The headline reads:
In a jolting surprise to the economic recovery and market expectations, the United States economy added just 39,000 jobs in November, and the unemployment rate rose to 9.8 percent, according to the Department of Labor.
The problem – it’s oil.
I have repeated over and over the problem isn’t peak oil but peak cheap oil. As I said here our current economic problems may in part be a result of the financial crisis but just as important was the spike in oil prices in 2008.
The world’s financial system is based on growth and that growth is dependent on cheap and plentiful liquid fuels. Gail Tverberg (Gail the Actuary) explains that the risk of peak oil represents a systemic risk to the world financial system.
While crude oil supply has not yet begun declining, it had been essentially flat since 2005, and this lack of growth is putting tremendous pressure on the world’s financial system, since we now must do more and more with essentially the same oil supply. Oil prices have risen, and this is one source of financial problems, because higher oil prices have a disruptive impact on balance of payments, and can also cause a reduction in profits of companies.
But higher oil prices can also lead to recession and debt defaults. High oil prices don’t give ordinary citizens more salary to spend, so they have to cut back on something else. One possibility is a cutback in discretionary spending, which will tend to lead to recession. If the cutback is in buying new homes, the price of new homes can be expected to drop. James Hamilton wrote a paper called, “Causes and Consequences of the Oil Shock of 2007-2008” showing that the run up in oil prices in the years prior to 2008 was sufficient to cause the major recession we have recently experienced.
If oil prices rise, they may also cause debt defaults. This occurs because people’s salaries don’t rise correspondingly, so they need to cut back somewhere, and some will default on debts. Businesses may also be more at risk of debt defaults, if their cash flow is declining. The lower values of homes may also play a role in increasing defaults.
While one cannot prove that the aforementioned problems were the only causes of the financial crisis of 2008, there is certainly a strong similarity between the expected problems and the types of problems we have recently seen.
It should be noted, too, that a seeming over-supply of oil should not be surprising. As higher prices give rise to recession, this causes a cutback in demand. Reduction in credit availability also tends to reduce demand. So the oil available may be more expensive than what individuals and businesses can afford. If the oil available were cheaper, the oversupply would disappear.
The world economic system is credit based and requires constant growth. That constant growth is dependent on cheap oil.
Our current economic system includes a huge amount of debt. Money is loaned into existence. Debt is used to finance many business expansions. Governments rely heavily on debt.
The US economy has been growing for many years, with only brief interruptions, so nearly all of our experience with borrowing money, and paying it back with interest, has been during periods of economic growth.
Borrowing from the future is relatively easy when the economy is growing, because when the time comes to pay back the debt, the debtor’s economic condition is likely to be as good as it was when the loan was taken out, and may even be better. So defaults are relatively uncommon, and the growth in the economy between the time the loan was taken out and the time it is repaid provides some contribution toward the interest payments.
But what if we start encountering a very different kind of world, one with a decline in oil supplies? If oil resources constrain economic growth, debt defaults can be expected to rise, and the whole debt system underlying our financial system is at risk. Insurance companies are very much at risk too, because many of their assets are bonds. In the past, these bonds would have been repaid with interest, but in a world with little economic growth, and perhaps economic decline, the risk of default becomes much higher.
Unfortunately those who say there is no alternative to oil are right. Without oil we can maintain the economic growth required to sustain the world financial system. It is not a matter of if but when the collapse will occur.
As one would expect, as the world economic sputters upward the price of oil follows.
Oil headed for its biggest weekly gain in a month on speculation that U.S. fuel demand will increase as the economic recovery gathers pace in the world’s biggest oil consumer.
Futures have climbed 5.3 percent this week, the most since the period ending Nov. 5, as data showed U.S. home sales rose and manufacturing expanded. A Labor Department report today may indicate that hiring in the U.S. increased for a second month. Oil reached a three-week high after the Bundesbank raised its forecast for German economic growth next year.
“Macroeconomic sentiment has improved with stronger data from the U.S. and China,” said Andrey Kryuchenkov, an analyst with VTB Capital in London. “However, this optimism has little to do with fundamentals. A sustained rally is unlikely here.”
Oil for January delivery on the New York Mercantile Exchange rose as much as 33 cents to $88.33, the highest price since Nov. 11. The contract was at $88.17 a barrel at 12:06 p.m. London time. It rose 1.4 percent yesterday to $88 a barrel, the highest settlement since October 2008. Brent crude for January on the ICE Futures Europe exchange in London advanced as much as 44 cents to $91.13 a barrel, the most since Oct. 3, 2008.
Crude will rise to $120 a barrel in 2012 as consumption in emerging economies increases, analysts at JPMorgan Chase & Co. said in a report today.
Any recovery will run into a brick wall – the price of oil. It will act like a feed back loop. Economic growth will result in an increase in the price oil which will in turn result in a slowing and eventual halt to growth.
Welcome to The Long Emergency.
Cross posted at Newshoggers