Nine Reasons Why Low Oil Prices May “Morph” Into Something Much Worse

[JohnyCanuck]

From actuary Gail Tverberg in her blog "Our Finite World":

Why are commodity prices, including oil prices, lagging? Ultimately, the question comes back to, “Why isn’t the world economy making very many of the end products that use these commodities?” If workers were getting rich enough to buy new homes and cars, demand for these products would be raising the prices of commodities used to build and operate cars, including the price of oil. If governments were rich enough to build an increasing number of roads and more public housing, there would be demand for the commodities used to build roads and public housing.

It looks to me as though we are heading into a deflationary depression, because the prices of commodities are falling below the cost of extraction. We need rapidly rising wages and debt if commodity prices are to rise back to 2011 levels or higher. This isn’t happening. Instead, Janet Yellen is talking about raising interest rates later this year, and we are seeing commodity prices fall further and further. Let me explain some pieces of what is happening.

1. We have been forcing economic growth upward since 1981 through the use of falling interest rates. Interest rates are now so low that it is hard to force rates down further, in order to encourage further economic growth.

Falling interest rates are hugely beneficial for the economy. If interest rates stop dropping, or worse yet, begin to rise, we will lose this very beneficial factor affecting the economy. The economy will tend to grow even less quickly, bringing down commodity prices further. The world economy may even start contracting, as it heads into a deflationary depression.

http://ourfiniteworld.com/2015/07/22/nine-reasons-why-low-oil-prices-may-morph-into-something-much-worse/

About the author:
My name is Gail Tverberg. I am an actuary interested in finite world issues - oil depletion, natural gas depletion, water shortages, and climate change. Oil limits look very different from what most expect, with high prices leading to recession, and low prices leading to inadequate supply.

[ChairmanAgnostic]

1. A rather simplistic view.

The actual economic reality is far more complex.

[RiverLover]

2. #9...I hope this is wrong. But it makes sense.

9. It is doubtful that the prices of energy products and metals can be raised again without causing recession.

We are not talking about simply raising oil prices. If the economy is to grow again, demand for all commodities needs to rise to the point where it makes sense to extract more of them. We use both energy products and metals in making all kinds of goods and services. If the price of these products rises, the cost of making virtually any kind of goods or services rises.

Raising the cost of energy products and metals leads to the problem represented by Growing Inefficiency (Figure 4). As we saw in Point 5, wages tend to go down, rather than up, when other costs of production rise because manufacturers try to find ways to hold total costs down.

Lower wages and higher prices are a huge problem. This is why we are headed back into recession if prices rise enough to enable rising long-term production of commodities, including oil.

This does take into account all of the complexities previously discussed. Add to that the fact that our banks are bigger than ever & more heavily into derivatives*, its not a good set up for a healthy economic future.

The lawmakers wrote to regulators that without this information, “the country risks moving blindly toward the same financial meltdown that plunged the economy into recession seven years ago.” Mr. Cummings is the top Democrat on the House Committee on Oversight and Government reform and Ms. Warren a member of the Senate Banking Committee. “We believe that if these banks want continued access to federally insured deposit funds, they must be more transparent about the risks they are taking with that money.”

Ms. Warren and Mr. Cummings are among the lawmakers who opposed a provision tucked into the end-of-year spending bill that largely eliminated a Dodd-Frank provision requiring banks to spin off certain of their derivatives trading activities into units that do not enjoy government support such as federal deposit insurance.

In January, the duo sent letters to four top Wall Street banks asking for details of how the Dodd-Frank change would impact the firms’ derivatives operations –...

http://blogs.wsj.com/moneybeat/2015/07/16/warren-cummings-continue-to-hammer-banks-on-derivative-rule/