by Gail Tverberg via OilPrice.com, Submitted by Tyler Durden on 02/13/2016
INTRODUCTION :
The increasingly interconnected worlds of debt, energy,
and economic growth are about to cause a very substantial disruption to the
economy, as oil limits, as well as other energy limits, cause a rapid shift
from the benevolent version of the economic supercycle to the portion of the
economic supercycle reflecting contraction. Many people have talked about Peak
Oil, the Limits to Growth, and the Debt Supercycle without realizing that the
underlying problem is really the same - the fact the we are reaching the limits
of a finite world.
[ This is the most interesting
article on Economics that I read so far ]
HERE ONLY EXTRACTS
What is ahead for 2016? Most people don’t realize how
tightly the following are linked:
..
1. Growth in debt
2. Growth in the economy
3. Growth in cheap-to-extract energy supplies
4. Inflation in the cost of producing commodities
5. Growth in asset prices, such as the price of shares of stock and of farmland
6. Growth in wages of non-elite workers
7. Population growth
2. Growth in the economy
3. Growth in cheap-to-extract energy supplies
4. Inflation in the cost of producing commodities
5. Growth in asset prices, such as the price of shares of stock and of farmland
6. Growth in wages of non-elite workers
7. Population growth
..
It looks to me as though this linkage is about to cause a
very substantial disruption to the economy, as oil limits, as well as other
energy limits, cause a rapid shift from the benevolent version of the
economic supercycle to the portion of the economic supercycle reflecting
contraction.
..
The problem of reaching limits in a finite world
manifests itself in an unexpected way: slowing wage growth for non-elite
workers. Lower wages mean that these workers become less able to afford the
output of the system. These problems first lead to commodity oversupply and
very low commodity prices. Eventually these problems lead to falling asset
prices and widespread debt defaults. These problems are the opposite of what
many expect, namely oil shortages and high prices. This strange situation
exists because the economy is a networked system. Feedback loops in a networked
system don’t necessarily work in the way people expect.
..
The idea of a bounce back to new higher oil prices seems
exceedingly unlikely, in part because of the huge overhang of supply in
storage, which owners will want to sell, keeping supply high for a long time.
Furthermore, the underlying cause of the problem is the failure of wages of
non-elite workers to rise rapidly enough to keep up with the rising cost of
commodity production, particularly oil production. Because of falling
inflation-adjusted wages, non-elite workers are becoming increasingly unable to
afford the output of the economic system.
..
How the Economic Growth Supercycle Works, in an Ideal
Situation
..
In an ideal situation, growth in debt tends to stimulate the
economy. The availability of debt makes the purchase of high-priced goods such
as factories, homes, cars, and trucks more affordable. All of these high-priced
goods require the use of commodities, including energy products and metals.
Thus, growing debt tends to add to the demand for commodities, and helps keep
their prices higher than the cost of production, making it profitable to
produce these commodities. The availability of profits encourages the
extraction of an ever-greater quantity of energy supplies and other
commodities.
..
GDP grows
sufficiently rapidly that the ratio of debt to GDP stays relatively flat.
..
Over time, the cost of commodity production tends to rise
for several reasons:
..
1. Population tends to grow over time, so the quantity of
agricultural land available per person tends to fall. Higher-priced techniques
(such as irrigation, better seeds, fertilizer, pesticides, herbicides) are
required to increase production per acre. Similarly, rising population gives
rise to a need to produce fresh water using increasingly high-priced
techniques, such as desalination.
..
2. Businesses tend to extract the least expensive fuels such
as oil, coal, natural gas, and uranium first. They later move on to more expensive
to extract fuels, when the less-expensive fuels are depleted. For example,
Figure 1 shows the sharp increase in the cost of oil extraction that took place
about 1999.
Figure 1. Figure by Steve Kopits of Westwood Douglas
showing the trend in per-barrel capital expenditures for oil exploration and
production. CAGR is “Compound Annual Growth Rate.”
..
3. Pollution tends to become an increasing problem because
the least polluting commodity sources are used first. When mitigations such as
substituting renewables for fossil fuels are used, they tend to be more
expensive than the products they are replacing. The leads to the higher cost of
final products.
..
4. Overuse of resources other than fuels becomes a problem,
leading to problems such as the higher cost of producing metals, deforestation,
depleted fish stocks, and eroded topsoil. Some workarounds are available, but
these tend to add costs as well.
..
As long as the cost of commodity production is rising only
slowly, its increasing cost is benevolent. This increase in cost adds to
inflation in the price of goods and helps inflate away prior debt, so that debt
is easier to pay. It also leads to asset inflation, making the use of debt seem
to be a worthwhile approach to finance future economic growth, including the
growth of energy supplies. The whole system seems to work as an economic growth
pump, with the rising wages of non-elite workers pushing the growth pump along.
..
The Big “Oops” Comes when the Price of Commodities
Starts Rising Faster than Wages of Non-Elite Workers
..
Clearly the wages of non-elite workers need to be rising
faster than commodity prices in order to push the economic growth pump along.
The economic pump effect is lost when the wages of non-elite workers start falling,
relative to the price of commodities. This tends to happen when the cost of
commodity production begins rising rapidly, as it did for oil after 1999
(Figure 1).
..
The loss of the economic pump effect occurs because the
rising cost of oil (or electricity, or food, or other energy products) forces
workers to cut back on discretionary expenditures. This is what happened in the
2003 to 2008 period as oil prices spiked and other energy prices rose sharply. (See
my article Oil
Supply Limits and the Continuing Financial Crisis.) Non-elite workers
found it increasingly difficult to afford expensive products such as homes,
cars, and washing machines. Housing prices dropped. Debt growth slowed, leading
to a sharp drop in oil prices and other commodity prices.
Looking at debt growth, we find that it rose rapidly,
starting about the time oil prices started spiking. Former Director of the
Office of Management and Budget, David Stockman, talks about “The Distastrous
40-Year Debt Supercycle,” which he believes is now ending.
The US government has recently decided to raise interest
rates. This further reduces the buying power of non-elite workers. We have a
situation where the “economic growth pump,” created through the use of a rising
quantity of cheap energy products plus rising debt, is disappearing. While
homes, cars, and vacation travel are available, an increasing share of the
population cannot afford them. This tends to lead to a situation where
commodity prices fall below the cost of production for a wide range of types of
commodities, making the production of commodities unprofitable. In such a
situation, a person expects companies to cut back on production. Many defaults
may occur.
Thus, we seem to be coming to the contraction portion of the
debt supercycle. This is frightening, because if debt is contracting, asset
prices (such as stock prices and the price of land) are likely to fall. Banks
are likely to fail, unless they can transfer their problems to others–owners
of the bank or even those with bank deposits. Governments will be affected
as well, because it will become more expensive to borrow money, and because it
becomes more difficult to obtain revenue through taxation. Many governments may
fail as well for that reason.
..
The U. S. Oil Storage Problem
..
Oil prices began falling in the middle of 2014, so we might
expect oil storage problems to start about that time, but this is not exactly
the case. Supplies of US crude oil in storage didn’t start rising until about
the end of 2014.
What is Ahead for 2016?
..
1. Problems with a slowing world economy are likely to
become more pronounced, as China’s growth problems continue, and as other
commodity-producing countries such as Brazil, South Africa, and Australia experience
recession. There may be rapid shifts in currencies, as countries attempt to
devalue their currencies, to try to gain an advantage in world markets.
..
2. Oil storage seems likely to become a problem sometime in
2016. In fact, if the run-up in oil supply is heavily front-ended to the
December to April period, similar to what happened a year ago, lack of crude
oil storage space could become a problem within the next three months. Oil
prices could fall to $10 or below.
..
3. Falling oil prices are likely to cause numerous problems.
One is debt defaults, both for oil companies and for companies making products
used by the oil industry. Another is layoffs in the oil industry. Another
problem is negative inflation rates, making debt harder to repay. Still another
issue is falling asset prices, such as stock prices and prices of land used to
produce commodities.
..
4. Debt defaults are likely to cause major problems in 2016.
As noted in the introduction, we seem to be approaching the unwinding of a debt
supercycle. We can expect one company after another to fail because of low
commodity prices. The problems of these failing companies can be expected to
spread to the economy as a whole.
..
5. Governments of some oil exporters may collapse or be
overthrown, if prices fall to a low level. The resulting disruption of oil
exports may be welcomed, if storage is becoming an increased problem.
..
6. It is not clear that the complete unwind will take place
in 2016, but a major piece of this unwind could take place in 2016, especially
if crude oil storage fills up, pushing oil prices to less than $10 per barrel.
..
7. Whether or not oil storage fills up, oil prices are
likely to remain very low, as the result of rising supply, barely rising demand,
and no one willing to take steps to try to fix the problem.
..
8. The many problems of 2016 (including rapid moves in
currencies, falling commodity prices, and loan defaults) are likely to cause
large payouts of derivatives, potentially leading to the bankruptcies of
financial institutions, as they did in 2008. To prevent such bankruptcies, most
governments plan to move as much of the losses related to derivatives and debt
defaults to private parties as possible.
..
9. All in all, 2016 looks likely to be a much worse year
than 2008 from a financial perspective. The problems will look similar to those
that might have happened in 2008, but didn’t thanks to government intervention.
This time, governments appear to be mostly out of approaches to fix the
problems.
..
10. Two years ago, I put together the chart shown as Figure
12. It shows the production of all energy products declining rapidly after
2015. I see no reason why this forecast should be changed. Once the debt
supercycle starts its contraction phase, we can expect a major reduction in
both the demand and supply of all kinds of energy products.
Conclusion
We are certainly entering a worrying period. We have
not really understood how the economy works, so we have tended to assume we
could fix one or another part of the problem. The underlying problem seems to
be a problem of physics. The economy is a dissipative structure,
a type of self-organizing system that forms in thermodynamically open systems.
As such, it requires energy to grow.
..
We know that historically
collapses have tended to take many years. This collapse may take place more
rapidly because today’s economy is dependent on international supply chains,
electricity, and liquid fuels–things that previous economies were not dependent
on.
..
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