The article below originally appeared in the January 15, 2006 edition of the Casey Energy Speculator, a monthly newsletter, written by best seller and renowned investor Doug Casey, which focuses on junior exploration energy stocks with the very real potential for 100% or better growth within 12 months. To learn more about a risk-free trial subscription, click here.

Is the Declining Dollar Causing High Oil Prices?

All kinds of theories have been floated over the past few years to explain the rapidly rising price of oil. But few analysts have noted that expensive crude might not be a function of supply and demand, but rather a simple function of inflation.

Since the younger Bush took office, the U.S. has been frantically printing money to stave off recession and keep the bloated American economy from collapsing. Fiat dollars have made their way around the world and now constitute the major foreign currency holdings of most countries. Central banks in China and Japan hold an estimated combined total of $1.3 trillion. With the modern equivalent of printing presses going flat-out, the world supply of money has almost doubled since 2000, from less than $2.5 trillion to just below $4.5 trillion.

Interestingly, as money supplies have increased, so too have oil prices. While there are certainly other factors at work, it is hard to ignore the correlation between the doubling of the money supply and the rise in crude.

Money Growth over IP and Oil Price moved together

Is it just coincidence, or could soaring energy prices be more a function of Alan Greenspan’s whims than of Saudi Arabia’s geology? The increase in oil has indeed come at a time when prices for almost everything else have headed skyward. Houses, copper, Starbucks coffee… you name it, and chances are it’s a lot more expensive than it was five years ago. (The exception is Wal-Mart consumer goods, which have become ridiculously cheap because of pennies-an-hour Chinese labor… itself a symptom of the over-inflated dollar.)

All of which suggests that inflation may be a much larger factor in the current crude price than most investors realize. Reports in mid-2005 from the Shanghai Securities News, in fact, suggested that China was already “exploring ways to use some of its huge foreign exchange reserves to buy imported oil.”

Given that the U.S. shows no sign of curbing the torrent of new bucks flooding the market, we expect the money supply to keep exerting upward pressure on oil. In fact, the rise may accelerate as the American fiscal situation deteriorates further. Just this month, Nobel Prize winning economist Joseph Stiglitz and Linda Blimes of Harvard forecast that the war in Iraq will ultimately cost the U.S. upwards of $2 trillion… an almost unimaginably large overrun from the $50 billion cost of war previously estimated by the administration. A lot of new money will be needed to pay debts like these, as well as to pay for cleaning up the Biblical level of hurricane damage to the Gulf Coast — meaning there will ultimately be more a lot more money chasing the same amount of oil.

The other implication is that real supply-and-demand problems may not yet be fully priced into the oil market, even with crude at $65. In fact, the ratio of the oil price to world money supply currently sits near its historical average (represented by the green line). That is, crude is not overly expensive, given the amount of money in the world.

Crude Price is not High Compared to Money Growth

Contrast this with the 1970s, when a major supply disruption-the Arab oil embargo-caused the crude-to-money ratio to spike to more than double where it sits today. If the ratio were to return to historic highs-due to a disturbance such as a war with Iran-the oil price would be sitting well north of $100 a barrel.

While much of what is currently driving investment into the resource sector is, frankly, bad news for the broad economy, there is nothing you and I can personally do to stave off the bad news. It’s coming whether we like it or not.

Therefore, the only intelligent thing to do is to rig for stormy weather by laying in a portfolio full of high quality precious metals and energy stocks.

Doing it now, ahead of the masses, could very well result in life-changing profits. Don’t miss out, subscribe to the Casey Energy Speculator now.