Some Economic Implications of Peak Oil
(Note: Commentaries do not necessarily represent ASPO-USA’s positions; they are personal statements and observations by informed commentators.)
World oil production probably peaked in 2008. Liquid fuel production, including oil, is indicated by the OPEC data  to have reached a peak in July 2008 at about 86 million barrels per day, with its price peaking at about the same time. ASPO International agrees, as indicated on the chart page of their recent newsletters .
Peak oil has profound economic implications, most of which are unwelcome. There is good evidence indicating that peak oil triggered the global economic crisis; that oil price was the limiting factor that broke the momentum as the global economy tried to keep expanding. [3,4].
Predictably some factor like the end of cheap oil must limit the ability of global investments to expand exponentially, while paying interest on the global debt bubble. The risk was evenly spread by instruments like credit default swaps, so the collapse was global.There is scholarly confirmation of the role of the 2008 oil shock on the global economy should see the April 2009 Brookings paper “Causes of the Oil Shock of 2007-08”, by UC San Diego economist Dr. James Hamilton: [5,6].
“...Whether we would have avoided those events had the economy not gone into recession, or instead would have merely postponed them, is a matter of conjecture. Regardless of how we answer that question, the evidence to me is persuasive that, had there been no oil shock, we would have described the U.S. economy in 2007:Q4-2008:Q3 as growing slowly, but not in a recession."
A hugely overextended bubble of unregulated, interlinked, securitized global debt and speculation set the stage for a collapse, as described in Charles Morris’ early 2008 book Trillion Dollar Meltdown. Kevin Phillips’ book Bad Money supplements the picture.
One subtle but important economic effect of rising oil prices is cost-push inflation, seen as stagflation during the energy crisis of the 1970s. This is a type of multiplier effect caused by the embedded cost of oil in goods slowly spreading price increases throughout the economy, seeming like a universal increasing tax.
The current relative collapse in oil prices, even if caused by peak oil, leads to the political problem of convincing the general public that oil dependence should remain a central concern when its price decreases.
The natural tendency of politicians in an economic crisis is to focus on unemployment. There is probably nothing politicians like to do more by their nature than spend public money. Keynesian economic stimulation is thus almost guaranteed to be popular, especially since it promises fast results. Popular belief is that FDR treated the depression with Keynesian-style deficit spending, although his remedy actually owed more to Irving Fisher .The Keynesian spending advocates, who prevail in the Obama administration and Congress, seek to use government spending to reverse the current deflationary spiral and restore US economic activity to its previous “normal” condition. Keynesian stimulus spending may be the theory, but far more public money is being committed to the banks, with no clear diagnosis or plan, along with a smaller amount of classic Keynesian stimulus. Most politicians prefer spending to reform. Meanwhile there are dominant political interests seeking to preserve the friendly old financial system [9,10,11].
There are at least three important problems with the current federal intervention strategy, which is a consensus action by the Administration, Congress, the U.S. Treasury and the Federal Reserve.
- The politically possible stimulus funds are not in scale with a global crisis. The biggest investment banks are on federal life support; “So far, $12 trillion has been pumped into the financial system while less than $450 billion fiscal stimulus has gone to the "real" economy where workers are struggling just to keep food on the table.” .
- 2. The US economic remedy is national in character whereas the trade collapse is global. A central contradiction is that while new dollars are massively created to try to revive the domestic economy, the same dollars try to serve their traditional but conflicting role as the standard reserve currency basis for global trade, preferably remaining stable enough to maintain trade hegemony .
- 3. Not many economists seem to have a good grasp of peak oil and its economic implications. If current government economic policy succeeds in stimulating a renewed economic expansion, falling production will lead to another oil price shock. Reflating the global economy is almost certain to revive a bidding war for whatever oil remains accessible to the open market. See "US elections", #1101 .
Newly issued federal credit along with existing obligations are becoming an alarming percentage of the total economy. Sooner or later, the massive amounts of easy federal credit now being injected into the system will cause money to circulate more freely and raise prices.
As spending revives, smart investors are likely to focus on those parts of the economy guaranteed to survive no matter what, largely involving food and energy. The sectors of the U.S. economy tied to cheap energy and discretionary spending, like distant vacations, have a bad investment outlook.
Even if traditional Keynesian techniques were perfectly employed on smart sustainable energy projects, we now lack the time for proper preparation as the Hirsch Report warned , all assuming our institutions were appropriate . Another oil price shock to the global economy seems unavoidable whenever rising global demand recreates a tight world market. This is likely to cause cost-push inflation to spread from fuel costs while leaving other sectors depressed.
The threat of inflation is partly hidden early on because there is not a strong link between the amount of money in general circulation and the public willingness to spend it. How much money there seems to be around depends on how freely other people who have it spend it.
However much economics strives to be a science, it is really based on a foundation of psychology and politics . An increasing velocity of money circulation can overcome the ability of the government to control runaway inflation when public behavior shifts.
Financial Sense , quoting an excellent historical analysis by Jens O. Parsons, explains the apparently favorable early effects of deficit spending. This contrasts to the unpleasant effects of inflation later on when the circulation of money speeds up and starts chasing limited goods.
Whether the feds will have the political ability to cool down inflation when the urge to spend it revives is an important issue. If those in charge are reluctant to take bold action such as regulating the banks now, why would they be any bolder when the time comes to raise interest rates; when it comes time to take away the proverbial economic punchbowl as Paul Volker once did? .
“...Meltzer says political pressure will prevent Bernanke, 55, and fellow policy makers from withdrawing liquidity quickly enough as the economy recovers....” John Ryding, founder of RDQ Economics LLC in New York and a former Fed economist, agrees that the central bank will be slow to soak up all the cash it has injected into the financial system, in part because policy makers will be fixated on still-high unemployment.”
What we need to do now, in terms of better public policy, is in many cases reasonably clear to experts and scientists. Awareness is increasing through the work of ASPO, the Post Carbon Institute, Worldwatch, the Oil Drum, etc., along with countless such efforts seen on the Internet. The public may not know the details, but they are aware that we could do a lot better.
One approach, suggested by economists at the Levy Institute, proposes a new governmental regulation and banking approach; “It’s That “Vision” Thing: Why the Bailouts Aren’t Working, and Why a New Financial System Is Needed” [8, 20].
Adding things up, the evidence indicates we need a new government regulated banking system or government bank that will consciously focus on new public spending goals, perhaps initially focused on preparing for the next oil shock and avoiding hyper-inflation, and then on providing for longer-term social needs.
Roger Baker is a member of the ASPO-USA Advisory Board, also a Founding Member, and is a scientific instrument designer, investor, writer, and transportation reform activist living in Austin (TX). Recently he has been writing commentaries on economics for the Austin-based Rag Blog.