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The Next Global Meltdown Is Baked In: Connecting The Dots Between Oil, Debt, Interest Rates And Risk
The bottom line is the Fed can only keep the machine duct-taped together by suppressing the market’s pricing of risk.
One of the Grand Narratives of our era is the substitution of debt for income: as earned income and disposable income have stagnated for 40 years, the gap between the rising cost of living and stagnant household income has been filled by borrowed money.
Money has been borrowed to replace income everywhere: consumers have borrowed money to buy things they otherwise couldn’t afford, students have borrowed over $1 trillion to attend college, governments have borrowed money to fund wars and social spending, corporations have borrowed money to buy back their own shares, pushing stock prices higher.
There’s one little problem with debt: interest must be paid on debt. Let’s focus for a second on the difference between cash income and borrowing money. Cash doesn’t cost money to maintain; debt does. In a functioning economy (as opposed to the dysfunctional mess we have now), cash would earn income from interest paid by borrowers.
If cash income is saved, the cash can buy stuff without debt or interest payments. That is a powerful advantage over debt.
How powerful is the advantage of cash over debt? It’s literally life-changing. Take a look at your credit card statements, which now include an estimate of interest you will pay and how long it will take to pay off the balance at a given monthly payment.
Those making minimal payments will end up paying 100% or more of the balance due in interest.
The phenomenally high accrued costs of interest is true of mortgages, student loans, auto loans, corporate debt and government debt: eventually, current spending is crimped as more and more net income is devoted to paying interest.
There are two words for what happens when real income declines and interest payments rise: impoverishment and insolvency. This dynamic is scale-invariant, meaning it works the same for individuals, households, enterprises and governments.
Let’s connect the rising cost of oil to debt. As we all know, oil matters because it’s the foundation of our economy, and the cost of oil is built into virtually every sector in some way. For example, look at how the the cost of food rises and declines in lockstep with the cost of oil:
Despite the substitution of cheaper natural gas for oil, we use a lot of oil.
While the recent increase of 3+ million barrels a day in domestic production is welcome on many fronts (more jobs, more money kept at home, reduced dependence on foreign suppliers, etc.), the U.S. still needs to import crude oil.
U.S. Imports by Country of Origin (U.S. Energy Information Administration)
The rising cost of oil acts as an economy-wide tax. Everything that uses oil in its production or transport rises in price without offering consumers any more value than it did at much lower prices.
Look at the impact on food prices as oil rose from $20/barrel in 2002 to $140/barrel in 2008. While government statisticians adjust the consumer price index (CPI) based on hedonics (as the quality of things goes up, the price is adjusted accordingly) and substitution (people buy chicken instead of steak, etc.), the reality is, as one heckler put it, “We don’t eat iPads:” that is, all the stuff that is hedonically adjusted (tech goodies, etc.) is non-essential.
The Status Quo has compensated for the relentless rise in the systemic oil “tax” by making debt cheaper to service. The Federal Reserve’s zero-interest rate policy (ZIRP) has two purposes:
1. Channel immense sums of free money to the too big to fail banks by relieving them of the onerous requirement of paying interest on deposits while giving them unlimited access to nearly-free money they can lend out at huge spreads. (This is crony-capitalism writ large. The winners were picked by the Fed and the rest of us are the losers. Yea for the godlike Fed, our modern-day Mammon.)
2. To keep consumption alive as income declined and the oil tax eroded household disposable income, the Fed made borrowing cheaper.
Unfortunately for the godlike deities residing in the Fed, zero-interest rates trigger malinvestments, which are inherently risky. When unqualified borrowers borrow a ton of money–for example, a student with no assets or income, or a poor credit risk household assumes an FHA mortgage, or a corporation sells junk-rated bonds– the risk of default is intrinsically higher than debt taken on by qualified borrowers.
This poses a systemic problem for the Fed: The Fed needs to enable more borrowing by the uncreditworthy to keep consumption growing and bank profits flowing, yet the inevitable result of such credit expansion is a massive expansion of systemic risk.
The more debt that is taken on by marginal borrowers–where marginal is defined as unable to weather any shock or decline to their financial position or income–the more risk piles up in the system.
The analogy is a forest where the deadwood is never allowed to burn: The Yellowstone Analogy and The Crisis of Neoliberal Capitalism (May 18, 2009). The net result of rising systemic risk is a massive conflagration that burns off off the accumulated risk and bad debt.
Such a fire sweeping through the mountains of risky debt piled up in the American financial system would bring down the entire Status Quo. So what’s a godlike Federal Reserve to do when it can no longer lower interest rates?
Answer: it suppresses visible risk by manipulating the stock market to reflect complacency.
“Old” VIX Plunges To Record Low (Zero Hedge)
Does a record low measure of risk reflect the systemic risk of default and a decline in consumption, or is it merely a reflection of the herd’s boundless faith in the godlike powers of the Fed to suppress risk even as Fed policies pile risk ever higher?
The bottom line is the Fed can only keep the machine duct-taped together by suppressing the market’s pricing of risk. Suppressing the market’s ability to price risk is throwing common-sense fiscal caution to the winds; when risk arises from its drugged slumber despite the Fed’s best efforts to eliminate it, we will all reap what the Fed has sown.
Charles Hugh-Smith of OfTwoMinds blog
54 Comments on "The Next Global Meltdown Is Baked In: Connecting The Dots Between Oil, Debt, Interest Rates And Risk"
Plantagenet on Tue, 1st Jul 2014 9:49 am
Obama has created more debt than any Person in world history. Annual US payments on our debt are now over 200 billion dollars per year
What a stupid waste of money.
Davy on Tue, 1st Jul 2014 9:59 am
Plant please I hate inaccuracies and exaggerations. Only global central banks have created money. You maybe could say Obama is spending more through the US government treasury than any other person. But, Plant, what about your cherished Republicans and their pork? I take it you hate Dems. We know the Democrats have a loose pen but the Republicans make sure the Rich get their huge welfare benefits through the rigged tax and investment regime in DC. Can you spell “WEALTH TRANSFER” Plant or in your mind is that lies of the MSM”.
MSN Fanboy on Tue, 1st Jul 2014 10:07 am
Plantagenet: Obama is a figurehead – a puttet on strings if you will. The entire American establishement is corrupt.
A
Dave Thompson on Tue, 1st Jul 2014 10:13 am
At the risk of sounding like an aging hippie of the 60’s plantagent, we have two choices Fear or love. both play a roll for the other, the trick is to recognize the dif.
Plantagenet on Tue, 1st Jul 2014 10:14 am
Davy please I hate misrepresentations. My post wasn’t about central banks printing money. My post was about the record levels of deficits and debt created by the Obama administration.
If you’ll read the topic header, this thread is about the dangers of debt.
MSN Fanboy on Tue, 1st Jul 2014 10:16 am
Plantagenet: Obama is a figurehead – a puttet on strings if you will. The entire American establishement is corrupt.
It happens in all societies eventually, that self serving Humian Naive.
While the economy is growing the growth in corruption can be absorbed quite nicely.
When the economy is not growing ( spun up bullshit )the corruption doesnt stop; however still grows. This may be shown multiple times over. Just look at income equality :/
This is an establishment/nature issue plant: truely, if you had your hand in the piggybank, wouldnt you be tempted to take a little more, then a little more. After all, you do deserve that ferrari etc… etc…
You are correct though, it is a stupid waste of money: just please dont treat Obama as an omni-present God, hes just another court jester.
Plantagenet on Tue, 1st Jul 2014 10:17 am
@ MSN Fanboy—You may be right that Obama is a puttet on strings. I’m not sure what a puttet is, but by any chance does it mean an incompetent ignoramous?
Davy on Tue, 1st Jul 2014 10:19 am
Damn you got me Plant on the money and debt thing, sorry. Yet, you are pointing your finger at one man and that is an inaccuracy and I am not the only one to point this out! The world is so much bigger than Obama.
Plantagenet on Tue, 1st Jul 2014 10:28 am
Davy—-of course the world is bigger than Obama. However, Obama is the leader of the USA, which still (just barely) is the most important economy and greatest military power on the planet.
The whole idea that we shouldn’t discuss Obama’s role in exploding US debt in a thread about the dangers of debt is wrong-headed—of course Obama is responsible for the debt created by his administration and his policies.
Northwest Resident on Tue, 1st Jul 2014 10:37 am
Plant — You’re on a peak oil and related topic forum, but ALL you want to do is blame Obama, curse Obama and spout your lunatic and idiotic political sentiments. Your comments are shit stain on this forum, and you’ve proven multiple times with your posts that you’re one of the dumbest assholes on the planet. Take your political bullshit somewhere else, please. You’re stench on this forum is nauseating.
Davy on Tue, 1st Jul 2014 10:38 am
Plant, one clarification there is US treasury debt and that debt is being purchased by the fed. The fed is facilitating the creation of debt by purchasing it there by indirectly creating money through the banking and investment sector. You surely are not say Obama and his pathetic administration is creating more debt dirrectly or indirectly than the fed? Not to mention all the mortgage debt the fed is buying indirectly facilitating debt creation there. Last I heard Obama does not control the fed.
Plantagenet on Tue, 1st Jul 2014 10:44 am
Davy — You are absolutely correct that the Fed is creating debt by printing money via QE etc. However, it is also true that Obama has overseen the greatest explosion of US government debt in history.
As far as Obama ‘controlling” the FED, the FED by statute is a quasi-independent federal agency. However it is worth noting that Obama hand-picked the chair of the FED and appointed several of its members. It is also worth reading the recent book by Obama’s former Treasury Head Geithner who spells out exactly how the Obama administration and the Fed are in constant communication and have coordinated their policies.
Northwest Resident on Tue, 1st Jul 2014 10:46 am
Davy said: “Last I heard Obama does not control the fed.”
While obvious to you and I and everybody else, Plantagent in his magnificent and unparalleled stupidity is just too frigging dumb to understand that. Just like he is TOO DAMN DUMB to understand so many other topics. Therefore, Plantagent the village idiot simply blames Obama for anything and everything, compensating for his complete and total lack of brain power.
Isn’t that right, Plantagenet, you stupid moron.
J-Gav on Tue, 1st Jul 2014 10:49 am
I’d call this a good analysis by CH Smith.
Since the ability for traditional price-discovery mechanisms to operate are fatally impaired, the stock markets can soar even as the real economy tanks.
The use of debt creation to work this black magic is hardly the invention of Mr Obama, however. You could say it started back in 1913 when exorbitant powers were granted to a small group of elite bankers with the creation of the Fed and their enhanced ability to make debt work for the rich.
You could fast-forward to 1971, when Nixon, (a Republican), took the U.S. off the gold standard, thus opening more possibilities for debt-based fiat money to expand while being less and less tied to real economic activity.
You could then take a quick peek at the Reagan years, when the assault on regulations gained steam and gave the credit-card, consumer society new meaning.
It’s true that Glass -Steagall was repealed under Clinton, a Democrat.
Now Bush Jr, whose 1st reaction after 911 was to tell Americans – “Go out and buy more.” Euh, but their salaries were stagnating so how could they do that? More debt!!
I’m not an Obama fan-boy, Plantagenet, but to suggest that the ‘debt problem’ is all his fault only makes you look silly and ignorant. Maybe it’s time for you to give that line a rest.
Plantagenet on Tue, 1st Jul 2014 10:56 am
3 Gav
I never suggested “that the ‘debt problem’ is all Obama’s fault’ For you to suggest that only makes you look silly and ignorant. Maybe it’s time for you to give that line a rest.
If you’d take a second to read the thread before sharing your opinions, you’d note that Davy and I have been discussing the role of the FED in US debt creation. Also, about half of the US government debt pre-dates Obama, including about a quarter of it created by Bush Jr. But the fact remains that the person responsible for the largest increase in US government debt in history is Obama.
Calhoun on Tue, 1st Jul 2014 10:57 am
What a laugh. As if McCain or Romney would have made a difference. Given the choice between a depression and debt any politician will choose debt. And it was Bush who set the stage for the current state of affairs — Bush, the great conservative. LMAO.
We now face permanent economic decline and neither party can do anything about it except print money to try to keep things going.
Plantagenet on Tue, 1st Jul 2014 11:09 am
@Calhoun
Your suggestion that “any politician will choose debt” simply isn’t true. Look at Germany—they have very little debt, and their economy is doing great. Look at China, they actually run huge surpluses and their economy is growing at 7-8% per year.
Pveroi on Tue, 1st Jul 2014 11:27 am
Plant is the reason some of us have zero faith left in the American public. You make all Americans look bad sir. You fool no one here, and whoever is paying you should take a look at how worthless you’ve been. Do something else please.
Pveroi on Tue, 1st Jul 2014 11:27 am
Plant is the reason some of us have zero faith left in the American public. You make all Americans look bad sir. You fool no one here, and whoever is paying you should take a look at how worthless you’ve been. Do something else please.
Northwest Resident on Tue, 1st Jul 2014 11:40 am
Plant is here to blame Obama, diss Obama, accuse Obama and to make inflammatory and totally off-topic political statements. Plant is a one-track record, playing the same lousy song over and over and over.
Plant, why don’t you go over to Politico dot com or to one of those other far-right “blame Obama for everything” websites, where your constant repetitive moronic accusations against Obama will be highly appreciated, and where you and your imbecilic like-minded buddies can join in daily orgies of blaming Obama for everything that you perceive is wrong the world? Come on, Plant, they’re waiting for you with open arms. Please go.
clifman on Tue, 1st Jul 2014 11:45 am
Reading the comments here sooooo makes me miss the quality of discussion that occurred on The Oil Drum…
clifman on Tue, 1st Jul 2014 11:49 am
To clarify, I refer primarily to Plantagent’s argument, and those who feel the need to rebut… But J-Gav’s comment certainly recall’s TOD’s greater depth.
Plantagenet on Tue, 1st Jul 2014 11:54 am
Yes. I miss TOD too.
They did a good job there of filtering out the creeps whose posts consisted mainly of attacks on other posters.
Davy on Tue, 1st Jul 2014 11:58 am
Plant you are losing a one man battle. I object to the China analogy. China has allowed more credit creation than any other country in the history of man. It may be internal but credit is credit and with every credit there is a debit. Plant Germany is the front man for a Europe that is by all practical purposes in default. I don’t need to regurgitate QE and the fed here for those thinking I am not being balanced. I side with Gav, NR, and others Plant admit you are vanquished in this aurgument like men do in battles lost.
eugene on Tue, 1st Jul 2014 12:11 pm
I find in interesting how “Plant” manages to totally distort most of the discussion to his agenda and it is an agenda. The best thing is to simply ignore his comments and continue with something akin to an intelligent discussion. I spent couple of decades as a licensed therapist and in that world, Plants comments are called distraction as he shifts the discussion to something he wants to talk about He has no intention of paying attention to any of you and you spend your time paying attention to him. You wind up discussing Plant and not the article.
PrestonSturges on Tue, 1st Jul 2014 12:18 pm
Plants agenda is simply to have people pay attention to him, like a baby crying for his bottle.
If people would just ignore Plant, he’d eventually have to get off his butt and shuffle out of his Unabomber cabin.
The people who are on the internet the most shouldn’t be on it at all.
Northwest Resident on Tue, 1st Jul 2014 12:27 pm
eugene — Excellent point. I more than others probably need to take your advice and put it into practice. Plant’s posts are just so inflammatory, so absurdly off-topic and ridiculous… But I’ll try to ignore the political troll from now on, starting… right now!
Davy on Tue, 1st Jul 2014 12:29 pm
True Eugene but ignoring also risks normalizing that agenda being ignored. I can take a little but for example The Mak show is too much negativity against me and my people.
Preston agreed too much internet time is bad for the spirt . The most spiritual time of my life was totally off line for 2 months on a 150 acres. I am now guilty of too much internet. It is my last addiction. I gave up nearly everything else must I give up the net too? I know moderation is the key!
Pveroi on Tue, 1st Jul 2014 1:15 pm
I just wanted to point out to whoever is paying him that among a group of people who study resources, he is a clear waste of time and money. No need to get emotional in my opinion.
Great article though. Another important read I’m happy to pass around.
Dave Thompson on Tue, 1st Jul 2014 1:23 pm
Humans have reached the age of decline of biosphere and earth energy extraction. The whole system is being propped up as long as possible by the string pullers of multinational corporate bankers and corporate industry. Geo-political finger pointing is silly. Lets all try and help each other as best as we can.
mike on Tue, 1st Jul 2014 1:28 pm
All: lay off Plant. Don’t you realise he is deliberatly winding you up? He doesn’t mean what he says. He only says it to act the devil’s advocate. He’s goading you and rattling the cage bars just to make you roar. It is obvious that he does not believe any of the stuff he writes, and that all he wants to do is get you going for his own amusement, so don’t go taking the bait; stay cool, ignore him, and he’ll just go away bored of being no longer the centre of attention.
Arthur on Tue, 1st Jul 2014 2:35 pm
“Plant is the reason some of us have zero faith left in the American public. You make all Americans look bad sir.”
@Pveroi… you are assuming a lot. Plantaget was a house of English rulers, whose claim to fame was based in getting it’s a** kicked by a girl from Domremy (Jeanny d’Arc), as well as losing control over Scotland.
Northwest Resident on Tue, 1st Jul 2014 2:55 pm
mike — You’re right, of course. But sometimes the stupid is so damn stupid that I just want to beat it to death with a baseball bat, burn it and flush the ashes down the toilet. Must… refrain… from… feeding… political… trolls…
Arthur on Tue, 1st Jul 2014 3:30 pm
Plant is absolutely not a troll, he means what he says and has a consistent line, what president Obama can confirm, assuming he is a lurker here.
Pops on Tue, 1st Jul 2014 4:47 pm
Lots of good analysis in the article. The upshot being that more and more money is being siphoned off into offshore, tax free accounts while lots of regular folks distracted by the outrage du jour (or president du jour) are looking the other way.
One advantage of the Peak Oil Forums is that members are able to click a button and ignore the plants/shills/one-trick-ponies.
J-Gav on Tue, 1st Jul 2014 5:32 pm
Yeah Pops, you get it, but since it isn’t mainstream, most won’t. At least for a little while yet – they are (very deservedly) losing readership these days, but still gaining perhaps on the ferociously right fringe.
Whether or not that translates into a Thomas Paine style ‘reclaim democracy’ movement, a major govt clampdown on freedoms in the name of … euh, let me guess – security? or an intensification of world conflict to the benefit of the sycophants and blood-suckers, remains to be seen.
The prospect of that other, alternative ‘New World Order’ so many desire, unfortunately, does not seem to be near at hand. Still, it’s only little by little on the local or regional level that anything can happen to counter the juggernaut. And there are some very worthy initiatives underway thanks to thousands of dedicated people who, as we used to say, “have their hearts in the right place.”
The time for blame games is nearly over (though its finale could yet be bloody). More payback and blowback are on the approach. Time is short. Within 10 years I reckon we’ll know if humanity, already demonstrated to be much less adaptive than bacteria, has an even chance of surviving this century.
To those for whom the preceding paragraph sounds extreme, I would say : do some research. Put oceans, soil, climate, water, energy and mineral viability, food production and biodiversity loss together and you have a recipe for what?
The time to move somehow is now, most of us know that here, and the question remains how? Nobody’s answer to that one could cover the range of possibilites we still have – for now, it’s both encouraging to see the number of intiatives undertaken here and there, and discouraging to see the same system that led to this mess continue unabated.
Norm on Tue, 1st Jul 2014 5:52 pm
There is a big red zit on my nose, cause Obama put it there. My knee hurts, cause of Obama. Plantagenet.
MSN Fanboy on Tue, 1st Jul 2014 6:06 pm
I meant puppet lol and everyone stop being mean to plant wtf… ?
We all know Obama is part of the problem, Plant just goes overboard (by quite a mile)but we all do the same.
We love blaming someone else for our problems.
Dont let them get you down Plant lol, the SmurfMan never got this much grief and he opposed everything the others said
Harquebus on Tue, 1st Jul 2014 6:10 pm
Forget cash. Fiat currencies are intrinsically worthless and is why constant inflation is required maintain them. Ever wondered why governments and reserve banksters will do anything to avoid deflation.
clifman on Tue, 1st Jul 2014 7:54 pm
Hey Plant. You will notice if you read more carefully that I criticized your argument, and said nothing about you personally. Yet you called me a creep, by strong inference. Nice going. Helps make my point nicely.
One more critique of PO.com is the apparent lack of ability to reply directly to other’s comments. Or maybe that’s a feature…
DMyers on Tue, 1st Jul 2014 7:59 pm
Hugh-Smith covers a lot of ground here.
When you consider the particular title subjects, it does start to look like there’s a meltdown uhh comin’ this uhh way.
Davy on Tue, 1st Jul 2014 8:05 pm
Gav, the great thing about this board for me is reading words that fit my thought train. It gives me a feeling of support I cannot find among family and friends generally. I found what you said above right on track with my thoughts.
chilphil1986 on Tue, 1st Jul 2014 8:31 pm
I agree with Gav’s assessment of the situation, and having only been struck with exactly how dire our circumstances are as a species less than a year ago, it still numbs me to go about my daily duties marking at every point where something is likely to go wrong in the next decade. I truly doubt I will be able to adapt quickly enough, though there is a sense of adventure in the undertaking that my life did not have prior. It is frustrating that so few people grasp the breadth and depth of the changes necessary to confront what is coming, yet ignorance is nature’s own distillation technique. I keep imagining Takami’s ‘Battle Royale’ with more space and no time-limit.
ronpatterson on Tue, 1st Jul 2014 9:06 pm
Northwest Resident Wrote:
“Plant — You’re on a peak oil and related topic forum, but ALL you want to do is blame Obama, curse Obama and spout your lunatic and idiotic political sentiments. Your comments are shit stain on this forum, and you’ve proven multiple times with your posts that you’re one of the dumbest assholes on the planet. Take your political bullshit somewhere else, please. You’re stench on this forum is nauseating.”
Amen, I just thought that was worth repeating. 😉
Makati1 on Tue, 1st Jul 2014 9:45 pm
WOW!
This one hit a nerve! If anyone gets down here to my post, I would like to add my two cents worth, for the record.
1. WE are responsible for the current state of our country. It IS still a voting democracy, no matter what may actually go on in DC. That we keep reelecting the same representatives and not forcing a change is OUR fault. We have just about come to the end of democracy even as lip service in the US. I’m not sure that there is a real democracy functioning anywhere in the world. Maybe there never has been.
2. Bush Jr was an airhead puppet that got elected through family, not votes, and got the Police State going. When they needed a seemingly more intelligent president that could get the minority vote, they put ‘Package O’ in the White House.
He has been able to take down the Bill of Rights & Constitution in the open and finish the construction of the Police State. He will retire with all he and his family needs, in a few years, or he will become dictator for life. At this point, I think it is 50:50.
In other countries, there would have been a revolt long before now over these same government actions, but not in the US. We are too “exceptional” to ever live in a Police State with a dictator. After all, don’t we have the strongest military and currency?
LMAO! Sorry, I couldn’t help it.
No. WE the people of the US created, day by day, the situation we are in now. We had a President with guts who told us what we had to do to survive, and WE booted him out of office because he told us the truth and we didn’t want to hear it. We were “exceptional”! NOW we know he was telling us the truth and we should have listened, but it is too late. We are going over Niagara Falls without a barrel.
No, today is OUR fault. Everyone of us of voter age. No one else’.
Kenjamkov on Tue, 1st Jul 2014 10:56 pm
The US is addicted to debt because both political parties are tied to the military industrial complex. Every congressional district has military factories employing thousands of people. If you vote no to military spending, you are out of a job next election. 47% of the US budget goes to military spending.
The reason that Germany and China can control their debt is they produce more stuff than the rest of the World.
Germany is going to get burned by the EU. China may do better with their gold reserves. In the end we are all screwed when the shtf in the financial world.
antaris on Tue, 1st Jul 2014 11:04 pm
Carter?
Makati1 on Tue, 1st Jul 2014 11:27 pm
Yep! Wearing a sweater when he made the speech.
clueless on Wed, 2nd Jul 2014 12:12 am
17 trillion dollars in debt, and expanding. How come US still claims that they are the biggest economy on earth?
Pathetic.
Norm on Wed, 2nd Jul 2014 1:30 am
probably 2 things would fix the debt.
First, the liberals would have to quit with the big socialist giveaways like to the welfare mammy’s. And the conservatives would have to quit with the big capitalist giveaways, like a billion bux to a defense contractor to produce a stack of paper.
Second, the rich would have to pay a proper tax rate on their billions of dollars of income.
Those two things together, we wouldn’t have a national debt.
Instead, everybody want to annoy and bicker and be self-destructive. OK good, then it will be like Road Warriors. As you like.