Tom Lowe
January 21, 2000
I have recently been studying two documents which are available on the Web. The first, published by the Jerome Levy Institute of Economics, is entitled "Seven Unsustainable Processes" by Wynne Godley. The other is "A Guide to Determining the World's Endowment and Depletion of Oil," by Colin Campbell. Both of these papers make a case in moderately technical language that the economic boom which we are currently experiencing cannot sustain itself. The two web sites upon which these papers reside are worth some additional time, and the reader is encouraged to explore.
First, we examine the Levy Economics Institute paper, which lists seven processes in the United States which cannot continue indefinitely: (1) the fall in private savings into ever deeper negative territory, (2) the rise in the flow of net lending to the private sector, (3) the rise in the growth rate of the real money stock, (4) the rise in asset prices at a rate that far exceeds the growth of profits (or of GDP), (5) the rise in the budget surplus, (6) the rise in the current account deficit [the foreign balance of payments deficit], (7) the increase in the United States' net foreign indebtedness relative to GDP.
We are now in the longest period of sustained economic growth in the history of the United States. Many of us have been wondering why this boom has continued in the face of a government surplus and a severe deficit in our balance of payments. A government surplus, which includes not only the federal government surplus but also the government surpluses of the states, acts in many ways like a vacuum cleaner for money as does a current accounts deficit. The United States is experiencing a relatively high negative deficit in its balance of payments due to its role of being a the purchaser of last resort in the wake of the Asian economic meltdown. Other nations are depending upon the United States to purchase both raw materials and their manufactured products in order to sustain their shaky economies.
If a government surplus and a negative balance of payments are vacuuming money from the economy, why is it expanding? Godley concludes that the increase in private debt has, up to now, more than made up for the deficit in the other two accounts. "Accordingly, the growing budget surplus projected by the CBO, taken in conjunction with the balance of payments projection ..., carries the implication, since the three balances must sum to zero, that the private sector deficit continues to rise for the next 6 or 7 years and even then does not fall significantly." It is simply impossible that private debt should continue to increase over the next 6 or 7 years sufficiently to balance the negative flows that are now occurring and will undoubtedly continue.
Every first-year student in economics learns that borrowing increases the money supply. When you borrow money from the bank, you have your money and the bank holds a negotiable instrument almost equal in value to the money you now hold, and when you deposit that money, as you almost always must, the bank can lend most of your deposit to other customers, with the same results. A dollar, thus recirculated, can generate many dollars in deposits, and ultimately, sales, depending upon a number of financial factors, the most critical of which is the portion of deposits that bank must hold in reserve against withdrawals, the "reserve requirement." Most of these factors are controlled by the Board of Governors of the Federal Reserve System, an agency virtually free of any democratic oversight from either the Congress or the executive branch.
The power of the Board of Governors of the Federal Reserve to regulate the quantity of money available for business transactions is awesome. By adopting an expansionist policy, such as low interest rates and low reserve requirements, the Fed can encourage a boom, low unemployment and, in some cases, inflation of the currency. By adopting a restrictive monetary policy, the Fed can bring about deflation, recession and high unemployment. The policies of the Federal Reserve are usually determined by the dominant economic paradigm. In the 60s and 70s, the governors saw their role as insuring full employment. Today, the Fed (and our national politics) is dominated by the teachings of the Chicago School, which emphasizes low inflation and as little regulation of finance and business as possible -- just like the 20s.
The Federal Reserve, having created the conditions that make it easier for private individuals and corporations to go easily into debt, is now in an unenviable dilemma: with a stock market priced at a level clearly not reflecting the actual earnings or the potential earnings of the underlying businesses, the Fed is in the precarious position of either encouraging further growth in the current bubble, or, by adopting a more restrictive monetary policy, of bringing about a crash in the stock market and a severe recession. The Fed has no easy choice. In all probability it will slowly raise interest rates by 1/4 of a point at regular intervals, hoping to cool a boom that has gotten out of hand. The behavior of the Fed and the market bears a strong resemblance in this respect to their counterparts of the late 1920s. Whether the reforms introduced in the wake of the great crash, but now being rapidly dismantled, will lead to a more benign adjustment remains to be seen.
We now consider the second paper that I previously mentioned: "A Guide to Determining the World's Endowment and Depletion of Oil." Campbell, a petroleum consultant, using many of the techniques of Dr. M. King Hubbert, a geophysicist who accurately predicted in 1956 that oil production in the United States would peak around 1969 and decline thereafter, predicts that world oil production will peak in the next few years, and decline rapidly thereafter.
The implications of a peak and then rapid decline in the supply of cheap fossil fuel are staggering. Our entire civilization runs upon cheap oil. Campbell makes it very clear that the world will not actually run out of oil; there is plenty of oil in the ground to be gotten. It is inexpensive oil that will run out -- $15/barrel oil, or even $35/barrel oil. And Dr. Campbell does not point out in this particular paper the obvious truism that if it costs more than a barrel of oil is worth to produce a barrel of oil, that barrel will not be produced, no matter how high the price.
From the previous oil crunches, we have learned that the demand for oil is highly inelastic in the short run but somewhat more elastic in the long run. That means that when the demand exceeds the amount that can be pumped from the world's oil wells, we can expect an immediate sharp increase in the price of petroleum products, including gasoline. Because we have become addicted to gasoline, with our sports utility vehicles, trucks, air conditioners, and other energy-intensive conveniences, we will suddenly discover that we must pay whatever the market will bear, and since most of our oil comes from overseas, a sharp increase in the price per barrel of oil will cause a sharp increase in our foreign deficit, making it all the more difficult for Americans and their businesses to continue increasing their debt. As in 1973, money will be flowing from our pockets overseas.
Dr. Campbell, in an article for the March, 1998 Scientific American, points out:
[u]nless alternatives to crude oil quickly prove themselves, the market share of the OPEC states in the Middle East will rise rapidly. Within two years, these nations' share of the global oil business will pass 30 percent, nearing the level reached during the oil-price shocks of the 1970s. By 2010 their share will quite probably hit 50 percent.
The world could thus see radical increases in oil prices. That alone might be sufficient to curb demand, flattening production for perhaps 10 years. (Demand fell more than 10 percent after the 1979 shock and took 17 years to recover.) But by 2010 or so, many Middle Eastern nations will themselves be past the midpoint. World production will then have to fall. (id. p. 83)
It is entirely likely that, if the current boom has not already ended, the shock caused by the sudden increase in the price of oil will end the bubble. Since stock market values, as we have seen, are, to a great extent, dependent upon this expansion of debt, a severe increase in the price of oil is virtually certain to bring about an immediate and severe decline in stock values.
This is disturbing news -- Chicken Little stuff. Besides, it is entirely possible that economists have solved the problem of the business cycle, and the current boom will continue during the lives of everyone now living. It is even possible that science will discover a cheap, portable, non-polluting source of energy that will take the place of fossil fuel. But the probability is rather low of these things happening, and irrespective of our economic and political philosophy, if we are over 35 years of age, we know, deep down inside, that nothing lasts -- nothing.
The next question is "Why haven't the oil companies prepared us for this? Why aren't they telling us the truth?"
Simple. Remember Nobel Prize winner Milton Friedmans's notorious (and incredibly evil) statement that corporations have no responsibility of any kind whatever to anyone but their shareholders? Corporate America has taken that to heart. An oil crunch that catches us unprepared would be a gigantic windfall for Exxon and its kin, who could get whatever they asked.
$10 a gallon gas, anyone?
1/30/2000
Note: An article in the New York Times today announced that the "recent run-up in energy prices is rippling across the American economy and affecting practically every family and business as it becomes more expensive to heat a home, refuel and automobile or buy an airline ticket." Nestled in the middle of the article is the fact that we now import approximately 50% of our oil, up from 37% in 1980. This was the prediction of Campbell in his article above. Quoting "economists," the NYT writes that the recent climb in oil prices, due to a decision by OPEC to cut production by 8%, is unlikely to cause a recession because the economy is booming and because oil makes up a much smaller share of the economy than it did then.
Our opinion: the "economists" might be right for the time being. We'll see.
2/19/20009
We are gratified to note that Robert Kuttner, in the February 28, 2000, edition of The American Prospect, has also noticed those "two small clouds on the economic horizon." In essence, those two clouds are the same clouds we warned about back on January 21: the increase in the price of crude oil and the boom in the economy, even though he doesn't quite link the latter to the extreme runup of debt in the private sector, as we did. The result, however, is the same; if prices, in the opinion of Mr. Greenspan, are increasing too quickly then the Fed will crunch the money supply, thus limiting the amount of further debt, and therefore money, that the private sector can create. Debt, of course, cannot indefinitely rise faster than income, so a tightening of credit (or a drastic increase in the price of crude oil) will only accelerate the day of reckoning. The long boom at this stage is beginning to look more and more like a Ponzi scheme.
Copyright 2000, Thomas Lowe. All rights reserved. Published in The Jackson Progressive, http://www.jacksonprogressive.com. Noncommercial reproduction of this article in its entirety is authorized, provided that this notice accompanies any reproduction.