The Next Global Meltdown Is Baked In: Connecting The Dots Between Oil, Debt, Interest Rates And Risk

Tyler Durden's picture

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

The bottom line is the Fed can only keep the machine duct-taped together by suppressing the market's pricing of risk.

One of the Grand Narratives of our era is the substitution of debt for income: as earned income and disposable income have stagnated for 40 years, the gap between the rising cost of living and stagnant household income has been filled by borrowed money.

Money has been borrowed to replace income everywhere: consumers have borrowed money to buy things they otherwise couldn't afford, students have borrowed over $1 trillion to attend college, governments have borrowed money to fund wars and social spending, corporations have borrowed money to buy back their own shares, pushing stock prices higher.

There's one little problem with debt: interest must be paid on debt. Let's focus for a second on the difference between cash income and borrowing money. Cash doesn't cost money to maintain; debt does. In a functioning economy (as opposed to the dysfunctional mess we have now), cash would earn income from interest paid by borrowers.

If cash income is saved, the cash can buy stuff without debt or interest payments. That is a powerful advantage over debt.

How powerful is the advantage of cash over debt? It's literally life-changing. Take a look at your credit card statements, which now include an estimate of interest you will pay and how long it will take to pay off the balance at a given monthly payment.

Those making minimal payments will end up paying 100% or more of the balance due in interest.
The phenomenally high accrued costs of interest is true of mortgages, student loans, auto loans, corporate debt and government debt: eventually, current spending is crimped as more and more net income is devoted to paying interest.

There are two words for what happens when real income declines and interest payments rise: impoverishment and insolvency. This dynamic is scale-invariant, meaning it works the same for individuals, households, enterprises and governments.

Let's connect the rising cost of oil to debt. As we all know, oil matters because it's the foundation of our economy, and the cost of oil is built into virtually every sector in some way. For example, look at how the the cost of food rises and declines in lockstep with the cost of oil:

Despite the substitution of cheaper natural gas for oil, we use a lot of oil.

While the recent increase of 3+ million barrels a day in domestic production is welcome on many fronts (more jobs, more money kept at home, reduced dependence on foreign suppliers, etc.), the U.S. still needs to import crude oil.

U.S. Imports by Country of Origin (U.S. Energy Information Administration)

The rising cost of oil acts as an economy-wide tax. Everything that uses oil in its production or transport rises in price without offering consumers any more value than it did at much lower prices.

Look at the impact on food prices as oil rose from $20/barrel in 2002 to $140/barrel in 2008. While government statisticians adjust the consumer price index (CPI) based on hedonics (as the quality of things goes up, the price is adjusted accordingly) and substitution (people buy chicken instead of steak, etc.), the reality is, as one heckler put it, "We don't eat iPads:" that is, all the stuff that is hedonically adjusted (tech goodies, etc.) is non-essential.

The Status Quo has compensated for the relentless rise in the systemic oil "tax" by making debt cheaper to service. The Federal Reserve's zero-interest rate policy (ZIRP) has two purposes:

1. Channel immense sums of free money to the too big to fail banks by relieving them of the onerous requirement of paying interest on deposits while giving them unlimited access to nearly-free money they can lend out at huge spreads. (This is crony-capitalism writ large. The winners were picked by the Fed and the rest of us are the losers. Yea for the godlike Fed, our modern-day Mammon.)

2. To keep consumption alive as income declined and the oil tax eroded household disposable income, the Fed made borrowing cheaper.

Unfortunately for the godlike deities residing in the Fed, zero-interest rates trigger malinvestments, which are inherently risky. When unqualified borrowers borrow a ton of money--for example, a student with no assets or income, or a poor credit risk household assumes an FHA mortgage, or a corporation sells junk-rated bonds-- the risk of default is intrinsically higher than debt taken on by qualified borrowers.

This poses a systemic problem for the Fed: The Fed needs to enable more borrowing by the uncreditworthy to keep consumption growing and bank profits flowing, yet the inevitable result of such credit expansion is a massive expansion of systemic risk.

The more debt that is taken on by marginal borrowers--where marginal is defined as unable to weather any shock or decline to their financial position or income--the more risk piles up in the system.

The analogy is a forest where the deadwood is never allowed to burn: The Yellowstone Analogy and The Crisis of Neoliberal Capitalism (May 18, 2009). The net result of rising systemic risk is a massive conflagration that burns off off the accumulated risk and bad debt.

Such a fire sweeping through the mountains of risky debt piled up in the American financial system would bring down the entire Status Quo. So what's a godlike Federal Reserve to do when it can no longer lower interest rates?

Answer: it suppresses visible risk by manipulating the stock market to reflect complacency.
"Old" VIX Plunges To Record Low (Zero Hedge)

Does a record low measure of risk reflect the systemic risk of default and a decline in consumption, or is it merely a reflection of the herd's boundless faith in the godlike powers of the Fed to suppress risk even as Fed policies pile risk ever higher?

The bottom line is the Fed can only keep the machine duct-taped together by suppressing the market's pricing of risk. Suppressing the market's ability to price risk is throwing common-sense fiscal caution to the winds; when risk arises from its drugged slumber despite the Fed's best efforts to eliminate it, we will all reap what the Fed has sown.

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AdvancingTime's picture

We  are all interconnected for better or worse. A bad apple can spoil the whole basket. Welcome to the world our leaders have designed or allowed to form. Whether by design or merely as a byproduct of globalization we have weaved a web of financial transactions that circle the globe. Over the last several years as money was printed by the central Banks it was not contained in the countries where in was printed. This money flowed across borders influencing and distorting markets and prices across the world. Some people have been calling for a "world currency" for years. the saying "one should never let a good crisis go to waste" means that a meltdown with high levels of fear would present a perfect opportunity and catalyst to advance this agenda down the field. Remember many people with agendas have a lot to gain when a major shift in the currency markets takes place. More on this subject in the article below.

thamnosma's picture

His post didn't contain anything awful, so is his link contaminated?  The jerk is actually attempting to spread a virus to ZH readers?

Fuh Querada's picture

The issue is that this jerk has been pimping his insipid blog on just about every ZH thread for months.

CrazyCooter's picture

So ... buy paying cash for almost all of my household purchases, reducing what little debt I have left to zero, purchasing older (non-GM) vehicles, and generally living a basic but content life, I am fighting the Fed?

That implies that when the Fed finally blows up, I can claim, with a bit of tongue in my cheek, that I won.



Pool Shark's picture



When it all blows up, those without debt will be the winners. Assuming we're not living in 'Mad Max' land, your accumulated precious metals and cash will buy the world's assets at fire-sale prices...



Professorlocknload's picture

When it all blows up, it will be the dollar (cash?) that does the blowing. But I agree on the gold and silver part,,,and anything else "real," including productive Real Estate.

Flakmeister's picture

The blowing up will be the bonds, not the cash...

Alot of debt will go to money heaven taking with it a lot of dollars...

Flakmeister's picture

No... the ones that can repudiate their debt or pay back in devalued currency will be the winner...

History lessson: Who was the biggest winner? 

a) bought a house in 1969 with a 30 year fixed

b) paid cash for same house in 1969

Upton's picture

I am going with [A]   14,000 dollar house at 30 year 4%.

20% down leaves 11,000 for a SP500  index fund 1969 to 1999, you make out real good.

But that is all rear view mirror stuff.

Flakmeister's picture

True re: rear mirror, but everybody now is calling for the dollar to be devalued once again..

Maybe they are wrong, but I don't see how (at least over the life of a 30 year)....

Monty Burns's picture

the ones that can repudiate their debt or pay back in devalued currency will be the winner...

I agree. It's become almost religious doctrine to say that those with no debt will win. Not a logical position if the debt is denominated in a decimated currency.

cornflakesdisease's picture

The dollar will collapse as soon as we run out of zeros.

Kirk2NCC1701's picture

NOTHING NEW or original in that blogspot, that we don't know on ZH.  Pure thread-jacking.

Kina's picture

Yet all the games the US plays in the Middle East and Ukraine now only help to elevate the price of energy. And may break it completely if things turn to wild fire.

Flakmeister's picture

What do you think the price of gasoline would be if the US was no longer able to exchange USD for oil?

Why do you think oil has been cheap compared to its real value...

Headbanger's picture

And why do you think the Federal Reserve is pulling back on stupidly futile stimulus efforts so they can help prop up the U.S. dollar now instead?

It's also why gold is being manipulated downward.

Flakmeister's picture

Since oil and gold were freely traded in the early 80's, it would appear that gold has been deflating against oil...

From historical data going back to 1950, the highest price that you could argue for gold is ~$1410 or about 6% higher than it currently is...

BTW, prop up the dollar relative to what exactly?

Headbanger's picture

Relative to other currencies (or metals) which could replace the dollar as the global means of exchange and store of value.

The U.S. is a global political, economic and military power only as long as the U.S. dollar remains the global currency because that has enabled us to borrow from the world to fund U.S. dominance.

The Federal Reserve is painfully aware of this dilemma and is now pulling back on futile stimulus efforts which have only benefited the wealthy while severely undermining the U.S. ability to continue funding itself.

I also suspect the numerous wars of late have been started by the U.S. government as an excuse to exert its military might while it can to maintain global political and thus financial dominance.

tarsubil's picture

"The U.S. is a global political, economic and military power only as long as the U.S. dollar remains the global currency..."

I think you have that backwards. It is the threat of force which allows the dollar to remain as the global currency. That is why we've waged war for the last 100 years. The dollar will pop when the US military is no longer the top threat to the world.

Headbanger's picture

"It is the threat of force which allows the dollar to remain as the global currency."

"The dollar will pop when the US military is no longer the top threat to the world."



And who are the fucking idiots who up-arrowed that stupidly mutually exclusive comment??

As Ted Knight would say:

GooseShtepping Moron's picture

Headbanger, I just wanted to say you are right in your general assessment. The Fed has pivoted from supporting the stock market to supporting the dollar. This is our (so far rather unconvincing) response to the coordinated efforts by China and Russia to permanently weaken the position of the US petro-dollar system.

The technical definition of 'dilemma' is not merely a difficult decision (which is how the term is used colloquially) but a decision between two or more options, each of which is unacceptable. The Fed is really in a dilemma now with monetary policy. A strengthening dollar is highly deflationary and will eventually destroy the financial system, but continuing QE is geopolitically impossible when Russia holds the oil cards and China is the global manufacturing hub. Ultimately only one decision is possible: the financial sector will be left in the lurch, and the dollar will strengthen. National survival will not be sacrificed for the exigencies of a banking system which has no raison d'être in a deflationary world.

This is reality reasserting itself. It took longer (and is taking longer) than any of us expected, but in the end it must happen this way and no other way. The petro-dollar will be destoryed. There will be a brief period of dizzying inflation followed by systemic seizure and deflation.

Paradoxically, my advice would be that if you're lucky enough to own some PMs, sell a little on the spikes. Begin pocketing those soon-to-be very valuable dollars. Don't panic during the inflation, and hang on to a goodly amount of cash. The non-petro dollar will be the last thing standing in a bankrupted, post-imperial America.

TVP's picture

That's not difficult for our enemies to accomplish.

China just has to stop manufacturing military supplies for us.  Then we're finished, because we moved all the factories over there.  No munitions = no military might.

Game over.  

Flakmeister's picture
The Chinese Yuan is basically pegged to the dollar and they are importing more oil than the US, i.e. they are also screwed... Are you suggesting the Euro (i.e. the DM) will prevail? The GBP or Yen?? The US is not "borrowing from the world", it is borrowing against its ability to service its debt obligation. And in case you did not notice, the amount of QE has also more or less tracked the recent budget deficits. And that tapering coincided with with the deficit being cut by ~$500 billion.... There will never again be a metal-based  international settlement of accounts... That bus left the station a long time ago. And if/when it does become feasible, the world will likely not need much international trade...   Don't get me wrong, the US is fucked and at some point there will be a repudition of some fraction of the debt, but I predict that the USD will be the last fiat standing, provided there are not too many large dark waterfowl on the horizon...
CrazyCooter's picture

Interesting sub thread/comments (flak/hb/etc) ... 

I am not a finance professional, but started reading ZH back in 2008. One of the central issues to "figure out" is what greases international trade when the dollar rolls over? Jim Rickards kind of cast it as four options (1) SDRs, (2) multiple floating reserve currences (3) gold (4) chaos.

I think that sums it up nicely and I haven't really seen a clear cut fifth option.

Mind me asking you folks up thread which is your horse (so to speak)?

I don't think the financial elite in the world will let chaos set it, although it may be a tool to get the SDR adopted. In absense of that, we will see multiple floating exchange rates and all the hell that ocmes with it (e.g. currency risk in trade deals that take 90 days to clear develiery).

Or, if this is genuinely a "west-vs-east" style show down, the east hordes gold and then walks away from the table. That is what it really looks like is happening to me.

Thanks in advance for your comments ... :-)




Spastica Rex's picture

Chaos is always my horse.

Heat dissipates.

TeethVillage88s's picture

V Guerrilla Economist is in a Video with W Security Manager/Analyst maybe on Hagman & Hagman.

Supposedly London is working with Europe to set up a Silver Metals Clearing House as a Future without the Dollar. I'm not sure if he said a Precious Metals Clearing House or if it will focus on Silver. Apparently London no longer has much Gold.

Yeah, I heard that Jim Rickards show where he was talking about SDRs from IMF/WB.

Flakmeister's picture

It could very well be a basket of currencies, with the USD being an important component. The is is probably the best case scenario...

Another alternative not considered by Rickards is to back a currency with energy production...

I truly believe that the East will be left holding the gold bag, much like the Japanese and US real estate in the '80s... The eastern gold will allow them to weather their local problems, i.e. the Rupee being ethereal and the devaluing of the Yuan when the Chinese RE bubble pops. I only see nominal gains in gold, but in all fairness, it will weather any currency storm.

Why would anyone tie their currency to a metal when they are running trade imbalances driven by commodities?? This is shooting yourself in the foot. It ain't gonna happen.

Chaos is a distinct possibility, but that truly is the end game, i.e. the collapse of the modern industrial civilization and the return to a subsistence level agrarian society. The powers that be will do all that they can to avoid that...

All paths are fraught with peril...

CrazyCooter's picture

Curious opinion regarding gold. I know the financial elite hate it and I suspect that is why the "west" nations have purged it from the system (my thesis); no gold standard if no gold. And if only a few countries have all the gold, it isn't good for trading unless you want to spend a lot of it (i.e. if the gold distribution is siginficantly imbalanced a gold standard system can't get off the ground sort of like you can't run a poker game if only a few players have all the chips).

Well, isn't a currency implicitly backed by the exports of a given nation anyway? ZH did a really good write up on ag currency here:

I printed that big food chart and put it on my wall. My thesis is is this the order countries go down if international trade really breaks down for any period of time (i.e. who starves first because they import all their food).

I suppose if there was a hard link established, but ag is only as good as all that oil the goes into producing it, which is the sub-thead on down a little bit. :-)



Flakmeister's picture

Yes, at some level it boils down to food and water...

Yet another reason why the US will be a player for years to come....

centerline's picture

Except that everything internally is propped by financial systems that are predicated on perpetual growth.

I dont disagree with you Flak.  The US is in a solid position for food and water among other critical resources.

Rather, I am adding to the picture that despite our resource richness, we are on course for something profoundly nasty internally.  Clearly explains the militarization of police, loads of weapons/ammo, drones, etc.

Flakmeister's picture

No real argument from me...

But all those apply to just about everyone else as well....

DanDaley's picture

Yes, and that profound internal nastiness you mention, all tied up with food, water, and other resources, might go something like this:


As in chess, when you are materially ahead, it is to your advantage to simplify the game, get the extraneous pieces off the board to make it easier to checkmate your opponent.


So the question is this: To whose advantage is it at this point in the game to simplify things on the chessboard, (get rid of useless eaters, say, through some nefarious means), to use their material advantage to simplify and thus come out ahead? This is what I look for to play out. Lots of possibilities.

DaddyO's picture

I think its important to note that the USD has about 200 Trillion in notional value floating around the world.

It will be very difficult for another currency to displace this from a reserve stand point. I have ruled out economic collapse in the near term, say 1-3 years.

A more likely scenario will be escalations of tensions and the outbreak of WWIII and the rise of the NWO and its militarized force.

Then we may see a unified currency and its being forced on the vanquished.


_disengage_'s picture

Freegold does not tie gold to any currency. It would be a great objective metric by which all currencies could be measured. As long as we use ratios and baskets with subjective currency on both sides, there is room for manipulation.

Flakmeister's picture


That is exactly what is happening now...

centerline's picture

Reality is that there is no good answer.  No utopia regarding currencies because all of them (even gold) are predicated on faith at some level.  And all of them are still subject to the "who" in terms of regulation.  It is the "who" that is the problem.  And when we remove the current "who", another equally bad "who" will eventually (if not immediately) develop.  Is just in our DNA.

So, economic systems, reserve currencies, etc. come and go on regular cycles as a result.  They become a mirror of the world at a particular time.  Is why the field of economics as currently preached is so laughable.  Is like using the image in your rear view mirror to drive forward.

Professorlocknload's picture

My take on the Fed's preferred treatment of the dollar is, it would devalue it in a heartbeat against any and all currencies, if it could. Problem is, fear of financial collapse is putting international support under it at this juncture.

Best horse in the glue factory and such.

The day will again come when some Treasury apparatchik will gleefully declare 'It's our dollar and your problem.'

Hard to think the Fed doesn't know that he who benefits most from devaluation is he who creates it.

TVP's picture

Considering the fact that central banks are now hoarding Yuan as if they were yesterday's Dollars, I'd say options 3) and 4) look pretty unlikely.  


One thing we can know without doubt: the new currencies will be backed by gold, whether that's the SDR by itself, or the SDR along with Yuan, Ruble, and Rembini.  


Don't forget - the BRICS nations have just funded a new bank, to compete with the IMF and World Bank, to the tune of $100 billion USD.  


Obviously, they don't intent for all those dollars to remain as such.  

TeethVillage88s's picture

Swiss Franc Maybe?

Heard Europe is siding with China and 104 other countries to get out of the Dollar. You probably know about the Rumor. First our dollar collapses, then hyperinflation, then the new world powers that hate the USA force us to either devalue, take a second international currency at devalued level, or adopt a world currency based on precious metals or a basket of goods.

I don't know could be just Fear Mongering. But US has Exponential Debt and no political will to fix anything.

Obviously Monetary policy doesn't work. Obviously many nations are losing Labor participation Rates (Jobs).

But Janet Yellen & Our (All Hail) Bankers seem to be in an International Cartel. US Bankers can just say well it is over we are moving out.

Funny about Charles Hugh Smith saying with debt "we have to find new money somewhere". Well bankers always make new money. They just don't give it to our Federal Government to Pay Off Debts. But get this. The States & Federal Government give the Banking Charter to each of these Banks!!!!

"...The B.I.S. acts as a clearinghouse for transactions among national central banks and also as a setting where central bankers can discuss monetary policy and other issues like financial stability or bank regulation.

Its board includes Janet L. Yellen, chairwoman of the United States Federal Reserve; Mario Draghi, president of the European Central Bank; and the heads of central banks from Japan, China, India and many other countries..."

CrazyCooter's picture

I am kind of expecting the US government, at some point, to lock down cash and treasuries. Literally take a CUSIP inventory of "known" partners/holders and invalidate everything else. This would be a huge write off, but it would disproportionately hit the shadow economy.

Same will happen with cash. All they have to do is say everything that isn't the new 100 bill is toilet paper. Want new 100s? Just come trade it in withing a narrow timeframe.

Voila - massive float shrink as much cash and debt in the system goes *poof* and some nice tax revenue opportunities as semi-legitimate cash visibily comes back into the system.

Regardless of what they *do*, I can assure you they have some kind of plan, even at that stage of the game, to keep their system intact particularly if the threat is external rather than internal strategy.



centerline's picture

A shift to an electronic currency (or near complete shift).  Is the old "green money, red money" thing.  What is hard to tell are the unitended consequences.

Have to say that trying to predict all of this is bitch.  What I always try to remind myself of is that the math does not add up no matter what is done with currencies.

There are millions, possibly billions, whose future depends on a virtual ponzi scheme.  Perpetual growth is the problem.  And long before we grind up against resource constraints in a way that really causes maximum pain, we hit the wall in terms of economic systems and social complexity - with the cascading effects of such.  That is where we are now.  Trying to buy time by papering over reality.  When this fails, chaos is coming.


TeethVillage88s's picture

“The individual is handicapped by coming face to face with a conspiracy so monstrous that he cannot believe it exists”
- J. Edgar Hoover, long time Director of the FBI

Well I can't say In understand the technical stuff or even CUSIP, Committee on Uniform Securities Identification Procedures, 9 digit code must allow tracking and surveillance on Bonds & Financial Instruments.

Yeah, Congress & the Fed can't really be so stupid as the act. They have a plan to keep bankers getting rich even after the currency collapse. It is a cartel. And they have a Known Preference for Foreigners and Undocumented Workers.

magpie's picture

Care to discuss the real value of oil compared to the real value of other energy sources ?

Flakmeister's picture

This is from an old OilDrum discussion (Nate Hagens):

This has been argued and debated often on TOD, mainly in response to some of my own quotes in media about 1 barrel equating to 25,000 hours of human labour (12.5 years at 40 hours per week). Ultimately the answer to this question depends highly on assumptions - but we can arrive at a good approximation. 1 barrel equates to 6.1 Gigajoules (5.8 million BTUs). Depending on the 'job', humans use roughly 100-700 Kilocalories per hour (Computer work requires an estimated 119.3 Kcals/hr). 1 kilocalorie (Kcal) = 4,184 joules. So 1 barrel of oil has 6.1 billion/4,184 = 1,454,459 kcals. Using a range of 100-700 kcals per human hour of work then results in a range 2078 and 14544 hours per barrel of oil. At 2000 hours per year (40*50), this is would then be 1.0-7.25 years per barrel. This was discussed in the comment thread here.

However, we aren't robots - we need to eat, sleep, breathe (we exhale energy), maintain, etc. So a wide boundary analysis would require other calories not devoted to doing work - thereby increasing the disparity between human work and a barrel of oil - there is a good discussion of human thermal efficiency here.

Lastly, there is the quality issue. Though one could expend enough calories to chop down a tree or carry a cord of firewood by hand, there are many activities which would be physically impossible for humans to directly accomplish -e.g there wouldn't be room for the required number of humans to stand behind a semi-truck and push it down the highway at 100 kph. Or fly a jet, etc.

The average american uses 60+ barrels of oil equivalent(oil, gas and coal) per year (360 billion joules), which implies a fossil fuel 'slave' subsidy of around 60-450 'human years' per person. Depending on assumptions another way to look at it is to take a midpoint of 10,000 hours per barrel. At $20 per hour average payroll compensation, that is $200,000 per barrel, not even quality adjusted....

CrazyCooter's picture

For those of you whose eyes glaze over when you see math, Nate's point is articulated naratively here:

It is a very important concept to grasp, so take the time to do so...



Flakmeister's picture

Robert Rapier is no dummy, in fact, his "prediction" at TOD of 10 years down the road was closest to reality...

CrazyCooter's picture

Which prediction? TOD was around a while ...



Flakmeister's picture

Juat about how peak oil was going to play out...

RR got the last laugh over those who were predicting an imminent fast decline....

He also took the simplistic application of Hubbert linearization to task...

centerline's picture

Is why oil might as well be revered as "magic."  It is what allowed this particular cycle of history to realize population growth to the degree that has occurred.  Social complexity off the charts.  Food production/distribution on scales never dreamed of.  etc.

At some point though, math dictates that a limit will be reached.  I wager that all the attempts to avoid inevitable consequences are resulting in multiple limits being reached (without failure as would expected), thus ensuring maximum consequences when it is no longer possible to avoid reality.