue to rise. The impact of increased oil prices can not be ignored in the US economy, and, in turn, can further weaken the dollar. Resource economics is a complex feedback loop where today’s resource boom is driven by many external factors. This complex system bears watching by all geoscientists.

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38 Responses

  1. Like the wizard in the “Wizard of Oz,” we have been asked to direct our attention away from reality. We are seeing the results of the inflation of the monetary supply that began in the last years of the Vietnam War, when we were told that the country could have everything without restrait.

    Thank you for a good piece of reportage here. Congressman Ron Paul was bringing up many of the same points, during his run for the White House. But he was viciously ridiculed for his trouble, by the other Republican candidates during the faux debates of last winter – well that, and his steadfast opposition to the invasion of Iraq (both in 1991 and 2003). Of course, he got a bit of revenge, when he, in his position as Chair of the (U.S.) House Financial Services Committee, he got to grill both Federal Reserve Chairman Bernanke and Secretary of the Treasury Paulsen, before Congress recessed for the summer.

    But of course, nothing much has changed. And with the price of oil dropping weekly, most Americans figure it is back to fairy-tale land.

  2. Ben says:

    We all know this isn’t a stable economic environment, a currency system based on perpetual expansion is either banking on some rapid expansion in the very short term or mass extinction.

  3. Mike says:

    Thank you for this post, extremely interesting! I will think about oil prices differently from now on…

  4. Not Sure says:

    Are you sure? How do you explain the increase in fuel costs around the world?

  5. Thomas says:

    I wrote about this some months back:

    http://www.lewrockwell.com/olson/olson11.html

    And of course, as the dollar rises, of late, commodities drop.

  6. Jonathan says:

    As always, the people in power go after everything BUT the source of the problem. Willful blindness, some might call it.

  7. Kyler says:

    Thank you Federal reserve, if everyone in this country understood how our monetary policy really operated, how our economy totally depends on the taxpayer being in debt, there would be a revolt against the government.

    The Fed makes money out of thin air, and then charges the taxpayer for it? When the congress has the full authority from the constitution to coin money free of charge! Wake up and demand this to be stopped!

  8. [...] Read the whole article… This entry was posted on Sunday, August 17th, 2008 at 8:03 pm and is filed under le Chat Marchet. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site. [...]

  9. Ed says:

    The value of the dollar not only affects oil but it affects everything we buy. And how is to blame for this? Both the government and the “New” American. Just think about every time the dollar falls an elderly person looses his savings, the honest man looses his ability to purchase what he’s worked so hard to get. On the other hand the Government and its politicians sit at their desks, many of whom haven’t worked a hard day in their life and spend spend spend. What do they spend? They spend the American peoples hard earned money. Oh wait, they don’t have the money, i’m sorry, they print it. And why do they print it you might ask? Well, what if the American people saw how much the government was spending in relation to their taxes. The government would cease to exist within the week. I mentioned above the “New” American. The one that sees a credit card as life support, the one who buys a 600,000 house with nothing down making less then 100,000 a year. The one that actually embraces and isn’t really fluttered by the idea of debt especially long term debt. Nothing in life is free. Everything must be paid for. That includes the debts the American people own. Who pays for it? All the hardworking, honest people who actually are responsible,save and pay for what they can with what they have not with this idea of credit. It all is just a question of how much longer the honest true Americans can take it.

  10. phil says:

    Ummmm, you’re assuming gold has constant value – it doesn’t. I moves just like any other commodity.

    The Euro is more interesting, it shows that yes oil has indeed gone up the falling dollar has made it look worse of course but it’s pretty ridiculous to say that oil hasn’t gone up.

  11. NBK says:

    This is flawed, faulty reasoning. Gold, like oil, goes up in bad economic times; it is a hedge. Accordingly, one cannot compare the price of oil to the price of gold, because gold is not fiat currency. This does show that the price of oil and the price of gold have been correlative in the last few years.

    The proper way to do this analysis:

    -Get the inflation rates since 2001
    -Get the list of oil prices since 2001
    -Using the rates, convert the oil prices into 2001 dollars

    The modest increases in inflation do not keep up with the huge increases in the price of oil. It just doesn’t. And since oil is traded in dollars, the bid spread would not be as vulnerable to currency fluctuations.

  12. [...] we need to shift our focus away from war and drilling; and towards a better economic policy at home.read more | digg [...]

  13. Andrew says:

    Have you stopped to notice that the price of Gold has gone up?

    The Price of oil has gone up, and so has the Gold. Creating the “Illusion” that the price of oil is remaining relatively constant.

  14. Big B says:

    I took a few intro Econ classes a few semesters back; the question of why gold is not currently used to back our dollar came up many times. Each time the answer was simply that there is not enough gold to back our dollars. I’m interested to know if anyone has an answer to this?
    Would gold not also fluctuate, just as every thing else does in economics? When I see the chart comparing the dollar to gold, I see apples and oranges. Of course gold can maintain a constant compared to dollars, gold has very little influences in it’s current state. Gold when introduced to a real much larger market it will fluctuate just as the dollar does.

  15. Mike says:

    Very good chart! One error in the text is worth correcting. The US ended being tied to gold officially in the early 1930′s — not 1971. Nixon allowed Americans to own gold. That has nothing itself to do with backing the dollar with gold.

    On a more controversial subject..

    Gold is hardly a stable measure of buying power. A simple exercise will prove it. Assume that I have something you really really want. Yesterday, when demand was down, I used to sell that something for one pound of gold (let’s call that price 1). Today, you really really want it, so I’ll charge you 2 lbs of gold. You buy it – but your reserves are being depleted at 100% faster — hence 100% inflation.

    Gold as a standard means nothing.

    Also, the “buying power of the dollar” is a totally relative term. Buying what? Buying Gold? Buying Euros? Buying oil? We really really want oil. We would pay more to just get it. That probably accounts for your chart matching the value to oil prices.

    Oil is up because of speculators — by the way: the oil bubble has burst.

  16. JC says:

    Hi,

    while it is true that gold is a good hedge against inflation, your article is poorly researched. if you had actually taken the time to review the numbers, you would see that the oil / gold relationship has been 15 barrels of oil to 1 oz of gold. HOWEVER, since 2001, that ratio of 15:1 has been diminishing. At its height of $148/barrel, the ratio was down to 6:1. Therefore, the price of oil has risen, in real terms, from only a few short years ago. For those of you bad with math, thats over a 200% increase in the value of oil relative to gold.

  17. Jim says:

    Fascinating…. and to think that the politician’s answer to this crisis was to stimulate the economy by printing some money and sending it to us as an “economic stimulus”. They’re even talking about a second round. Sounds like a classic positive feedback mechanism.

  18. Phil says:

    I hope you’re not a professional economist. Your utter misunderstanding of facts is ASTOUNDING.

  19. Stephen says:

    The value of the Canadian dollar has remained stable yet the price in gas has skyrocketed there also! The value of the Canadian dollar relies mainly on the value of its resources exported rather than the value of the U.S. Dollar, thou the U.S. is Canada’s largest exporter.

    Do you find it odd that two weeks ago OPEC cut it’s production of oil yet the price of oil didn’t spike in panic? You are comparing a resource with a resource, one that as I type this is actually dropping in value. The problem isn’t the actual value of a barrel of oil. It’s the perceived value on paper of a barrel of oil. It’s called speculation. The value of oil has rose world wide regardless of the value of the U.S. dollar. If a group of investor speculated that a barrel of oil cost $130.00 on paper, then a supplier like Exxon could say, I am selling at $130.00 a barrel because that is the perceived value. it’s like trading Beenie Babies. The cost has not changed, but to someone the value of the item has!

    Be for warned. As of September Wall street is allowing average investors speculate on commodities. That means Joe Blow will have the ability to guess the value of a barrel of oil!! The media has blown the whistle on the pros, now they are stepping back and letting armatures have a hand.

    I would be less worried about the power of the American dollar on the world market and worry more about the Chineese investment in the U.S.

  20. [...] piece here on the apparent real price of oil. The Real Price of Oil: Dollars, Gold, and the Price of Tea in China The value of oil has not been increasing in real terms, currency has just been decreasing in [...]

  21. völlliger stuss says:

    There is a simple but big mistake: the price of metals like copper or gold *increased* in the same way as oil did.
    You should have taken the GNP to compare the real inflation of goods and money.

  22. Acronyms says:

    Have you even considered the option that both commodities went up? if you want to compare then compare to the set of products rather than to individual commodity (same asset type).

  23. jacky says:

    lolz

    like, put that next to your average basket of groceries a family buys every week and track that on the graph. You’ll be like “OMG, the price of Oil and Gold are the same while EVERYTHING else on the earth has dropped in value, relatively”. Like, wow. Amazing revelation. Gold=hedge against oil price rises. Go back to school :)

  24. Dude says:

    Doesn’t this really mean that the cost of both oil and gold have increased by roughly the same amount?

  25. lawrence says:

    the interesting thing is that the Dollar is really only backed by the US’s rep as a do good nation. It points out the immediate consequences we face when we fail to hold up to our end of the bargain of by being a do good nation and start invading countries.

    http://goldprice.org/james-turk/uploaded_images/Oil-Price-780567.GIF

  26. Vito Rispo says:

    In the Digg comments and in these RideLust comments, there are a good number of people saying that I’m “subversively be supporting the gold standard”, which I am emphatically not. I don’t really like the gold standard and I don’t think it would work.

    I do support getting rid of fiat money and using competing currencies. But I’m not talking about either in this post. I’m just offering up some facts. Interpret them as you like.

  27. ameya says:

    I think your research and your interpretation is seriously flawed. your ‘analysis’ is not worth the bandwidth you are wasting by putting this up. Gold has gone up by leaps and bounds during the last few years, simply coinciding with the same time that oil prices have gone up.

  28. Malcolm says:

    Has anyone considered/realized that gold prices have been BOOMING over the past few years. That does NOT represent everything in the market…

  29. gk says:

    Of course the price of gold has ‘gone up’…. Since the dollar is weaker (worth less), it takes more of them to purchase the same amount of gold. The author points out (and correctly) that the same amount of gold still buys the same amount of oil as it did 7 years ago.
    That the number of pieces of paper printed by a government to purchase an ounce of gold fluctuates does not mean the value of the gold itself is also changing.

  30. JP says:

    The fact that the price of gold has gone up is the crux of the whole argument. Gold inherently has VALUE whereas the US currency does not have inherent value. It take more dollars to buy both gold and oil.

  31. JP says:

    Reply to Dude: QUOTE “Doesn’t this really mean that the cost of both oil and gold have increased by roughly the same amount?”

    That is exactly what it means. It means that the cost of both oil and gold have increased by the amount of the devaluation of the currency. It takes more DOLLARS to buy oil and gold. The actual cost of taking the oil or the gold out of the ground has not gone up…except to the extent that the dollar has gone down.

    I have to say it: Ron Paul has been right about SO many things including this. I am still amazed that the people of this country turned their backs on him.

  32. dai says:

    Stunning!

    It is the evidence of failure of money system.

  33. Neo says:

    People saying that the graph is b.s. obviously can’t read a graph… Usually saying that the price of oil has gone up as well as gold… Well, this still shows in RELATION to the amount of value the Euro and Dollar have changed under the same timeline… Yes, the graph shows that gold has a steady line across, this doesn’t mean they didn’t rise in cost… They both just remained very proportional to each other… The value of the dollar and euro have not… And printing money out of air is a huge problem.. Support auditing/abolishing the fed as well as support economic growth without bailouts as they devalue the dollar in the long run… With all the bailouts lately, wars, unethical spending, it’s going to make us look good in the short run, but the long run will be an even bigger collapse…

  34. Arthur says:

    might I have permission to utilize this image as a part of a presentation on Air pollution

  35. Joe says:

    “What this chart makes obvious is that the value of oil has not been increasing in real terms…”

    Uh, wrong… and a complete failure in terms of logical reasoning.

    Look at some graphs: oil and gold have both shown parabolic increases over the past few years. And yes, the purchasing power of gold has greatly increased.

    Why not compare oil or gold to something that has really been constant? The price of a gallon of milk, a loaf of bread, etc. Do this comparision and your conclusions will be quite different from what you have posted here.

  36. Gold Price says:

    Would you happen to have an updated chart you could post on this article as well? I would love to see the movement for gold and silver if possible.

  37. Gold24 says:

    Impressive!It is the evidence of failure of economic system.