Over the years I have developed a powerful respect for Mr. Bill's opinions. He is one of the few people on po.com I implicitly trust to be well-informed, even-handed and informed.
He is definitely on to something in terms of equating skills and degrees of removal from true wealth production/extraction.
What most people don't seem to understand is that we've been a period of hyperinflation for almost a decade. The difference betweeen this and "classic" hyperinflation is that it has been "sectoral" in various forms -- most recently housing. Another wrinkle in the equation is credit as a driver for the inflation. This has almost nothing to do with energy costs. This is really the ultimate extension of greed, short-sighted financial planning, and a largely under(financially)educated US populace that doesn't understand the ramifications of borrowing against assets that do not have a lot of intrinsic value.
In terms of how to mitigate the effects of peak oil in broader terms, the only solution is a marriage of sound fiscal policy combined with drastic lifestyle changes on the part of every first-worlder. When you think about it, the solution will be born out of necessity. Either there is or isn't enough food, energy, water, land, etc. The burn rate doesn't really matter, as eventually there will come a point when there is an insufficient supply for current consumption rates. The options from that point are relatively simple -- either some go completely without, or everyone gradually reduces.
PeakOil is You
THE Oil and Inflation Thread (merged)
Re: peak oil & inflation: burning the candle at both end
by jdumars » Mon 23 Jul 2007, 21:48:20
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jdumars - Coal
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Re: peak oil & inflation: burning the candle at both end
by MrBill » Tue 24 Jul 2007, 03:36:37
$this->bbcode_second_pass_quote('CrudeAwakening', '')$this->bbcode_second_pass_quote('MrBill', ' ')Money supply is not something you can 'arbitrarily' cut back on. Money supply is a function of demand for money and credit as controlled by interest rates set by the Federal Reserve. You raise the cost of money and borrowing and you reduce demand. You cannot simply reduce money supply.
MrBill, I don't follow this. What happens when the central bank uses open market operations to sell bonds to the general public or commercial banks?
Thanks for everyone's comments. Will try to get to all your questions in time. For those I piss off, sorry. Sometimes when you have covered the same ground enough times it just gets tedious. So, it is good to get the creative juices flowing and to look at issues from a different angle once in a while.
The growth of money and credit is based on the cost of money. If Fed funds are offered at 5 5/16ths (5.3125% ) at the moment that is where any bank that is a member of the Fed system can borrow money from the Open Window. That is essentially the floor price for US dollars.
If a bank wants to borrow in the money market from another bank, and not the Fed, then they would have to pay approximately 5.32% p.a. today for one week money (LIBOR). So the Fed directly controls the cost of short-term money by raising and lowering its 'target' Fed funds rate.
Bonds are another story. They are issued by the Treasury. They represent the Federal government's borrowing. There is a very loose connection between Fed funds and the rate of interest charged on bonds. Those differences reflect the supply of bonds & the demand for those bonds by both domestic and foreign investors. Also, of course, there are 2-year to 30-year bonds, plus shorter-term Treasury notes, so there is a time element (interest rate gap) as well.
Open market operations aside - where the Fed mops up excess liquidity by selling its own stock of US treasuries for cash, or adding liquidity by buying bonds on the open market and therefore releasing cash into the system - the Fed controls short-term rates, but the market determines long-term rates for bonds. The value of those bonds, their real rate of return net of inflation, is determined by the market's inflation expectations. Of course, for foreign investors they also factor in their expectations for the US dollar relative to their home currency as well when they decide to invest (or not to invest) in US treasuries.
The excess global liquidity, which we all see signs of in the price of everything (it seems) stems not from governments issuing scrip backed by the government's ability to tax its citizens - like any other asset backed security - but from keeping the cost of money too low AND by governments (Federal, State and Municipal) running budget deficits.
If the cost of money is too low - like Fed funds at 1% when the global economy is expanding at 4-5% p.a. - then it is stimulative for the economy. That is it grows faster than normal. It discourages individual savings, while at the same time encourages investors to take on more debt.
When governments (at all levels) spend more than they tax, and thus run a deficit, which becomes its debt, essentially they are also stimulating the economy (Keynesian supply side economics). Technically, that borrowing should balance over the business cycle, and that debt would be re-paid plus interest, which should act as a drag on consumption. So ideally the wise government would borrow (issue debt via bonds) when the business cycle was depressed, and pay it back when the economy is expanding. But governments are not always wise, and they hate to repay debts, so they just keep issuing bonds all the time because they can always find a project that they want to fund.
So low interest rates and government debt are stimulative. They produce more economic activity than would otherwise be. One causes asset price inflation, and the other causes general inflation.
Governments do not need a currency backed by gold and silver. What they need is to pass laws that make it illegal for the government to run budget deficits. Then they need to pay down debt. That would bring inflation down and therefore create a low interest rate environment and a strong currency.
This is essentially the infamous 'Washington Consensus' that everyone loves to hate. It is self-imposed fiscal discipline, or in the case of the IMF and its aid recipients, externally imposed fiscal discipline.
But the price of oil & gas as well as every other commodity agriculture, metal or otherwise is subject to its own supply & demand fundamentals. In most cases those fundamentals have become global, and not local, with some exceptions like nat gas that is not as fungible as crude oil for example. The demand for those basic commodities is dependent on global growth. Actually higher prices would encourage these producers and exporters to use those inputs more sparingly reducing relative demand.
$this->bbcode_second_pass_quote('', 'C')ommodities Weekly
Nickel: How low can we go?
While nickel prices may overshoot to as low as $25,000/mt, we maintain our medium-term price outlook at $35,000/mt and increase our long-dated forecast to $23,000/mt from $15,000/mt.
Are we there yet? If not, we will be soon ...
Prices may overshoot to as low as $25,000/mt, but we expect prices to fluctuate around $35,000/mt over the medium term.
Another upturn in demand could result in another nickel price rally
Nickel, like the rest of the base metals complex, is trading in a new, higher price range, and an upturn in global demand would likely push prices higher.
Chinese ferronickel supports long dated prices at $23,000/mt
High shipping and energy costs suggest Chinese ferronickel producers will be the marginal producers in the market.
We don't see a large inventory overhang waiting to be unwound
Prices have pulled supply and demand back together, but we don't see a large inventory overhang that will need to be unwound.
Source: Goldman Sachs Commodities Research
July 23, 2007
I will give my detractors this. If real interest rates were a lot higher, and therefore demand for money and credit a lot lower, then we would have slower, more stable economic growth. Especially, if the USA could not inject a $1 trillion stimulus to the world economy each year.
However, what they miss is that a stronger US dollar due to this fiscal discipline, although good in itself, does not mean that other countries will not take advantage of a strong US dollar to increase their exports by keeping their currencies artificially weak through low interest rates and excessive credit creation (i.e. the yen carry trade).
The notion that a strong US dollar can eliminate inflation is just wrong headed. As I just showed it would just shift production elsewhere and increase imports, so demand would not really be destroyed. And on a finite planet with limited natural resources, and an expanding population, higher living standards naturally have to come at the expense of higher real prices for everything. No matter in which currency you measure them. In other words scarcity.
In the end it is consumption that determines scarcity. In first year Forestry you would learn the concept of Total Allowable Cut. That is you cannot harvest trees any faster than you can re-plant and grow them if you want to have a sustainable harvest. If it takes 70-years to grow a hardwood tree then you can cut down 1/70th of your forest per year.
It matters not one bit in which currency you denominate exports of lumber, or whether the house buyer pays cash or credit for his home. Demand cannot exceed supply for long. Otherwise it is not sustainable. Anything that is not sustainable by definition cannot continue indefinitely. And that is a basic tenant of economics. Scarcity. "Man's wants are unlimited and his means are limited."
Peak oil is no different except of course unlike forests, petroluem will not quickly regenerate itself. It truly is a finite resource with few substitutes that are as efficient or cost effective. Given that, the current economy in its present shape and form is not likely to survive intact when global petroleum demand exceeds world supply. There will be an economy. It just won't be this one. But even in the new economy, the laws of supply and demand will be the same, whether you choose to call them Jevon's Paradox or something else.
UPDATE: Deficits DO Matter!
$this->bbcode_second_pass_quote('', 'A')merica's new faith-based guns-and-butter policy is hurting both guns and butter. The war is costing us $12 billion a month. Hormats examined the Congressional Budget Office's projections for domestic costs: "In 2006, spending on Social Security, Medicare, Medicaid and interest on the federal debt amounted to just under 60% of government revenues" and "if they continue on their current path, they will account for two-thirds by 2015."
Social security from $550 billion to $960 billion
Medicare from $372 billion to over $900 billion
Medicaid from $181 billion to $390 billion
Worse yet, these commitments will continue skyrocketing in later decades. The CBO projects the federal debt rising from 40% of GDP to 100% in the next 25 years: "Continuing on this unsustainable path will gradually erode, if not suddenly damage, our economy, our standard of living, and ultimately our national security."
The organized state is a wonderful invention whereby everyone can live at someone else's expense.
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MrBill - Expert
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