Monday, December 08, 2008

Falling gas prices linked to credit woes.

Worse, she seems to be saying that letting the dollar implode and switching to a new currency may be the only real solution.

The Oil Drum
Why are gasoline (and oil) prices so low -- and where are they headed?
Posted by Gail the Actuary on December 8, 2008 - 10:20am
Topic: Economics/Finance

...I am becoming more and more convinced that the drop in gasoline prices has a huge amount to do with all of our credit problems (which in turn are related to limits on the oil supply). These credit problems are causing more and more defaults on debt and more and more bankruptcies. These defaults and bankruptcies have a double impact on oil prices--partly from reduced demand, and partly from distressed sellers disposing of futures contracts at low prices, because they are easy assets to sell.

We often hear that "soon" oil prices will hit a bottom, and start shooting back up again. I am less and less certain that this will be the case. Instead, I am concerned that we may on a relentless path to a point far below the point where energy companies can expect to have any chance of making money. We may be on a path toward more and more bankruptcies and defaults of all types--energy companies, owners of commercial real estate, homeowners, financial institutions, auto makers, airlines, and many more. If this is the case, there will be a huge strain on governments, and some may find it necessary to default on their debt.

In order to ultimately get past this crisis, it may be necessary for governments to establish new currencies in which debt is severely limited, and at the same time unwind the debt in the existing currency. I expect that a huge amount of derivatives of all types will need to disappear as well, so that financial assets start bearing a close relationship to physical resources...

...I think what we have happening now is a mixture of (1) supply and demand of the physical product, and (2) credit issues, both of which are focusing on commodity prices of all types--oil, natural gas, coal, copper, corn, and many others. With respect to supply and demand of the physical product, when the US was busy building huge numbers of houses to keep the economy going, and workers around the world were buying many new cars, there was a great deal of demand for these commodities. Once we started building fewer houses and cars, less oil was needed for manufacture and transportation.

...The second problem is debt, and it doesn't work as nearly as rationally. Debt, and the repayment of debt, works as long as there is a growing economy, because with the growth, there are funds for a reasonable percentage of debtors to pay back their debts with interest. When a government senses that the economy is not growing as fast as it would like, it can encourage more and more debt, to try to keep the economy going. It seems to me that since 2001, we have had a considerable amount of government encouraged debt, to try to get the economy to expand faster than its natural rate.

...Without real expansion, debt will eventually start to unwind--there start to be too many defaults. The debt probably would have started to unwind on its own, because of the slowed growth rate, even apart from the oil price increases. The increases in oil and food prices between 2005 and mid 2008 helped prick this debt bubble, but the underlying debt set the stage. The underlying issue that slowed the growth rate was limitations on resources. These resources are not becoming more abundant, so it seems to me that it will be virtually impossible to get the real growth to increase again to the point where it again makes sense to have very much debt. I would argue that it probably never made sense to have the level of debt that we have had in the past few years.


No, it doesn't make sense from any individual family or business's point of view, but at the macroeconomic level (the one from which the banks and the government were encouraging more debt) it made sense because if people had little choice but to live within their wages, this economic collapse would have happened quite a while back - wages are lower now than they were (in real, inflation adjusted terms) back in the 70s. People can't continue to spend more money to "grow" the economy when they have LESS income.

...So what does this have to do with the supply and demand curve? Oil prices can be expected to keep dropping, as long as there is more and more credit imploding, resulting in fewer people being able to buy products made with oil. Given the huge amount of debt outstanding, and the lack of growth to make this debt "repayable", more and more defaults seem likely.

We can ask ourselves, "At what price of oil (or of gasoline) will credit stop imploding?" since the answer to that question will tell us when the price of oil can be expected to start rising again. I believe the answer is, "Whenever governments can figure out a way to get the economy to start growing fast enough so that debt (and its repayment with interest) 'works' again." I would argue that governments will never be able to make this happen.


"Growth forever" was never doable in a closed system in the first place - even if that system is the whole planet. A sustainable economy simply provides what everyone needs when they need it - no "growth" involved at all. This is the kind of economy we're going to have to develop. Gail the Actuary falls short of this obvious fact, though, thinking we just need to do this "for a while."

...We have reached a point where resources (oil and other finite resources) are in such limited supply that the best we might be able to hope for is a level economy for a while. More likely, we are going to see decline. Because of the lack of growth, we are at a point that we need to unwind the debt we have, and learn to live without the vast majority of it.

"Growth forever" will never be a doable paradigm - we will have to learn to be satisfied with limits to production. However, if the transition is handled correctly, there is no reason that our current excessive overproduction cannot be simply reduced to a "maintenance" level instead of a "growth" pattern. Only greed kept us from doing this already.

...If the price of oil and other commodities continues to drop, we are likely to see more and more energy companies going bankrupt. Some of these may be large--we have heard rumors about the financial problems of Glencore, a large privately owned international trading company. The economies of Texas and Louisiana are likely to take major hits, as will Russia and some Middle Eastern countries. Even with the low energy prices, many of the problems the US has are likely to continue (too few houses and cars being built to "pump up" the economy, declining prices on homes and commercial property, and many workers laid off).

The amount of debt we have outstanding is extremely high...According to one web site, the amount of debt Americans have outstanding is $53 trillion, plus unfunded governmental promises (including Social Security and Medicare) of $64 trillion, and plus trillions of dollars of related to derivatives. Not counting the derivatives, this amounts to $386,091 per person. I don't know whether these numbers are precisely correct, but it is clear that with limited resources and a declining economy, there is no way that amounts similar to these amounts are going to be paid in full.


As I myself mentioned recently, there is no way on God's green earth we or ten generations of our children could ever pay off the amount of debt we have right now, much less what they're adding every day. As soon as we admit that and take whatever lumps follow and start living within our means, we can be on the road to sustainability. Until that time, every thing we do to try and prop up the failing debt economy only makes things worse. Hence my suggestion of a Jubilee - Gail the Actuary agrees, in a roundabout sort of way.

...we will need to get rid of most of this debt, and start over again with a monetary system that is more closely tied to resources and discourages debt. It is possible that forward-looking leaders could even start the new monetary system before the old one is phase out. The new monetary system might, for example, start out as more of a rationing system for food and energy products, and eventually be expanded to cover other products as well.

I am afraid I don't have all of the answers. My problem is that when I see a trend line based on oil prices pointing almost straight down, and I can't see a good reason for prices to suddenly start rising, I start worrying that the consequences of the current price collapse could be far worse than any of us on The OIl Drum have been talking about.


As long as demand is so severely depressed, prices will not rise, of course. If we could implement mass transit and debt-free sustainable economics, prices would still have no reason to rise - and that would be a good thing, because we will still need some autonomous vehicles. Government especially needs ambulances, police cars, fire trucks, border patrol, and so on. Low gas prices means less tax dollars we have to cough up to keep basic government services going - and the less gasoline that is wasted on private automobiles, the longer resources for civil service will last. That's hardly a bad thing. And if energy has a "tragedy of the commons" problem in regards to usage and production costs, then obviously it is an industry that SHOULD be nationalized and non-profit.

The Robber Barons will have to find some other way to live like kings at their customer's expense. Boo-hoo. Let them eat cake.

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