Keith Fitz-Gerald

   

The $700 billion banking bailout package proposed by this "Dynamic Duo" directly impacts the flagging U.S. dollar. And the dollar, for reasons we've just explained, helps determine oil prices.

There are exceptions, of course, but the relationship between currencies and oil prices generally suggests that 90% or more of the decline in price that crude oil has experienced since mid-summer can be accounted for simply by how much the dollar has risen since July.

But here's the trick -- the reverse is also true.

We mentioned inflationary pressures before. Well, if Congress actually passes the bailout plan, another $700 billion would be pumped into the world financial system. And that would mean far higher prices are ahead. We're talking Econ 101 here: Every one of the bailout bucks dilutes the buying power of every other dollar already in circulation. That erosion in buying power is the textbook definition of inflation.

In fact, that's just how it played out this week. When the bailout plan was rejected Monday, meaning those bailout bucks wouldn't be joining the financial system, oil prices fell precipitously, since there would be no additional inflationary pressures. But when investors started to rethink that thesis Tuesday -- meaning they believed some sort of new bargain would be reached -- oil prices reversed course and rose in anticipation of that money possibly being pumped into the financial system.

While a bailout could jump-start the financial markets for a while, history suggests that over time the "cost" of the liquidity Bernanke and Paulson have cobbled together may manifest itself in the form of far higher oil prices. Other commodities would rise significantly, too. Investors have only started to see this outcome.

So, what happened back on that Monday, Sept. 22, when oil prices made that record one-day run?

My experience as a professional trader makes me think that somebody simply got trapped on the wrong side of the markets and was trying to cover a humongous position at any cost.

And what I saw on my screens seems to confirm that. It was a late-session spike at a time when traders either had to get in line for delivery or unwind their positions before the October crude futures contracts expired. With a mere 30 minutes remaining, there were no sellers to balance prices, while the market makers who normally would provide a modicum of orderly behavior were nowhere to be found amidst the chaos.

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