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Both of these stories can’t be true

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Yesterday I wrote about the way a lack of short-term stability was impacting the economy.  Because of the lack of a defined end state for the pandemic and as a result of the ongoing threat of further government lockdowns and restrictions, businesses cannot make investment decisions and households cannot decide whether to save or spend.  This state of economic “learned helplessness” at the consumption end of the economy has fed back through the just-in-time supply chains; generating shortages and threatening inflation on a scale not seen since the 1970s.

Whether governments are capable of creating stability is a moot point.  They are certainly capable of causing a lot of trouble when they get things wrong.  For the most part, government ministers are reactive while government bureaucracies are blinkered and sclerotic… hardly a recipe for decisive action.  Just as they found themselves “fighting the last war” when the pandemic arrived; successive governments have been fighting the last economic war since the crises of the 1970s.  Each new economic policy – usually reacting to the latest mutation of the crisis – was supposed to restore the glory days of the 1953-1973 boom years.  None though, succeeded.  And largely irrespective of government, prosperity continued its remorseless retreat.

The reason for this is that we have entered the era of depleting surplus energy.  As the energy cost of securing energy increases, so our inability to power the wider, non-energy sectors of the economy grows.  In practice, this simply means that a growing number of the things we used to be able to do – like manned missions to the moon, commercial supersonic flight and automated car washes – are no longer possible… at least without massive state subsidies (essentially forcing energy away from still viable activities to power that which is unsustainable).

This ought to tell us something about the economic direction that we are headed in.  But because economists, politicians and business journalists see the economy as primarily a financial system, the assumption is that if states print and properly deploy new currency, a new era of economic stability can be created.  This, undoubtedly, is the basis of the raft of “cheerleading stories” which have led business news coverage as the economy has gradually been unlocked.  For example, on the BBC’s business pages today, we find a claim that Britain’s “recovery” is to be stronger than previously thought:

“The Organisation for Economic Co-operation and Development says the UK is likely to grow 7.2% in 2021, up from its March projection of 5.1%. The OECD raised its forecast for global growth to 5.8%, compared with the 4.2% it predicted in December…

“The OECD said prospects for the world economy had brightened, with activity returning to pre-pandemic levels.”

On the same page though, we find the first rumblings of a problem which will likely become – or perhaps trigger – the next short-term crisis:

“Petrol prices have climbed to their highest level in two years, according to the RAC… Pump prices fell in May 2020 to a low of 106p as oil prices plummeted, but motorists had to abide by travel restrictions.

“The average cost of a litre has since soared to 129.27p, the highest level since August 2019.  The cost of a litre of unleaded is now more than 22p more expensive than a year ago – the biggest 12-month increase seen for 11 years…

“The future of fuel prices is hard to predict more than a few weeks in advance and even more so now as the pandemic appears to have altered the dynamics of fuel retailing…”

Since a litre “classic bottle” of coke cola is currently selling at £1.65, it is all too easy to underestimate the importance of oil to the economy.  This was precisely the mistake which central bankers made in the years immediately prior to the 2008 financial crash, when rising oil prices were treated as a product of too much demand.  In fact, 2005 had been a repeat of 1973.  As Robert McNally explains, both occasions mark the end of a period of cartel control of global oil prices which, in turn, had created a platform of stability upon which the wider economy had been able to grow:

The post-war recovery and the economic boom between 1953 and 1973 were underwritten by the price stability maintained by the Texas Railroad Commission.  During the war, the USA had produced 6 out of every seven barrels of oil consumed; with most of the seventh coming from Venezuela.  Of course, the rest of the world was soon playing catch-up.  Nevertheless the extensive and well-developed US oil fields provided the TRC with the means to set global oil prices.  If prices rose too high, they could increase production.  If prices fell too low, they would order production cuts.

The end came when US oil production peaked in 1970-71; after which oil prices rose steeply, aided in part by the artificial oil shock in 1973.  High and volatile oil prices in the ensuing decade resulted in a period of stagflation in which unemployment and inflation rose together.  It was this which prompted the policy responses which have come to be known as neoliberalism – insecure and lower-paid employment, financial deregulation, offshoring of manufacturing and expensive but ineffective crony government.  And it is, perhaps, worth remembering that in the early days, neoliberal policies made the crisis worse.

By the mid-1980s, and with new oil deposits being produced, the OPEC cartel managed to restore a degree of stability – albeit at much higher prices.  This paved the way for the debt-fuelled boom between 1995 and 2005.  But just as the US peak of oil production ended the TRC’s cartel, so the peak of global conventional oil production removed OPEC’s ability to exert control over global supplies.

After 2005, oil prices began to rise sharply.  And since oil is involved in the manufacture, transport and delivery of almost all goods and services in the economy, from 2006 generalised price increases set in.  As Frank Shostak from the Mises Institute points out:

“If the price of oil goes up and if people continue to use the same amount of oil as before then this means that people are now forced to allocate more money for oil. If people’s money stock remains unchanged then this means that less money is available for other goods and services, all other things being equal. This of course implies that the average price of other goods and services must come off.

“Note that the overall money spent on goods does not change. Only the composition of spending has altered here, with more on oil and less on other goods. Hence, the average price of goods or money per unit of good remains unchanged.”

This was not though, how the central bankers chose to view the situation.  Their text books told them that rising prices were a monetary phenomenon to be tackled using higher interest rates.  And so business and households were hit with a double-whammy.  Not only were they paying more for their fuel, but they were also diverting more of their income to servicing debts.  As we discovered to our cost, this was a particular problem for the so-called “sub-prime” mortgage holders.  So long as prices and interest rates had been stable, these folks had been servicing their debts while the values of their properties rose toward the point where they could be sold at a profit.  Higher fuel and interest payments pulled the rug out from under them, collapsed the mortgage market and exposed the Ponzi house of cards that the banks had built.

On the face of it, the US fracking industry appeared to pick up where OPEC and the TRC had left off.  Although the recession which followed the 2008 crash brought oil prices down, they remained well above an economy-busting $80 per barrel until 2014.  As shale oil production ramped up, however, it removed OPEC+Russia’s ability to maintain higher prices.  And by the end of the decade, US shale production had overtaken the USA’s 1970 peak.

Lower oil prices between 2015 and 2019 served to halt the economic decline of the first half of the decade.  But despite lower prices, the retail apocalypse gathered pace as prosperity retreated and ever less discretionary spending was taking place.  One reason was that the “shale oil miracle” was sucking even more energy away from the non-energy sectors of the economy.

The stability under the TRC and OPEC was based upon an oil price which allowed producers to profit without bankrupting the customer base.  This was only possible because the cost of producing the oil – Energy Cost of Energy – was low.  Low enough in the immediate post-war years, indeed, that the workers’ share of profits across the economy was able to grow for one of the rare times in human history.  The cost of producing oil in the OPEC era was higher, but with a degree of price stability in which producers could profit without crashing the economy. 

The shale period has been very different.  The pricing effects are not the result of an active attempt to fix prices.  Rather, they are a consequence of the geology and the peculiar financial environment in the aftermath of the crash.  Fracked shale wells deplete rapidly, forcing companies to drill ever more wells and to keep the oil flowing… whatever the cost.  OPEC+Russia were simply unable to cut their production sufficiently to match the additional US output without crashing their own economies – remember that oil-producing governments need the tax income from oil too.  Indeed, as Debora Rogers from Economic Policy Forum has shown, shale oil production is seldom profitable.  Nevertheless, in such a low-interest environment, investors were desperate for returns and some, at least were prepared to pump billions of dollars into an industry which returned millions of dollars of oil:

There is a less obvious corollary to this – one which is wrongly presented as a good news story.  Since we have found, and have largely passed peak production of planet Earth’s large and profitable oil fields, the big oil companies have ceased looking for more and have begun to switch to deploying non-renewable renewable energy-harvesting technologies instead.  Some smaller companies will continue to eke out a living from small and expensive deposits.  But there is no longer a possibility of a new cartel having access to sufficient reserves to control global prices.  And that means that the periods of oil price stability on which economic booms are built are the stuff of history.

It is for this reason that both of those BBC stories cannot be true.  Alternative energy sources account for less than 20 percent of global energy; and nuclear and hydroelectric account for most of that.  Fossil fuels continue to power almost all of our transport, agriculture and heavy industry; with diesel fuel still indispensable in providing life-support to eight billion humans.  If the price of oil increases, then, there is no alternative energy source waiting in the wings to save the day.

In practice, this means that we are in similar territory to 2005-08.  As oil prices ratchet up toward $80 once more, spending patterns across the economy will have to shift away from discretionary spending to account for the increased cost of fuel – both direct and as embodied in all of the things which depend upon oil.  This adds to the woes of marginal sectors of the economy such as non-food retail and hospitality, where even a small decline in custom is sufficient to push a business into bankruptcy. 

This though, may be just the beginning.  In the event that central banks are foolish enough to raise interest rates, the very basis of employment may well be undermined.  Throughout the industrial age – and particularly since the Second World War – employment has been regarded both as a route out of poverty and as a route to prosperity.  Deferred gratification has been encouraged and adopted on the understanding that, for example, getting a college degree or spending several hours a day commuting, this may lead to a more prosperous future.  As people are obliged to withdraw from discretionary spending, and as routes to prosperity vanish, the often unacknowledged costs of having a job will be subject to cuts.

For many of us, for example, having a car is a prerequisite of having a job.  But add up the cost of fuel, maintenance, insurance, tax and parking fees and we are spending thousands of pounds a year.  Public transport alternatives often cost even more.  A 12 month rail season ticket from Maidenhead – in the London commuter belt – to London Paddington currently costs £3,360.00; with tube fares across London adding another £1,000 again.  Housing costs are also high for workers seeking to buy or rent within travelling distance of the major employment centres.  And having a job also comes with smaller expenses such as work clothing and daytime meals.  These costs are tolerable so long as the economy can guarantee rising prosperity.  Remove that potential reward though, and the job is no longer worth the investment.

It is very likely that in the aftermath of the pandemic, as the cost of living rises remorselessly, more people we re-localise their employment; seeking lower paid employment close to home in order to save the cost of having a job further afield.  This is one reason why current centres of prosperity like London are likely to be the worst affected by the fallout.

Rising oil prices in an economy which can no longer afford them rule out economic growth of any kind.  Instead, we face a period of economic disintegration in which much of what we have taken for granted in previous decades will be beyond us.

As you made it to the end…

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