Are much lower oil prices good news for the U.S. economy? Only if you like collapsing capital expenditures, rising unemployment and a potential financial implosion on Wall Street. Yes, lower gasoline prices are good news for the middle class. I certainly would rather pay two dollars for a gallon of gas than four dollars. But in order to have money to fill up your vehicle you have got to have an income first. And since the last recession, the energy sector has been the number one creator of good jobs in the U.S. economy by far. Barack Obama loves to stand up and take credit for the fact that the employment picture in this country has been improving slightly, but without the energy industry boom, unemployment would be through the roof. And now that the “energy boom” is rapidly becoming an “energy bust”, what will happen to the struggling U.S. economy as we head into 2015?
At the start of this article I mentioned that much lower oil prices would result in “collapsing capital expenditures”.
If you do not know what a “capital expenditure” is, the following is a definition that comes from Investopedia…
“Funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment. This type of outlay is made by companies to maintain or increase the scope of their operations. These expenditures can include everything from repairing a roof to building a brand new factory.”
Needless to say, this kind of spending is very good for an economy. It builds infrastructure, it creates jobs and it is an investment in the future.
In recent years, energy companies have been pouring massive amounts of money into capital expenditures. In fact, the energy sector currently accounts for about a third of all capital expenditures in the United States according to Deutsche Bank…
US private investment spending is usually ~15% of US GDP or $2.8trn now. This investment consists of $1.6trn spent annually on equipment and software, $700bn on non-residential construction and a bit over $500bn on residential. Equipment and software is 35% technology and communications, 25-30% is industrial equipment for energy, utilities and agriculture, 15% is transportation equipment, with remaining 20-25% related to other industries or intangibles. Non-residential construction is 20% oil and gas producing structures and 30% is energy related in total. We estimate global investment spending is 20% of S&P EPS or 12% from US. The Energy sector is responsible for a third of S&P 500 capex.
These companies make these investments because they believe that there are big profits to be made.
Unfortunately, when the price of oil crashes those investments become unprofitable and capital expenditures start getting slashed almost immediately.
For example, the budget for 2015 at ConocoPhillips has already been reduced by 20 percent…
ConocoPhillips is one of the bigger shale players. And its decision to slash its budget for next year by 20% is raising eyebrows. The company said the new target reflects lower spending on major projects as well as “unconventional plays.” Despite the expectation that others will follow, it doesn’t mean U.S. shale oil production is dead. Just don’t expect a surge in spending like in recent years.
And Reuters is reporting that the number of new well permits for the industry as a whole plunged by an astounding 40 percent during the month of November…
Plunging oil prices sparked a drop of almost 40 percent in new well permits issued across the United States in November, in a sudden pause in the growth of the U.S. shale oil and gas boom that started around 2007.
Data provided exclusively to Reuters on Tuesday by industry data firm Drilling Info Inc showed 4,520 new well permits were approved last month, down from 7,227 in October.
If the price of oil stays this low or continues dropping, this is just the beginning.
Meanwhile, the flow of good jobs that this industry has been producing is also likely to start drying up.
According to a new study, investments in oil and gas exploration and production generate substantial economic gains, as well as other benefits such as increased energy independence. The Perryman Group estimates that the industry as a whole generates an economic stimulus of almost $1.2 trillion in gross product each year, as well as more than 9.3 million permanent jobs across the nation.
The ripple effects are everywhere. If you think about the role of oil in your life, it is not only the primary source of many of our fuels, but is also critical to our lubricants, chemicals, synthetic fibers, pharmaceuticals, plastics, and many other items we come into contact with every day. The industry supports almost 1.3 million jobs in manufacturing alone and is responsible for almost $1.2 trillion in annual gross domestic product. If you think about the law, accounting, and engineering firms that serve the industry, the pipe, drilling equipment, and other manufactured goods that it requires, and the large payrolls and their effects on consumer spending, you will begin to get a picture of the enormity of the industry.
And these are good paying jobs. They aren’t eight dollar part-time jobs down at your local big box retailer. These are jobs that comfortably support middle class families. These are precisely the kinds of jobs that we cannot afford to lose.
In recent years, there has been a noticeable economic difference between areas of the country where energy is being produced and where energy is not being produced.
Since December 2007, a total of 1.36 million jobs have been gained in shale oil states.
Meanwhile, a total of 424,000 jobs have been lost in non-shale oil states.
So what happens now that the shale oil boom is turning into a bust?
That is a very good question.
Even more ominous is what an oil price collapse could mean for our financial system.
Based on recent stress tests of subprime borrowers in the energy sector in the US produced by Deutsche Bank, should the price of US crude fall by a further 20pc to $60 per barrel, it could result in up to a 30pc default rate among B and CCC rated high-yield US borrowers in the industry. West Texas Intermediate crude is currently trading at multi-year lows of around $75 per barrel, down from $107 per barrel in June.
“A shock of that magnitude could be sufficient to trigger a broader high-yield market default cycle, if materialized,” warn Deutsche strategists Oleg Melentyev and Daniel Sorid in their report.
If the price of oil stays at this level or continues to go down, it is inevitable that we will start to see some of these junk bonds go bad.
In fact, one Motley Fool article recently stated that one industry analyst believes that up to 40 percent of all energy junk bonds could eventually go into default…
The junk bonds, or noninvestment-rated bonds, of energy companies are also beginning to see heavy selling as investors start to worry that drillers could one day default on these bonds. Those defaults could get so bad, according to one analyst, that up to 40% of all energy junk bonds go into default over the next few years if oil prices don’t recover.
In addition, plunging oil prices could end up absolutely destroying the banks that are holding enormous amounts of energy derivatives. This is something that I recently covered in this article and this article.
As you read this, there are five “too big to fail” banks that each have more than 40 trillion dollars in exposure to derivatives. Of course only a small fraction of that total exposure is made up of energy derivatives, but a small fraction of 40 trillion dollars is still a massive amount of money.
These derivatives trades are largely unregulated, and even Forbes admits that they are likely to be at the heart of the coming financial collapse…
No one understands the derivative risk positions of the Too Big To Fail Banks, JP Morgan Chase, Citigroup, Bank of America, Goldman Sachs or Morgan Stanley. There is presently no way to measure the risks involved in the leverage, quantity of collateral, or stability of counter-parties for these major institutions. To me personally they are big black holes capable of potential wrack and ruin. Without access to confidential internal data about these risky derivative positions the regulators cannot react in a timely and measured fashion to block the threat to financial stability, according to a National Bureau of Economic Research study.
So do we have any hope?
Yes, if oil prices start going back up, much of what you just read about can be averted.
Unfortunately, that does not seem likely any time soon. Even though U.S. energy companies are cutting back on capital expenditures, most of them are still actually projecting an increase in production for 2015. Here is one example from Bloomberg…
Continental, the biggest holder of drilling rights in the Bakken, last month said 2015 output will grow between 23 percent and 29 percent even after shelving plans to allocate more money to exploration.
Higher levels of production will just drive the price of oil even lower.
At this point, Morgan Stanley is saying that the price of oil could plummet as low as $43 a barrel next year.
If that happens, it would be absolutely catastrophic to the most important industry in the United States.
In turn, that would be absolutely catastrophic for the economy as a whole.
So don’t let anyone tell you that much lower oil prices are “good” for the economy.
Are we about to see U.S. stocks take a significant tumble? If you are looking for a “canary in the coal mine” for the U.S. stock market, just look at high yield bonds. In recent years, almost every single time junk bonds have declined substantially there has been a notable stock market correction as well. And right now high yield bonds are steadily moving lower. The biggest reason for this is falling oil prices. As I wrote about the other day, energy companies now account for about 20 percent of the high yield bond market. As the price of oil falls, investors are understandably becoming concerned about the future prospects of those companies and are dumping their bonds. What is happening cannot be described as a “crash” just yet, but there has been a pretty sizable decline for junk bonds over the past month. And as I noted above, junk bonds and stocks usually move in tandem. In fact, junk bonds usually start falling before stocks do. So does the decline in high yield bonds that we are witnessing at the moment indicate that we are on the verge of a significant stock market correction?
The S&P 500 and the iShares iBoxx High Yield Corporate Bond ETF are a mirror image since the start of the year, but since the end of October, high yield has diverged to the lower right, and yet the S&P 500 has continued to record highs. Since separating in October, the S&P 500 is up 3 percent, while the high-yield ETF is down 4 percent.
On 10 occasions since 2007, the high-yield ETF dropped 5 percent in 30 trading days. During nine of those instances, the S&P 500 fell as well, with an average return of negative 9 percent, according to CNBC analysis using Kensho.
Only once did high yield give a false sell signal. That was last year, when the market was already entranced by the Federal Reserve’s quantitative easing program, which has seemed to elevate stocks with an abnormal consistency. And even then, the S&P 500 managed just a 0.4 percent climb amid the junk debt rout.
Personally, I am convinced that this correlation between junk bonds and stocks is very significant.
Let’s just go back and look at what happened during the financial crash of 2008 for a moment.
In the chart posted below, you can see that high yield bonds began crashing in the middle of September that year…
But U.S. stocks did not crash at the same time. In fact, the chart below shows that they did not really begin crashing until early October…
That is why analysts often refer to junk bonds as a “leading indicator”. What happens to high yield debt is often a really good indicator of what is about to happen to stocks.
Now let’s take a look at what is happening today.
Since the beginning of November, junk bonds have been falling steadily…
Meanwhile, the Dow has continued to reach new heights…
This is not a state of affairs that can persist indefinitely. Either junk bonds will rebound or U.S. stocks will start falling.
If the U.S. economy was on solid footing, you could perhaps argue that it could go either way.
Unfortunately, that is not the case. At this point, the stock market has become completely divorced from economic fundamentals. Price to earnings ratios are at absurd levels, margin debt is hovering near record highs, and the “real economy” continues to fall apart. We are enjoying a massively inflated standard of living which is being propped up by the largest mountain of debt in world history, and it is only a matter of time before reality starts catching up with us.
And the signs of our long-term economic decline are all around us if you are willing to look at them. For example, the lead headline on the Drudge Report today was about how China has now overtaken us and has become the largest economy on the planet…
Hang on to your hats, America.
And throw away that big, fat styrofoam finger while you’re about it.
There’s no easy way to say this, so I’ll just say it: We’re no longer No. 1. Today, we’re No. 2. Yes, it’s official. The Chinese economy just overtook the United States economy to become the largest in the world. For the first time since Ulysses S. Grant was president, America is not the leading economic power on the planet.
It just happened — and almost nobody noticed.
The International Monetary Fund recently released the latest numbers for the world economy. And when you measure national economic output in “real” terms of goods and services, China will this year produce $17.6 trillion — compared with $17.4 trillion for the U.S.A.
Meanwhile, some of the most iconic companies in the United States continue to struggle deeply. For instance, Sears has just announced that the number of store closings for this year is going to reach a total of 235 and that the company lost more than half a billion dollars during the third quarter of 2014 alone…
Sears Holdings Corp., posted a disappointing third quarter Thursday that saw revenue, earnings, and sales at stores open at least a year all fall as the retailer tries to salvage its business.
Sears, which owns Kmart, lost $548 million, or $5.15 a share, for the period ended Nov. 1. That’s up from a loss of $534 million, or $5.03 a share, in the year-ago period.
Even though Sears is losing more than 500 million dollars a quarter, banks and investors continue to inject new money into the corporation. That is a crying shame, because Sears is a company that is going to zero. Anyone that is investing in Sears at this point is just pouring their money into a black hole. As Kevin O’Leary would say, they are guilty of murdering money.
And of course what is happening to Sears is just part of the broader “retail apocalypse” that I keep writing about. In order for retailers to thrive they need healthy consumers, and consumers are not financially healthy because the real economy is a disaster zone.
But these days so many people are in denial. The stock market has been soaring for so long that many skeptics are now proclaiming that another 2008-style crash will never happen. Even though the fact that we are in the midst of an absolutely insane financial bubble should be glaringly obvious to anyone with half a brain, these skeptics have convinced themselves that the current state of affairs can persist indefinitely.
Sadly, it looks like what is about to hit us in 2015 is going to serve as a very rude wake up call for them and for the millions of other Americans that currently have their heads in the sand.
Could rapidly falling oil prices trigger a nightmare scenario for the commodity derivatives market? The big Wall Street banks did not expect plunging home prices to cause a mortgage-backed securities implosion back in 2008, and their models did not anticipate a decline in the price of oil by more than 40 dollars in less than six months this time either. If the price of oil stays at this level or goes down even more, someone out there is going to have to absorb some absolutely massive losses. In some cases, the losses will be absorbed by oil producers, but many of the big players in the industry have already locked in high prices for their oil next year through derivatives contracts. The companies enter into these derivatives contracts for a couple of reasons. Number one, many lenders do not want to give them any money unless they can show that they have locked in a price for their oil that is higher than the cost of production. Secondly, derivatives contracts protect the profits of oil producers from dramatic swings in the marketplace. These dramatic swings rarely happen, but when they do they can be absolutely crippling. So the oil companies that have locked in high prices for their oil in 2015 and 2016 are feeling pretty good right about now. But who is on the other end of those contracts? In many cases, it is the big Wall Street banks, and if the price of oil does not rebound substantially they could be facing absolutely colossal losses.
It has been estimated that the six largest “too big to fail” banks control $3.9 trillion in commodity derivatives contracts. And a very large chunk of that amount is made up of oil derivatives.
By the middle of next year, we could be facing a situation where many of these oil producers have locked in a price of 90 or 100 dollars a barrel on their oil but the price has fallen to about 50 dollars a barrel.
In such a case, the losses for those on the wrong end of the derivatives contracts would be astronomical.
At this point, some of the biggest players in the shale oil industry have already locked in high prices for most of their oil for the coming year. The following is an excerpt from a recent article by Ambrose Evans-Pritchard…
US producers have locked in higher prices through derivatives contracts. Noble Energy and Devon Energy have both hedged over three-quarters of their output for 2015.
Pioneer Natural Resources said it has options through 2016 covering two- thirds of its likely production.
So they are protected to a very large degree. It is those that are on the losing end of those contracts that are going to get burned.
Of course not all shale oil producers protected themselves. Those that didn’t are in danger of going under.
For example, Continental Resources cashed out approximately 4 billion dollars in hedges about a month ago in a gamble that oil prices would go back up. Instead, they just kept falling, so now this company is likely headed for some rough financial times…
Continental Resources (CLR.N), the pioneering U.S. driller that bet big on North Dakota’s Bakken shale patch when its rivals were looking abroad, is once again flying in the face of convention: cashing out some $4 billion worth of hedges in a huge gamble that oil prices will rebound.
Late on Tuesday, the company run by Harold Hamm, the Oklahoma wildcatter who once sued OPEC, said it had opted to take profits on more than 31 million barrels worth of U.S. and Brent crude oil hedges for 2015 and 2016, plus as much as 8 million barrels’ worth of outstanding positions over the rest of 2014, netting a $433 million extra profit for the fourth quarter. Based on its third quarter production of about 128,000 barrels per day (bpd) of crude, its hedges for next year would have covered nearly two-thirds of its oil production.
When things are nice and stable, the derivatives marketplace works quite well most of the time.
But when there is a “black swan event” such as a dramatic swing in the price of oil, it can create really big winners and really big losers.
And no matter how complicated these derivatives become, and no matter how many times you transfer risk, you can never make these bets truly safe. The following is from a recent article by Charles Hugh Smith…
Financialization is always based on the presumption that risk can be cancelled out by hedging bets made with counterparties. This sounds appealing, but as I have noted many times, risk cannot be disappeared, it can only be masked or transferred to others.
Relying on counterparties to pay out cannot make risk vanish; it only masks the risk of default by transferring the risk to counterparties, who then transfer it to still other counterparties, and so on.
This illusory vanishing act hasn’t made risk disappear: rather, it has set up a line of dominoes waiting for one domino to topple. This one domino will proceed to take down the entire line of financial dominoes.
The 35% drop in the price of oil is the first domino. All the supposedly safe, low-risk loans and bets placed on oil, made with the supreme confidence that oil would continue to trade in a band around $100/barrel, are now revealed as high-risk.
In recent years, Wall Street has been transformed into the largest casino in the history of the world.
Most of the time the big banks are very careful to make sure that they come out on top, but this time their house of cards may come toppling down on top of them.
If you think that this is good news, you should keep in mind that if they collapse it virtually guarantees a full-blown economic meltdown. The following is an extended excerpt from one of my previous articles…
For those looking forward to the day when these mammoth banks will collapse, you need to keep in mind that when they do go down the entire system is going to utterly fall apart.
At this point our economic system is so completely dependent on these banks that there is no way that it can function without them.
It is like a patient with an extremely advanced case of cancer.
Doctors can try to kill the cancer, but it is almost inevitable that the patient will die in the process.
The same thing could be said about our relationship with the “too big to fail” banks. If they fail, so do the rest of us.
We were told that something would be done about the “too big to fail” problem after the last crisis, but it never happened.
At this point, the five largest banks in the country account for 42 percent of all loans in the United States, and the six largest banks control 67 percent of all banking assets.
If those banks were to disappear tomorrow, we would not have much of an economy left.
Our entire economy is based on the flow of credit. And all of that debt comes from the banks. That is why it has been so dangerous for us to become so deeply dependent on them. Without their loans, the entire country could soon resemble White Flint Mall near Washington D.C….
It was once a hubbub of activity, where shoppers would snap up seasonal steals and teens would hang out to ‘look cool’.
But now White Flint Mall in Bethesda, Maryland – which opened its doors in March 1977 – looks like a modern-day mausoleum with just two tenants remaining.
Photographs taken inside the 874,000-square-foot complex show spotless faux marble floors, empty escalators and stationary elevators.
Only a couple of cars can be seen in the parking lot, where well-tended shrubbery appears to be the only thing alive.
I keep on saying it, and I will keep on saying it until it happens. We are heading for a derivatives crisis unlike anything that we have ever seen. It is going to make the financial meltdown of 2008 look like a walk in the park.
Our politicians promised that they would do something about the “too big to fail” banks and the out of control gambling on Wall Street, but they didn’t.
Now a day of reckoning is rapidly approaching, and it is going to horrify the entire planet.
Did anyone out there anticipate that 2011 would be such a wild year? The year is barely over two months old and we have already seen multiple civil wars erupt, rumors of more wars all over the mainstream media (potentially even including the United States), riots and revolutions breaking out all over the globe, oil prices soaring into the stratosphere and chaos on global financial markets. So why is all of this happening? Is all of this one big coincidence or is there a reason why we are witnessing such global chaos right now? Is it just coincidence that revolutions have broken out in over a dozen countries in the Middle East all at the same time? Is it just a coincidence that global prices for oil, food and precious metals are all skyrocketing? Is it just a coincidence that world financial markets suddenly seem more vulnerable than at any time since 2008? Looking at what is going on in the world right now, it is very tempting to use the phrase “a perfect storm” to describe it. Unfortunately, this “perfect storm” is very likely to plunge the global economy into yet another financial collapse if it continues to get even worse.
After decades of relative stability, the Middle East has erupted in chaos in 2011. In the post-World War 2 era, we have never seen a time when there have been so many major internal revolutions all at once. All of these simultaneous revolutions are driving the price of oil rapidly upwards.
The price of West Texas crude is now over $102 a barrel and the price of Brent crude is now over $116 a barrel and if the chaos in the Middle East continues those numbers are likely to go a lot higher.
Meanwhile, gold has set a new all-time record this week and the price of silver is absolutely exploding.
In fact, just about every kind of “hard asset” that you can possibly name is going up in price. Investors don’t like all of this instability and they are looking for safe places to put their money.
Unfortunately, the global situation looks like it may become even more heated.
The calls for military action against Libya are rapidly reaching a crescendo.
The U.S. Senate has unanimously passed a resolution calling for the UN Security Council to impose a no-fly zone over Libya, and many members of Congress are openly declaring that the U.S. and NATO should take unilateral action no matter what the UN ultimately decides.
But implementing a no-fly zone is not a simple thing. It is not just a matter of telling Libya not to fly their planes. Rather, imposing a no-fly zone over Libya would constitute a major military operation.
“Let’s just call a spade a spade. A no-fly zone begins with an attack on Libya to destroy the air defenses … and then you can fly planes around the country and not worry about our guys being shot down.”
You would have to remove the air defense capability in order to establish the no-fly zone so it – no illusions here, it would be a military operation.
Essentially, imposing a no-fly zone over Libya would be an act of war.
Most of our representatives in Washington D.C. seem to be quite ready to go to war in Libya, but it is another story entirely when it comes to the American people. A recent Rasmussen poll found that a whopping 67 percent of Americans do not want the U.S. to get more involved in the unrest going on in Arab countries and only 17 percent of Americans do want the U.S. to get more directly involved.
But the American people don’t get to decide whether we go to war or not. Our leaders in Washington D.C. do. The USS Enterprise and other major warships are on their way to Libya, and U.S. forces throughout the Mediterranean are on high alert.
So could the U.S. really get involved in another war in the Middle East?
Well, if the U.S. and NATO choose to get involved they will do it without the approval of the rest of the world.
On Wednesday, the Arab League issued a statement which specifically rejected “any foreign interference within Libya on behalf of the opposition”.
Not only that, but any military action by the UN will most likely be blocked by both China and Russia.
“If someone in Washington is seeking a blitzkrieg in Libya, it is a serious mistake because any use of military force outside the NATO responsibility zone will be considered a violation of international law.”
But Libya is far from the only crisis point in the Middle East.
In fact, a much larger problem may be brewing in Saudi Arabia.
On Facebook, a “Day of Rage” is being hyped for March 11th. Other dates being promoted for “revolution” in Saudi Arabia include March 20th and March 21st.
But if Saudi Arabia sees the same kind of chaos that we have seen in other countries in the Middle East there is no telling how high the price of oil could go.
Could we see $125 oil?
Could we see $150 oil?
Could we see $200 oil?
Saudi Arabia exports more oil than anyone else in the world, so if their oil production gets interrupted it is going to have a dramatic impact on the global economy.
For decades, the entire globe has been blessed with very cheap oil and this has resulted in a massive economic boom.
But times are changing.
The economic situation over in Europe is already deteriorating and any additional bad news could plunge that entire continent into a major crisis. A recently released report from Ernst & Young is warning that if oil goes up to 150 dollars a barrel and it stays there, “at least” one eurozone country will default and the entire eurozone will be plunged back into recession.
A much higher price for oil would obviously not be good for the U.S. economy either. Do you remember what happened back in 2008? The price of oil hit a record high in June and then the entire financial system came unglued just a few months later.
But if we see a repeat of 2008 it may be a lot worse this time because the global financial system is now more unstable than ever.
The truth is that the entire world is still trying to recover from the last financial crisis. The Federal Reserve is pumping massive quantities of dollars into the U.S. economy in an attempt to stimulate it back to life, but so far it is not working too well.
The rest of the world does not appreciate all of this “money printing” and the inflation that this is causing is beginning to create massive imbalances on global financial markets.
The world is starting to lose faith in the U.S. dollar. Right now, approximately 85% of all foreign-exchange transactions in the world involve the U.S. dollar. Not only that, 60% of all the currency reserves in the world are in U.S. dollars. With the U.S. dollar rapidly becoming less stable, many are now wondering if it should continue to be used as the reserve currency of the world.
The truth is that if the U.S. dollar falls, it is going to create a tremendous amount of financial chaos in almost every nation on the globe.
Unfortunately, as I have written about so many times previously, the U.S. economy is dying. The U.S. government is absolutely drowning in debt, and leaders all over the planet are calling for the establishment of a new global reserve currency.
The days of the United States being the “economic engine of the planet” are rapidly coming to an end.
The U.S. economy is not ever going to fully “recover”. In fact, the U.S. economy is basically “running on empty” at this point as Gerald Celente recently noted during an interview on RT television….
The entire U.S. economy was designed to operate on massive amounts of very cheap oil. Americans do more driving than anyone else in the world. Many of us are so lazy that we won’t even walk to a store if it is on the other side of the parking lot.
If oil hits record levels in 2011, it is going to be a massive shock to the U.S. economic system. Any hopes for an “economic recovery” will be completely dashed.
In fact, if one wanted to “take down” the U.S. economy, driving up the price of oil would be a perfect way to do it.
And if one wanted to drive up the price of oil, a perfect way to do that would be to create all kinds of chaos in the Middle East.
So is all of this craziness that we are seeing in 2011 just a big coincidence or is there a reason why all of this is happening?
Please feel free to leave a comment with your opinion on the matter below….
Despite what Federal Reserve Chairman Ben Bernanke says, rampant inflation is officially here. The federal government is constantly monkeying with the numbers to keep the “official” rate of inflation below 2 percent, but it is becoming very difficult to deny that the cost of almost everything is really going up these days. The American people are not stupid. They notice the difference when they go to the grocery store or stop at the gas station. The dollar is losing value rapidly now. The price of gold set another new all-time record today and is currently hovering just above $1430 an ounce. The price of West Texas crude has moved above 100 dollars several times recently and the price of Brent crude is currently above 116 dollars. These higher oil prices are really starting to be felt in the United States. The average price for a gallon of gasoline in the United States has now reached $3.38. There are some gas stations in the U.S. where the price of a gallon of gas is already over 4 dollars. But it is not just the American people that are feeling the pain. The global price of food recently hit a new record high and almost every major agricultural commodity has absolutely skyrocketed in price over the past 12 months. Meanwhile, Ben Bernanke just told the Senate Banking Committee that he really isn’t concerned about inflation at all.
When it comes to inflation, the key is not to look at the official U.S. government numbers (they are highly manipulated) or how the U.S. dollar is performing against other major currencies (because they are all being devalued as well). Instead, you can get a truer sense of what is really happening to inflation by looking at what the U.S. dollar is doing against precious metals, commodities and other hard assets.
So are we experiencing rampant inflation right now? Well, just open up your eyes and look at these 5 charts….
1 – The price of oil is racing back up to record levels. The chart below from the Federal Reserve is a couple weeks out of date. As noted above, the current price of West Texas crude is about $100 a barrel….
2 – The price of a gallon of gasoline in the United States seems destined to hit a brand new all-time record at some point this year. Was it really just a few short years ago when the average price of gas in this country was about a dollar a gallon?….
3 – The value of most precious metals is very consistent over time. So when you see precious metals go up dramatically in price, it means that the dollar is being devalued. The price of gold just set another new all-time high and it seems destined to keep going even higher….
4 – The chart below from the Federal Reserve is a measure of the price of all commodities. These price increases are inevitably going to be passed along to consumers in the United States….
5 – After a couple of years of stable food price, the price of food is starting to take off yet again….
In fact, many analysts are warning that we could experience a major food crisis over the next couple of years. The global demand for food continues to grow at a very brisk pace, but all of the crazy weather we have been having around the world has caused some very bad harvests.
Unfortunately, the global price of food has gone up substantially in recent months and it is likely to keep going up very rapidly. Just consider the following five facts….
That says a lot about where we are at as a country.
We have allowed so much of our industrial infrastructure to be exported to China where workers slave away in almost unbelievable conditions.
A reader named Rish recently described what things are like over there….
As a product developer I went to china and saw the way the factory workers lived and worked in person. 50$ a month is about right, but if you are a skilled quality control expert you might make as much as 150$. at least this was true about 2 years ago the last time I went. The barracks were pretty meager, bunk beds with just plywood, no mattresses, if you wanted you could go to a store just outside the factory gate and buy a thick comforter that they sell as a “mattress” .
It will be interesting to see how the next few years changes the face of the USA. Who knows? if the unemployment rate and lack of jobs keeps going and enough people become homeless, we might become the next Bangladesh, and people will be lining up of the 30 cents an hour corporate factory jobs, and living in barracks just like those…
The only way the U.S. has been able to “thrive” during this deindustrialization is by borrowing gigantic amounts of money. But all of this borrowing is slowly but surely destroying the U.S. dollar, and we are getting closer to the point of absolute catastrophe.
Peter Schiff recently shook folks up when he talked about these issues during a recent interview on CNBC….
But it is not just the United States that is printing tons and tons of money. All of the major industrialized nations have been firing out gobs of currency. That is a huge reason why so many investors have been racing to get into hard assets recently.
Now Ben Bernanke and other top Federal Reserve officials have been dropping hints that more quantitative easing may be necessary.
Unfortunately, just like with any other addiction, once you give in a few times it becomes easier and easier to engage in destructive behavior. Now that the Fed has gotten a taste for quantitative easing it is going to be really hard to stop.
Nor can the Fed stop at this point. If they did it would be disastrous for the U.S. economy. But if the Fed continues on this reckless course it will make the eventual collapse of our economy even worse.
Under our current debt-based system there is no way out. The Federal Reserve can attempt to put off the inevitable for a while by pumping up the debt bubble even more, but at some point it is going to burst.
When that happens we are going to be facing a financial crisis which will blow what happened in 2008 completely out of the water.
So enjoy these good economic times while you still can. This is about as good as things are going to get from here on out.
Are you ready for an economy that has high inflation and high unemployment at the same time? Well, welcome to “Stagflation 2011”. Stagflation exists when inflation and unemployment are both at high levels at the same time. Of course we all know about the high unemployment situation already. Gallup’s daily tracking poll says that the U.S. unemployment rate has been hovering around 10 percent all year so far. But now thanks to rapidly rising food prices and the exploding price of oil, rampant inflation is being added to the equation. Normally inflation is a sign of increased economic activity, but when the basic commodities that we depend on to run our economy (such as oil) go up in price it actually causes a slowdown in economy activity. When the price of oil goes up high enough, it fundamentally changes the behavior of individuals and businesses. Suddenly certain types of economic activities that were feasible when oil was very cheap are not profitable any longer. When the price of oil rises to a new level and it stays there, essentially what is happening is that more “blood” is being drained out of our economy. Our economy will continue to function when there are higher oil prices, it will just be a lot more sluggish.
In some way, shape or form the price of oil factors into the production of most of our goods and services and it also factors into the transportation of most of our goods and services. A significant rise in the price of oil changes the economic equation for almost every business in the United States.
Today, the price of WTI crude soared past 100 dollars a barrel before closing at $98.10. The price of Brent crude increased 5.3 percent to $111.25. The protests in Libya are certainly causing a lot of the price activity that we have seen over the past few days, but the truth is that oil has been going up for a number of months. Right now we are only seeing an acceleration of the long-term trend.
Things are likely to get far worse if the “day of rage” planned for Saudi Arabia next month turns into a full-blown revolution. Up to this point, the revolutions that have been sweeping the Middle East have been organized largely on Facebook, and now there are calls all over Facebook for the “Saudi revolution” to start on March 20th.
That date is less than 4 weeks away. If Saudi Arabia plunges into chaos, the price of oil is going to go through the roof.
A rapidly rising price for oil is really bad news for the U.S. economy, because it is going to mean lots of inflation. Unfortunately, this also comes at a time when the economy is also feeling the inflationary effects of more quantitative easing by the Federal Reserve.
So if rising oil prices are going to cause more inflation and if rising oil prices are also going to cause our economy to become even more sluggish, what does all of that add up to?
It adds up to stagflation.
Wikipedia defines stagflation in the following manner….
In economics, stagflation is the situation when both the inflation rate and the unemployment rate are persistently high.
This is going to rapidly become the “new normal” for America. High oil prices are going to cause the cost of just about everything to go up, and high oil prices are also going to cause the economy to slow down thus making the unemployment numbers even worse.
It is going to be just like the 1970s all over again.
Economists differ as to how much rising oil prices affect U.S. GDP, but almost all of them agree that rising oil prices do cause a decline in U.S. GDP at least to some extent.
If American families have to spend $10 or $20 more each time they visit a gas station, that means that they are going to have less discretionary income. They won’t be able to spend as much at the stores.
Not only that, but since the price of oil affects the price of almost everything else, Americans will find that their dollars have reduced purchasing power.
An oil crisis would force American families to stretch their already overburdened budgets even farther.
So where is the price of gasoline going from here? Well, the average price of gasoline in the United States is rapidly sneaking up on the $3.20 a gallon mark. Almost everyone believes that it is going to be going significantly higher.
Tom Kloza, the chief analyst for the Oil Price Information Service, was recently quoted in USA Today as saying that he believes that the average price for gasoline in the United States will reach somewhere between $3.50 and $3.75 a gallon by April.
As I wrote about yesterday, there are other analysts that believe that we are going to see $4.00 gasoline in the United States by the end of the year, and there are some that believe that we could see $5.00 gasoline if revolution sweeps Saudi Arabia.
If gasoline becomes that expensive and it stays there for a while, it is going to seriously start affecting the behavior of American businesses and American consumers.
Just remember what happened back in 2008. Andrew Busch of BMO Capital Markets recently told CNBC the following….
“Remember when oil was last at $140 (a barrel), Americans reacted and cut the amount of miles they drove.”
Can you imagine what it would do to the economy if millions of Americans start sitting in their homes instead of doing their normal amounts of driving and flying?
In addition, one of the biggest problems with a higher price for oil is that it would cause our trade deficit to explode. According to the U.S. government, more than half of the oil that we use is imported. So every month we send the rest of the world billions and billions of our dollars and they send us massive amounts of oil. We rapidly consume all of the oil they send us and we continually need more. So we keep sending larger and larger amounts of money overseas and they keep sending us larger amounts of oil. In the process, our national wealth is being drained at an astounding rate. It is one of the greatest transfers of wealth the world has ever seen.
When the price of oil rises substantially, the transfer of wealth accelerates. This is a very bad thing for the U.S. economy. For example, when oil prices were above $100 a barrel back in 2008 our trade deficit for the year was almost 700 billion dollars.
It would be great if the Middle East would settle down and oil prices would start declining because that would really help out the U.S. economy. Unfortunately, it does not look like that is going to happen. Instead, it appears that we are steamrolling directly towards stagflation. Anyone that lived through the stagflation of the 1970s knows that it is not a lot of fun.
The cold, hard reality of the matter is that without cheap oil our lifestyles are going to change. Our economy was not set up to run on expensive oil. If oil moves well above $100 a barrel and it stays there it is going to bring about significant societal changes.
For the rest of 2011, the price of oil will be the number one economic indicator to watch. If it gets too high it is going to be an absolute disaster for the U.S. economy.
One of the quickest ways to bring down the U.S. economy would be to dramatically increase the price of oil. Oil is the lifeblood of our economic system. Without it, our entire economy would come to a grinding halt. Almost every type of economic activity in this country depends on oil, and even a small rise in the price of oil can have a dramatic impact on economic growth. That is why so many economists are incredibly alarmed about what is happening in the Middle East right now. The revolution in Libya caused the price of WTI crude to soar more than 7 dollars on Tuesday alone. It closed at $93.57 on Tuesday and Brent crude actually hit $108.57 a barrel before settling back to $105.78 at the end of the day. Some analysts are warning that we could even see 5 dollar gas in the United States by the end of the year if rioting spreads to other oil producing nations such as Saudi Arabia. With the Middle East in such a state of chaos right now it is hard to know exactly what is going to happen, but almost everyone agrees that if oil prices continue to rise at a rapid pace over the next several months it is going to have a devastating impact on economic growth all over the globe.
Right now the eyes of the world are on Libya. Libya is the 17th largest oil producer on the globe and it has the biggest proven oil reserves on the continent of Africa.
Libya only produces 2 percent of the oil in the world, but with global supplies so tight at the moment even a minor production disruption can have a dramatic impact on the price of oil.
Before this crisis, Libya was producing approximately 1.6 million barrels of oil per day. Now the rest of the world is wondering what may happen if revolution spreads to other major oil producing nations such as Kuwait (2.5 million barrels of oil per day) or Saudi Arabia.
Saudi Arabia produces 8.4 million barrels of oil a day. It produces more oil than anyone else in OPEC.
If revolution strikes in Saudi Arabia and a major production disruption happens it could be catastrophic for the global economy.
David Rosenberg, the chief economist at Gluskin Sheff & Associates, is warning that if there is major civil unrest in Saudi Arabia we could end up seeing oil go up to $200 a barrel….
“If Libya can spark a $10-a-barrel response, imagine what a similar uprising in Saudi Arabia could unleash. Do the math: we’d be talking about $200 oil.”
200 dollar oil?
Don’t laugh – it could happen.
In fact, if it does happen the global economy would probably go into cardiac arrest.
The truth is that if the flow of oil from Saudi Arabia gets disrupted there is not enough spare capacity from the rest of the globe to make up for it.
“The world has only 4.5m barrels-per-day (bpd) of spare capacity, which is not comfortable.”
Horsnell also said that even in the midst of potential supply problems, the global demand for oil continues to grow at a very robust pace….
“In just two years, the world has grown so fast as to consume additional volume equal to the output of Iraq and Kuwait combined.”
For now, Saudi officials are saying all the right things. They say that there will be no revolution in Saudi Arabia and that there are not going to be any supply problems.
For example, Saudi Arabian Oil Minister Ali al-Naimi recently announced that the rest of the world should not worry because his country is definitely going to be able to make up for any shortage in the global supply of oil….
“What I would like you to convey to the market: right now there is absolutely no shortage of supply.”
But what happens if revolution comes to Saudi Arabia?
Suddenly the whole game would change.
But even with a peaceful Saudi Arabia the price of gasoline in the United States is already rising to alarming levels.
The average price of gasoline in the United States reached $3.14 a gallon last week. This closely mirrors what happened back in 2008. Three years ago at this time the average price of gasoline was right around $3.13 a gallon.
Let’s certainly hope that we don’t see a repeat of what happened to oil prices back in mid-2008. The price of oil reached an all-time record of $147 a barrel and gas prices in the United States absolutely skyrocketed.
So how high will the price of gas in the U.S. go in 2011?
We haven’t even come close to 4 dollar gas yet, but a large number of analysts believe that it is coming this summer.
Is there even a possibility that we could see 5 dollar gas in America at some point in the next couple of years?
Well, there are some in the oil industry that are convinced that it could actually happen. Just consider the following quotes….
“The money that you spend filling up your car is money you don’t have to spend at the shopping mall.”
Not only that, but when gasoline costs more it has a negative effect on economic growth. Almost all economic activities involve the use of oil in one form or another. When the price of oil starts getting really high it motivates people to start cutting back on many of those activities.
The truth is that our whole economic system is based on the ability to use massive amounts of very cheap oil. Now that the price of oil is rapidly rising again, many economists are becoming very alarmed.
Nobuo Tanaka, the Executive Director of the International Energy Agency, recently told CNBC that his organization is extremely concerned about what high oil prices could do to the global economy….
“That is our concern, regardless of the margins of disruption, if the $100 per barrel of oil is continued in 2011, the burden of oil to the global economy is as bad as 2008.”
So what was so bad about 2008? Well, the price of oil soared to $147 a barrel in mid-2008 and this was a huge factor in the financial collapse that happened a few months later. Now oil prices are returning to levels that we have not seen since 2008….
So if the price of oil breaks the all-time record this year will we see another global financial crisis?
It is hard to say. But what almost everyone agrees on is that it will not be good for the global economy at all.
In addition, a higher price for oil will also have a huge impact on the trade deficit. Because oil prices were at such a high level back in 2008, oil imports actually made up almost 50 percent of the U.S. trade deficit that year.
In 2010, the U.S. trade deficit was just a whisker under $500 billion. If the price of oil gets up to 140 or 150 dollars a barrel we could easily see the U.S. trade deficit explode to 700 or 800 billion dollars in 2011.
That would be really, really bad for the U.S. economy.
So where are oil prices going next?
Well, if you could predict that with 100 percent certainty you could make a whole lot of money. Nobody knows for sure.
But almost everyone believes that the price of oil is going to go up. In fact, a lot number of investors have been making some very large bets that the price of oil is going to go up very significantly this year.
Let us hope that the price of oil does not rise that rapidly, but as the past couple of months have demonstrated, the world is becoming a very unstable place. Just about anything is possible at this point.
If the price of oil rises significantly above $100 a barrel and it stays there for an extended period of time, it is going to be absolutely devastating for the U.S. economy.
So what do you all think is going to happen to the price of oil in 2011? Please feel free to leave a comment with your thoughts below….
As if the world economy did not have enough problems already, now the riots in Egypt threaten to send the price of oil soaring into the stratosphere. On Friday, the price of U.S. crude soared 4 percent. A 4 percent rise in a single day is pretty staggering. The price of Brent crude in London closed just under the magic $100 a barrel mark at $99.42. The incredibly violent riots in Egypt have financial markets all over the globe on edge right now. Any time there is violence or war in the Middle East it has a dramatic impact on financial markets, but this time things seem even more serious than usual. Many believe that we could see an entirely new Egyptian government emerge out of this crisis, and the uncertainty that would bring would make investors all around the globe nervous. Financial markets like predictability, peace and security. If Egyptian President Hosni Mubarak’s 30 year reign is brought to an end, it will severely shake up the entire region, and that will not be good news for the global economy.
Have you seen how violent these protests have become? Cars and buildings are on fire all over the place. Even the headquarters of Hosni Mubarak’s political party was burned down. The Egyptian military has been deployed on the streets of Cairo. Protesters have been showering government forces with stones, firebombs and anything else that they can find to throw. Security forces have been using rubber bullets, water cannons and tear gas to try to disperse the protesters but those efforts seem to be doing little good. Deaths and injuries are being reported all over the place. There are even rumors that the wife and son of Hosni Mubarak have already left the country.
At this point, Mubarak has gone on national television and has announced that he has asked his cabinet to resign. That is an absolutely stunning move, but it is doubtful that the protesters will be satisfied. All over Cairo protesters continue to chant for Mubarak to resign.
The following is a short compilation of some raw video from the riots in Egypt….
These riots in Egypt come on the heels of violent uprisings in Algeria and Tunisia. In fact, it seems like virtually the entire Middle East is in a very foul mood right now. Riots have been reported in Lebanon, in Jordan and in Yemen over the past few days.
Some of the rioting has been motivated by economic factors, but unfortunately all of this rioting is only going to make the global economic situation even worse. Concern over all of these riots is driving up the price of oil and driving up the prices of agricultural commodities. These higher prices are going to make it even harder for the poor people in the Middle East to afford food.
But also it must be acknowledged that much of this rioting is being done for very deep political and religious reasons as well. Many westerners are cheering the protests in Egypt because they envision the protesters to be some sort of “freedom fighters”. But the vast majority of these protesters do not desire “American-style democracy”. The Muslim Brotherhood is one of the groups at the heart of these protests. The government that they intend to set up would not give “liberty and freedom for all”. Rather, it would be a hardline Islamic government based on Shariah law. According to Wikipedia, the Muslim Brotherhood bills itself as the “world’s most influential Islamist movement”, and their goal is to impose their version of Islam on society….
The Brotherhood’s stated goal is to instill the Qur’an and Sunnah as the “sole reference point for … ordering the life of the Muslim family, individual, community … and state”
So unless your version of “freedom” includes being forced to live like the Taliban, then you probably would not enjoy the “liberty” that the Muslim Brotherhood wishes to impose on you.
Coptic Christians all over Egypt are already being slaughtered even with a relatively pro-western president in power. On New Year’s Day, an attack on a Coptic Christian church in Egypt killed 21 people. The following is how one eyewitness described the scene to a reporter from the New York Times….
“There were bodies on the streets,” said Sherif Ibrahim, who saw the blast’s aftermath. “Hands, legs, stomachs. Girls, women and men.”
Once a radical Islamic government is installed in Egypt it will be open season on all Christians.
Yes, there is a whole lot of blame to be passed around to other nations, organizations and individuals in the Middle East for things they have done as well, but that does not excuse the horrific persecution of the Coptic Christians in Egypt.
We have to call a spade a spade. We cannot condemn some forms of tyranny and persecution and then make excuses for other forms of tyranny and persecution just because those doing it are on “our side”.
Replacing one form of tyranny (Mubarak) with an even more repressive form of tyranny (The Muslim Brotherhood) is not something that those who love liberty and freedom should be celebrating.
In any event, everyone should be able to agree that these events are going to severely rattle world financial markets that were already very nervous about 2011.
If these violent riots in Egypt and other countries in the Middle East keep going on, the global price of oil and the global price of food will continue to soar.
Not that oil and food were not going to be heading in that direction anyway. Yesterday I wrote about the warning signs for the global economy that we are starting to see. Wheat and corn have absolutely skyrocketed in price over the past 6 months. The UN had already been projecting that we would see a 30 percent increase in the global price of food in 2011 even before these riots.
If you add rampant political instability into the mix, there is no telling how bad food inflation could get this year.
Many experts have already been forecasting substantial food shortages throughout the world this year based on all the extreme weather we have been having. So what is going to happen if something causes those food shortages to be even worse than anticipated?
We live in very interesting times my friends. The globe is becoming an increasingly unstable place. Even nations that seemed perfectly stable just a few months ago can erupt in rioting at almost any moment.
People around the world are getting angry. Thanks to the Internet, people are able to circumvent official government propaganda more easily than ever before. This is making it harder and harder for governments to control people.
Egypt tried to regain some of that control during the riots by shutting down cell phones and by shutting down the Internet but it did not work.
Let’s just hope that Egypt can soon find peace and that the changes that are made in the Egyptian government are good for freedom and liberty.
The price of oil has been hovering around 80 dollars a barrel for quite some time now, but get ready, because it is going to move significantly higher. Oil prices have already risen about 9 percent over the past month, and many believe that this could very well be the start of a new trend. Lawrence Eagles, a top analyst at JP Morgan, recently made headlines across the globe when he stated that oil could hit 100 dollars a barrel “much sooner than we expect”. Not only that, but a number of top OPEC officials are also publicly discussing the possibility of 100 dollar oil. But just because a few people are talking about it does not mean that it is going to happen. So are there any other reasons why we should anticipate a significant increase in the price of oil?
Well, yes there is.
*The Decline Of The U.S. Dollar
Since August 27th, the U.S. dollar has declined approximately 4.8% against the currencies of major U.S. trading partners. Unfortunately, there seems to be every indication that the dollar is going to continue to decline. As the U.S. dollar continues to display weakness, just about everything priced in dollars (including oil) is going to continue to rise.
*The Threat Of Quantitative Easing By The Federal Reserve
For weeks, top Federal Reserve officials have been making public statements about the need for more quantitative easing. If the Fed does initiate a significant program of quantitative easing in the coming months, that is going to put even more downward pressure on the U.S. dollar and even more upward pressure on the price of oil.
*Other Commodities Have Been Skyrocketing
Over recent weeks, the prices of a wide array of key commodities have been absolutely skyrocketing. As I noted in a previous article, not only has the price of gold been setting records, the truth is that almost every major commodity has been spiking. In a recent column entitled “An Inflationary Cocktail In The Making“, Richard Benson noted some of the commodity price increases that he has been tracking this year….
-Agricultural Raw Materials: 24%
-Industrial Inputs Index: 25%
-Metals Price Index: 26%
-Palm Oil: 26%
-Iron Ore: 103%
The increase in the price of oil is just part of a larger trend of soaring commodity prices. As long as this trend in commodity prices continues it is unlikely that the price of oil will go down.
*The Strikes In France
The austerity strikes in France have interrupted the flow of gasoline in that country. Once the strikes are over there will be an increase in demand as inventories are restocked.
*Increased Demand From China And Other Emerging Nations
Most analysts are forecasting that the demand for oil in China and other emerging nations will continue to grow at an impressive pace. This growing demand will also cause upward pressure on the price of oil.
*The Potential Of War In The Middle East
As always, war could break out in the Middle East at any time. A minor conflict in the Middle East would likely push the price of oil over 100 dollars a barrel very quickly. A major conflict would likely push it over 200 dollars or even beyond. War is very, very difficult to predict, but it does seem quite likely that some kind of conflict will break out in the Middle East at some point over the next several years.
So how soon will oil reach the 100 dollar mark?
That is very hard to say.
But even now, Americans are already having to dig deeper into their wallets at the gas pump.
For the two week period ending October 22nd, the average price of gasoline in the United States increased 5.23 cents to $2.82 a gallon.
As the price of oil continues to rise significantly over the long-term, it is going to have an impact on thousands of other prices. Virtually all products must be transported, and an increase in the price of oil will cause those transportation costs to go up.
So an increase in the price of oil would be really bad news.
If we do see 100 dollar oil, that will be a huge challenge for the U.S. economy.
If we end up seeing 150 dollar oil (especially for an extended period of time) it will be an absolute nightmare for the U.S. economy.
So where do you think the price of oil is going? Feel free to leave a comment with your opinion….