In one sense, energy doesn’t
matter all that much to what’s coming. Once debt reaches a certain
level, oil can be $10 a barrel or $200, and either way we’re in trouble.
But the cost of energy can
still play a role in the timing and shape of the next financial crisis.
The housing/derivatives bubble of 2006 -2008, for instance, might have
gone on a while longer if oil hadn’t spiked to $140/bbl in 2007. And the
subsequent recovery was probably expedited by oil plunging to $40 in
2008.
With the Middle East now lurching towards yet another major war,
it’s easy to envision a supply disruption that sends oil back to its
previous high or beyond. So the question becomes, what would that do to
today’s hyper-leveraged global economy? Bad things, obviously. But
before looking at them, let’s all get onto the same page with a quick
explanation of why everyone seems so mad at everyone else over there:
The story begins in 570 A.D. in
what is now Saudi Arabia, with the birth of a boy named Muhammad into a
family of successful merchants. After having some adventures and
marrying a rich widow, around the age of 40 he begins having visions and
hearing voices which lead him to write a holy book called the Qur’an.
More adventures follow, eventually producing a religious/political
system called Islam that comes to dominate a large part of the local
world.
In 632 Muhammad dies without
naming a successor, creating a permanent fissure between the Shi’ites,
who believe that only descendants of the Prophet Muhammad should run
Islam, and the Sunnis, who want future leaders to be chosen by
consensus.
Now fast forward to the end of
World War I: British leader Winston Churchill sits down with some other
old white guys to draw a series of rather arbitrary lines through the
Middle Eastern territories recently captured from the Turkish Ottoman
Empire. They name their creations Jordan, Syria, and Iraq and appoint
kings to rule them. Unfortunately, the new borders enclose both Sunnis
and Shi’ites, along with Kurds and Christians who don’t get along with
either kind of Arab Muslim. Shortly thereafter, Israel is tossed into
the mix and massive but unequally-distributed oil fields are discovered,
pretty much guaranteeing instability for as far as the eye can see.
Since then, the Western powers
have been trying to keep the oil flowing by periodically
deposing/replacing leaders and making/breaking alliances. All without
the slightest idea of what they’re doing. So the situation has gone from
really bad in the 1960s and 1970s to potentially catastrophic today as
various Middle Eastern dictatorships and terrorist groups plot to create
a pan-Islamic “New Caliphate” while secretly developing weapons of mass
destruction.
Which brings us to the present
crisis: The US, having deposed Iraqi dictator Saddam Hussein and spent a
trillion or so dollars trying to create a functioning democracy, has
pulled out, only to see the new Shi’ite government oppress the Sunni
minority into rebellion. With the help (or leadership, it’s not clear)
of Syrian Islamists trained in that country’s ongoing civil war, the
Sunnis are on the verge of taking over Iraq, and both the US and
(Shi’ite) Iran are being pulled back in — apparently on the same side.
It’s a mess, in other words, and the flow of oil, of which Iraq and Iran produce a lot, is now threatened.
So what would $150/bbl oil mean today? Several things:
Another recession.
The US economy contracted at an annual rate of about 2% in the first
quarter and isn’t nearly as strong as analysts had predicted going
forward. Let gas go to $5 a gallon, and the consumer spending on which
the US economic model depends would dry up. Put another way, we might
spend the same amount but it will be mostly for gas and not much else.
So much for the recovery.
Equity bear market.
Stock prices depend on corporate profits, which in turn depend on
sales. If Americans buy less, corporations earn less. With blue chip
equities currently priced for perfection, major companies faced with a
sales slowdown will, if they want to keep their stock prices from
tanking, have to borrow even more money and buy back even more shares,
which will only work until interest costs start consuming what’s left of
their profits. Then US stocks fall hard.
Currency crisis.
If Saudi Arabia manages to stay out of this latest conflict, it will
see its revenues surge as it sells the same amount of oil at higher
prices. But it’s not happy with the US (something about us recently
tilting towards Iran) and apparently no longer feels obligated to accept
only dollars for its oil. Let it start accepting euros, yen and yuan,
and the result will be lessened demand for dollars, a falling dollar
exchange rate and all manner of turmoil in global bond markets.
Derivatives implosion.
Derivatives — basically private bets on the behavior of interest rates,
currency exchange rates and corporate bond defaults — on the books of
major banks have actually increased in the five years since those
instruments nearly destroyed the global financial system. There are
between half a quadrillion and one quadrillion dollars face value of
derivatives out there, and a spike in financial market volatility would
cause a lot of them to blow up.
There are other possible
consequences of a major Middle East war, but the preceding is enough to
make the point that the more leveraged a system is, the more vulnerable
it is to external shocks. And no one has ever been as leveraged as we
are right now.
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