Thursday, September 17, 2009

How high energy prices create new economic 'norms'

Henry CK Liu wrote an interesting article in 2005 in which he outlines the rather dire implications for the US and global economy from rising energy prices. He claims, by the way, that the then quite dramatic rise in the price for gasoline was not the result of peak oil. Rather, he appears to say in this case, it came from high refinery costs. Please correct me if I've misinterpreted that point (and others). It is conceivable that the high cost of debt experienced by the petroleum cartel could also (easily) be added to the price of oil.

I've summarised the ten points Mr Liu has made on the subject below:

Fact 1: Energy prices are so basic to the global economy that, when they rise, the same material quantity in transactions simply involves greater cash flow. Higher oil prices do not take money out of the global economy but shift the profit to different sectors. Foreign oil producers must then shift their dollars back into US Treasury bonds or other dollar assets as part of the rules of the game of US dollar hegemony. A rise in monetary value of assets adds to the monetary wealth of the economy.

Fact 2: High energy costs translates into reduced consumption in other sectors unless higher income can be generated from the increased cash flow. Wage rises have a long time lag behind price increases. Workers may be able to increase their income by working longer hours in the meantime. The latter does not necessarily translate into productivity increases.

Fact 3: As cash flow increases for the same amount of material activities, the GDP rises while the economy stagnates. Purchases and sales amount to the same (maybe less) at a higher price and profit margin and with slightly more employees at lower pay per unit of revenue. The inflation from rapidly rising energy costs resulted in businesses hedging to protect themselves in the expanding structured finance world.

Fact 4: The impact of the sharp rise in energy prices results in asset values – in fact the entire commodity price chain - being in a upward spiral. It becomes possible to carry more debt without affected the debt-to-equity ratio. In effect this gives substance to a debt bubble and represents a defacto depreciation of money that is misidentified as growth.

Fact 5: High energy prices threaten the economic viability of some commercial sectors.

Fact 6: No interest-rate policy from any central bank can contain energy-cost-related inflation. Central banks can and do create debt bubbles.

Fact 7: War is a gluttonous consumer of oil. Waging war will translate therefore into rising dollar interest rates due to a higher US federal budget deficit. This is recessionary for the globalised economy but an economic stimulant in the US as long as collateral damage from the war occurs somewhere else.

Fact 8: In a debt bubble, oil in the ground can be more valuable than oil above ground because it can serve as a monetizable asset through asset-backed securities (ABS) in the wild, wild world of structured finance (derivatives). Also gasoline prices will not come down because there is no economic incentive to fix the shortage of crude oil refinery capacity. Refineries are among the most capital-intensive investments and the return on new investment will need continued high gasoline prices to pay for it.

Fact 9: The reason the US imports oil is that importing is cheaper and cleaner than extracting domestic oil – not because the US has a shortage of proven oil reserves.

Fact 10: Fifty-dollar oil [+] will buy the US debt bubble a little more time. Despite all the grandstand warnings about the need to reduce the US trade deficit, a case can be made that the United States cannot drastically reduce its trade deficit without paying the price of a sharp recession that could trigger a global depression.

The real problems with $50 oil
By Henry C K Liu May 26, 2005


Brenda Rosser said...

“The US has experienced six recessions since 1972. At least five of these were associated with oil prices. In every case, when oil consumption in the US reached 4% percent of GDP, the U.S. went into recession. Right now, 4% of GDP is US$80 a barrel oil.... “If you have a flat—or heaven help us, declining—supply of oil, then the emerging and fast-growing economies will have no choice but to start bidding away the oil from the advanced or slow-growing economies. That is consistent with what we’ve seen in the data starting in about 2006. For China to grow, it will have to take away the oil of Japan, the US and Europe, just as it has in the last three years.

National Post

Brenda Rosser said...

Another piece of evidence that US oil reserves (if they are very large, as asserted) will not save the day:

“..the constant dollar cost of producing oil in the United States..has risen exponentially since the mid 1960s, doubling approximately every 15 years.
Barry Commoner, ‘Making Peace with the Planet’ in the chapter ‘Redesigning the Technosphere’