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As oil prices drop, Fed should get credit

Since the Panic of 2008, the Fed's easy-money policy has been blamed for a global surge in oil and other commodity prices. With oil prices are falling, it’s time to give the Fed some credit.

Since the financial Panic of 2008, the Federal Reserve’s easy-money policy has been widely blamed for a global run-up in commodity prices — especially oil. Now that oil prices appear to have peaked and are coming back down, it’s time to give the Fed some credit.

After flooding the financial system with cash for more than two years in an effort to stabilize  financial markets and economy, the Fed is getting ready to turn off the taps. The anticipation is one reason oil prices are coming back down, according to oil market watchers like Peter Beutel, president of Cameron Hanover.

“The major factor in this market — through riots in the Middle East, floods along the Mississippi, the lack of new offshore drilling or a national energy plan, slow employment gains and a housing market in the dumps, through gains in gasoline stocks or declines in consumption — is the U.S. dollar,” he said. “And that is determined by actions taken by the Fed.”

For all of the complex forces acting on the global oil market, the dollar has a powerful sway for the very simple reason that oil is priced in dollars. With the Fed signaling it plans to shut down its virtual printing presses, the dollar has begun showing signs of strength. Just as a weaker dollar helped send oil prices surging, a stronger dollar is reining them in.

The Fed can’t take all the credit for the strengthening dollar. The U.S. currency is also getting a lift from renewed worries about the threat of default by Greece and other Eurozone countries, for example.

But there has been no doubt about the drop in the price of crude – which crashed by more than $20 last week to under $100 a barrel — including a stunning loss of $12 in a single session. That kind of drop hadn’t seen since 2008. Prices continued to slide this week amid daily price gyrations of up to 8.5 percent.

The dollar, meanwhile, is up 3 percent so far this month after sliding 15 percent against other currencies over the past year.

The oil market has had plenty of news to trade on during the run-up in the last three months. Widespread unrest in the Middle East — including the ongoing shooting war in Libya — got plenty of attention from traders. The gradual recovery of the global economy also has helped boost oil prices.

But it has been hard to find headlines that could account for the historic volatility that has gripped the market over the past two weeks. The death of Osama Bin Laden, while a major victory in the war against terror, could hardly be considered a significant development for global oil production.

Like many historic market moves, the latest sell-off seems to have been prompted by a new mindset gradually taking hold among oil traders.

Simply put: The forces that drove prices higher seem to have reversed course. Global growth seems to be slowing. The dollar is strengthening. And the inflation threat from the Fed's easy-money policies may be easing.

Despite fears the unrest in the Middle East could crimp the flow of oil, it’s hard to blame tight supplies for the price surge that took hold earlier this year. U.S. crude oil stocks have ranged well about average and domestic production has been rising slowly for the past several  years.

Help from abroad
The Fed isn’t the only central bank backing away from a easy money policy. Inflation fears in Europe prompted the European Central Bank to raise interest rates last month. Policymakers there have made clear they expect more rate hikes are coming.

Developing countries are also stepping on the monetary brakes. This week China boosted the amount of money banks have to hold in their vaults as the central government tries to keep a lid on inflation and tighten the supply of cash in the Chinese economy.

“Inflation is the real worry,” Mark Mobius, chairman of Templeton Emerging Markets Group, told CNBC. “A lot of these emerging countries are taking measures (to contain it.) Around the world, they’re raising interest rates. But I think this is a temporary phenomenon, frankly."

The slide in oil prices could also be temporary. Tensions remain high in many Middle East countries that export oil. Saudi Arabia, as the only major producer with spare production capacity, has promised to keep the global market well-supplied; any restriction of output could tighten global oil stocks. Global economic growth could pick up speed, intensifying demand. And Congress and the White House could stumble in reaching an agreement to raise the debt ceiling, sending the dollar plunging.

One thing is fairly certain, though. Until the outlook for oil prices becomes clearer, expect more daily price swings that will send even the most seasoned traders looking for cover.