Alex. Brown

Economic Monitor – Weekly Commentary
by Eugenio Alemán

Real money supply and the real price of petroleum, examined

May 19, 2023

The phrase “The dogs are barking Sancho, a sign that we are moving forward!” is used in Spanish to convey that if there is a lot of noise, it is because what we are doing is effective, and someone probably is not liking it.1 The phrase is well-known but is incorrectly attributed to the famous fictional character from the novel, Don Quixote de la Mancha, written by Miguel de Cervantes Saavedra.

At this point, you may ask, correctly, what does this have to do with economics or the economy? We ask that you continue to follow our argument as our line of thought is going to become clear in the next several paragraphs.

Over the last year or so, there has been a barrage of commentaries and stories going around the internet on economic topics like the U.S. dollar’s impending demise or issues on the U.S. creating a central bank digital currency, etc., that are clearly conveying that something is happening, that is: “The dogs are barking Sancho, a sign that we are moving forward!”

We have already written about what we think about the ‘impending’ demise of the U.S. dollar. However, today, we thought we should write about money supply and the price of petroleum, but more specifically, about real money supply and the real price of petroleum, that is, adjusted for inflation. We are not going to write about what we think the price of petroleum is going to be, we leave that to the experts on this topic. What we are going to write about is what happens to the price of petroleum, ‘normally,’ when monetary authorities decide it is time to shrink the money supply. 2

The reason for this is that we think that all of this noise is probably the consequence of current monetary policy in the U.S. as well as across the global economy. We think it is not a coincidence that the stories about the U.S. dollar’s demise involve some of the countries that have the most to lose if the price of petroleum declines – Saudi Arabia and Russia.

1 This is our translation of the original Spanish phrase “Ladran, Sancho, Señal que ”

2 We say ‘normally’ here because it is not always the case. One of us learnt early in our professional career as an economist that it is very difficult, if not impossible, to forecast oil prices because the price of oil is not only determined by market forces but also by the whims of the OPEC and OPEC+

In the graph on the previous page, we have plotted the real price of West Texas Intermediate (WTI) petroleum as well as real M2, real money supply. Although it is fairly difficult to see the relationship between these two variables, it is somewhat clear that when real money supply is relatively constant or even declining, the price of petroleum remains low and/or comes down. The correlation between these two variables is 0.74 between December of 1960 and March of 2023. This is a very high correlation. Although correlation does not mean causation, the very high correlation makes us think that these variables are related.

Furthermore, we also calculated the 12-month moving average rate of growth of real M2 and real WTI and we also plotted that relationship on the graph above. We also calculated the correlation of the rate of change between real M2 and real WTI and we get a negative correlation of 0.41, which is also a very high correlation for a rate of change between variables. This means that, in general, a period of growth in the supply of real M2 is followed by a period of growth in the real price of petroleum, WTI. Conversely, a period of decline in the rate of growth of real M2 is followed by a period of decline in the real price of oil.

The trouble with cutting petroleum production today

The OPEC+ cartel has announced several petroleum production cuts over the last year or so. However, the price of petroleum, after a temporary upward spike following the announcement of such cuts in production, has tended to go down rather than up. So, the question is, why is it that with lower oil production, the OPEC+ cartel is having trouble increasing the price of petroleum. Once again, we are not experts on forecasting the price of petroleum, but we believe that there are, at least, two potential reasons for this.

First, there have been reports that the sanctions imposed on Russia after its invasion of Ukraine have made Russia sell its petroleum at a discount, and China and India are taking advantage of this situation and are buying directly from Russia at a lower price. This, of course, is putting downward pressure on the price of oil. Second, we believe that the slowdown in the growth rate of real money supply in the U.S. as well as in the rest of the world, is helping to put downward pressure on the real price of oil as well. This follows from the analysis we showed in the previous section.


Our conclusion is that the increased noise we have seen surrounding the US dollar, the stories of the end of the petrodollar, the stories that Saudi Arabia, Brazil, Russia, and other countries are transacting in Russian rubles, or Chinese yuan (renminbi), etc., are probably just the consequence of increased noise due to the impending difficulty of keeping the price of petroleum high.

That is, as we argued in our dollar piece several months ago, that there is nothing there, there… today, we will say as Don Quixote would: “The dogs are barking Sancho, a Sign that we are moving forward!”

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