The next months are set to deliver absolute economic turmoil. First quarter growth reports will reveal that major economies are starting to shrink again in the case of those that are currently growing, and in the case of those that are not, that they are shrinking faster than they were. Inflation destroys growth because higher prices reduce the amount of goods that an economy can consume. Whilst GDP may look good on paper, once you adjust the numbers for the change in the value of money, the inflation monster starts to bite.
Oil prices have leapt 15% since the uprising in Libya and will only climb further. Without disruptions to the market from the Arab world we can easily expect them to continue a trend of +8 to 10 % a month depending on how fast the world economy "overheats". This overheating has driven up prices of key commodities, feeding through to higher inflation for consumers. Experts such as Richard Heinberg, and Michael Ruppert predict that as the world economy recovers to its 2008 high, capacity limits to oil extraction will again be breached, driving up prices of consumer goods, marking a return to a state of recession. The evidence points towards this "bumpy plateau" roaring back into life around about now. The soaring oil prices of late, which have in turn driven up food prices, have certainly acted as a major catalyst to the "shock and awe" events in Egypt, Tunisia, and Libya. More will follow as the poor of the middle east become inspired to overthrow their authoritarian governments. This is not a bad thing- the people are long overdue for the type of democratic freedoms that we enjoy in the west- but in return, we are going to have to learn to share a lot more of the oil that we used to get from them, with them.
In the long term, Europe cannot rely on exports of oil from the likes of Saudi Arabia, Lybia, etc, even if stability returns. In Saudi Arabia, domestic oil consumption is growing at 10% a year, which is rapidly eating into (albeit slowly) dwindling production levels. Over the next 9 years, Saudi Arabia will actually become a net importer of oil. This "9 year" phenomenon was first identified by the developer of the Export Land Model (Dallas Geologist Jeffrey Brown), which shows exports of a commodity from a country who has declining domestic production, but rising domestic production. With oil, the time between a countries production peaking and it becoming a net importer has never exceeded 9 years. From the UK, it was 6.
Europe may be able to rely on exports of oil from Russia for a little longer however. Russia's domestic consumption of oil has not grown for a decade, and over the next five years it has a number of significant oil mega-projects to bring old Soviet era oil fields back into production. Russia's exports of oil, including natural gas liquids (of which it has extensive reserves), should grow by 1% a year over the next decade. It will be one of the few countries not to either plateau or decline over the coming years, but it will not manage to compensate for rapidly declining exports in the Arab world.
The inflation threat posed by rising oil prices will probably suppress demand again by bringing economies back into recession, but with the financial system so heavily dependent on growth, how long can this roller-coaster last before a sharp collapse like the one that we almost saw in 2008 becomes unavoidable? In 2008, collapsing real estate prices lead to a slump in investor confidence in bulk mortgage investment packages, leading to a multi billion dollar derivative meltdown. Debts which banks had previously considered to be assets became so invaluable as sub-prime lenders defaulted, driving down property prices to record lows in some US states, that packages of mortgage backed securities became liabilities, ruining the balance sheets of major banks, forcing them to brutally contract lending in order to stay afloat. Even then, some still sank.
In banking law, assets must exceed liabilities by at least the reserve requirement (a percentage excess as a sort of financial breathing room to ensure against losses). When a decline in asset values or a rise in liabilities leads to the reserve requirement being approached, a bank must find emergency cash (normally through borrowing from other banks) to fill the gap. When all banks reach this situation, central banks or governments must step in to avert bank closures. The modern economies dependence on long lines of credit from the banking system means that a real closure of any bank beyond a certain size that led to depositors loosing their money would almost certainly lead to a total economic collapse. It is likely that the powers that be would intervene to prevent this by injecting new money to prop up the system. Surprise surprise, they have already been doing this with successive waves of "quantitative easing" (money printing in normal people speak) both here in the UK, across the pond in the US, and across the channel in the EMU.
After the collapse of the housing bubble, banks have been investing in another asset bubble- commodities. Of course, just like it did in 2008, this is bound to come crashing down, just as high prices start to destroy demand; something that Michael Ruppert eloquently explains in his recent, and highly accredited film "Collapse". The world economy is in a trap, sitting at the crossroads of two potential paths. One is an inflationary rapid decline in GDP, leading to a second great depression, triggered by the ongoing commodity price "escalator". The second is that by some miracle say the Saudi's magic up a two million more barrels of light sweet crude from the desert, the oil price falls off a cliff, and other commodities fall too as the cost of extracting, processing, and distributing them come down. This will destroy the balance sheets of banks, by ruining their prized - and so far successful - commodity asset bubble. This would result in a second banking crisis, which governments might just be able to paper up, depending on how much money they are prepared to print. In turn, this will drive up inflation, eat into growth, and send us back into recession (or depression). Last year I suggested Gold as a good investment, and my hunch was right, it flew from $1100 an ounce, to over $1400. I wasn't so certain on silver, but this year either is good. Investors will look to protect what wealth they can when they realize the true severity of the situation.
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