Oil Prices Fall as Economy Falters

US consumers may be celebrating the recent fall of gas prices, but a number of disturbing fundamentals lie behind this seemingly positive development .

If we examine the underlying causes for the recent fall of oil from about $150 to under $70 a barrel, we will find some unsettling surprises.

First, we must understand that price is determined by the balance between supply and demand.
About a year ago, demand for oil exceeded supply for a number of reasons. First, the OPEC nations were limiting production to maintain high prices.

Second, a large amount of American capital was being invested in speculation on the continued rise of oil.
Investors were buying up ever more oil in the belief that its value would continue to appreciate.
This created bubble conditions in which the price escalated beyond an appropriate level, only to collapse at the first sign of trouble.

Third, US consumers were spending borrowed money freely, buying expensive gas and oil along with the large homes and vehicles that consume them. Once the US credit market tightened, the outlook was for consumer demand for oil to drop radically in the coming years.

All of this points to a disturbing conclusion: although the low price of oil may be convenient for the consumer in the short term, it reveals deep failings in the economy. Speculative investors have sustained massive losses on oil, and several hedge funds have lost all of their capital in this venture alone.

Consumers are curtailing their consumption of oil so abruptly that even substantial production cuts by OPEC cannot keep pace.

When investors are sustaining losses and consumers are unwilling or unable to spend, we are on the threshold of a major recession, if not a depression.

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