Speaking At Jackson Hole
by Andrew McKillop
Author & Consultant
August 25, 2009
STILL AN UNCERTAIN OUTLOOK
“Strains persist" in the world banking system and finance markets across the globe, Ben Bernanke said on August 21 at the Jackson Hole, Wyoming annual Federal Reserve meeting of banking and finance deciders. He of course cautioned, like other leading bankers that the economic recovery "...is likely to be relatively slow at first, with unemployment declining only gradually from high levels.”
Energy and food prices are rising faster than warranted by fundamentals, in the opinion of many deciders, including Bernanke. As these deciders, and influential purveyors of market comment such as Nouriel Roubini and The Economist's columnists will quickly add, higher food and energy prices could increase the risk of double-dip recession. This outlook, they say, is driven faster by "speculative trades", working exactly like, and hand-in-hand with those which have driven equity values up by around 40% in the past 4 months on most major markets.
THE OIL PRICE THREAT
Bernanke, in Jackson Hole, specially identified oil as a looming threat. “Last year, oil at $145 a barrel was a tipping point for the global economy as it created negative terms of trade and a disposable income shock for oil-importing economies,” he said. He went on to add the oil-phobic punch line we heard many times in the most recent 2004-2007 period of oil-levered global economic growth. Denying the existence of what we can call Petro Keynesian growth, Bernanke sternly warned on August 21 that: “The global economy could not withstand another contractionary shock if similar speculation drives oil rapidly toward $100 a barrel.”
Trenchant J-C Trichet of the European Central Bank, also at Jackson Hole, was less publicly concerned with oil shock, more especially because the Euro serves as a way to measure the dollar's decline. This makes oil cheaper in Euros as the Fed devalues the dollar. Put another way, any trading day the dollar declines chances are that oil prices and the Euro will increase, the same way that equities usually rise when the oil price rises. Trichet's worries include continuing money meltdown in the new Eastern Empire of the Eurozone, in small but dangerously unstable economies like Lithuania, Latvia or Hungary, and rising jobless numbers everywhere in Europe. His public worry N°1 however goes straight to the essential of Keynesian go-for-growth tinkering. Trichet expressed concern on how to design what he calls a "credible exit strategy" from printed and borrowed money inexorably driving up European debt.
As Bernanke, Trichet, central bank governors worldwide, and the IMF regularly say, since 2008 the global economy is receiving the biggest-ever Keynesian spending injections the world has ever known. National debt relative to GNP could attain exotic highs - if this Keynesian medecine does not lever up growth. Each day that growth decides to not return, is another day for nail biting on rising national debt mountains.
KEYNESIAN DEBT AND PETRO GROWTH
Basic Keynesian theory is you can borrow money from the future and hope economic growth is strong enough, and concern about money depreciation and stability is low enough to repay, or to absorb rising debt later on. The official hope is that debt will not grow, due to growth. If that however fails, money depreciation or a change of currency, tricking the CPI figures, austerity cures and other weapons can be wheeled on stage, if public and political opinion gets too roused by rising public debt and higher taxes to pay for it. One problem is very simple to state: maybe Keynesian deficit spending works, and maybe it does not. The jury is out to lunch on this one, and arguments on the subject stretch back more than 70 years.
Petro Keynesian growth stimulus to the global economy is different. Sometimes it works too well. Its outright and unambiguous success through 2004-2007 was quickly followed by failure. As we know, and Bernanke reminded us on August 21, global growth turned south, when oil prices went far north in 2008. The basic reason for this is unpalatable to those, like Trichet and Bernanke who hope growth will soon return, to trim the soaring peaks of national debt. Due to another kind of peak, peak oil rather than OPEC or exuberant Wall Street oil traders, it was simply not possible to produce enough oil to prevent last year’s oil price overshoot.
High oil prices were also joined by supply side limits on world grains and food output, including water shortage and climate change impacts. More bad news for inflation and consumer spending potentials outside food and energy basics, was delivered by shortage inducing factors affecting supply/demand outlooks for most metals and minerals. Through 2004-2007, peaking in 2008, even such basics as cement aggregates, iron ore, alumina and world bulk shipping charges climbed smartly in price.
What Jim Rogers calls the Commodity Super Cycle, now with an Asian resource demand turbo effect, in fact stretches back to well before Keynes invented his theories, including his debt based remedies for fighting recession. Long-term read outs from high and low commodity price surges and crashes, and global growth, is that higher prices for energy and resources have certainly levered up the economy, in some periods, and not in others. Bernanke may be right to fear higher oil prices, but he can only claim to be right about 33% of the time. With present stakes so high, is that enough ?
OIL PRICES AND GROWTH – THE TWIN SPIRAL
The simple answer to the question is that higher oil prices can and very likely will boost and bolster growth, but not for long, if we look at 2004-2007 performance. The Petro Keynesian growth driving paradigm and process is easy to set out. Wealth is transferred from global consumers to energy and resource producers, most of them lower income, who then spend more. Classic debt based Keynesian programs in high income economies tend only to shift more spending power to the already rich, who spend a lower percent of their revenue gains, received through government tax cutting largesse and printing press activity. OPEC ability to spend more when revenues rise is easy to forecast: not too many OPEC states are in the Qatar or Saudi camp, where more personal consumption, at least for national citizens and not economic migrants presents challenges for the imagination. A lot of more are in the Nigeria, Algeria, Iran or Venezuela camp.
The same quick reinjection of revenue gains, or windfalls to the global economy applies for revenue gains of iron ore or bauxite, rubber, coffee, sugar or cotton exporting countries. With some exceptions, more spending almost automatically generates on the back of revenue gains, when real resource export prices increase. Keynes and his latter-day followers fondly imagined, with Greenspan and Bernanke that a similar process would work in the the case of tax cuts and government largesse applied to higher income groups in the USA or other wealthier nations.
Certainly since the 1980s, the growth generating feedback from tax cuts and selective aid to high income groups inside the OECD countries has been low or absent. Debt has grown, and financial and economic deciders need to find a quick way to lever up growth, or face monetary torment.
The basic problem for Petro Keynesian growth is that it works, but the stimulus it delivers to the global economy has no self-limiting feedback. Like we know, and a thousand rousing editorials say, oil traders always go a mile or three too far talking up oil prices, the same way natural gas traders currently talk prices down. Few editorialists are roused by bargain basement natural gas prices, but their selective ire grows with every dollar on the barrel price. To be fair, plenty of fundamentals aid the quest of oil traders to get that ultimate high barrel price, and oil geopolitics also helps. The Cleantech revolution and investor surge in the sustainable economy is however one direct spinoff from now almost permanent high oil prices.
The reason for this is simple. Oil depletion and capacity shortage supplies at least 50% of the real drive to save or substitute oil in the global economy. Hunting down the Evil Molecule CO2 to fight global warming occupies the high ground media slot as the politically correct reason we have to transit away from fossil fuels. More pressing and urgent, global oil and fossil energy reserve outlooks show we are in a narrowing comfort zone between voluntary energy transition, or being forced into embracing Cleantech, or long-term recession and high debt.
Using IMF figures on anti-crisis spending and guarantees, loans and bailouts, including aid to the car industry to generate the coming oil saving electric car boom, and the US troubled assets buyback program we have likely seen about 11 000 billion US dollars being used, Keynesian style, since late 2008. As Roubini, Bernanke and Trichet say, even this massive spending can’t guarantee the green shoots will keep growing. Using Bernanke’s scare scenario of 100-dollar oil, this translates to an annual oil bill for G20 importer countries of around 1 300 billion US dollars. Some 8 years at that rate are needed to rival a single year’s debt-based Keynesian splurge.
Rising oil prices with a faster and wider leverage impact than Keynesian tax cuts can supply the missing real economic credibility, at least in the short term, which Keynes often said is a whole lot more important than the long. The 2004-2007 petro growth cycle showed that oil prices close to or above $ 125 a barrel can be absorbed, and these energy prices, with related non energy commodity prices, drive the green shoots of global growth – and the need for Cleantech. The danger is clear: outside this pain ceiling, the petro growth process implodes - specially when aided by a massive rout in the ultra leveraged world of hubris and self-delusion, called financial engineering and trading.
MANAGING A COMPLEX FUTURE
As Bernanke and others said at the Jackson Hole meeting, global finance and economic trends are for the least complex, even contrarian and opaque – and OPEC seems to be adding a wild card. In fact Bernanke, Trichet and other G20 central bankers could add fuel to the fire, when or if they raise interest rates too far and too soon. Adding higher borrowing costs, to higher food and energy, and other raw material commodity prices would be the worst thing, at the worst time. Helping the Cleantech revolution to shift the global economy away from fossil energy is one sure solution, but it takes time, and will need its own spending packages.
When oil prices regain the 100-dollar price level we could expect some ritual shudders from the finance and banking establishment, but if they decide not to panic they can expect a Petro Keynesian growth fillip. How long this lasts is the 63 trillion dollar question. This is the approximate 2008 value of global GDP, and it can grow or decline depending on how the coming oil price surge is handled. Within three or four years, about the life expectation of of a petro growth surge, world oil demand could be trimmed as much as 20%, if energy transition is given the spending currently reserved for covering the collateral economic damage from the debt-and-derivatives party on world finance markets.
© 2009 Andrew McKillop
Andrew McKillop | Author & Consultant | Email