Goldman Sachs Group Inc. (GS) already is on record for $200-a-barrel oil. As you all know, our own Keith Fitz-Gerald – Money Morning’s investment director – has projected a crude-oil price of $225 a barrel. Do I hear $250? What about $5 a gallon gasoline by July 4th?

Sometimes, these daily price gyrations take on lives of their own, but at the end of the day, the basic laws of supply and demand always work themselves out.

The upcoming week’s hectic economic calendar could go a long way to clarifying the “Are we in a recession, yet?” discussion. Crucial news from manufacturing and labor highlight the week and any renewed strength in these sectors could put an end to the “R” talk for the time being (or until next week). In fact, the National Association of Business Economic forecast 0.4% economic growth for the 2nd quarter and a much stronger 2.2% gross domestic product (GDP) pickup in the 3rd quarter as the U.S. Federal Reserve and those tax rebates begin to work their ways through the system. Suddenly, economists are projecting a rebound and cries of recession have become somewhat muted (and replaced by cries of inflation).

Market Matters

Now that Memorial day has come and gone, investors seem to be monitoring the daily energy trades even more closely than usual (if that is possible) for signs that prices have peaked and Americans will be able to afford summer travel again. Well, in the aftermath of the holiday, gas prices actually continued their trek toward that dreaded $4/gallon level and hit a new national average of $3.96 late in the week. In fact, 11 states and the District of Columbia already are reporting average prices at the pump in excess of that psychological barrier.

While crude prices fell from last week’s record highs of $135/barrel, the ongoing “supply/demand vs. speculation” debate rages on. In one corner…The Department of Energy said that exports from the top oil producers dropped by 2.5% in 2007 and are on pace for a similar showing this year. While much of the increased demand focus has been on China, oil consumption throughout the Middle East (and Saudi Arabia, in particular) has skyrocketed in recent years, thus, leaving less to export and meet the growing demand abroad.

On the flipside, conspiracy theorists cry wolf that prices have been running without any regard to true supply/demand issues. They point to escalating trades in commodity (petro) futures indexes and make Internet bubble comparisons (remember those fun days?) as explanations for the wild price swings. This week, the regulators got involved (typically a day late and a dollar short) as the Commodity Futures Trading Commission initiated a probe into potential market manipulations by energy insiders.

And suddenly those increased water cooler discussions about the dreaded “I” word are starting to move from speculation to reality. Dow Chemical announced a 20% across the board price increase to “mitigate the effects of raw material costs.” German-based DHL soon will be “outsourcing” its North American delivery biz to competitor UPS as its seeks to reduce costs. Discounter airline JetBlue will not be adding to its fleet as expected because it too suffered the ill-effects of rising fuel prices that have prompted major changes throughout its industry (can you say consolidation?). Likewise, automakers continued to struggle from consumer activity (rather inactivity) as both Ford Motor Co. (F) and General Motors announced major reductions to their respective workforces. Apparently, the “rich and famous” have been impacted far less than others as Polo Ralph Lauren and Tiffany both reported better than expected quarterly earnings. Even Dell Inc. (DELL) surprised many analysts with a solid quarter on strong sales in Asia. Turning to financials, shareholders finally approved the JP Morgan Chase & Co. (JPM) acquisition of The Bear Stearns Cos. (BSC) (like they had much of a choice), though $10 a share is a far cry from the $170 the stock traded at in early 2007.

Investors took their clues from declining crude prices this week and again looked for value in the equity markets. The major indexes traded higher (often at the expense of fixed income). In fact, the yield of the benchmark 10-year drifted back above 4.0% for the first time in about five months as talks of inflation seemed to overshadow prior recessionary fears (see below). Still investor sentiment can change on a dime these days and next week brings significant economic releases that are sure to be over-analyzed. Until then, happy motoring (at $4/gallon).

In short, the economy will be getting smaller and more expensive. It is the beginning of the decline and fall of the American consumer economy!

The success of all of these seemingly disparate sectors depends, to a large extent, on the ability of Americans to continue to borrow cheaply and easily. Now that home equity extractions and zero-interest credit card rollovers can no longer be used to fund electronics purchases, vacations or tuition, those corresponding sectors are suffering. The foundation of our bloated service sector economy, supported by overseas savings and production, is now giving way.

This diminished capacity will result in a wave of bankruptcies and consolidations to restore profitability in what will become a much smaller service sector. The days of cheap consumer goods at Wal-Mart and cheap airfares at Jet Blue are coming to an end. It is all part of the process of an unprecedented decline in America’s standard of living, which is the inevitable result of years of living beyond our means.

Failure of business models

For retailers, the business model of selling cheap foreign imported goods to over-leveraged Americans was doomed from the start.

It is fitting that just prior to the collapse, Wall Street private equity firms decided to jump aboard a sinking ship (Linens ‘n Things was purchased by the Apollo Group for $1.3 billion back in 2006). No doubt the added debt subsequently piled on to the firm by the profit-squeezing buy-out boys hastened the company’s demise. As revenues decline and debt servicing costs rise for many retailers (who have been similarly hog-tied by private equity firms), look for additional blow-ups down the road.

The roots of inflation

As the dollar continues its historic decline, imported goods will become too costly for many Americans. More of those products still made (or, more likely, grown) here will be exported to wealthier foreign consumers whose appreciated currencies increase their purchasing power. As a result, fewer products will be available to fill our shelves and those that remain will carry much higher price tags.

In addition, as defaults on credit and store charge cards continue to increase, the market for such debt will soon disappear. The credit crunch will spread from subprime mortgages to all forms of consumer credit. Therefore, not only will Americans be staring at higher prices, but they will have to pay in cash.

Similarly, the coming airline consolidation will usher in a harsher era for the American airline industry. Given the rising costs of building, flying and servicing aircraft, U.S. carriers currently supply more planes and passenger miles than American consumers can afford to use. While this may seem illogical in a time when domestic flights are usually fully booked, it is important to realize that these crowded planes do not translate into profit at current ticket prices. While mergers may help the airlines hold down costs for a bit, the only lasting pathway to profit is fewer flights and significantly higher ticket prices. Of course, this will mean that Americans of modest means will travel less by air. Unfortunately, that fact is simply an inevitable consequence of a sagging currency and diminishing national wealth.

Although many Americans have come to regard affordable air travel as a birthright, from a global perspective it remains the province of the wealthy. The massive borrowing that has financed the American economy for generations, combined with an evaporating industrial base and a lack of domestic savings, have combined to lower American’s wealth in comparison to the rest of the world.

Diminishing prosperity

As more materials, technicians and jet fuel go to service the burgeoning Asian air travel industry, the higher the costs will become for American travelers. As with other hallmarks of a diminished standard of living, Americans now have to confront the reality of staying closer to home.

The same mathematics will come into play for our ridiculously expensive higher education system, which cannot exist without a well lubricated loan infrastructure. Limit the ability of students to take on heavy loans, and college education becomes untouchable for anyone but the wealthiest Americans. If loans dry up, universities will be forced to slash their bureaucracies and substantially reduce tuitions. Ironically the silver lining here is that with low tuitions students will no longer need the loans that kept tuitions so high in the first place.

****Make sure you sign up for our FREE TFN News Feed for breaking news, special reports and new financial videos. Sign up through your favorite reader here. Or, if you prefer, have the feed delivered to your email.