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Guest Post: Why Oil Prices Are Killing the Economy
From ChrisMartenson.com contributor Gregor Macdonald
Why Oil Prices Are Killing the Economy
"Oh, that was easy," says Man, and for an encore goes on to prove that black is white and gets himself killed on the next zebra crossing.” ? Douglas Adams, The Hitchhiker's Guide to the Galaxy
Have rising oil prices just put the final coffin nail in the entire 2009-2011 economic recovery?
Given the slowdown in China, the new recession in Europe, and the rocky bottom in the US economy, it certainly seems that way.
Oil's Relentless March Higher
Oil prices emerged from their spider-hole over two and half years ago. Having fallen from the towering heights of $148 a barrel in the summer of 2008, the early months of 2009 saw a return to prices in the $30’s. Interestingly, during that great oil crash, the price of West Texas Intermediate Crude Oil (WTIC), spent only 20 trading sessions below $40. That is the exact price most analysts, only three years prior, believed oil could never sustain as the world would pump “like crazy” should prices ever reach such “impossibly high levels.”
Given the enormous debt troubles the West is currently facing, and the fact that oil has averaged over $100 during several months this year, it does seem reasonable to suggest that, once again, the economy has been pushed off a ledge by oil. Let’s take a look at oil prices, over the past several years.
Many economists and older energy analysts, although they won’t admit to it, have been simply blown away by the persistence of oil prices: especially in the weak economic environment post the 2008 crisis and financial market crash. How did oil prices manage to recover to $80 (let alone to $40 or $60), and make their way back all the way to $100? (And this is just a chart of WTIC oil. Brent oil has been even stronger the past year). Why, for example, has a 12% reduction in US demand and weak economies elsewhere in the OECD not translated to much cheaper oil prices? Why did oil simply not flatten out in price, post 2008? After all, many claimed oil was nothing but another in a series of 'Made in America' financial bubbles. With “no shortage of global supply” (as many said), and with a market “awash in oil” (as others said), why didn't oil prices simply go to sleep at, say, $50 per barrel?
Do Higher Oil Prices Really Cause Recessions? (Answer: yes)
Before we unpack some of the factors behind oil’s strength, I want to address the subject of oil prices and recessions. I think readers should be aware that some analysts reject any reflexive, easy causality between high oil prices and sharp contractions in the economy. There are a range of views on this topic, from those who embrace the idea of substitution to those who assert oil prices and oil supply rise concurrently with movements in the economy.
Substitutionists tend to also be positive, or constructive, transititonists I might add. Many of these come from technical and engineering backgrounds, and often have very good exposure to economic theory. In their view, higher oil prices drive human innovation and spur entrepreneurs to create new technology. High oil prices for them are actually a positive. Understandably, they also want all subsidies and other externalities, which we pay as a society to the fossil fuel industry, to be phased out. And frankly, I myself sympathize with that view.
Meanwhile, analysts who see the relationship between energy supply and the economy as more equalized, more symbiotic if you will, tend to hold the view that if the economy demands more oil--and is willing to pay the price--then the earth will reliably “give it up” to the resource extractors, over time. You can see this view very much at play currently, in the excitement over natural gas and also oil extracted from shale. Indeed, the learning curve, in which the hydraulic fracturing technique moved from experimentation to perfection, conforms very much to theory.
If one expands on these two schools of thought---human innovation that conquers limitations, and, a symbiotic view of the economy and energy supply---it becomes rather easy to imagine that high oil prices present a real, but, rather small problem for the economy.
Of course, I take a different view.
Writing with my friend and colleague Chris Nelder at the HBR Blog, earlier this Fall, we warned of not one but two risks associated with stubbornly high oil prices. First, we referred generally to the history of oil spikes and recessions, noting that in the post-war US economy, one generally followed another. For an economy that has been geared towards oil for many decades, this should come as no surprise -- especially when energy expenditures rise over certain thresholds, as they did in the 1970’s, and again more recently. But we also warned that an over-confidence had developed over the decades, and especially in America, that any pressure from energy prices was ultimately solvable. And, we encouraged corporate management to be more skeptical of the idea that the global oil and gas industry would be able to continue bringing resources to market, that most could afford.
One of the more thoughtful reactions to our essay came from Michael Levi at the Council on Foreign Relations. Levi called into question that any reliable threshold existed, of energy expenditures to GDP, that would trigger recession once crossed. In a general sense, that strikes me as reasonable. And to clarify, the notion of proving a magical threshold -- say, when energy expenditures to GDP rise above 5% -- was not exactly our central point. Indeed, I would agree with Levi more specifically that the rate of change might be at least as damaging, if not more so, than any threshold. In Does Expensive Oil Inevitably Cause Recession? Levi also makes an additional point worthy of attention:
There is, however, a possible back door explanation for why high petroleum expenditures relative to GDP seem to correlate with recessions even if they don’t do a good job explaining them: it is easier for petroleum expenditures to undergo big changes in short periods of time if they are starting from a high level. If, say, the price of oil rises 50% from a starting point where petroleum expenditures are 2% of GDP, the change in spending is 1% of GDP; in contrast, if the price of oil rises the same 50% from a starting point where petroleum expenditures are 6% of GDP, the change in spending is 3% of GDP. Whatever your transmission mechanism – supply side contraction, demand destruction, shifts in consumer preferences for durable goods – the 3% jump is going to be far more economically damaging than the 1% one. Indeed the years where oil spending was high but recession was absent generally come from a period where prices were fairly stable.
As we look at the historical table from IEA Washington, showing expenditures to GDP from 1949-2010 (opens to PDF), what’s illustrative to Levi’s point are the levels from which we rose, starting in 2004. Because in 2003, the level was already sitting at 6.8%. But in 2005, that rose to 7.3% and then reached the very high level of 9.8% in 2008. Today, I am mainly concerned with the outlook to 2012, given that the global economy was granted only the most brief reprieve from high energy prices in 2009, before resuming in 2010 and this year 2011. To provide the most to up-to-date data, let’s also look at the chart, also from EIA Washington:
Understanding Causality
It is difficult to satisfy a demand for precision, when asserting that high energy prices, or fast rates of change in energy prices, or energy-prices-to-GDP thresholds, have caused a recession. The most significant hurdle lies in the organic complexity of the economy itself. With all its political and cultural variances, and the mercurial nature of social moods and trends, how does one make certain claims about such a large system?
Some have suggested therefore that high or rising oil prices cause changes in GDP--and hence, recession. To try and put this in layman’s terms, Clive Granger attempts to assert causality within a more uncertain matrix: saying, essentially, that certain events follow others reliably---but in a sequence where causality is difficult to quantify. As has been pointed out by some, Granger is unfortunately paired with the word causality, when in fact it is really a test or a method by which to determine predictability. (For some of the best work on energy prices and recessions, and Granger Causality, I point readers to the work of James Hamilton, who also runs the popular macroeconomics blog, Econbrowser.)
A broader discussion of the economic impact of energy prices would also include the problem of energy transition. Or, if you like, the broader subject of adaptation. For example, perhaps oil-induced recessions historically were exacerbated or ultimately made possible by policy mistakes. It once was the habit of central banks to raise interest rates in the face of higher oil prices. But what if the economy had simply been left to handle higher prices on its own? More recently, Ben Bernanke has allowed that the central bank cannot control oil.
“There’s not much the Fed can do about gas prices per se. After all the Fed can’t create more oil. We don’t control emerging markets.” --Ben Bernanke, 2011
This suggests an evolution in thinking over his predecessors. Could the economy adapt better to resource price pressures, if policy mistakes were not a feature of the economy?
I’m not so convinced of that either. After all, the volatility in free markets can have its own deleterious effect on new investment. One of the most vexing features of any reliance on high fossil fuel prices alone, as a trigger for investment in alternative energy, is the volatility of prices. If those with capital are to be encouraged to invest in new energy technologies, many of which capture more diffuse energy -- or which create energy but at a higher cost -- then there must be some confidence that cheap fossil fuels will not re-enter the scene, making new investment uneconomic. Encouragingly, that particular issue now looks more resolved than ever because the price of the master commodity -- oil -- which is still the primary energy source of the world, is now structurally higher and is almost certain to stay that way.
Asking The Right Question
And so, to answer the question, do high energy prices cause recessions, I would say with full respect to uncertainty and causality, yes. Eventually, however, the energy transition away from fossil fuels will gather enough momentum that we will interpret high energy prices differently: we will say they forced (helpfully) a necessary transition. But as we are so early in any global transition to alternatives, it would be better for economists, policy makers, and business to consider the Douglas Adams quote that’s in the header of this essay. Trying to prove that black is white may be a noble effort -- in the fullness of epistemology and causality -- but in the short term it could get you run over in a crosswalk.
We face a more immediate question: is the global economy headed back into recession in 2012? Almost certainly, I think.
The Coming 2012 Global Recession
In Part II: Why Its Now Easier to Predict The Outcomes of the Coming Recession, I will explain why oil prices currently are so stubbornly high, and I’ll pay particular attention to how tight the oil market has become (again) post the 2008 crisis. So as not to be simplistic, however, I will not reject the fact that debt saturation and crises of confidence will play a role in 2012. Indeed, Granger causality can be employed in both directions, not merely whether energy prices affect GDP, but whether GDP affects oil prices. This is useful because the combination of a very tight oil market, along with Western economies that have reached the terminus of credit-based consumption, makes for a very tricky price landscape in 2012, for oil. This is no doubt why bets on volatility, a very wide band oscillation in oil prices, are popular for next year.
Finally, how much can the global economy adapt, should oil prices reach even higher levels? Can we make the right policy choices should another oil spike unfold? Remember, policy making which is always at best imperfect can be even more dysfunctional in a crisis.
Click here to access Part II of this report (free executive summary, enrollment required for full access).
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It ain't so much the price of oil as it is the counterfeiting, aka: the loss of value of the so called "basket of [fiat] currencies".
This is f...... depressing....this will end badly and many will get hurt and or die.
Saw this on TF today...Classic Xmas video for silver
http://youtu.be/AtBrctgDb1I
http://www.youtube.com/watch?v=CUzbzt15nv4
TERENCE MCKENNA
Why hasn't anyone mentioned that oil priced in worthless dollars tends to trend up as dollar printing floods the marketplace? perhaps because the FED, Bernank, and the bankers have so thoroughly destroyed markets that we can no longer point to simple cause and effect summaries. It's a brave new world bitchezz.
Well, Crude dropped to about $75 last Aug. and Oct., coinciding with stock market plunges at the time. They´ve been pumped together and will most certainly be dumped together as well.
The 3-month charts are virtually identical.
http://finviz.com/futures.ashx
The scale is different, S&P is 1050-1300 while Crude is 70-105, once you account for that you see that this moves in perfect unison.
42
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....he said epistemology....
And when Iran blows, oil goes to 300-500$ a barrel and it's game over.
Oil doesn't trade off strictly oil fundamentals [if anybody really know what they are] any longer. Oil is now a legitimate asset class that attracts large amounts of money. Throw in possible supply disruptions from the nutbags in MENA and you got a market at $100 / bbl and reluctant to go lower should there be a problem. From a hedging standpoint, why sell crude and get locked into a short squeeze should Iran [or another] misbehave? Besides, everybody knows they misbehave on purpose just to keep shorts extremely nervous.
http://vegasxau.blogspot.com
There are two reasons for high oil prices:
1. Bernanke's devaluing the dollar.
2. East Asia's economic boom.
Speaking of high oil prices during a recession, this is the first recession in my life that prices of everything haven't come down and the more the Fed helps the higher the prices go. That is, evrything except the slowly deflating housing bubble.
The great waste of our time is using NAT GAS for electricity generation given its very high value as a fuel & the huge transformation loss in the making of electricity by any fuel type - therefore the fuel used should be low value / high capital cost ventures but with a high energy density.
Only Lignite , Nuclear & Hydro should be used for this generation.
The opportunity cost of this great rush to gas is huge - it should only be used for cooking ,heating & to a lesser extent in combustion engines.
And as for wind.......................Sweet Jesus
http://www.iea.org/stats/pdf_graphs/DKELEC.pdf
http://www.iea.org/stats/pdf_graphs/FRELEC.pdf
http://www.iea.org/stats/pdf_graphs/DKTPES.pdf
http://www.iea.org/stats/pdf_graphs/FRTPES.pdf
Well, yes, the US and western world is going to be forced, one way or another, to transition away from dependence on crude oil and its derivatives.
There is a larger supply of readily-available natural gas in the US than remaining accessible crude oil ... but recently the greenies and the EPA have been spreading largely-false fears about fracking,for reasons which totally escape me. Calorie for calorie, natural gas is priced at 1/3 that of crude oil and it can be utilized efficiently in vehicles, but the vehicles and the infrastructure must be built to employ it.... eventually though the natural gas will also run out ...
hydrogen, solar, wind, and fairy dust are NOT alternatives.
The other viable alternatives are .... horses, donkeys, and camels.
The part that no one, not the liberals, not the conservatives, not the environmentalists or the peak oil prophets want to talk about is:
people must die.
A lot of people must die.
Because an economy without oil is not going to be able to produce nearly so much food as we have been, and it will not be able to distribute it with the efficiency that we now enjoy. It will no longer be possible to fly salmon and tomatoes from Chile to feed the people on food stamps in Chicago and Detroit. They will die.
And money has nothing to do with it. Gold and silver are not very good to eat either. Neither are guns. Humans are ...I recommend slow cooking and a lot of MSG because humans are not very tender ... we may still come to that ...
an economy USING OIL to produce food can't produce enough with less oil. An economy producing food without oil however, with LOCAL production, no heat winter gardening, permaculture no till methods, greater crop variety and perennial foods has a much better chance at survival. These methods are MUCH more productive in calories and nutrition. Of course, like everything else, the longer we postpone transition, the longer the dead list.
why , you wanna know whether there is enough oil supply or not? Whether the current price of oil is too high or too low? Whether there is speculation or physical demand? All this is very simple , put 100% margin on oil futures and all related products and make sure through tough regulations that no one who is not interested in physical supply is able to put money into crude oil.I bet that the price would go down to 2001 levels within a matter of weeks and would remain there for an extended period of time.And no , crude oil is not gold and silver , low price would not lead to a run on cheap oil , oil needs to be stored somewhere , capacity is limited , expenses are high.Today's oil prices are modern day robbery , fully authorised by the United States government of course
If you are a Malthusian inspired guy and you think there are too many people (you & yours excluded, of course) then the idea of cheap oil is an anathema to you. And you'll do what is necessary to avoid cheap oil for the good of (the right kind of) humanity.
The problem with the idea that 'oil prices' are partially to blame for the state of the economy, is that this 'idea', can be so easily manipulated by the MSM media, politicians and others, so that they don't need to take responsibility for any of the causes of our current economic situation.
They can blame the current inflation, not on monetary policies, not on HF market manipulation, not on the lawlessness, corruption or fraud, not on the loss of real free market policies, or anything else that is causing 'life' to be more expensive.
High prices at the pump are felt by everyone, so are always blamed on whatever it is that they want to use to push their collective agendas of the day; endless wars in the Middle East, higher taxes for the middle classes, more anti-competition regulations that will only be enforced on the little guys, cuts in services, and more debt creation; terrorists, environmentalists, 'rich' people not paying enough tax, lax regulations, unions, illegal immigrants, private property laws that are keeping 'American' companies like Exxon from drilling domestically because they don't currently own all the land so the EPA should own it, whatever it is that they want to tell the sheeple that day, is what they will say, is 'causing' the high gas prices and pain.
Blaming the symptoms for the cause is the best way to manipulate the masses. This is my problem with getting into this kind of overly simplistic conversation about oil prices.
"Eventually, however, the energy transition away from fossil fuels will gather enough momentum that we will interpret high energy prices differently"
Energy transition? WTF are you talking about? Momentum? The idea that ACO2 is the evil trace gas of the planet and is highly toxic and classified as a pollutant is a bald face lie!!! The momentum in which your so called energy transition is collapsing to a point of a slow crawl because the very premise in which this bull shit was to springboard the so called "green energy" bull shit is based on fraud.
"Finally, how much can the global economy adapt, should oil prices reach even higher levels?"
How in the hell do you think the world will adapt? What in the hell do you believe countries will do? They will drill because the world is loaded with oil and natural gas. You can take this propaganda piece and stick it up your ass!
I sense a lot of anger... have you been cutting back on the meds?
We meet again Mr. Flakmeister...LOL...When those that have an undying motive to make the world believe a lie they indeed step over a boundary because then it becomes a crime against the ignorant, vulnerable and naive as these charlatans try to mobilize them to loot them blind.
There has never been a looting fraud that has sewn so much bull shit as the global warming/climate change con.
"the world is loaded with oil and gas" Yeah, that's not the only thing it's loaded with. The world is loaded with a growing number of people and cars and factories and a lot of stuff made out of oil and funny, it's not growing. So when exactly, will the stuff get harder to pump? Of course, if you are the "abiotic man," then this discussion is meaninless, for a lot of reasons.
Any disruption in the economy causes a recession. Recessions are temporary and self correcting. But we are not in a recession. We are in a depression. Depressions are caused by long term abuse of the macro economy. We may have a further downturn next year and it may be partially due to high oil prices. But the main culprit will be that we have reached the end of tbe road for the Feds temporary "fixes".
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