Is the prescription for high oil prices caused by loose monetary policy increased oil supply?  That seems to be the conclusion of the Obama Administration and others, as the International Energy Agency approved the release of oil from several of its members’ stockpiles, from Bloomberg:

The IEA announced the release of 2 million barrels a day for 30 days yesterday to make up for supplies choked off by an armed rebellion in Libya. The U.S. Strategic Petroleum Reserve will provide 30 million barrels, European members will supply about 20 million and Asian nations the remainder.

The problem is that oil is not in short supply.  Oil is in a glut, with US inventories at their highest point in over a decade, with US demand declining, and world demand slowing in its growth.  Even China’s demand has slowed its rate of increase. 

Inflation, i.e., a cheapening of the currency that pushes prices higher, always tends to cause oversupply.  As higher prices caused by inflation (as always, a monetary phenomenon) work through supply and demand metrics, they temporarily create an illusion of expanding demand (if prices go up, ceteris paribus, demand must have expanded, or so the market is fooled into thinking).  This at first actually creates more demand by compelling purchasers to buy now what they think they will only need later.  Thus ultimately creates an oversupplied market, which eventually results in a collapse in demand and prices. 

Thus additional supply to the oil markets will only accelerate the coming of the day when it is finally realized that markets have been egregiously oversupplied, and prices collapse.  This may seem to accomplish what the politicians wish, but collapsing oil prices perhaps won’t be as benign as they believe.  Collapsing oil prices will instead bleed into every sector of the economy, causing the general decline in prices that every central banker economist has nightmares over.

Market economies allow supply and demand metrics to determine prices and allocate resources.  It is clear through the interventions of their central banks, that the developed world abhors allowing markets to set prices.  Now the politicians have entered the fray, trying to manipulate specifically the price of one of many commodities traded internationally.  There have only been two other times when the reserves were tapped–during the first Gulf War and after Hurricane Katrina.  If nothing else this release proves the precarious situation of the developed-world’s economies, while illustrating the myopia of its leaders.

As always, the markets will do as they wish.  The bottom-line reality for the developed world is stagnating demand that no amount of monetary mischief can ameliorate.  Prices wish to decline and ultimately will.  This policy of adding to an already oversupplied market will do nothing but shorten the amount of time it takes for markets to shake off the effects of loose monetary policies intended to inflate them.

 

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