The oil-gold nexus

Crude oil has a unique status in global energy markets and underpins global economic activity. Since the 1970s, it has taken on a role as a quasi-monetary commodity. By the end of World War II, the US held around 70 percent of global gold reserves. The US supplied 6 billion out of the 7 billion barrels of oil consumed by the Allies for the period of World War II. Japan and Germany’s deficiency in oil were key factors in the Allied victories.

The Bretton Woods agreement of 1944 shifted the dominant trading currency from the pound sterling to the US dollar, fixed national currencies to the US dollar, and converted the dollar to a fixed amount of gold. The collapse of Bretton Woods in 1971 occurred at the same time as US hegemony in oil production passed its peak. By 1973, when the US was dependent on imported crude, it became impractical to regulate the price of oil and local price regulation of oil ended. This marked the beginning of the modern era of oil markets.

In Australia, the local oil price was regulated, which led to a sharp disparity when the world price rose in 1973. In 1975, the Federal Government introduced a levy on domestic production, and in 1977 introduced a phased introduction to import parity pricing.

Since the 1970s, oil and gold prices have tracked remarkably closely. One explanation is that in the absence of a metallic monetary base, oil has taken on a role as the base for a quasi-monetary commodity (Sager 2016). In recent years, both oil and gold seem to have been driven by factors other than simply supply-demand relationships. Oil and gold can also act as safe havens during extreme declines in other asset classes, such as equities and bonds. The departure from the relationship since late 2014 suggests that the current low oil price should be seen as an deviation from the long-run trend, and that a price of in the range $60 to $80 would better reflect fundamentals.


Oil and gold price in current USD. Source: St Louis Federal Reserve

In the US, high and rising oil prices often precede US recessions and there seems to be a threshold for expenditures, above which the US economy tends to be in a recession (grey shaded areas in graph). At $45/barrel, oil makes up around 2% of global GDP, but its role in the macroeconomy is much greater than its factor share would suggest.

None of the other energy sources or natural resources seem to have this intimate role with the monetary base. Wood and coal are solids and shipped by bulk transport, and require materials handling at each stage. Combustion produces a solid waste that must be disposed of. At standard pressure, natural gas is only tradable within fixed pipeline networks, but can be shipped as a highly pressurized liquid, at a cost. Both coal and gas can be upgraded via Fischer–Tropsch to substitute for petroleum, although the upgrade carries a significant net-energy penalty. Electricity has the highest utility (i.e. is easily convertible to heat, light or motion) but requires connection to a grid operating in a real-time supply-demand balance.

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