Harry Truman once said, "Give me a one-handed economist! All my economists say, On the one hand ... on the other hand."

So ... where are we?

The China issue is pretty straightforward. The Chinese have been promising 'clear, smog free skies' for the Olympics for several years. They finally had to bite the bullet and shut down factories and get cars and smoky diesel trucks off the road. This will end as soon as the Olympics are done and the international pussycats (the news media) are gone.

In China, retail prices for liquid fuels is set by the government. Sinopec must buy expensive crude, refine it and resell the products at prices that are below cost. The government pays Sinopec and other refiners a rebate but this is not particularly profitable and is untenable when prices are skyrocketing. There have been shortages of gas and diesel in China .... that are unrelated to the Olympics. They relate to the low prices fixed by the government.

I don't THINK the Chinese have been that active in the futures market, preferring to buy in the spot market. Why? The Chinese have an aversion to complex markets. Markets have been unfriendly to the Chinese, see the Shanghai stock market. The Chinese bankers are still smarting over their 'investments' in Wall Street Banks. The Chinese tend to view international markets - that don't play by Chinese government 'rules' - as being hostile the China. They are right, of course. I believe one reason the Chinese have accumulated such a large stake in US currency and US denominated debt, and have pegged their currency through thick and thin to the dollar, is because of a fundamental Chinese fear of US currency speculators. Their fear is understandible; the speculators beginning with George Soros and his raid on the Bank of England in 1992 can wipe out governments' currency reserves! Currency pirates have raided the cash reserves of Mexico (twice), Russia, Thailand, Indonesia, S. Korea, Argentina, and Brazil. China rather would just pay cash and walk away with the product, thank you ...

Now ... price of crude in what context. There is fundamental disagreement about the current state of affairs in both the US and Eurozone economies: inflation or deflation. First, some definitions. Inflation is an increase in the amount of a currency and CREDIT in relation to the goods available for purchase. Deflation is the opposite, a decrease in the amount of currency and credit available.

This is important, because in the context of deflation, the decline of ten or twenty percent or more ... in the (nominal) price of any commodity say oil may represent a contextual increase; that is, the relation between the value of the currency and the commodity has the commodity increasing in value. In other words, if the dollar was to decline in value to one tenth of today's value (in a short period of time) yet the crude price averaged $114 a barrel, obviously crude would be a (nominal) drop- dead bargain.

There are compelling arguments to be made on both sides of the inflation/deflation topic. Doug Noland is very articulate in supporting the inflation scenario:

http://www.prudentbear.com/index.php/commentary/creditbubblebulletin?art...

Inflation is simple: the prices keep going up! Jean-Claude Trichet and several Federal Reserve governors agree, that we are facing incipient inflation.

On the other hand, there is an even more convincing argument to be made for deflation:

http://globaleconomicanalysis.blogspot.com/2008/04/deflation-in-fiat-reg...

The biggest factor is the shrinkage of available credit ... worldwide! While ALL the central banks are pumping currency into the world economic system in order to keep the 'growth machine' going, little of that credit is reaching the parts of the economies where productive activities take place. In the US, that area is in mortgages and real estate, ditto parts of Europe; demand for manufactured goods from Japan is declining; both long bond rates (US 30yr Treasury, mortgage and Investment grade securities) and short (LIBOR) are rising, which means credit is hard and harder to get. Another factor is declining employment. The unemployed cannot demand wage increases nor can they afford gasoline - at any price.

In a deflationary regime, 'things' (like oil) will become 'cheaper' when priced in a currency, but will actually become more expensive as that curreny becomes harder and harder to get. I believe this will become more apparent beginning next year as more banks fail and the cumulative effects of that and the failure of the 'bailouts' to trickle down and really increase production and earning. In the US, one more big bailout will be the end of US government stimulus ... party is then over. (US hasn't really spent any money on Freddie or Fannie ... yet. It's just talked about it.)

>>>>>>>

An upshot in oil; the US and the West MUST coordinate on interest rates and credit. OPEC and the other producers are absolutely dependent on the consuming world for money and credit, without money, Saudi Arabia, Russia, Venezuela, Nigeria, Kuwait, Iran ... are paupers! The hardest thing to find in any business is a CUSTOMER. These countries have no economies or production to speak of ... other than pumping and selling oil. They cannot even grow sufficient food ... or any food ... in then case of Saudi Arabia and Kuwait!

If the US was smart and tough and didn't have a president who was a tough- talking wimp, they would repay all of the outstanding dollar denominated debt in foreign hands ($5 trillion or so) with dollars. The Treasury would print as many dollars needed to repay ALL the out-of-the-country debt. (the foreign holders would have no choice to take this deal, this or nothing). The US could then eliminate the dollar and make a new currecy - The Obama - that would not trade overseas (just like the Chinese Renmimbi). Sorry Saudi Arabia, the oil party is over!

We could trade the Saudis one shipload of food for a shipload of oil. Five shiploads of food for fifty shiploads of oil - or any number of our choosing. We have enough oil (as do the Brits and the rest of Europe) to withstand our side of a credit embargo. I guarantee you Saudi Arabia cannot go a year without food or the dollars to buy it! Europe could do the same thing and not even bother with inventing a 'new Euro'. Since 'Euro' is a meaningless currency (which country backs it, exactly?) and China would never risk trading its own currency .. the producers would have little to trade oil for. Mexican Peso? Rupee? South African Rand? Yen? Gimme a break. The Yen is even more worthless than the Peso. If credit is closely held to the 'consuming' countries ... well, what exactly is being consumed? Anyway? Money - real, valuable money - is just as scarce as oil is becoming.

... none of this would never happen, it's a fantasy. The western economies will go into a severe credit deflation beginning next year and the bosses will wring their hands. Oil prices will decline in nominal terms but the relative price will continue to increase.

Rambling over ... (Edited for spelling and grammar.)