THE SKEPTIC: The Fluid Dynamics Of Oil & Interest

Wednesday March 26, 12:37 AM By Erik T. Burns A DOW JONES NEWSWIRES COLUMN

LISBON (Dow Jones)--Central bankers would do well to pay special attention to the fancy footwork and rhetorical twists of OPEC ministers, and not just because of fears a war-driven oil price could choke growth in Western economies.

No, the current OPEC shuffle illustrates something different: how to deal with two opposing messages under extraordinary pressure.

OPEC's problem is very like what faces the major central banks: a whopping surplus of supply, but a market that's scared of scarcity and begging for more.

With OPEC, the group repeatedly pledges to deliver as much crude oil as necessary to cool prices, while the market bids up nearby oil futures to near-record levels. At the same time, OPEC is worried about prices crashing, because of traditionally weak demand in the second quarter, and because the countries are pumping near capacity, sloshing more oil into the market than real demand merits.

It's an unusual situation - the Iraq war, the turmoil in Venezuela, and the growing unrest in Nigeria all present real threats to supply - but also one that's short-lived, not structural. When uncertainty fades, the premium will disappear, and quickly, as with the near 30% drop in crude prices as Operation Iraqi Freedom took wing.

Then OPEC will race to cut production - a much harder task for the group renowned for talking a collective game but acting individually, pumping as much as possible in order to garner market share.

Central banks, funnily enough, face the same slippery dilemma, though perhaps on a more metaphysical level.

Interest rates in the U.S., Japan and Europe are near historic lows, meaning it's cheaper than ever to print money by taking out loans or selling bonds. Indeed, monetarist Europe, stuck with the Bundesbank legacy, has staunchly ignored blistering growth in M3 money supply - it's up 7.4% in January, far above the ECB's 4.5% reference rate.

Meanwhile, M3 in the U.S., where there's less obsessing over the figure, is also on the rise.

The problem? Companies and individuals aren't taking the bait - they aren't snapping up that loose money and converting it into capital investment or goods and services. This may reflect a general lack of confidence, or it may reflect the hangover of the stock market bubble, with folks loathe to get fooled again.

It could, however, also reflect the notion - so patent during the dotcom boom - that investors are waiting for a final Fed or ECB move before resuming the investment cycle.

At this point, that's ridiculous. Another quarter point or half point off rates will make little difference. Even the psychological effects are nearly zero. The ratesetters' ammunition is all but depleted - they could probably boost confidence more by making it crystal clear no more cuts are in the offing.

And just as at OPEC, there's trouble looming. All the world needs is a catalyst and all that liquidity sloshing around the financial system will suddenly be tapped.

Pundits politely call this "reflation," which is just dandy if the result is an orderly resumption of growth. But just as oil prices could easily crash, so could consumer prices soar toward danger levels, if the money in the system is suddenly and forcefully channeled into the real market.

And the two effects together - cheap oil and cheap money - could kick off a new round of global growth ... but not without threatening a new round of global overheating.

That means central banks should take a tip from OPEC and pay attention to the huge reservoirs of liquidity they've built up to fend off fears of an emergency. The dam could burst quickly, letting the oil - or the money - flood the plains.

-By Erik T. Burns, Dow Jones Newswires; (351-21) 319-1863; erik.burns@dowjones.com