The indirect consequence of the oil-price rise and the dollar-value drop is the largest increase in commodity prices since 1973. Commodities finished their best first-half year in 35 years. And what is unique about 1973?

On October 17, 1973, Arab nations, including the Opec members, suspended all shipments of oil to countries perceived as supporters of Israel during the ongoing Yom Kippur War. The United States, as well as Western European nations and Japan, saw their fuel supply cut. Further, wellhead prices were raised in concert with the oil embargo.

Gold doubled in price from January 1973 to 1974. The price of soybeans, wheat and corn also rose by at least 100 percent, closely tracking the price of crude oil. The US dollar lost more than 15 percent of its value and the New York stock exchange fell 25 percent during that period.

But this is not 1973. Unlike then, consumption, particularly consumption by consumers, is falling quickly in response to rising prices. The basic economic law that people don’t pay for what they can’t pay is rapidly coming to play.

Total petroleum-product use in the United States is falling by at least 2 percent over 2007. Jet-fuel consumption is down nearly 4 percent. Gasoline is down 2.1 percent in the last month. Year-on-year gross imports to the United States are down 2.7 percent. This sort of drop in demand will soon be reflected in falling prices.

The fall in consumption is not limited only to oil. It is happening around the world in other commodities. India is the largest gold buyer in the world. Yet, Indian gold purchases plunged 50 percent from a year earlier. The prices of metals like copper have gone up dramatically, in part because of sales to China. Here again, consumption is dropping. On June 10 China reported that imports of copper fell 19 percent in May to the lowest level since August 2007.

In addition to falling consumption, suppliers are increasing production from wheat in the United States to steel in China. Globally, wheat farmers will boost production by 8.2 percent in the next 12 months in light of the fact that wheat jumped to its highest price ever in February. And oil consumption is an even more interesting situation, looking globally.

Many governments around the world subsidize fuel prices. With the yearlong run-up in prices, these governments have reduced or eliminated these subsidies. During the last 12 moths, oil speculators believed governments would continue to subsidize prices, thereby keeping demand constant. But now, prices have gone over the edge. Continuing subsidies in India would create a 9-percent current-account deficit. India’s rupee is already one of the worst-performing currencies in the world. Inflation is at more than a three-year high. Countries like India and China are boxed in between rising inflation and falling volume of their exports.

As the government fuel-price subsidies disappear, and they will, crude-oil demand will drop. Economics 101.

Oil watchers look at two waves to gauge US crude-oil consumption. Gasoline usage goes up in summer as people drive to take vacations. Already, travel plans are down. The big summer holiday, the July 4th Independence Day weekend, is a very good barometer of gasoline consumption. Americans plan to travel much less this upcoming weekend. Driving their cars and traveling by airplane is projected to be down by 1.5 percent to 2 percent. But it may be much less than that as the distance traveled could fall by as much as 5 percent.

The second high fuel-usage period is during the winter months. Individual Americans spend thousands of dollars to heat up their homes during the colder winter months. Shifting to other heat sources, electric and wood-burning stoves, for example, will further reduce oil demand.

What we are facing is a giant, vicious circle. Increased demand forces prices higher for oil. Then investors buy oil while selling their New York stocks. A shift from dollar-denominated domestic shares to offshore investments causes dollar selling. The dollar selling forces the dollar-based oil prices to go higher.

As the dollar is dropping, investors look to other nondollar vehicles. Commodities like wheat may be priced in dollars in the United States, but not elsewhere. Investors then buy wheat and other commodities like copper. Copper trades in British pounds sterling on the London Metals Exchange. Investors not only gain from a weaker dollar but also from increased demand for copper.

Ultimately, though, end-user demand is the driving force for prices. Prices go too high, demand drops. We watched the “winding up” over the last year. Now, we will see the “unwinding” of the same process. The unraveling begins slowly and then will accelerate.

Already, the “big-money boys” are lightening their investments in these high-flying vehicles. From Bloomberg: “Second-quarter [2008] net inflows into European exchange-traded products linked to commodities fell about 58 percent from the previous quarter, Barclays Capital said.”

“Future” oil prices have been pulling “spot” or cash prices higher. If oil for delivery six months from today is $20 more than the spot price today, oil dealers will raise prices, saying to customers, “Look, prices will be higher tomorrow so don’t complain about the price today.”

Now, the difference between the “future” price and the “spot” price is narrowing, indicating that the momentum is changing, and soon, the “spot” price will move the “future” price and that direction will be down. 

E-mail comments to mangun@email.com.

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