NEW YORK (TheStreet) -- Easy money policies of the Federal Reserve create asset bubbles, including the crude oil bubble which inflated from $49.90 in January 2007 to the all-time intraday high at $147.27 in July 2008.
The Federal Reserve first cut the federal funds rate in October 2007 which helped fuel this Fed-induced bubble as speculators and money managers forced oil prices higher on investment demand, not consumer demand.
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Part of the inflating bubble was caused by "fake demand" from money managers who increased their allocation to the commodity asset class.
Many commodity investment contracts are benchmarked to the iShares S&P GSCI Commodity-Indexed Trust ETF (GSG) , which is more than 70% weighted in crude oil. Increasing investments in commodities thus helped inflate the crude oil bubble, then when investors sold these contracts the crude oil bubble quickly popped.
Without Fed-induced overly easy monetary policy and without speculative buying the price of crude oil may have stayed below $50 per barrel with gasoline at $1.50 per gallon which may have prevented the steepness of the Great Recession. Let the economic forces of supply and demand rule by avoiding the monetary fuel for speculation.
When institutional money managers want to increase allocations to the "third asset class," commodities, they do so through investing in a commodity contract structured by an investment firm such as Goldman Sachs (GS) . One option is to have an investment contract match a commodity index, and the most popular is the GSCI. The investment firm takes in the cash value of the investment, then trades the contract according to Wall Street rules as a speculator on margin.
Demand from commodity investors is not real demand that actually uses products made from crude oil and thus artificially inflates the price of crude oil. This was the case between January 2007 and July 2008, as it was clearly not caused by consumer demand at the gasoline pump.
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