Are Lower Oil Prices Leading to Recession?

About a month ago Don Luskin, CIO at Trend Macrolytics LLC, wrote an op-ed in the Wall Street Journal claiming the U.S. is in recession due to falling oil prices.

According to Luskin,

"The drop is entirely the result of America’s supply-side technology breakthrough with horizontal drilling and hydraulic fracturing—“fracking.” 

This is a common view among the usual crowd of investors (including energy analysts and strategists), market pundits, and economists.

There is no denying that improvements in hydraulic fracturing technology have led to impressive increases in oil-well productivity in the various shale oil basins throughout the U.S. And the decline in oil prices is beginning to have an adverse impact on the industry as companies begin to slash capital spending and lay off workers. On the margin, supply and demand dynamics has some influence of course. But step back and think, has global supply and demand shifted so drastically over the past year or so to account for such a massive drop in crude oil? Or for that matter, so many other raw commodity prices.

What Luskin and many others miss is that the strength of the U.S. dollar is the reason for the decline of global oil prices (and the general decline in commodities overall as measured by the CRB Index). Neglect of the dollar by the Administration under clueless U.S. Treasury Secretary Jack Lew and secondarily by a hapless Federal Reserve Board is why it is wreaking such havoc in markets across the globe.

Crude oil is priced globally in U.S. dollars. As those dollars appreciate in value, the best market indicator being the price of gold, it takes fewer dollars to purchase a barrel of oil. Recall, oil rose to >$100 per barrel back in 2011 as the dollar was plummeting in value (gold having peaked at just under $2,000/oz.). It didn't rise to this level because there was a global shortage of oil or because demand suddenly rose sharply. The weak dollar was driving a global commodities boom.

If oil remains below $50 per barrel for an extended period of time, there will be more pain to come in terms of layoffs and capital spending cuts in extraction-related industries. Commodity-dependent emerging market nations will also suffer from additional painful adjustments. The market must cleanse itself of malinvestment wrought by "money illusion."

If recession does come to the U.S., it will be due to this process and it will be a good thing.

Why? Because a reorientation of investment capital away from energy extraction in the U.S. and towards "first order goods" that John Tamny describes in a recent column will eventually redound to the benefit of our economic well-being. Extracting raw commodities from the earth is not particularly profitable and can be done by countries far less advanced than ours. Our comparative advantage lies elsewhere in technology and health care, for example.

What the U.S. (and world) economy desperately needs is a stable dollar that is defined as fixed weight of gold. Fiat currency schemes simple don't work. The damage floating currency values do the economy by disrupting vital market price signals is being abundantly demonstrated before our eyes today.