Why is the price of oil so low now? In fact, why are all commodity prices so low? I see the problem as being an affordability issue that has been hidden by a growing debt bubble. As this debt bubble has expanded, it has kept the sales prices of commodities up with the cost of extraction (Figure 1), even though wages have not been rising as fast as commodity prices since about the year 2000. Now many countries are cutting back on the rate of debt growth because debt/GDP ratios are becoming unreasonably high, and because the productivity of additional debt is falling.
If wages are stagnating, and debt is not growing very rapidly, the price of commodities tends to fall back to what is affordable by consumers. This is the problem we are experiencing now (Figure 1).
I will explain the situation more fully in the form of a presentation. It can be downloaded in PDF form: Oops! The world economy depends on an energy-related debt bubble. Let’s start with the first slide, after the title slide.
Growth is incredibly important to the economy (Slide 2). If the economy is growing, we keep needing to build more buildings, vehicles, and roads, leading to more jobs. Existing businesses find demand for their products rising. Because of this rising demand, profits of many businesses can be expected to rise over time, thanks to economies of scale.
Something that is not as obvious is that a growing economy enables much greater use of debt than would otherwise be the case. When an economy is growing, as illustrated by the ever-increasing sizes of circles, it is possible to “borrow from the future.” This act of borrowing gives consumers the ability to buy more things now than they would otherwise would be able to afford–more “demand” in the language of economists. Customers can thus afford cars and homes, and businesses can afford factories. Companies issuing stock can expect that price of shares will most likely rise in the future.
Without economic growth, it would be very hard to have the financial system that we have today, with its stable banks, insurance companies, and pension plans. The pattern of economic growth makes interest and dividend payments easier to make, and reduces the likelihood of debt default. It allows financial planners to set up savings plans for retirement, and gives people confidence that the system will “be there” when it is needed. Without economic growth, debt is more of a last resort–something that might land a person in debtors’ prison if things go wrong.
It should be obvious that the economic growth story cannot be true indefinitely. We would run short of resources, and population would grow too dense. Pollution, including CO2 pollution, would become an increasing problem.
The question without an obvious answer is “When does the endless economic growth story become untrue?” If we listen to the television, the answer would seem to be somewhere in the distant future, if a slowdown in economic growth happens at all.
Most of us who read financial newspapers are aware that more debt and lower interest rates are the types of stimulus provided to the economy, to try to help it grow faster. Our current “run up” in debt seems to have started about the time of World War II. This growing debt allows “demand” for goods like houses, cars, and factories to be higher. Because of this higher demand, commodity prices can be higher than they otherwise would be.
Thus, if debt is growing quickly enough, it allows the sales price of energy products and other commodities to stay as high as their cost of extraction. The problem is that debt/GDP ratios can’t rise endlessly. Once debt/GDP ratios stop rising quickly enough, commodity prices are likely to fall. In fact, the run-up in debt is a bubble, which is itself in danger of collapsing, because of too many debt defaults.
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